Dylan Grice is a strategist with Societe Generale and is based out of London. He is the co-author of the French investment bank’s much-followed Popular Delusions analysis. “History is replete with Great Disorders in which social cohesion has been undermined by currency debasements. The multi-decade credit inflation can now be seen to have had similarly corrosive effects… I fear a Great Disorder,” he says. In this interview he speaks to Vivek Kaul.
What is debasement of currency?
Sometimes the most basic questions are the biggest ones! I’ll try to keep it as simple as possible by defining currency debasement as an increase in the supply of money which increases the purchasing power of whomever issues that money, by reducing purchasing power for everyone else.
And since when is it happening?
In the story of our civilisation, coins of a defined weight first appear at around at around 700BC. Around 400BC Aristophanes references inflation in his comedyThe Frogs, probably a reference to the currency debasement caused by the Peloponnesian war. So money debasement is as old as money itself. Traditionally, money debasement would involve issuers or traders ‘clipping’ tiny amounts of gold or silver from the coin, but still passing that coin on as though it was of a given weight. After a few rounds of clipping, your ounce of silver might only be worth nine tenths of an ounce of silver. Or maybe treasuries would mint gold or silver coins alloyed with base metals, again hoping that no one would notice. The intention was again to pass a coin containing less than an ounce of silver off as an ounce of silver and the effect would be an increase in the price level. Since more gold coins were needed to obtain a given amount of gold, more coins were also needed to buy given goods.
And why would people do this?
It’s important to understand that currency debasement is a mechanism for redistributing wealth. Anyone clipping coins kept the clippings for themselves and therefore secured an increase in their purchasing power. Any treasurer minting coins alloying gold or silver with copper or tin similarly benefitted because they now had more coins. Since the twentieth century the dominant circulating currency has been paper money and more recently, electronic money. Currency debasements have taken different shapes and forms this century – from the hyperinflations of central Europe following WW1 to the credit inflations of the 1920s or 2000s – but the fundamental principle has remained the same: the supply of money was increased in a way which redistributed societies’ wealth towards the issuer of the new money and away from everyone else.
What is the Cantillon effect?
Cantillon observed that when precious metals were imported into Spain and Europe from the New World in the sixteenth century causing a general price increase, the gold miners – the money creators, in other words – and those associated with them benefitted. When they spent their new found wealth on goods like meat, wine, or wool the prices of meat, wine and wool would rise as would the incomes of anyone involved in the production of those goods. For this group, money creation was highly beneficial. The problems arise for other groups. Anyone not involved in the production of money or of the goods the newly produced money purchased, but who nevertheless consumed them – a journalist or a nurse, for example – would find that the prices of those goods had risen while their incomes hadn’t. In other words, their real incomes had declined. Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.
Why do governments debase money?
Governments usually raise revenue through taxation which has the benefit of being transparent and open. Everyone knows why they are poorer and by how much. They know who the perpetrator is, if you like. But raising money by simply creating it, debasing the existing currency stock is very different. For the government, the effect is the same. Whether printing money today, or clipping coin in the past, the debasement represents a real increase in government revenues and therefore purchasing power. But it’s better increasing in tax revenues because you can pretend you’re not actually raising taxes. You can hide what you’re doing. By printing one billion dollars, it now has one billion dollars more to spend without having to be open about what you’ve done. But we know that revenue cannotbe raised without someone somewhere paying. And here is the problem such an action creates: who pays?
The answer is that no one knows who or by how much. Most people are completely unaware that they are even being taxed. Keynes said that inflation redistributed wealth arbitrarily and in a way in which “not one man in a million is able to diagnose.” All people see is that they are suffering a decline in their own purchasing power. They can’t afford to buy the things they used to buy. They know something is wrong but they don’t know why. And they don’t who to blame. They don’t know who the perpetrator of this wrong they’re suffering is, so the group dynamic unleashes suspicion and speculation just like it does in Agatha Christies novels.
Could you explain that in detail?
Unfortunately, things being more complex in the real world than in whodunit novels, the group finds someone to blame. But there does seem to be a coincidence of past currency debasements with past social debasements in which society looks for an enemy to blame for its problems. History is replete with Great Disorders in which social cohesion has been undermined by currency debasements. The multi-decade credit inflation can now be seen to have had similarly corrosive effects. Yet central banks continue down the same route. The writing is on the wall. Further debasement of money will cause further debasement of society. I fear a Great Disorder.
Can you give us an example?
In medieval Europe, for example, the seventeenth century currency debasements coincided with the peak in witch trials. During the French (and Russian revolutions), rapidly debased currency coincided with the revolution’s transition from a representative movement to one which becomes bloody and self-consuming. The hyperinflations in Central Europe after WW1, most infamously in Weimar Germany but also in Austria and Hungary saw societies turning viciously on their Jewish communities. In Zimbabwe more recently, the white farmers were made scapegoats for the country’s ills and in Venezueala today, Chavez blames “profiteers” variously defined.
What sort of great disorder do you expect to play out in the days and years to come?
Although what we’ve seen in the last few decades has been an unprecedented credit inflation, which is a different type of currency debasement to the monetisations of the past or quantitative easing of today, today’s problems have the hallmarks of past inflations. So we see Cantillon redistributions in the very sudden increase in wealth inequality which has favoured those closest to the money creation (the financial sector and anyone with access to cheap credit). Everyone else has suffered. Median US household incomes have stagnated during the past twenty years while there is a record number of US households on foodstamps.
That’s a fair point…
We also see the in-group trust turn to suspicion as societies look for someone to blame. The 99% blame the 1%, the 1% blame the 47%, the public sector blame the private sector, and private sector blames the public sector. In the Eurozone the Northern Europeans blame the Southern Europeans, Germans blame Greeks, Greeks blame bankers. In Spain, the Catalans blame the Castillians and want independence. Meanwhile in China, popular anger seems to be deliberately directed by the Party towards the Japanese. So everywhere you look, everyone is blaming everyone else for the overall malaise. But that malaise is really just a consequence of the various credit inflations each of those societies experienced. The US, China, Spain, Greece etc all experienced one way or another, quite extreme credit inflations. In all of this I just think we’re seeing the usual debasement of society we might expect following a currency debasement.
But the money printing isn’t stopping…
The central banks’ solution to these problems is to print more money. But I think this solution is actually the problem. I understand why they’re doing it, and I appreciate what a difficult situation they find themselves in. But since these problems have been cause by their past currency debasement – asset price inflation engineered by credit inflation – I don’t see why another round of more traditional currency debasement is going to heal anything. I hope I’m wrong by the way, but I’m worried that this is the beginning of a Great Disorder in which social frictions increase. I’m concerned that distrust deepens both within societies and between them and inflation ultimately becomes uncontrollable. Obviously, financial markets reflect an environment like this, the financial analogue to less trust being higher yield. So I think the historically low yields we see today in bond, equity and real estate markets will go much higher. Of course, that implies their prices go much lower.
A shorter version of the interview appeared in the Daily News and Analysis on November 12, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])