Wednesday, May 4, 2011

Do Not Return to a Gold or Silver Backed Currency

As I mentioned earlier this week, I suspect that in the future our currency will be tied to something of real measurable value:  electricity.

I'm writing this post because the Wall Street Journal had a series of op-ed articles last week about returning to a gold or silver standard. The goal of this post is to debunk the idea that we should return to a currency backed by gold or silver. (Interestingly, the price of gold and silver has plummeted since May 3rd after silver started dropping in Asian market, but note that the goal of this post is not to speculate on the direction that gold or silver prices should go.)

I think that the idea of investing in gold or silver just for the sake on investing in gold or silver is silly. It's like investing in something that can guarantee you no rate of return on investment. How is investing in gold or silver any different than investing in sand?

Well, you might say, gold and silver are worth more per ounce than sand because it's easier to store it and there's a limit supply of gold and silver compared with sand. But why do gold and silver have more value than sand? The reason is that gold and silver have three main uses: 1) as catalysts for various chemical reactions; 2) as electrical wires due to their high electrical conductivity; and 3) as jewelry because they are shiny and hard to oxidize (But I should note that I've bought some purposely-oxidized silver jewelry as gifts before and it looks better than normal silver.)



What about these three main uses for gold or silver make it logical to use them to back-up a currency? Why should we back-up a currency with something whose only uses are as catalysts, electrical wires or jewelry?  I understand the desire to tie our currency to something tangible, but gold and silver have virtually no intrinsic value (i.e. our society could survive if all of the gold and silver disappeared today.) Gold and silver have almost no effect on our society, and there are replacement metals for each of the three uses I described above. Why would we want to back our currency against something that we don't need or require? I can't use gold or silver to help me with anything but look shiny. I understand that some people are just looking to purchase items that won't lose value if there is inflation, but why not purchase inflation-adjusted US Treasuries even if the inflation-adjusted Treasuries are at 0%? The Treasuries are a risk-free, investment with essentially zero rate of return on investment. [Note: Increased trust in the US gov't since Sunday might be the reason why silver prices have dropped so rapidly since Monday. The reason for the increased trust might include the killing of Bin Laden and the fact that the US brought in more tax revenue than it expected earlier.] So, unless you think that gold and silver is more stable than the US government, then it'd be stupid to invest in gold or silver. Why? Because there are gold and silver mines. This means that we are constantly finding more gold and silver. By buying gold and silver, you are actually taking on a fair amount of risk: you are assuming that the rate of introduction of new gold or silver will be slower than the rate of new markets for gold and silver (as catalysts, as electrical wires or as jewelry.) There is no guarantee that the price of gold and silver will increase with time. If there's a mine that finds a large supply of gold or silver (or even a different metal that can economically replace gold or silver as catalysts, wires or jewelry), then the price of gold and silver will drop. One mine could have a large impact on the price of gold or silver because gold and silver make up such a small percentage of our economy.

On the other hand, our society could not survive without electricity. Slowly over time, our society is using more and more electricity, and this is a good thing. Electricity represents the most pure form of work. And once the majority of our transportation vehicles become plug-in electric or plug-in hybrids, we will have made the transition to a society in which electricity is the dominant source of work. Once this is the case, then it will make sense to back our currency with electricity. (In the mean time, I understand that we might want to force the Federal Reserve to preserve 0% inflation of a basket of commodities, such as oil, electricity, food, houses, and other major items. I'm pretty angry right now that the Federal Reserve doesn't include food and energy in its 'core' basket of commodities.) In the long-run, I suspect that we will chose electricity to back our currency because it will be the dominate form of work in our society, completely dominating other forms of work, such as: work by human muscles, work by animal muscles, work by mechanically-driven piston engines (such a cars and trucks today), and work by old-school wind-mills and water-mills (in which wind or river movement is directly converted into force times distance work in a mill.) Today, we rely nearly equally on electricity and mechanical work (in the form of piston-driven vehicles.) These two forms of work drastically out-weigh the work done by human or animal muscles, even though these were the main sources of work a couple of centuries ago.

