§1 Overview
In recent times, many foreign nations have been grappling with significant inflationary pressures, while domestic perspectives tend to harbor concerns regarding the looming specter of deflation. However, upon closer examination, the prevailing economic indicators within the domestic sphere paint a picture more akin to inflation. This is evident through the directional issuance of currency, where monetary injections fail to permeate the market circulation but instead remain idle within financial institutions.
§2 Understanding Inflation and Deflation
Sir Isaac Newton, in his capacity as the Director of the Royal Mint, collaborated with John Locke to establish the exchange rate between pounds and gold in 1717 at 3 pounds, 17 shillings, and 10.5 pence per ounce of gold. Remarkably, this fixed exchange rate endured for over two centuries. Across the Atlantic, approximately 70 years later, Alexander Hamilton implemented a financial framework for the United States closely resembling that of the United Kingdom. Like Newton, Hamilton advocated for a fixed exchange rate between the U.S. dollar and precious metals, namely gold and silver. The maintenance of a stable and robust monetary system emerged as a cornerstone of prosperity for both Britain and the United States throughout the 18th and 19th centuries. During the late 19th century, several other nations also briefly adopted the gold standard as the foundation of their currencies.
Can anchoring currencies to precious metals lead to prosperity? Does a stable monetary system truly wield such transformative power? To address these questions, it's essential to first delve into the nature of currency itself.
According to our textbooks, currency serves various functions: as a unit of value, medium of exchange, store of value, means of payment, and even as a global reserve currency. However, at its core, prior to fulfilling any other functions, money primarily serves as a measure of value. This fundamental aspect allows for the flexibility seen in historical instances such as Germans using cigarettes as currency post-World War II, candies being used as change in 1970s Italy, and why "Gong Zhi" liked to refer to pots of beef. Unfortunately, in recent years, under the sway of High Finance, not only have we disregarded the paramount function of currency, but the Federal Reserve itself seems to have lost sight of its original mandate: to stabilize the value of the U.S. dollar, rather than using interest rates as a tool to steer economic development. When the value of a currency becomes distorted, often due to excessive over-issuance, it undermines public confidence in the currency. Consequently, the currency's price depreciates, impairing its role as a reliable measure of value and triggering inflation. Modern economists sometimes argue that a moderate inflation rate of around 2% is acceptable. However, the question remains: how do we characterize higher inflation rates as detrimental inflation?
According to the Federal Reserve, inflation manifests when the prices of goods and services escalate over time. However, consider a scenario where the price of a particular commodity, such as a work of art, surges several times over among a specific group of individuals. Is this instance considered inflation? Some economists categorize such occurrences into monetary and non-monetary inflation, where the latter exhibits a narrower duration and scope compared to conventional inflationary trends. Monetary inflation pertains to price distortions stemming from a currency's loss or depreciation in value. For instance, purchasing a product for \$100 today only to sell it for \$150 the next day, yet discovering that the \$150 can no longer purchase the same product, illustrates this concept.
In contrast, deflation can be simplified as currency appreciation accompanied by falling prices. Despite experiencing a price decline in the late 19th century, where the ratio of dollars to gold remained constant but the supply of dollars surged exponentially, the United States still thrived for over a century. This resilience was attributable to the stable dollar system established by Hamilton, which instilled confidence among investors that their currency holdings would retain their value (will not depreciate), thereby attracting substantial foreign capital investment. As productivity soared, commodity prices naturally plummeted. For instance, from 1870 to 1890, the cost of steel production plummeted to a mere one-sixth of its original price, while global steel output surged twentyfold, facilitating massive infrastructure development projects in United States. During the 1880s, the United States annually added over 7,000 miles of railways, reminiscent of our nation's own historical experience. Remarkably, the decline in prices spanning various sectors, including automobiles and everyday essentials, did not spiral into a debilitating cycle of deflation, contrary to some economists' predictions. Instead, it propelled the United States to become the wealthiest nation on Earth.
§3 How Inflation Occurs
Since the inception of 'Jiaozi' and the Song Dynasty's monopoly on issuing banknotes, the Northern Song Dynasty government resorted to various credit instruments like 'Jiaozi', 'Yanchao', and 'Yanyin'. Consequently, prices surged fivefold from 1007 to 1049 and skyrocketed twelvefold by 1111, leading to multiple devaluations of the currency. Eventually, the government was compelled to declare certain batches of banknotes invalid, resulting in financial losses for those in possession of them. This scenario mirrors the root cause of inflation witnessed in later generations: overreliance on excessive currency issuance to address fiscal challenges.
In the Western world, both ancient Rome during Nero's reign and the Weimar Republic experienced inflationary crises stemming from currency devaluation. The Weimar Republic attempted to address its mounting debt by resorting to excessive currency issuance. Between 1919 and 1920, the Republic's money supply surged by 58%. As this trend became apparent, the value of the mark began to plummet. Using gold as a benchmark, the total supply of marks amounted to \$6.25 billion in January 1919, dwindling to \$1.12 billion by January 1922, and further plummeting to a mere \$101 million by 1923. Despite attempts by the Bundesbank to accelerate money printing to match the escalating prices, these efforts ultimately proved futile.
However, it's crucial to clarify that increased money issuance does not necessarily equate to inflation. Beyond serving as a measure of value, currency also functions as a commodity, with its price influenced by the dynamics of supply and demand.For instance, despite the Swiss franc's supply vastly surpassing the size of Switzerland itself, its inflation rate has consistently remained lower compared to currencies like the mark, the dollar, or the pound, attracting substantial demand from investors worldwide. To meet this escalating demand and prevent currency appreciation, the Swiss National Bank has been compelled to substantially augment the supply of Swiss francs. Similarly, between 1775 and 1900, the base money supply in the United States expanded by an estimated 163-fold, yet the value of the dollar vis-a-vis gold remained relatively stable, indicating that the increased money issuance during that period did not trigger inflation. The robust economic growth experienced by the United States during the 19th century amplified demand for the U.S. dollar. Concurrently, due to the aforementioned gold standard, international investors also favored the United States, propelling it to become the world's foremost industrial powerhouse by the century's end.
§4 Summary
The most significant repercussion of inflation lies not in mere price hikes but in the concentration of wealth among a select few individuals, reminiscent of figures like Bezos during the pandemic. Persistent currency devaluation seriously violates hard-working individuals, while investors chasing capital gains in the stock market attain an almost divine status. Consequently, both individual prosperity and national development suffer profound setbacks. Under inequitable monetary policies, economic progress exacerbates societal inequality, even as GDP figures paint a rosy picture.
We have gold because we cannot trust governments.
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