Debt may be a giant monetary short-sale, but it’s not a capital short-sale.
Hence why I contend that a system based on fixed monetary units representing capital — which actually has infinite expansion potential — has the capacity to be so disruptively squeezed. And that’s the case whether the fixed units are gold, bitcoin or fiat.
In a fixed regime, you’re lending units for the purpose of creating more capital — which can be expressed in many other things than just the units you’re lending — but expecting only the underlying fixed units back, not a pay off in the new capital. Unless the money supply grows in tandem with the new capital created, however, there is always going to be a squeeze. This is what the cross of gold argument is all about. It punishes the economy for creating new capital.
As Paul Krugman has explained in the past:
First, a gold standard would have all the disadvantages of any system of rigidly fixed exchange rates–and even economists who are enthusiastic about a common European currency generally think that fixing the European currency to the dollar or yen would be going too far. Second, and crucially, gold is not a stable standard when measured in terms of other goods and services. On the contrary, it is a commodity whose price is constantly buffeted by shifts in supply and demand that have nothing to do with the needs of the world economy–by changes, for example, in dentistry.
The United States abandoned its policy of stabilizing gold prices back in 1971. Since then the price of gold has increased roughly tenfold, while consumer prices have increased about 250 percent. If we had tried to keep the price of gold from rising, this would have required a massive decline in the prices of practically everything else–deflation on a scale not seen since the Depression. This doesn’t sound like a particularly good idea.
In that piece Krugman also cites the moral of the story of King Midas, which in his opinion is about teaching Midas that gold is only a metal, and that its value comes only from the truly useful goods for which it can be exchanged.
That’s not to say that a gold standard isn’t a good thing in economies that are prone to depleting resources and capital rather than adding to them. But discouraging waste is a very different to discouraging growth.
As an aside, purpose-based currency could change this because it could see people paid back in underlying goods produced rather than money, preventing the money supply short squeeze from happening at all. That, I have to say, would be a truly great monetary innovation in a world which clearly can’t tolerate the central bank adjusting supply by judgment alone.
That way, if you have a need for bread rolls in your local area, you provide the start up capital to a company committed to making more bread rolls. When you’re paid back in bread rolls or in kind rather than dollars, it doesn’t really matter if the expansion of bread roll supply in your area prevents the company from being able to fetch enough money to pay off its debt to you. You just care about receiving the rolls which you would not have got had you not invested.
Had the debt been in dollars not bread terms, the only way business — which might still be viable, necessary and desired — could sustain itself is through cheap credit and the ability to continuously roll the debt on and make the payments on it. And then it might be classified a zombie business, even though it’s not.
The China case
Which leads me to the only place in the world where they seem to understand this fundamental problem with money-supply short squeezes: China.
China has managed to get itself out of the poverty trap (a.k.a the Cocktail trap) — a trap in which hard work is never enough to allow you to catch up with incumbent wealth since success is actually dependent on serendipity or luck, not meritocracy — by understanding that the West’s fixed monetary supply obsession can be used to their advantage if one is prepared to expand the money supply in their place.
What do I mean? Well, it’s very similar to taking advantage of the Bitcoin no-debt doctrine. As I’ve explained before this is the idea that you can always enter the Bitcoin economy via work or labour alone, and that that’s a fair system. In reality ‘s stacked in favour of incumbents or capital owners.
What China realised, however, is that this vicious cycle can be broken if the money earned by labour is prevented from returning to those who own all the capital, and switched into a more accommodating currency instead.
From China’s perspective that meant a) attracting dollars to China by means of extremely cheap labour and b) retaining them in China by substituting them with a much more flexible currency such as the yuan, thus preventing them from being spent on goods, resources and services produced by US capital owners.
To the contrary, yuan were spent on Chinese goods and services which ended up empowering Chinese capitalists instead.
