Why the money supply should be linked to economic growth

Andreas Bjerkedal

January 27, 2021

Capitalism is under attack. Our economic system is blamed for the escalating imbalances we witness in the world today. But capitalism is not at fault, the monetary system is. Capitalism lifted Western workers out of poverty, from the subsistence level to a state where most could afford to buy several times the food they needed. After the monetary gold standard was abolished in 1971, however, prosperity growth has slowed in many countries. Inequality has soared.

Gold became the unifying world currency because it was trusted by all nations. The trust was mainly based on the ability of gold keep prices stable, a quality it owed to a supply that increased roughly in line with economic growth. This made it difficult for banks to lend money that was not earned by the real economy. Consequently, global debts stood at approximately 100% of GDP when the gold standard was unilaterally suspended by the US government in 1971.[i] That level has since risen to about 300% of GDP. The increase appears to be exponential, with debts outgrowing the world economy by a factor of 7 in 2017.[ii]

The tripling of debt relative to real economies has resulted in a situation whereby banks have almost tripled in size relative to, and at the expense of, the rest of society.[iii] This is problematic because only debt growth that corresponds to economic growth is productive. The remaining debt expansion bids up prices rather than economic growth and leads to a misallocation of human and capital resources from productive endeavors towards speculative ventures. This has resulted in a steadfast decline in economic growth to a level that is less than half of what it was prior to the suspension of the gold standard in 1971.[iv]

In 2017, global debts increased $21 trillion from an economic base of $76 trillion (GDP). Of the $21 trillion in new debt, only $3 trillion can be said to have originated in the real economy as measured by GDP growth[v]. The remaining $18 trillion was added by the financial system. $2 trillion of it went into inflating consumer prices (CPI). The rest, a staggering $16 trillion, or 21% of world GDP, inflated other prices, such as those of stocks and real estate[vi]. Even if only the CPI component that is targeted by governments is officially called inflation, all $18 trillion of excess debt growth inflate prices and are also inflation. The main beneficiaries of this inflation are banks, who can create loans and deposits at will[vii], and investors eligible for bank credit.

Several reasons are cited as justification for the inflationary monetary system. The simplest argument is that we need inflation to make sure we never revisit the deflation that brought about the Great Depression of the 1930s. However, Alan Greenspan, the longest serving chairman of the US Federal Reserve (1986-2005) had a different view. He explained that the Great Depression was brought about by US policy mistakes rather than the monetary gold standard. When the United Kingdom experienced capital flight in the late 1920s, the US Federal Reserve tried to help by making US investment less attractive for UK investors. The Fed added reserves to US banks in order to lower US interest rates, but the unintended consequence of this move was massive expansion of US debt. The debt growth fueled a stock market bubble, which, once it burst, was met with another policy blunder by the Fed who this time raised interest rates.[viii]

A second theory that suggests that inflation is good is based on observations by economist A. W. Philips. Mr. Phillips combed 60 years of UK data, a stretch that spanned two world wars and the Great Depression, and found that unemployment tends to decline when prices rise [ix]. Phillips´ observations were no doubt real, but they were based on periods that were not representative of normal market behavior. When governments sent soldiers to war and created money to pay for it, inflation rose and unemployment fell, but this does not mean that inflation is good. Similarly, when Winston Churchill withdrew excess Pound Sterling from circulation following World War I, the result was deflation and rising unemployment, but this still does not mean inflation is good. This was confirmed after the gold standard was abolished at the end of the Vietnam War.  At this time both inflation and unemployment rose in what was later called the stagflation of the 1970s. After this, Phillips´ theory was largely discredited.

To replace Phillips´ observations, a new reasoning in defense of inflation has emerged. It is now argued that inflation protects businesses in economic slowdowns by allowing them to improve their financial situation without having to resort to potentially destabilizing wage cuts. The prospect of rising prices to lift corporate sales and revenue provides companies with a cushion whereby they can keep wages stable, or increase them slightly, and still manage in an economic recession. This is good news for business, but for workers it means that their purchasing power may deteriorate without them even being aware of it. When we take into consideration that only $2TR of the $18TR in inflationary debt growth are actually associated with a loss in purchasing power, this becomes particularly problematic. Inflation is much higher than what is reported.

Bitcoin is often referred to as digital gold. Due to its un-political and trustworthy nature, some people believe Bitcoin will assume gold´s role as world currency. They have named this concept the Bitcoin Standard. The main problem with Bitcoin in this context rests in its fixed supply of 21 million coins. The gold supply, in contrast, grew more or less in line with the real economies. When the supply of money grows slower than economic growth, prices must fall to compensate. This is what we call deflation. Falling prices would make people hoard the currency and steer away from buying things that could be bought later at a lower price. This would include housing. The resulting rise in unemployment in the construction sector would likely spread to other sectors and trigger a deflationary spiral. A fixed circulation currency would motivate currency hoarding until GDP growth hit 0%, at which time prices could stabilize. However, with productivity growth always a factor in free society, a 0% GDP growth would mean rising unemployment and a prolonged economic recession that could ultimately threaten the fabric of society. Bitcoin´s deflationary nature makes it unsuitable as a new global currency standard.

