Sunday, August 24, 2008

The “Inevitable” Decline of Fiat Currency

Mises wrote that all fiat currencies eventually end in hyperinflationary events, and since this is always going to happen, he concluded that money should be based on a gold standard, which cannot be hyperinflated at policy maker's whims.

If one considers that all things eventually come to an end, that is, all nations eventually fall, and that nothing lasts forever, then I suppose it is true that the dollar will one day collapse in an inflationary spiral. But does it have to be that way? I posit that neither inflation nor hyperinflation is an economic necessity, but rather a choice made by those who regulate the supply of printed currency.

I’d like to reconsider the idea in light of the cash-inventory equivalency, where the worth of all goods for sale in an economic system equals the money supply. Previous posts have supposed that inflation results from (1) an increase of money supply; either that or (2) a decrease of the inventory of goods for sale (in other words, increasing scarcity). Either would tend to cause general price increases, and their reversal would put downward pressure on prices. Now, neither one of those conditions absolutely has to happen. Therefore, inflation need not be considered a given.

The amount of printed currency is under the control of those who print it. The amount of inventory is under the control of those who produce it. Either one could fluctuate over time, such that the cash to inventory ratio could either increase or decrease. Thus there is no inevitability that fiat currency has to eventually become worthless if those who produce cash wish it not to be so. Cash value could simply cycle up and down over time. (I'm leaving credit out here because its effect on money supply is temporary; it increases money supply when lent, decreases money supply when paid back, and its net effect over time is zero.)

Now, the banking industry, who regulates money supply through the Fed, does seem to prefer some inflation. Whatever reason that is would be their own, but I suspect it keeps the credit machine lubricated, and makes people more likely to take out loans because they anticipate rising prices down the road. Taking on credit to avoid higher prices later encourages borrowing, thus banks profit. But even mild inflation if held constant at say 2% will eventually follow a hyperbolic pattern skyward leading to hyperinflation.

The wealth of the banking industry comes from debt payable in U.S. dollars, and so I argue they, in taking the pathway of greatest profitability, would stop the policy of mild inflation before it reaches hyperinflationary proportions.

And so, fiat currency does not have to decline, inflation is not inevitable, nor is it the motive of those who produce currency for it to become worthless. Inflation happens only as long as it serves the interest of those who print the money. So long as the banking industry has control, hyperinflation is never in their interest.

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