Currency as a store of value (some unpleasant contradictions)

In an amusing post on “Ron Paul’s Money Illusion”, David Andolfatto calls out the absurdity of claims that the Fed has stolen “95% of the purchasing power” of money since 1913. While it’s true that $1 has only 5% of the real value that it did in 1913, it’s not clear why this should matter to anyone whose savings plan didn’t involve stuffing cash under a mattress for 88 years.

In response, some commenters complain that cash should be a long-term store of value—shouldn’t the government be looking out for the little guy who has no other way to save?

I don’t think that they understand what they’re proposing.

The household sector has almost $50 trillion in financial assets. In contrast, even after multiple rounds of QE the monetary base is only about $2.5 trillion. If any appreciable fraction of household wealth was held in the form of currency, the monetary base would have to be far, far bigger—and the Fed would need to buy assets with all the money it put into the system. What, exactly, would it buy?

There are two main options: either (1) the Fed could plow all the money into Treasuries or (2) it could invest in private debt and equity throughout the economy. It’s hard to imagine two alternatives less consistent with the libertarian principles of Paul’s followers: either the Fed would encourage government spending and indebtedness on a massive scale, or it would permanently extend its scope to making large private sector investments.

The problem, of course, is that real wealth can’t be transferred between generations simply by carrying around green pieces of paper: there needs to be some actual claim on future income streams, whether through investment, debt repayment, or collection of taxes. This requires a financial intermediary*. And that financial intermediary can either be the government or a private bank.

I prefer the latter. Paradoxically enough, many self-declared libertarians seem to disagree.

* Unless, of course, you have a “rational bubble“. But somehow I don’t think that’s what they have in mind.

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3 Comments

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3 responses to “Currency as a store of value (some unpleasant contradictions)

  1. “The problem, of course, is that real wealth can’t be transferred between generations simply by carrying around green pieces of paper: there needs to be some actual claim on future income streams, whether through investment, debt repayment, or collection of taxes.”

    Not sure I see how green pieces of paper fail to be claims to future income streams that interest bearing government paper (bonds backed by tax collection) are. If the institutional structure of the economy remains stable both will be able, with varying real returns, to purchase consumption goods if carried by the next generation.

    Intermediation is also beside the point, who issued the paper (interest bearing or otherwise, physically or metaphorically made of paper) is irrelevant, governemts and private banks can both default.

    At the individual level, subject to differeng real return and risk characteristics, cash, government bonds or privately issued bonds all represent claims to future consumption and so, if the claims are honoured, allow indiviuals to transfer wealth to their children. If green paper has a disadvantage it can only be that you think its real return is inferior (which is not the case in Japan).

    In aggregate the situation is different.

    Transferring real wealth from generation to generation, in aggregate, requires long lived real assets. We forgoe consumption today to build something that actually provides consumption for our kids. But money will be a claim the consumption stream the asset yields.

  2. “Not sure I see how green pieces of paper fail to be claims to future income streams that interest bearing government paper (bonds backed by tax collection) are.”

    They are. Sorry–I think that this part wasn’t very well written.

    I meant that currency can’t transfer wealth between generations except to the extent that it’s a claim on future income streams, either on taxes to be collected or on some other kind of financial asset that the Fed buys using newly minted reserves. In the first case, it’s no different than government bonds (in fact, it might be directly replacing those bonds), while in the second, the Fed is acting like a private financial intermediary, transferring wealth from savers to real investments. I suspect both of these would be distasteful to Paul supporters, which is the premise of the post.

  3. Agreed, I just think it’s important to make the more nuanced argument because it’s so much stronger.

    To the extent that defending the purchasing power of today’s stock of money inhibits real investment we are making the future holders of that money stock poorer, not richer.

    And if expanding the money supply facilitates real investment that otherwise wouldn’t happen then the Fed makes us and our kids richer!

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