In an earlier post I wrote about the likelihood of continued market volatility as asset prices veered back and forth between the effects of monetary stimulus and the deflationary forces unleashed by a generational deleveraging event. In this tug-of-war between the forces of inflation (money printing) and deflation (deleveraging) the dollar is the medium through which stress is felt from either side and checking the value of the dollar is the way to see whether inflation or deflation is winning the tug-of-war. Currently, with virtually every country in the world cranking up the printing press to devalue their currency and grab a larger share of a diminishing pool of world trade, we are on the verge of what James Rickards calls a ‘currency war’. As Rickards points out in his book on the subject, currency wars are nothing new, and he quotes numerous examples including the Great Depression, when nations engaged in competitive currency devaluations and imposed tariffs which ended up collapsing world trade. “Whether prolonged or acute, these and other currency crises are associated with stagnation, inflation, austerity, financial panic and other painful economic outcomes. Nothing positive ever comes from a currency war.”
It doesn’t have to be this way. It has been almost 100 years since the founding of the Federal Reserve System with the mandate of containing financial disruptions and promoting the goals of maximum employment, stable prices and moderate long term interest rates. Since then the dollar has lost over 90 percent of its value and 100 year bonds, a commonplace at the end of the 19th century when corporations felt confident they knew what the price level was going to be over the next 100 years, have completely dried up.
While no monetary system is perfect, most observers of the classical gold standard (1879-1914) have noted that, with all its anomalies and exceptions, it basically worked. It was automatic, self-correcting, and over the long run achieved exceptional price stability without any monetization of government debt. The key to understanding why the gold standard worked was that governments had to redeem the money they issued in gold, a discipline which forced them to control the amount of money in circulation. It has become increasingly clear to economists and lay people alike, that governments can never impose this discipline on themselves, it has to be imposed on them from the outside.
I am not proposing a return to the gold standard, although gold does have a strong and justified claim on the affections of those who desire their money to hold its value over long periods of time. Rather, we should let the market decide the best form of money just like it is currently deciding the fate of web standards, or just like it decided the fate of Blu-ray Disks and HD DVD discs in the optical disc format war (old timers will also remember the VHS and Betamax videotape format war of the late 1970’s and early 1980’s). This discovery process is what markets do best because nobody can accurately forecast the outcome of these struggles, least of all a government committee.
In addition to precious metals and baskets of commodities there are other potential currencies of the future that look promising. For example, cryptography expert Satoshi Nakamoto has created the first completely decentralized, anonymous, electronic currency, called Bitcoins, a real-world currency with no government control, no central bank supervision and no rules. Bitcoins are digital coins that can be sent over the internet or stored on disk and transactions are private, anonymous, and safe. Bitcoins have all the features that meet the definition of money. They are a medium of exchange (anonymous and across great distances), a unit of account (private), divisible (up to eight decimal places), scarce (21 million), portable (transferred electronically), and a store of value (current exchange rate as of October 12 is 1 Bitcoin equal to $12.00).
However the emergence of a currency not controlled by a nation state has potentially widespread disruptive effects. Think for a moment about the effect on payment firms such as VISA, Mastercard and PayPal. Or what about new asset protection vehicles using Bitcoins, that transfer inter-generational wealth without the need for trusts or trust administrators? Whatever the potential disruptive effects, most of which are currently unknowable, the increasing disenchantment with central banks should ensure that the idea of private currencies continues to gain traction in the years ahead.
“…there is no justification in history for the existing position of a government monopoly of issuing money. It has never been proposed on the ground that government will give us better money than anybody else could. It has always, since the privilege of issuing money was first explicitly represented as a Royal prerogative, been advocated because the power to issue money was essential for the finance of the government – not in order to give us good money, but in order to give to government access to the tap where it can draw the money it needs by manufacturing it.” Friedrich Hayek