Money Creation and Economic Growth
Jerome Powell, the current head of the U.S. central bank, revealed that he liked this job. “Yes, … I love my job,” he said. “It’s a chance to do work that I think helps people.” (see Reference 1 below).
On the other hand, President Trump once stated bluntly that the Fed and its chairman “had no guts, no sense, no vision.” (see Reference 2 below). There will be presidential elections next year in the U.S. If Chairman Powell does not want to be asked by President Trump to come to the White House for a “chat” once again, he should think twice before making his next moves. Therefore, I am not sure that he still loves his job so much. And I am sure that many ordinary people think that he does not help them at all given a recent rise in interest rates.
So why is there so much pressure on central banks and central bankers?
The thing is that for quite some time we have been living in an age when money creation has been considered a sustainable source of economic growth. If this is the case then we should not feel anxious since central banks have a sufficient stock of paper, Excel spreadsheets or even fancy digital tools to create “money”. Though, my preferable definition of this “money” is transactional and accounting certificates. Why? Because the textbook definition of money is anything that can serve as a
- medium of exchange, something that people can use to buy and sell from one another;
- unit of account, that is, provide a common base for prices;
- STORE OF VALUE, which means people can save it and use it later — smoothing their purchases over time (see Reference 3 below).
Can the existing form of fiat money be considered a store of value that facilitates a transfer of purchasing power over time?
Money Illusion and Reality Distortion
In 1971, the U.S. finally abandoned the gold standard. Since then the U.S. dollar ($) has lost more than 85% of its purchasing power.
In 1933, the U.S. government confiscated privately held gold holdings. In 1934, it revalued the price of gold by 75%. Since that time the U.S. dollar has lost more than 90% of its purchasing power.
In 1913, the U.S. established the Federal Reserve, its central bank, in an effort to address banking panics. Since then the U.S. dollar has lost more than 96% of its purchasing power.
John P. Morgan had a net worth of $80 million when he died in 1913, or about $2.3 billion in today’s money, according to his biographer Ron Chernow. Though some speculate that his fortune at the peak of his career might have been worth as much as $60 billion in 2022 dollars (see Reference 4 below). What is certainly known is that at the peak of his powers, in the early 1900s, Morgan dominated corporations with more than $22 billion in assets, including the first billion dollar corporation in history, U.S. Steel (see Reference 5 below).
When John D. Rockefeller read this in the papers he supposedly said, “And to think, he wasn’t even a rich man.” His personal worth at that time was nearly a billion, that’s $190 billion in today’s money (see Reference 5 below). When John D. Rockefeller died in 1937 his net worth was $1.4 billion.
Elon Musk had a net worth of $219 billion in 2022 (he is still alive, don’t worry!)
So is Musk richer than Rockefeller? No, he is not. Rockefeller’s net worth at the time of his death is estimated to be at least $340 billion in today’s money (see Reference 6 below). We may argue about the exact numbers, but most academics agree that he was the richest entrepreneur who has ever lived (see Reference 7 below).
In the early 1900s, 80% of American families earned less than $500 a year (see Reference 5 below). In these good old days the American dream was to become a millionaire. These days a millionaire will soon become just a representative of the upper middle class.
Central Banks as the Saviors of the World
As we mentioned earlier, the U.S. and the rest of the developed world completely abandoned the gold standard in 1971. This monetary policy regime implied that the exchange rates of various paper currencies were pegged to the price gold. The reason behind this move was as simple as possible: so much paper money had already been printed by that time that it was clearly no longer possible to maintain this peg.
Thus, in the past 50 years we have been living in a new, experimental world of fiat or “paper” money where the money supply is regulated to smooth out the fluctuations in the economic cycles.
In theory, the fiat monetary system is a workable solution if there is a proper framework in place to exert a real, effective and independent control over the supply of money.
In fact, over the last 50 years fiat money has been used to prop up every economic downturn. The result is that ordinary people, businesses, and governments alike behave like preschoolers who expect their “parents” — central banks — to help them in all situations.
What do we have in the end? We have a declining pace of technological progress since the 1970s. We have wealth and income disparity last seen during the roaring 1920s. It is true that there have been smoother economic downturns at the expense of rising debt and almost no consumer inflation over the last 30 years thanks to incorporating China into global supply chains.
