A WEEK IN ECONOMICS (25/03/13 – 01/04/13) BLAME NOT THE SYSTEM FIRST; THINK OF THE INDIVIDUAL

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Week-in-Economics

In light of the Cyprus economic crisis, there has been an upsurge in interest in alternative currencies. It was with horror that the Cypriots realised that their money in the bank could be held from them, and worse, appropriated by the banks. Conservative elements within the US jumped on the crisis to scaremonger, and propose that what happened in Cyprus could happen in the US: the state could confiscate a portion of a citizen’s income. Consequently, US states are attempting to pass into law the recognition of gold and silver as legal tender.  Utah have passed it already.The argument goes that with fiat money, the state has control over it, and over its value. Gold and silver have an intrinsic value that is recognised throughout the world, and is not determined by the state. Inflation will stabilise as money will not flood the market – with paper money, there is potential of too much cash in the market, reducing its value (as was the case with the 1923 hyperinflation in Germany). With commodity money, this is not possible as there is a finite amount.

There is also a finite amount of bitcoins in the world economy of 21 million. Bitcoins undoubtedly mark the next chapter in the evolution of the financial markets, and has recently drawn the interest of financial commentators and economists. It is virtual currency, or crypto currency, created on the internet, distributed through the internet, and has no state backing. It represents the progress (or regress depending on how one wants to look at it) of economic transactions from the real world to the virtual world, of the indelible integration of Information Technology to the phenomenal world. A cottage industry, with the trading of bitcoins, has been created, and recently, there were reports of establishing a bitcoin ATM machine. The price of bitcoin shot up at one point to $147as more people became interested in its self-proclaimed status of being secure, stable and independent of government influence.  Unfortunately, commentators are speaking of a bubble in bitcoins, which will burst in a few months.

There has been a growing advocacy of transacting in alternative currencies such as gold or bitcoins, usually by left wing revolutionary types who see something subversive about the present monetary system, or advocates of an authentic “Islamic system” who believe that commodity money is the only permissible means for transaction.  Their cynicism has justification. The credit crisis has revealed the power of banks to shake the very foundations of the economic system. This has led to growing mistrust of authorities that control and produce money, including governments whose policies appear to be aggravating the economic malaise. Focus has fallen upon the mechanisms of money making, and banks control. Moreover, alternative currencies offer far more independence from state or central bank interference.

But the economic fraternity have broadly discarded the idea of a return to commodity money. The gold standard, while encouraging fiscal discipline, constrained governments during the first and second world wars, and was ceremoniously discarded for the duration of the wars. By doing so, it allowed governments to print money to buy required goods for the war effort.  Following the war, the gold standard was reinstituted, but eventually foregone in 1971. The main reason was not state suppression, but the ability to use monetary policy to manage the economy. With production of goods and services increasing at a geometric rate – not seen in any time in human history – it was difficult for a fixed amount of gold to act as a means of transaction. According Fredrick Hayek, returning to a gold standard would cause massive instability in prices regardless as to whether the value of gold is fixed or allowed to fluctuate.

On the other hand, Hayek did believe money developed and accepted away from state sanction could be an effective solution to instability. Bitcoins appear to fit that description. The problems with bitcoins are that they are not entirely secure – hacking is a concern– and their values, as seen can fluctuate. However, they do offer a platform on which other forms of E-money can be created. Inevitably this is the future of currency as more individuals continue to transact on the internet.

We can see that method of exchanging goods and services as evolved throughout history: barter, commodity money, fiat money and E-money. These methods have run parallel to the development and geographic growth of the market, and accounted for the changes in working practices, technology, and economic ideas.  In evolving, efficiency has also increased, and today we are living in a system where there is instantaneous buying and selling.

In criticising the current monetary system, problems such as price instability and state control have been put forth. But perhaps these are not essential problems, and the focus on the right form of currency espouses excessive criticisms on the current system. If the reasons for the credit crisis could be summarised in one word, that word would be greed. The mechanisms allowed the greed to balloon and spread, but this is not entirely the fault of the system. It is a perennial scourge that can only be regulated, and not removed. For those who desire, means will be found.

Debasement of commodity money was common in the medieval ages: sellers of goods would receive gold pieces not worth the value stated thereby creating an instance of fraud. Hoarding of gold was an evil moralists would criticise. Spendthrifts felt their ire too. Today, there are fraudsters, hoarders of money and spend thrifts – the latter two have not committed any crime. The problem is not so much if you have the money, but what you do with it. There are currently millions of excessively rich individuals, many of whom are bankers. Yes, they benefited from system privileges, but in another system, be it gold based or bitcoin based, there will a group of people who will gain from system flaws. Then they will become like the reviled bankers of today. Thus, blame not the system first, but think of the individual and their motivations. In the end, they make the system.

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