Economic Perspectives 111 – 1 January 2022– Emile Woolf

Why governments practise currency debasement – and how to cure them

[With my gratitude to Patrick Barron for his inspiration and insights

I have written on the subject of currency debasement many times, but it is now reaching crunch-time – even for the pound, dollar, yen and euro.  Most respected economists persist in defining inflation as a rise in the general level of prices, and it is therefore not surprising that this imprecise usage is accepted by members of the public at large – after all, it accords with their everyday experience.

It is rare to encounter any serious attempt to identify the cause of inflation – which is far more important than simply being able to recognise its symptoms. After all, ignorance of the cause of inflation is something of a handicap if you wish to do something to cure it. Even columnists in the business pages of mainstream papers will regularly cite suppliers’ greed, rising wages, energy shortages, Brexit and that convenient fall-guy, capitalism, as if these, or any of them, are the cause of inflation.

These imbibers of economic folklore need to dig deeper if they are interested in causes. In economics, the term “inflation” means “the increase in the quantity of money, currency and the total of deposit liabilities in the banking system, measured over a defined period”.  Today’s ubiquitous price rises are therefore not inflation itself, but are one of its most recognisable consequences. Therefore, by definition, the price rises must follow the inflation. Further, since money is under government control, only government can inflate its supply – and hence must bear full responsibility for its consequent loss of purchasing power. Simply put, inflation is, and always must be, a monetary phenomenon engineered by government.

 

 

What about motive?

 

 

Being in control of the currency enables a government to spend it as it wishes – usually on a project for the “public good” but, more likely, to get re-elected. An ability to create as much money as it pleases is an irresistible temptation for any government and, like the sorcerer’s apprentice, the difficulty is knowing when to stop. But governments have the advantage of enjoying theoretical academic support for this madness in the shape of the most authoritative economist of the age – John Maynard Keynes.

Keynes’ core belief was to stimulate “aggregate demand” as the means of ensuring a flourishing economy – his basic advice to government is to “spend your way out of recession – and if at first you don’t succeed, spend more and spend again!

The consequence of creating unending streams of unbacked money is, as we have seen, is the currency’s debasement – its loss of purchasing power, and the more money that’s created, the greater that loss.

 

The “Cantillon effect”

 

 

The 18th Century French economist, Richard Cantillon, pointed out that the early receivers of newly minted money benefit at the expense of all subsequent receivers. Since the eventual, but inescapable, consequence of inflating the money supply must always be to push up prices, its early receivers, close to the Treasury in banking and related financial circles, are able to escape the worst consequences of debasement by spending recently issued money before it pushes up consumer prices. However, the less fortunate later receivers, including pensioners and others struggling on fixed incomes, are compelled to do their shopping after prices have risen – a process of ineluctable wealth-transfer from poorer to wealthier members of society.

The ways in which governments debauch their currencies are legion, whether by coin-clipping, quantitative easing, or legitimising the practice of “fractional-reserve” banking (allowing banks to retain a mere fraction of deposits they hold as custodians and lending the balance out to third parties at far higher interest rates) – all these processes expand the money supply directly or indirectly, of course.

 

Enter the “legal tender” buttress

 

The state gets away with this blatant dishonesty because of the public’s default attitude: “the government must surely know what it is doing” – a fatal supposition that precedes every economic cataclysm. Yet, just to be on the safe side, governments entrench their sway over the national currency by granting it the grand status of “legal tender”, which may be loosely defined as anything recognized in law as a means of settling a public or private debt or meeting a financial obligation, including tax payments, contractual payments and legal fines or damages”.

Legal tender also has a narrower technical meaning, with little application in everyday life: if you present payment in legal tender to settle an existing debt, you cannot be successfully sued by your creditor for failing to repay it. But the idea of legal tender is easily misunderstood, and it’s worth pausing a moment to clarify it.

 

Take an example: customers in a pub may be told that only card payment can be used when buying drinks – especially now that “contactless” use is accepted up to £100. You may protest, cash in hand, saying “but it’s legal tender!” However, the pub doesn’t have to accept your cash, even though it’s legal tender. Business-owners are always free to choose what form of payment they will accept. If you want to pay for a pack of gum with legal tender in the form of a £50 note, it’s entirely permissible for the shopkeeper to turn you down. In other words, when entering into a transaction the parties are at liberty to agree on its terms – including the form that payment will take.

 

 

A more consequential (and destructive) role for legal tender

 

 

But legal tender takes on a more consequential role for individual traders when the transaction involves a house, or even a car. The purchaser will require proof of payment in legal tender as evidence of the change of ownership, or to register a title with the Council, or to pay any taxes due.

 

The most important point is also the most obvious: no seller of goods would willingly agree to accept payment in a currency, legal tender or not, whose purchasing power is evaporating by the day. And there comes a point when even the most astute government statisticians can no longer mask what’s happening. In any case, who needs statistics when comparing the current cost of your weekly shopping bill with last year’s? Especially if your latest pay-rise was based on the “official” inflation rate of 2 or 3 per cent?

 

 

Legitimising theft – and the solution

 

 

Governments steal our wealth by debasing the currency and enacting legal tender laws that compel us to use it. If there were no legal tender laws, sounder private monies would drive governments’ fiat monies out of the market – although the plight of the Eurozone, in the grip of control-freaks like Draghi, von Leyen and Lagarde, so determined to preserve their doomed currency “whatever it takes”, presents a major obstacle to even the most basic reforms.

 

However the doom that stalks the euro will encourage Germany, with a tradition of monetary rectitude learnt the hard way, to escape the clutches of the ECB’s own wealth-transfer stealth. Respected German banks such as Deutsche Bank and Commerzbank could feasibly issue gold-backed redeemable securities for purchase by their customers at market price, the only constraint on the size of the market being the banks’ gold reserves. If the public preference for sound money is as great as my sources anticipate, funds would flood into these banks, allowing them to buy more gold, should their reserves become depleted by redemptions.

 

 

The miserable alternative – do nothing!

 

 

Indeed, governments themselves would prefer their tax receipts to be in the form of sound money – yet their own legal tender laws oblige them to accept tax payments in the currency whose purchasing power they themselves have systematically debauched. Debasement in Venezuela (annual loss of purchasing power 200,000%); Zimbabwe (prices doubling every day); Argentina (60% inflation; Turkey (60%); Congo (45%); and so on down the ever-lengthening list of countries dominated by morons who remain in power by bribing their citizens with welfare promises that can never be honoured by their bankrupt treasuries.

 

And the icing on the cake is the certainty that international pressure on interest rates will push them up towards the market level – and just think what that will cost a Treasury that’s been living the dream of zero-coupon debt for the past 5 years.

 

 

Who says there’s no justice?!

 

 

I repeat: were it not for legal tender laws, private money freely convertible into specie would drive governments’ fiat monies out of the market. 2022 could be the year!

 

[EMILE WOOLF – ECONOMIC PERSPECTIVES 111 – JANUARY 2022]