Fiat Money’s Fatal Flaw

As you may already know, I recently wrote a post titled The Inflation Myth in which I tried to show Bitcoiners and other “hard money” enthusiasts that the “inflationary” quality of fiat money is not in itself terminal to the current economic system. Indeed, “inflation” is what allows fiat money to saturate an economy well enough to more precisely measure economic value and facilitate demand for goods and services.

I’m sure many would disagree with me and point out that “money printing” has systematically reduced purchasing power, particularly of the U.S. dollar, and that, eventually, such reckless expansion of the monetary base will lead to hyperinflation and, ultimately, the self-destruction of the economy. Is that possible? Of course, but it does not follow that simply “inflating” a money will lead to that outcome. Indeed, the purchasing power of the Japanese yen has remained remarkably stable, even in the face of the Japanese central bank’s perpetual quantitative easing (QE) efforts; Japan has been doing the very things that critics of the U.S. Federal Reserve claim will lead to hyperinflation while barely making a dent in its inflation rate. The expansionary qualities of the yen have not lead to runaway inflation. In fact, the opposite has happened, with it being in a deflationary state for a quarter of a century now. And no one would claim that Japan has become a “shithole” country as a result.

Does that mean that I’ve bought into the idea that fiat money is perpetually sustainable? Hell no. I wouldn’t have written The Currency Paradox if I did and would have taken it down if I’d changed my mind or been conclusively disproven. I just wanted to show Bitcoiners and their “hard money” ilk that monetary “inflation” has an actual purpose and is not an evil in itself. However, that does not mean that fiat monies are without weakness. The issue is that said weakness is more complex than simply being a matter of a money “inflating,” as I hope to show in this post. We may call that weakness “inflation” but it is much more than that.

Let me start with a thought experiment that I recently posted on another medium:

1) 100 eggs worth $1

2) 100 dollars worth 1 egg

3) 100 dollars worth 100 eggs

In the first scenario, the money holds the value;

In the second, the egg holds the value;

In the third, there is equilibrium between the eggs and dollars (1:1).

Which is better?

This example really helped me more fully understand the challenge facing the current economic paradigm. The ideal scenario is one in which there is relative equilibrium between goods and services and the money with which they are monetized, as in Option 3. The equilibrium can be expressed as “1:1,” with the basic premise that the money supply perfectly reflects the economic value of goods and services as well as other considerations. Indeed, the true ratio is really “1:1:1,” as the demand for money by people for consumption and investment is also a key consideration of the economy. Ideally, the money supply would be maintained in relative balance with goods and services, which it monetizes, as well as the demand for it by people.

However, there is a significant impediment to reaching that ideal in the current monetary paradigm: economic value is regarded as subjective, rather than objective. Because prices are set as the result of an aggregation of the knowledge and conditions of billions of people every day, our economy operates under the illusion that economic value is being effectively measured. The fact is, the setting of prices in the current system is not only arbitrary and highly imprecise but extremely distortionary. It is this particular condition that facilitates the highly asymmetric outcomes within the current economy. The claim by many has been that, because the system itself is, by nature, amoral, then it is inherently “fair,” which is preposterous. The natural results of the economy under these condition is zero-sum or very near so. But the disparities are not always or strictly in money (though a great bit of it is).

It isn’t the inflationary quality of the money in a fiat money paradigm that is the threat, it is the subjectivity of the money. There is no practical means to attain equilibrium between the population, goods and services, and the money supply. The subjective nature of money guarantees that true equilibrium is unattainable and, thus, neither is true economic stability. Inflation (or deflation) is how that disequilibrium manifests. The solution is the creation of an objective marker of value, one that can be used to precisely measure economic value relative to the demand for that value.

Bitcoiners think that BTC is the answer but… why? What makes Bitcoin a more accurate or precise measurement of economic value? The fact is, it’s not. It has the same flaw of imprecise subjectivity as fiat money with the added flaw of inefficient dispersion due to its deflationary nature. Bitcoin solves no problem of the fiat money paradigm from an economic standpoint. Not a single one.

Again, the flaw of fiat money isn’t inflation but its subjectivity as a marker of value which makes achieving economic equilibrium impossible (the irony is that the exact same problem exists with deflationary money as well). Because of that condition, Voltaire was correct that all “paper” monies would tend to their intrinsic value, which is zero. There is simply no practical way to ascertain when a money precisely measures either the individual or aggregate value of the goods and services within an economy. This is further distorted because the demand for money itself also cannot be practically measured. The ugly secret of economics is that prices are an aggregation of price negotiations but not an equilibrium.

There are some who will claim that such an equilibrium is impossible regardless. However, measuring the state of that disequilibrium is not. Money, as it has previously been conceptualized, has been fairly ineffective as a tool for that measurement. A group of people may come together and agree that a shelf is a particular height and, relative to an objective standard of measurement, they may actually be pretty close; that’s the general presumption with prices. But, what if there is no objective standard to which to compare? Or many? Then the act of many people getting together to agree on the height of the shelf is a completely useless exercise and yields a completely nonsensical consensus. If you haven’t properly defined the unit of measurement, you cannot properly measure. It’s really that simple.

What is the solution? Objective money, money that represents a measurement that can be applied to economic value in a way that is fixed and relatively indisputable. Ideally, it would be denominated in an indisputably precise universal standard that everyone can agree is personally relevant. In other words, simply make a better ruler.

Many thought that such a money was impossible. In May 2014, not only was that premise disproven, such a money was shown to actually be plausible.