Summary Part 1: The Price of Money: Navigating the Financial Landscape by Rob Dix

Henry Ford once said: ‘It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

Money, the lifeblood of economies, facilitates trade and improves lives. Its value lies not in its physical form but in its ability to exchange for goods and services.

Understanding Money: Money serves as a medium of exchange, enabling trade and economic activity. As stated in The Price of Money, "all that’s needed for a currency to ‘work’ is for a critical mass of people to voluntarily use it to trade with one another." The essence of money is its utility in facilitating transactions, regardless of its physical form. The trust and acceptance of a currency among a large group of people give it value.

The Broken Nature of Money: Despite being a cornerstone of modern economies, money often fails as a store of value. As mentioned in the book, "currencies have tended to fall in value significantly over long periods of time." This erosion of value, driven by inflation, has profound implications for wealth preservation. The pound, for instance, has lost over 99% of its buying power in just a few generations, highlighting the fragility of fiat currencies as stores of value.

The Mechanisms of Inflation: Inflation, a persistent rise in prices, is a consequence of increased money supply. The Random House Webster’s Unabridged Dictionary defines inflation as a "[p]ersistent, substantial rise in the general level of prices related to an increase in the volume of money." Governments target moderate inflation to avoid deflationary spirals, which can lead to economic downturns and unemployment. However, excessive inflation erodes purchasing power, affecting savers and fixed-income earners disproportionately.

 The Evolution of Money and Power: Throughout history, the nature of money has evolved, reflecting changes in governance and economic structures. Early forms of money, such as gold coins, provided intrinsic value, while modern fiat currencies derive value from governmental backing. Central banks emerged to regulate money supply, consolidating control and shifting power dynamics within economies.

Money Creation and Borrowing: Commercial banks play a central role in money creation through lending. As explained in the book, "banks make loans whenever they want to–and new money is created in the process." This process of fractional reserve banking allows banks to expand the money supply by issuing loans, contributing to economic growth but also increasing debt levels.

The Impact of Borrowing: Rising household debt, particularly in mortgages, reflects differing borrowing patterns among socioeconomic groups. Low-interest rates incentivize borrowing for asset acquisition, such as real estate, leading to wealth disparities. However, excessive debt burdens can pose risks to financial stability, as seen in the 2008 financial crisis.

Monetary Policy and Economic Stability: Central banks influence the economy through monetary policy, adjusting interest rates to control inflation and stimulate growth. The book highlights the role of inflation targeting as a policy tool adopted by many countries to maintain price stability. However, the effectiveness of monetary policy remains uncertain, given the complex interplay of economic factors.

Here are some of the extracts of the book which I found important:

Money loses value for the same reason the prices of individual products change: supply and demand. To be more precise, the supply of money has increased over time–and as the quantity of money increases, the value of each unit falls.

What causes inflation?

Remember that the purpose of money is to ‘sit between’ every trade you want to make, allowing you to buy the goods and services you need more conveniently than relying on bartering with your neighbours. If the government went nuts and printed enough money to deposit a million pounds (or dollars, or euros) in everyone’s bank account, what would happen? There would be the same amount of stuff to buy, yet everyone would have more money to buy it with. In response, prices would have to rise–otherwise there would be a shortage of everything, because creating the extra money hasn’t made companies magically able to create more stuff. What happens in the real world is less extreme, but the mechanism is the same.

Why do governments want inflation?

The first is, ‘because it’s better than deflation’. If you know prices will be lower next month than today, you might delay making a purchase–then delay making it again next month if you believe prices will fall even further. If enough people do the same as you, fewer goods will be produced because otherwise they’d just sit around unsold. As a result, companies might need to lay off workers because they can’t afford to pay them (and there’s no demand for what they’re producing anyway). This ‘deflationary spiral’ is what governments are scared of: deflation leading to unemployment. They therefore prefer to aim for some inflation rather than zero, because then there’s a margin to undershoot without deflation taking hold. (Does this deferral of purchasing happen in reality? You could argue not: we all broadly buy TVs and iPhones whenever we want them, although we’re fully aware that their price will go down and quality will go up over time. Still, this is the theory.)