Once electricity becomes over ~75% of the total work in the US, the price of electricity will reflect the price of nearly every other object that is sold in the US. And hence, I suspect that there will be no difference between the rate of inflation of electricity prices and the rate of inflation of the basket of items mentioned above. What I'm saying is that once electricity becomes the dominant form of work in our society, then there will be virtually no difference between the inflation rate of average electricity prices and the inflation rate of commodities. And if this is the case, then moving to an electricity-backed currency (i.e. having a 0% inflation rate on the average price of electricity) would be the same thing as having a ~ 0% inflation rate on everything sold in the society. So, when electricity is the dominant form of work, having an electricity-backed currency is virtually the same thing as guaranteeing that the purchasing power of your hard-earned dollar doesn't change. A dollar in 2030 will have the same purchasing power as a dollar in 2060 (provided that electricity is the main form of work and that an electricity-back currency is implemented by 2030, and through 2060.)

Once we move to an electricity-backed currency, there will likely be no more talk of moving to gold or silver standards (except by those people who are trying to game the market.) Once we have an electricity-backed currency, nobody in their right mind would want to change to a gold or silver backed currency and take the risk that their dollars could be affected simply by the opening or closing of a few gold mines. Instead, their dollars would be backed by the largest form of work in society, and perhaps, their dollar would be convertible into electricity (which would have the capability of being used for virtually everything, except as energy for human/animal muscles and as energy for the few remaining piston-only vehicles.)

So, what would be the benefits of an electricity-backed currency?

1) Like any 0% inflation currency, the purchasing power of your dollar does not decrease with time
2) If the US gov't guarantees that you can convert dollars into a certain amount of electricity, then the paper and electric money you own is guaranteed to be convertible into something of real, measurable value.

There are other benefits to an electricity-backed currency that I'd like to focus on.

I think that we could teach the subject of economics more easily if we lived in a society with 0% inflation and in a society in which our currency was backed by a form of work. One of the most difficult things to predict in economics (and hence to teach as well) is: the effect of inflating your currency in order to lower the trading value of your currency with respect to the currency of other countries. (For example, there have been thousands of op-eds in the US about wanting the Chinese currency to rise against our currency, and then speculating on the effects of such a rise. Even economists can't agree on whether this would be a good or bad thing.) So, why don't we move to an electricity-backed currency and then suggest for other major countries move to an electricity-backed currency? I think that this would effectively end trading between currencies. Instead, we would know that one US dollar could always buy a certain amount of electricity in other country (on average). There would be no need to trade in currencies because the value would essentially never change. (This would eliminate the need for currency-traders, which means that they could be employed in sectors of the economy with more direct benefits, such as electricity-generation, health care, building construction, etc...) Instead, we could build electricity lines between our countries and then start trading electricity and have the Federal Reserve of each country maintain a 0% inflation-rate on the average price of electricity in the country.

Imagine how much easier economics would be to teach if you didn't have inflation and if you didn't have the value of different currencies changing with time. (You might ask: how would be know if one society were doing better than another society if the ratio of the currencies didn't change. I'll let you think about that for a second because the answer is pretty simple...and I don't want to state the answer yet...even though, I've stated a few times before in earlier posts.)

Teaching economics with zero inflation and zero change in the ratio between currencies is one of the goals of this blog. I hope to be able to start converting these ideas into a book in order to reach a larger audience because I think that there are multiple benefits to an electricity-backed currency. While you might think that it's worthless to teach economics for a hypothetical economy that doesn't exist, I think that it would be extremely valuable to learn economics first without inflation or currency-trading, and then once you get the basic principles of economics, then you can teach yourself additional in topics like inflation and currency-trading. Once you know that the fundamental question is  "How I do I achieve a positive, unsubsidized, inflation-adjusted rate of return on investment?", then you have no need to waste your time with questions like: should I buy gold or silver? Or should the US inflate the money supply to devalue the dollar? These questions are virtually meaningless in the hypothetical society with electricity-backed currencies, and hence should be virtually meaningless in the real world as well. We need to find win-win businesses associated with growing the economy, and not get stuck on the win-lose nature of betting for/against gold, inflation, silver or currency ratios. (Betting on gold, silver, and currencies is a form of gambling, and gambling doesn't provide a positive rate of return on investment for society.)

