Sound Money Monthly: (ed.4) Where can we place our trust?

TLDR: The foundations of social trust are being tested. Our unsound monetary system with its negative consequences is a driver of this trust deficit. Communities that adopt sound money assets take a proactive step towards trustworthy relationships and away from the insidious consequences of unsound money.

Youtube summary video:

Trust – there’s simply not enough of it.

Look around and tell me honestly, do you trust? If you’re like me, you trust your family, neighbours and colleagues. But do you trust the people further afield in the next suburb, town or city? From the number of protests on the news across the globe in recent years, I worry that societal trust isn’t quite where it should be. What do you think? And what about government? They play a big role in your life; do you trust them?

Trust in government is an articulation of social trust. Governments are elected to represent our communities, cities and provinces. If we trust government, there’s a broader sense of social stability. Trust in the US government has trended steadily lower over the past 40 to 50 years. Gallup reports that the percentage of Americans who have zero trust in government has risen from 2.5% in 1972 to 19% in 2020. The American National Election Survey (ANES) shows that the percentage of Americans who trust their government has fallen from 50% in the 1950/1960s to 17% in 2016. We see similar stats across western democracies.

Money is half of every interaction

Money and our monetary system are at the centre of our economic and political life. Unless you live off-grid, money is a component of almost every daily interaction. In this piece I argue in that our unsound money is a key factor driving the trust deficit.

In this context, “sound” does not relate to the audible sensation in our ears; it means free from defect, healthy, financially safe, secure and trustworthy. For example, “sound advice” is trustworthy advice.

Short-termism is constant – what’s different?

Our unsound monetary system is defective, unhealthy, insecure and untrustworthy. It allows record low interest rates and record high debt levels with no consideration of the consequences. Consequences like, weak economic growth, low social ability, constrained investment returns and wealth inequality, which erode our societal trust . In edition 3 we said that our natural short-termism is a major cause. Governments “stimulate” economic policy at any sign of economic, social or financial volatility because they don’t want to rock the boat while they’re in power. But humans have always had a short-term focus. And the world hasn’t always lived in such unsound monetary and financial conditions. So, what’s different now? There must be more to this story than just short-termism, and election-focused politicians!

Trust real constraints over politicians

Historically, monetary systems had constraints on money and debt growth. A dollar, pound, euro or rand would have equalled a certain amount of a commodity. The only way to increase the money supply would’ve been to (1) produce more of the commodity or (2) honestly devalue the currency relative to the commodity. The time and production costs limit creation of the chosen commodity, leading to a monetary soundness, or at least honesty if the devaluation path (2) was chosen. A measure was in place to ensure monetary truth and trustworthiness. Politicians couldn’t just manipulate money for their political ends at a whim without clear and immediate consequences.

Throughout history, the market gravitated towards gold as the commodity to provide this constraint. Sometimes people think of gold as this mystical substance and envision gold investors as old men under green lights in a basement, so let’s debunk that myth. There’s nothing magical about this yellow metal. Gold has certain metallurgical properties, which make it a good “store of value”.

Precious for a reason

Gold is difficult to find, expensive to mine, non-perishable and doesn’t corrode easily. It’s literally, precious. We don’t use precious substances to make “useful” day-to-day products like laptops, cars and ovens because they age and are replaced. It would be a waste to extract the gold from a laptop every few years. Gold has ornamental characteristics, rather than traditional “use-cases”. Its scarcity, durability, transportability and network effects* imply that it’s good at storing value. As an example, if you bought a piece of gold in 1900, you’d be confident it would still be valuable in the future, through numerous unpredictable political, economic and social regimes.

*Gold’s network effects are NB – it’s useful that other people will exchange value for gold. Obscure metals like ruthenium and rhodian are scarcer than gold, but they have no network effect. I.E. The fact that you can sell gold at a local pawn shop, is useful.

Gold’s scarcity properties are well characterised in the stock-to-flow ratio, which reflects the global stock /quantity of a commodity, relative to the new annual supply of that commodity. Since gold is always stored, we don’t consume it and therefore the stock grows higher each year. The stock is massive relative to the flow or newly mined gold each year. Gold’s elevated stock-to-flow ratio is in stark contrast to every other commodity. We eat wheat, we burn oil and we use copper to make perishable products. You can store these commodities, but it’s expensive because they take up space. And many of these items perish/erode over time. That doesn’t imply that they aren’t useful, but they aren’t good stores of value.

Constraints, consequences and trade-offs

Gold’s store of value characteristics meant that it provided a sound foundation for monetary systems. If money is linked to gold, politicians can’t suddenly get their hands onto new quantities of money. No matter the change in the price of gold or the political pressure, the growth in new annual supply doesn’t change much because it’s difficult to suddenly increase production. A natural commodity constraint introduced a powerful restraint on politicians. If government wanted to raise new finances, they’d have to issue debt on the open market and face up to the market’s opinions of their plans. If central banks wanted to stimulate policy through lower interest rates, it would be far more temporary in nature, because otherwise trading partners would demand gold rather than currency (like the French tried in the late 1960s). Stockpiling would be required in advance of crises leading to prudence and longer-term strategies as opposed to the short-termism endemic today.

The global monetary system broke its linkage to gold in 1971 when US President Richard Nixon ended convertibility between the US dollar and gold. Ever since, the US budget deficit and government debt levels have become unhinged.

The US acts as the world’s hegemon, leading economic, political and financial trends. The rest of the world followed in its profligate footsteps over the past 50 years.

The consequences of the unsound monetary system have also become obvious since 1971. For example, financial assets were much more fairly valued before the Nixon Shock, which speaks to the unequal wealth impact of unsound money.

