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Monday, January 30, 2012

The Value of a dollar

What is the value of a dollar? What determines the value of any fiat currency? What is a dollar worth and why that specific number? What is the fundamental force that values a dollar or a euro or a yen? If you state that the value of any currency is related to some precious metal, such as gold, you just push the question back another step. Now the question becomes what determines the value of gold?
I have listened to many heated arguments between people with differing political ideology. I have read the musings of many economists. The best explanation I have read was written by Adam Smith in 1776. He points out that with specialization workers need some medium to exchange the surplus of their labor. If a farmer raises more wheat than his family can eat, he needs to exchange the surplus with a blacksmith that builds more farm implements than his family can use. In 1776 the wheat came from France and the farm implements came from Brittan, now a method for valuing two separate currencies and exchanging them was needed. This explains the need and utility of a currency, whether it is a precious metal or paper printed by a government. This explanation also points to what establishes the value of money. The value of a dollar is based on the average American working person and their needs. Value is created by the labor of a worker. This is the classical view of Adam Smith.
Early in my career I was a machinist, I made products for the oil industry. I personally had no need for an oil field valve and traded my labor for a pay check. The pay check had to cover my cost of living, provide my family with shelter, food and some entertainment. A dollar had to have enough value for me to purchase these items. I saw this again in 2008 when gas prices topped $4, some of the low wage hourly employees with gas guzzling vehicles and long drives stopped coming to work. The cost of working exceeded the cost of living and it became cash negative to go to work. Once they added up all their cost of living, such as rent, transportation, child care, food, utilities, etc., the pay check did not provide enough. Without these workers the company had troubles completing and shipping product. As a member of management we had long, serious and heated meetings about this. We had to have the employees at work every day. The crisis passed without management having to take any action on wages or bonus or gas credits or any of the other ideas proposed. The incident stayed with me, it reinforced my belief that the average working person establishes the value of a dollar. The dollar must have enough value to provide survival or it is meaningless.
This is an overly simple example. The paycheck has to cover more than the immediate needs, it has to cover the cost of education and development, provide for some surplus and economic safety to cover future needs in education and development at a minimum. My proposition is that Adam Smith basically got it right. Labor produces the added value to raw material that is tradable for other tradable products. If the value of the dollar or euro or yen is too small then labor will not show up for work and produce the tradable products. The purchasing power of a day’s wages must equal or exceed the cost of living for a day.
The modern theory of money is that a fiat currency derives its value from government regulation and laws, it has no intrinsic value. The value of a dollar is based on the full faith and credit of the American government. To me, the faith and credit of the American government is based on the labor and production of the average worker.
The value of the fiat currency of any government is based on the output of tradable goods by the wage earners of the society that government represents.

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