Establishing a Pure Fiat Money System
Inflation is
another word that has become completely confused in everyday conversation.
Inflation used to mean an undue expansion of the money supply.
By undue, one would refer to an increase in the money supply over the supply of
gold. Today, on the other hand, our parents refer to a general increase
in consumer prices when they speak of inflation. In reality, it is simply an
increase in an arbitrary compiled index. The change of the very meaning of the
word inflation is of immense importance, because the conclusions and policy
implications that will be resorted to under the two different definitions can
be diametrically opposites.
If inflation is
defined as an undue expansion of the money supply, then it is easy to know when
the banking system inflates. By comparing outstanding money notes with gold in
reserves one can immediately determine if there has been inflation or not.
Under the second definition things becomes far more obscure because there will
be a considerable lag between the change in the money supply and its effects on
prices. Inflation with our parent’s definition does not occur before the
retailer changes his prices announced to his customer. In other words,
the causal connection between inflation and money expansion
appears broken, and replaced by a new causality between the whims of a store
clerk and his idea of what prices should be. Please observe; the reason and
hence blame for increasing prices can no longer be put on the government, but
the evil capitalist. For whom, other than the capitalist, does the actual act
of increasing prices?
With our parent’s
definition of inflation also follows a depraved definition of deflation.
Nowadays deflation is defined as falling consumer prices. Deflation through
modern history has often been highly correlated with economic depressions, and
today’s economists believe falling prices causes depressions.
Think about that for a minute. Can falling prices actually be the reason for
lower economic activity? Say we were on strict commodity based money standard
with outstanding notes 100 per cent backed by said commodity. In this world, we
could reasonably assume economic output of consumer goods to exceed output of
commodity money. In that case consumer goods prices will most surely fall.
However, there is no depression in this economic constellation as prosperity
increases through higher purchasing power for everyone. The policy response
when equating falling prices with hardship and poverty would be to damage this
healthy development through inflating the money supply. Such is the world
created by our parents, where good is bad and bad is good. No wonder we tend to
be confused.
Still, the most
important reason they decided to change the definition is even more
opportunistic. In order to maintain a 100-year trend toward fiat money
it was necessary to change the definition of inflation. Before WWI most western
countries were on some sort of gold standard, which worked relatively well.
Prices were falling in the 1870s and 80s but prosperity rose all over. With the
end of WWI the global economy adopted a gold-exchange standard, which in
reality was a pound/dollar standard controlled by the Anglo-Saxons in London
and New York. After WWII New York managed to push the Brits out and were able
to run the global monetary system solely to their own advantage. However, there
were still an official link between gold and dollar so foreign central banks
could in theory keep the dollar inflation in check. That said, as soon as the
French tried to exchange dollars for physical gold the dollar exchange standard
collapsed. Since 1971 we have been on a pure fiat standard.
Up until 1971
policymakers had constantly reduced the original intent of a gold standard as
proposed by David Hume through meddling with the automatic price specie flow.
For every action follows a reaction. But the reactions were often painful to
bear, so instead of dealing with the pain head on, previous generations rather
turned the going monetary system into a watered down monstrous Frankenstein of
it old self. After 1971 the obvious question of what to replace the pure fiat
with arose. There was no natural next step when the bust came and global
central banks were forced to hike interest rates to unprecedented levels in the
early 1980s. This was too much to bear, so instead of accepting reality
one defined the problem away: First in the 1960s by getting
rid of the old definition of inflation, and then in the 1980s and 90s by
changing the definition of the consumer price index itself. The reason consumer
prices fell so steadily during the “Great Moderation” was much more due to
changes in the index than to competent monetary policy makers. Today we hear
once again about the wonders a new consumer price index will have; it will cut
future state liabilities through lower pension payments, it will reduce growth
in wage indexations and hopefully clear the labour market and so on.
Under a pure fiat
standard one has to resort to measures like changing the consumer price index
in order to justify increasingly higher monetary inflation to keep a rotten
system going.
And this is
exactly what our parents have been doing. They have had to increase money
inflation at an exponentially rate to maintain their ever increasing debt
levels. This of course consumes and misallocates capital and reduces future
productivity. When deflation comes, which it inevitably will, the end game is
near. Then our parents panic and starts to print money like never before in a
desperate hope to push the problems over to our generation!
One of the most
visible effects of this policy was the dramatic shift in house prices. Our
parents bought their houses in the 1960 and 1970s just when monetary inflation
started in earnest. Now, that we have moved out, our parents will move into
smaller apartments while we have to buy their houses with inflated prices,
which amounts to nothing less than a gigantic wealth transfer! No generation
through history has ever taken more out of society without going through some
sort of social revolution.
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