Sound money isn’t what you think it is

Many people define sound money as being when a currency’s purchasing power is not declining, but stable. This isn’t quite right, so let’s drill down.

Consider two relentless processes occurring in the economy. They are both happening at all times, but it will be easier to look at them separately. One is good, and one is destructive.

First is the quest to reduce costs. This is otherwise known as increasing efficiency. Companies seek to produce more with less. Less what? They want to reduce the use of land, energy, plant, labor, time, and materials. This is occurring at every farm and mine. It is the same at every transportation, logistics, storage, and handling company. And manufacturers are doing it too, as are firms in communications, health care, construction, and even in toys and entertainment.

Suppose the same number of cattle can be raised on half the land, each cow can produce twice as much milk, and a smaller workforce can look after the cows. Isn’t that all to the good?

It is.

At one time, all of the productivity of all of the people was barely sufficient to produce food and shelter. Improved methods of farming freed people from endless back-breaking labor. In other words, the cost of food declined. A meager meal no longer costs a full day’s labor. In fact, today’s unskilled laborer could eat three decent meals on his wage for an hour (and this is despite decades of falling real wages).

Falling costs drive falling prices.

There is a second process, a more sinister and pernicious practice, which is also occurring. The Federal Reserve, which centrally plans our dollar, has a mandate for “stable prices”. In an Orwellian twist, this means a policy to cause prices to rise relentlessly at two percent per year.

To achieve this goal, the Fed tries to devalue the dollar. Right now, it isn’t succeeding on its own terms. The Fed certainly has that power. It’s obvious that the Fed can trash the dollar, just as a petulant toddler can break any toy you put into his hands.

Suppose we lived in a different world. Imagine that the people elected a president who wanted economic growth, along with stable purchasing power for the dollar. This president appointed a new Fed Chairman, who defines stable prices the way you would expect. If a pound of copper cost $2.10 today, then his goal is for it to cost $2.10 in the year 2025.

What would this mean, in practice? Companies in every industry will go on cutting costs and prices, of course. How could they do otherwise? If you are a manager at a food processing plant, and you see a way to save 10% of the shrink wrap used, would you decide not to do it because Congress demanded the Fed deliver stable prices?

So how is the Fed to deal with this unwanted improvement in efficiency? How will the Chairman deliver what the president demands?

He has an idea. The Fed will measure the rate of cost cutting in every industry, and average these rates to come up with some kind of aggregate measure. He calls it IE for Improvements to Efficiency. He will then try Debasement of the Currency—or DC for short—at the same rate. He writes his equation like this:

DC = -IE

He tells the president that efficiency gains can be cancelled out by undermining the dollar. The president calls him brilliant. The Chairman smiles the smile that every bureaucrat has ever smiled, the hubris of central planners the world over. He gets to work on the dollar.

However, there’s just one loose end to tie up. This new arrangement needs a new term. Whatever it is, “sound money” it is not.

Keith Weiner is president of the Gold Standard Institute USA in Phoenix, AZ, and CEO of precious metals fund manager Monetary Metals. He created DiamondWare, a technology company that he sold to Nortel Networks in 2008. He speaks and writes about free markets, money, credit, and gold.