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When you save money in the bank, you expect interest on your investment. But if you invest, on, say property, gold, or other durable goods, you don't expect your house or gold to multiply. Why? Is it because the value of money almost always decrease, so you expect some compensation from it?

Why is money different from other durable commodity in this sense? Is it because money keeps being printed? But don't new houses also get built, and gold get mined?

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6 Answers 6

Your house doesn't need to multiply in order to earn a return. Your house can provide shelter. That is not money, but is an economic good and can also save you money (if you would otherwise pay rent). This is the primary form of return on the investment for many houses. It is similar for other large capital investments - like industrial robots, washing machines, or automobiles.

The value of money depends on:

  • the amount of useful economic activity going on (the actual valuable stuff)
  • how much money there is in general
  • how quickly the money changes hands (the velocity of the money)

As long as the size and velocity of the money supply changes about as much as the overall economic activity changes, everything is pretty much good. A little more and you will see the money lose value (inflation); a little less and the money will gain value (deflation).

As long as the value of inflation or deflation remains very low, the specifics matter relatively little. Prices (including wages, the price of work) do a good job of adjusting when there is inflation or deflation. The main problem is that people tend to use money as a unit of account, e.g. you owe $100,000 on your mortgage, I have $500 in the bank. Changing the value of those numbers makes it really hard to plan for the future! Imagine if prices and wages fell in half: it would be twice as hard to pay off your mortgage. Or if the bank expected massive inflation in the future: they would want to charge you a lot more interest!

Presently, inflation is the norm because the government entities, who help adjust how much money there will be (through monetary policy - interest rates and the like - ask about it if you're interested), will generally gradually increase the supply of money a little bit more quickly than the economy in general. They may also be worried that outright deflation over the long term will lead to people postponing purchases (to get more for their money later), harming overall economic activity, so they tend to err on the slightly positive side.

The value of money, however, has not really "ordinarily decreased" until the modern era (the 1930s or so). During much of history, a relatively low fixed amount of valuable commodities (gold) served as money. When the economy grew, and the same amount of money represented more economic activity, the money became more valuable, and deflation ensued. This could have the unfortunate effect of deterring investment, because rich jerks with lots of money could see their riches increase just by holding on to those riches instead of doing anything productive with them. And changes in the supply of gold wreaked havoc with the money supply whenever there was some event like a gold rush:

Because precious metals were at the base of the monetary system, rushes increased the money supply which resulted in inflation. Soaring gold output from the California and Australia gold rushes is linked with a thirty percent increase in wholesale prices between 1850 and 1855. Likewise, right at the end of the nineteenth century a surge in gold production reversed a decades-long deflationary trend and is often credited with aiding indebted farmers and helping to end the Populist Party’s strength and its call for a bimetallic (gold and silver) money standard.

-- The California Gold Rush

Today, there is way too little gold production to represent all the growth in world economic activity - but we don't have a gold standard anymore, so gold is valuable on its own merits, because people want to buy it using money, and its price is free to fluctuate. When it gets more valuable, and people pay more for it, mines will go through more effort to locate, extract and refine it because it will be more profitable. That's how most commodities work.

For more information on these tidbits of history, some in-depth articles on:

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"As long as the size and velocity of the money supply changes about as much as the overall economic activity changes" How do you propose overall economic activity be measured? Should it be measured in the actual thing you are trying to calculate (i.e. money)? –  Muro Feb 23 '12 at 13:07
    
@Muro - That's a good question! It's a hard problem! You could ask about it on the front page, but the short version is: see how the cost of a certain typical set of purchases changes from year to year, take that change as a rate of inflation, and then measure the economy in real (inflation-adjusted) terms, using a unit like "1999 dollars" or "2011 dollars". There are various indexes for doing that. The US government maintains some here: bls.gov/bls/inflation.htm –  fennec Feb 23 '12 at 18:21

You expect interest because you forgo the opportunity of using the money as well as the risk of losing the money if the borrower can not pay you back. This is true also with gold - you would expect interest if you loaned someone your gold for a time period.