The solution to the problems associated with inflation and deflation is to have neither. The only way to do this is to link the currency supply to economic growth. By mirroring money and the real economy, money will be a pure representation of real value. Since 1944, when a reliable calculation for economic growth was presented at the Bretton Woods conference, we have had the capacity to create real money. GDP, Gross Domestic Product is an expression of the value of economic activity within a country, defined as the total market value of goods and services produced. Knowing this number, and the fallacy of inflation, there is no reason why the banking system should be allowed to create and lend money that is not earned by the real economy.

GDP-linked money will also remove the ever-larger boom and bust cycles that follow from a monetary system based on inflation. As long as governments continue to target consumer price inflation, debts will continue to grow relative to GDP and lead to higher asset prices. The longer the inflation campaign continues, the more obvious it will be who is in charge of it. If nothing is done to contain it, governments should prepare to admit responsibility for the consequences of systemic inflation. Even if central banks were able to refine their methods for managing the markets to perfection it would still not justify inflating asset prices to the extent that people become dependent on inheritance to own a home. Certainly, this is not how capitalism used to work, or should work.

Money has three functions. It should be a way of pricing and paying for things, and it should be a reliable store of value. Gold served all three functions reasonably well, but after we abolished the gold standard there is no longer a monetary store of value in existence. This undermines balance and integrity in our national and international enterprise. The virtue of free trade has never been refuted, but it relies on sound money to be fair and sustainable. When the current monetary system was dictated by the US at Bretton Woods in 1944, the US was by far the largest creditor in the world, owning 70-80% of gold reserves. Today, the US is the world´s largest debtor and runs the world’s largest trade and budget deficits. It is time to reinstate real value as the cornerstone of the global monetary system.

A GDP-linked global currency with a status similar to that of gold would makes nations trade within their means. A nation cannot run a continuous trade deficit because there would be no money to finance it. When the gold standard was in operation, this protected Western workers from undue foreign competition and gave rise to the equality and prosperity that was the hallmark of Western society in the 1950s and 1960s. A GDP-linked world currency will reinstate that level of equality on a higher level of prosperity.

A GDP-linked world currency does not preclude national currencies. On the contrary, individual countries should keep their national currencies, just like they did when the monetary gold standard was in operation. Countries must have flexibility. There is nothing wrong with using monetary policy to smooth out national business cycles as long as it takes place from a balanced base. A way of accomplishing this would be to regulate the money supply in such a way that it increases with average rather than actual economic growth. Nobel laureate (1974) and dean of the monetarist school of economics, Milton Friedman, proposed a solution like this with his k-percent rule.[x] The k-percent rule was based in the standard conceptual framework used to analyze monetary- and balance of trade problems historically, namely the so-called quantity theory of money.[xi] As a national policy instrument, the k-percent rule would be a simple way to conduct prudent and pro-active national monetary policy, but as a global benchmark currency it would fall short because it would entail an element of politics that would be unnecessary for a global currency.

To quote Friedrich August Hayek, Nobel laureate 1974 and dean of the Austrian School of Economics:[xii]“Though there is every reason to mistrust government if not tied to the gold standard or the like, there is no reason to doubt that private enterprise whose business depended on succeeding in the attempt could keep stable the value of the money it issued.”

A global currency must define money as a pure representation of GDP growth and cannot deviate from this definition without becoming subjective and political. Gold was objective and un-political, but never a pure representation of GDP growth. The gold supply was erratic and lagged economic growth for most of the 20th century.

Unlike gold, Globe currency will be a 100% representation of real value as measured by global GDP data. Globe is a perfection of the gold standard and has only one objective: to supply the correct amount of money to the world in the most transparent and trustable manner. As nations transition to a GDP-linked global currency such as Globe, human and capital resources will flow towards productive enterprise, trade will balance, and people´s purchasing power will be protected. The balance that GDP-linked money represent on the national level will allow governments the leeway to focus more on the larger challenges that humanity is faced with. It is not a minute too early.

Trond Furnes, Globe

  • [i] US Federal Reserve/Bank for International Settlement/World Bank
  • [ii] Institute of International Finance, April 2018
  • [iii] International Monetary Fund (IMF), annual bank asset expansion since 1973
  • [iv] World Bank, IMF
  • [v] Institute of International Finance, April 2018
  • [vi] International Monetary Fund, World Economic Outlook, October, 2018
  • [vii] Bank of England, Money Creation in the Modern Economy, 2014, M. McLeay, A. Radia, R. Thomas
  • [viii] Ayn Rand, Capitalism, the Unknown Ideal, page 99-100
  • [ix] Encyclopædia Britannica
  • [x] Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1963
  • [xi] Thomas M. Humphrey, Economic Review, May/June 1974, Federal Reserve Bank of Richmond
  • [xii] F. A. Hayek, Denationalization of Money, The Argument Refined, 1976, page 36

Andreas Bjerkedal

January 27, 2021

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