A state controlled currency is widely accepted simply because people don’t know any different. It is deemed to be the norm. Every country has a government with a central bank that is in charge of the money. There is an unspoken trust for the government to act in the best interests of the people, and to act competently. But unfortunately for the majority of us, this centralised control of our money provides the means and the incentive to abuse the currency in order to indulge in human desire and create short term unsustainable economic growth at the expense of increased inequality in society and an inevitable future economic downturn, that is, when the boom eventually becomes a bust. So what can we do about this?
This post is the last in a three part series about money. In the first part we spoke of the rapid expansion of the amount of money in the economy. The money supply is going up, and the value of our money is falling. This has been happening on a huge scale in the last 40 years since the fall of the Bretton-Woods agreement when the last link to gold through the US dollar was severed. At this time an ounce of gold was agreed at $35, but since 1971 the price of an ounce of gold has soared, and peaked at $1900 in August of this year. The money that we use, however, buys nothing like what it did back in the day. The devaluation of our currency makes prices rise, and ordinary people bear the brunt. In the second part, we established that the root cause of economic discontent lies with the central bank, and hence with the government. We talked specifically about the system of fractional reserve banking and how it relies on confidence. If confidence was to be lost, everyone would attempt to withdraw their money from the bank and not everyone would get it back. We spoke of how the government and the banking sector are jointly involved in creating money. The Bank of England buys government bonds and other financial assets, using money created out of thin air, which in turn increases the money in the banks. The Bank of England also supports the creation of money and credit by the banks themselves in its role as the ‘lender of last resort’, which guarantees the credit worthiness of the banks so they can all compete by lowering rates in order to create and lend more money.
The sad truth is that so long as the management of our currency is left to government, it will continue to be debased at our expense. Depreciation of the value of our currency will continue indefinitely until one of two things happen - The government voluntarily changes its policy and embraces the subsequent recession, or continues in its money creating activities, artificially spurring growth until the economy becomes so reliant on monetary expansion to survive that the only possible outcome is total collapse of the financial system. Or is there a third option? Can we find a way to release our currency from its strict bounds and permit a free flowing stable monetary system, immune to the human forces that seek to manipulate it? In this post, I talk about the management of our national currency and some of the proposed solutions to break up this vast concentration of power.
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As Governor of the Bank of England and chairman of the Monetary Policy Committee, Sir Mervyn Allister King is a powerful man. He can create money, and he makes the final decision about when to do it, and how much to create. He has the power to tax people at the push of a button, and to add zeros to the bank accounts of whom he pleases. Arguably this privilege makes him more powerful than even the Prime Minister. Of course, Mr King must obtain the permission of the Chancellor of the Exchequer in order to execute direct money creation, but he will always insist that it is the Bank of England’s ‘independent’ decision.
The Pound Sterling and the US dollar are the oldest currencies in existence today. Sterling evolved from the Anglo-Saxon system of silver pennies, 240 of which weighed one pound (lb). The Frankish accounting system was adopted with one pound equal to twenty shillings, one shilling equal to twelve pence and one penny equal to four farthings. Decimalisation only began in 1971. The grand institution that is Pound Sterling is hard to criticise. It has seen many ups and downs, been traded all across the world since the days of the British Empire, and is still used in the UK today in addition to a number of regional variations from countries such as Scotland, the Isle of Man, the Channel Islands and South Georgia. The Central Bank has controlled the production, issue and regulation of paper notes since its inception in the year 1694.
The Pound Sterling and the US dollar are the oldest currencies in existence today. Sterling evolved from the Anglo-Saxon system of silver pennies, 240 of which weighed one pound (lb). The Frankish accounting system was adopted with one pound equal to twenty shillings, one shilling equal to twelve pence and one penny equal to four farthings. Decimalisation only began in 1971. The grand institution that is Pound Sterling is hard to criticise. It has seen many ups and downs, been traded all across the world since the days of the British Empire, and is still used in the UK today in addition to a number of regional variations from countries such as Scotland, the Isle of Man, the Channel Islands and South Georgia. The Central Bank has controlled the production, issue and regulation of paper notes since its inception in the year 1694.
Notwithstanding the great traditional and historical significance of the Pound Sterling, in order to rescue it from its path to destruction, we must become more open-minded about the management of our currency and our established way of thinking.
