GDP and Inflation

Money matters, monumentally

Monday October 02, 2017 Konrad Hurren

Part one: Check your wallet


At time of writing a general election looms. So large, it looms, that without taking precaution and explicitly identifying them more important developments might pass us by. Indeed, history is being made before our eyes while we quibble over taxes, selling farmland, and bits of dirt with boxes on them that are, allegedly, in crisis. The history being written, and so far relegated to barely a footnote, is of currency.


This is a website article, so for brevity we’re going to split this topic over as many short(ish) articles as necessary. Here, we present a very short history of monetary theory and New Zealand money and an identification of the problem. Next, a proper description of why money has value, followed by the machinations of Fractional Reserve Banking. We’ll finish the series of articles with the “what next”.


The story begins and ends with the existence of a State monopoly on provision of currency. So-called fiat currencies exist only by legislative decree and are only accepted, begrudgingly, as a medium of exchange under the knowledge that liabilities settled in any other medium will not be barred from being enforced at court. This is your “legal tender” legislation at work.


A brief rundown of the history of New Zealand currency: New Zealand used British currency up until 1932 when the RBNZ came into existence and we got our own New Zealand Pound. This implies that we used standardised measurements of gold until 1914, followed by Bank of England notes as legal tender. Followed by New Zealand Pound; eventually, fiat NZD pegged in value to the USD which was pegged to gold, finally NZD floating in 1985, tradeable for any other currency at whatever price. Quick and dirty history for illustrative purposes only, not even close to a full treatment. The history is not central to the issue, and is not economics, no matter how fascinating.


We’ve written previously on the importance of listening to dead economists. On this issue, there are none so influential as Murray Rothbard and Ludwig Von Mises. The former meticulously traced the theory of how a monopoly on currency provision granted to The State leads to the ability for private banks to defraud the population through currency debasement, via Fractional Reserve Banking. The latter (Mises) comprehensively described how such a process leads to the boom and bust business cycle and destruction of capital. Ultimately culminating with a “crack up boom” and the abandonment of the fiat currency.   


Such works (despite all efforts by the authors) can be impenetrable to non-economists. To get some perspective on what currency debasement means to you consider the chart below, of the amount of money it would take to purchase $10 worth of goods in 1914. This is calculated using official CPI data, a large grain of salt is advised. Ignoring any issues on CPI calculation what is clear is that after the abandonment of sound money in 1914 your purchasing power has been eviscerated. We calculate that in 2016, it would require $762 to purchase a basket of goods (adjusted for quality improvements) costing $10 in 1914.


moneymatters 1


Below, for the especially geeky among our readers, we present a calculation of the official inflation rate (per annum) over the decades. Some of these decades are incredibly interesting, others are boring, we challenge the reader to pick out which. The last two decades here show periods for which the “official rate of inflation” under the Policy Targets Agreements act has been attained (1 – 3%, seems to have been around 2%). This is a period economists are calling “low inflation”.


Suspicion about this result is not unwarranted. Since the widespread adoption of the Personal Computer and internet we know productivity has skyrocketed (even though official statistics can’t pick it out). This implies the price level will have fallen tremendously in that time, simply because there have been so many more goodies and stuff produced, using less scarce resources. This heightened era of productivity masks the pernicious effects of currency debasement. We’ve written before about asset price inflation – that story shows what CPI inflation cannot.


This should give one pause, unsound money has robbed us of the wonders of increased productivity.


moneymatters 2


Next, we’ll run through in a light hearted way, why money has value.