In Part 39, I started my work of doing some cleanup of various topics before moving on to discussing solutions. We talked about what would happen if the U.S. federal government paid off its debt and if that would be a good thing.
In this post, I’ll address two last cleanup items.
First, a question that arises when you talk about getting rid of a fiat currency: What would happen if the government suddenly has a large expenditure need, such as a war or natural disaster, and can’t create money at will anymore to pay for it?
Could it get insurance, which was invented specifically for this purpose of protecting a financial entity against uncommon, unpredictable, and financially catastrophic events? Probably not–do you think there’s an insurance company out there that is so large it could sell war insurance to a government and be able to pay for the cost of that war without going bankrupt? Not even close. And even if one were large enough to do that, I doubt any would because governments usually (but not always) have a fair amount of control over whether they get into a war, so war insurance would almost act like an incentive for the government to go to war because now their insurance company would be paying for it. Natural disaster insurance is possible, but unlikely.
So, aside from getting insurance, how else could a government prepare for a large unpredictable expense? Think about how individuals prepare for something like that. They get insurance for all the biggest things, and then for all the rest they do this crazy thing called saving up an emergency fund. Usually that means saving 3-6 months’ worth of expenses. That way, if the primary breadwinner of the family suddenly loses their job, or if their house burns down, or whatever, they already have enough money to cover the gap in income or the large unexpected expense.
What I’m suggesting, then, is that governments should save up for an emergency rather than reactively take our money through inflation or, in the absence of a fiat currency, rapidly jack up taxes and borrow a ton of money.
What I think would be amazing is if a government could save up enough that it could continue running indefinitely just on the interest its earning on its emergency fund, which would be invested in stocks and bonds. This would work just like a university with a huge endowment. Imagine that–no more taxes!
But, realistically, maybe saving up something like 50% of annual expenditures (equivalent to a family’s 6-month emergency fund) would be a good solution. No politician would be able to convince enough people to forego all their urgent funding requests to ever make this happen, so a requirement to do this would probably have to be written into the country’s constitution. Maybe it would say that the government is required to save 3% of all income every year until it has built up an emergency fund that is equal to 50% of the most recent year’s spending. And the tricky part would be figuring out how to define an emergency that would allow that money to be used and not abused. But when any of that money ever gets used, then the 3% savings requirement goes back into effect immediately once the emergency is over. An emergency fund like this wouldn’t cover the biggest expenses, but it would buy time for the government to figure out alternative financing options, such as cutting spending, increasing taxes, and borrowing.
But having a fund like that also may incentivize governments to go to war, so maybe there should also be a required war tax implemented any time the country goes to war. That way, the cost of it is felt directly and immediately by the people, so politicians would be more likely to take the unpopular cost of a war tax into consideration when they are deciding whether to enter or start a war. Without inflation to hide taxation, the government would always have to rely on less hidden forms of taxation, so citizens would be able to quantify much better the cost to them of their country entering a war, which would also discourage politicians from inducing such large and unpopular costs on citizens.
These ideas probably sound crazy, but that’s only because we’re so used to governments creating money whenever they want. And the two main problems that creates are (1) their spending choices are insulated from public opinion because they’re not directly seen and (2) we pay for emergencies through inflation, which is definitely the most damaging form of taxation to an economy.
Overall, I’m trying to make it clear that even though spending for an emergency through inflation feels normal to us, it is the worst way of doing it. An emergency fund would be way better.
