If you don’t feel inspired to draft an economic treatise, you’ve finished the newest Swedish crime novel, and sleep still eludes you on an intercontinental flight, you can always catch up on the latest Hollywood blockbusters. You might not bother to see them in a theater, but it’s a long flight.
A couple of days ago, trapped in such a state of mind and body, I watched “The A-Team” on the in-flight entertainment panel. Thinly based on the formulaic hit TV series of the 1980s, there was plenty of good-guys-versus-bad-guys action and lots of pyrotechnical chase scenes. In the end, rest assured, the good guys win, and one of them even gets the girl. But what tickled my economist’s antennae was the storyline: The A-Team’s mission was to recover stolen plates used for printing US hundred-dollar bills. As their CIA handler put it, they had to get those plates back before some rogue element uses them to print “unbacked currency.” Sounds grave, doesn’t it?
Indeed, my reaction was, “So what?” Currency hasn’t been backed since the collapse of the Bretton Woods system in 1973. Until then, you could get a dollar’s worth of gold from the Federal Reserve for each dollar bill you turned in. Now, all you’re likely to get in exchange from the Fed is another dollar bill (and a puzzled look from the person behind the counter).
What actually supports a paper currency’s value? Nothing, it turns out, other than our steadfast belief that it is “worth” something. The entire, vast international monetary system is built upon this self-fulfilling confidence. Inflation – when a currency is losing its value – reflects waning confidence in that currency. This would logically mean that deflation’s lower prices indicate a currency has risen in value. In other words, our confidence in it as a store of value has increased.
But this is one of those times when logic and reality remain far apart. Economists have a useful term for describing how much money flows through an economy. They call it the monetary base. This refers to money in public circulation or in commercial bank deposits held at the central bank. Does the tidal wave of unbacked US dollars now flooding the monetary base of the US really reflect greater confidence in the dollar’s value? This amount has soared from 800 billion to a dizzying 2 trillion dollars since 2008.
Has the financial crisis really made us more confident in our governments and central banks? Some well-regarded economists argue that the Fed can print as much unbacked currency as it wants. As long as this money doesn’t find its way to the public, through loans made by financial intermediaries, they say it has no impact at all. The Fed and the other central banks are just “pushing on a string,” as the much-used metaphor goes.
This is a rather half-baked thesis, in my view. Carried to its logical conclusion, it would mean that countries without financial intermediaries would never face inflation, which is simply not the case. Such countries are usually very poor and the printing press has always been a major source of government revenue, and inflation. The technical term for this type of revenue comes from the Middle Ages: seigniorage. It describes a situation where only lords (in French, seigneurs) had the right to mint coins, which allowed them to profit from the difference between the face value and the intrinsic value of the coins.
In a similar vein, governments in very poor countries often use unbacked currency to pay their bills. This practice tends to erode confidence in the value of their currency and, thus, fuel inflation. In the developed world, when we read press reports that, “under quantitative easing, the Fed is buying US Treasuries,” it sounds like rather serious high finance, doesn’t it? In fact, it is good old seigniorage.
It comes wrapped in more complex terminology to hide the fact that things may no longer be quite under control. My view on the ongoing deflation/inflation debate is that, yes, due to various misperceptions, deflationary pressure may persist for a while yet. But in a world awash with unbacked currency, the inevitable outcome of running the printing presses is inflation. As Colonel Hannibal Smith, leader of the A-Team and played by the redoubtable Liam Neeson, tellingly says, “There is no Plan B.”
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