Firstly, the Bank of England has enjoyed a monopoly for far too long.
As you are well aware, a monopoly is when there is only one supplier of a certain commodity, product or service. It means that there is only one vendor who controls the whole market. Large set up costs, laws, patents or other ownerships prevent other competitors from entering the industry. The absence of competition means that there is no pressure for the monopoly to improve the product for the consumer. If there were other competing firms in the industry, and the consumer had a choice to use another product, then all the firms in the industry would have an incentive to keep costs and prices low and to develop better products so that more people opt specifically for their product instead of the others on the market.
Imagine if Land Rover owned a monopoly in the UK, let’s say because they controlled all the supply lines of metal needed to make cars and UK laws prevented the import of foreign cars. Land Rovers would therefore be the only cars available in the UK. Everyone who wanted to drive, would have to buy a Land Rover. The company would therefore have no incentive to improve the quality of its cars or lower its prices, because consumers have no other option. The only way that the company would lose business is if they produced a product so bad or so expensive that people decided they were better off without a car altogether.
Fortunately the car market has lots of competition, and even British producers are struggling for market share in the UK as well made German cars and cheaper French models are very attractive to British motorists. Sadly, the money market does not have these same attributes. The Bank of England is the only producer of money in the UK and the existence of ‘legal tender’ laws mean that we cannot use foreign money as payment for goods and services in the UK. Well, one could, supposedly, convince a vendor to accept payment in another currency if you could convince the vendor that the price was right and sufficiently compensate him or her for the cost of exchanging or banking in that currency. However this uncertainty and higher cost completely removes any real benefit of trying to use foreign currency in the UK.
If there was competition in the money market, and people had a choice of using other currencies, then the money producers would suddenly have an incentive not to abuse the currency.
Competing currencies have been theorised by various economists, famously by Hayek in 1975.1 In being able to chose between different currencies, people would naturally gravitate towards the more stable currency - the currency with a reliable producer, the currency that does not rapidly lose its value.
For this to happen in the UK, the legal tender laws would have to be changed and different currencies would have to be ‘legalised.’ This is not an alien concept. There are many places in the world where a number of currencies can be used. Towns that sit close to the border of another country tend to accept multiple currencies in shops as many travellers pass through the town. Even cities like Belfast or Geneva, have many places that accept the Euro because of their proximity to Euro-using countries. At airports or on the Eurostar for example, you can also use multiple currencies.
Historically the problem has always been that the very nature of money, in essence what makes it money, is that it is all the same; it has to be recognisable. With the legality of different forms of coin, people would lose the ease of using money, in that it would no longer be easy to recognise and check. In present circumstances, it takes only a split second, and perhaps a glance through a bank note to check the water mark, in order to check the validity of cash and hence execute your transaction with no difficulties. The existence of other currencies in the mix would confuse and unnecessarily prolong trading. It is therefore a logical conclusion that a single money producer should be the norm. Today however, electronic payments are more popular than cash payments and therefore this experiment could feasibly be tested with electronic payments only, until it becomes stable and some traders begin to start accepting foreign coin if they desire.
The main issue with this ‘solution’ is that it is untested. People rightly fear that the end result could be the death of some currencies and the dominance of others. Then again, many countries in Europe have already experimented with something equally as radical...
Secondly, let us deinstitutionalise inflation.
The Bank of England has a description of its monetary policy on its website, where it says “A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase..” “..Price stability is defined by the Government’s inflation target of 2%”
As you are well aware, a monopoly is when there is only one supplier of a certain commodity, product or service. It means that there is only one vendor who controls the whole market. Large set up costs, laws, patents or other ownerships prevent other competitors from entering the industry. The absence of competition means that there is no pressure for the monopoly to improve the product for the consumer. If there were other competing firms in the industry, and the consumer had a choice to use another product, then all the firms in the industry would have an incentive to keep costs and prices low and to develop better products so that more people opt specifically for their product instead of the others on the market.
