The Importance of Value

The Importance of Value
March 31, 2011

(This originally appeared on Forbes.com on March 31, 2011.)

http://www.forbes.com/2011/03/31/gold-standard-monetary-policy-opinions-contributors-nathan-lewis.html

We have a lot of foundation to establish before we are able to create alternatives to the present monetary chaos. One of the most important concepts is a focus on currency value.

Virtually everyone today has a grossly excessive focus on quantitative monetary measures. This could be base money, M1, M2, current accounts, bank reserves, various credit measures and so forth. Most of this is confusing at best, and often worse than worthless.

Instead, focus on the value of the currency. This is apparent in the currency’s exchange rate with other currencies and gold.

Although it may seem counterintuitive, the dollars in your wallet and the dollars being traded on the forex or gold markets are the same dollars. They have the same value. The dollars in your pocket are going up and down in value just as indicated on your Bloomberg terminal. Of course, McDonald’s doesn’t change the price of a Happy Meal depending on foreign exchange rates, but that is, I would say, the reality of the situation.
When a currency changes value, certain effects result. The most obvious effect is that if there is a forex fluctuation, there are changes in the profit and loss of traders, exporters, importers and so forth.

In the bigger picture, and over the longer term, broader effects can be perceived. Let’s assume that gold has a stable value, as is traditionally held. If the exchange value of the dollar falls by a factor of four compared to gold–that is, if the “price of gold” goes up fourfold in a certain currency–then the value of the dollar is falling.

What happens to the price of a Happy Meal? You would expect that markets–including the market for Happy Meals–will accommodate this change in monetary reality, over time. It will eventually take about four times as many dollars to buy the Happy Meal, more or less. This process takes decades in some situations, and in other situations perhaps only a few days or even hours.

How about if the dollar rose in value? For example, if it took half as many dollars to buy an ounce of gold, or the “price of gold” fell by 50%.
After a while it might take half as many dollars to buy a Happy Meal, as markets gradually adjust.

For the most part, it is this change in value that causes economic effects, not a change in quantity. We have a lot of metaphors about pipes and pressure and so forth, most of which are marginally useful at best. What is really happening is that humans are reacting to changes in the value of the currency.

I think it is very worthwhile to spend some time thinking through what happens to an economy when it experiences a “monetary distortion,” a meaningful change in currency value.

Thus we come to the purpose of a gold standard, which is to produce a currency of stable value. This is because the effects of unstable currency value are unpleasant and unproductive.

The proper quantity of money is the quantity that produces a stable value. This might be $100 billion or $10 million or $1 trillion. Who knows. It might mean a 50% increase in the “money supply” or a 50% decrease. It depends on the situation.

If you sift through the miasma of confusion regarding monetary systems today–including gold-standard systems–you will see that there is far too much focus on various quantitative measures. People will say that the quantity of money should be linked to the quantity of gold, or should be fixed and unchanging, or should grow at a certain rate per year, or be subject to current account balances, or is related to mining or a “money multiplier” or government budget deficits or the “velocity of money” or whatever. I would take all these quantitative things and pretty much throw them in the trash.

In a value-based system, the quantity is a residual. You adjust the quantity to get the preferred value, typically a fixed exchange rate with gold, or possibly another currency.

It’s like driving a car. You adjust the amount of gasoline sent to the engine to maintain a stable speed. You don’t try to drive a car based on quantitative measures of gasoline, X milliliters per second or something. How much is the right amount? Well, if you’re going uphill into a headwind with a big load, it might be a lot. If you are going downhill with a tailwind, it might be almost nothing. If we look at the speed, then we can say: “look, the speed is stable, everything is fine.” However, if we were to look only at the consumption of gasoline per second, it might be fluctuating all over the place. A careless person might then create all sorts of erroneous conclusions from looking at the record of gasoline consumption.

We drive a car with a gasoline adjuster targeting speed, and we drive a currency with a quantity adjuster targeting the value of gold (or another currency, or a currency basket, or whatever happens to be the target). his is the currency board linked to gold I talk about.

This focus on value is simplicity itself, but we are so saturated with quantitative notions today that it can seem difficult. But unless a person can fully integrate it, I don’t think that person will ever be able to design or manage coherent monetary systems.

Maybe it seems strange that I am talking about monetary arcana instead of current events. I would say that current events are simply an example of what happens when people don’t understand the most fundamental monetary concepts. It is also apparent to me that you can say we should have a gold standard all you want, and if nobody understands what that means–in most cases, including the writer!–then nothing can possibly happen.