Incredibly clear and incredibly prescient book by Detlev Schlichter. I’m reading it a second time. He saw it coming a decade ago, and his macroeconomic analysis is thus far spot on.
Amazon link: https://www.amazon.com/Paper-Money-Collapse-Folly-Elastic/dp/1118877322
Highlights:
Prosperity needs economic and political freedom of individuals. Only they have the information needed for sensible economic decisions. No central planner can obtain this information, however sophisticated his instrument kit may be.
It is no surprise that all recorded currency collapses occurred exclusively in complete paper money systems.
But here the consensus faces a problem. One of the key features of the capitalist economy happens to be that it makes things cheaper over time.
we can already mention the fundamental origins of rising productivity: increased division of labor and the accumulation of productive capital. Technological innovation plays a role, too,
So if the consensus maintains that moderately rising prices are a good thing (a notion we will put to the test as well), it has to face up to the fact that, if left on its own, the free market will produce the opposite over time.
Moderate deflation is the norm in capitalist economies, not the moderate inflation that the consensus claims to be superior.
A political authority will have to guide them in order to achieve this. From this follows that the belief in the benefit of constant moderate inflation requires a further belief in the desirability of monetary policy, of a systematic influencing and directing of key monetary processes by a central authority.
the central bank can stabilize the system by keeping interest rates low or lowering them further, by accelerating the production of money and by producing—in theory—unlimited amounts of new money. This can sustain “aggregate demand,” and keep the banks liquid and the economy from correcting. Furthermore, the mere knowledge that the central bank has these powers and is willing to use them may sustain public confidence in the system, which by itself should further enhance financial stability.
It is precisely the hallmark of an established consensus that it is the basis of debate and hardly ever the topic of debate. This belief system is thus an intellectual tool with which analysts analyze monetary phenomena. The belief system itself is beyond reproach.
Therefore, the idea seems to have taken hold that injections of new money are, as a general rule, a good thing, as they help avoid deflation, encourage banks to lend, and thus aid economic growth in general, and that the only constraining factor to this positive prospect is the risk of inflation.
Instead, the ongoing injections of new money must systematically distort market signals and cause misuse of resources, mispricing of assets, and misallocation of capital. In fact, such a system is unsustainable in the long run. It is bound to generate larger and larger crises and is likely to end in total collapse.
As long as we allow prices to be reasonably flexible, there can never be a shortage of money. If we had a smaller stock of money, prices would be lower—that is all.
Every injection of new money must lead to changes in relative prices, to changes in resource use, to a redirection of economic activity from some areas to others, and change income and wealth distribution.
As more needs are satisfied (the new tastes) or satisfied more easily (through new technologies), society overall becomes more prosperous. We will see that this is decidedly not the case with the changes that result from money expansion. They do not enhance wealth in aggregate, and they redistribute wealth arbitrarily.
Interest rates, however, are crucial relative prices (to be precise, they are the relationship between similar goods at different points in time)
Ongoing moderate monetary expansion does not stabilize the economy but, slowly and surely, destabilizes it.
Such moderate, secular deflation has many advantages and is the normal corollary of a capitalist economy.
This system is truly unique in that, for the first time in history, the entire world is on a paper standard.
Money has become completely elastic. In its present form, the system came into being only as recently as August 15, 1971, when President Richard Nixon unilaterally closed the “gold window,”
Reinhard and Rogoff demonstrated that, since 1971, the number and intensity of banking crises around the world has increased.
The paper money system unsurprisingly has fed the powerful trend of “financialization” of the economy, making banks and the entire financial sector disproportionately big and also disturbingly unstable.
There has been one major new—and positive—development in the sphere of money that is potentially revolutionary, that did come as a surprise to me, and that has profound implications for what is discussed in this book: It is the rise of cryptocurrencies, and in particular, of bitcoin.
Bitcoin is inelastic, hard, apolitical, and completely global money. It thus ticks all of the boxes that this book suggests are the true characteristics of good money
The U.S. Federal Reserve (Fed) is now on its third round of quantitative easing (QE), started in September 2012, and this time the program is officially open-ended. Under current arrangements, the Fed is on target to produce more than $1 trillion of new base money per calendar year. A policy tool that was deemed highly unconventional when introduced in 2008 to stabilize the banks in the wake of the Lehman collapse has now, five years after the recession officially ended, become a tool for boosting overall economic activity and in particular the rate of employment
And Japan confirmed my expectation that policy makers will not be content for long to produce just enough monetary accommodation to keep things from deteriorating further, but will at some point go “all in” to create a new upswing at almost any cost.
“Living within your means” is now called austerity and has predominantly a negative connotation.
Capitalism is a term that still has negative connotations in many circles, but it is a fact that the only advanced, highly productive, and wealth-generating societies we know, whether from experience or theoretical investigation, are in a broad sense capitalist societies.
Money is not the creation of the state. It is not the result of acts of legislation, and its emergence did not require a society-wide agreement of any sort. Money came into existence because the individuals who wanted to trade found a medium of exchange immediately useful. And the more people began to use the same medium of exchange, the more useful it became to them.