This was the main genius of the “currency-swap” strategy. The second bit of genius was ensuring that Chinese capitalists, unlike American capitalists, could never rely on a safe yuan-denominated store of value, because it would be constantly debased.
What you ended up with, consequently, was a yuan fractional reserve system collateralised by dollar reserves. Think of it like a giant ETF that issues way more units than it holds in underlying collateral, and pegs its units to a depreciating rate versus that collateral by taking a nice sovereign level management fee for itself.
The constant debasement of yuan relative to the US capital stock it retained soon enough created a negative savings rate for the population. This meant no matter how wealthy the Chinese capital owners and/or employees got, they would be “debased” unless they reinvested that money in capital expanding operations. As always capitalists sought out the most productive ventures and/or investments which they thought would be hard to debase like property — though this just led to a massive incentive to build loads of property.
Since this made wealth accumulation very difficult in China, the richest (and luckiest) one per cent became very prone to corruption, nepotism and/or capital exodus into economic zones which were much more sympathetic to protecting capitalist interests. Those who couldn’t protect wealth in that way had a greater incentive than most to spend on luxury goods and other wealth symbols.
This proceeded into a very positive feedback loop for China. The more the yuan was debased to spread wealth around, the cheaper Chinese goods became for those who still had dollars in the US, encouraging even more dollars to flow into Chinese coffers and be trapped there against an ever expanding yuan base.
The only dollar exodus was now in exchange for raw materials and commodities.
As far as the Chinese state was concerned, as long as the dollars didn’t flow back into the US in a way that benefited US capital owners but the wider population, which would now redirect those dollars back to China anyway, that’s all that mattered. And so the trapped dollars came to be reinvested not in a way that sent dollars back up the capital chain but rather towards public securities like USTs and later MBS. In short, rather than rewarding capital owners via Chinese consumer spending choices, the state — by issuing yuan against the dollars it collected — could chose how to strategically deploy those dollars according to its much more socialistic agenda. The result was cheaper financing for the US state, as well as for US leveraged property buyers.
China, in short, was able to subsidise US public spending and housing.
Had the US offset the Chinese debasement with its own debasement much earlier on, however, it would have prevented China from capturing as much wealth as it did at the cost of US capitalists.
QE, however, shows that the US now realises that capital owners not debased by its own hand can still be debased by the hands of other clever states that have the means to attract dollars and stop them being returned to the US.
Putting this in Bitcoin terms..
Imagine if I wanted to leverage the increasingly concentrated capital in the Bitcoin economy. All I’d need to do is acquire a handful of bitcoin via my own labour, and then refuse to spend them in the bitcoin economy. Instead, I would issue my own dizzycoins against that bitcoin supply, and allow that supply expand more quickly than the supply of bitcoin. Since this would depreciate my dizzycoins versus the bitcoins, bitcoiners would be incentivised to spend bitcoins in my economy, not theirs, because the exchange rate would be much more favourable. I’d then mop up even more bitcoins and issue even more dizzycoins against them.
Eventually I could totally squeeze the bitcoin economy simply by refusing to trade out of bitcoin. Unless Satoshi changed the rules and started printing more bitcoin to compete with my favourable valuation, the entire bitcoin economy would be squeezed to smithereens and suffer a deflationary collapse.
In the meantime, if I felt the bitcoin economy was particularly unfair because it was rewarding drug barons and pimps rather than the wider public, I could deploy my bitcoin with conditionality back into the bitcoin system. For example, I could lend all my bitcoin to people who promise to dedicate it to public infrastructure spending or housing development.
Either way my ability to corner bitcoin supply and deploy a greater number of dizzy coins in their place would be the means by which I could extract wealth from that economy.
Naturally, I would have little interest in liquidating my bitcoin reserves unless bitcoiners retaliated with FX wars of their own, prompting my currency to become overvalued in comparison, and encouraging my citizens to leverage themselves in bitcoins rather than dizzycoins. (This is approximately where we are now.)