Imagine if Land Rover owned a monopoly in the UK, let’s say because they controlled all the supply lines of metal needed to make cars and UK laws prevented the import of foreign cars. Land Rovers would therefore be the only cars available in the UK. Everyone who wanted to drive, would have to buy a Land Rover. The company would therefore have no incentive to improve the quality of its cars or lower its prices, because consumers have no other option. The only way that the company would lose business is if they produced a product so bad or so expensive that people decided they were better off without a car altogether.
Fortunately the car market has lots of competition, and even British producers are struggling for market share in the UK as well made German cars and cheaper French models are very attractive to British motorists. Sadly, the money market does not have these same attributes. The Bank of England is the only producer of money in the UK and the existence of ‘legal tender’ laws mean that we cannot use foreign money as payment for goods and services in the UK. Well, one could, supposedly, convince a vendor to accept payment in another currency if you could convince the vendor that the price was right and sufficiently compensate him or her for the cost of exchanging or banking in that currency. However this uncertainty and higher cost completely removes any real benefit of trying to use foreign currency in the UK.
If there was competition in the money market, and people had a choice of using other currencies, then the money producers would suddenly have an incentive not to abuse the currency.
Competing currencies have been theorised by various economists, famously by Hayek in 1975.1 In being able to chose between different currencies, people would naturally gravitate towards the more stable currency - the currency with a reliable producer, the currency that does not rapidly lose its value.
For this to happen in the UK, the legal tender laws would have to be changed and different currencies would have to be ‘legalised.’ This is not an alien concept. There are many places in the world where a number of currencies can be used. Towns that sit close to the border of another country tend to accept multiple currencies in shops as many travellers pass through the town. Even cities like Belfast or Geneva, have many places that accept the Euro because of their proximity to Euro-using countries. At airports or on the Eurostar for example, you can also use multiple currencies.
Historically the problem has always been that the very nature of money, in essence what makes it money, is that it is all the same; it has to be recognisable. With the legality of different forms of coin, people would lose the ease of using money, in that it would no longer be easy to recognise and check. In present circumstances, it takes only a split second, and perhaps a glance through a bank note to check the water mark, in order to check the validity of cash and hence execute your transaction with no difficulties. The existence of other currencies in the mix would confuse and unnecessarily prolong trading. It is therefore a logical conclusion that a single money producer should be the norm. Today however, electronic payments are more popular than cash payments and therefore this experiment could feasibly be tested with electronic payments only, until it becomes stable and some traders begin to start accepting foreign coin if they desire.
The main issue with this ‘solution’ is that it is untested. People rightly fear that the end result could be the death of some currencies and the dominance of others. Then again, many countries in Europe have already experimented with something equally as radical...
Secondly, let us deinstitutionalise inflation.
The Bank of England has a description of its monetary policy on its website, where it says “A principal objective of any central bank is to safeguard the value of the currency in terms of what it will purchase..” “..Price stability is defined by the Government’s inflation target of 2%”
This level of inflation is regarded as ‘acceptable,’ in that there needs to be a very good reason for the inflation rate to exceed 2%. Governments have supposedly learnt from our past experiments with paper money systems and they now know that as soon as inflation gets too high, people lose confidence in the system and the currency collapses. This has happened many times in history. Hyperinflation in Germany in the 1920s and recently in Zimbabwe in the 2000s caused the destruction of the Mark and the Zimbabwean Dollar respectively.
This level of inflation is also regarded as ‘necessary,’ in that inflation of under 2% is also thought to be bad for the economy. Without inflation, they say, there will not be enough money in the economy: As trade increases, and the population rises, more people need more money to execute more transactions; therefore we need to create more money and credit to support growth in the economy. So, it is believed to be essential for the money supply to slowly rise and for the purchasing power of money to slowly depreciate.
In fact, the expectation that the value of money must fall is so engrained in our way of thinking about economics, that it is almost impossible to imagine any different. All businessmen of our generation simply accept that economic growth is when prices, profits and wages rise and recession is when prices, profits and wages fall. It is popular belief that only the expectation of price rises can provide the incentives and environment for investment and innovation.
Consider, briefly, a world in which the purchasing power of the currency was rising slowly over time, instead of falling, i.e. money was gaining value instead of depreciating.
So, instead of the current situation of inflation, price rises, wage rises (hopefully), and rising profits, imagine that prices were instead falling, and wages were also falling; the availability of money was slowly decreasing and money was slowly becoming more and more valuable.