Once you realize that we need to achieve a positive rate of return on investment for society, then you realize that you actually need to invest your money into things that can yield a positive rate of return on investment for society. These investment include, but are not limited to: equipment required to build cheaper electricity power plants, equipment to increase the production of food, equipment to decrease health care costs, equipment to decrease the cost of communication, people who can teach your children valuable life-lessons, and people who can help us see the world anew (scientists, artists, philosophers, etc...) I mentioned artists here because I don't want people to think that an electricity-backed currency would force us to eliminate the need for artists. For example, I think that Ludwig van Beethoven has had an enormous positive rate of return for our society. A substantial amount of monetary investment when into the pieces that Beethoven wrote, and we are still seeing a positive return on that investment because he was able to imagine a world that was not yet, and has not yet to be created. If you listen to the end of the 5th Symphony, you will understand that there is a society (like the New Republic) that he imagined that is even better than the one we have today, and significantly better than the one in which he lived (which is represented by the oppressive forms in the beginning of the symphony.) We need artists as much as we need bread, and we need artists just as much as we will need electricity. We need to be able to see the world with new eyes in order to see how much better the world could be. And from seeing the world anew, we can generate the ideas that will generate positive rates of return on investment and improve our society.

--Eddie D.



Answer to the question above:  If all major countries adopted an electricity-backed currency and if electricity were the dominate form of work in these societies, then you could measure the relative size of the economy by measuring the amount of electricity (in GigaWatts) produced in the society.
If it is not the case that electricity is the dominate form of work, then you have to sum up all of the different forms of work, such as mechanical, electrical and chemical.
Today, we measure the wealth of a nation by using the GDP, but once electricity is the dominate form for work in a society, it will be a lot easier to measure the wealth of a nation by calculating the electricity generation.

2 comments:

  1. Would power-backed currency be in a more dynamic flux than gold or silver? If so, could this be a disadvantage?

    On a side note, this is the most interesting blog post on currency I have read all year. And surprisingly it happens to be the only one that didn't come from an economist.

    I think I might become a follower!

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  2. RJ
    Thanks for the question.
    I suspect that an electricity-backed currency would have less fluctuations in trading between currencies than if we went back to a currency backed by silver or gold. There's a lot of risk in backing a currency with a material whose price would change rapidly if a new gold/mine opened up or if an old one closed.
    Because gold/silver mining and the use of gold/silver make up such a small portion of our society, it's way too easy for a group of individuals to game the system by buying up gold/silver. The amount of currency we have on the market should not be dictated by the amount of silver or gold available, instead the amount of currency on the market should be a direct function of the amount of 'work' we are capable of doing. Once electricity becomes the dominant form of 'work' (in the force-times-distance sense of the word), then we will want to increase or decrease the amount of currency in the open market depending on whether the amount of electricity we generate increases or decreases. More electricity generation requires more currency on the market in order to maintain constant purchasing power. Less electricity generation requires less currency on the market to maintain constant purchasing power.(Here, I mean on a quarterly or yearly average whether there is more or less electricity generation, not hour-to-hour.)

    As far as fluctuations in an electricity-backed currency, I would expect that the amount of trading in currency to drop to virtually zero because the Federal Reserve of each country would maintain a constant buying power (though, there would be some day-to-day trading.) If the purchasing power of currencies of the major countries don't change with time, then there's no incentive to "buy yuans" because they'll grow faster than "dollars" and vice versa.
    Eventually, the goal should be to connect electricity transmission lines between countries. At that point in time, there might be significant trading in actual electricity instead of currency. 'Currency traders' would become 'electricity traders.' And this would be a good thing because we would need people figuring out who needs electricity the most at any given moment in time.

    Let me know if you have other questions or see any gaps in the argument for an electricity-backed currency.

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