The Scandal of Money: Why Wall Street Recovers but the Economy Never Does - George Gilder (2016)
Chapter 8. Where “Hayeks” Go Wrong
Where “Hayeks” Go Wrong
From Italy’s financial community arises a different critique of prevailing moneys, one that applies not only to fiat currencies like the dollar and the euro, but also to gold and its digital imitators. Let us take this critique seriously and see what we learn about it using our new information theory of money.
Ferdinando Ametrano has seen currencies come and go. He can look the dollar in the face and detect Botox in its apparently smooth Ben Franklin jowls. A self-described “fat, short, bald, and ugly” nerd in his forties, with red eyeglass frames and fashionable bristles, Ametrano began as a physicist. Like so many “quants,” he is a master of the interplay of math and matter. In 2010 he invented the open-source QuantLib framework for monetary math. As he describes it, “QuantLib is a free, open-source quantitative finance C++ library for modeling, pricing, trading, and risk management in real-life.”1 Derivatives traders use it around the world to guide their decisions.
Sounding like Steve Forbes, Ametrano stresses, “When the value of money changes . . . it is not just the value of one good that is changing, but the unit against which every other good is measured.” He warns, “If high inflation is money’s heart attack, persistent deflation is money’s cancer.”2 Both gold and bitcoin, he declared, show a fatal deflationary bias.
“In the last twenty years,” Ametrano points out, “it has become more and more clear that the banking system built around fiat currencies is not adequate to the new digital realm defined by mobile communication, Internet, and social networks. . . . As everybody gets used to carrying around in their mobile phones powerful computers, hours of video and audio entertainment, and immediate access to an immense amount of information, the expectation has arisen to be able to pocket a whole efficient and fair monetary, financial, and banking system along with it.”3
Yet, in his view, gold and digital gold cannot play this role because of their deflationary bias. To back up his critique, Ametrano summons Friedrich Hayek. The eminent Austrian offered similar objections to a proposal for private money backed by gold: “It would turn out to be a very good investment, for the reason that because of the increased demand for gold the value of gold would go up; but that very fact would make it very unsuitable as money.”4
Ametrano adds, “The unfeasibility of a bitcoin [or gold] loan is similar to that of a bitcoin or [gold] salary: neither a borrower nor an employer would want to face the risk of seeing her debt or salary liabilities growing a hundredfold in a few years.”5 He concludes, “This is the cryptocurrency paradox: In the successful attempt to get rid of any centralized monetary authority using the Bitcoin protocol, the bitcoin currency has inadvertently thrown away the flexibility of an elastic monetary policy.”
In a presentation to the Bank of Italy, Ametrano rejected the idea that bitcoin will lose its instability with wider adoption: “This is indeed true, but not at all sufficient for stable prices, as demonstrated by the need of monetary actions to stabilize even globally accepted currencies such as the Euro and US dollar.”6
One can imagine the eminent men of Banca d’Italia nodding solemnly at this observation. But Ametrano is a devout Hayekian and does not like arbitrary policy from central banks any more than he likes arbitrary deflation from a distributed peer-to-peer currency.
As an alternative, Ametrano presents the idea of a new kind of coin that he dubs “Hayek money.” Let’s call them “hayeks.” These coins overcome the putative volatility of gold or bitcoin as units of account by continually rebasing the value in response to changes in a commodity index. He would have all the wallets in the digital coin system regularly increment or decrement the number of units in accord with the movement of the index. If you had fifty hayeks when the index was at one hundred, you would have one hundred hayeks when the index went to two hundred.
In response to objections that these quantitative changes in individual wallets are alarmingly novel and unorthodox, the Italian guru points out that central banks now do the same thing. They routinely manipulate their own digital wallet—the “monetary base”—by expanding it during deflation and reducing it during inflation. As Ametrano observes, these actions of the central bank affect all the holders of the currency, depleting the accounts of debtors during contractions or of creditors during inflations.
As the Austrian school of economics explains, these actions also impart immediate benefits to the banking institutions that carry them out, affording them the profits of seigniorage, gains stemming from the difference between the coin’s cost of production and its value. The central banks and government Treasuries win most of these gains. But these quantitative changes also lavishly benefit any early borrowers or lenders of the government money who can act before related price changes propagate through the economy.