Your perception of wealth in such a society would not be the size of your wages, but the costs of the things you have to buy relative to your wages. Prices would be falling and companies would be making less and less profit in numerical terms, but our quality of life would still be measured in a similar way as it is today, which is: what we are able to buy with our money. Such a system would demonstrate that it is not big wages and big bank balances that creates wealth; it is the availability and affordability of goods and services.
As a whole, we do not need lots of money to be prosperous. Remember that money has no real value other than its use to buy goods and services, i.e. as a medium of exchange. It doesn’t matter how much money there is in total, it only matters how much of it you have in relation to others. To give an example, imagine if a magic wand was waved and the value of everyone’s money doubled overnight, i.e. all 50p coins became £1, all £5 notes became £10 etc. etc. instantly, and everyone knew about it. Would anyone be any richer? Not really. Prices would rise instantly. What used to cost £1 in the shops would immediately cost £2. There is no good reason to increase the amount of money in the economy as the only way for it to have any effect at all, is if you give it to some people and not to others.
This is not to advocate that we should pursue monetary contraction (decreasing the money supply) as policy. Today, such a society with slow deflation instead of inflation, is seen as recessionary. At this present moment in time, when we have being enjoying an economic boom, but are yet to have the bust, deflation really does equal recession. But one can hardly call it a curse, rather a return to normality.
A society in which the money supply is contracting would reward the savers and punish the big borrowers and spenders. It would rebalance the economy. It would encourage people to be resourceful and to buy only what they need.
In the long term however, in terms of our physical standard of living, it would be no better than an inflationary society, as it is still biased towards some groups of people and disadvantageous towards others. But it is necessary to understand that expansion of the money supply is not essential for economic prosperity. Inflation need not be the norm.
Consider, briefly, a world in which the purchasing power of the currency was rising slowly over time, instead of falling, i.e. money was gaining value instead of depreciating.
So, instead of the current situation of inflation, price rises, wage rises (hopefully), and rising profits, imagine that prices were instead falling, and wages were also falling; the availability of money was slowly decreasing and money was slowly becoming more and more valuable.
Your perception of wealth in such a society would not be the size of your wages, but the costs of the things you have to buy relative to your wages. Prices would be falling and companies would be making less and less profit in numerical terms, but our quality of life would still be measured in a similar way as it is today, which is: what we are able to buy with our money. Such a system would demonstrate that it is not big wages and big bank balances that creates wealth; it is the availability and affordability of goods and services.
As a whole, we do not need lots of money to be prosperous. Remember that money has no real value other than its use to buy goods and services, i.e. as a medium of exchange. It doesn’t matter how much money there is in total, it only matters how much of it you have in relation to others. To give an example, imagine if a magic wand was waved and the value of everyone’s money doubled overnight, i.e. all 50p coins became £1, all £5 notes became £10 etc. etc. instantly, and everyone knew about it. Would anyone be any richer? Not really. Prices would rise instantly. What used to cost £1 in the shops would immediately cost £2. There is no good reason to increase the amount of money in the economy as the only way for it to have any effect at all, is if you give it to some people and not to others.
This is not to advocate that we should pursue monetary contraction (decreasing the money supply) as policy. Today, such a society with slow deflation instead of inflation, is seen as recessionary. At this present moment in time, when we have being enjoying an economic boom, but are yet to have the bust, deflation really does equal recession. But one can hardly call it a curse, rather a return to normality.
A society in which the money supply is contracting would reward the savers and punish the big borrowers and spenders. It would rebalance the economy. It would encourage people to be resourceful and to buy only what they need.
In the long term however, in terms of our physical standard of living, it would be no better than an inflationary society, as it is still biased towards some groups of people and disadvantageous towards others. But it is necessary to understand that expansion of the money supply is not essential for economic prosperity. Inflation need not be the norm.
A return to a gold standard would be advantageous in many respects, primarily as there would be a fixed supply of money. The only way that prices would rise, would be if lots of new gold was mined from the earth, in which case we would have ample time to plan for such an event. With a relatively fixed supply, money would slowly appreciate. As more and more people need money to perform their economic transactions, a fixed amount of money would need to be shared between more people and more trades, so money would slowly become ‘rarer’ and hence more valuable. Deflation of this kind would mean that people generally spend less and save more, as it pays to hold money which is getting more valuable.