The term intrinsic value is meaningless in economics. All value is subjective, meaning it is the result of acts of valuing by people. Gold and silver have certain physical properties that are intrinsic to them, but how those are valued is always the result of a subjective assessment by the users of gold and silver.
then-chairman Ben Bernanke explained in a newspaper article that with short rates already at zero, a more effective monetary stimulus could now be implemented by depressing long-term rates through large-scale asset purchases: “Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Over the next few years, the Fed will probably not only repeatedly buy U.S. Treasuries and mortgage-backed securities, but will ultimately include corporate bonds, auto loans, student loans, and equities into its asset purchase schemes,
Second, consumer price inflation has persistently been positive but subdued, yet many asset markets experienced substantial inflationary pressures, in particular more recently. This includes certain financial assets, real estate in various locations, prime private property, arable land in many countries, fine art, antiques, rare old cars, and so forth.
Reinhart and Rogoff in their IMF working paper suggest that overall debt levels in advanced economies, and in particular sovereign debt levels, are already too high to be meaningfully reducible via growth or public sector spending restraint (“austerity”), and that the likely solution requires a combination of defaults, restructurings, and higher inflation, supported by measures to keep domestic investors captive through capital controls and other restrictions (“financial repression”).
High inflation means volatile inflation and it is always at acute risk of spinning out of control.
All paper money systems in history that did not end with a voluntary return to commodity money have ended in hyperinflation and currency collapse. All these disasters were overseen by state-appointed monetary authorities, and it is fair to assume that none of them were particularly keen on total monetary annihilation. Yet this is what happened.
Britain and the United States have repeatedly linked the pound and the dollar back to gold after extended and inflationary paper money periods.
Thus, it would require a gold price of $14,230 per ounce to back the monetary base of the U.S. financial system fully with the government’s gold.
The fact that gold has been trading substantially below levels that seem consistent with sufficient gold backing probably indicates that the market does not consider a full remonetization of gold likely, and that the market also remains still fairly sanguine about any imminent inflation risks for the dollar.
The idea seems to get further support from the fact that China, Russia, and South Africa are among the five largest gold producers in the world, China indeed being the single largest. Additionally, China and India are the biggest importers of the precious metal. However, the official gold reserves in these countries are still relatively small.
it is clear that one of the key advantages of a gold standard remains that it provides a stable framework for global cooperation on free markets. A globalized world needs a global currency, not a group of more or less freely floating paper currencies, some of them dominant, that are being “managed” according to various domestic political objectives.
If there was only one thing we could change about our monetary system now, it should be to completely privatize money and credit, to take the state out of money and the economy completely. How could this be done?
Whatever the legal case might be, there can be no question that practical and operational control over the U.S. Fed rests with the state. The U.S. Fed was installed by an act of Congress, its main policy parameters are set by politicians, and its senior staff is selected and appointed by politicians and remains answerable to them.
Most people only consider their bank deposits safe because they believe the state would not allow Bank XYZ to default, not because they have any confidence that Bank XYZ is run prudently.
The uniform, constant, and uninterrupted effort of every man to better his condition . . . is frequently powerful enough to maintain the natural progress of things toward improvement, in spite both of the extravagance of government and of the greatest errors of administration. —Adam Smith
Good money, as we have demonstrated at length, should be hard, global, inelastic, and apolitical money. This is precisely what Bitcoin promises to be.
But, in turn, these banknotes are not backed by anything of particular value either (their paper or cotton content is hardly what gives them value). Fiat money banknotes are irredeemable. Fiat money constitutes no claim on anything.
Money is the most fungible good in the economy. In principle, its physical properties are unimportant, although it could reasonably be suggested that nonmateriality is even an advantage. It aids fungibility in an increasingly digitalized world.
The motto here should be “In cryptography and markets we trust.”
That bitcoins are exhibiting very distinct features of moneyness right now, nobody can deny.
The only thing that money can do for me is give me purchasing power. How can I know what that purchasing power is? I certainly need some point of reference and that must be the purchasing power that was observable very recently in previous exchanges.
They developed a complex and sophisticated technology, a cryptographic vehicle that allows the secure transfer of distinct digital units—the “bitcoins”—in a peer-to-peer network. Bitcoins are goods in their own rights. As I stated before, they can be thought of as cryptographic commodities.
But those who wanted to join the Bitcoin network but did not want to mine bitcoins themselves had to purchase bitcoins from miners, either by paying for them with established fiat currencies or by offering goods or services in exchange, and it is very likely that the miners used the costs of mining as a first reference point for their asking price. Enough people were evidently attracted to this project for reasonably stable exchange relationships between bitcoins and fiat monies to emerge,
The historical track record is not encouraging. We have seen that throughout history, when the ruling state paper money system was in disarray, authorities frequently banned the use of gold and silver or tried to disrupt the markets for these metals.
Mistrust of markets seems more common than skepticism toward state power. When new crises occur, the initial impulse will probably be to ask for yet more state action.
Ludwig von Mises put it: It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. Ideologically it belongs in the same class with political constitutions and bills of rights.