Fiat Ate The World
I’m going to make a controversial statement — printing money doesn’t cause inflation — they gasp in horror! Though the books, economics classes, inflation theory, and even the Maestro’s autobiography say differently, I’m looking out at the world as a practitioner and seeing something different. Yes, this is the same world where central banks print money at prodigious rates. Still, I challenge you to entertain that over long periods of time, central banks increasing the amount of money in circulation doesn’t cause inflation.
Fundamentally, humans rely on commerce because “someone has something you want”. Immediately, this concept conjures images of early humans bartering. The problem with barter as a means of commerce is what’s known as the “convenience of wants”. In this case, two parties must each hold simultaneously and conveniently, an item the other wants to exchange these items directly without monetary medium. Most likely due to its cumbrance, significant evidence of barter doesn’t exist in anthropological work.
So, human societies developed means to record commerce — first with cumbersome tablets of debits and credits — and subsequently with currencies. The Mesopotamian shekel is known as the first currency — which emerged 5,000 years ago. Typically, currencies represented inanimate objects rarely found in nature. Early examples of currency were typically stamped gold or silver. While the concept of money quickly spread around the world, money tended to remain idiosyncratic to tribes, cities, states, or nations. For money to function as a medium of exchange, a collective belief or trust must form around the value of the money, which drives localization in money adoption. Absent collective belief, currencies become worthless pieces of metal. Therefore, collective belief or trust, not pieces of metal or paper, is the means of facilitating commerce.
To facilitate the trade of wine and clothe between Spain and England in David Ricardo’s theory of comparative advantage, countries need a way to convert independent sovereign currencies into one another. Conducting international trade between different currency blocs, required merchants to agree on a common value — with gold or silver prevailing. Technically, bills of trade formed the basis for a lot of international trade but given these bills of trade tied back to local currencies, they inherently tied to precious metals. Largely coinciding with the creation of large nations in the 17th and 18th centuries, most of the world’s leading governments transitioned to the gold standard, which underpinned global capital markets.
Crucially, the gold standard marries the act of production (generating economic value) with the act of saving. Workers finishing their shifts in newly created companies and industries as part of the Industrial Revolution could rest assured that their pay in a specific currency could be converted at a set rate to a set amount of silver or gold — a “safe” asset.
In 1971, Richard Nixon severed the connection between production and saving. By removing the US from the gold standard, Nixon initiated fiat money, which created an intervening step between production and saving. Workers needed to take their currency generated through production and invest the currency into productive assets — securitized primarily through stocks and bonds. Workers needed to convert their currency into savable assets because fiat currency isn’t savable as it isn’t safe sitting in banks that can fail.
The need to identify and invest in productive assets created the “Savings Industry” — operated by what we know of now as venture capital firms (Kleiner Perkins founded in 1972), growth equity firms (General Atlantic founded in 1980), mutual funds (Vanguard founded in 1976), private equity firms (KKR founded in 1976), asset managers (PIMCO founded in 1971), investment advisors (Charles Schwab founded in 1971), and others. The droves of investment professionals distributing a “product” of savings around the world to institutions and individuals proliferated in recent decades — in my view because of this new need to identify productive assets to facilitate the saving of money. Investment professionals identify the highest quality productive assets to fulfill the portfolio needs of institutions and individuals. These investment professionals fight to deploy capital in exciting opportunities and leverage their clients’ capital to create interesting productive assets that benefit the world.
A long-held belief amongst academics posits that increasing the amount of currency in circulation creates inflation. Under certain economic paradigms, this notion holds true. Particularly in the gold standard, increasing the numerator (currency) over a fixed denominator (gold) simply reduces the exchange rate of currency to gold (inflation). Inflation is a bad thing when experienced in excess.
The common trope then, particularly from people born before 1971 and therefore raised in the collective belief or trust of the gold standard, is that we shouldn’t print money. We should be careful with national debts. We should keep rates high, regardless of its impact to employment or production. Inherently all these arguments rely on the idea that supply remains static over time.
Understandably from a gold bug perspective, gold supply is relatively static and therefore increasing the amount of currency is bad and causes inflation. The amount of goods and services an economy produces is static (tied to gold supply which can only facilitate a certain amount of commerce) and therefore increasing the amount of currency in circulation will cause inflation.
I fundamentally disagree and here’s why.
Since we’ve divorced the concept of production and saving, the act of saving requires productive assets. When central banks increase the supply of money, this money doesn’t immediately hit the economy through spending. The increase in money makes a stop in productive assets (companies). The increase in money supply increases the demand for productive assets. Increases in demand for productive assets initially drives prices higher for productive assets, but over time encourages new entrants to create productive assets to house the increased money supply. The supply response seems to constantly evade the hawks. You can see this in the below chart showing the violent increase in business applications following the dramatic increase in the Federal Reserve balance sheet in 2020.
The argument that increases in money supply doesn’t cause inflation rests on the underlying premise that the necessary conditions of collective belief and trust coupled with infrastructure to facilitate economic growth exist in a society. Places like Zimbabwe and Weimar Germany experienced hyperinflation not just due to central bank or treasury activity, but because the fundamental building blocks of collective belief and trust coupled with the process for identifying and building productive assets to house those the increase in money supply did not exist or thrive.
Inherently, in a world where fiat money relies on investment in productive assets, money is not safe. There is no fall back that can sustain money’s value with 100% safety. Every company’s bond, even the largest in the world like Apple or Microsoft, possesses a non-zero probability of default. Every equity security inherently contains the risk of ruin. Cash deposits are only safe up to $250,000 of FDIC insurance, but also subject to purchasing power erosion due to inflation. Commodities — including gold — are subject to wild price swings. The idea inherent in portfolio theory — investing in non-correlated assets — is bankrupt in my view precisely for this reason. We’re all connected. We’re all in this together. Elon Musk or Jeff Bezos are worthless without the collective belief in the economic system 100 billion humans have advanced to this stage. The same goes for money — which is worthless without collective belief or trust.
Web3.0 and the crypto currency revolution are fascinating for this reason — collective belief or trust creating value. Absent the collective belief that these currencies hold value, they’re worthless computer networks. However, the collective belief “created” $2.5 trillion of value within a short period of time. The collective belief probably found traction when combined with the increased supply of money generated by the US Federal Reserve in response to the COVID crisis. Is it a bad thing that “excess” money entered a potentially revolutionary technology, even if it caused momentary increases in value to border on irrational?
The collective belief and trust in crypto currencies is manifested in the miners and nodes that comprise the network and facilitate the blockchain. In exchange, these participants are rewarded with cryptocurrency. What’s interesting about this is that we’re returning, potentially, through the widespread adoption of cryptocurrencies, to a world where production and saving are once again linked. The act of production (mining) earns you a savable asset (cryptocurrency). It’s unclear what that means for the world and how humans organize themselves, but certainly it makes you wonder about the Savings Industry (amongst others) and whether we’ve seen the start of its process of disruption. Regardless, to expect a stasis in the evolution of collective belief or trust as it relates to commerce at this stage in human progress would be foolish. As a result, it’s imperative we remain open minded about how things will change.