Friday, June 13, 2014

Hard money is not the same as sound money

A post by Jonathan Finegold on sound money pointed me towards how to express an important distinction--that hard money is not the same as sound money. JF defines sound money thusly:
a monetary system that best promotes coordination between market agents.
Unsurprisingly, a somewhat "Austrian" definition, but clear enough. I would go with the money that maximises its transaction utility, but it would come to much the same thing. Which is to say, money being sound is not merely about the exchange value of money (either for other monies or for goods and services), nor even its exchange value across time (i.e. its role as an asset), but also about the exchanges (transactions) it is used in. If money maintains or increases its exchange value against goods and services (measured by, say, the GDP deflator) but at the cost of depressing the level (measured by goods and services) of exchanges it is used in, then that is not sound money.

It is, however, hard money. 

Which is the difference: hard money is money that maintains or increases its exchange value for goods and services (or other monies or both). The more it increases its said exchange value, the "harder" it is. But that does not tell us that how sound it is: indeed, often hardness and soundness are contra-indicated (more of one is less of the other). To increase money's value as an asset is to reduce its moneyness and that way disaster (or, at least, much economic unpleasantness) lies, remembering that being an asset is the least distinctive thing about money.

Deflation distinction
The distinction between good, bad and ugly deflation is useful (pdf) here. Good deflation comes from falling prices due to increasing productivity. The IT industry is a classic example of good deflation--Moore's law and all that. There is a sense in which the entire increase in living standards from whenever is all good deflation--if, for example, we use labour-time at average wages as our measure.

Bad and ugly deflation--what we might call monetary deflation--is all about money increasing in value relative to output, thereby depressing aggregate demand (i.e. total spending on goods and services), pushing downwards on income, raising the value of debt. Bad and ugly deflation is from hard money, from money increasing in exchange value. It is not sound money, as the actual use of money in productive transaction is trending downwards as money's exchange value is trending up. Money-as-asset is overwhelming money-as-facilitator-of-transactions--the real point of money; what makes money, money.

Central banks should be sound, not hard
We do not want central banks to obsess over providing hard money, we want them to provide sound money. To focus on money as tool, not money as asset; to focus on its utility, its role in the economy as a whole, not on its (exchange) value. Narrow inflation targeting central banks--such as the Bank of Japan (BoJ) during the "lost decades", the European Central Bank (ECB) since the Eurozone crisis--produce hard money. They do not produce sound money. The Reserve Bank of Australia (RBA) does that.

The most disastrous example of producing hard money which was desperately unsound was the policies of the Bank of France (BoF) in creating the Great Depression, the classic example of ugly deflation at its ugliest. Money was extremely hard (and getting harder and harder) but also catastrophically unsound. Money was "better and better" as an asset, worse and worse as a facilitator of transactions.

One problem is that hard money is actually relatively easy to produce and has a whole lot of ready-made chest-thumping rhetoric to go with it. It does not help that Austrian school theory has such a presumption towards central banks being inflationary, that the problem of hard money is simply not natural to their analytical framework. (Not a sin of all Austrian economists--several above links are to works by economists associated with the Austrian school--but one very common in the wider Austrian community.)

Disorder dangers
Another problem is the conservative penchant for producing fetishes of order--such as "preserving" the "value" (rather than the utility) of money. Hence so many conservatives riding the gold standard down to destruction in the Great Depression and so many obsessing over utterly imaginary inflationary dangers today. They focus on money as asset, losing sight of money as tool. On the thing itself and not its wider role, thereby actually failing to defend the wider system. They defend the fetish (the gold standard, narrow inflation targeting) as a bulwark of order, regardless of how much actual disorder it is creating.

Thereby, of course, undermining and discrediting the very social order they are so keen to defend.

Including the international order. Not only does the social disorder created by hard money make extremist regimes more likely, the economic contraction and stagnation hard money creates undermines the confidence and capacities of Western states. Folk have pointed to how much like a late 1930s Hitler Russian President Vladimir Putin is, except on behalf of Russians outside Rodina rather than Germans outside the Reich. That both were confronting Western Powers weakened in both strength and confidence by central bankers disastrously pursuing hard, rather than sound, money policies is another similarity less remarked upon.

Money qua money is a tool for transactions. Sacrificing its use (in transactions) for its (exchange) value is to undermine its real utility to an economy--which is to facilitate transactions, to have maximum transaction utility; to have a monetary system that best promotes coordination between market agents. 

Hard money is really, really not the same as sound money.  It would be a massive step forward in public policy if more people understood that.

[Cross-posted at Skepticlawyer.]

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