Now, however, when a partial decoupling from China is already underway, all the previously hidden problems — vulnerable supply chains, resource scarcity, no meaningful technological progress, high inflation, income disparity, rapidly depreciating fiat money, gigantic debts, financial bubbles, cryptos, fintech, political instability, etc. — have re-appeared as expected (see Picture 1,2,3,4,5,6,7,8,9 below).
Did Central Banks Have Any Master Plan: Welcome to Japan?
Right now we are still dealing with the consequences of the Global financial crisis. At the same time, this crisis was the result of a massive financialization of the world economy launched in the 1980s (see Picture 10 below). Why was it launched at that time? Financialization was launched to support debt-based consumption amid declining technological progress and labor productivity in the aftermath of a severe stagflationary period — economic stagnation and high inflation — in the 1970s. So now we have come full circle in economic terms by returning back to the stagflationary 1970s.
Did major central banks have any “master” plan to prevent stagflation when they started implementing zero interest rate policies in the aftermath of the Global financial crisis? In the short run it was obvious that they wanted to avoid a deflationary experience of the Great Depression. But what about the long run? Probably, they looked at Japan and its zero interest policy introduced in the 1990s and thought that nothing bad had happened.
First, I would say that NOTHING has been happening in Japan since the introduction of this policy. Nothing implies both “nothing bad” and “nothing good”. There has been neither inflation, nor growth. Japan is just stuck in its post-World-War-II world.
Second, you should admire the Japanese stoicism in enduring this sense of no development. Japan is certainly a wealthy country, but you still need hope for a better future. Is there any hope left in Japan?
Third, out of necessity, Japanese people are among the world’s most desperate and adventurous retail investors. They bought Uridashi bonds issued in high-yielding Australian and New Zealand dollars. They were happy to place their funds into deposit accounts denominated in even higher-yielding South African rand, Mexican peso and Turkish lira. They invested in North and South American shares and structured products. Do you know why the yen always rises when there is a crisis somewhere in the world? Because our Japanese friends try to sell their foreign assets and run to the safety of their home currency.
I do not know whether the creator of bitcoin Satoshi Nakamoto is a real person or a group of persons. But his Japanese name perfectly fits the collective image of a Japanese retail investor who has tried it all.
Fourth, Japan was able to “export” some of its problems to the rest of the world. It was just an isolated case of zero interest rates at that time.
Was the rest of the developed world prepared to live in this samurai-like stoic conditions of no development, no growth and no hope for 10, 15, or 20 years?
Or rather the major central banks’ “comprehensive and far-sighted” battle plan was borrowed from Napoleon: “Engage and we will see”… In fact, they were hoping for a major technological miracle. But miracles do not tend to happen in accordance with some strict time schedule.
So what is the morale of this story: you can win almost all individual battles but still lose the war.
Give Me Control of a Nation’s Money Supply, and I Care Not Who Makes Its Laws
So should we expect the major governments and central banks publicly admit that the existing fiat monetary system has failed? I doubt it.
The founder of the Rothschild banking dynasty once said: “Give me control of a nation’s money supply, and I care not who makes its laws.” (see Reference 8 below). He was absolutely right.
If you surrender control over monetary policy, you have only fiscal and structural policy tools left available. However, these tools might be politically tricky and unpopular to use in the short run, while their many useful effects can be achieved in the long run only. When you control monetary policy, you may start printing money whenever it suits you. But there are long-term risks associated with this approach.
First, economic agents may start thinking that they have a solution for all problems. It discourages them from thinking and working harder.
Second, monetary policy makers are not independent. They are under constant pressure to smooth out economic fluctuations. This is the fertile ground for creating various financial bubbles, accumulating huge debt piles, and spurring hyperinflation.
Finally, there are price shocks that are not associated with monetary policy: wars and military conflicts, geopolitical crises and revolutions, epidemics and pandemics, natural and technogenic disasters, supply chain and labor market disruptions.
In the early 1980s, the U.S. central bank was able to raise its base interest rate to 20% to fight a 15% inflation that was raging at that time due to oil and geopolitical crises of the 1970s. But then the U.S. private debt was around 100% of the country’s nominal GDP, while the U.S. government debt was less than 40% of the nominal GDP. Now the U.S. private debt is equal to around 150% of nominal GDP, while the U.S. government debt exceeds 100% of the country’s GDP (see Picture 7 and 8 below).
