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Paper presented at the 2010 New Zealand Society of Actuaries Conference,
Blenheim, N.Y., November 23, 2010
Louis Boulanger (LB Now, Auckland, New Zealand),
Professor Antal E. Fekete
(New Austrian School of Economics, Budapest, Hungary)
Synopsis.
Highest
standards for science must include observation, or experimentation, and
measurement. Measurement in economics is carried out in terms of currency
units; only economic activities measurable in that unit of account are
recorded. But as experience shows, the value of any currency now fluctuates
greatly. What does that say of 'economics' as science? What does it say about
our choice of unit of value?
What is Money?
Money
is any object that is generally accepted as payment for goods and services
and repayment of debts in a given country or socio-economic context. The main
functions of money are distinguished as: a medium of exchange, a unit of
account, a store of value, and occasionally, a standard of deferred payment.
The gold standard, a monetary system where the mediums of exchange are paper
notes that are convertible into pre-set, fixed quantities of gold, replaced
the use of gold coins as currency in the 17th-19th centuries in Europe. The
gold standard notes were made legal tender, and redemption into gold coins
was discouraged. By the beginning of the 20th century, almost all countries
had adopted the gold standard, backing their legal tender notes with fixed
amounts of gold.
After
World War II, in accordance with the Bretton Woods
Agreement, most countries adopted fiat currencies that were fixed to the US
dollar. The US dollar was in turn fixed in terms of gold. In 1971, the US
government defaulted on its international gold obligations. After this many
countries de-pegged their currencies from the US dollar, and most of the
world's currencies became unbacked by anything
except the government's fiat of legal tender.
So,
while money originated as commodity money, all contemporary money systems are
based on fiat money. Fiat money is without intrinsic use value, unlike a
physical commodity, and derives its value by being declared by a government
to be legal tender; that is, it must be accepted as a form of payment within
the boundaries of the country, for "all debts, public and private".
People do accept fiat money under duress, even if unconsciously so.
What is meant by a 'unit of account'?
A
unit of account is a standard numerical unit of measurement of the
market value of goods, services, and other transactions. Also known as a
"measure" or "standard" of relative worth and deferred
payment, a unit of account is a necessary prerequisite for the
formulation of commercial agreements that involve debt. To function as a 'unit
of account', whatever is being used as money must be:
- Divisible
into smaller units without loss of value;
- Fungible:
that is, one representative unit must be perceived as equivalent to any
other; and
- Measurable as
a specific weight.
So,
a unit of account is a monetary standard capable of measuring the
value of goods, services, or assets. It serves as one of the three well-known
functions of money. It lends meaning to profits, losses, assets and
liabilities.
Unfortunately,
the accounting monetary unit of account suffers from the congenital
disease of not being a stable unit of account over time.
Inflation destroys the assumption that money is stable, which happens to be
the very basis of the science of accounting.
In
today's modern economies, money in the form of currency usually serves
the role of the standard unit of account. The use of money, under conditions
of price stability, vastly improves the efficiency of market economies; but
not when the monetary unit itself is unstable.
The
use of a unit of account in financial accounting allows investors to
invest capital into those companies that provide the highest rate of return.
The use of a unit of account in managerial accounting enables firms to
choose between activities that yield the highest profit. All this, of course,
is falsified if the unit of account is no longer stable.
In
economics, a standard unit of account is used for statistical purposes
to describe economic activity. Indexes such as GDP and the CPI are so broad
in their scope that compiling them would be impossible without a standard unit
of account. After being compiled, these figures are often used to guide
governmental policy; especially monetary and fiscal policy. So, one could
argue that the measurement of our economic performance and/or
financial performance, individually or in aggregate, is only as good or
reliable as our money/currency is. If so, then how good or reliable is
our currency as a measure?
Measures of Money
When
we scan the modern economic literature, the only measure(s) of money we find
today are aggregate measures. For example, the money supply is the
amount of financial instruments within a specific economy available for
purchasing goods and services. The money supply is usually measured as M0,
M1, M2 and M3, four escalating categories, each containing the previous. The
categories grow in size with M0 being so-called "high powered
money"; that is, money issued by the central bank of a country. M1 is
the issued currency (coins and notes) and checking account deposits. M2 is
the currency, checking accounts and savings accounts. M3 is all that plus
time deposits and repos. M1 includes only the most liquid financial
instruments, while M3 also includes relatively illiquid instruments.
The
above chart is based on official data supplied by the US central bank, but
produced by John William's Shadow Government Statistics service (because the
US central bank stopped calculating and updating M3 in 2006, shortly before
Greenspan passed the baton to Bernanke). It shows that the US money supply,
as measured by M3, grew from US$0.3 trillion at the beginning of the 1960s to
more than US$10 trillion today, at an annual rate of change that varied from
-6% to +18%.
Please
note the collapse of the rate of growth in the money supply starting in the
milestone year of 1971 and, in spite of the reversals of 1995 and 2005,
continuing to this day. This collapse scares the wit of central bankers and
Treasury secretaries, who do not realise that it is
their own doing.
