Colossal Policy Mistake: Campaigns to Preserve the Static Buying Power of a Dynamic Asset

Commentary by Roger Erickson

Recent discussions with co-authors here at MNE drove home how vast our distributed policy mistakes are becoming. It all seems to stem from a fundamental decline in Situational Awareness. We're simply not sharing enough operational information, across disciplines. The consequences are devastating. Failing to appreciate the most basic aspects of fiat currency operations is one glaring problem, but not the only one. Lets look at fiat currency operations.

Our starting premise is that a "fiat" currency regime exists only if both foreign exchange (Fx) rates and the entire national currency supply actually float freely, in every sense of the word. A national currency is always first and foremost a dynamic unit of account, whose volume must float freely with net economic activity. No liquidity, no economic activity. Consequently, our ongoing effort to stabilize the static buying power of an inherently dynamic asset is our most fundamental and colossal mistake.

What kind of fool would try to save "fiat?" For example, I can sit in a deck chair with a cold beer - ostensibly saving "fiat" all I want, smugly consoling myself that all my saved initiative is steadily appreciating in real value. NOT! By the time I decide to put all that saved initiative to actual work, I might not even be capable of shaving myself unassisted! Repeat after me. Fiat is a dynamic, not a static asset! Ditto for fiat currency.

The advantage of fiat currency is a growing policy space and unlimited policy agility. Those benefits are more than worth having - but ONLY if it they are utilized aggressively, with a bias to action.

Yet our vast financial system is applying astounding, inappropriate pressure to coerce us into trying to save fiat! Why? Whatever the diverse reasons, ALL of them are tragically misguided.

Logic dictates that we should use liquidity to grow capabilities, not fail to put currency to work. The whole concept of currency-based savings is illogical, and criminally tragic. The better lesson is to accumulate appreciating assets, and use depreciating assets ONLY for liquidity, when and as necessary - so that we can be agile, when executing real transactions with real returns.

Let's describe some basic fiat currency operations.  In any fiat currency regime, the currency supply automatically follows net actions of the electorate, not the reverse. Note the following observations.

1) A fiat currency issuing government COMMITS TO ACTION FIRST, then appropriates and issues a 'floating' amount of fiat currency as a consequence. The currency issuer guarantees it's own liquidity.
2) Then, that government destroys some small amount of currency, by collecting some small amount of taxes per arbitrary policy (to fine tune both aggregate demand & particular activities). The net currency left in play constitutes the net private stock of currency savings.
3) Only after that does it coincidentally issue T-Bonds - and then ONLY to drain excess banking-reserves, which only exist as a historic relic of happenstance.
4) Subsequently, for any and all transactions opened and closed by non currency-issuing citizens, the nation's licensed banking sysem guarantees real-time "liquidity" for real assets, by automatically issuing and slowly destroying temporary changes in currency supply - as the difference between [honestly appraised?] credits to sellers accounts and unpaid debits to the accounts of supposedly qualified buyers. That way, the electorate guarantees it's own liquidity too, insured by the currency issuer.
[Note that in a fiat regime, all the emphasis shifts from controlling the currency supply itself, to regulating White Collar Crime, or credit fraud. That transition requires accelerating agility of supposedly-accredited bank operations and their supposedly-vetted loan recipients. We want the added policy space and economic agility, so we must invest a fraction of the net returns into adequate regulation - otherwise we quickly produce our current problem, TBTJ banksters who think they own us, and our little government too.]

Next, as an example, note the following, simple consequences.

Within the huge market in fiat-currency T-bond trading, many traders erroneously assume that T-bonds occur in a buyers, rather than a sellers market. Just think about that for an instant. Does any issuer of fiat really depend on a bond buyer to get the fiat it can supposedly issue in unlimited quantities, at will? Wouldn't it behoove any T-bond trader to look into the real operations of CB/Treasury bond sales, and ask how they actually proceed, and why they bother with the T-bond process at all? What if one of the core axioms held by many bond-portfolio traders was simply completely backwards? An understanding of actual reserve-banking operations can save bond traders from significant losses. A great example, involving pre-euro, Italian gov bonds is described here (note that this occurred back when Italy still had it's own fiat currency, before ceding fiat to a foreign entity in Brussels, which had "other" primary interests and was immune to most feedback from Italy, or Greece for that matter).

Next, consider the national budget projections regularly released by the US OMB. Again, if you don't know the context, the data is meaningless.

Context for fiat budgets.

Consider the DoD alone, and the institutional momentum it adds to the political arena. The DoD operates on a Planning, Programming, and Budgeting System (PPBS), which continously works on 3, overlapping, 5 or 6 year Future Years Defense Plan (FYDP) - plus a Quadrennial Defense Review (QDR) every 4 years, as a "fix" for the deeply flawed PPBS! Meanwhile, Congress appropriates annual budgets, yet it takes at least eighteen months to prepare an FYDP, so defense staff "can be working on as many as three FYDPs at one time: the budget plan currently before Congress, finishing the budget plan the president will submit in January, and the early stages of preparing the FYDP the president will submit a year later."

