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Money Is Not a Store of Value

April 24, 2013
the Economy: Home and the World
3 Comments

Mark Thoma takes us to David Andolfatto on why Bitcoins and gold “make lousy money”:

Imagine having gone to work for gold a few weeks ago, only to see the purchasing power of your wages drop by 10% in one day. Imagine having purchased something using Bitcoin, only to watch the purchasing power of your spent Bitcoin rise by 100% the next day. It would be frustrating.

And why stable inflation isn’t so bad after all:

Is it important for a monetary instrument to hold its value over long periods of time? I used to think so. But now I’m not so sure. While I do not necessarily like the idea of inflation eating away at the value of fiat money, I don’t think that a low and stable inflation rate is such a big deal. Money is not meant to be a long-term store of value, after all. Once you receive your wages, you are free to purchase gold, bitcoin, or any other asset you wish. (Inflation does hurt those on fixed nominal payments, but the remedy for that is simply to index those payments to inflation. No big deal.)

The point Andolfatto is making here is actually intimately connected to a piece by Tim Duy a few days back arguing that the Federal Reserve can only successfully achieve two of: low inflation, full employment, and financial stability. The import of Duy’s argument is that we would have to tolerate significant asset inflation – increasing risk of financial instability – to increase employment without increasing consumer prices.

A lot of what he talked about concerns recent financial dynamics, but it’s worthwhile studying Medieval monetary policy in both considering the veracity of this claim and applying it to Andolfatto’s dilemma. And a new paper by Anthony Hotson at Vox is the perfect place to start. Today we control consumer price inflation, or a basket of goods that the government thinks represent our living expenses. Ipso facto, assets like equity are excluded (they aren’t necessary to live, after all). Back in the good ol’ days, under the gold and silver standards, governments controlled asset inflation. But to do this they had to let consumer prices go haywire:

Image

Or as Hotson explains this dynamic:

There was no parallel in medieval monetary policy to the modern preoccupation with the price of ordinary commodities, as measured by consumer price indices. Indeed, when faced with a change in the relative price of bullion and ordinary commodities, the authorities would resolutely keep bullion prices pegged and allow ordinary commodity prices to adjust. Relative price changes could be significant, not least as a result of new mining discoveries in the Spanish Americas.

This provides pretty solid backing to Duy’s argument that if we provide asset price stability, consumer prices will become highly volatile. And as Andolfatto argues, when the real value of money is highly uncertain on a daily basis – as the annual (light orange) data indicates – it fails to become unit of exchange. Of course there is stability vis-a-vis the money value of bullion, but this is hardly useful on a day-to-day basis.

But my conclusion is slightly different than Andolfatto’s:

If the existence of a gold reserve does not prevent a government from reneging on its promises, then why bother with a gold standard at all? The key issue for any monetary system is credibility of the agencies responsible for managing the economy’s money supply in a socially responsible manner. A popular design in many countries is a politically independent central bank, mandated to achieve some measure of price-level stability. And whatever faults one might ascribe to the U.S. Federal Reserve Bank, as the data above shows, since the early 1980s, the Fed has at least managed to keep inflation relatively low and relatively stable.

He speaks, rightly, that gold is not inherently better than fiat. Because we are using government-issued banknotes, revaluation can cause significant inflation, as did FDR. Arguably, it’s a lot easier to create inflation under a gold standard than with fiat currency. But the gold standard has an even more fundamental flaw, which is that by stabilizing bullion prices, consumer inflation can become highly volatile.

So with the gold standard, the Dollar note becomes what Bitcoin is today, if slightly less volatile. And asset inflation hawks should note that the gold standard only guaranteed the price of gold. If the Fed were to manage asset inflation altogether the consequences to consumer prices would be untold.

Indeed, consumer inflation could be solved by dropping the full employment mandate, and that is his chilling conclusion:

 If Kocherlakota is correct and monetary policy can only pursue the dual mandate in the context of financial – and, by extension – macroeconomic instability, then we really need to consider which part of the dual mandate needs to be loosened to reduce the reliance on financial instability.  My fear is that if Fed policy makers were asked this question, they would unanimously answer that it is the full-employment portion of the mandate that should be jettisoned.

