The effect of inflation on currency, and why the world may abandon the USD.

- Written in NZ english, written once in a quasi-academic manner, without too much attention to grammar and punctuation - I really just want to get my message out there and get some feedback.

Reserve currency is the term we normally use for the type of money countries use to settle foreign trade accounts. For example, if New Zealand buys goods from Canada, it is likely we would still settle our Balance of Payments using US dollars.

There are two characteristics of a currency that make it useful in international trade: one, it is issued by a large trading nation itself, and, two, the currency holds its value vis-à-vis other commodities over time. It is these two characteristics that drive demand for a reserve currency. The inflationary preferences of the USA FED have been well documented and discussed in this forum. This habitual increase in the monetary supply has caused a comparative loss in value to other commodities, but no viable alternative to a worldwide reserve currency existed, until now.

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[Explanation for those new to the theory of inflation - read on if financially / economically literate]

Inflation is a term used to describe the real value of a currency over time, as opposed to its nominal value. An appropriate example to illustrate this is if you put $100 into a bank that paid 5% interest yearly. At the maturity of a calendar year, you should have $105, or an increase in 5%. In this same year however, the government may opted to print more currency in place of the overwhelmingly unpopular decision to raise taxes. The FED may have increased the money supply to the tune of 3%, and without a corresponding increase in economic productivity, the result is inflation.

The original $100 you deposited into the bank turned into a ‘nominal’ amount of $105, but after accounting for inflation, you are left with an ‘inflation adjusted’ figure of $100 plus 5%, less 3%.

Mathematically it would look something like this.

Year 1 = n1
Year 2 = n2

(n1 x 1.05) x.97 = n2

or:

($100 x 1.05) x .97 = $101.85

Therefore, $105 is actually equivalent to $101.85 when chained to the value of the preceding years ‘monetary value’ in a 3% inflation environment. It would also be fair to say that the Government has imposed a hidden tax of $3.15 onto your wealth in addition to income, business, excise and other regulatory taxes. If you had chosen to not place your money into a savings account, the $100 that you held in cash, would need to increase to $103 to buy the same amount of whatever commodity the next year.

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Here are some links to illustrate the correlation between money supply and inflation:

USA:
http://kapitalcon.files.wordpress.com/2011/02/graph-of-money-supply-and-inflation2.gif
Mexico:
http://www.economics.utoronto.ca/jfloyd/modules/moninfmx.jpg
New Zealand:
http://blog.greens.org.nz/wp-content/uploads/M1-M3-CPI-1988-2013.jpg


Now that this relationship has been illustrated, it may beg to question why everybody hasn’t abandoned the US currency entirely. The truth is, big companies like DuPont are already beginning to settle payments in Chinese Yuan and the Euro. One major factor that has prevented such a swift abandonment of the US dollar, is that other major nations have inflated their currencies too. Japan inflated its yen to a larger extent to what the US has in a feeble attempt to revive its stagnant economy by cheapening its currency in the hope its exporters will receive more Yen than it would have before. The destruction of inflation is not limited to the US, it is one of the political elites favourite means of confiscating wealth from their citizens.


“It is my contention that if any person or organization ever obtains the monopoly right to create money, that person or organization will tend to use this right to the hilt. The reason is simple: Anyone or any group empowered to manufacture money virtually out of thin air will tend to exercise that right, and with considerable enthusiasm. For the power to create money is a heady and profitable privilege indeed.” - Murray N. Rothbard (1992)

There US dollar is susceptible to abandonment, or at best serious decline to multiple threats. I postulate that the first of these is the first major nation that stops inflating its currency.



