Digital Tulips and Inflation’s Ghost
Published in El País
(Spain) on 4 March 2021
by Miguel Otero Iglesias (link to original)
The rise of Bitcoin is a speculative fever that signals fear of a rise in the cost of living and a lack of confidence in political power, a factor that has always been historically associated with the appearance of private pseudo-currency.
The history of money is fascinating, as is the history of civilizations. Both are closely related, and there is always one constant: Financial innovation generates prosperity, while political decadence presages monetary crises. Once again, today we live in an era of drastic political upheavals, from which it would be convenient to return to history to see what might happen with our money.
Perhaps the first study regarding money was published in China in the 7th century B.C. (yes, it’s been a while) and was known as the Guanzi. Then, Chinese academics concluded that coins did not need to carry value intrinsically. Money was the bond that the sovereign would issue, and it was a key tool to exercise power. If the sovereign issued a lot of currency it stimulated the economic activity, but if there were too much money in circulation in relation to what they could create, this would cause a rise in prices and a certain level of instability, from which the sovereign would have to restrict spending in order to lower prices. A complicated balance.
Another lesson they discovered was that money has a redistributive component. Deflation benefits creditors, while inflation is advantageous for debtors. This creates tensions. On the other hand, since money did not have to have value, the governing body could create it at will and, every time it did so, would redistribute wealth from subjects to the state coffers. This discovery brought the final lesson to the Chinese academics: the sovereign should maintain a monopoly on the production of money if it wanted to ensure political and social stability.
Thanks to these first studies, China was well ahead of Europe in monetary terms. The first paper money (or “flying money” because it weighed nothing and was easy to carry) was minted in the Tang dynasty in the 7th century and perfected in the Song dynasty in the 11th century. As such, when Marco Polo arrived in the 13th century, the use of paper money was spread throughout the Grand Khan’s empire. Meanwhile, in Europe, the first paper bill was not printed until the 17th century in Sweden.
It is also true that throughout the centuries, many Chinese governments did the opposite of what the Guanzi prescribed, which accompanied periods of hyperinflation. The extent was high enough that in 1455 ,the Chinese authorities prohibited paper money; from then on, the country became obsessed with silver until the Communist Party rose to power in the second half of the 20th century.
These painful experiences between China and its European counterparts, such as the hyperinflation of the assignat after the French Revolution or of the Weimar Republic, explain why until 1971, when Richard Nixon definitively destroyed the gold standard, the monetary anchor to a precious metal was also the prevailing rule in the West.
In this half-century of fiat money, we have incorporated some of the lessons of the Guanzi. Money does not have intrinsic value, and after the “stag-flation” of the 1970s inflation has remained low. Nevertheless, what we have not done is leave the monopoly of issuing currency in the hands of those in power. Today, the commercial banks are those who create money through the factionary reserve system and credit has grown enormously. On the other hand, we have also discovered that the quantitative theory of money is questionable: We have grown monetary mass enormously (above all since the 2008 financial crisis) and we have not seen a rise in inflation.
But the lessons of history suggest that this could change. After the Great Recession and the war against COVID-19, global public and private debt have reached 365% of the world GDP, a historic record. Just last year the U.S. Federal Reserve printed one-fifth of all dollars that are in circulation. No wonder the U.S. Stock Exchange is through the roof. Last year, the price of gold and the Dow Jones hit record highs — rather unusual because they typically go in opposite directions. This anomaly indicates that liquidity is creating asset bubbles and distorting price discovery by economic agents.
This has increased the fear of inflation. The rising in prices of Bitcoin indicates this. The cryptocurrency represents the desire to return to the gold standard. Its attractiveness is in the fact that the offering is limited because there can only ever be 21 million bitcoins “printed.” But it is exactly this reason why it would never be a coin, much less a currency. As demand rises and supply wanes, the price of bitcoin rises. But let us not fool ourselves: Bitcoin is not a means of exchange (very few are going to buy their Tesla with bitcoins) nor a unit of currency (its value is measured in dollars or Euros), and it is a deposit of worth that is too volatile. We are facing a digital tulip fruit of a speculative fever.
But the mania of Bitcoin must make us reflect. Historically, the appearance of private pseudo-currency has always indicated that political power is losing legitimacy. The disregard of our democratic system and liberal international order by wide layers of our society is unquestionable. The Capitol attack is the most evident reflection. Normally, political and monetary instability right themselves. And one must think that 50 years of fiat money are a brief moment in the history of finance.
So, what does the future hold for us? For now, cheap money will continue because we must win the war against COVID-19, and because the Fed cannot allow a stock market crash if half of Americans have their savings there. But it is immediately after the war is over when inflation will appear. Perhaps we will live another 20 happy years of euphoria, but at some point, the deficit will have to be reduced. And for that it is an opportunity to consider four scenarios.
Growth: this would be the ideal. Using the cheap money of today to invest and grow our productivity. But it could turn out that we wind up with little growth and too much inflation. Adjustment: central banks will maintain their independence, interest rates will rise when prices begin to rise, the cost of debt will rise and we will enter into a difficult recession. We hope that inequality will lessen then because if not, social unrest will grow. Inflation: the political class seizes the central banks with “fiscal dominance,” and opts to reduce the deficit thanks to the rise in prices. It could work, but it is a rather dangerous strategy. Inflation is an animal that is difficult to dominate when unchained.
Finally, leaves us the restructuring of debt: Thomas Piketty and another hundred signatories have proposed this recently. Logically, they have found themselves with head on opposition from the establishment. Restructuring of national debt in the core of our monetary system should be the last resort. But perhaps, if the other three do not work, it leaves no other choice. The Jubilee year of the Old Testament has already contemplated the cancelation of debt every 50 years, and that document is even older than the Guanzi.
