Cryptocurrency: Backed By What Exactly

grarpamp grarpamp at
Wed May 11 23:06:36 PDT 2022

Roots Of Our Current Inflation: A Deeply Flawed Monetary System

A monetary system that allows the creation of money out of thin air is
vulnerable to the fits of credit expansion and credit contraction.
Periods of credit expansion typically occur over many years and even
decades while the phases of credit contraction happen like sudden
implosions. The monetary policy makers tend to promote the
prolongation of credit expansion because they fear deflation.

By doing this, however, the central banks prevent monetary moderate
deflation as it would happen as the natural consequence of rising
productivity. This way, an antideflationary monetary policy lays the
groundwork for an upsurge of price inflation along with augmenting the
risk of an abrupt contraction of the financial markets.
Credit Cycles

Financial cycles can extend over long periods of time. In the past
decades, there has been a massive global credit expansion, each of
which has received new waves of boosts as it happened since the 1980s
and as the result of such events like the 2008 financial crisis, the
2020 pandemic policy, and the current policy of sanctions in response
to the war in Ukraine.

Figure 1: Global debt since 1970 as a percentage of World GDP

The chart (fig. 1) shows total global debt, public debt, household
debt, and non-financial corporate debt as a percentage of the global
gross domestic product. Calculated in absolute terms, total global
debt is rapidly approaching $300 trillion.

With the end of the US dollar's link to gold in the 1970s, the
international monetary system lost its anchor. Global debt in relation
to the world’s gross domestic product has risen from one hundred
percent to over two hundred and fifty percent. The attenuation of this
credit cycle is long overdue. However, again and again, the major
central banks have been fighting any sign of a credit contraction for
several decades.

In Japan, the battle against credit consolidation began as early as
the 1990s. In the United States, the fight against a perceived threat
of deflation began around the turn of the millennium. Since the
European debt crisis in 2010, the European Central Bank has also
joined the monetary orgy. Obviously, the monetary policy makers ignore
the risk that by not letting moderate deflationary contraction happen,
they produce a monetary overhang. This in turn, poses the twin risk of
higher price inflation along with an uncontrolled collapse of the
credit markets.

Central banks are waging a relentless fight against deflation. Being
traumatized by the Great Depression, the modern monetary policy makers
suffer from the psycho-pathological condition of
“apoplithorismosphobia”—the fear of deflation. The battle of the
central banks against deflation has created so much liquidity that the
earlier deflationary tendency begins now to manifest itself as an
upsurge of price inflation that even the official statistics cannot
hide anymore.

Having internalized the monetarist lesson about the origin of the
Great Depression, central bankers have a deep-seated fear of price
deflation, assuming that a fall in the general price level would
provoke an economic contraction. However, had central banks left the
system alone, deflation would have happened gradually without much
turmoil. The economic actors would have had enough room and time to
adapt. As such, deflation would not only be harmless but also
beneficial. Trapped by their obsession with “stabilization,” central
banks have not permitted the economy to move on its natural path.
Instead of allowing the self-correcting economic fluctuations,
monetary policy has fabricated one artificial expansion after the

The conventional monetary theory claims that a growing economy would
need an expanding money supply. Even monetarist economists like Milton
Friedman supported this idea. Yet Murray Rothbard has shown that there
is no need of expanding the money supply to provide more liquidity
even when the economy grows. If the money supply remains constant and
productivity increases, prices would fall accordingly. This would be a
beneficial deflation. Why complain when the goods are getting cheaper
for consumers and the real wages rise? The crucial point is whether
the price deflation happens due to productivity gains in the economy
or abruptly as a sharp decline of the liquidity due to a financial
market crisis.

When central banks intervene and expand the money supply, as it
happened in the form of the "zero interest rate policy" (ZIRP) or in
some cases of a "negative interest rate policy" (NIRP), tensions will
arise between the natural tendency of the interest rate to rise and
the monetary interest rate that is kept low through the interventions
of the central bank. Because of this discrepancy, there will be an
additional demand for money. Over time, this monetary overhang
promotes financial fragility and lays the foundation for future price

The massive expansion of the Federal Reserve’s money supply in the
form of its monetary base did not immediately lead to price inflation
because the velocity of money experienced a sharp fall since 2008. The
trend of a falling velocity began to stop in the third quarter of
2020—well before the outbreak of the war in Ukraine. Given that the
monetary overhang had persisted, prices began to rise right away, and
the official consumer price inflation has accelerated to its highest
rate in the past four decades.
Changes in Relative Prices Do Not Cause Price Inflation

The increase in individual prices—for example, crude oil—manifests
itself as the change in the relative price. One specific good becomes
more expensive in relation to other products. Only if there is a
monetary overhang as the result of a previous or ongoing credit
expansion, such individual price increases would show up in the
so-called price level as an increase of general price inflation.

When the policy makers manipulate the interest rate, they create a
discrepancy between human time preference and the monetary interest
rate. Stimulus policies push down artificially the monetary rate below
the natural interest rate, which would emerge in the unhampered market
if there were no central bank intervention. Disproportions occur in
the financial markets the same way as they do when the state
intervenes in the market for goods. Relative prices then no longer
reflect consumer preferences and the marginal cost of production. The
consequences are economic disruptions in the supply and demand of
these goods.

The monetary system possesses a natural degree of elasticity. Even if
the money supply were tied to a fixed supply of central bank money or
in a gold standard, there would be expansions and contractions in
macroeconomic spending and the nominal national income. With an anchor
of the money supply, these variations of economic activity would
happen mainly as fluctuations and short-term swings and not as
prolonged phases. The whole idea of stabilization stands in contrast
to the need for a system in motion to fluctuate.

Money does have loose joints to do its job, yet it should have an
anchor to prevent extreme cycles. Under a gold standard, for example,
there is an elasticity of money, even if the gold stock is constant.
In this respect, the current monetary system is dysfunctional.

The use of money will oscillate naturally also with a fixed
quantitative amount of its base. It is wrong to claim that only the
artificially created so-called fiat money would offer financial
flexibility. Rather, the decisive point is that with an anchored
monetary system, the degree of deviation is limited, while under the
current fiat money regime, there is no restriction.

A state-sponsored fiat currency system with only a partial reserves
coverage of the money in circulation allows the commercial banks to
put more money into circulation than they hold in cash. By
persistently pursuing an anti-deflationary policy, the central banks
have fueled an ongoing credit expansion.

They artificially prolonged the cycle of credit expansion. This means
that a natural contraction has been prevented. Along with an upsurge
of price inflation, this policy has also increased the risk of an
uncontrolled implosion of the credit markets. The current outbreak of
price inflation does not come by accident or because of external

The foundation for rising prices was laid over a long period of time.
As a consequence, another severe financial crisis looms now again on
the horizon.

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