Let’s pay heed to history. Jeremy Stein is smart, and knows that bankers are on a binge of cheap money right now. This might be a reason for expansionary fiscal policy.* But unless we renege on consumer price stability or full employment, now is not the time to cut back.  We save and invest in assets (perhaps gold and Bitcoins). It is important to maintain short term price stability of currency, but not its status as a store of value.

*An interesting question is whether this brings doubt to the “Krugman condition”. Even Krugman, the poster child of fiscal policy, believes it is justified only at the zero lower bound. If financial instability is of key concern, might there be conditions where of tight money and deficits come hand-in-hand?

Learning from our Confederate Past

December 30, 2012
Uncategorized
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Watching Lincoln encouraged me to familiarize myself with 19th Century government and, most importantly, the political system of the Confederacy. The Old South teaches us a lot about what not to do (hint: slavery), but the real lessons from the Civil War are not just Lincoln’s political acumen, but the innovative government of Jefferson Davis.
 
The long-term ability for the President to effect change is checked by two opposing forces: the inability to truly see lasting change in the blink of four years against the importance of considering reelection from day one.
 
The Confederacy dealt with this by restricting its president to one, six-year term. This is a tremendously inventive and powerful idea. It acted as a check on presidential authority by precluding reelection, but also gives great political capital by removing the need to consider actions from a purely partisan standpoint. 
 
I am not concerned by the financial burden of reelection for an economy as large as ours as much as the political burden it places on a president to ignore sweeping reform in preference to piecemeal actions that do not conglomerate into a coherent narrative. 
 
The Confederate model, by itself, is not desirable. A grand President is, by definition, a rare phenomenon. It would be undesirable to turn away such an icon for unfairly harsh electoral rules that seem to overrule the will of the people. After all, if a striking majority of people want the incumbent, is the Constitution not getting in the way of popular will?
 
Bill Clinton himself told Piers Morgan that the two-term limit seems unduly austere in today’s world, noting that he would have probably been ready to run again for a third time. But in understanding the perplexities of term limits as they apply to the President, it is important to understand the more important underlying message.
 
We don’t want a President to define a generation. In the United States we are deeply suspicious of political dynasties and central authority. We occasionally drink into conspiracy theories that our elections are not democratic after all, succumbing to mad dreams that there is a big Man behind it all, running our elections, as Chomsky would say, manufacturing our consent.
 
Term limits serve a check on this grander, greater-than-human belief that we are but pawns on the Chessboard of kings. But there is very much a way to reconcile this suspicion with a greater reform. Adopt, partially, a Confederate model – a President may win the Electoral College only once.
 
However, after five-years of incumbency, give Senate the authority to proffer an official Censure Vote on the President. If this vote of no confidence passes by simple majority, the House of Representatives would be granted authority to announce an Electoral College precisely one year later, narrowing the campaign process to a little under a year’s time.
 
If Senate fails to present an official Censure on the President or it is ultimately rejected by the House, the President is granted authority to serve for six more years, at which point a general election would be called regardless.
 
This accomplishes several objectives. It decreases the political cost of the first five years of Presidency and removes the need to campaign cross-country allowing the President to focus on the issues that matter. It increases the maximum tenure of a President from eight to twelve years, understanding that today’s politicians serve well into old-age. 
 
Finally, it would increase the importance we as a Nation place on midterm elections. It would increase the voter turnout on Congressional campaigns and would increase voter awareness of our Legislative branch in the large. Indeed, this acts as an important check on the President by forcing awareness of midterm elections in the two years after election, but it also allows for grand action where it is important.
 
Ultimately, we need to ensure that general elections are run by Federal authorities, with uniform security across all states. Our decentralized voting system for a highly centralized office lies in the dreams of yore when the President was far weaker than he is today.
 
Importantly, this kind of reform would have very predictable political consequences if implemented for the next election. Indeed such a system would benefit our President today as the Senate is not likely to Censure Obama. However, if we promise to implement such a system in ten to fifteen years, it would require deep arrogance for any politician to think his party will either benefit from or be victim to this reform.
 
The way we elect our president is in dire need of reform. This evolution can achieve bipartisan support while, at the same time, move towards engendering a healthier relationship between the President and his legislators, to heal the wounded relationship Washington has with its people.

 

Technology at the End of History

December 2, 2012
Uncategorized
2 Comments

In 1989, Francis Fukuyama penned his now famous essay, The End of History? This is a topic I’ve written about several times over the past few years, usually in the context of current unemployment and the divorce between human dignity and economic models.

