Sunday, June 12, 2011

How to Implement Today a Zero % Inflation Currency Tied to the Generation of Work in kW-hrs

The Federal Reserve has recently argued that monetary policy by itself can not solve the recession that we are currently facing. (Thank you, Ben Bernanke, for stating the obvious.) The goal of monetary policy is not to be Big Brother and solve our problems; only we can do that. The goal of monetary policy should be to maintain a currency with a known, constant value.

In previous posts, I've argued that we will eventually want to move to an electricity-backed currency in order to have a zero-inflation currency in which we can easily convert our money into something of tangible value.

But the Wall Street Journal is still letting people write op-ed articles suggesting that we go back to a gold or silver backed currency. There is no justification for moving back to a currency backed by gold or silver. Gold and silver have no intrinsic measurable value, even though there are some uses for gold and silver. Having gold and silver sit in bank deposits ends up driving up the cost to make jewelry and certain precious metal catalysts.

Instead, we need to move to a currency that's backed by work. And as usual, I mean the thermodynamic sense of work (force times distance or voltage times charge.) In a previous post, I mentioned how to implement an electricity-backed currency, but the difficulty is that electricity is not yet the dominant form of work in our society, i.e. there are other major forms of work in our society (mainly from the piston engines in our vehicles.)

A pure electricity-backed currency should only be implemented once electricity is the dominant form of work. This would mean that electricity is over 80% of the total work in our society. Using the data from the BP Statistical Review of Energy, I calculate that the US economy is right now roughly 60% based off of electrical work and ~40% based off of mechanical work. (My next post will be on just this topic and will show the graphs summarizing what I've stated here.) I calculate that, in the major world economies, electricity is between 57% (Russia) and 79% (China) of the total amount of work generated in that country. This means that China might be able to implement a pure electricity-backed currency today because the other forms of work are only 21% of their economy. Whereas the US and Russia need to account for the mechanical forms of work generated in their economies.

Given the fact that our currency is rapidly losing value due to the 3%-6%/yr inflation rate, we need to implement a near-zero-inflation currency as soon as possible. The problem with inflation is that we have to spend so much time recalculating the profitably of a business plan because the value of a dollar keeps on changing. Making a business plan would be a lot easier if the value of the dollar was a constant in time. And this could be the case if the units for the dollar were kW-hr's (i.e. work).

So, how do we implement a work-based currency? Well, it's not as elegant as the case of an electricity-backed currency, but it's still pretty simple.

The Federal Reserve's job would be to maintain a 0% inflation in the average price of doing electrical and mechanical work, which is defined below:
[(Amount of electricity * average price of electricity) + (Amount of gasoline consumed to generate work * average price of gasoline at the pump * average efficiency of converting gasoline to motion) + (amount of natural gas used to generate work * average price of natural gas * average efficiency of converting)] / [Total amount of electrical and mechanical work]

You can see that this is a little bit more complicated than just maintaining a constant average price. This quantity weights the different forms of generating work by the price and the efficiency of use (where the efficiency of electricity is 100%). What I'm assuming here is that all coal consumption goes into generating electricity. Whereas almost no gasoline is used to generate electricity. In the US, roughly 33% of all natural gas consumption goes into producing electricity, and the rest is consumed for home-heating or steam generation.

So, how would this really work. As in the previous post on how to implement an electricity-backed currency, there's at least 3 different levels to the this 'work-based' currency. You could start with method#1 and then move on to Method#2 if Method#1 works. And so on. If Method#2 or Method#3 don't help grow the economy, then you can always go back a step.

Method#1 =  The Federal Reserve's job would be to maintain a 0% inflation in the following quantity given above. That's it.

Method#2 = Method#1 plus the ability to convert your currency into credits for the purchases of electricity, gasoline and natural gas, i.e. your money actually has value. The amount of credits you get depends on the weights in the equation above, such that, this makes a simple transition to an electricity-backed currency once electricity is the dominant form of work in our society. If you have no need for one of the items above, the law would have to guarantee that you would be able to trade for the other credits. For example, suppose you have no need for natural gas because there is no natural gas company where you live. Then you could convert your natural gas credits into electricity or gasoline credits. The nice thing about this 'work-based' currency is that you know that your money has a certain amount of value. It's value in kW-hr's of work does not change with time.

Method#3 = Method#2 plus Method#1 plus the ability for government to pay off debt by selling known amounts of electricity, gasoline, or natural gas (given the weightings above that convert gasoline and natural gas into kW-hr of work...i.e. not the enthalpy of the fuel, but the average amount of work that you actually get out of the fuel.)

In conclusion, we need to implement a work-based (kW-hrs) currency as soon as possible so that we a) avoid taxing everybody through inflation, b) simplify our ability to estimate the rate of return on investment, c) have faith in a currency because it has guaranteed value, and d) understand that our society can only grow by increasing our capability to do work, which is measured in kW-hrs.

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