Race to the Bottom

"Today we see considerations of the value of money driving all other considerations into the background in both domestic and international economic policy. We are not very far now from a state of affairs in which 'economic policy' is primarily understood to mean the question of influencing the purchasing power of money. Are we to maintain the present gold-content of the currency unit, or are we to go over to a lower gold-content? That is the question that forms the principal issue nowadays in the economic policies of all European and American countries. Perhaps we are already in the midst of a race to reduce the gold-content of the currency unit with the object of obtaining transitory advantages (which, moreover, are based on self-deception) in the commercial war which the nations of the civilized world have been waging for decades with increasing acrimony, and with disastrous effects upon the welfare of their subjects." - (Source: Ludwig von Mises, The Theory of Money and Credit, 1953, p.18) 

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In today's text, Ludwig von Mises mentioned a kind of "race" and "war" related to monetary system. I think such race and war did not stop in his time, but have been continuing to the 21st century. They might have changed in external forms, but the susbtance remains the same. I see the relevance of the text in relation to a popular idea in our time, the reality of the so-called "race to the bottom". 

Today, the concept of race to the bottom is understood in different ways. In Financial Times, it is defined as:

"The situation in which companies and countries try to compete with each other by cutting wages and living standards for workers, and the production of goods is moved to the place where the wages are lowest and the workers have the fewest rights."

This is not the kind of race I see in reading Mises' text. The race that Financial Times describes pertains to a situation related to competition, the reduction of "wages and living standards of workers", and the transfer of goods and services to areas "where the wages are lowest and the workers have the fewer rights." To me, such definition paints a negative impression of those who are perceived to have authority in reducing the salary and the living standards of workers. The definition fails to account the source of the reduction of wage and living standard, which the Mises' text can provide. 

Another definition of "race to the bottom" is given by Wikipedia:

"The race to the bottom is a socio-economic phenomenon in which governments deregulate the business environment or taxes in order to attract or retain economic activity in their jurisdictions, resulting in lower wages, worse working conditions and fewer environmental protections. An outcome of globalization and free trade, the phenomenon may occur when competition increases between geographic areas over a particular sector of trade and production." 

In this definition, Wikipedia is more specific than the Financial Times in identifying the kind of situation where this race is taking place. Wikipedia is clear in describing this race as a "a socio-economic phenomenon" and adds four more ideas to competition, lower wages and "worse working conditions". These are "deregulation", "fewer environmental protections", "globalization", and "free trade". Again, this definition fails to explain the root cause of lower wages and worse working conditions. 

The above definitions are consistent with the dominant intellectual framework in our time, which is anti-free market at its core. In the case of our text, the kind of race Mises was describing was related to the reduction of "the gold-content of the currency unit." We do not have this kind of race in our time for currency these days are no longer connected to gold. What nations are doing now is they are competing with each other in devaluing their own currencies. And since nothing backs up these currencies except the governments themselves, our race at present is far worse than Mises' time. 

Mises saw that during his time the act of nations to race with each other in reducing the gold-content of currency was economically disastrous. Today, since all currencies are no longer connected to gold, would it not be logical to say that the continuation of the existing monetary system is more economically disastrous? 

Nations pursued the above race to attain transitory advantages. They include boosting the export industry, restricting import of foreign goods, easing the financial burden of local companies with big debts, preventing the fall of wages, and maintaining the prices of goods and services. For Ludwig von Mises, this pursuit is based on self-deception for in reality by doing this, nations are engaged in "commercial war," which is economically disastrous to their citizens.

Fiat Currency and Politics

"At the very moment when the manipulation of purchasing power is declared to be a legitimate concern of currency policy, the question of the level at which this purchasing power is to be fixed will attain the highest political significance. Under the gold standard, the determination of the value of money is dependent upon the profitability of gold production. To some, this may appear a disadvantage; and it is certain that it introduces an incalculable factor into economic activity. Nevertheless, it does not lay the prices of commodities open to violent and sudden changes from the monetary side. The biggest variations in the value of money that we have experienced during the last century have not originated in the circumstances of gold production, but in the policies of governments and banks of issue. Dependence of the value of money on the production of gold does at least mean its independence of the politics of the hour. The dissociation of the currencies from a definitive and unchangeable gold parity has made the value of money a plaything of politics." - (Source: Ludwig von Mises, The Theory of Money and Credit, 1953, pp. 17-18) 

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Not many people today are aware that the existing monetary system called the "managed fiat currency standard" is actually not a result of the decision of the market, but of the political class. That's why it's difficult to understand intellectuals who blame the market for the present economic chaos. This only shows that mainstream education has been successful in its goal of mind control. 