As someone very interested in technology, computer science and politics, the emergence of technology in political analysis fascinates me. XRDS, a CS magazine I frequently read, had an essay a few months ago describing how algorithmic social choice theories might solve vote manipulation. Technology really can be in the service of democracy.

This was the thesis of an essay I wrote to win a scholarship from the Telluride House at Cornell. During my interview (with an English major, computer science PhD, and urban planner) I was taken to task on my pretty assertive belief that technology is the ultimate equalizer. The Internet, after all, is the purest democracy.

Is there anything wrong with my opinion, I was asked? Well, I certainly couldn’t get away with the hubris that “my opinion is perfect”, and luckily I did have a few concerns in mind, namely the ability to exploit technology to one’s benefit lies in the hand of the few, i.e. The ability for a technocrat to reap disproportionate benefits.

However, in the past few months, I was wondering if there is a graver consequence of modern technology, intimately connected with Fukuyama’s concept of the end of history. Imagine yourself in a world where the political government is perfect – in perfect accordance with the classically liberal ideas of free-markets, exerting little more influence than an independent court system that enforces contracts between private parties.

The political government, that is. Running in tandem to this government is a black-box technocracy that models the world as a complex system, and with incredible computational power, brilliant algorithms, and intuitive heuristics, achieves a top-down organization of the economy. This black-box is entirely unbiased, and has the simple outcome of optimizing the economy based on a set of weights determined by the people (income, equity, mobility, satisfaction with work, etc.) This computer could have some flexibility to operate among different cultures (that is in a more family-oriented society could optimize for employment in family units perhaps at the cost of greater income, or the like).

Before I go on, let me clarify, I have no idea whether such an algorithm could even exist. This is just a thought experiment to make my greater point. Would it be sad, ahistoric, aclimactic to live in this world? The theoretical satisfaction of our society would be maximized, god knows poverty might be irradiated, but would this life be a happy alternative to the current world, very much in the mires of history and ideological struggle?

With caution and qualification, I say no – this society would be no better. The ownership of our destiny would be ultimately wrested from our convictions and beliefs to an algorithm. Even if life is perfect, and scarcity is scarce, what pleasure is there from living in a world that tells you precisely what to do next and how to do it. Other than the orgasmic reactions this would have from Marxist intellectuals, what real happiness is there? My sentiments to this society are perfectly captured by Fukuyama’s nostalgia at what he considered to be the end of history – dispassionate victory that brought down the Berlin Wall:

The end of history will be a very sad time. The struggle for recognition, the willingness to risk one’s life for a purely abstract goal, the worldwide ideological struggle that called forth daring, courage, imagination, and idealism, will be replaced by economic calculation, the endless solving of technical problems, environmental concerns, and the satisfaction of sophisticated consumer demands. In the post-historical period there will be neither art nor philosophy, just the perpetual caretaking of the museum of human history. I can feel in myself, and see in others around me, a powerful nostalgia for the time when history existed. Such nostalgia, in fact, will continue to fuel competition and conflict even in the post-historical world for some time to come. Even though I recognize its inevitability, I have the most ambivalent feelings for the civilization that has been created in Europe since 1945, with its north Atlantic and Asian offshoots. Perhaps this very prospect of centuries of boredom at the end of history will serve to get history started once again.

Yet, when reading Fukuyama’s gripping essay years ago, I had one big qualification, a fleeting hope for the end of history. Ideological struggle is romantic for those of us who sit in comfort and liberty. For the scholars who write in the dimmed halls of Harvard. For the precocious high schoolers who fawn on every dripping word from their history teacher.

But for the many who are in the throes of historical struggle, there is nothing poetic about history. For the Russians who were slave to the Gulag, the romanticism of Wilson’s To the Finland Station, is but a Western concoction of reality, beautifully written for the scholar.

Just as the post-Soviet world might feel anticlimactic to the likes of Fukuyama, in its end is very much an unabashed victory of liberalism (in his own words) that has lifted millions out of silence and poverty. Who am I to say that algorithmic perfection would be sad, after all, when I have fallen on the right side of inequality.

For the small actors in history, the girls murdered by Taliban and the dissidents silenced by Communists, the real victory would be a textbook of history blank after today.