Attaining high economic growth through zero inflation

Government voices have become muted as evidence piles up that the root causes of the world’s economic problems are not free markets but the debasement of currencies by central banks, high taxes, excessive regulation and profligate government. In fact, few countries can claim to have free markets in the true sense of the term. Governments have eroded the freedoms of their citizens to the point that the term can no longer apply.

Debasement of currencies, including the wrecking of the once mighty dollar, has become the fashion since the removal of the link between the dollar and gold in 1971. As the world reserve currency, the dollar sets the tone for most other currencies. Debasement of the dollar has led to lock-step debasement of the currencies of the nations that trade with the US. Smaller countries even attempt to stay slightly ahead of the dollar in reducing the purchasing power of their own currencies in a lemming-like rush to destruction. The general notion is that for a country to export, it has to have a “weak” currency, which means debasing its currency at a faster rate than the countries with which it trades and simultaneously inflicting high levels of inflation on its populace.

In a world of zero inflation, there would be no untoward increases in the money supply. For instance, the SA Reserve Bank would not have more than doubled its issue of notes and coin in circulation (high-powered money) from R54.2bn on 31 December 2005 to R112.1bn on 31 December 2012, an increase of R57.9bn (106.83 per cent) in seven years, a period during which real GDP grew by no more than 30 per cent. The harm inflicted on the economy by the excessive issue of notes and coins is far greater than the apparent “costless” gain achieved by the central bank.

In a fiat money environment, it is too easy to print excessive quantities of money, which reduces the purchasing power of all money already in circulation and causes general price increases. The exchange rate of the rand against the dollar in the period 2009/12 has shown marked fluctuations, declining from R7.74/$1 in March 2008, to a low of R10.27/$1 in February 2009, strengthening to a high of R6.57/$1 in May 2011, and now to the current R8.92/$1. During the twenty seven months from February 2009 to May 2011, the period of the rand’s strengthening, notes and coin increased by R18.18bn (15.7 per cent), a lower rate of increase than in other periods, which provides some evidence of how to bring about an improvement in the exchange rate.    

According to Allan Sloan, writing in Fortune magazine (February), the US Federal Reserve paid $322.7bn to the US government during 2009/12 out of its “profits”, most of it earned on “money it essentially created out of thin air”. Of course, no money can come “out of thin air”. It comes out of the pockets of the holders of the currency that is being debased. What do we call it? A surreptitious tax? Or should we be more blunt and label it a form of theft? Sloan further reports that the exchange rate of the dollar declined by 10.1 per cent against the currencies of its major trading partners between 2009 and 2012, with a high of an initial 5 per cent gain, followed by substantial fluctuations and a low of a 15 per cent loss in between.

If, instead of the financial shambles that exists around the world today, there was zero currency debasement, there would also be zero inflation in the sense of general price increases. If everyone, everywhere, were to wake up one morning and find that there was no inflation, anywhere, they would be in total shock. That is a slight exaggeration as they would not immediately realise that their lives had undergone a dramatic change. The intoxicating realisation would set in later.

A zero inflation economy would require zero debasement of the currency. In such an economy, prices, including prices for labour, would remain relatively constant. Some product prices could remain the same for decades. Reliable information would be forthcoming in that increases in prices of products and services would signal shortages and decreases in prices would tell of surpluses. Salary and wage increases would result from increased productivity. Surges in productivity due to new innovations would be inclined to result in steady reductions in many more prices than the stand-out price declines in today’s electronic products. The greatest advantage of long-term inflation-free price stability is that it makes long-term economic calculation and business planning possible, substantially increases the potential for economic growth and reduces the risks attached to carrying out large projects.

In a healthy zero inflation economy, a steady decline in prices would be nothing to panic about. Your money would buy more. Saving would become worthwhile. The purchasing power of money would gradually increase rather than waste away as it currently does. There would be none of the surreptitious tax to which people are now subjected, a tax that is not reflected anywhere in official figures. The R57.9bn by which SA notes and coins increased in seven years reflects as a liability on the Reserve Bank Balance Sheet, a liability that will never be repaid. This loss of purchasing power of money is spread across all holders of existing currency in issue. The loss is not visible until everyone holding rands find that they are paying more for purchases of goods and services than previously.

The kind of money that is least likely to be debased is gold. A return to gold the world over would provide savers with non-eroding purchasing power and buyers of goods and services with a constant measure of value. Exchange rates between currencies would be constant and determined by weight of gold and not by some mysterious demand and supply mechanism that attempts to determine or guess which paper money is being debased more than others on the whim of a government or central bank.

Certainty and stability in money as a measure of value, together with economic freedom in all spheres of the economy, are the proven, dependable determinants of whether a country will have high economic growth.

Source: This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

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