When you deposit your money in the bank you are loaning your money to the bank who then loans the money to others. This is how the bank is able to pay interest on your accounts.

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The reason is governments print extra money to cause inflation (hopefully reasonable) so that people don't just sit comfortably but do something to make money work. Thus inflation is an artificial measure which leads to money value gradually decreasing and causing people invest money in one way or another to beat inflation or maybe even gain some more money. Printing money is super cheap unlike producing any kind of commodity and that makes money different from commodities - commodities have their inherent value, but money has only nominal value, it's an artificial government-controlled product.

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Sorry, I'm not very knowledgeable about monetary policy and stuff, so can you give any reference that explains that this is one of the reasons government prints money? Would love to know how it works –  Fitri Feb 21 '12 at 16:41
    
also, if that is the logic, is there similar need for governments to prevent people from just buying gold and "sit comfortably"? –  Fitri Feb 21 '12 at 16:52
    
Printing money isn't the only reason for inflation, even spice backed currencies can face inflation when a government gets access to a new proven reserve of the spice. –  rob Feb 22 '12 at 18:03

You get paid interest on deposits because banks only keep a fraction of the deposits on-hand. The rest is put to other uses, such as loaning money to others. If you deposit money and yield 1% interest, the bank is able to fund an auto loan, at 5%. By saving, you are actually making more capital available in the marketplace.

"Fixed" or "durable" assets like gold, real property, or durable goods are different -- their value is based on attributes such as demand (gold, oil) or location (real property). If you bought an apartment in Manhattan in 1975, it appreciated greatly in value over the course of 30 years... but it did so because demand for apartments in New York City grew, while the supply of apartments grew more slowly.

The government prints money for two core reasons:

  • To ensure that sufficient capital is available to prevent panic from severely damaging the financial system. (The 2008 financial crisis is an example of this)
  • To meet immediate fiscal need. Most countries print money when they are at war, for example. Once people believe that a government is printing too much money, the value of the currency can drop, sometimes dramatically. (Examples include: 1970's Italy and Greece, Weimar Germany, 1970's Argentina.)

Think of it this way: Money is valuable because it is money.

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The more canonical form of the latter statement in economics is, "Money is money because people believe it is money." –  fennec Feb 22 '12 at 1:31

It is in circles. Today Money is fiat money. From economic stand point a moderate inflation is good. It there is near zero inflation or deflation, then economy would come to standstill and would stagnate. Hence everything has to becomes expensive. This keeps the economy in motion.

House or Gold does increase in value otherwise one would not have purchased them. If you are saying on buying a house, you keep it with someone and after a period of time you get one extra room or keep an ounce of gold and after some years it becomes 2 ounce, well it does increase but differently. There reason there aren't many such schemes is because quantifying it is difficult. It would normally fetch more money than one had bought it for.

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Yes, I understand that the value of gold investment increases differently. That is my question, actually. For gold and property, you don't have to expect them to multiply in number, and it's still normally an acceptable investment. But when it comes to money, this logic doesn't apply, one would expect the money to multiply in number in order for the investment to become acceptable. Why is the logic different, if they're both just commodity ? –  Fitri Feb 21 '12 at 16:55
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I can't agree about "would not purchase them" - a person has to live in some decent place, why would he not buy himself a house for living? –  sharptooth Feb 21 '12 at 16:59
    
@Fitri Money can "multiply"... I can borrow money from Bank A, then deposit that money into Bank B, which then gets lent out to another borrower. There's a concept called the "velocity of money" that helps to illustrate this. Note that if you have a gold-backed currency, you can do this with a paper note that represents a quantity of gold. –  duffbeer703 Feb 21 '12 at 19:24

Currently, the quantity theory of money is widely accepted as an accurate model of inflation in the long run. Consequently, there is now broad agreement among economists that in the long run, the inflation rate is essentially dependent on the growth rate of money supply. However, in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates - Wikipedia: Inflation causes

You also asked "can you give any reference that explains that this [encouraging people to work] is one of the reasons government prints money?" See the list of positive effects of inflation in that article.

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