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Popular Delusions

Memo to Central Banks: You're debasing more than our currency
Dylan Grice
Société Générale, Cross Asset Research, 2 October 2012

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At its most fundamental level, economic activity is no more than an exchange between strangers. It depends, therefore, on a degree of trust between strangers. Since money is the agent of exchange, it is the agent of trust. Debasing money therefore debases trust. History is replete with Great Disorders in which social cohesion has been undermined by currency debasements. The multi-decade credit inflation can now be seen to have had similarly corrosive effects. Yet central banks continue down the same route. The writing is on the wall. Further debasement of money will cause further debasement of society. I fear a Great Disorder.

I am more worried than I have ever been about the clouds gathering today (which may be the most wonderful contrary indicator you could hope for...). I hope they pass without breaking, but I fear the defining feature of coming decades will be a Great Disorder of the sort which has defined past epochs and scarred whole generations.

“Next to language, money is the most important medium through which modern societies communicate” writes Bernd Widdig in his masterful analysis of Germany.s inflation crisis “Culture and Inflation in Weimar Germany.” His may be an abstract observation, but it has the commendable merit of being true . all economic activity requires the cooperation of strangers and therefore, a degree of trust between cooperating strangers. Since money is the agent of such mutual trust, debasing money implies debasing the trust upon which social cohesion rests.

So I keep wondering to myself, do our money-printing central banks and their cheerleaders understand the full consequences of the monetary debasement they continue to engineer? Inflation of the CPI might be a consequence both seen and measurable. A broad inflation of asset prices might be a consequence seen, though not measurable. But what about the consequences that are unseen but unmeasurable . and are all the more destructive for it? I feel
queasy about the enthusiasm with which our wise economists play games with something about which we have such a poor understanding.

If you take a look around you, any artefact you see will only be there thanks to the cooperative behaviour of lots of people you don.t know. You will probably never know them, nor they you. The screen you watch on your terminal, the content you read, the orders which make the prices flicker . the coffee you drink, the cup you hold, the bin you throw it in afterwards . all your clothes, all your accessories, all the buildings you.ve been in, all the cars . you get the idea. Without exception everything you own, everything you want to own, everything you need, and everything you think you need embodies the different skills and talents of a mindboggling number of complete strangers. In a very real sense we constantly trust in strangers to a degree, as strangers trust us. Such cooperative activity is to everyone.s great benefit and I find it is a marvellous thing to behold.

The value strangers put on each other.s contributions manifests itself in prices, and prices require money. So it is through money that we express the extent of our appreciation for the many different talents embedded in each thing we consume, and through money that our skills are in turn valued by others. Money, in other words, is the agent of this anonymous exchange, and therefore money is also the agent of the hidden trust on which it depends. Thus, as Bernd Widdig reflects in his book (which I urge you all to read), money ...

“… is more than simply a tool for economic exchange; its different qualities shape the way modern people think, how they make sense of their reality, how they communicate, and ultimately how they find their place and identity in a modern environment.”

Debasing money might be expected to have effects beyond the merely financial domain. Of course, there are many ways to debase money. Coin can be clipped, paper money can be printed, credit can be created on the basis of demand deposits which aren’t there ... the effects are ultimately the same though: the implied trust that money communicates through society is eroded.

To see how, consider the example of money printing by authorities. We know that such an exercise raises revenues since the authorities now have a very real increase in purchasing power. But we also know that revenue cannot be raised by one party without another party paying. So who pays?

If the authorities raise taxes explicitly and openly, voters know exactly why they have less spending power. They also know how much less spending power they have. But if the authorities instead raise money by simply printing it, they raise the revenue by stealth. No one knows upon whom the burden falls. People notice only that they can’t afford the things they used to be able to afford, or they can’t afford the things which everyone else can afford. They know that something is wrong, but they just don’t know what, why, or who is to blame. So inevitably they look for someone to blame.

The dynamic is similar to that found in the well-worn plot line in which a group of strangers are initially brought together in happier circumstances, such as a cruise, a long train journey or a weekend away. In the beginning, spirits are high. The strangers exchange jokes and get to know one another as the journey begins. Then some crime is committed. They know it must be one of them, but they don’t know who. A great suspicion ensues. All trust between them is broken down and the infighting begins....

So it is with monetary debasement, as Keynes understood deeply (so deeply, in fact, that it's ironic so many of today.s crude Keynesians support QE so enthusiastically). In 1921 he said:

“By a continuing process of inflation, Governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some …. Those to whom the system brings windfalls …. become “profiteers” who are the object of the hatred … the process of wealth-getting degenerates into a gamble and a lottery .. Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

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