Friday, 16 January 2009

Purchasing Power is Wealth - Not Money

Today, more than ever people are obsessed with money. It has become a key driver of the employment people choose, how we view individuals and one of the measures that helps form class structures. Yet money today, is one of the causes that has disrupted and distorted our financial systems and ultimately, that affects our prosperity. Sound money it seems, always evaded society, instead a continual debasement of currencies is the preferred approach. Yet it doesn't have to be like this. We could implement sound money, thus abolishing the periodic economic disasters we have become indoctrinated to accept. Unsound monetary expansion that occurs when banks expand credit in concert with the support of a Central bank and government, always leads to a loss in purchasing power of the money we have saved, the preferred commodity we use to store our labour. Our paper notes that we assume always have the ability to store wealth, don't. It is constantly debased, inflated, to pay for government programs, the invisible taxation. I think an historic, hypothetical example is required in order to explain this simple process.

The King who acquires money, without taxation

Let me explain the title above. It's no magic act, just monetary trickery. Lets say our King lives in the Kingdom of Hyper, and decides he needs money for his own consumption, in order to buy a new castle and land and chooses debasement to pay for his pet project. He announces to his people to call in of all of the gold coins in the kingdom to be re-minted with the kings face on the new coins. Currently each coin within the kingdom contains 10 grams of gold, and these are used to pay for goods, the unit is called the Crown. During this process however the King decides to readjust the amount of gold in the Crown, and only puts 5 grams of Gold in each Crown, using the excess Gold to create new coins for himself to use. The people don't really notice the weight as it is the unit, the crown, that they use to purchase goods not the gold content. However the money supply, to pay for the Kings extravagant life style, has increased 100 percent. With more Crowns in circulation and the same goods and services, the effect is that prices rise as the the money supply has increased, thus distorting the previous price equilibrium. The King benefits the most as he is the first to use the new crowns thus has the purchasing power he requires to pay for his consumption, but as the money moves through the Kingdom it effects the prices of goods and leads to inflation.

Other common historic forms of debasement was the alloying of Gold and Silver coins with more common forms of metal, thus giving the illusion of the coins having the same weight but they would now contain less Gold or Silver. The effect was the same. More Coins were minted and it lead to the inflation of prices.

So how does the above example link into the modern financial system we live in today? Well in modern times all a government had to do was print more paper money, they didn't even need to re mint coins. Today it has become even easier, in fact far to easy with the use of computers. They can just digitalise the extra monetary units without the need for deforestation and paper printing. This is what is happening now as this post is been written. Governments are now deploying "Quantitative Easing" in order to "Stimulate" the economy. In other words taxing all of us, ensuring our currencies have less purchasing power. Rather than all of us enjoying the fruits of prices falling in a free market system, we instead have to continually witness the decline of our wealth we have built up, for those of us who are prudent enough to save - which is a crucial function in any developed economy. Savings pay for increased productive efficiency.

We can see Debasement directly in our own currencies

Ever wondered why a unit of pound Sterling is called a pound? Well a pound used to be worth a pound of silver, or 16 ounces of silver. Now a pound is worth around, well, not even 1 ounce of silver. Rather it now takes around £8 to buy an ounce of silver. I'll leave the reader to do the arithmetic, as this shows the complete loss of purchasing power Sterling has had and most of it within the past century. Sovereigns, a common bullion coin that are still traded today used to represent a pound and contain 1/4 ounce of gold. That same coin today is now worth around £137. These were still used in the later years of the 19th Century, which shows how much inflating our governments have done. Ever look at your coins and wonder what they are made of? Very cheap metal, however the debasement has got so serious that even these more common metals used in the 1p and 2p coins are now being melted down as the metal is worth more than the coins. The new editions however are just copper plated steel - it makes you wonder whats next. We might as well start using monopoly money.

When we had currencies backed by gold or silver, our notes used to read redeemable in gold or silver, whichever metal was the preferred backing chosen. Now they just have empty promise statements, meaningless in terms of future purchasing power and value. One of the reasons that the US had to abandon Bretton Woods in 1971 and consequently loose ties the Dollar had with gold, was due to the printing during the sixties, that paid for Vietnam, President Johnson's Social spending programs and NASA's space adventures along with various other deficit spending policies. When the French and British got wise, they started trading some of their Dollars for physical gold. With a run on Fort Knox Nixon had to act, thus removed the Dollar from Gold convertibility. It was quite simple - the currency was being debased, just like the King of Hyper above.

So why are goods still so cheap?

Simple - The Free Market. Through technological advance, the reinvestment of capital to increase productive capacity and the relocation of production to low cost destinations (recently China), this has all created the mirage for a seemingly stable purchasing power. However we should have all basked in the falling prices of the free market more than we have. Perpetual inflation means we have to work until we are 70 and not 50. It means we have to speculate on investments, in order that inflation does not destroy the value of our money we save for the future. Investments that are based on rising capital gains caused by inflation, rather than dividend payments from solid business models. These investments where main street looses, while Wall Street gains. Just like a casino, the players (public), don't stand a chance. DVD players for £20 - more like 10 pence if our currency had retained value. We have China to thank for the gain in purchasing power we have received as they began industrialising, along with artificially pegging the Yuan lower, in order to achieve spectacular export growth. Their huge productive capacity has flooded our markets with goods - we haven't increased our production - they have provided the illusion. I don't care if I have £1,000 or £1,000,000 - I care about how much that money may be worth in the future. Money that has in all likelihood been gained by the use of my labour.

We mistake wealth for money when real wealth is the labour and goods that we produce - its stuff. Money is mearly the preferred mechanism we use to exchange these goods and services between one another, a contractual agreement. In order for these contracts to be valid, it is vital that money is a stable store of value. This, however, as history has shown, and economic theory can prove, is not the case.

"To put it another way: a continuing, sustained inflation — that is, a persistent rise in overall prices — can either be the result of a persistent, continuing fall in the supply of most or all goods and services, or of a continuing rise in the supply of money. Since we know that in today's world the supply of most goods and services rises rather than falls each year, and since we know, also, that the money supply keeps rising substantially every year, then it should be crystal clear that increases in the supply of money, not any sort of problems from the supply side, are the fundamental cause of our chronic and accelerating problem of inflation. Despite the currently fashionable supply-side economists, inflation is a demand-side (more specifically monetary or money supply) rather than a supply-side problem. Prices are continually being pulled up by increases in the quantity of money and hence of the monetary demand for products."
Murray Rothbard, The Mystery of Banking