There’s a website that posts charts on this theme, @WTF_1971. Labour hasn’t been compensated for its productivity growth since 1971 as returns have accrued to capital. Once again, US data but the trends are global.

The unsoundness of the current monetary and fiscal regime boils down to the lack of constraint on government’s ability to conduct expansionary monetary and fiscal policies. Constrained supply assets, like gold and bitcoin, impose constraints on government, limiting the insidious consequences of their unsound policies. There’s nothing magical about gold, it’s merely difficult to find, expensive to mine, doesn’t erode has thousands of years of network effect. Apart from the history, Bitcoin holds similar characteristics. Its algorithm ensures scarcity. There will only ever be 21 million bitcoins. It’s costly and difficult to create new bitcoins, due to Proof of Work (PoW). If you don’t understand PoW, don’t worry. Just appreciate that gold and bitcoin (digital gold) and sound money assets, because they impose supply constraints and are difficult to create.

Challenge and opportunity of our lifetime

I’ve come to the realisation that sound money is the challenge and opportunity of our lifetime. Challenge, because numerous social ills are indirectly linked to our unsound financial system; weak growth, low social mobility, constrained investment returns, inequality and now we can add deteriorating social trust to the ever-growing list. I’ve committed myself to help people understand and overcome these challenges through proactive solutions. Gold and bitcoin are unconventional, volatile and come with risks, but they present incredible opportunities to create peace of mind, integrity and a semblance of trust within an uncertain world. Social trust isn’t going to emerge when your favoured politician comes into power. Social trust will emerge when the foundation of our economic, social and political system is based on reality, something sound.  Regime change towards monetary soundness will take time, but people and communities who adopt sound money assets, take a step towards reality and away from the insidious consequences of a defective monetary system.

Relevant links and previous editions:

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9 thoughts on “Sound Money Monthly: (ed.4) Where can we place our trust?

  1. Thank you for a very thoughtful article.
    In particular, the evidence that you bring to bear here is so persuasive. This is one of my favourite posts. Extremely persuasive. And worrying. Perhaps most worrying for me is the idea that these practices begin to distort objective reality. I’ve always thought about the direct consequences of failing to follow sound money principles as being clear and direct. Hyperinflation. It seems to me that the consequences of unsound money in a modern economic system are pernicious and multi-faceted. Where I am a bit sceptical is that you may be overfitting the social ills before us to debt and low interest rates. I understand the power of economics in making our world. But can it be this direct and pronounced? I don’t necessarily think that human beings are short term in their thinking but rather that we are caused to be short term in our thinking by political structures that create bad incentives. And I think that there is something about democracy that makes us prisoner to short term thinking. Just the idea that every four or five years we need to rethink where we are headed. A reset, with new ideas, new needs and objectives to fulfil. And so I’ve been thinking if unsound money is a product of democracy that needs to be inoculated against in a constitution. In studying various histories of monetary systems, have you come across societies that were organised in a different political system to a democracy that have come under destruction as a direct consequence of unsound money?

    1. Thanks Mak.

      I’m cognisant of over overfitting.

      I’m trying to walk step by step through the relationships, rather than just jump straight to the conclusion. All I can recommend is that you, me and others critique each step the analysis. If we look at all the conclusions at once, then I look like a conspiracy theorist 🙂 Conspiracy theories are not my intention. I genuinely think that we need to solve our unsound monetary system to solve numerous societal ills. I really desire positive solutions and better outcomes for people.

      Turning to the example in this note, trust. I’ve gone into the mechanics of why our monetary and financial system is untrustworthy. Perhaps an example may also help.

      E.G: When the US government prints US dollars to bail out banks (unsound monetary practices) what does it do to societal trust? People know that the bankers still got their bonuses and that they never felt the consequences of their imprudent actions. Movies and books are produced in the years thereafter, which show the untrustworthy decision-making… I’m sure that these actions slowly erode trust. Probably not overnight and not linearly, but it certainly doesn’t make people trust banks and the monetary system more! I’ve only given one example.. Imagine the thousands of shady deals that happen in the background under an unsound monetary regime that slowly erode trust.

      I maintain that humans have a natural inclination towards short-term thinking. Call it our primal or animal nature. We all want to eat, drink and satisfy our desires asap, particularly when we’re children. Obviously to varying degrees, but I think its pretty clear that most 2 year olds think shorter term than 20 year olds, who think shorter term than 40 year olds. A combination of natural maturity through age and positive social structures encourage longer-term thinking.

      In a “good society” there are all sorts of social pressures towards longer-term thinking. A social institution like marriage isn’t necessarily natural, but it stops people from looking for a mate and causes them to plan out their future together, which I’d argue causes longer term thinking (most of the time). I’m not saying its the perfect mechanism, but I do think its a mechanism that societies have instituted to encourage longer-term thinking, elevating society above the individual. I’d argue that most basic societal rules play a similar role. Children love to lie, cheat and steal but society coerces us into better (longer-term) social practices.

      Personally, I don’t think that democracies would’ve been possible without sound money. Societies with unsound money would’ve been too chaotic to create something as complex, sophisticated and luxurious as democracy. I don’t know the history well enough, but I doubt that there were many successful societies in history that didn’t have reasonably sound monetary systems. It was usually the shift from sound money towards unsound money that was a key component of the eventual downward of the empire, like the Romans.

      Democracies certainly aren’t a final static destination. They require work and participation. Modern democracies appear to be getting complacent and highlighting the flaws in democracy in recent years. This trend looks set to continue.

      I’m obviously not sure, but I don’t think democracies would’ve gotten themselves into so much trouble if they had sounder monetary systems. Unsound money creates government and social excess, which wouldn’t been possible under sounder regimes.

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