The Poison Fruit of The Magic Money Tree - Part 3 of 6

Let us take a country that finds itself with a large and rising debt, and which decides to take Paul's advice that it cannot go bust, and that it can simply print more of these bits of coloured paper with which to pay its creditors. What is the obvious conclusion of such a procedure? Somewhere, in one of the drawers in my house, I have the evidence of what happens. Its a 10 million Lira banknote that my dad brought back from Italy, where he was stationed during the latter part of the war, and after. Another manifestation is what happened in Zimbabwe, which had similar rampant inflation, and, as a result, had to abandon having their own currency, and instead were forced into using the US Dollar.  Had Greece let the Eurozone in 2015, it would have faced the same situation, with the Drachma becoming worthless, and Greece's creditors refusing to accept it as currency.

If we take two countries and assume that the level of productivity in both is the same, they produce two different commodities, each of which they exchange with each other. Country A produces 1 million cars, and Country B produces 10 million tons of wheat. They use national currencies to facilitate this exchange, which actually occurs via hundreds of individual producers in each country. Country A's currency is the Dollar, and Country B's currency is the Euro. The currencies are at parity. Now, Country A decides to double the quantity of its currency units in circulation. If each of these units continued to represent the same amount of value, i.e. a claim on the same amount of social-labour-time, what would be the consequence? First of all, it would mean that people in Country A would have currency able to buy 20 million tons of wheat from Country B. Unless, Country B has increased its output of wheat, all of this additional liquidity would mean that demand exceeded supply, and so the market price of wheat would rise.

In practice, in modern global markets, the fact of the increased quantity of Dollars put into circulation in A, would quickly be picked up by foreign exchange dealers, who would adjust the value of Dollars to Euros. Instead of parity, the exchange rate would be $2 = €1. So, for importers in Country A to buy wheat, they would now have to hand over $2 to get €1 with which to buy wheat. The actual exchange value of cars in wheat would not have changed – 1 million cars = 10 million tons of wheat – but the value of Dollars, as the indirect measure of value would have fallen. The Dollar price of wheat would have doubled, whilst its Euro price would remain constant.

Now its argued that such a currency depreciation benefits A, because, whilst the Dollar price of its cars remains the same, its Euro price has halved, which makes them more competitive. But, the truth is that, on this basis, Country A would now have to sell twice as many cars to Country B as before, in order to be able to buy the 10 million tons of wheat. If the Euro price of a car is halved, then the 1 million cars sold to B, produces only half as many Euros for A from their sale, which means that, either they can only buy half as much wheat as they did before, or else they must sell twice as many cars. Put another way, the workers in A would have to work twice as long in order to have the same standard of living.  Meanwhile, because twice as many Dollars have now been transferred to B, to obtain the Euros required to buy wheat, these additional Dollars can now flow back into A as a demand for cars, so that the Dollar price of cars would then itself rise.

If country A attempted to get around this problem by simply printing more Dollars, so as to continue buying wheat on the same scale, without increasing its own production of cars to exchange for it, then this would simply compound its problem, because the value of the Dollar would then just fall further. This is the problem that all countries face when they try to cover their debts – and the purchase of imports automatically results in a debt – by simply printing additional currency tokens, rather than increasing the value of its own output available to exchange via export for those imports. In the 1960's, the US, increased the amount of Dollars in circulation hugely, as it sought to pay for the Vietnam War, and the expansion of its welfare state, by such means. It had the advantage that the demise of the global power of Britain had made the Dollar the global reserve currency in place of the Pound. All global trade was priced in Dollars, and trade was paid for in Dollars as an alternative to gold. Gold itself was priced in Dollars at a fixed price of $30 an ounce.

But, even the huge US economy, and the power of US hegemony came up against these limits. As the US printed more and more Dollars and used them to pay for its imports, whilst its currency was pegged at an unreal value of $30 to 1 ounce of Gold, which formed the basis of the value of all other currencies, it meant that the US was buying commodities from all other countries in funny money, essentially getting something for nothing. In 1971, France had had enough and refused to accept payment in Dollars, demanding instead payment in gold at the official exchange rate of $30 an ounce. Of course, the US could not do that, because, as events were to show, the real value of the Dollar was just a fraction of that. By 1980, the price of gold had risen more than 25 fold from $30 to $800 an ounce. President Nixon was forced to end the convertibility of the Dollar to gold, which meant that its value dropped significantly against other currencies. It provoked a decade of global currency crisis, which ended with all currencies, including the Dollar freely floating against each other.

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