Similar but less convoluted processes go on in every single one of the smaller Federal agencies.

So now what do you think of our ongoing Balanced Budget Debates? It's clear, as many experienced Senators and Representatives will readily admit, that we decide what to do first, and THEN we simply appropriate a budget to denominate what we'll have to hire ourselves to achieve. Paralysis from our current policy debates - in both major parties - could go down in history as one of the classic policy and/or military blunders of all time.  Balancing our own fiat? What does that even mean? It's lazy, disorganized semantics, nothing more and nothing less, and it's embarrassing to see it tying up our entire Congress, POTUS and electorate.

What did we say? In any fiat currency regime, "a government COMMITS TO ACTION FIRST, then issues fiat currency as a consequence, and then collects taxes per arbitrary policy, and only after that does it coincidentally issue T-Bonds - and then ONLY to drain excess banking-reserves."

Once again, if you stop and think about this, it drives home the point that a "fiat" currency regime exists only if both Fx and the entire national currency supply actually float, in every sense of the word. A fiat currency automatically denominates any and all real transactions, NOT the other way around.

The real meaning of a fiat currency regime is NOT that we can "spend" or print any amount of currency that we want to. Rather, it means that we can denominate ANY real transactions that any people in our country can convince us to let them execute, from local to national. Fiat simply means actions first, then obligatory accounting recognition of what has occurred in the real world - as an automatic stabilizer of real, dynamic-outcomes-accounting or functional finance. It all comes down to our methods for linking fiat to adaptive function.

That finally acknowledges that the real causality of any currency system is officially inverted from former theory. Prior to John Law, we simply had it backwards - same as for many other things that we only sorted out after the fact. Progress always follows the same principles. First we invent and explore unpredictably emerging options. Then we rationalize surprises through initially formulaic theory that eventually always turns out to be embarassingly inept - in retrospect. Finally, we eventually discover even more options to explore, by forgoing obsolete form in return for emerging function - thereby imposing the need to realign outmoded theories and entire paradigms.

Note that most of our frictions involve previously exalted theorists being repeatedly embarrassed by emerging realities on the ground. Sound familiar? Every capable grandchild can learn at least one new principle that their grandparents and/or parents were completely clueless about. Our practiced skill in absorbing unchanged principles while also openly admitting unpredictable errors is how we increase, or decrease, our Adaptive Rate.

The overall lesson is to just follow the emerging operations, and let the theory follow ... as fast as it can. This shouldn't be news to anyone, but we've allowed an entire generation of isolated economists to be surprised by the mundane - and another crop of the same is on the way. Better brace yourself. And if you can think of a way to head that inept army off at the pass - please do so immediately, for the sake of your country. Otherwise, we'll get ongoing austerity-insanity and national self-suicide, as we pursue the unattainable and unwanted goal of preserving the static buying power of a dynamic asset ... our fiat currency.

How does all this play out, in a population our size? In the case of fiat currency systems and current fiscal policy, everything subsequent comes down to nth order feedback loops among hundreds of millions of people. All those feedback loops sum - randomly or in an organized pattern - and the sum feedbck then affects what we all think one another should or should not do. One impact is indirect pressures to underfund and overtax activities which given groups don't initially approve of in other groups - especially if they aren't intimately familiar with one another.

The outcome? If there isn't adequate interaction and coordination between all subgroups, then absolutely appalling mistakes, lost opportunities and a growing Output Gap may ensue - as we flounder between alternately narrow policy positions. That's a tragic outcome for a nation of capable but dissociated citizens, because we're failing to grow the astounding potential return on optimal coordination.

When disorganized people try to manage a fiat currency system, a common blowback is that unprepared citizens hoarding fiat currency suddenly get an interest in preserving the static buying power of that dynamic asset. Once that occurs, they may easily lose track of the bigger option - utilizing "fiat" as an unlimited, coincidental outcome of fully floating and un-suppressed coordination. Things get sticky once that becomes an issue, because by then the complaining party has - by definition - already lost sight of the bigger options exposed through national affinity.

To understand organization, affinity and return on coordination, it's useful to keep a simple system mantra in mind.

Interactions drive awareness.
..Awareness exposes group opportunities.
Opportunities demand timely, coordinated actions.
..Coordinated actions drive interaction.

Organization is a positive feedback loop, referred to as autocatalysis. It is a runaway proces, but only if we set it in motion and keep it running freely.

In short, we as a nation, are what we practice. Fiat bookkeeping to track the dynamic value of diverse transactions is just one of the many, trivial data patterns we use. They're all coincidental to the outcomes we as a people desire and of he efforts we organize to achieve those outcomes.

If we don't let our aspirations as a nation float freely, then we cannot maintain a functional fiat currency - only a growing Output Gap. Our pursuit of our aspirations comes first, and the tangible measures of fiat follow coincidentally ... if we let them.