Usually, this toxic combination of high inflation and high debt is the final straw when the fiat monetary system cannot solve the inflation problem by raising interest rates sharply.
However, any old monetary system usually does not die quietly. You need a political crisis, a revolution, or a war to launch a new monetary regime.
Back to the Gold Standard?
There was almost nothing behind gold or silver, except for the fact that they were universally accepted, they were durable, and they maintained their purchasing power very well. You could use precious metals for making fancy jewelry too. But, most importantly, you could not “print” them.
When you could “print” them, the final outcome was quite predictable. When the Spanish conquistadors brought a lot of gold and particularly silver from Central and South America back to Spain, it was one of the reasons for the Spanish Price Revolution across Western Europe and unrelenting inflation in the 16th and 17th century. Prices rose on average roughly six-fold over 150 years (see Reference 9 and Picture 11 below).
How did this Price Revolution eventually end? Rather soon Europe was already experiencing a severe silver deficit. The reason was a large trade deficit with Asia. Yes, “advanced” Europe was struggling to sell its goods to China, India, and other “backward” countries, while importing highly coveted tea, porcelain, silk, cotton, spices, etc. and, accordingly, depleting its silver reserves. The situation started to change after the Opium Wars with China and the colonization of most of Asia in the 19th century. Selling opium and other “useful” stuff was the effective way of balancing the foreign trade books.
What happens if you are not able to balance your foreign trade books militarily anymore? We can recall what happened to the political, military, and administrative heart of the Roman Empire — the city of Rome and Italy:
“For two centuries Italy enjoyed an “unfavorable” balance of trade — cheerfully bought more than she sold… This immense trade produced prosperity for two centuries, but its unsound basis ruined Roman economy in the end… Rome tried to stave off the breakdown of her import system by conquering new mineral regions… and by debasing her once incorruptible currency — turning ever less [ gold ] bullion into ever more coin. When the costs of administration and war mounted nearer to the profits of empire, Rome had to pay for goods with goods, and could not. Italy’s dependence upon imported food was her vital weakness; the moment she could not force other countries to send her food and soldiers she was doomed…” (see Reference 10 below).
How fast did it take for the Roman money to lose its value? At that time, the Roman monetary system was bimetallic: due to its lower value, silver was primarily used for transactional purposes, while gold was predominantly used for storing value.
The silver content of the denarius, a Roman silver coin, was lowered to 93.5% of its former quantity under Nero (AD 54) and then gradually to around 50% under Septimius Severus and Caracalla (between AD 198 and AD 211). It then dropped to 42% by AD 250. Thus, in around 200 years the price of silver rose by some 140% or 2.4 times in terms of denarii (see Reference 11 below).
The gold content of the aureus, a Roman gold coin, gradually fell from 8.18 grams under Julius Caesar (50 BC) to 4.55 grams under Constantius Chlorus (AD 305). This means that in around 350 years the price of gold rose by 80% in terms of aurei (see Reference 12 below).
Since 1971, the price of gold has risen almost 50 times in terms of US dollars, while the price of silver has risen more than 18 times. The Swiss franc is justifiably regarded as “paper gold” due its relative stability (see Reference 13 below). Still, its exchange rate has appreciated “only” 4.8 times in terms of US dollars since 1971. Probably, now it is much easier to understand the old maxim that “Money is power, gold is money.”
In the long run gold maintains its purchasing power very well. However, the gold standard had its obvious problems due to its rigidity (see Reference 14 below). Life was harsh and dynamic under the gold standard: during the 19th century and early in the 20th century the United Kingdom and the United States — the centers of the global financial system — experienced financial crises and panics every 8 to 10 years. But the gold standard system also had one advantage: in the long run prices remained stable. Central banks simply did not have the ability to “adjust” the money supply, so periods of high inflation alternated with periods of deep deflation (see Picture 12 below).
A Decentralized Monetary System
What we need is a decentralized hybrid of the gold standard and the fiat monetary system where the supply of money is regulated AUTOMATICALLY without relying on any “independent” and “smart” decision makers. If an individual or a group of individuals is able to print gold, silver, paper money, electronic money, or digital money, sooner or later, he, she or they will exploit this possibility.
