- Gilder, George.
The Scandal of Money.
Washington: Regnery Publishing, 2016.
ISBN 978-1-62157-575-7.
-
There is something seriously wrong with the global economy and the
financial system upon which it is founded. The nature of the
problem may not be apparent to the average person (and indeed, many
so-called “experts” fail to grasp what is going on), but
the symptoms are obvious. Real (after inflation) income for the
majority of working people has stagnated for decades. The economy
is built upon a pyramid of debt: sovereign (government), corporate,
and personal, which nobody really believes is ever going to be
repaid. The young, who once worked their way through college in
entry-level jobs, now graduate with crushing student debts which
amount to indentured servitude for the most productive years of
their lives. Financial markets, once a place where productive
enterprises could raise capital for their businesses by selling
shares in the company or interest-bearing debt, now seem to have
become a vast global casino, where gambling on the relative
values of paper money issued by various countries dwarfs genuine
economic activity: in 2013, the Bank for International Settlements
estimated these “foreign exchange” transactions to be
around US$ 5.3 trillion per day, more than a third of U.S.
annual Gross Domestic Product every twenty-four hours. Unlike a
legitimate casino where gamblers must make good on their losses,
the big banks engaged in this game have been declared “too
big to fail”, with taxpayers' pockets picked when they
suffer a big loss. If, despite stagnant earnings, rising prices,
and confiscatory taxes, an individual or family manages to set
some money aside, they find that the return from depositing it in
a bank or placing it in a low-risk investment is less than the
real rate of inflation, rendering saving a sucker's bet because
interest rates have been artificially repressed by central banks
to allow them to service the mountain of debt they are carrying.
It is easy to understand why the millions of ordinary people on
the short end of this deal have come to believe “the system is
rigged” and that “the rich are ripping us off”,
and listen attentively to demagogues confirming these observations,
even if the solutions they advocate are nostrums which have failed
every time and place they have been tried.
What, then, is wrong? George Gilder, author of the classic
Wealth and Poverty, the
supply side
Bible of the Reagan years, argues that what all of the dysfunctional
aspects of the economy have in common is money, and
that since 1971 we have been using a flawed definition of money
which has led to all of the pathologies we observe today. We
have come to denominate money in dollars, euros, yen, or other
currencies which mean only what the central banks that issue
them claim they mean, and whose relative value is set by
trading in the foreign exchange markets and can fluctuate on
a second-by-second basis. The author argues that the proper
definition of money is as a unit of time: the time
required for technological innovation and productivity
increases to create real wealth. This wealth (or value) comes from
information or knowledge. In chapter 1, he writes:
In an information economy, growth springs not from power but from
knowledge. Crucial to the growth of knowledge is learning,
conducted across an economy through the falsifiable testing of
entrepreneurial ideas in companies that can fail. The economy is a
test and measurement system, and it requires reliable learning
guided by an accurate meter of monetary value.
Money, then, is the means by which information is transmitted within the
economy. It allows comparing the value of completely disparate things:
for example the services of a neurosurgeon and a ton of pork bellies,
even though it is implausible anybody has ever bartered one for the
other.
When money is stable (its supply is fixed or grows at a constant rate
which is small compared to the existing money supply), it is possible
for participants in the economy to evaluate various goods and
services on offer and, more importantly, make long term plans to
create new goods and services which will improve productivity. When
money is manipulated by governments and their central banks, such
planning becomes, in part, a speculation on the value of currency in
the future. It's like you were operating a textile factory and sold
your products by the metre, and every morning you had to pick up the
Wall Street Journal to see how long a metre was today.
Should you invest in a new weaving machine? Who knows how long the
metre will be by the time it's installed and producing?
I'll illustrate the information theory of value in the following way.
Compare the price of the pile of raw materials used in making a BMW
(iron, copper, glass, aluminium, plastic, leather, etc.) with the
finished automobile. The difference in price is the information
embodied in the finished product—not just the transformation of
the raw materials into the car, but the knowledge gained over the
decades which contributed to that transformation and the features of
the car which make it attractive to the customer. Now take that BMW
and crash it into a bridge abutment on the autobahn at 200 km/h. How
much is it worth now? Probably less than the raw materials (since
it's harder to extract them from a jumbled-up wreck). Every atom
which existed before the wreck is still there. What has been lost is
the information (what electrical engineers call the
“magic
smoke”) which organised them into something people valued.
When the value of money is unpredictable, any investment is in part
speculative, and it is inevitable that the most lucrative speculations
will be those in money itself. This diverts investment from improving
productivity into financial speculation on foreign exchange rates,
interest rates, and financial derivatives based upon them: a completely
unproductive zero-sum sector of the economy which didn't exist prior to
the abandonment of fixed exchange rates in 1971.
What happened in 1971? On August 15th of that year, President
Richard Nixon unilaterally
suspended the
convertibility of the U.S. dollar into gold, setting into
motion a process which would ultimately destroy the
Bretton
Woods system of fixed exchange rates which had been created
as a pillar of the world financial and trade system after World War II.