As we've seen already in previous post, government's use of inconvertible notes leads to currency devaluation. In reality, this political act is a manipulation of the purchasing power of the consumers. It is not the fault of the market that prices of goods and services are increasing unnaturally. Politics play a big role in it.

Prior to 1971, though the value of US dollar in relation to gold had already declined dramatically, at least, some measure of limitation on politics was still maintained. After President Nixon disconnected the US dollar from gold, the political control of money has been completed. The present turmoil both in the larger economy, the stocks and the financial markets are just inevitable consequences after more than four decades of ignoring sound money. 

Ludwig von Mises was emphatic that what endangers the value of nations' currencies are "the policies of government and banks of issue." In order to discontinue this subtle erosion of the value of money, the way is to return to the gold standard. This will stop the "value of money a plaything of politics". Only under the gold standard that the manipulation of the purchasing power of consumers by politicians can be terminated. Understanding therefore this "old monetary system" is the way to arrest the monetary devaluation that is continually destroying the people's purchasing power. This will liberate money from political control. 

Short-term Benefits of Currency Depreciation

"In Central Europe, the first country to follow Great Britain's example was the Republic of Czecho-Slovakia. In the years immediately after the War, Czecho-Slovakia, for reasons of prestige, had heedlessly followed a policy which aimed at raising the value of the krone, and she did not come to a halt until she was forced to recognize that increasing the value of her currency meant hindering the exportation of her products, facilitating the importation of foreign products, and seriously imperilling the solvency of all those enterprises that had procured a more or less considerable portion of their working capital by way of bank credit. During the first few weeks of the present year, however, the gold-parity of the krone was reduced in order to lighten the burden of the debtor enterprises, and in order to prevent a fall of wages and prices and so to encourage exportation and restrict importation. Today, in every country in the world, no question is so eagerly debated as that of whether the purchasing power of the monetary unit shall be maintained or reduced." - Source: The Theory of Money and Credit, pp. 16-17

The passage is about the short-term benefits of currency depreciation. All in all, Ludwig von Mises identified five immediate benefits so far: 

1. Assisting export industry

2. Restricting import of foreign goods

3. Easing the financial burden of local companies with big debts

4. Preventing the fall of wages, and 

5. Maintaining the prices of goods and services. 

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During his time, Mises mentioned Czecho-Slovakia as the country which adopted this policy of currency depreciation after the example of Great Britain. Previously, Czecho-Slovakia practiced the stronger currency policy. But after witnessing the impact of a strong krone on both export and import, the government decided to change its direction.

Moreover, strong krone that time would also mean putting the domestic companies, which depend on bank credit for their working capital on a serious financial risk. And so krone was depreciated in order to reduce the financial burden of these local companies.

Reading this section, I realized that during Mises' time, currency depreciation was a hot issue in every country. Today, yes, it's becoming hotter in countries that are aware about what's going on in global economy. How about in the Philippines? Is this the kind of issue that is now being publicly debated? Why not? Are we not part of the global economy? Or do our policy makers think that our economy is too strong and protected from currency depreciation? In fact, not many Filipinos are aware that we are following the same path as the United States in terms of monetary depreciation. 

Currency depreciation is a serious monetary and economic issue that affects our standard of living. Politicians cannot see the long-term detrimental results of such monetary policy for they only focus on immediate results. I wish and pray that the deafening silence about this very important subject will soon be stopped. And that the Lord will raise political leaders that truly understand this topic and will bring it into public attention. 

Monetary Depreciation

How about the text below? How do you understand this passage? And why is its message relevant for our time? 

"But the motive for recent experiments in depreciation has been by no means fiscal. The gold content of the monetary unit has been reduced in order to maintain the domestic wage-level and price level, and in order to secure advantages for home industry against its competitors in international trade. . . . In this case, however, Great Britain began by abandoning the old gold content of the pound. Instead of preserving its gold-value by employing the customary and never-failing remedy of raising the bankrate, the government and parliament of the United Kingdom, with bank-rate at 4.5 per cent, preferred to stop the redemption of notes at the old legal parity and so to cause a considerable fall in the value of sterling. The object was to prevent a further fall of prices in England and above all, apparently, to avoid a situation in which reductions of wages would be necessary."

