I’m not happy with this post. I tried to mix some rather speculative economic thinking with an attempt to explain to a wide audience, and it doesn’t work. I’ll rewrite it as geeky economic article.
The asset bubble that started in the late 1990s and exploded in 2007 as the financial crisis was caused, in my opinion, by our monetary system. In particular, the following cycle took place:
- The general public in western, mainly Anglo-Saxon, economies started using real estate as hard money, profiting from its parasitic appreciation linked to GDP growth. The real economy deflated against housing.
- Banks issued new money backed by the rising real estate. This broke monetary policy by expanding the money supply first as intended but then beyond, as banks used securitized debt to evade regulation and recycle their license to create money and use it as their capital.
- A positive feedback loop developed, where appreciating houses led to banks issuing more money, which led to inflation of money against housing. The market responded by raising house prices further, until both housing and housing-backed money crashed.
The system of money used by western economies, although no secret, is not widely understood by the public. I’ll explain how our monetary system works, how it caused the crisis, and how it ought to be reformed in principle. Obviously I have no tried and tested new system to propose, but I’ll try to articulate what new conditions it should meet.
Hard money and its parasitic appreciation on GDP
The traditional conception of money is as a fixed quantity, such as a ton of gold. It changes hands, and some people hoard it, but it doesn’t grow or shrink. That way the value of goods can settle against gold through the market. This “hard money” concept served well for most of history because the size of the real economy didn’t change much either. In a static economy, a gold coin buys a sack of wheat, say, now or in a hundred years. Using gold does nothing to erode inequality, but doesn’t amplify it either. Sitting on gold yields zero return, so any productive investment whose risk-adjusted real return is above zero beats that, and will probably get funded.
Continue reading →