Miguel Otero Iglesias is Senior Analyst at the Elcano Royal Institute and Professor at IE School of Global and Public Affairs.
The history of money is fascinating, as is the history of civilizations. Both are closely related, and there is always one constant: Financial innovation generates prosperity, while political decadence presages monetary crises. Once again, today we live in an era of drastic political upheavals, from which it would be convenient to return to history to see what might happen with our money.
Perhaps the first study regarding money was published in China in the 7th century B.C. (yes, it’s been a while) and was known as the Guanzi. Then, Chinese academics concluded that coins did not need to carry value intrinsically. Money was the bond that the sovereign would issue, and it was a key tool to exercise power. If the sovereign issued a lot of currency it stimulated the economic activity, but if there were too much money in circulation in relation to what they could create, this would cause a rise in prices and a certain level of instability, from which the sovereign would have to restrict spending in order to lower prices. A complicated balance.
Another lesson they discovered was that money has a redistributive component. Deflation benefits creditors, while inflation is advantageous for debtors. This creates tensions. On the other hand, since money did not have to have value, the governing body could create it at will and, every time it did so, would redistribute wealth from subjects to the state coffers. This discovery brought the final lesson to the Chinese academics: the sovereign should maintain a monopoly on the production of money if it wanted to ensure political and social stability.
Thanks to these first studies, China was well ahead of Europe in monetary terms. The first paper money (or “flying money” because it weighed nothing and was easy to carry) was minted in the Tang dynasty in the 7th century and perfected in the Song dynasty in the 11th century. As such, when Marco Polo arrived in the 13th century, the use of paper money was spread throughout the Grand Khan’s empire. Meanwhile, in Europe, the first paper bill was not printed until the 17th century in Sweden.
It is also true that throughout the centuries, many Chinese governments did the opposite of what the Guanzi prescribed, which accompanied periods of hyperinflation. The extent was high enough that in 1455 ,the Chinese authorities prohibited paper money; from then on, the country became obsessed with silver until the Communist Party rose to power in the second half of the 20th century.
These painful experiences between China and its European counterparts, such as the hyperinflation of the assignat after the French Revolution or of the Weimar Republic, explain why until 1971, when Richard Nixon definitively destroyed the gold standard, the monetary anchor to a precious metal was also the prevailing rule in the West.
In this half-century of fiat money, we have incorporated some of the lessons of the Guanzi. Money does not have intrinsic value, and after the “stag-flation” of the 1970s inflation has remained low. Nevertheless, what we have not done is leave the monopoly of issuing currency in the hands of those in power. Today, the commercial banks are those who create money through the factionary reserve system and credit has grown enormously. On the other hand, we have also discovered that the quantitative theory of money is questionable: We have grown monetary mass enormously (above all since the 2008 financial crisis) and we have not seen a rise in inflation.
But the lessons of history suggest that this could change. After the Great Recession and the war against COVID-19, global public and private debt have reached 365% of the world GDP, a historic record. Just last year the U.S. Federal Reserve printed one-fifth of all dollars that are in circulation. No wonder the U.S. Stock Exchange is through the roof. Last year, the price of gold and the Dow Jones hit record highs — rather unusual because they typically go in opposite directions. This anomaly indicates that liquidity is creating asset bubbles and distorting price discovery by economic agents.
This has increased the fear of inflation. The rising in prices of Bitcoin indicates this. The cryptocurrency represents the desire to return to the gold standard. Its attractiveness is in the fact that the offering is limited because there can only ever be 21 million bitcoins “printed.” But it is exactly this reason why it would never be a coin, much less a currency. As demand rises and supply wanes, the price of bitcoin rises. But let us not fool ourselves: Bitcoin is not a means of exchange (very few are going to buy their Tesla with bitcoins) nor a unit of currency (its value is measured in dollars or Euros), and it is a deposit of worth that is too volatile. We are facing a digital tulip fruit of a speculative fever.
But the mania of Bitcoin must make us reflect. Historically, the appearance of private pseudo-currency has always indicated that political power is losing legitimacy. The disregard of our democratic system and liberal international order by wide layers of our society is unquestionable. The Capitol attack is the most evident reflection. Normally, political and monetary instability right themselves. And one must think that 50 years of fiat money are a brief moment in the history of finance.
So, what does the future hold for us? For now, cheap money will continue because we must win the war against COVID-19, and because the Fed cannot allow a stock market crash if half of Americans have their savings there. But it is immediately after the war is over when inflation will appear. Perhaps we will live another 20 happy years of euphoria, but at some point, the deficit will have to be reduced. And for that it is an opportunity to consider four scenarios.
Growth: this would be the ideal. Using the cheap money of today to invest and grow our productivity. But it could turn out that we wind up with little growth and too much inflation. Adjustment: central banks will maintain their independence, interest rates will rise when prices begin to rise, the cost of debt will rise and we will enter into a difficult recession. We hope that inequality will lessen then because if not, social unrest will grow. Inflation: the political class seizes the central banks with “fiscal dominance,” and opts to reduce the deficit thanks to the rise in prices. It could work, but it is a rather dangerous strategy. Inflation is an animal that is difficult to dominate when unchained.
Finally, leaves us the restructuring of debt: Thomas Piketty and another hundred signatories have proposed this recently. Logically, they have found themselves with head on opposition from the establishment. Restructuring of national debt in the core of our monetary system should be the last resort. But perhaps, if the other three do not work, it leaves no other choice. The Jubilee year of the Old Testament has already contemplated the cancelation of debt every 50 years, and that document is even older than the Guanzi.
Miguel Otero Iglesias is Senior Analyst at the Elcano Royal Institute and Professor at IE School of Global and Public Affairs.
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