Under Bretton Woods, the dollar was fixed to gold, with sovereign
holders of dollar reserves (but not individuals) able to
exchange dollars and gold in unlimited quantities at the fixed
rate of US$ 35/troy ounce. Other currencies in the system maintained
fixed exchange rates with the dollar, and were backed by reserves,
which could be held in either dollars or gold.
Fixed exchange rates promoted international trade by eliminating
currency risk in cross-border transactions. For example, a German
manufacturer could import raw materials priced in British pounds,
incorporate them into machine tools assembled by workers paid in
German marks, and export the tools to the United States, being paid in
dollars, all without the risk that a fluctuation by one or more of
these currencies against another would wipe out the profit from the
transaction. The fixed rates imposed discipline on the central banks
issuing currencies and the governments to whom they were responsible.
Running large trade deficits or surpluses, or accumulating too much
public debt was deterred because doing so could force a costly
official change in the exchange rate of the currency against the
dollar. Currencies could, in extreme circumstances, be devalued or
revalued upward, but this was painful to the issuer and rare.
With the collapse of Bretton Woods, no longer was there a
link to gold, either direct or indirect through the dollar.
Instead, the relative values of currencies against one another
were set purely by the market: what traders were willing to
pay to buy one with another. This pushed the currency risk
back onto anybody engaged in international trade, and forced
them to
“hedge”
the currency risk (by foreign
exchange transactions with the big banks) or else bear the
risk themselves. None of this contributed in any way to
productivity, although it generated revenue for the banks
engaged in the game.
At the time, the idea of freely floating currencies, with their
exchange rates set by the marketplace, seemed like a free
market alternative to the top-down government-imposed system
of fixed exchange rates it supplanted, and it was supported by
champions of free enterprise such as Milton Friedman. The author
contends that, based upon almost half a century of experience
with floating currencies and the consequent chaotic changes in exchange
rates, bouts of inflation and deflation, monetary induced
recessions, asset bubbles and crashes, and interest
rates on low-risk investments which ranged from 20% to less
than zero, this was one occasion Prof. Friedman got it
wrong. Like the ever-changing metre in the fable of the
textile factory, incessantly varying money makes long
term planning difficult to impossible and sends the wrong
signals to investors and businesses. In particular, when
interest rates are forced to near zero, productive investment
which creates new assets at a rate greater than the interest
rate on the borrowed funds is neglected in favour of bidding up
the price of existing assets, creating bubbles like those in
real estate and stocks in recent memory. Further, since free
money will not be allocated by the market, those who receive
it are the privileged or connected who are first in line;
this contributes to the justified perception of inequality in
the financial system.
Having judged the system of paper money with floating exchange
rates a failure, Gilder does not advocate a return to either
the classical gold standard of the 19th century or the Bretton
Woods system of fixed exchange rates with a dollar pegged to gold.
Preferring to rely upon the innovation of entrepreneurs and
the selection of the free market, he urges governments to
remove all impediments to the introduction of multiple,
competitive currencies. In particular, the capital gains
tax would be abolished for purchases and sales regardless of the
currency used. (For example, today you can obtain a credit
card denominated in euros and use it freely in the U.S. to
make purchases in dollars. Every time you use the card, the
dollar amount is converted to euros and added to the balance
on your bill. But, strictly speaking, you have sold euros
and bought dollars, so you must report the transaction and
any gain or loss from change in the dollar value of the euros
in your account and the value of the ones you spent. This is
so cumbersome it's a powerful deterrent to using any currency
other than dollars in the U.S. Many people ignore the requirement to
report such transactions, but they're breaking the law by
doing so.)
With multiple currencies and no tax or transaction reporting
requirements, all will be free to compete in the market, where we can
expect the best solutions to prevail. Using whichever currency you
wish will be as seamless as buying something with a debit or credit
card denominated in a currency different than the one of the seller.
Existing card payment systems have a transaction cost which is
so high they are impractical for
“micropayment”
on the Internet or for fully replacing cash in everyday transactions.
Gilder suggests that
Bitcoin or
other
cryptocurrencies
based on
blockchain
technology will probably be the means by which a successful currency
backed 100% with physical gold or another hard asset will be used in
transactions.
This is a thoughtful examination of the problems of the contemporary
financial system from a perspective you'll rarely encounter in the
legacy financial media. The root cause of our money problems is
the money: we have allowed governments to inflict upon us
a monopoly of government-managed money, which, unsurprisingly,
works about as well as anything else provided by a government
monopoly. Our experience with this flawed system over more
than four decades makes its shortcomings apparent, once you cease
accepting the heavy price we pay for them as the normal state
of affairs and inevitable. As with any other monopoly, all that's
needed is to break the monopoly and free the market to choose
which, among a variety of competing forms of money, best meet
the needs of those who use them.
Here is a
Bookmonger
interview with the author discussing the book.
November 2016 