Central banks currently change the money supply through a Rube Goldberg contrivance of open-market operations buying and selling Treasury notes, “quantitative easing” through purchase of private bonds and other assets, adaptive “twists” of yield curves and maturities, reserve requirements regulating bank leverage, and interest-rate manipulations that change the cost of money.
These measures deny most of the users of the money any pro rata increase in their quantities during inflations and inflict borrowers with the full brunt of contractionary policy (they have to pay back their loans with more valuable units than they received). In the late 1990s, an unexpected 26 percent deflation (increase in the dollar’s value) bankrupted a thousand companies that had incurred large debts in the multifaceted process of building out the Internet with advanced fiber optics.7
By contrast, Hayek money would automatically expand or shrink the money supply in an entirely equitable and proportionate way, distributing these changes across the entire range of coin holders, with no preference for cronies, or affiliated banks, or other special interests.
Hayek money is the proposal of a libertarian. Hayek is the cynosure of libertarians, and he wished currency to become market-based. Escaping the distortions of monopoly and sovereignty, management of hayeks could rely on an automatic formula. If it didn’t work well, other entities would launch competitive currencies. Hayeks might return the world to the Edenic realm of “free banking” of the nineteenth century. Free banking might have failed as the country was unified by railroads and telegraphs. But today it may well become possible again on the Internet.
Hayek money is the proposal of a banker, who believes in the power of monetary policy. And Ametrano’s system would be based on the analysis of an economist, who believes in the validity of price indices.
The issuance of new coins would be governed by the change in the prices of a basket of commodities comprising precious metals, such as gold and silver; standard foodstuffs, such as wheat and soy; and energy units, such as “Brent crude oil” and natural gas. All these items benefit from their relatively immutable unit definitions. Whether troy ounces of gold or British thermal units of energy or standard bushels of wheat, these items—so it is maintained—have not changed in character or essential quality for a century.
An economist with a specialty in quantification, “a quant,” Ametrano also believes that the appropriate index could be modulated by inclusion of other relatively scientific price-level indices such as the general inflation corrective, the Federal Reserve’s GDP deflator. Also available are the personal consumption expenditures inflation indicator of the Department of Commerce and the consumer and producer price indices (CPI and PPI) tracked by the Department of Labor. As the Fed explains, the most common type of inflation measure “excludes items that tend to go up and down in price dramatically or often, like food and energy items.” For these, “a large price change in one period does not necessarily tend to be followed by another large change in the same direction in the following period. . . . Core inflation measures that leave out items with volatile prices can be useful in assessing inflation trends.”8
Ametrano’s excellent paper incorporates, with stark lucidity, the fundamental weaknesses of the prevailing theories of money. They are all trying to find some stable proxy in the real world to “peg” to. “Two families of Hayek monies” might peg to different commodities, writes Ametrano: “Gold, as the immemorial monetary element,” and “petroleums, grains and industrial metals.” But we already know of Ametrano’s and Hayek’s ambivalence about gold, and “petroleums, grains and industrial metals” show more volatility. After all, grains and petroleums are precisely the items that tend to be excluded from “core inflation.”
Thus hayeks would move the focus of monetary policy from quantitative changes to changes in the composition of the commodity index. That is already happening in the world of the dollar, with “hedonic” adjustments and other technical adaptations of the CPI. It takes armies of accountant-economists, in several branches of the U.S. government and similar entities at the Organisation for Economic Co-operation and Development, the United Nations, the World Bank, and other institutions, to track all the price movements in the market. Pursuing the calculation of “purchasing power parity,” they try to gauge which changes signify the “real” level of prices. MIT includes literally millions of prices around the world in its comprehensive index called “Beta.” Giving up on all these perplexities, the Economist sometimes throws up its hands and resolves on a global “Big Mac” index. Others prefer a “Brooks Brothers Index” tying the price of a business suit to an ounce of gold.9
Under the “hayek” regime, the management of the basket on which all valuations and arbitrage will rely becomes all-important. The central question in political economy would then become the procedure and timing of basket management. We already know that Ametrano (and putatively Hayek) have impugned gold in this role because of its deflationary bias. Ametrano proposes a commodity price index determined with a “resilient consensus process that does not rely on central third party authorities.” He seems to prefer an index heavily influenced by the prices of grains and Brent crude oil and makes an effort to show that such an index would result in relatively stable prices.
