THE SHORT HAPPY LIFE OF FIAT CURRENCY
By Christopher Mayer
"We inflate our paper currency, we repair commerce with
unlimited credit, and are presently visited with unlimited
bankruptcy."
- R.W. Emerson, The Young American, 1844
According to the Chambers Dictionary of Etymology, the
quotation above was the first appearance in English of the
verb inflate - meaning an increase in currency. If only
Emerson could see now what inflating has wrought.
In the pages of a book titled "Triumph of the Optimists:
101 Years of Global Investment Returns" there is a spread
of telling graphs conveying the inflationary damage done to
the world's currencies. Here we can see that not only the
dollar, but also all paper currencies, are engaged in a
race to the bottom.
Monetary inflation is uniquely a 20th century problem that
continues to the present day. Prior to that, monetary
systems, such as they were, consisted of commodity-backed
money. Inflation, then, was most often a product of
temporary suspensions of the commodity standard, usually
occurring during wars or panics.
At times, inflation also occurred as the supply of gold and
silver grew. There were spikes in some countries and
regions during certain periods of time when the supply of
gold jumped due to discoveries and such (in California
during the gold rush, for example). But, by and large, a
dollar in 1900 had held its purchasing power with the
dollar of 1800.
The 20th century American had a vastly different
experience. As the "Triumph" authors note, "A dollar bill
put under the mattress 101 years ago would today have only
4.2 percent of its 1900 purchasing power, that is, four
cents in 1900 had the same purchasing power as $1 in 2000."
Said another way - that's a loss of 95%.
Furthermore, the pace of price increases was much greater
in the period subsequent to 1970, where, as "Triumph"
notes, annual prices rose at a 5.1% clip compared to 2.4%
for the first seventy years of the century.
What is particularly scary about the dollar is that it has
been the third-best-performing currency in the world. Only
the Swiss franc and the Dutch guilder (by a very small
margin) have held up better. In the UK, for example, the
rate of price increases over the same full 101-year period
was 4.2%, compared to the 3.2% in the U.S. - a seemingly
small difference. And yet, compounded over time, U.K.
prices increased 55-fold, a factor more than 2 times that
of the U.S.!
In a line graph found on page 92, the authors show us a
spread of sixteen currencies, plotted in terms of nominal
exchange rates against the U.S. dollar. Because of the
German hyperinflation in the early 1920s, the German mark
just falls off the graph, literally becoming worthless. The
other currencies turn in visibly worse performances than
the dollar, with the aforementioned exceptions of the Swiss
franc and Dutch guilder.
Keep in mind, as I pointed out earlier, the dollar has lost
95% of its purchasing power... and yet, it still beats
almost all of its rivals, sometimes by very large margins.
The performance of fiat currencies in the past century has
been dreadful.
But what has changed? If anything, the monetary setting of
today is worse than that of the 20th century, for at least
in the earlier part of that century there was still a gold
standard. Really, up until 1971, there was some semblance,
however weak, of an international gold standard.
The monetary shackles on today's central bankers are, I
would argue, much more lenient. Hence, the threat of
inflation is far more lethal. As horrid a performance as
the dollar turned in for the 20th century, the 21st might
make it look pretty good.
Paper monetary systems have a tendency to blow up, in what
is commonly called a hyperinflation. They are really not so
rare, looking again at the 20th-century experience, as one
might suppose. Yes, there is the famous German
hyperinflation of 1922-23, where price inflation was 3,422%
in 1922 alone (and where, in January 1923, one could buy a
dollar for 20,000 marks - but by early November it took 630
billion marks to buy that same dollar). The numbers are
simply staggering and hard to comprehend. Yet, Hungary's
hyperinflation of 1945-46 was even more spectacular, with
price inflation of 19,800% per month.
Phillip Cagan wrote, in the 1950s, what many consider to be
a classic study of hyperinflation, in which he set the
definition of the term at an arbitrary price inflation rate
exceeding 50% per month. Even so, Cagan finds seven
hyperinflations meeting his definition, the limiting factor
being that these seven were the only ones where monthly
price data was available. They include the great German
hyperinflation, two in Hungary and also hyperinflations in
Austria, Greece, Poland and Russia. These all occurred
between 1921 and 1946. Witness, then, that the phenomenon
was not a rare thing.
To update Cagan, I hunted around for some more recent
hyperinflations. There were many, mostly in emerging
markets. A recent essay by a pair of IMF researchers
(Carmen Reinhart and Miguel Savastano, "The Realities of
Modern Hyperinflation") revealed a bunch more, occurring in
places like Argentina, Bolivia, Brazil, Peru and the
Ukraine. And they don't cover them all. Further searching
provided examples of devastating hyperinflations in
Zimbabwe, Zaire, Georgia and Nicaragua. I suspect there are
many more.
The most interesting part of the IMF researchers' essay was
their conclusion. They wrote: "The benign inflation
environment of recent years may lead some to believe that
chronic high inflation and hyperinflation have been
eradicated for good. History suggests that such a
conclusion is not warranted."
Indeed, that is precisely the point. Do not be deceived by
recent experience. Structurally, all the pieces are in
place to experience very high levels of price inflation.
Crystal ball gazing on monetary systems is extraordinarily
difficult, of course. There are lots of things that can
happen along the way. It was not that long ago - 1996, to
be exact - that economist Steven Hanke wrote a piece titled
"Argentina, the 'Germany' of South America." He meant the
Germany of the post-WWII era, where the sturdy mark proved
to be one of the world's most stable currencies. His case
rested mainly on the passage of tougher laws and a currency
board-like system.
This prediction, of course, proved very far off the mark,
since the Argentina of today is recovering after its most
recent financial meltdown. Far from being the Germany Hanke
envisioned, it became more like the Germany of the 1920s.
This is not to say hyperinflation is imminent or even
likely in the U.S., but it points to the dangers of men
with printing presses. And it points to the weakness of the
dollar - or any paper currency - as a long-term investment. |
