Important Questions About Money
Summary
- Cryptocurrencies are playing a greater role in the financial area of economies these days and are going to play an even greater role in the future.
- To understand cryptocurrencies, investors must understand that they are more a part of the trend of financial innovation coming out of the 1980s and 1990s than just new creations.
- Cryptocurrencies are playing the role of a store of value and the action in these assets reflects this particular characteristic.
- Digital currencies, like the one being created by China, are aimed to serve as a medium of exchange and this will distinguish one from the other as the role of money continues to evolve.
Gillian Tett, Chair of the editorial board of the Financial Times and editor-at-large, U.S., just published a very interesting article, something that she does quite often.
The current article I am interested in was just published last Saturday. The subject of the piece was the 50th anniversary of the move by President Richard M. Nixon to separate the U.S. dollar from the gold standard.
Previously, the U.S. dollar had been tied to gold. The price of gold was $35 per ounce. Other currencies were then tied to dollar.
This was the era of the "gold standard."
Mr. Nixon announced, on the evening of August 15 1971, that he was severing this tie.
Ms. Tett, in her Financial Times article, is interested in the story surrounding this action.
Three Days At Camp David
Ms. Tett writes that before just recently, we did not really have a more complete description of what went on before August 15, nor much information on what came afterward.
Well, Ms. Tett announces, now we do have a source.
The source is the brand new book by Jeffrey E. Garten titled "Three Days At Camp David," published by Harper. Mr. Garten has been professor at the Yale School of Management and is a former U.S. undersecretary of commerce. Mr. Garten has given us a very readable, by comprehensive source, for what went on during that time.
Ms. Tett argues that Mr. Garten's book raises three questions that were crucial to the Nixon action, that are very relevant to the issues President Joe Biden faces.
Whereas Ms. Tett's issues are quite important and, I think, of interest to Seeking Alpha readers, I would like to take a slightly different look at the events and draw out some points that are very important in this day and the emergence of digital currencies and cryptocurrencies to our situation.
The Characteristics Of Money
Money is seen as having three functions: money serves as a medium of exchange; money serves as a store of value; and money serves as a unit of account. We will stick to the first two of these in the following discussion.
One concern Ms. Tett focused upon is what allows money to command value and trust?
The answer: "money has gained value either because it was a commodity in limited supply or was tethered to one." This, Ms. Tett argues, is the basis of the store of value characteristic of cryptocurrencies. The supply of the commodity is limited and so this can produce value.
However, money can also gain value and trust by relying on "the credibility of an individual, institution, or group." This, Ms. Tett states, is the world we now live in.
Both systems have their own foundational support.
The first system creates value "by being rigid by design."
Thus, this system can collapse by being too restrictive. This is what happened to the gold standard. The United States did not have enough gold in its vaults to handle all the transactions it was forced to engage in.
The second system faces the opposite problem: it can be too flexible and governments, in this day and age can produce more money and more debt by working with its 0s and 1s. After all, money and finance is just about information and information can be created in seconds through altering the zeroes and ones.
And, this flexibility can produce inflation, financial controls (like the wage and price controls set up by the Nixon administration) and write-offs.
The problem here is that debt can be money and debt can be created almost without cost and this means that its ability to expand is almost unlimited.
What's Going On Now
And, this gets Ms. Tett into the realities of today.
"The total global debt is now more than three times the size of the global economy, since debt--and money--has expanded inexorable since 1971."
This is problematic. Going forward, how is this debt--and money--going to be handled?
Will it cause a direct or indirect restructuring or a social or financial implosion?
Ms. Tett is, obviously, concerned with what a possible restructuring would do.
Credit Inflation
This gets into the subject that I have been discussing for several years now.
I have called this inflation of money and debt, "credit inflation." Credit inflation actually began in the 1960s when the Kennedy/Johnson administrations began to pump up the economy, using the arguments of the Phillips Curve, to get a little lower unemployment rate at the expense of a little more inflation.
The Nixon administration accepted this view, and continued to pump up money and credit in order to keep the economy growing and unemployment dropping. The rationale, as is talked about over and over in the Garten book, is that keeping unemployment down is crucially important to getting a president re-elected.
But, there are consequences to such a policy.
The Nixon administration discovered the reality that the store of value it was using to back the dollar was limited in supply. If a government continues to inflate the economy, the store of value, in this case gold, become relatively more scarce.
And, Mr. Nixon finally had to go off of gold standard and try and establish value and trust in the U.S. dollar without the gold backing.
But, credit inflation carried on... for the next fifty years or so.
Financial Engineering
This environment created a new opportunity, an opportunity for the development of financial innovation, the development of more and more assets that could be used as a store of value.
Financial innovation took off in the 1980s. The U.S. had to go through the dark period of the late 1970s and the inflation fighting of the 1980s, but, the financial sector was primed once the inflation was stopped to change the nature of finance, through financial innovation.
In effect, many more assets that could serve as a store of value were created and the financial sector of the economy took off. Now, when credit inflation took place, investors did not have to allocate much of the increased money into real investments, capital investments that built up the productive capacity of the economy, they could allocate funds into the "financial circuit" of the economy and generate major returns, with less risk, than could be attained by putting their money into the "real circuit" of the economy.
And, what happened to price inflation?
Well, in the 1990s and beyond we got asset price inflation, asset price bubbles, but we did not see much consumer price inflation. And, this carried over into the 21st century, becoming particularly noticeable in the 2010s in the period following the Great Recession.
The economic recovery that followed the Great Recession was notable for lack of consumer price inflation during the time. For the full period of economic expansion, the annual compound rate of inflation was only 2.2 percent, the lowest rate of inflation for any period of economic recovery in history.
But, asset price bubbles happened here and there. The asset price bubbles were taking place in areas where financial innovation produced opportunities for investors to put their money into what we have called "stores of value." It seems as if this was one of the major results of the financial innovation that took place since the 1960s.
And, Now For The 2020s
Now, we are moving into the 2020s. Gillian Tett has raised some important issues that must be considered. But, maybe we need to add a little bit to Ms. Tett's discussion.
We now have cryptocurrencies. And people are worrying about how they will fit into the picture.
So far, the cryptocurrencies have primarily served as a store of value and their prices and price behavior have mirrored what we would expect in markets for stores of value.
But, cryptocurrencies are not really serving as a medium of exchange. I have written about this many times.
In fact the cryptocurrencies can be looked at as a continuation of the expansion of financial innovation, supplying investors with more and more opportunities to channel their investment monies.
As far as a these "digital" assets becoming a medium of exchange, that seems less and less likely now. The movement into digital currencies is occurring, but it seems as if the leaders in this information technology is coming from governmental sources, like in China for example. Again, I have written quite a lot in this area.
So, we are seeing growth in the area of the medium of exchange, but we must reflect on the fact that much of the private development of cryptocurrencies are producing assets that serve as a store of value. And, their performance is more like a store of value.
Investors must consider these distinctions going forward. It is going to play a major role in understanding the future evolution of the financial system.
Credit inflation was the backbone of the economic performance of the last sixty years. I perceive that it will be very important going forward as the cryptocurrencies play a bigger and bigger role in the world.
This article was written by
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Comments (3)
China's cryptocurrency seems more like a strategic extension tool of the yuan, as they are outlawing bitcoin & other competitors.
which "translates" to The Global economy is less than 1/3 of the total global debt ...
And yes, I think that's bad, especially given the exponential rate at which it is increasing.