Crossing the Rubicon – VI

The Descent of Money

Some time ago I came up with a definition of money. Not that there is anything new or uncommonly brilliant about it. It’s just a reminder of what that, which is considered by many the root of all evil, is. So there goes:

Money is the outcome of a process of entrepreneurial discovery for solutions to the coordination problems of the division of labour: time and space mismatches between production and consumption.

This says about everything there is to know about money except perhaps that that which is used as money sees its value increased by that same usage (and decreased when it is abandoned). Because it can be exchanged by just about everything (yes folks there are things money just can’t buy) it is the good with the less decreasing marginal utility.

Being such a valuable asset it is no wonder rulers of all ages wanted to get a piece of the action and control its trade. Putting their face on either side of a coin was a clear intent of preventing competition over a certain territory and an efficient mean of advertising who was in charge. Profit came by means of seignorage, meaning a certain amount of precious metal was kept as commission for the service of coinnage. If rulers became too greedy or too indebted they could resort to increase seignorage or decrease the amount of precious metal contained in the minted coins. The first was sure to make gold sail to be minted elsewhere while the second only drove away the coins produced before degradation was performed (and after people started to take notice). In the late 16th early 17th century, Father Mariana wrote that it was ok to overthrow a tyrant and was never bothered by anyone about it (well, the French did try to judge him in absence because somebody took to kill their king) but when he said that the act of degrading money was equivalent to stealing money from inside people’s pockets found himself thrown in jail and investigated by the Holy Inquisition.

Modern economic theories act a bit like the Holy Inquisition, for the common good. They tell us how ignorant we are to think like Father Mariana. It is not only ok to degrade money, it is actually good for economic growth because it “stimulates exports” and makes local industries “more competitive”. Some people might even argue that, in serious countries, money is not being degraded at all as the central bank is issuing new money against securities, usually government bonds. But if the idea is to make that currency decrease its value against its international counterparties then it can only be done by issuing increased local currency against an equal amount of foreign reserves or by buying increased quantities of local securities taking in assets of inferior quality (or paying up assets of the same quality).

Now, it seems to me that any devaluation to stimulate exports is made at the expense of domestic wealth as those holding the old currency and those with fixed rents (or wages) are in fact subsidizing those exports. On the other hand it is most likely short-lived as economic agents will try to accommodate the best and fastest they can to the new situation by negotiating increased wages and or interest rates (not that they will get them for sure of course). Devaluation might correct some prices that are being kept artificially high by legislations and regulations (or easy money policies), not by admiting those prices were wrong but by trying to move every other price into a reasonable comparative level. It is like using a bazooka to kill a rabbit, there is no telling what else will be shot in the process and the rabbit itself will be pretty much useless to eat anyway. Furthermore, devaluations are usually followed by more devaluations. Short-lived as perceived benefits usually are, they became like addictive drugs. As people get used to them, increased doses are required to compound the same effect.

But if devaluations can, for a short period of time, stimulate exports, they are completely useless in making a competitive economy more competitive. They can be the inevitable outcome of expansive fiscal policies. But why not? One of the reasons is explained above, a bazooka cannot be used to efficiently catch a rabbit for lunch. Another is that there are inputs into the domestic economy that have to be purchased abroad. These inputs become more expensive as the foreign currency becomes more expensive. Now, people usually think these inputs are just raw materials or equipment but they are not, they are everything that is imported including both capital and consumer goods. If those things are being imported is because the cost of producing them domestically is larger. Now, it is true that man’s inventiveness might find new, better, usages to existing resources because a foreign alternative becomes unavailable but to devalue one’s currency in order to achieve such goal is again like using the bazooka to catch lunch.

Because subsidizing one’s exports is seen by international competitors as cheating, mainly because it is cheating, they in turn will demand from their government the same sort of measures by adequately stating that they would be more competitive if the ratio between the two currencies is maintained. This is why every country sees an advantage in devaluating (although a non-existing one, for the population at large at least) but has to prevent others from doing the same if it is to be a successful bazooka. Reversed Clausewitz teaches us how politics are the continuation of war by other means, so the G7, G7+1, G20 and Gwhatever are very costly meetings where people go and try to agree on how much one or the other can devaluate or free ride with no guarantee whatsoever on what will happen. This is what happened in this last summit, where the Yen was allowed to devaluate only if the Japanese keep quiet about it.

When the old gold standard was in place (not that rulers liked it), if a country tried to devaluate it would suffer the consequences as capital had a fast way of leaving the country – gold shipments. Furthermore, deficits and borrowing were kept in check because sooner rather than later gold would have to leave the country contracting the local economy. Most of the times this kept governments and people from reckless spending and international prices in equilibrium and open to competition (sure there were a lot of duties on imports, the world was not perfect).

Going back to the initial definition of money, modern currencies are not the process of entrepreneurial discovery. They are not the best answer to the coordination problems of the division of labour. In fact, they are the opposite, they are instruments to prevent it and, in the process, make the whole of mankind poorer. When we hear of how the world economies turned to protectionism after and due to the Great Depression we fail to acknowledge this was the natural outcome of people and governments not trusting one another’s currencies, with the international pricing system being severely hampered. The Great Depression as a worldwide event started not in 1929 but in 1931 when each country went their way some sticking to an overvalued gold standard, others devaluing their currencies acknowledging it was unsustainable while putting in place severe restrictions on capital movements. Is this what we are to expect in the future?


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