This is a polemic.
Let me use a recent post as a jumping off point. You probably saw the Casey Research post on worthless fiat currencies. I don’t believe “hyperinflation is caused by government budget deficits” as Peter Bernholz does.
Hyperinflation is not just about deficits
Hyperinflation has very specific preconditions that are not apparent in the US (yet). In particular, the US has no foreign currency liability, price pressures are still anchored, and currency revulsion has not set in via tax avoidance or use of other currency media of exchange. I should also add that the US has not lost vast amounts of productive capacity as Zimbabwe and Weimar Germany did before their hyperinflations.
I reckon Japan would be the first place to look for hyperinflation if you thought it could happen anywhere in the advanced world. They have a dysfunctional, government, high debt and deficits and have suffered a tragic loss of productive capacity. Yet, as you can see, the Japanese yen is stronger than ever. In the US, despite political dysfunction and the threat of default, US bond yields are remarkably low. None of this speaks to hyperinflation.
People arguing that hyperinflation is around the corner usually are pushing this view because of an ideological bias against fiat money. This is a bias I share because I believe that fiat money allows excessive money creation that winds up as a credit super bubble – and our experience over the past 40 years demonstrates this…The hyperinflation talk is a gimmick used to push a particular ideological viewpoint. While I share that viewpoint and don’t like fiat money, I am not a fear monger, so you won’t see pushing an ideological agenda which has the economics wrong.
That said, I do share hyperinflationists’ loathing of government coercion. This makes me sceptical of fiat money. I called this post “Government tax coercion versus fiat money liberty” because I think this is the juxtaposition which lies at the heart of every hyperinflationist’s prediction of doom. On the one side, we have government coercion with its monopoly of both legally sanctioned physical violence and taxation. On the other side, this coercion is countered by the complete lack of constraint that fiat money represents. This, to me, is the Achilles’ heel of all fiat money.
I’ll try to make this brief but I know I won’t succeed here because I have a lot to say. So, let me go back into the archives for a few quotes from previous posts that express the bits and pieces here and I will try to pull the threads together at the end. I’ll start with government’s role.
Government’s effectiveness and limitations
When I was discussing ideology and economics this Spring, I said:
“My view is that the most logical way of thinking of government’s role is to differentiate between effective and ineffective policy. I am mostly a pragmatist; so what concerns me is the efficacy of government policy, not its size or scope per se.”
I went on to use a quote from a late 2008 on the role of government which basically said that we should be asking ourselves what are our priorities as a people and how best to use government to meet those. I expanded upon this saying “that is not the delineation normally used to frame government’s role in most all economic ideology. Instead, we are presented with arguments about the size and scope of government.” And I think this is the debate largely being waged over the debt ceiling.
I know most Europeans don’t really understand this debt ceiling debate because European countries have universally accepted bigger government – and for valid reasons. But, in the US, I would say government coercion is less acceptable because it is part of the ethos that has defined America to its citizens as the “home of the free and the brave” since the American Revolution.
The question we should ask ourselves is how we can follow that same Libertarian ethos when revolution is not warranted or desired.
My answer has been predicated on the concept that government has coercive power no other entities in society have. For me, what this means is that government can be a force of benevolence or malevolence, depending upon the mood of the people and who controls the reins of power. When looking at government, it is its effectiveness that counts.
Nevertheless, human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies. That is why the U.S. government was established with natural checks and balances via a bicameral representative legislature, an executive and a judicial branch which all shared powers.
I would go further and say that government must always be held in check – even in times of economic distress. If not, a self-perpetuating bureaucracy develops, with a cadre of individuals dependent on government and wedded to institutions or to the coercive power that government allows individuals to exert through their public function. That’s my idea of limited government.
Let me synthesize these threads by saying this: we want effective government. In the United States, by dint of national history, effective government will usually mean limited government. However, in times of economic plenty or in times of economic stress, this sets up a tension between the ideology of limited government and the exigencies of the times.
What happens is that when times are good, people relax and start to have a ‘deregulated’ mindset which says “times are good. We don’t need government interfering with that. They will make it worse.” This type of ideology reaches an apogee when times are toughest, but then the pendulum swings inexorably in the other direction. “Times are bad. We need government like never before. They will make it better.”
As John Kenneth Galbraith tells it from a control fraud point of view:
At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."
I don’t think this works differently in other countries. it’s just that the US has a more anti-Government bias than most. Hence the debt ceiling debate.
On coercion and corporatism
Let me go back to that quote on limited government again and underline something. I said:
Nevertheless, human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies. That is why the U.S. government was established with natural checks and balances via a bicameral representative legislature, an executive and a judicial branch which all shared powers.
This is the problem – checks and balances, not just within government but of and by government. We see this problem during times of plenty when people are embued with a deregulated mindset.
I happen to be a Libertarian-minded individual, so I have nothing against the free markets or the concept of limited government and deregulation. Freer markets and more limited government are my preferred ideal. However, I am a realist. I understand that markets are never truly free and government fulfils a necessary function.
So, when you hear someone talking about getting government out of the way and allowing the free markets to work, you should be thinking about the influence and control this would naturally engender.
