Red-Blooded Risk: The Secret History of Wall Street

Paper versus Metal

The biggest misunderstanding about paper money is the idea that it is a promise for gold or silver, and that it serves the same function as precious metal coins. It's an entirely different thing. Rules requiring it to relate to gold and silver are passed in order to destroy true paper money, to turn it into a mere token or a convenient substitute when precious metal is in short supply.

Silver coin money measures the relative value of everything for sale at the moment. You can go into the marketplace, note the prices of everything, and figure out what is cheap that you can turn into something expensive. You don't worry about where the cheap stuff came from or who will buy the expensive stuff; all you care about is the relative price. Silver is entirely irrelevant. It could be worth a hundred times as much or one-hundredth as much; all that matters is the relative prices. There is only one silver, not lots of different kinds issued by different banks. This is the economic driver that created Western civilization.

Paper money creates a much more nuanced set of price signals. There are things you can barter, things you can buy or sell for silver, and things you can buy or sell for paper money. That last is really many sets, as the money of different banks will be good in different degrees in different places and for different things. Each type of paper money has its own interest rate, which is measured by both the interest the bank pays on deposits (if any) and the ...