Hard Money

Hard Money was the money backed by a physical commodity like gold or silver in the past. Its value depended on the commodity associated with it, indicating that any change in the value of gold, silver, or other metals that acted as the underlying for such money impacted its exchange value.

The currency value was directly related to the value of said commodities/metals. Such money came to be known as hard money because of the direct association of physical metals in their tangible form. It must be noted that it has several meanings in different contexts, including real estate loans, government funding, political donations, etc.

Hard money, backed by precious metals like gold, was used for government funding in the past. Later, most economies in the world shifted to fiat money. Historically, this kind of money was a physical currency directly linked to a valuable commodity. Hence, it had the potential to maintain a stable market value. It was important in an economy as it helped maintain market stability and control inflation. It also exhibited a strong exchange rate against foreign currencies. Its characteristic features have been discussed below in more detail:

• Stability: The value of such money was linked to certain underlying commodities. This made countries with such money more stable compared to those that had currencies not backed by any commodity or underlying. This stability existed because the value of such money was not entirely dependent on government control or economic factors.
• Commodity fluctuations: While it offered more stability, its value was vulnerable to fluctuations in the price of the underlying asset or commodity. For example, if the price of gold declined, the value of currencies tied to it would decline proportionately.
• Global relevance: As the value of such money was linked to precious metals like gold, it was useful for international trade. It facilitated trade and commerce across international borders.
• Money circulation issues: The amount of money or currency in circulation in an economy was directly connected with the available commodity reserves. Hence, if a country did not have enough gold, its economic growth was restricted. 
• Handling challenges: While hard money reduced the risks associated with transactions considerably, handling it was challenging. This was because carrying, transporting, and storing precious metals was expensive and inconvenient.

Today, countries prefer fiat currency, which is not backed by any physical commodity. When there is no metallic money, many other monetary instruments can be treated as metallic money in domestic and international markets. Bitcoins, part of cryptocurrencies, are a simple example of it. 

Hard money loans and hard money for political contributions are two other independent concepts. While hard money loans refer to loans backed by a physical asset, hard money for political contributions is a sensitive subject that falls under the purview of campaign finance. It talks about the money given as donations to political parties. 

In the context of government funding, such money refers to funds extended by government agencies for welfare purposes. A hard money loan in real estate indicates funds backed by tangible property.

The history of hard money goes back to Gresham’s Law, which states that "bad money drives out good". This principle came to the fore when Sir Thomas Gresham observed a phenomenon where individuals chose inferior currency instead of superior currency. Gresham (1519 to 1579) was involved in coin minting and studying financial matters. He oversaw the inauguration of the Royal Exchange in London. Although the law bears his name, it was Henry Dunning Macleod, a Scottish economist, who attributed it in a formal manner in the 19th century.

Mints were initially established to produce gold, silver, and other precious metal coins, which gave the coins an intrinsic value. New coins with less metal content had lower market value than old coins, which had a higher metal content. When the metallic currency standards were abolished, Gresham’s theory threw light on the currency movement in global markets.

As world economies shifted to paper money from metal-based currency, a crucial link between these forms of currency developed. Many nations believe that a hard money policy is useful as it offers stability in international markets.

In this section, let us study some examples to understand the concept. 

Example #1 

Suppose Kylie is a businesswoman who wants to fund a political party she supports. Such a donation is called hard money in terms of political contributions. In 1978, the Federal Election Commission issued funding rules that applied to political campaigns. Over time, people found that the 1978 ruling had many loopholes. Donations are contributions to political campaigns. If they are given for political advertisements that ask people to vote for a candidate, such donations must be funded by hard money. If the party intends to educate people, it is considered a party-building activity. Such initiatives must be funded by soft money.

In Kylie’s case, she planned to fund advertising with the hard money she contributed to the political party of her choice. 

Example #2

In today’s times, the hard money concept extends to using digital currency, given the existence of a dual economy worldwide. In a February 2021 International Monetary Fund (IMF) blog, this has been discussed in great detail. 

Under the contemporary monetary system, which involves both privately-issued money and publicly-issued money, both forms of money are important. Privately-issued money comes from banks, specialized payment providers, telecom companies, etc., while central banks deal with publicly-issued money. This dual system offers significant advantages. For instance, innovation and product diversity come from the private sector, while the public sector guarantees stability and efficiency.

Today’s dual economy is the modern equivalent of the interactions between hard money backed by physical commodities of the past and fiat currencies. 

In the table below, we will understand the differences between the three types of money and see how they are applicable in the form of loans in today’s finance industry.