By
the way, the same goes for any other currency: the money supply statistics
are abundantly available and appear to be very reliable measures as they seem
very precise. That's all good and fine, but what of the basic unit of
measure of that money supply itself? There is nothing to find in
today's literature on the 'measure' itself; more precisely, nothing in
absolute terms. On the other hand, there is an abundance of information and
ongoing speculation in relative terms: currency exchange rates and the price
level in terms of currencies. So, we need to understand what makes a unit of
measure accurate and reliable, and ask ourselves if we have that in what we
use today as 'money'.
Scientific Measurement
Units
of measurement are essentially arbitrary. Nothing is inherent in nature to
suggest that a mile is a better measure of distance than a kilometre. Over the course of human history, however,
first for reasons of convenience and then for reasons of necessity, standards
of measurement have evolved so that communities would have common
benchmarks. The Old Testament calls false weights and measures an abomination
and says that all those who want long life in this world must shun them.
Laws
regulating measurement were originally developed to prevent fraud in
commerce. Today, units of measurement are generally defined on a
strictly scientific basis, overseen by governmental or supragovernmental
agencies, and confirmed by international treaties. The metre,
for example, was redefined repeatedly, the last time in 1983, as the distance
travelled by light in vacuum in 1/299,792,458th of a second. Now, that's
precise!
What
can be said of our monetary unit of measure today? Well, one could
argue that it is about as precise as the measure for length was before the
French Revolution: the King's foot! If the King died, the measure changed. If
the new king had a longer foot, the producers of cloth were out of luck; if
shorter, then the consumers were.
As
a matter of history, over time, length (as well as weight and time, for
example) became measured more and more accurately. In fact, in all scientific
endeavours, precision in the definition of the unit
of measure has improved. The ONLY exception is economics, in particular
monetary economics. 'Money' today, as far as its value is concerned, is based
on government fiat, which is itself a highly elastic measure, with an
irresistible bias on the side of falling short. What we now use every day in
our actions and interactions of a monetary nature, and never give a second
thought to it, is, quite simply, based on fiat and so, quite unreliable. This
is clearly an aberration in the history of Western Civilisation.
There
is only one rational explanation for this: the propensity of governments to
use a fraudulent unit of value in order to cheat their subjects. And it makes
no difference whether the government is absolutist or democratic, malignant
or benign.
Final Thoughts
The
present financial crisis is far from over. In fact, it is getting worse. It
can be described as a debt crisis, but its true nature is a monetary crisis. At
its roots, it is a belated gold crisis. It is a punishment for discarding the
honest unit measuring value: gold.
The
landmark year was 1971, when the United States defaulted on its international
gold obligations under the Bretton Woods Agreement.
There have been many defaults in history, but the one forty years ago was
unique in that it exiled gold internationally and without recourse to the
Courts from the monetary system; thereby gold has been prevented from
discharging its natural function as the ultimate extinguisher of debt ever
since.
There
is a direct cause and effect relationship between that decision in 1971 and
the present global financial crisis. We are about to pay the price for our
collective delusion as participants in this insane monetary experiment. Our
monetary system today did not grow naturally, nor was it the result of
careful study and planning by competent scientists. As we have just seen, it
has no accurate and reliable unit of measure. In fact, it was imposed through
bribe and blackmail on the people.
So
it is prudent, to say the least, to measure one's net worth in gold units
rather than legal tender units. And it is incumbent on the actuarial
profession (not to mention the profession of accountants) to resist
government duress to use a badly debased and depreciating monetary unit of
measure and advocate in the strongest possible terms for a return to sound
money.
Blenheim,
New Zealand, November 23. 2010.
ANNOUNCEMENT
New
Austrian School of Economics
Course
Two at the Martineum Academy in Szombathely,
Hungary,
from March 5 through 13, 2011. Title of the course:
ADAM
SMITH'S REAL BILLS DOCTRINE AND SOCIAL CIRCULATING CAPITAL
What
makes this course especially topical today is the fact that more and more hints
are being dropped about the possible rehabilitation and restoration of the
gold standard -- following the ignominious collapse of the irredeemable
dollar. However, a gold standard
without its clearing house, the bill market, is not viable and
itself is liable to collapse in short order -- as it did in the early 1930's.
The level of public ignorance about the necessity of a clearing house is
appalling. It is made that much worse by a tottering banking system. We have
an urgent message: only gold standard cum
real bills can restore prosperity to the world, in view of the fact that we have to write off the world's banking
system as a total loss.
This
is the second in a four-course series on Austrian Economics, a branch of
economic science based on the work of Carl Menger
(1840-1921). It is meant for those, including beginners, who are interested
in the theory of money, credit, and banking, with special emphasis on the current financial and economic crisis.
The complete program consists of four courses (10 days, 20 lectures each).
Completion of each course will earn one credit. Participants who have
accumulated four credits get a diploma signed by Professor Fekete. Course One that was given in 2010 is not a prerequisite. It is
available on DVD for purchase.
Scholarships
for students are still available.
For
further information please contact Dr. Judith Szepesvari,
e-mail: szepesvari17@gmail.com
Antal E. Fekete
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright © 2002-2008 by Antal
E. Fekete - All rights reserved
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