Friday, February 8, 2013

Your money: The untold story

I've said many times I am not an economist, but I am interested in economics, as we all should be. 
My daughter posted an interview with a legitimate economist regarding the demise of the penny. Very briefly here is what the main stream media are missing from this story.

Withdrawn from circulation this week, the penny is suffering a battering of name-calling. An annoyance, a pest, a nuisance – a budget document on the penny’s elimination reads “Some Canadians consider the penny more of a nuisance than a useful coin. We often store them in jars, throw them away in water fountains or refuse them as change.”

But according to Dr. George Bragues, Acting Vice-Provost and Program Head of Business at the University of Guelph-Humber, the real story behind the end of the penny is one that has yet to be told.

Throughout mainstream media, the elimination of the penny is being touted as something we’re all happy to see disappear. But what’s the real story here?

The story that many seem to be missing is, Why has the government been compelled to give up the money in the first place? Why has the value of the penny become so minimal? And that story has to do with how the government has managed money.

How so?

The real story is that over the last couple of generations, we have seen inflation increase on average 2-3% per year. Seems minimal - but over time, that adds up.

We know that it now costs 1.6 Canadian cents to produce each one cent coin. To this end, Finance Minister Jim Flaherty declared the penny as “a currency without any currency in Canada.”

Again, this should raise the question – what has happened here? That the price of the copper that goes into the penny is now worth more than the penny itself is an indication of the government’s inflation of the money supply.

So the fact that we’re giving up the penny should be alerting us as to how the government has been systematically cheapening our currency. That tells me that the government has not managed its money as well as it should have.

Obviously not the message the government would want to send out.

Of course, the government has no interest in declaring that. They can’t say, We’ve inflated the currency for the last 50-60 years, so we’re now going to have to go to nickels as the smallest unit of account.

Also, the economic establishment tends to be in favour of the monetary policy we’ve had in the post WWII era – which has essentially been an inflationist policy, where we tolerate 2-3% inflation per year. Prior to WWII, and certainly prior to WWI, that was not the norm. Throughout the 19th century, prices were either stable or declining. But with the Great Depression – the most seminal event of modern economic history – came an interpretation of that event that has shaped our current policy.

The predominant interpretation of that event – what went wrong, where policy makers failed – has led to a phobia of declining prices, or in other words, deflation. This became viewed as economically destabilizing. And now because of this horror, we’ve since gone with this inflationist policy, which basically says we should do everything in our power to keep prices from coming down, which includes increasing the money supply.

Where do you see this headed?

There is the slippery slope argument – that this will inevitably lead to a recession or even a depression and the next thing you know you’re the new Zimbabwe.

I share the view that at certain times, like now, increasing the money supply out of fear of deflation leads to bad policy. I would argue that this fear of deflation led to the financial crisis of 2008 – and has since led to an excessively easy monetary policy that has put too many people into debt, particularly in the United States and around the world. I fear that the policy now, where we’re pumping up the money supply while having 0% interest rates, is going to create the same sort of distortion – perhaps not in the real estate market, but may appear elsewhere.

Originally posted here.

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