Fiat's Failings, Gold, & Blockchains

The world stands on the edge of a cyclical downturn, exacerbated by trade tariffs initiated by America. We know what will happen: the major central banks will attempt to inflate their way out of the consequences. And those of us with an elementary grasp of economics should know why the policy will fail.

In addition to the monetary and debt inflation since the Lehman crisis, it is highly likely the major international currencies will suffer a catastrophic loss of purchasing power from a new round of monetary expansion, calling for a replacement of today’s fiat currency system with something more stable. The ultimate solution, unlikely to be adopted, is to reinstate gold as circulating money, and how gold works as money is outlined in this article.

Instead, central banks will struggle for fiat-based solutions, which are bound to face a similar fate with or without the blockchain technology being actively considered. The Asian and BRICS blocs have an opportunity to do something with gold. But will they take it?

Introduction

Central banks around the world are praying that there won’t be a recession, and if there is that a further monetary stimulus will ensure economic recovery. Their problem is Keynesian theory says it will work, but last time it didn’t. In fact, it has never worked beyond a temporary basis. The big surprise this time was the lack of officially recorded price inflation. But this is due to the system gaming the numbers, making it appear there has been some moderate growth when a proper deflator would confirm most Western economies have been contracting in real terms for the last ten years.

Most likely, the monetary planners believe their own numbers. That being the case, any softening in an economy will be deemed to require yet more aggressive monetary expansion than that which followed the Lehman crisis. The ECB is even talking about creating money to invest in renewable energy as well as funding budget deficits. Jay Powell is giving the Fed some leeway on the potential for price inflation, the anticipated consequence of revved-up monetary inflation to deal with upcoming challenges. To encourage governments to increase their budget deficits to give yet more Keynesian stimulus, quantitative easing will give them the means, while at the same time recapitalising the banks. But with things not working as the textbooks said they should, many monetary planners are highly concerned, speculating some sort of monetary reset will eventually be required.

Classical economics is very clear on the matter: the wealth transfer of the Cantillon effect is permanently impoverishing the majority of producers and temporally enriching governments, banks, large zombie corporations and speculators. Businesses that should not see the light of day obtain easy money. No one expects to have to repay debt, which around the world is now estimated to be $255 trillion, up over 45% since Lehman’s failure, and they know it will be reduced in real terms by inflation.

We are past the point where monetary stimulation creates a temporary economic benevolence, which according to Keynes is all that’s required to revive animal spirits. But the animal in us all is suffering severe monetary anaemia, having been bled to near-death over repetitive cycles of credit inflation.

We know the planners are worried about loss of control. It is reported that seven out of ten central banks are examining cryptocurrency and blockchain solutions. The Bank for International Settlements probably hosts an unofficial committee to coordinate ideas and identify significant issues. A blockchain might allow a central bank to monitor and direct ownership of money as a means of complimenting their monopoly of the supply and transfer of benefits between savers and borrowers. It threatens to take the socialisation of money to a new level and offers the prospect of increasing statist control over its use.

This article attempts to provide context for the dilemmas faced by a failing fiat-money system. The error at the outset is to think that money is a creature of the state. The state can legislate as much as it likes but ultimately any socialising monetary system fails. If in their lack of wisdom central banks mistakenly replace one form of fiat with another, then they will merely be issuing a new mandat to replace a failed assignat; the mistake that France’s revolutionary parliament made in the turbulent 1789-96 period.

In that sense, the world is where France was in the early 1790s, a period that led to civil insurrection, Napoleon and European-wide wars. That was bad enough. But on a global scale, mistakes in establishing a future form of money are potentially far more dangerous for mankind.

Defining money

It is time to properly define money and its function to provide a baseline for critics of socialising states in order to comprehend the errors that are likely to be committed in the replacement of failing currencies. It is no exaggeration to accuse monetary planners of misconceptions and ignorance about their own subject. The only form of money which they believe is acceptable is the fiat money of their own issuance. But the population does not use it of its own free will, having been forced to by being stealthily robbed of sound money over decades in order to use state-issued fiat until it has become fully accepted through habit.

Fiat money satisfies only some of the conditions of sound money, but its flaws in the other conditions are the reason for its eventual downfall. Here is a summer of those conditions:

• It must be the most commonly used medium of exchange in a market society.
• It is the most marketable good, whose primary purpose is to be later exchanged for the goods and services its users need and desire.
• It must be readily accepted for goods, services and the satisfaction of debts.
• It must facilitate the division of labour upon which all economic progress is based.
• Its quantity and purchasing power can only be decided collectively by its users acting as individuals.
• The role of the state and the banks must be strictly limited to providing fully backed money substitutes.
• It must be widely accepted across national borders in order to be truly credible.

