A New Prosperity, or, The Monetary Dilemma
What’s the ideal way for a government to handle the question of money? There’s a lot of discussion in economic circles as to whether a gold standard or fiat currency, or even freebanking, is the ideal way to go to foster the most stable or most productive economy. Unfortunately, each system of currency we’ve tried (and even those we haven’t) has fundamental flaws making them unsuitable for a post-industrial economy.
To start from the beginning, Bartering is inefficient. I don’t know of many people clamoring for a return to the barter system, so I won’t spend much time on it, but the system limits transactions to times and places where one has on his person a suitable exchange. There are good reasons money was developed, and a barter system is totally unsuitable for an industrial economy.
The Gold Standard - or a fixed currency - was tried for a long time - most of human history in fact - and even still has its proponents. People agreed gold was valuable despite its inherent lack of value, and since it was inconvenient to carry gold everywhere, eventually paper currency was developed to stand in its place. The reason the gold standard worked for so long is that for most of human history, there was virtually no economic growth or increase in productivity. Feudalism was in place for thousands of years in many places, and even the rise of the merchant class and overseas trade, though enabling cheaper transport of goods, did not significantly increase productivity. The gold standard was stable because relative to gold, whose supply did not grow, the overall economy’s growth was negligible.
But then came the industrial revolution. Suddenly workers became vastly more productive, and new wealth was created where it did not previously exist - something heretofore thought impossible under Mercantilist thought. Real wealth was growing at a rate unprecedented in human history, and the money system could not cope. Since the amount of gold does not increase, and a dollar on the gold standard is worth a fixed amount of gold, the wealth increase relative to gold can only drive the value of the dollar upwards over time. This sounds like a good thing to ears accustomed to inflation-fighting rhetoric, but what this does is it creates a disequilibrium between the value of currency and the value of assets - deflating the dollar and driving prices down. Expected deflation creates an incentive to sell assets and hoard currency, knowing that it will be more valuable down the road. This disequilibrium was the driving force behind the first business cycles in human history, and eventually of the Great Depression: companies hoarded money even as productivity soared, keeping money out of the hands of wage earners, eventually leading to a classic production glut.
So we eventually end up going off the gold standard. But Fiat Currency has the opposite problem. With no automatic mechanism in place to regulate its value, the government steps in to pull strings - in almost every case leaning towards inflation. The rise in the money supply exceeds the rise in productivity - which gives the illusion of an economy growing faster than it actually is. This again creates a disequilibrium between currency and goods, giving incentives to value goods higher than an equivalent amount of money on the expectation that the price will rise. Though government tinkering has in many cases been able to smooth out the business cycles inherent in a deflationary economy, there are still serious consequences to an inflationary model as well. The incentive to hoard goods over currency is an incentive to go into debt to buy goods, which we see happening not only around the US, but in the government as well: national debt continues to soar, even as our economy continues to lag. The housing crisis that caused the current lag was in fact caused by this disequilibrium: while the 1929 crash happened because currency was overvalued (because of expectations that it would continue to rise in value), the 2008 housing crisis happened because houses were overvalued relative to cash (again because of unfounded expectations that prices could only rise).
There are obviously dangers in both an inflationary and deflationary economy. But what if the value of currency could be driven by competition and the market? On its surface, Freebanking would seem to solve this problem: good currencies succeed, bad ones fail, and the good ones keep each other in check valuewise, so that none of them falls into inflation or deflation. However, this presents its own, more mundane problems: the consumer credit card market is a perfect parallel. Proprietors only want to equip themselves for a few cards (currencies). Basically anyone will take Visa and Mastercard. Fewer take Discover and American Express, and beyond that good luck getting anything with it. Same thing with currencies: once one or two do well enough for a long enough time, they will entrench themselves in the same way that Visa and Mastercard have, making other currencies drop in relative value simply because they aren’t accepted consistently - perhaps later being bought out, or merging to compete. And once we have one or two major currencies, competition is lost along with all the benefits of free-banking, and we’re back to the former problems, depending on the type of the dominant currency.
Though many would say that we’ve done well enough on the gold standard or fiat currency for long enough, both of these are unsustainable. Just as earthquakes can be rated based on how often they occur (i.e., a once-in-200-years quake), so can economic booms and busts. The industrial revolution was recent enough that we don’t know how often they come, but they come, and if Russia is any indication, the Great Depression is not the worst the US will ever wear. The question is not if, but when, as long as we are living with a disequilibrium between currency and goods - if there is inflation or deflation.
The payoff of a stable currency would be enormous: booms and busts would cease. Safe in the knowledge that the value of their goods and currency will not shift around relative to each other, confidence will skyrocket, opening up all kinds of new capital for investment, even enough for a new prosperity of the magnitude of the industrial revolution. The question is, how do we do it? Is there a particular good that is consistently well-indicative of economic growth to which we could peg the currency? Could it be pegged to economic growth estimates or forecasts?
Bounce some ideas off me; I’m open to them and still searching for a reasonable solution.
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