Monday, August 24, 2015

Flexible Standards, VII: Appreciating Currency


Last Thursday we looked at what “uniform and stable” means in terms of a currency standard, and what happens when the currency standard isn't what you could call standard.  Today we’re looking at what happens when the price of the standard rises or falls relative to other prices.

Let’s start with the scenario in which the standard becomes more expensive in real terms.  To do that, we have to come up with a standard to measure the standard — yes, this sort of thing gets a little complicated.  One good way of measuring economic value is in terms of bread, “the staff of life,” a commodity so basic that it has become proverbial.

Bread: the Staff (and Stuff) of Life
A quick search reveals that, at least in recent years, the price of a Kilowatt Hour (Kwhr) has been around 10-12 cents on the average.  We’ll say 10¢ to make our calculations easier.  We will also assume that a loaf of bread costs $1.  Our “Kwhr Dollar” is thus pegged to 10 Kwhrs, that is, the dollar is defined as having the same value as ten Kwhrs, which also happens to be the value of a loaf of bread.

Suppose that it becomes more expensive between Monday to Friday to generate a Kilowatt Hour.  That is, a Kilowatt Hour on Friday costs twice as much to produce as on Monday.  Does that mean our dollar on Friday is only worth half what it was on Monday?

In terms of purchasing power, yes.  The price of a Kilowatt Hour will stay at 10¢ — that’s fixed by law.  The dollar will still equal ten Kwhrs — again, fixed by law.  The only change will be that a loaf of bread that cost $1 on Monday will cost $2 on Friday because the “real” cost of energy has increased, and that increase is reflected in all prices measured in terms of energy, inflating the currency.

Henry VIII's inflated currency: why he was "Old Coppernose."
This is “cost-push” inflation, the kind that results from actual changes in supply and demand.  “Demand-pull” inflation results from manipulating the value of the currency artificially.  Both kinds of inflation are “too many dollars chasing too few goods and services,” but “cost-push” is natural, while “demand-pull” is artificial.

So — what happens when the cost of the standard decreases in real terms?  Basically, we see the same thing as when the cost of the standard increases, only in reverse.  As the cost of the standard decreases, you can buy more with the same amount of money, in our example, loaves of bread.  Carrying this out to the reductio ad absurdum (as if the real cost of energy could ever get as low as .1¢ [1 mill, or 1/1,000 of a dollar] in terms of today’s dollar), and assuming a direct correlation and energy as the only input in making bread, we get:

10 Kwhrs in
Historical
Terms
Dollar of
10 Kwhrs
Loaves of
Bread for
Kwhr Dollar
 1.00
 1.00
1
 0.75
 1.00
 1.33
 0.50
 1.00
 2.67
 0.25
 1.00
 10.67
 0.10
 1.00
 106.67
 0.05
 1.00
 2,133.33
 0.01
 1.00
 213,333.33

Obviously, this is completely unrealistic, but it tells us what we want to know: as the cost of the standard decreases, everything becomes cheaper in real terms, and your money becomes worth more.  Will you ever be able to buy 213,334 loaves of bread for a dollar?  Probably not.  Even if energy were free, there would still be costs associated with it (“Yes, ma’am, our energy is free . . . you just have to pay for delivery, infrastructure, and all that other stuff so you can use it”), and other things go into bread, such as wheat, flour, leavening, and so on.

Bread for the World.
The point we’ve proved, however, is if you want to benefit people, increase the value of your currency naturally by making it buy more, not less.  The bonus here is that, using an energy standard, and working on ways to generate and deliver energy more efficiently, makes your currency worth more.

It’s not inconceivable that with advancing technology and alternative sources of energy, there could be a 400% increase in efficiency.  When that happens, a 10 Kwhr dollar could buy at least as much as a dollar did fifty years ago.  Save your money . . . it might be worth something some day.

That is surely a desirable goal.  “But wait,” you say.  “We need inflation to generate the savings to finance new capital formation and fund innovation and all that . . . don’t we?”

No — and we’ll see why tomorrow.

#30#

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