Fiat

It would appear to me that inflation cannot be sustained unless there is a federal bank somewhere in the background creating money, probably to buy foreign reserves as a hedge or as a means to impact currency exchange rates, to increase economic activity, or even just paying off dividends on government bonds.

A quick glance on-line reveals a whole cadre of commentators bemoaning the fact that our federal banks are ripping us off by printing money simply because the ensuing inflation means we cannot keep our dollars under the bed for retirement. Inflation forces us to engage with the economy, to invest our excess money; at the very least to place what excess we have of it in the local bank. I suspect it could be a lot worse; someone might rob the stash under the bed.

It is said that fiat money has to exist in ever increasing levels as economies grow otherwise there will be shortage of ‘liquidity’. However, I wonder what liquidity really means in the era of electronic money? Deflation, where goods cost less than before, doesn’t seem so bad so long as the reduced profits also have more purchasing power. I suspect that there is no real risk that lending will cease if there is mild deflation other than the risk of borrowers not having the means of repaying if the period of deflation is accompanied by depressed consumption. If so the lack of lending isn’t really a result of a liquidity crisis (shortage of fiat money), it is due to a poor economic outlook leading to a reduced capacity for repayments. Giving the banks cheap money to lend doesn’t seem to solve this problem; one of our previous Labor governments instead gave it away free cash (they didn’t print it but they could have) in the form of goods and services to consumers.

However if there is a serious shortage of currency then the unit of ‘money’ may become an asset, like Bitcoin has been. The trouble with this is that the value of assets are susceptible to price bubbles and speculation. And if you think inflation is a problem then losing out on a speculative effort on your local currency would be much worse.

Thinking about this further it would appear that the reason we have inflation is to drive productivity and consumption. It is probably the most effective means to drive individuals and companies to both consume and invest because our earnings or debts have the highest crystallised value when we first earn them. Thereafter we had better use them or suffer the consequences.

In fact it hasn’t been discussed much but I wonder how much the industrial revolution in England was successful because the bankers over there latched onto money supply and also caught onto the idea of low levels of constrained positive inflation as the key driver for a consuming, investing and high-growth society? In fact I bet if one plotted greenhouse gas build up with fiat currency growth there would be some very nice correlations dating back to 1700. That is a slightly over-supplied fiat currency drives consumption which consumes fossil fuels which increase greenhouse gases.

One almost inevitable side effect of a complex multi-nation system of countries with different currencies and open currency trading is that the system will be oscillate into periods of ‘instability’. Well, we see them as ‘unstable’ periods because it’s either very easy to invest to make or lose money. Anyone that has ever played around with complex mathematical modelling environments (a.k.a. kinetics) will know that systems often either settle down to a single steady-state, or they have oscillating and sometimes even semi-random behaviour between a number of steady-states.

The tendency towards the latter in our global financial system is helped by key inputs from humans, very few of whom are guaranteed to understand the systems they are using. This includes, I suspect, some of central bankers who are cargo-culters, i.e. playing their role according to some barely understood set of inherited ‘operating rules’ which apply in most but not all situations. The input by the truly uncaring and greedy business and political types certainly doesn’t help. But, hey, the system is self-correcting so it doesn’t really matter that much.

But here is the real problem. The idea of reducing our consumption of fossil fuels and diminishing resources is a real challenge with our current monetary systems which were designed to encourage consumption. The idea of a replacement trading system with different motivating impacts on our behaviour is a lovely thought but things will have to get pretty serious before such a thing occurs.

One alternative is to revert to bartering. Another is to use a finite resource as a trading proxy, e.g. gold or a bit-coin (which is linked to the high energy consumption used to create it). Whatever we do, the answer to our problems is probably not going back to pre-industrial days; well not without utter mayhem because a good fraction of the population would have to go in this scenario. In order to go forward peacefully we need a system that encourages productivity gains (a.k.a. technology) but only in areas where consumption of resources is either reduced (from current levels) or converted from consumption to ‘fair use’ (borrowed for use and not irrevocably consumed).

This needs much more thought.