Wednesday, August 19, 2015

Flexible Standards, V: How it Should Work

Replacing a debt-backed currency with an asset-backed currency and restoring an actual standard to the currency can be devastating, relatively painless, or positively beneficial.  It all depends on how bad the situation is, and how it is done.

Rice currency in Japan, 1946.
The first method (the devastating) is the easiest . . . for those who have wealth and power, “wealth” meaning not money or currency, but assets that produce marketable goods and services.  As long as such assets continue to produce, the value of the currency is, ultimately, meaningless.  If the currency has a stable and uniform value, a producer will accept it for the goods and services he or she produces, and use it to exchange for goods and services that others produce.  If the currency is inflating or is otherwise untrustworthy, a producer will refuse it (unless compelled by force of some kind), and accept something with recognized value.  In Japan right after World War II, the actual currency was rice.  In Germany, it was cigarettes.

Germany, 1923: Money to burn.
For the first method, then, those in power simply demonetize all the old currency and institute a new currency.  Usually this is done by giving a period of time during which the old currency can be exchanged for the new currency, but in disaster situations that is often meaningless.  When Hjalmar Schacht instituted his reforms in 1924 in Germany, the official rate of exchange for the old Reichsmark to the new was a trillion to one, and was pegged to 4.2 to the U.S. dollar.  Since you could purchase anywhere from 16 to 24 trillion old Reichsmarks for $1 in U.S. money on the black market, it sounds as if smart operators could purchase black market old Reichsmarks valued at 4 to 6 times the official rate and exchange them for new Reichsmarks, making a 400-600% profit . . . right?

In theory, yes.  However, picture what 24 trillion Reichsmarks looks like . . . and then tote up the cost of truck rental and labor required to haul massive amounts of paper down to the bank.  A truckload of the old Reichsmarks was worth a little over 33¢ in U.S. money, but probably five or ten dollars as waste paper.  Any takers?

The second method usually just drops zeros off the old currency, and the old coin and currency continues to circulate alongside the new.  If that’s all that’s done, it usually doesn’t take too long before the country has to do the same thing all over again, with no real benefit.  It’s just a way of maintaining the status quo.

An energy currency . . . is ALIVE!
We think that the only way to do it is to carry out a three-step program.  1) Peg the existing currency (assuming it still retains value) to something of value, and make certain it’s convertible into that thing on demand.  Traditionally this has been silver.  More recently gold was the metal of choice.  If you read yesterday’s posting, we recommend energy — specifically, the Kilowatt Hour (Kwhr).  You can’t really convert your currency into energy, but you can convert it into a certificate or voucher to pay for your energy at the conversion rate (we went into all this yesterday).  This gives you a de facto convertible currency.

Sir William Petty, velocity of money pioneer.
2) If at all possible, mandate that ALL (and we do mean all) new money is backed by the present value of existing and future marketable goods and services.  We’ve described how to do this in many previous postings, but to summarize, bills of exchange represent the present value of future marketable goods and services, while mortgages represent the present value of existing marketable goods and services.  New capital can be financed by discounting and rediscounting bills of exchange, thereby turning the future increases in production into current money to finance the capital that will produce the goods and services.  Existing inventories can be cleared by selling securities backed by the mortgages, which are turned into current money through central bank open market operations, and redeemed when the inventories are sold.  It is theoretically possible for the effective quantity of money in an economy to be exactly equal to the present value of all existing and future marketable goods and services in that economy.  (We say “effective quantity” of money, because we have to factor in the “velocity” of money, or the average number of times each unit of currency is spent in a year.  Otherwise the quantity theory of money equation would be “M = P x Q” instead of “M x V = P x Q.”)

3) Create ALL new money (and, again, we do mean all) in ways that create new owners so that every single child, woman, and man can produce all that he or she consumes, either directly or by exchanging with others through money, by means of both capital and labor.

Yes, it really is that simple.  Tomorrow we’ll finish up by looking at some side issues that need to be raised, such as how the value of the currency would reflect reductions in the cost of energy.


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