The concept of “sound money” has received increased attention in recent years due to exponentially higher government spending, continued devaluation of the U.S. dollar and other common currencies, and the rise of popular potential alternative currencies such as Bitcoin. Generally speaking, “sound money” refers to a reliable and stable form of currency that maintains its value over long periods of time. Stable and reliable currency is often associated with economic predictability, growth, increased investment, and overall societal stability.
Money has three primary functions: to act as a (1) store of value, (2) medium of exchange, and (3) unit of account. As a store of value, sound money holds its value over long periods of time. As a medium of exchange, people widely accept sound money as a method of payment. Lastly, as a unit of account, sound money acts as a recognized standard measure to value economic transactions.
What are the primary characteristics that make sound money?
- Scarcity/Limited Supply. Sound money is a relatively scarce asset that takes work to produce and not at the click of a button. While the supply doesn’t have to be finite, the supply only increases at a slow, predictable pace. Scarcity assists in value stability over time, minimizing inflation and deflation of the money.
- Divisibility. Sound money should be divisible into smaller units without the asset losing value or wasting. Divisibility supports transactions in various denominations for both large and small everyday transactions.
- Durability. Sound money should withstand wear and tear over time, allowing storage over long periods of time.
- Portability. Sound money is easily portable across long distances, thus able to contain significant value in small weights and dimensions.
- Fungibility. Sound money units are essentially indistinguishable from one another and interchangeable if the units are of equal value.
- Verifiable. Sound money is easily verified to be what it purports to be without much effort.
Other characteristics of sound money include:
- Recognizability. People easily recognize sound money when they see it, ensuring confidence in its value for transactional use.
- Historical Track Record. Sound money has a long history of wide acceptance and maintaining its value over time, thus fostering confidence and trust in its use now and going forward.
- Independence from Government and Political Influence. Of increasing importance, sound money aims to operate outside the political system and is resistant to government manipulation. This independence helps ensure the money’s value is not subject to political decisions, and is recognized and accepted across borders without government decree.
Contrast those characteristics with the type of money used most throughout the world today – “fiat money.” Fiat money is money created by governments and is not backed by any real-world good or commodity. Fiat money has no intrinsic value and does not represent an asset in a vault somewhere. It is money by decree, meaning it is money because the government says it is money, and other people accept that idea enough to accept it as payment. Through the government’s central bank, the government can increase the amount of money in circulation almost at will. If the government is not careful, this “money printing” can result in potential inflationary dangers, political favoritism, economic distortion, and increased mal-investment and speculation due to too much money in circulation.
Governments across the world previously backed their currencies primarily with commodities such as precious metals (most commonly gold). The gold standard officially ended in 1971, when the United States fully removed the U.S. dollar from gold backing. The government now backs the dollar with the “full faith and credit” of the government, meaning the government pledges to fulfill its payment obligations in a timely manner. This article is only a primer on the characteristics of sound money, so the nuances of leaving the gold standard are beyond the scope. However, an interesting website called “WTF Happened In 1971” attempts to correlate leaving the gold standard with many negative economic and societal issues occurring since that time. While there are likely many other contributing factors to those issues, the website is thought-provoking nonetheless.
Proponents of sound money believe if money meets the above-listed characteristics, sound money creates better conditions to foster sustainable economic growth and prosperity, free of distortions and mal-investment caused by government interventionist policies and money printing. There has been an increasing call to return to some form of a sound money or asset-backed currency system, potentially using precious metals (i.e. gold) or some other basket of commodities. Although not the subject of this basic article, many proponents of Bitcoin believe it checks all the sound money characteristics, thus making it an essentially perfect form of sound money if it were to achieve mass adoption.
Predicting what will happen going forward is difficult and depends on many economic, societal, and geopolitical factors. As renowned economist Friedrich Hayek stated in 1984, “I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take it violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.”
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