Aug

29

Cullen Roche is right when he writes that "a government with a monopoly supply of currency in a floating exchange rate system has no solvency risk unlike a nation such as Greece which exists in a single currency system with what is essentially a foreign central bank. A government with a monopoly supply of currency in a floating exchange rate system is never revenue constrained" - i.e. it can always write a check that the Federal Reserve will clear. The only problem is that such a system literally makes people chattel. They are never in the position where they can save wealth that stands beyond the government's reach. To put it in terms that Washington, Hamilton, Madison, Jackson, Grant and Cleveland would all have agreed, the citizens have the fundamental right to insist on holding their savings as specie. And why should this matter? The answer is one that even the most rabid Keynesian acknowledges: when people can insist that the government exchange its monopoly currency for gold, the price of that currency - what it will buy - remains wonderfully stable. Some things get more costly and others get cheaper; but there is no persistent, steady devaluation similar to what the last century has offered people who have chosen to keep their money in a cookie jar.

There is another reason why a financial system has to have room for people who want to just say no, who, in Anthony Newley's words, want to "stop the world and get off ". If a "monetary system" does not allow the citizens and foreigners both to withhold their money and thereby restrict the government's ability to expand legal tender, the entire information structure of rational expectations itself begins to collapse. Everyone - even Marxists - now pretty much agrees that economic decisions are based on expectations about the future; only the Marxists persist in the fantasy that those expectations can be perfectly realized. If that is so, then where to the mistakes go? Where is the trash can for the part of investment=savings that never pays off? For the economist Wynne Godley this question - and the inability of equilibrium theorists to answer it - called into question the entire notion that prices themselves represented some perfect meeting of supply and demand. The only area where, in fact, supply and demand perfectly met was in the financial part of the economy. Everywhere else both individuals and firms needed what Godley called a "buffer", a saved resource for future income and spending that whose price was itself uncertain. Historically, for individuals the buffer was saved money that did not depend on the government's fiat; for firms it was money, in part, but also something more. For a goods producer the buffer was inventory; for a service firm it is slack labor capacity. That was, in fact, how the system of the production, distribution and sale of goods and services actually worked. In Godley's words, "outside financial markets there is neither need nor place for equilibrium conditions to bring supply into equivalence with demand." But, as [Dailyspec contributor] Tyler McLellan and others have properly reminded us, under a fiat currency system, equilibrium is always and everywhere present. It is literally impossible for firms and individuals to adjust the quantities and terms of trade at will without affecting the quantity of money itself. The result is a world where the needed buffer is nothing but an accounting entry and the banks and other dealers in credit have no actual money reserves. The further consequence is that individuals and firms have no means of calculating what an adequate buffer should be; their only possibility of finding safety is to trade in political influence so that enough of the persistent inflation of the money supply is directed to their pockets.

The ever watchful Charles Pennington adds:

The graph is a bit mis-specified. It is more accurate to plot the price level on a log scale.

This shows that inflation has decreased since the 1970's.

That said, I agree with Stefan's remarks.


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3 Comments so far

  1. Alec Misra on August 29, 2011 10:45 pm

    Dear Stefan,
     im sorry to keep responding like this to your recent fascinating posts on the subject of money supply. But I do feel that you idealize the free-banking era somewhat - in particularly people of the era were not happy to see liquidity dry up purely due to the absence of a lender of last resort. They were not so happy at the idea of being sacrificed on a pyre of free-banking, a chronically deflationary gold standard and classical economics as you seem to think.
     Conversely, as you correctly point out, people today are not happy at the steady or not so steady depletion of their savings under a Keynesian system. Nevertheless three points can be made. Firstly, under a truly free-market system, people are free to change their fiat into gold etc. at any time, one does not need a formal gold-standard (which is also manipulable) for this to be the case. And as I said before a 100% gold standard is profoundly deflationary (leading to an arbitrary increase in MS of about 1% per anum) and leads to gratuitous liquidity crises and associated depresssions. But the point is that people can “say no, stop the world and get off” if they want to, which ironically was not the case under Bretton Woods.
     Secondly, the problem in this case is not inflation perse but negative real interest rates. When these occur the situation is akin to a stealth confiscation (since the real value of savings go down. But, as just mentioned, people are still free to buy gold. Indeed, gold prices do rise in just these situations. For people who just “keep their savings in a cookie jar” however there is indeed no hope sadly.
     Thirdly, and this is my fundamental point, it is possible to imagine a government operated fiat system which is as good as gold, but not so inflexible. Prudent monetary and fiscal policy are sufficient for this and constitutes the basis for a third way as I have written in the free book on my website. And this is not ipso-facto wishful thinking as governments such as the Swiss and others have proven. See my brief article on an alternative measure of inflation for more on this:
    http://sicsemperliberalis.wordpress.com/2011/06/25/inflation-a-better-measure-4/
     As for the whereabouts of the trash-can when fiscal prudence is not maintained - look about you, the trash-can for markets not allowed to clear has become apparent everywhere since 2008 - like Naples, its everywhere

  2. Ralph Di Fiore on August 30, 2011 3:46 pm

    The history of the gold standard is one of deflation and depression. Anyone with even an ounce of business smarts realizes that money loses value over time so it can’t be left idle but rather needs to be invested when it will grow beyond the inflation rate. In my neck of the woods, Toronto, putting your money into real estate in the last century was a win/win proposition. Since 2001, with the fiat system giving money away, hard assets like housing have exploded and fortunes have been made. The 2008 financial crisis didn’t even making housing take a breath, it kept on climbing. Farmland in Ontario has reached unprecedented heights. Those who cash out now have made fortunes. You have to know how to play the fiat system game and it is a far greater generator of wealth than the gold standard ever was or ever will be.

  3. Craig Bowles on September 2, 2011 6:38 am

    I saw a long-term chart of home prices and they didn’t go anywhere until the Fed came into being. A house was viewed more as a necessity item. As for economic data in general, the move toward web generated data like that daily “billion price index” is hopeful. One problem with govt data is that it often doesn’t add up. Unemployment is reported as one thing but comes out to 2% higher if you back in by adding up claims of their reported duration as a percentage of their total workforce. Haver Analytics often finds problems with their data and points it out. Then the govt just fudges numbers to make whatever they reported work. It’s kind of an unbelievable response the way Haver tells it.

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