Most importantly, a commodity backed currency would greatly reduce the power of the central bank to set monetary policy, and greatly reduce the practice of fractional reserve banking. The government would no longer be able to depreciate the currency at will, as it cannot just create gold out of thin air. Fractional reserve banking would be greatly restrained due to the genuine risk of a loss of confidence in the bank’s ability to repay debts. The central bank would no longer be able to provide an unlimited backstop for excessive government spending and bank lending. The government would no longer have full control over the financial system. The big banking 1% would be tamed.
However, a timely return to gold is unlikely, and many are rightly sceptical of another monetary system imposed by government. Most importantly, many fear we are already at the point of no return and to implement a gold standard at this point in time would significantly hike up the cost of borrowing, upon which our economies are so regrettably reliant, thereby initiating an intolerably deep recession. Of course, as governments continue on the path of inflation, and realise that the present system is unsustainable and irreparable, a return to gold will begin to look ever more viable. Gold has always been, and always will be, the chosen money of capitalism.
Optimists will stay true to their convictions that debt will eventually be repaid, banks will undertake deleveraging or that fractional reserve banking will be slowly reduced, controlled, or even prohibited. Others are not so confident in the foresight of the current establishment and believe that the ruling coalition of bankers and politicians are highly unlikely to cede the privileges and power they wield through their monopoly money.
Finding a solution to circumvent monetary breakdown will not be easy, and will require not only a rebalancing of power, but new financial experiments and a complete rethink about our monetary system, which nobody wants to even suggest, let alone undertake. But if we don’t open our minds to other solutions and strive to implement them sooner rather than later, the complete collapse of our financial system will be the most probable eventuality.
It has happened before on numerous occasions, and each time the sun rose the next day and life went on. The next instance may not be too far away.
Detlev Schlichter, a former banker, gives his view on the current financial system in a recent speech:
Most importantly, a commodity backed currency would greatly reduce the power of the central bank to set monetary policy, and greatly reduce the practice of fractional reserve banking. The government would no longer be able to depreciate the currency at will, as it cannot just create gold out of thin air. Fractional reserve banking would be greatly restrained due to the genuine risk of a loss of confidence in the bank’s ability to repay debts. The central bank would no longer be able to provide an unlimited backstop for excessive government spending and bank lending. The government would no longer have full control over the financial system. The big banking 1% would be tamed.
However, a timely return to gold is unlikely, and many are rightly sceptical of another monetary system imposed by government. Most importantly, many fear we are already at the point of no return and to implement a gold standard at this point in time would significantly hike up the cost of borrowing, upon which our economies are so regrettably reliant, thereby initiating an intolerably deep recession. Of course, as governments continue on the path of inflation, and realise that the present system is unsustainable and irreparable, a return to gold will begin to look ever more viable. Gold has always been, and always will be, the chosen money of capitalism.
Optimists will stay true to their convictions that debt will eventually be repaid, banks will undertake deleveraging or that fractional reserve banking will be slowly reduced, controlled, or even prohibited. Others are not so confident in the foresight of the current establishment and believe that the ruling coalition of bankers and politicians are highly unlikely to cede the privileges and power they wield through their monopoly money.
Finding a solution to circumvent monetary breakdown will not be easy, and will require not only a rebalancing of power, but new financial experiments and a complete rethink about our monetary system, which nobody wants to even suggest, let alone undertake. But if we don’t open our minds to other solutions and strive to implement them sooner rather than later, the complete collapse of our financial system will be the most probable eventuality.
It has happened before on numerous occasions, and each time the sun rose the next day and life went on. The next instance may not be too far away.
* * *
Detlev Schlichter, a former banker, gives his view on the current financial system in a recent speech:
1 - Hayek actually took this idea a step further and proposed a model for complete denationalisation of money in which private producers would be able to issue money and compete with governments. I highly recommend his paper Denationalisation of Money for its theoretical creativity; it is certainly way before its time. However, it is unconvincing that newly issued bank currency would be accepted, as it would require the general public to have a much greater understanding of money for people to see and reap the benefits of such a system. The world would have to be a very different place before the idea became feasible.
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