Ametrano quotes Hayek: “Changes in the importance of the commodities, the volume in which they were traded, and the relative stability or sensitivity of their prices (especially the degree to which they were determined competitively or not) might suggest alterations to make the currency more popular.”10 An extreme example, says Ametrano, “would be a major breakthrough in green energy that would make petroleum useless.” So much for Brent crude.
What Ametrano sees as an exotic possible breakthrough in energy technology, however, is in fact the condition of the entire entrepreneurial economy. All existing goods and services are vulnerable to innovation, which is, as Joseph Schumpeter insisted, the very law of capitalism. To treat it as some kind of exceptional or anomalous event is a fundamental error.
The information theory of capitalism defines growth as learning. Its microeconomic manifestation is the learning or experience curve in individual businesses and industries. As we saw in chapter 2, it is the most thoroughly documented phenomenon in all enterprise, ordaining that the cost of producing any good or service drops by between 20 percent and 30 percent with every doubling of total units sold.
Crucially, the curve extends to customers, who learn how to use the product and multiply applications as it drops in price. The proliferation of hundreds of thousands of applications for Apple’s iPhones, for example, represented the learning curve of the users as much as the learning curve at Apple.
All these curves document the essential identity of growth and learning as a central rule of capitalist change. Sound management of money cannot focus on finding stable elements among existing goods and services that are endlessly multifarious and changing. These very changes are what money must measure. The only feasible goal of policy is to foster neutrality between the past and the future. This entails equity not between industries or localities but chronological equity: equity not in space but in time.
What Ametrano is advocating, with all the confidence of his expertise, is submission of monetary policy to the interests of the most-static and stagnant interests in the economy—the very parts that have passed beyond their learning curves onto a plateau of drifting costs defended by expanded political lobbies. This is what “commodities” are. It is rearview-mirror monetary policy reflecting the need of recumbent sectors for protection against more-creative domestic and foreign rivals.
By seeking to impart a bias of inflation to prices, the commodity basket tends to a zero-sum vision that fosters trade wars of devaluation. The basket of commodities is the one part of the economy that operates as a zero-sum game. As it erodes through the advance of innovation, its prices tend to drift upward, skewing the time value of money.
The redemptive force of gold is its neutrality in time and thus its orientation toward the future. Hayeks would substitute an anachronistic commodity basket for a predictable deflation based on the scarcity of time and abundance of learning.
Commodities are by definition low entropy, but if all valuation and arbitrage is based on them, politics will converge on the basket and its composition. What is the composition of a representative basket of goods? It is the backward-looking selection of products that were important in the existing economic configuration. It is a representation of the economy of the past, consisting of mature products and ingredients. These are goods that have already attained volumes that put them beyond the fast-moving parts of their learning curves. As the key element in a monetary index, commodities impart an inflationary bias to economies, penalizing the future, rewarding borrowers, and punishing investors.
The genius of gold is not to root valuation in some politicized process of sampling the past, but to root it in the residual scarcities in a capitalist economy of abundance. The deflationary bias reflects the reality of a capitalist economy of abundance and creativity playing out against the irreversible passage of time.
To the Austrian economics of subjectivity, time provides an objective foundation. In reaching for commodities in which to anchor his system of value, Ametrano should have ended with gold, with its intimate links to the irreversibility of time. In the end, a test of bitcoin or any other blockchain will be the price of gold. If in a mature bitcoin system the gold chain massively bifurcates from the blockchain, it will signify a disorientation of values. As in bitcoin itself, the majority of users will decide which branch bears economic truth.11
Since its creation in 2009, bitcoin’s price movements have been 80.4 percent correlated with the gold price.12 Bitcoin’s relatively tiny float has imparted much greater volatility. But its following gold down in 2014 should not have been alarming. If and when bitcoin matures into a meaningful currency, its kinship with gold, rooted in time, should become increasingly manifest.
The conservative theories of money fail to address these issues. Let us now turn to the premier money theorists on the Left and see what they get right and wrong.