Wednesday, March 30, 2016
Ashton, What’s Wrong with Money?
Historically, there has been a “marked tendency” for fiat currencies to collapse. They have failed in one of three ways: “slowly, suddenly, or first slowly and then suddenly.” (p. 48) Money fails slowly when “lazy central banks add too much to the supply of money.” It shows up as “inflation creeping slowly higher.” Money fails suddenly “when a traumatic event has a dramatic impact on the society as a whole, and consumers and investors begin to question the survival of the system itself.” (p. 49) This failure is seen in hyperinflation. In the third case “inept or insouciant monetary policy can lead to creeping inflation, which gradually drags at the edges of commerce until it hits a level, a tipping point, where economic actors begin to question whether there is a light at the end of the tunnel after all. This is a common theme in developing countries and especially common in Latin America.” (p. 50)
Where are we, in the United States, now? “Our money is like a 1975 Ford Pinto that is still on the road today. The good news is that it has survived this long, and may well make it another few miles. The bad news is that it also might explode at any moment. We are defying the odds.” (p. 122) The massive expansion of aggregate reserves by the Federal Reserve has led to a “highly flexed economy and highly flexed markets. A break in this steel bar is almost assured.” (pp. 119-20) When it breaks, it will break to higher inflation. And inflation has long tails. Over the last century in the United States, inflation has been over 4 percent 31 percent of the time. And “once inflation exceeds 4 percent, historically about one-third of the time it will be above 10 percent!” (p. 120)
What is the solution to this problem, assuming that it is in fact a problem, that we’re heading toward potentially crippling inflation? Ashton suggests that “it is crucial that we restore to the Federal Reserve the ability to slow money growth by restricting required reserves.” (p. 126) And “while the Fed is making this adjustment, … they should work to keep medium-term interest rates low, not raise them, so that money velocity does not abruptly normalize. Interest rates should be normalized slowly, letting velocity rise gradually while money growth is pushed lower simultaneously. This would cause the yield curve to flatten substantially as tighter monetary conditions cause short-term interest rates in the United States to rise. Of course, in time the Fed should relinquish control of term rates altogether, and should also allow its balance sheet to shrink naturally. … But those decisions are years away.” (p. 127)
Ashton acknowledges that this course of action would entail dislocations in the economy and markets. But he believes it is the smarter trade-off.
In the third part of his book Ashton considers how to invest with inflation in mind. In finance there are only three miracles: thrift, compound interest, and rebalancing. Otherwise, the investor can add TIPS to his portfolio, using a liability-driven approach.
If a person expects a currency disaster, holding gold is not a satisfying answer. “In a calamity, perhaps everyone will suddenly accept gold coins in exchange for goods and services. But I cannot think of why they would. Gold is not inherently valuable to me. I cannot eat it or use it. I can wear it, but I suspect post-Armageddon bling has limited utility.” (p. 176)
The ultimate in Armageddon preparedness is to invest in human capital. Have skills to barter. And “prepare for the lean years by laying up stores of favors with friends.” (p. 177)