Money and currency is our medium for the exchange of goods and services. In the US, we use dollars. It is printed and regulated by the US Government. It is divisible, scarce, durable, portable, difficult to counterfeit, universally accepted, and stable.
The value of a nation’s currency is correlated to its scarcity and wide acceptability. The value of a nation’s aggregate currency represents the total collective worth of its products and services.
Much like the stock of a publicly traded company, its price and capitalization is dependent on the stability of the business and the demand for its products and services.
A company’s stock price and the firm’s capitalization represents the total value of the business. A nation’s currency represents the value and capitalization of the country. A nation’s currency is directly correlated to the combined total worth of its products and services.
If a nation’s output of products and services is of high value, then the currency will also be relatively strong.
When a company issues more stock, its action dilutes the real value of all existing stock. In converse, when it buy’s back stock, it increases the value.
When currency is printed it adds inflationary pressure. Inflation is the effect of dilution, ie. the watering down of a nation’s currency.
In the case of US Dollars, it affects everyone who trades, works and saves in Dollars. It dilutes and inflates the value of the currency, and its purchasing power is reduced. Not unlike adding water to soup, it gives one the illusion of having more.
Since 1913, the US Dollar has inflated away 97% of its original value, relative to gold.
Inflation is caused by aggressive money printing. Deflation, in converse, has the effect of increased buying power.
When you are able to get more for the same amount of money, that is a deflationary phenomenon. The value of the currency rises, and the nominal price of products and services decline.
There is a direct correlation between the currency and the products and services available to purchase in that currency. Based on that relationship, there is an equilibrium. The marginal change in that equilibrium indicates inflation or deflation.
When the marginal quantity of products and services increase relative to the currency, there will be deflationary pressure. When the marginal quantity of a currency increase relative to the availability of products and services, there will be inflationary pressure.
If inflation is caused by aggressive money printing, then deflation is sourced from productivity, technology and trade.
Productivity and technology allows for greater and faster production of goods and services. Free trade allows for specialization and increased efficiency of production. This adds downward pressure and competition for existing dollars and prices will fall.
When the relationship of a nation’s currency is extremely asymmetrical (ie. extreme money printing) to its availability of goods and services, you may encounter hyperinflation.
Inflation ultimately dilutes from savers and anyone who holds the currency. Deflation rewards savers.
New money printing adds cumulatively to the existing stock of the currency. It is never destroyed. Unless you literally burn your green dollars, all money will remain in circulation. Only the government can retire or reduce the money supply.
Money is always working somewhere. Money naturally flows to go where it has the most value. Into a new business, the stock market, the bond market, savings account, a new home. It ebbs and flows and reaches equilibrium. It’s only idle when buried in the ground, or underneath your mattress. Money is constantly flowing and working. It changes hands. It’s the intermediary for all financial transactions.
Taxation is government redistribution of the currency. It moves money from person A to person B, from one sector of the economy to another. Taxation doesn’t reduce the money supply, it merely changes its direction and flow. Taxation alters the direction of where the next nominal dollar will be spent.
The government, as a sovereign nation, has the power to print its own currency. It does not need to tax to pay its debt. It taxes to change the flow and the direction of money.
The US Treasury is a government office in charge of the IRS. They are comparable to the accounting department of a business. They manage the collection of revenue (Taxes) and the payment of government bills. They manage the act of printing paper dollars and minting coins. They issue government bonds and buy back bonds. They work in cooperation with the Federal Reserve Bank.
The Federal Reserve is the Central Bank of the United States. They are the bank to the banks. They handle all bank deposits, hold deposits for banks and for foreign countries. They can buy treasury bonds, create money and determine bank interest rates.
New money is created by the Federal Reserve. The Federal Reserve can inject new money by crediting the deposit account of the US Treasury. They can also buy bonds from the open market or directly from the Treasury.
When the Federal Reserve buys back bonds, it pays interest. That interest paid is fresh new money.
The US Treasury raises money by selling bonds to the capital markets. The capital markets can sell these bonds back to the Federal Reserve and new money is created.
The US Treasury uses new money and taxes collected to pay for government services. This is where fresh nominal currency enters the economy. Who are the fortunate recipients of new money? Banks, government contractors, defense contractors, government employees, entitlement recipients, home buyers, schools, et al.
The US Dollar has special advantages unlike other global currencies. 70% of world trade is conducted in Dollars. Oil is traded in US Dollars. When a country wants to buy oil or trade globally, it must do so in Dollars. This bestows unique privileges to the United States.
This current affair creates a “commodity” like demand for Dollars on a global scale. The US has the ability to export its inflation to anyone holding Dollars.
The US Dollar is the international reserve currency. Foreign countries will trade goods and services for Dollars. On the margin, this is equivalent to getting free stuff, in exchange for an IOU letter.
Since the late 1970’s, the US has enjoyed muted inflation. Inflation has been mild globally, even as first world nation’s have levered up their money printing.
From the early 1980’s, global trade has grown exponentially. The Soviet Union has collapsed, opening up the former Eastern Bloc nations, China and Communist SE Asian countries. Capitalism and the Free Market System has spread across the world.
This unprecedented access to new markets, producers and workers have added massive deflationary pressure.
The internet, including email, instant messaging, video conferencing, smartphones, Apple, Google, Facebook, YouTube, Amazon, et al, have created extraordinary speed and efficiency to our business paradigm.
The internet has created an environment for hyper meritocracy. Talent and creativity is free to rise. Blogging, vlogging, software programming, news dissemination, entertainment, teaching, writing, etc.. Former gatekeepers disintermediated.
The entry of 2+ billion additional people into our trading market coupled with the incredible efficiency of the internet has created a deflationary value add economy like never before.
This global environment has hyper accelerated the creation of new products, services and content. It has pushed back on inflation and concealed the adverse effects of central bank easy money policies.
The End
