You, the people, agree to put up with a “moderately good” money in return for us, the regime, providing benefits in terms of employment and economic prosperity which…
[This article is adapted from A Guide to Good Money: Beyond the Illusions of Asset Inflation by Brendan Brown and Robert Pringle (2022, Palgrave Macmillan).]
Bad money regimes base themselves on a dysfunctional social contract.
You, the people, agree to put up with a “moderately good” money in return for us (the regime) providing benefits in terms of employment and economic prosperity which would be unavailable if you (the people) had insisted on a high-quality money. Causality in the contract is upside down. The strong and stable demand which money of excellent quality from the viewpoint of the individual enjoys is essential to the monetary system not getting “out of control”, inflicting severe economic and social damage.
By contrast a monetary system founded on “moderately good money” exposes all the other “machinery in the economy” to considerable storm danger. (The allusion here is to the quote from J.S. Mill made famous by Milton Friedman that “when money gets out of control it becomes the monkey-wrench in all the other economic machinery.”) In practice users of this “moderately good money” under the actual monetary regime during the past quarter century have found that it is at best “moderately bad.”
They must reckon with worse than just the perpetual “small” annual loss of purchasing power as stated in the “two per cent inflation standard” prospectuses as periodically updated by the Federal Reserve and other central banks. There are long stretches of monetary repression where these institutions manipulate interest rates down to abnormally low levels. In between are high inflation shocks; the loss of money’s purchasing power which occurs during these are not reversed subsequently.
The promised advantages for society of the actual monetary regime have not materialized.
At the level of society there has been virulent monetary inflation featuring sometimes severe symptoms of asset inflation, sometimes of goods and services inflation. Monetary inflation has spawned the disease of economic sclerosis. This is recognizably by painfully slow if any gains in general economic well-being as rampant mal-investment and advancing monopoly power sap the dynamism of free market capitalism. Now the spoken or unspoken fear of many is that another global financial crisis looms with its potentially devastating economic and social consequences.
Good Money vs. Bad Money
Let’s consider the counterfactual. How much better off would society have been with top-quality money from the viewpoint of the individual—most of all as a medium of exchange and as a store of value? High quality as a store of value means well-founded confidence that the money will sustain its purchasing power over the very long run. Confidence stems from the money having a solid anchoring system which prevents its supply veering persistently ahead of (or below) demand.
Holders of the good money, however, should expect periods of considerable and uneven length during which prices on average of goods and services rise or fall in accordance with a natural rhythm driven by such factors as famine or gluts, business recession and recovery, and spurts or lulls in productivity growth. Over the long-haul, these episodes of rising or falling prices would tend to even out. From the viewpoint of the individual, a money which fluctuates in purchasing power according to the natural rhythm described is better than one where the issuer is set on stabilizing its real value in defiance of that rhythm—an aim which is any case doomed.
Defiance of natural rhythm fosters asset inflation and subsequent bust. Defiance also paralyses the invisible hands of market forces guiding the distribution of spending over time.
For example, low prices in recession coupled with expectations of price recovery further ahead stimulate individuals and businesses to bring forward spending, lessening present economic weakness. High prices during a period of severe resource shortage coupled with expectations of lower prices beyond encourage individuals to defer spending, thereby relieving the present famine. The anchoring system which is essential to money delivering these high-quality services as a store of value should apply to base money.
Under fiat regimes the central bank creates base money and absolutely determines its supply. In the case of gold, monetary base for all countries on the gold standard consists of above ground stocks of gold in the form of bullion and coins. In some fiat systems historically, the central bank has followed a rule which constrains the supply of base money; for gold the constraint derives from geology and mining economics.
Success of the anchoring system in preventing monetary imbalance depends crucially on a stable demand for monetary base. Otherwise, the task of designing an anchor such as to restrain money supply so as not to veer persistently ahead of (or below) demand becomes a lot harder or impossible.
How to Design Good Money
How to design a monetary system in which demand for base money is broad and stable? That is the question which the monetarist experimenters of the 1960s, 1970s, and 1980s failed to ask, let alone answer. Those monetarists cited empirical research which seemed to support the hypothesis of stable money demand. They had no interest, however, in monetary system design to foster conditions for the good money they sought. The revealed instability in the various calculated velocities of money during their spell in power, contradicting the earlier empirical work, undermined the monetarist regimes. Lesson learnt. Good money requires good monetary system design.
The assets which make up monetary base should have “super-money” qualities, otherwise described as an extreme degree of “moneyness.” An indication of this quality is the historical fact that all the components of base money paid no interest (until 2008 in the US). Their monetary services (whether as store of value or medium of exchange) were so much appreciated that even so they enjoyed strong demand. In passing we should note that a reputation of a money as a safe store of value adds to the super-money attributes of its monetary base components. We can see here the makings of a virtuous circle. Under the actual monetary regime, we witness a vicious circle. Super money qualities of the monetary base have waned or even faded away. A solid anchor could not be applied to it.
How to re-build these super-money qualities?
Crucially, too big to fail contingency funding (now implicitly available for Big Banks) and deposit insurance have to be reined back or abolished. This would mean banks in marketing “safe” deposits must demonstrate to clients that they have a high ratio of cash backing. There should be no regulatory and monopolistic disincentives to the use of banknotes whether as a medium of exchange or store of value. Banks and non-banks would be able to offer safe stable coins backed by large amounts of cash.
Interest rates must be wholly market determined—short-term money rates by conditions in the overnight market for reserves (which would pay no interest), long-term rates by a decentralized mass of individual decision-makers with access to highly specific information. This latter includes investment opportunities and the individual’s preference for present versus future consumption. Financial engineering and surmising the course of Fed policymaking would no longer be “the name of the game” for investors. The random walker down Wall Street would enjoy the sunshine of well-founded growth in prosperity rather than the stress of navigating violent monetary tides.
Brendan Brown is a founding partner of Macro Hedge Advisors (www.macrohedgeadvisors.com) and senior fellow at Hudson Institute. As an international monetary and financial economist, consultant, and author, his roles have included Head of Economic Research at Mitsubishi UFJ Financial Group. He is also a Senior Fellow of the Mises Institute. He is the author of Europe’s Century of Crises under Dollar Hegemony: A Dialogue on the Global Tyranny of Unsound Money with Philippe Simonnot. His other books include The Case Against 2 Per Cent Inflation (Palgrave, 2018) and he is publisher of “Monetary Scenarios,” Euro Crash: How Asset Price Inflation Destroys the Wealth of Nations and The Global Curse of the Federal Reserve: Manifesto for a Second Monetarist Revolution.