"The example of Great Britain was followed by other countries, notably by the United States. President Roosevelt reduced the gold content of the dollar because he wished to prevent a fall in wages and to restore the price-level of the prosperous period between 1926 and 1929."

(Source: The Theory of Money and Credit, p. 16) 

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In the above text, Ludwig von Mises continued his explanation about monetary depreciation as the unavoidable outcome of government's utility of inconvertible notes. Here, he indicates that the government's intention in depreciating the currency is not primarily fiscal, that is, not related to the increase of tax collection and to the increase of spending ability. The motive says Mises is threefold: to influence the level of workers' salary, to maintain the prices of goods and services, and to protect local industry from its foreign competitors. The last is the essence of protectionism and a favorite tool of an interventionist government. This shows that a country that practice this does not really have a free market economy. This reminds me of Hitler's style, the other face of socialism. 

Currency devaluation during Mises' time was done through the reduction of gold content in monetary unit. In our time, it's different since as far as I know, no existing currency is backed up by gold since 1971 when President Nixon disconnected the USD from this precious metal. However, the act of monetary depreciation remains. The external form of this depreciation is different, but the essence of the act stays the same. 

I think the text is relevant to our time for we are facing the same issue in today's monetary system. As England depreciated its sterling/pound in the past, the US has been depreciating the dollar for so long. I think we are touching the root of the existing crisis in global economy. Since money is the lifeblood of the economy, it is difficult to see the solution to the present problem economic as long as both governments and central banks of the world are committed to currency devaluation.

Government's Unlimited Source of Fund

"When governments do not feel strong enough to procure by taxation or borrowing the resources to meet what they regard as irreducible expenditure, or, alternatively, so to restrict their expenditure that they are able to make do with the revenue that they have, recourse on their part to the issue of inconvertible notes and a consequent fall in the value of money is something that has occurred more than once in European and American history" (The Theory of Money and Credit, p. 15).

I'm having difficulty "decoding" the meaning of this long sentence by Ludwig von Mises. What is he saying here?

The way I see it, Ludwig von Mises combined four ideas in one sentence: 

1. About government's hesitation between taxing the people and borrowing money or restricting its expenditures with the available funds provided by current taxes, 

2. That if a government is not satisfied between these two options, it will choose to fund its programs using "the issue of inconvertible notes," 

3. That resorting to such way of providing fund for its expenditures will result to currency devaluation, and 

4. That this kind of government action is not new, but has a root in European and American history.

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The most difficult part in the above sentence is to exactly find out the meaning of "inconvertible notes". I googled it, and what appears are links to the definition of "convertible notes". I googled it again and add Mises' name, and there we can see links to his book The Theory of Money and Credit, but still I cannot find the exact meaning of the term "inconvertible notes". And so I decided to just deduce its meaning from the definition of convertible notes. 

Reading the Financial Times, I see that "Convertible notes are often used by angel investors who wish to fund businesses. . ." These "notes are structured as loans at the time the investment is made." These notes are described as "convertible" because they can be "automatically converted to equity" later on. 

Now, let us return to the meaning of "the issue of inconvertible notes" that will be used by the government to fund its expenditures. Who will issue this inconvertible banks? The central bank? Why these notes are described as "inconvertible"? I do not know the exact answer. All I can do is guess. Perhaps unlike the convetible notes, these inconvertible notes cannot be converted into equity. But I assumed that they can be converted into cash. For if not, then how can a government provide a fund for its expenditures? 

To me, I understand inconvertible notes as a form of loan that will be used by the government for its programs, which will be financed by the people through taxes in the future. The quote also talks about three ways the government fund its expenditures:

1. Through direct taxation,

2. Through direct borrowing, and

3. Through the issue of inconvertibles notes, which to me is a form of indirect taxation and indirect debt.

Directly taxing the people and borrowing money are better ways to source out fund in a sense that it is obvious and the taxpayers can see their impact on their personal and family expenses. And because of this, each individual and family can adjust financially. This I think what makes inconvertible notes dangerous. I wonder how many citizens understand its nature. But Mises is clear that once the government used this credit instrument, the outcome is monetary depreciation. So inconvertible notes are also taxes, but done in an indirect way that make them invisible. I suspect that the use of these notes has a lot to say about monetary corruption and the ongoing crisis in global economy. Utilizing this tool, politicians can expropriate the people without the latter knowing how it is being done. Government has found people's pockets as an unlimited source of fund.