The Pitfalls of a Monetary System

This post talks about why any monetary system (based on the concept of money as a medium of exchange) does not fit into an ideal design of the global economy. This is just a bird’s eye view of a failed system.

Before I start the topic, I want to provide my view on the age old question – was the gold standard (monetary system) any better than the current? The proponents of the gold standard argue it is easier to keep interest rates stable over a long period under a narrow band (How interest rates are set?). Theoretically, it keeps a check on the liquidity in the system. However, some of the pitfalls of such a system, in my view, are the same as the current one. The gold standard could be a relatively better system but I disagree it would serve us better. I feel the gold standard is not a good substitute to the current one. However, this post is not about current versus the gold standard.

Resources are limited and the quantity is unknown:

Let’s forget about the complexity of any monetary system and try to lead the case with common sense. Where do resources come from? We need resources for sustenance and resources, including energy resources, are provided by nature. The problem is that the monetary system evolved without a consideration of the current and future availability of resources. There is a disconnect between the resources that lie with nature and the amount of liquidity we have in the system to exploit those resources. My argument is that it would never make a good idea to align the monetary system with the basket of resources that are available in nature (this is also impossible and impractical). Why do I think so? The reason for this belief is that the monetary system allows creation of debt (and a network of transactions that could be expanded or contracted – velocity of money). I think that is enough to disturb the balance between the supply of resources and the demand based on the monetary system. We may argue that inflation tends to bring the demand and supply to equilibrium but as I will state later in this post, unequal distribution of wealth and government intervention forces debt creation, while controlling inflation artificially and temporarily. The result is a lagged but a more intensive effect. Perhaps the gold standard would not have done better because we cannot relate the availability of resources to the value of gold available. Thus, the value of gold is nothing more than a figment in a gold standard. Even in the gold standard, resources would be exploited to a point where further expansion would require a stretch in the monetary base. Would the population in an economy adjust to this so quickly? Or would the governments be tempted to do away with the gold standard as majority cannot afford a life at that point? I think we already know the answer. Corporate taxes, government debt and subsidies transfer wealth from the rich to the poorer. Taxes are not enough and would run dry if there is no widespread consumption. This leaves the government with no choice but to use debt and subsidies to sustain their vote banks, thanks to the brilliant system of central banks. The rest, as we know, is history.

Monetary system dilutes the natural check on human population:

We can see what governments and central banks have done with loose monetary and fiscal policies, and subsidies. A monetary system provides a false sense of security for guaranteed future consumption. The illusion of prosperity is almost perceptional as it linked to the store of wealth and not the availability of resources in nature. In addition, vaguely quantified asset valuation models create a further disconnect between resources and the monetary system. So what is the issue? This leads to a population boom. I strongly attribute human population boom to two reasons: use of energy for transportation of resources, and availability of cheap credit to sustain the trade. I pointed out in my previous post that we were able to lift the natural checks on human population with trade, which has resulted in (perhaps) an unsustainable food-water-energy nexus.

The monetary system allows unequal distribution of wealth:

In US, the top 1% of the population owns 40% of the US wealth, and the bottom 80% owns just 7% (read this). So we know the reason for (government) debt creation and subsidies. However, for how long is debt and subsidy sustainable?  And does debt/subsidy make a better future for the poor who initially benefit from it. No, it does not because the monetary base is handled without a consideration to the availability of resources, and the population that feeds on it. Eventually, people take up on the governments to fight hunger and poverty. But what is poverty? Is it lack of money? No, there is ample in the system; it is lack of resources available to sustain such a big population that reels under inequality and the mounting burden of government debt.

Prosperity linked to the monetary system takes focus off key resources:

The concept of wealth takes focus off other important resources such as food and water, which are truly necessary for survival. People tend to gravitate towards dealing in resources that pay more rather than the ones that are essential for a living. In addition, basic commodities are often subsidized, creating disequilibrium between the supply and the demand, and sometimes asset bubbles and even (possibly) wars. It takes the focus away from actions needed for survival towards activities that pursue wealth creation, regardless of the cost incurred by the environment.

One could propose more pitfalls of a monetary system but the ones above are strong enough to encourage us to think we need something more sensible and sustainable. It is not easy to steer ourselves away from this mess. However, it takes just one step to display responsibility so that others can follow. I am certain more than 90% of us may not be aware of where humanity is heading, and it brings the responsibility to a few who can guide us towards sustainability.


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