As long as these criteria are satisfied, anything can act as money. Sound money can only be commodity money, such as gold and silver or gold and silver substitutes respectively which are fully backed by bullion. Other forms which do not satisfy all the listed conditions but can circulate for a temporary period include token money where a coin takes its value from its face value and not its commodity value, credit money which is not redeemable into gold on demand, fiat money in its various forms, and more recently cryptocurrencies as well as any other forms of money yet to be invented.

It stands to reason that a form of money that evolves from the people’s choice instead of one imposed upon them by their governments through legislation will be more durable. Decentralised ledger cryptocurrencies such as bitcoin offers this advantage. Gold, the longest lasting form of money, has been used for millennia and accepted as having value as money across diverse civilisations. It has only been displaced by fiat money through the evolution of discriminatory legislation in the last century.

Fiat money evolved from masquerading as a money substitute. Even during the gold standards of the nineteenth century, banks issued money in the form of credit simply by creating it without the backing of gold. Consequently, gold substitutes and fiat currency circulated with no means for the public to distinguish the fiat element from gold substitutes. The inability of anyone to tell the difference has been exploited by governments throughout history, leading more recently to the last fig-leaf of gold substitution being reneged on altogether in 1971.[ii] The current monetary crisis has come about through the unfettered inflation of supply by governments and their central banks taking full advantage of their seigniorage monopoly.

The gold standard for a new money

Any monetary reform designed to last must dispense with the temptation of utilising seigniorage as a means of funding by the state. This condition makes it impossible for spendthrift governments to consider any monetary reform that embraces sound money unless they are able to reform their role in their economies as well. Furthermore, they have to overcome the misdirection of what they believe to be the path to economic progress, falsely termed as growth, but is in fact monetary inflation. The combination of statistical, mathematical and Keynesian economics which have been taught and evolved from fallacies for at least a century is barely more sophisticated than John Law’s experiment which bankrupted France three hundred years ago.

Nothing less than the re-adoption of gold, always the people’s preferred choice for their money, will survive both space and time. Gold substitutes are not only permissible but desirable, because no one will want the inconvenience of weighing gold and testing for its purity in order to settle a transaction. Both cash and electronic settlements must be fully backed by physical gold, and deferred settlements contracted in gold or gold substitutes. Banking must be realigned separately into acting as deposit banks as custodians and acting as arrangers of finance as intermediaries to rid the system of unbacked bank credit. And all fiat masquerading as gold substitutes must be legislated to be fraudulent.

There are many prizes for an economy that uses gold and fully backed gold substitutes as its medium of exchange, giving certainty on the money side to everyone. Trade imbalances disappear and the general level of prices is regulated by gold arbitrage between centres. Thus, if it is generally cheaper for citizens in Parsimonia to buy goods from Ruritania, Parsimonian gold or gold substitutes will move to Ruritania as payment for goods. The increased quantity of gold relative to demand for goods in Ruritania will raise the general level of prices there, while the lower stock of gold resulting in Parsimonia will lower its domestic price level until they coincide with those of Ruritania, allowing of course for frictional costs. Where there are different relative preferences between money (gold) and goods, prices will tend to balance out through the arbitrage process.

This does not happen with national currencies which are not gold substitutes. Any trade arbitrageur is faced with the additional step of selling one currency and buying another. Furthermore, governments use the cover of gold substitution to intervene in currency markets by deploying unbacked fiat, as evidenced in the days of the Bretton Woods Agreement.

A further benefit comes from the necessary realignment of government activities. When gold and gold substitutes are money, governments can no longer finance themselves through the expansion of bank credit, nor can they socialise money except to an extent strictly limited by taxes. Consequently, producers, in which we include ordinary working men and women as well as organised businesses, have greater certainty over the value of their earnings, profits and future values. And with the state taking a lesser role in welfare provision, the strictures that come with increased personal responsibility encourage saving.

The cycle of credit expansion, speculation and crisis simply disappears. In the absence of bank credit periodically expanded without gold backing, capital is invested with the greatest efficiency, failures being cut quickly so that all forms of productive capital can be redirected into more successful enterprises and ventures. Measured in gold and gold substitutes prices decline over time through product innovation, technologies and competition. Instead of relying on currency debasement to reduce the burden of debt, a borrower knows that it is in his interest to repay his debts at the earliest opportunity, and the saver knows that his savings will not be depreciated over time.

This is a brief summary of the best replacement for failing fiat currencies, which is gold and its fully backed substitutes. It is strongly disliked by modern states, because it hands monetary power to the people, depriving governments of the ability to regulate money and credit while benefiting from its seigniorage. Its introduction cuts off a source of wealth transfer upon which the state has become accustomed to depend. The reintroduction of gold as money means welfare payments have to be curtailed and future welfare commitments withdrawn. Sound money is not an electable proposition.

