The Cost of Cash

As mentioned yesterday, the cryptocult believes that cryptocurrencies offer a solution to inflation. They shouldn't be completely confident about that. Advocates for the gold standard make the same claim, but that didn't stop the US government from de-valuing its gold-backed currency, nor the Romans or anyone else. Granted, I can't fathom how they would manage to inflate something like Bitcoin if it was the direct sovereign currency, but I'm certain they'd figure something out.

The question to ponder is why governments are so driven to inflate the currency. There seem to be many misconceptions. Many compare it to the aforementioned Romans, who watered down the denarius until it was worthless. The Romans would pay their expenses using the denarius, but demand payment with more sound denominations. Their scam amounted to a false tax rate. The were extracting more real wealth from the populace than it would seem. The same trick shouldn't work in our modern fiat currency. The government takes a set percentage of your income. Let's say it's pegged at 30%. It doesn't matter whether that income is denominated as twenty dollar or two million, the government gets 30% of your incoming real wealth in either case. Inflating the currency as a tax scam works when the currency has an intrinsic value, like gold, but not in a modern fiat system where the currency is given value by the tax collection itself.

This point is worth understanding. Most who talk about monetary policy still seems stuck in the pre-Nixon era, including almost everyone on the right. There has been a major paradigm shift, and once you pick it up you'll see these logical errors everywhere.

The reason we are told that governments lean towards inflation is to avoid a deflation spiral. They want to keep currency circulating freely. They measure the currency's performance by "velocity of money" calculations. Well, money doesn't have a very high velocity when it's stuffed under your mattress. Under deflation, that's just what happens. Your dollar will be worth more tomorrow than today. So why not hold on to it? That's just what happens with Bitcoin. Hardly anyone shops with bitcoin, save as a novelty. Most people are buying it because it is deflationary. As long as people are buying, the cost per coin goes up, which encourages more investment, which drives the prices higher, and so on. It's like a case study that confirms the validity of the deflation spiral fear. All those billions that could be invested in something more productive end up chasing themselves in a Ponzi scheme. So the official reason given for inflation is legitimate.

Some are more cynical. They suspect the government is intentionally inflating the currency to scam their lenders. It's realistic. Inflation favors the indebted. Governments have tried to inflate away their problems before. Weimar and Zimbabwe are always given as examples. There is no reason to trust governments not to do so, but then these are extreme examples. Evidence doesn't show that our current governments are particularly concerned about debt. As problems go, it's a massive problem. The US national debt is something like $170K per taxpayer, quite near the median home price of $188K. If we had another eight years of the trends under Obama, the national debt would exceed the total value of all housing in America! Can you even comprehend that? A government so in debt it would have to sell all the homes in the country to break even. It's a towering problem, but it's a tower in the distance. It's tomorrow's problem.

The interest on the national debt consumes about 6.5% of revenues. That is a big chunk of money. Politicians who've gotten their high-status jobs based on promises to balance budgets without cutting services would kill to get their hands on that. They'd certainly prefer that there wasn't a debt. But they must be even more fearful of economic turbulence. The downturn in 2008 caused state revenues to fall an astonishing 31.7%. Recession is much more ominous than debt to politicians elected to 2-year terms in Washington, or bureaucrats appointed to keep the ship upright just long enough to hand it off to the next one. These people may be dumping cash out of helicopters, but the intention is not to marginalize debt. They're doing just what they say they're doing: keeping the economy well lubricated.

One thing I suspect they aren't thinking about is the cost of currency. Nearly everyone thinks of money the way we normally think of money. It has value, and you can't spend less than you make. It really doesn't work the same way for governments. They spend money into existence, they collect it in taxes, and they pay interest on the money in circulation. The government pays a penalty for maintaining the money supply! Isn't that something? Most people don't realize this. Let's say you stash a hundred dollars under the mattress. That bill isn't backed by gold and it doesn't have intrinsic value. It was created because the government bought a bond from the bank. The bank charges interest, currently about 3%. Every year you keep that hundred dollars in the sock drawer, the government pays $3. (They must increase the money supply to achieve their desired liquidity.) If you have a thousand dollars, then they are paying $30 a year in interest. Never thought of it that way before, have you? We can clearly see two reasons why inflation must happen. First, the banks are not lending money for free. The government must pay back more than it borrowed.The whole process transfers wealth from the public to the central bank. Second, inflation must be maintained because the government can't afford for you to be holding onto cash. Imagine people were hoarding cash the way they are holding Bitcoins right now. The system would crash within a year. Inflation is a way of passing the costs of hoarding onto the hoarder. 

This all brings us to one last point. Many people assume the government must hate Bitcoin and is itching for any excuse to ban it. They're surprised it's been permitted to go on for as long as it has. But I don't see how Bitcoin competes with the USD at all. In fact, the government should love Bitcoin; it provides liquidity that they don't have to pay for! If I turn some of my savings into Bitcoins, the dollars go back into the economy, and Bitcoin becomes my savings, or is used to purchase goods. The velocity of money increases. These are all things the government should want. The next question that arises is: if not the government, then who is paying for the cryptocurrency money supply? It's an interesting question, and one we'll save for another post.