The second is that it forces people to put their money to work. Inflation provides a disincentive to hold onto a lot of cash, because its value will always be falling. Instead, people are motivated to either buy things with it (which helps keep people employed and the economy growing today), invest it (perhaps in the stock market, pushing up its value and making everyone feel wealthier), or at least put it in a savings account to earn some interest (where it could contribute towards loans to businesses that will allow more to be produced in future).

From bullion to banknotes

Why would people start accepting worthless paper as a representation of valuable metal? Because these banknotes could be exchanged at the Bank of England for a fixed quantity of gold: the note was effectively a ‘receipt’ for real gold stored at the bank.

From bullion to banknotes

It was important for public confidence that the banknotes could be exchanged for gold on demand, but in practice they rarely were: people would happily accept banknotes in exchange for goods and services, safe in the knowledge that they were backed by something they trusted.

The Bank cottoned on to the fact that people were quite happy with the notes and rarely turned up to claim the gold, so it started issuing many more banknotes than it had the gold to back. In the 1730s, the Bank almost collapsed when too many people turned up demanding gold at the same time–but it survived, and fifty years later it was still paying out gold on demand.

The classical gold standard

While increased international trade was far more prosperous and less gruesome than war, it came with one massive headache: the effort involved in constantly converting between national currencies. To overcome this, most nations decided to join the United Kingdom in ‘pegging’ their currencies to an amount of gold. Every currency could be converted into gold at a set price, which had the effect of fixing exchange rates between different currencies too. 

The precious metal was literally shipped between each country’s central bank to settle payments–so if a particular country bought more from other countries than it sold to them, its central bank’s gold reserves would diminish (and vice versa).

In 1970s, the US gold supply dwindled to the point where some kind of action was needed–and on 15 August 1971, President Nixon announced that the convertibility of the US dollar into gold would be ‘temporarily’ suspended.

In other words, on a temporary basis, $ 35 would stop equalling 1oz of gold–or any amount of gold. On a temporary basis, a US dollar would be backed by nothing–and therefore so would every currency with its exchange rate tied to the dollar. That temporary basis has now been going on for fifty years and counting.

In principle, this means there’s nothing to prevent governments from creating as much of their own currency as they want to–and naturally, as they have throughout history when the opportunity presents itself, they do. When they take advantage of this ability, what happens?

A three-step pattern which we’re now very familiar with:

The amount of money in circulation goes up. Each unit of money therefore becomes worth less–meaning you can buy less with it (it loses buying power). So prices–when denominated in pounds, or dollars, or whatever–go up.

Now, for the first time, the only reason major global currencies have value is because governments say they do.

Where money comes from?

Possibly it’s that you and I aren’t allowed to create money out of nothing, but those who work for certain privileged entities get their very own coat of arms when they give it a try.

Now that we have a system where money isn’t ‘backed’ by anything and any amount of it can be created, someone needs to be responsible for deciding how much of it we need.

At a very simple supply-and-demand level, if the extra amount of money in circulation matches the extra amount of goods being manufactured and sold, prices should remain stable–which seems like a reasonable state of affairs.

Who decides how much money should be created? a consensus nevertheless emerged that politicians shouldn’t be in charge of the money supply. Why? Basically, because the desire to be popular and win votes can make them impatient (so they change too much too fast) or reluctant to take actions that are helpful in the long term but painful in the short term. The solution? Hand the job over to central banks instead.

It might seem surprising, but even though, say, the Bank of England has the power to create any amount of money on a whim, it mostly allows commercial banks (like Santander, HSBC, or other high street names) to do it instead. Why? Because giving the job of money creation to a group of central bankers doesn’t help solve the ‘How much money do we need?’ problem. Central bankers may be better positioned than politicians to come up with the right answer, but getting it right still involves an impossible omniscience about both the current state of the economy and how millions of individuals and businesses would collectively respond to various actions they could take.

The role of the central bank is to influence the money creation of these commercial banks: taking actions that cause banks to dial it up or down, rather than getting directly involved with creating money itself.

Commercial banks are actually responsible for the bulk of the money that’s created.

Conclusion: "The Price of Money" provides valuable insights into the intricacies of the financial system, shedding light on the mechanisms that shape economic outcomes. By understanding the dynamics of money creation, inflation, and borrowing, individuals can make informed decisions to navigate the complex world of finance and secure their financial well-being.