That’s deregulation as crony capitalism. It is not about liberty. It’s not about freedom. It’s about entrenching the interests of a select few at the expense of the rest. The beneficiaries of this cronyism will use all means necessary – especially ideology, as a means of co-opting those against whose interest this looting works – in order to further their kleptocratic interests. That’s what I meant when I derided the voodoo economics causing the debt ceiling standoff yesterday. Of course, corporations play a huge role in this. So I call this phenomenon corporatism masquerading as liberty.
On coercion and fiat money
Some act as if you can pick and choose where government power should be checked. Sure, we can have government dominate monetary policy but it shouldn’t have intrusive social controls. In my view it is consistent to take the sweep of government action across social, economic and military activities and apply the same firm checks on its power.
So go to my quote above about “human nature is such that coercive power can be intoxicating. Left unchecked this power will almost certainly be used only for the benefit of those wielding it and their allies.” That gets you to fiat currency.
Randall Wray asked “Why would anyone accept a ‘fiat’ currency?” and explained that it is because Taxes Drive Money. Taxes are coercive. They are not a voluntary arrangement between two parties like a mortgage. Government tells you that you must pay. If you don’t, you suffer the consequences. This means you need government’s money to expunge your tax liability.
But, why would anyone accept this coercion – especially if “human nature is such that coercive power can be intoxicating?” I call this the confidence trick of fiat currency:
The key to confidence in a fiat currency is the belief of citizens that the government issuing the currency will manage its finances in a way that promotes general “life, liberty and prosperity”. If confidence erodes, tax evasion will rise, citizens will begin surreptitiously using other media of exchange to transact and inflation and currency depreciation will spiral out of control.
The question we are asking right now about the debt ceiling in the US goes to the existence of and need for artificial constraints in maintaining this confidence trick.
Translation: when government is seen as a poor economic steward, inflation and currency depreciation are the result. Currency revulsion steps in – and in very specific circumstances in extremis this can lead to hyperinflation. That’s what those failed fiat currencies were about. Should we impose artificial constraints to prevent this outcome?
Conclusion: The dollar standard must end
Tying this all together, what I am saying then is that there is a kernel of truth in the hyperinflationist’s story. In a fiat world, government has a monopoly of power countered by the ability to create money at will. This is a recipe for excess money creation, trade imbalances, financial crises and all of the ills we have witnessed over the past forty years. The age of fiat currency has been a 40 year experiment in inflation – money and credit creation out of all proportion to the underlying increase in GDP for which they are used.
In the post-1971 period, as emerging economies have grown and developed economies expanded credit, the U.S. has been forced to satisfy global claims for U.S. dollars. This has induced an even larger deficit because there has been no check on balance of payment imbalances without the gold anchor. These imbalances are unsustainable as it puts the U.S. in a situation in which U.S. dollar denominated public and private credit claims cannot be settled with the current dollars outstanding. Either more and more U.S. dollar net financial assets have to be manufactured or the dynamics of debt deflation will kick in.
In plain English: the reason credit has surged dramatically over the last generation has much to do with the monetary system; unless we successfully reflate asset prices, the claims on dollar-based assets cannot be met under this jury-rigged monetary system with the U.S. dollar at the core. I see this as a Ponzi scheme which is now in its final chapter.
There are two exit strategies from this.
- Manufacturing more U.S. denominated financial assets. Implicitly, this is the strategy we are now following. The goal is to limit the currency depreciation through the additions from the real economy value which ostensibly underpins these new net financial assets. Obviously, if you think spending more money is likely to misallocate resources, as I do, you aren’t going to like this approach.
- Maintain existing money stock despite the credit claims. Debt that cannot be repaid, won’t be repaid. It’s as simple as that. The problem here, of course, is that this is deflationary. Yes, it rewards savers by not diluting their assets, but there is the real threat of a deflationary spiral and geopolitical tension as a result.
Both of these solutions have major problems. The first solution is a form of Ponzi finance in my view. It’s kicking the can down the road as it leads to debt deflation eventually anyway – unless you want to go the Weimar or Zimbabwe route. The second is deflationary and puts acute stress on economies with high levels of indebtedness due to debt deflation and resulting social unrest that accompanies it.
Ultimately, I hope this highlights the untenable nature of current currency system, because that is what is at the heart of the problem. From a U.S. perspective, a diminished reserve currency role will actually help alleviate much of the problem.
The origins of the next crisis are the debt revulsion we now see all around us. A huge slug of advanced economies are actively attempting to reduce both public and private debts at the same time. This can’t be done under glide-path scenarios unless that debt is defaulted on or written down, which leads to a debt deflation. Of course, governments could attempt to reduce the real value of the debt by depreciating the currency. And this would work for one country in isolation like Great Britain after World War II. However, unless we get a coordinated devaluation, these attempts lead to currency wars, acrimony, and worse.
To me, this makes a very strong case for ending the dollar standard and imposing constraints. I am not advocating the debt ceiling or the gold standard here. We saw during the Great Depression that the gold standard was ineffective at eliminating the trade imbalances that create friction or the super bubbles that lead to financial crisis.
The most straightforward (and least coercive) approach to dealing with this is to end government’s monopoly on money. Allow other monies to be used in payment of tax and as legal tender. But I do think something like Keynes Bancor idea deserves more attention as well. The point is there are ways to mitigate credit creation and the imbalances they create. We are on the wrong path now and I believe that fiat money and the ability to print money at will is central to why. This age of fiat currencies will end badly if remedies are not taken.