What if we had an ‘Orange Juice Standard’ instead of the Dollar Reserve Standard?
Money trades on one side of every economic transaction in the economy. Hence, when it comes to entrepreneurial affairs, it should be ignored at one’s peril!
Analogies are usually a great way to illustrate concepts, so — to demonstrate the profound implications of a tainted monetary system — I thought I’d consider a world with orange juice as the sole legal tender. An ‘Orange Juice Standard’ — if you will.
What are Legal Tender Laws Anyway?
But what does the term ‘legal tender’ mean anyway? As Jörg Guido Hülsmann wrote in his excellent essay, ‘Legal Tender Laws and Fractional Reserve Banking‘:
A legal tender is an economic good (typically a medium of exchange) that may be used to pay contractual debts even though the contract stipulated payment in terms of another good (typically another medium of exchange). Suppose that Paul gives a credit of 1’000 ounces of silver to John. They agree that, after one year, John has to pay back 1’000 ounces of silver to Paul. Legal tender laws might stipulate that all silver debts may be discharged in gold at a ratio of 10 to 1, or they might stipulate that debtors, such as John, can fulfill their obligations by paying with silver-denominated banknotes of the FR Bank, or with copper tokens issued by the public Mint. The important point is that these legal stipulations overrule any private agreement.
So, in a world with orange juice as the sole legal tender, debts would only be enforceable in terms of orange juice. That is, the court of law would only recognize orange juice as a legitimate medium in which debts can be settled.
Scarcity & Abundance:
With the introduction of such legal tender laws, there would be a concomitant rise in the importance of orange juice. Conceivably, orange juice would eventually dominate exchange.
Orange Juice – which trades on the futures markets in a frozen concentrate form – has historically been subject to wild price swings. Of course, the state of the orange juice market depends on a whole host of complex and unforecastable factors. The 1983 film, ‘Trading Places’ illustrated the volatility in this market (if in an amusing and fictitious context):
With such wild swings in the supply/demand balance of the legal tender, it should be clear that the prospect of economic calculation would be a daunting one indeed. To put it bluntly, the majority of entrepreneurs operate under the structure of ‘selling money’ to buy things (thus accruing cost receipts) followed by selling things to ‘buy money’ (thus receiving selling proceeds). Hence, with orange juice as the sole legal tender, the attainment of a profit (i.e. lower cost receipts than selling proceeds) would be highly dependent on the supply/demand balances of oranges at the initial and final points. In this way, it would be extremely difficult for entrepreneurs to generate profits denominated in the legal tender. Or, if you will, such profits would be distributed in a peculiar fashion in the short-run, and decidedly in favor of orange juice experts in the long-run!
Not too dissimilar to the current monetary system:
So, with the above in mind, let’s move on to today’s monetary system. With today’s pseudo-centrally planned monetary system, we find that the above patterns have emerged (although in subtler ways).
Today, the United States’ money supply consists of Federal Reserve notes (& Fed balances) and IOU claims upon those notes & balances. The Federal Reserve notes & balances are — themselves — ‘backed’ by financial assets (in particular Government bonds. Mortgage-backed securities & gold). Most other countries have monetary systems that are based around the US; they have central bank notes (backed mostly by dollar-denominated assets) and IOU claims upon those central bank notes. In short, modern monetary systems are characterized by myriads of complex claims upon financial assets. Paper shuffling is the name of the game.
Alas, just as the ‘Orange Juice Standard’ would have brought about a wealthy class of Orange Juice experts, the dollar reserve standard has brought about an alarmingly large financial sector. Just as Orange Juice experts would find the best times to buy or sell orange juice (for things), we seem to have entered a society where the successes of the entrepreneurial classes are based on optimal timing in the framework of financial instruments. (Arguably, this is changing, but nevertheless the road to a less financialized future will come to pass with twists and turns relating to the sphere of paper shufflers in general).
Just as the supply/demand balance of the orange juice market can change swiftly, so can the supply/demand balance for dollars. A most painful example of this lingers in many of our minds; the trends evident in the 2007-2009 period. We witnessed an extraordinary ‘scarcity of money’ that was manifest in a mass extinguishment of IOU claims upon central bank notes. The vast price swings in the S&P 500 price of dollars should demonstrate the degree to which the behavior in dollars affects entrepreneurs.
Whether entrepreneurs realize it or not, correct anticipation of monetary trends has become a pre-condition to long-term success. After all, the results of decisions to take on debt, engage in long-term wage and rent contracts etc. depend on the path of the monetary systems. Given that the World’s central bank notes are based on financial instruments, there is a contingency upon successful financial analysis.
Attacking the Symptom, Not the Cause:
However, the above is not news to the academic classes. After all, the great economists of the past few centuries have been very aware of the periods of inflation and deflation that have been inherent in the boom/bust cycle. For example, Irving Fisher wrote the following in ‘The Money Illusion’ (available at the greshams-law.com book store).
First of all, unstable money explains at least part of the secret of business fluctuations, the so-called “business cycles”! Booms, recessions, liquidations and recovery have long puzzled the business world. While certain plausible, and partially true, explanations have readily been given, they were as incomplete and unconvincing as the German shop woman’s explanations (quoted in the first chapter) of the “high cost of living” and its effects upon the price of the shirt, and for the same reason. Wherever unstable money does its work we find the public mystified; for unstable money remains behind the scenes. Its tricks are like whose of a sleight-of-hand artist. Because of the Money Illusion, one of the principal causes of booms and panics is unperceived. Only after an economic and statistical analysis do we come to realize that trade fluctuations are caused, in large part, by changes in the buying power of the dollar.
Monetary depreciation (rising price level) stimulates, and monetary appreciation (falling price level) depresses business. The reason is simple. When producers get higher prices they do not, at first, have to pay correspondingly higher costs; for instance, wages and salaries do not rise so fast, being fixed by contract for months or years in advance. Much less do they, at first, have to pay higher rent or interest. Such lagging of important expenses usually involves a lagging of total expenses behind total receipts. Consequently, profits, the excess of receipts over expenses, tend at first to increase. Conversely, a falling price level diminishes profits.
So, why do we have the centrally planned monetary system which – it would seem – has precisely the same problems as many years ago? It would seem that a rudimentary error has been held above all others; that – in some sense – ‘government is good’. Rather than recognizing that the vast, sweeping tides of inflation and deflation are the result of government meddling with money, academic economists have sought to use government to stabilize the money. Of course, due to the inherent limitations in any centrally planned system, this has only acted to aggravate the distortions.
So, instead of recognizing that government tinkering is to blame, people have sought to attack the symptoms without addressing the problems. Today, we call this ‘monetary policy’.
Whenever certain institutions find themselves owing too many central bank notes (compared to what they own), central banks respond by debauching what they owe and enshrining what they own. In our Orange Juice-centric universe, ‘monetary policy’ would amount to adding water to the orange juice, yet nevertheless pretending that the consistency remains the same!
Due to the monopolization of money production, entrepreneurial success seems to be contingent on a full and deep understanding of monetary trends. Just as Orange Juice experts would rise to greatness in an Orange Juice Standard, Dollar experts seem to have risen to greatness in the current dollar reserve standard. Although the situation could be very different in 30 years, the discipline of understanding the monetary system remains important for the investor/entrepreneur.
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012