Thursday, November 22, 2012

"Fiat Currency" as "Investment Haven" = A Semantic Oxymoron

commentary by Roger Erickson


Main Street, we have a problem. There's a bigger test going on simultaneously, our ability to THINK, coherently, as a group.

Operationally, there's no Public Purpose in trying to make any fiat currency into a long term haven for investors. That's a misuse of fiat currency, which was invented precisely to achieve scalable, agile national policy via unlimited short-term liquidity.  When complexity of scale demands additional innovation, the solution always involves further separating previously muddled concepts, e.g., liquidity and store of value.  This ain't rocket science, but try explaining that to people who conflate science and surgery.

Seems there is overwhelming confusion among hundreds of millions of people ... over this operationally simple point. "Fiat currency" as "investment haven" defines a semantic oxymoron.

Monetary policy = trying to maintain a short term liquidity tool as a long term store of value? That's the dadgum problem right there.

People think that hoarding depreciating, static assets is au courant, and hoarding compounding, dynamic value is the past?  If so, we're toast, unless we start thinking outside the toaster!

Distributed problems of perception - aka, lagging Situational Awareness - can easily cause group Adaptive Rate to sink below survival tolerance limits.  Anyone wonder if we are, as a non-thinking nation, already there, and just not aware of it?


11 comments:

Anonymous said...

A currency should not gain purchasing power since that rewards risk-free hoarding of it. But progress requires risk-taking so money hoarding is self-defeating in absolute terms (one might gain in relative terms though). Thus the supply of a currency should increase to keep pace with real economic growth. OTOH, a currency should not lose purchasing power either since that represents a transfer of wealth (to the creators and first receivers of the excess currency) rather than the creation of new wealth. Loss of purchasing power is also bad for the reputation of a currency and decreases the desire of foreigners to hold it and that in turn decreases the ability of the money issuer to obtain real goods and services for mere currency.

So ideally, a currency should neither gain nor lose purchasing power except perhaps in the short run as the money supply catches up to the economy or vice versa. A long term loss of purchasing power therefore indicates some degree of failure (However, a long term increase in purchasing power would be far worse, I'd bet).

So why has the US dollar lost purchasing power since 1913? The answer is most likely the credit cartel which has the power and economic incentive to create price inflation on its own during the boom. And since the bust is economically destructive and painful, the monetary sovereign has a strong incentive to prevent prices from falling as they otherwise would. That essentially means that the monetary sovereign is held hostage by the credit cartel and must ratify the price inflation it causes or else suffer recessions/depressions?

y said...

if it were possible to maintain 0% inflation/deflation indefinitely, would that be a bad thing? Might it not be something to aim for?

Tom Hickey said...

A currency should not gain purchasing power since that rewards risk-free hoarding of it. But progress requires risk-taking so money hoarding is self-defeating in absolute terms (one might gain in relative terms though).

f it were possible to maintain 0% inflation/deflation indefinitely, would that be a bad thing? Might it not be something to aim for?

Central banks operate on the premise that max growth occurs at about 2% inflation rate in order to encourage investment over saving. The slight inflation shakes the money out of savings.

Roger Erickson said...

"slight inflation shakes the money out of savings"

In textbook theory. In real life, theory & the practice of wealth/income disparity diverge wildly.

Income/wealth disparities - and the interwoven social frauds that cause them - are influences that operate orthogonal to Orthodox Economics dogma, a point Bill Black harps on continuously.

John Zelnicker said...

frlbane -- I would question the statement that the dollar has lost purchasing power since 1913. Of course, this is when the Fed was created and the goldbugs, among others, are always harping on how the Fed destroyed the purchasing power of our currency since a nickel loaf of bread in those days costs $2.50 today.

However, I don't think the dollar is the constant that one should use in this calculation. Purchasing power is more accurately measured in terms of what can be purchased by one hour of wage labor. That is how most people actually get their purchasing power, they get paid for their productivity (generally speaking). Then the comparison becomes much different. I don't know the result, but the question is how much labor does it take to afford that loaf of bread. I would wager that it is a lot less now than in 1913.

John Zelnicker said...

As I understand it, money has generally had three characteristics; it is a medium of exchange, it is the unit of account for economic transactions, and it is a store of value. However, in a fiat monetary system like we have now, money can no longer serve as a store of value (except for the short term). I see this as one of the issues that many people have a hard time understanding. Roger has been writing more lately about fiat as the necessary liquidity tool for achieving national goals and public purpose. I like that approach and maybe it will help people drop the idea that money is, or should be, a long term store of value.

Anonymous said...

I would wager that it is a lot less now than in 1913. John Zelnicker

That certainly should be true given the enormous productivity increases since 1913 and is true according to this:

"In 1914 the average work week was 49 hours and the average weekly earnings were $10.92; the average wage per hour was 22 cents. So you could buy 4 loafs of bread for an hours work. If a loaf of bread from the bakery costs $3.00 now then a wage of $12 an hour would be compatible (allowing one to buy four loafs of bread for an hours work)." (from http://wiki.answers.com/Q/What_was_the_cost_of_a_loaf_of_bread_in_1914 ) since the median hourly wage in the US is now about $22.

But the question I have is not whether workers are better off (they are) but if they are as well off as they should be given the vast increases in productivity.

Tom Hickey said...

Purchasing power is more accurately measured in terms of what can be purchased by one hour of wage labor.

Right there is only a loss of workers' purchasing power if prices don't increase across the board, including the price of labor. Otherwise, tit is a wash. But it is true that wage do adjust last, so workers to do lose to a degree in an inflationary environment.

However, savers do lose purchasing power if they hold nominal savings, and creditors also lose unless loans are adjusted for inflation, which ordinarily they are not. This is why creditors, savers and those living on fixed incomes not inflation-adjusted are so opposed to policy they view as inflationary (rightly or wrongly), and why debtors like inflation.

Tom Hickey said...

money can no longer serve as a store of value (except for the short term).

Right, wise savers put their savings in real assets that gain first in an inflationary rather than holding a currency that is inflating. This is why all the folks over at ZH are running to gold and why they are likely to get trapped in a bubble when the trade comes too one-sided..

Anonymous said...

This is why creditors, savers and those living on fixed incomes not inflation-adjusted are so opposed to policy they view as inflationary (rightly or wrongly), ... Tom Hickey

The irony is that the creditors (i.e. the banking cartel) are a major cause of the price inflation since credit is the creation of new purchasing power.

Tom Hickey said...

The irony is that the creditors (i.e. the banking cartel) are a major cause of the price inflation since credit is the creation of new purchasing power.

That's why bankers have shifted the focus of their business away from traditional banking to financial engineering and prop trading.