The dollar is very susceptible to losing its vaunted reserve currency position by the first major trading country that stops inflating its currency. Should China peg the value of its currency to gold, the world may adopt the Yuan as the trading currency. Currently China is buying US debt to prop the US economy up to keep consumer demand for Chinese exports. When China no longer wishes to hold trillions of US debt, demand for the Yuan will increase, and demand for the US dollar will decrease. China, possibly the worlds largest trading nation would diminish its holding of US dollars. Dollars held overseas would begin making their way back to the USA, causing more inflation and subsequent price increases. According to a report by congress “The Use and Counterfeiting of U.S. Currency Abroad”, Part 2. March 2003, 60% of US dollars exist overseas. Even if this were to happen, I don’t think it would take long for Digital Currency to supplant the new, pre-eminent economic superpowers one, albeit the US economy will still be in tatters.

Hayek’s ‘Denationalisation’ of money is the best known proposal for the separation of currency and state. The proposal includes the abolition of legal tender laws that would allow every individual to issue their own currency, whether in paper tickets (which existed at the time), or digital with their own insignia and names. These currencies would run in tandem to the current dollars, euros and yen that have maintained monopolies by the government. This would mean that DYNA could create DYNA COIN’s, Dnotes could develop Dnotes, I could make TeeGeeCoin, drug users PotCoin, and shibes Dogecoin. Hayek also suggested the creation of a bank that would issue ‘ducats’ - gold or silver coins that would be issued to be used to price each new currency. This obviously is an exact map of what Bitcoin is to the current Digital Currency realm, and the Nobel Laureate was very confident that these ‘ducats’ would easily out-compete the over-inflated currencies backed by nation states.

The thing about money is it is not demanded, nor required for its own sake. It is not like a computer or food where people can derive utility from its use. Money is demanded for no other reason than that it already functions as money, when people know it can be used to buy and sell as a medium of exchange. Anybody may issue their own currency, but issuance and acceptance are two very different matters. Nobody will accept a new currency as they might new Iphones and TV’s.

Ludwig Von Mises "regression theorem" showed as far back as 1912, that nobody will accept any currency as money unless it has been previously demanded and exchanged earlier. This would make it obvious that one would need to go back in time to the original transaction that would have made such an entity count as ‘money’. Rothbard (1992) postulates that since something can not have been used as money before its first transaction, it could only have been demanded because it is a ‘non-monetary commodity’ and therefore had a preexisting price, even in the era before it began to be used as a medium.

“In other words, for any commodity to become used as money, it must have originated as a commodity valued for some nonmonetary purpose, so that it had a stable demand and price before it began to be used as a medium of exchange. In short, money cannot be created out of thin air, by social contract, or by issuing paper tickets with new names on them”
(Rothbard, M 1992, The Gold Standard: An Austrian Perspective. Lexington, MA: D.C. Heath, 1985, pp. 1-17 ).

At the time Hayek’s idea was first put forward, it was considered idealistic and unworkable. Printing new names on bits of paper wouldn't make people accept its function as money; the dollar would still reign supreme. It was also said that the removal of legal tender laws wouldn’t work, for the new names would not be able to emerge into currency from first being useful ‘commodities on the free market’ as Von Mises’s theorem suggested they must. This would have left the deeply entrenched government currencies unchallenged as money, and money would not have ended up denationalised at all. Money would remain a function of the state, holding all the citizenry hostage to its theft, and liable to its irresponsible fiscal decisions; there would not be any separation of money and state.

I postulate that Digital Currency has rendered Von Mises’s theorem obsolete. Mining currencies has turned such ‘rewards’ in the form of coins as a commodity, which has already allowed some to break through this pre-requisite to be accepted as money, and truly allowed the denationalisation of money as put forward by Hayek. The blockchain technology will allow us to be truly free from the shackles of our bureaucratic rulers, I will write future pieces soon on how I believe Dnotes fits into this picture. I’m very interested in hearing what the community has to say on such posts, and topics that would both interest and help the community and adoption of Dnotes that I could do research on.

Few references:

[The Gold Standard: Perspectives in the Austrian School. Edited with an Introduction by Llewellyn H. Rockwell, Jr. Copyright © 1992. The Ludwig von Mises Institute. Auburn, Ala. Pp. 116-130; retrievable here: http://mises.org/rothbard/genuine.pdf

http://www.treas.gov/press/releases/docs/counterfeit.pdf