It is likely that a monetary reset will not be aimed at the adoption of sound money in an incorruptible form to replace a failed monetary system, if only because it would require a negation of all socialising economics. But there could be a difference in approach between nations whose leaders understand the basics of sound money and those who do not. At this distance in time it would appear that Asian and Middle European nations who have suffered socialist depravation within living memory are more inclined towards sound money than the Anglo-Saxons, Western Europeans and Japanese, who are all still drifting inexorably away from free markets into greater regulation and micro-management by the state through monetary manipulation. 

A monetary reset is likely to expose the rift between East and West

The divide between ex-socialist states and those drifting into greater welfare socialism is characterised by a difference in state finances. Those enduring the heaviest welfare burden can least afford the immediate strictures for long-term monetary stability, while Russia, China and the other Asian nations who in the past have suffered communism do not have the high levels of government indebtedness and welfare commitments on the scale of the Europeans, British, Japanese and Americans. There is a risk that the financial war being raged today between the two groups will polarise opinions on the subject of a monetary reset, in which case China and Russia should emerge in a stronger position than the welfare states in the West.

Even so, China has adopted monetary inflation as its primary management tool for promoting economic objectives. The remarkable success of the liberated economy is due its emergence from decades of communist suppression, rather than monetary inflation, though it has admittedly been accelerated by state-directed monetary and credit expansion. It is therefore unlikely China’s leadership will easily give up the facility of monetary inflation for domestic use. But as the dollar and euro particularly begin to lose purchasing power through accelerating monetary inflation, China and the rest of the Eurasian world-island are able to turn to gold as backing for cross-border settlement at the least.

This will differ significantly from the route taken by the welfare-dependent nations, who instinctively will want to exclude gold, and instead look for a solution incorporating their own failing currencies. Mark Carney’s speech last August at Jackson Hole confirmed this to be his thinking. It centred on the dollar as reserve currency no longer being suitable for a global economy which has changed enormously since it became the de facto standard in 1971. Carney’s solution is to rearrange the deck chairs on the Titanic.

Clearly, any move to lessen the dollar’s role would be resisted by America. Furthermore, in the Eurozone, new splits are already developing between the cautious bankers in the Bundesbank and the increasingly inflationist ECB. It is hard to see how central banks representing the welfare-heavy nations will be able to agree on anything

Blockchain solutions are being explored

Seven out of ten central banks are said to be actively looking at the possibilities offered by blockchain technologies. Other than a need to appear proactive towards new technologies, it is hard to see a positive role for the technology, except perhaps for a scheme to differentiate between currency circulating for trade settlements and domestic circulation. One thing is certain: if it comes about, the use of blockchains will be aimed at increasing control by the state of how money is used.

Presumably, that is the superficial attraction to monetary planners. China is reported to be well advanced in its undeclared plans for a blockchained currency and could make an announcement shortly. It is difficult to see how this would advance the role of the yuan for domestic circulation, because banking technology is already highly developed and efficient when it comes to circulating currency. Furthermore, the state controls the banks and has access to all the banking information that would be provided by a blockchain, rendering it unnecessary. But there may be a role for blockchain technology in trade settlement.

Both the BRICS initiative and members of the Shanghai Cooperation Organisation may be suited for a dollar replacement in their cross-border trade. There are two likely options. The first is a new blockchained currency representing a mixture of currencies relevant to the trading parties, to be used exclusively between members of the two organisations. There would be a number of political advantages to such a scheme, such as making a clean break with the dollar, other than for trade with non-members.

In its battle to maintain the dollar’s hegemony, America will have convincingly lost its financial war with China, finding that half the world’s population represented by most of Asia, Brazil and South Africa will have turned its back on the dollar. At a stroke, Mark Carney’s vision of a post-dollar world would have happened, but perhaps not in the fashion he expected. It would be a major defeat for the dollar and mark the end of its hegemonic status and for that reason alone has its attractions for an embattled China.

A blockchained trade settlement currency would also supplement exchange controls, prevalent among the members of the two organisations. The disadvantage is that being only backed by the participant’s fiat currencies, it would be vulnerable to a currency collapse in one or more of its components.

The second option, to introduce gold backing into a new blockchain currency would be more enduring, and here, it should be noted that all members have gold reserves, mine gold, and in most cases are actively adding to their gold reserves. While the devil may be in the detail, this option is a more sensible solution than one based on pure fiat.

Conclusion

Talk of a global monetary reset is little more than just that. We have seen what is required for an enduring solution to the world’s monetary ills, but western welfare-heavy states have neither the mandate nor the theoretical knowledge to implement and understand it. For these nations, which use dollars, euros, pounds and yen, there is no apparent escape from an eventual fiat money collapse.

The outlook for BRICS members and those of the Shanghai Cooperation Organisation has the potential to be more positive, if they are prepared to link a new blockchained currency to gold. But the replacement of the dollar for inter-membership trade for half the world’s population would almost certainly trigger an immediate dollar crisis, to the obvious detriment of everyone else and implications for the BRICS and SCO members. But the dollar’s goose is cooked anyway.