Second, I want to list a few of the other ways that inflation hurts the economy and slows wealth building:
- It messes up calculations of the profitability of companies, especially companies that have asset depreciation as a major portion of their costs. Here’s an example. Let’s say a company owns a small factory, which has a single machine that makes bolts. It bought the machine for $300,000 and expects it to be used for 30 years, making 20,000 bolts per year. It will depreciate the machine by $10,000/year so that it will be fully depreciated at the end of its 30 years. The company has other costs of about $5,000/year. If it is selling bolts for $1 each and selling all of them the machine produces every year, its revenues are $20,000/year, and its costs are only $15,000/year ($10,000 of which comes from depreciation, so it can keep that $10,000 and put it in a savings account to slowly save up for the time when it has to buy a new machine). This company is pretty profitable! Then serious inflation strikes–100% over a very short period of time–and the company has to raise its prices to $2/bolt. Its other costs also double from $5,000/year to $10,000/year. So its revenues are now $40,000/year, and its costs, assuming it sticks with the same depreciation plan for its machine, are now $20,000/year. Now the company looks even more profitable! Its stock price soars, and it definitely doesn’t want to update its depreciation schedule now, even though if it doesn’t it may not be able to buy a new machine when the current one dies. Seeing all of this success in the bolt industry, tons of other investors start bolt-making companies because of how profitable of an industry it appears to be. But then, at the end of the 30 years when that machine is fully worn out and the company goes to buy a new one with the $300,000 it saved up (by putting $10,000 in its account every year for 30 years, remember), it finds that the cost of a new machine is $600,000 due to inflation. It can’t get a loan to buy a new machine and goes bankrupt. Suddenly everyone realizes that the profitability of the bolt companies are super overvalued because they hadn’t been adjusting their depreciation for inflation! Investors’ decisions were also totally skewed because of the complexities inflation caused in accurately evaluating the profitability of different industries. Which means investments were not going to the highest-potential projects. This is yet another explanation of why achieving a stable-value currency is so imperative to an efficient economy.
- Long-term fixed contracts become much more risky when the risk of inflation is larger. Businesses usually need large investments to get going or to try new things, so long-term contracts are the foundation of most innovations. But when those contracts are more risky, more of them fail simply because of the impossible-to-predict changes in the value of the money they borrowed.
- Inflation suspends the market’s punishment of unprofitable firms because everybody seems to be profiting until prices finally adjust.
- Inflation encourages people to buy sooner than later because they believe things are cheaper now than they’ll be tomorrow. Thus, inflation encourages going into more debt than would otherwise be prudent.
- Inflation is the primary cause of business cycles, as I have shown already in this series.
All right, I did it. I got through those last two things that I wanted to address before moving on (next week) to discussing how to fix a monetary system.
There are, of course, so many other things about the theory of money that I haven’t even touched. For example, there are theories out there about bankers and their control over governments (especially when it comes to decisions about war) because of their power over money and how much they stand to gain when they finance those wars through debt to governments, which gives them even more control over government actions. And I haven’t covered the different stages of evolution that money goes through from an international perspective, including the stepwise abolition of the gold standard, fixing exchange rates, using some currencies as reserves for other currencies, the Bretton Woods Conference, sneaky ways governments have transferred wealth to other governments, etc. And don’t forget about the curious and questionable things the International Monetary Fund and World Bank are doing!
But I won’t discuss any of those in this series, and we’ll see if I ever decide to do a The Theory of Money, International Version series. I am not planning on it yet, for multiple reasons:
- I am, for the time at least, satisfied with this foundation of the theory of money. It gives me enough to have a solid idea of which monetary policies to support and which to oppose.
- I haven’t yet taken the time to thoroughly process the international aspects of money shenanigans.
- I am not yet ready to write more about money because I want to get back to my primary focus of healthcare (although I’m sure I’ll write a blog post here or there on money topics).
- Most importantly, I feel like I have conveyed through this series what the world needs most from a theory of money standpoint. Until you read a ton of books on the subject like I have, you don’t understand how much clearer money issues become when you have the theoretical foundation in this stuff that I have explained, like the purposes of money, the difference between wealth and money, Wealth Units, where wealth comes from, determinants of the aggregate wealth in a society, the characteristics of optimal money, how inflation hurts a society, and everything else in this series. I wanted to provide a clear theoretical foundation of money that can act as a launchpad to enable you to read anything else on money (or analyze any monetary policy-related current event issue) and truly understand it, even if the author or reporter or “expert” talking head doesn’t quite understand it themself. And the reason that’s so important to me is because the more people who understand this stuff, the more people who can advocate for sound monetary policies and spread this knowledge to others to do the same, which ultimately can result in a shift in our world toward monetary systems that no longer exploit citizens and benefit governments and banks instead.
Part 41 here.
Clear Thinking on Healthcare 