A case for monetary reform

2021.10.18 by The Last Hawk

Since the financial crisis in 2007-2008 reckless monetary policy has become the new normal globally. The result has been a massive asset price inflation that has eroded the purchasing power of peoples salaries and savings. Inequality has surged and many people have started questioning if the money system can be improved to better serve the needs of ordinary citizens.

A successful money system needs to have three key properties. First of all it must be a medium of exchange to faciliate the sale, purchase, or trade of goods between parties. Secondly it must function as a unit of account so that it becomes possible to put a price on goods and services, as well as keeping a balance of money gained or lost in transactions. Finally it must be a store of value.

There have been several attempts at making a sound money system throughout history. One of the oldest is commodity money. Gold has been used as money by a large number of civilizations since ancient times, and it has a great track record as a store of value. The reason it works so well for this purpose is because it exists in limited supply, doesn't decay and has a high percieved intrinsic value. In todays digital world it is however not convenient to use commodity money as a medium of exchange, and a purely gold based system will probably never become mainstream again.

A more viable alternative is representative money where the currency can be converted to a commodity at a fixed rate. For much of the 20th century many currencies were linked to gold in this way. Representative money puts a restriction on the money supply as there cannot be more money than the amount of commodities backing it up. This limits the monetary toolbox, but it also ensures true price stability in the long run. For workers and savers this is good news as the system protects the purchasing power of their salaries and savings.

The United States abandoned representative money in 1971 when president Nixon announced that dollars could no longer be converted to gold. At the time the market had started doubting if the US owned enough gold to cover its deficit spending, and Nixon wanted to prevent a gold run on the reserves. Since many currencies were pegged to the dollar through the Bretton Woods system this change in effect also turned those currencies into fiat money. Fiat money is a type of currency that has no intrinsic value. Instead its value is purely based on what the people using that currency think it is worth.

Unfortunately fiat money has a poor track record as a store of value, and today most central banks even have in their mandate to continuously reduce the purchasing power of their currencies. This has fueled an interest in inventing alternative money systems, and in 2009 the first cryptocurrency was launched. Most cryptocurrencies don't however work well as a store of value either, and many face regulatory or technical challenges that prevent them from becoming an efficient medium of exchange.

An interesting idea is to combine some of the technological innovations of cryptocurrencies with the principles of a representative money system. This could lead to a currency that is great for doing transactions and for storing value. Governments will naturally oppose all alternatives to fiat money, but such a currency will have huge benefits both for societey and for ordinary citizens. The outcome will be no more hidden tax in the form of inflation, as well as much more efficient use of resources.

While perhaps still some time away, a monetary reform seems increasingly attractive.