This could be achieved by automatically changing the current level of main monetary policy instruments (money supply and interest rates) after the publication of inflation data. This monetary regime can be called an “inflation board” similar to the “currency boards” used to maintain exchange rates of unstable currencies.
One should not expect, however, that the existing monetary system can be reformed without political upheaval.
One of the possible options may be the emergence of competing blocs of countries, where one of the blocs will decide to create a “sound” monetary system as its competitive advantage. It is true that politicians may announce the launch of a new asset-backed currency. But the launch of an automatically regulated monetary system is very unlikely.
Therefore, the creation of a new monetary system is likely to follow the path of cryptocurrencies. In other words, it is likely to be developed in a decentralized way. Some ten years ago it might have seemed something improbable, implausible, and simply impossible. But the emergence of bitcoin, ethereum, and other cryptocurrencies has proved that the unrelenting depreciation of official “money” makes this path not only practically feasible, but also inevitable.
Undoubtedly, the governments of many countries will try to implement prohibitive and punitive policies aimed at any competing monetary system beyond their control. But these policies will eventually fail because most existing official monetary systems are fundamentally flawed. I am sure that the governments of many countries would be happy to ban the circulation of gold, but they know very well that this measure will only contribute to the emergence of a flourishing black market.
We now know that the definition of money is a medium of exchange, unit of account, store of value.
The history of gold has demonstrated that the characteristics of a “safe haven” asset are 1) universal acceptability of value, 2) anonymity and perpetuity, 3) limited or controlled supply, 4) stability and independence of demand, 5) durability.
This is what most cryptocurrencies have been trying to achieve but at a more advanced level in terms of technology. This implies that there is no need for physical storage of “safe haven” assets, while their transfers and payments are on course to becoming almost instant and increasingly secure.
In general, most popular cryptocurrencies have technology to become a medium of exchange. They also have a good chance of becoming a store of value due to their anonymity, limited supply, technological durability (no physical storage is needed), and slowly rising acceptability.
In Roman terms they are well equipped to become digital “gold” to store value, but they are not yet ready to become digital “silver” to be used for transactional purposes. What they are lacking right now is the stability of their prices.
The simplest and most feasible way to achieve this is to create a cryptocurrency whose exchange rate versus “paper” money will fluctuate depending on the level of inflation. Initially, the exchange rate of this “anti-inflationary” cryptocurrency versus the currently dominant “paper” money — the U.S. dollar — would be 1:1. All other individual currencies could be exchanged using their respective market exchange rates versus the U.S. dollar.
The International Monetary Fund and the World Bank regularly publish data on percent changes in weighted average global consumer prices. Following the publication of the global inflation data, the exchange rate should automatically adjust to reflect this change. For example, if the rate of global inflation is 1% over a certain period, then the new exchange rate will be 1 unit of the “anti-inflationary” cryptocurrency per 1.01 U.S. dollar or any other equivalent rate for each individual currency. In a deflationary scenario, if the global price level decreases by 1% over a certain period, the exchange rate of 1 unit of the “anti-inflationary” cryptocurrency will depreciate to 0.99 US dollars or any other equivalent rate for each individual currency.
The British prime minister Benjamin Disraeli once said that “there are three kinds of lies: lies, damned lies, and statistics.” That is why there is certainly room for decentralization on the statistics front too. A decentralized algorithm-based constantly updated flow of consumer price changes around the world would allow calculating the global weighted average rate of inflation. This, in turn, would allow the exchange rate to become floating in a continuous rather than in a discrete manner.
The underlying logic behind this approach is very simple, namely, the preservation of the purchasing power in terms of the “anti-inflationary cryptocurrency”. This approach also implies that the exchange rate of this cryptocurrency should be considerably less volatile compared to other crypto world alternatives, whose main purpose is achieving high investment returns. Preserving the purchasing power of money should not require taking on risky investments. Risky investments should be taken if you want to significantly improve your financial situation.
Low price volatility and stable purchasing power are the right prerequisites for any cryptocurrency to eventually become a medium of exchange and a unit of account.
One may argue that it is necessary to maintain some small level of inflation in order to stimulate consumption. This argument implies that consumption is the engine of economic development. This is fundamentally false. Economic progress is facilitated only by our human striving to create truly innovative, interesting, and useful things. The massive financialization of our economies over the last 40 to 50 years as well as debt-based consumption associated with it have proved it very well. Higher sustainable consumption is just a by-product of significant scientific advances and successful technological innovations.
The prevention of bank panics was one of the major reasons why the “gold standard” was abolished. Thus, one may also argue that monetary policy instruments are also needed in order to maintain the stability of the financial system. However, the events of recent decades have demonstrated that one-sided monetary policy can ultimately lead to financial bubbles too. If you want to prevent bank panics and financial instability or if you deal with the aftermath of a financial or banking crisis, you can use various macro- and micro-prudential policy and financial regulation instruments.
There are many other tools available to authorities in a crisis situation. You may recall that “liberal” Britain temporarily nationalized its largest banks during the Global financial crisis in 2008. You may also recall that “economically conservative” Switzerland essentially forced UBS to acquire the agonizing Credit Suisse, when a 50 billion Swiss franc ($54 billion) credit line with the country’s central bank had failed to stabilize its situation in March 2023. You may also recall that in March 2023 in the “strictly capitalist” United States J.P. Morgan, Wells Fargo, Citigroup, Bank of America and seven other banks deposited $5 billion apiece in uninsured deposits into First Republic Bank, a troubled U.S. regional bank, to shore up confidence in the industry. They even considered converting these deposits into equity. Extraordinary times call for extraordinary measures as they say.
The history of the last 50 years proves that money should not be viewed as the engine of growth. The role of any monetary system, first and foremost, is to facilitate the long-term stability of prices. Easy and unstable money destroys motivation, distorts reality, and fuels bubbles. Only rising growth rates of technological advancements and labor productivity are the sources of sustainable economic development.
The leader of the Russian Bolshevik Revolution Vladimir Lenin once said that “…the way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”
The father of mainstream macroeconomics John Maynard Keynes agreed: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”
The most influential classical liberal economist of the 20th century Friedrich August von Hayek thought along the same lines: “I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.”
If the people with so contrasting socio-economic and political views are so close in their opinions, then there is probably something in it after all.
Money is power. Power to the people!
References:
- “Powell’s Valentine to the Fed: ‘I Love My Job’”, Ann Saphir, Howard Schneider, Reuters, 10 February 2021.
- “Trump on Fed: ‘No “Guts,” No Sense, No Vision!’”, Reuters, 18 September 2019.
- “What Is Money”, Irena Asmundson and Ceyda Oner, Finance & Development, International Monetary Fund, September 2012, Vol. 49, №3.
- “Who Was J.P. Morgan?”, Andrew Beattie, reviewed by Jefreda R. Brown, Investopedia, updated 1 May 2022.
- “John Pierpont Morgan and the American Corporation. A Biography of America”, Donald L. Miller, retrieved from Learner.org.
- “10 Richest People Who Ever Lived — Net Worths, Ranked: Elon Musk and Jeff Bezos Don’t Come Close to Genghis Khan, Oil Tycoon John D. Rockefeller or ‘Trillionaires’ Catherine the Great and Joseph Stalin”, Faye Bradley, South China Morning Post, 29 October 2022.
- “John D. Rockefeller: The Richest Man in the World”, Tom Nicholas, Vasiliki Fouka, Harvard Business School, December 2014, revised March 2018.
- “Monetarists Anonymous”, The Economist, 29 September 2012.
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- “A Multi-Analytical Approach on Silver-Copper Coins of the Roman Empire to Elucidate the Economy of the 3rd Century A.D.”, Giovanna Marussi, Matteo Crosera, Enrico Prenesti, Davide Cristofori, Bruno Callegher, Gianpiero Adami, edited by Maria Perla Colombini, Molecules, published online 14 October 2022.
- https://en.wikipedia.org/wiki/Aureus#cite_note-Scheidel-2
- “How to Become Rich The Swiss Way. Applying Macroeconomics and Geopolitics to Your Life and Financial Strategy”, Olegs Jemeljanovs, DataDrivenInvestor, Medium, 21 July 2022.
- “The Gold Standard, the Golden Jubilee, and the Role of Gold in an Investment Portfolio”, Olegs Jemeljanovs. DataDrivenInvestor, Medium, 20 August 2022.
