Friday, July 21, 2017

Dictionary money












Voila, instant inflation.



  1. "In the 1700s monarchs began to adopt the practice of inscribing the actual unit of account directly on the coin's face"

    Any idea WHY monarchs started this practice?

    1. Weber's theory (link at bottom) is that early coinage degraded too quickly for the monarch to trust putting the unit of account on it. Technological advancements such as the ability to put designs on the rim and industrial presses made coins more durable and gave monarchs sufficient confidence.

  2. "Or they might raise or lower a currency's peg."

    Is this not the same thing as changing the definition? Please educate me. Thank you.

    1. It has the same final result. But it's not the same thing.

      For instance, say the UF is defined as 10 Chilean pesos, and the peso in turn is pegged to the US$ at a 1:1 rate.

      To deflate the price level by half, the Chilean monetary authorities can either redefine the UF as 20 pesos, or they can repeg the peso so that it is now worth US$2.

      Same result, but in the first they are just altering the word UF; in the second they are changing the nature of the underlying instrument, the peso. The first is effortless to achieve. The second is tougher; to double the value of the peso, they need ammunition like reserves. If they don't have enough, they won't be able to pull it off.

    2. Gene: to say the same thing a different way, a "pegged" exchange rate normally means the central bank has stocks of the two currencies, and offers to buy or sell one for the other at that announced exchange rate.

  3. Good post JP! I had no idea it was that prevalent.

  4. Interesting post and concept!

    This separating unit of account and unit of exchange is something I noticed is happening naturally in Bitcoin, at least for the time being. Speaking with a French artist who paints bitcoin related art work she was contemplating listing her prices in bitcoin with no peg or relation to another currency, as in a piece of art was priced at 1 btc, regardless of what btc traded against for the Euro/USD/GBP etc. Though she opted instead to allow the price in btc, to fluctuate with the price of euros (as do most vendors right now) which if I'm understanding this UF/peso concept correctly, would make the Euro the UF and btc to peso?

    I wonder what effects changing the peg would have on savings in the country (most likely in Peso) and would generally be better for those who can hold assets priced in UF instead of pesos themselves. Or if expansion of the peso supply would override the peg and cause UF prices to rise even when the peg remains the same.

    Then again I'm always a skeptic of monetary policy in general...

    1. "...which if I'm understanding this UF/peso concept correctly, would make the Euro the UF and btc to peso?"

      Yes, it's similar in that the unit of account has been split off from the medium of exchange, just like the UF.

      The difference is that the authorities control the content of a UF, whereas the bitcoin content of a euro is market determined.

      "I wonder what effects changing the peg would have on savings..."

      Well if the peso is pegged, and then it loses its peg, there will be consumer price inflation. The UF will be automatically adjusted to compensate for that inflation so that anyone setting prices (say a salary) in UF terms will get the same consumption basket before and after.

  5. Hey JP,

    Think this is another modern example of a unit of value not representing the underlying note .
    Latin American countries (like Brazil) often did this to curb runaway inflation. The benefits of doing so are not only ease of adjustment , like you mention, but they actually play a role in people's psychological perception of expected inflation. The policy was actually successful in this case.

    1. Great point, Tony. I really want to write about the Brazil example; hopefully later this summer I'll be able to take a crack at it.

  6. Really interesting post.. I guess it seems nice to be able to price things in UF because its tied to consumption.. But on the other hand UF can only exist because Pesos exist too right? Like if everything was priced in UF, it would be the same as any other currency.

    So it seems like the UF/Peso divide is a way of splitting up 1 economy into 2 economies? e.g I can buy/sell housing in UF, buy/sell food in Pesos. Since the govt. can create inflation/deflation in Pesos relative to UF, and wages are in UF, it is letting the govt. easily control how much spending money you have in the Peso economy. In this case seems like the Peso economy is for consumption and the UF economy is more for basics like wage & rent, so it can control consumption day to day..

    What happens at the intersection of the two currencies though? If i am running a business selling in Pesos and my main costs are wages, paid in UF, I would have to take on all the currency risk no? On the flip side as a consumer I am earning in UF and paying in Pesos, also taking on a currency risk. So basically everyone is standing in 2 economies, but the exchange rate between them is fixed by government rather than market... strange.


      That depends. Say there is some peso inflation and along within everyone else you increase your selling prices. But if you've denominated your wage costs in UF, then wages will increase by that same amount. So things balance out.

      You get some risk if you can't increase your selling prices as fast as the average business can increase them.

  7. Brilliant post, JP! It's really good to find out about something I never knew. Keep it up, I like what you're writing!
    Best regards.

  8. Interesting read, thanks!
    It appears to me that, theoretically, nowadays the central bank has two ways to manage the value of money: either by controlling prices (mostly done indirectly by setting interest rates and hoping for the complex monetary transmission process to do its thing), or by controlling supply.

    Dictionary money is basically a form of supply control. While it is an interesting angle, the effect on people's wealth is similar to price control. My wealth is W = V / P, the volume of money I hold divided by its price (the amount of goods I can buy). Inflation means higher prices, higher P hence lower W.
    But when supply is adjusted in the way you explain, then P may stay the same but V is lowered. The result is the same: lower W.

    I have been thinking about this in the context of cryptocurrency monetary policy. Interest rate setting is a no go (for now) to achieve price stability of cryptocurrency. Algorithmic supply management is theoretically possible (an algorithm managing supply based on measured prices of a basket of goods). The effect on people's wealth is, in the end, the same (abstracting from such hugely important details as distribution of wealth, debt, et cetera). But of course the question is what you gain with such monetary policy. The algorithm has successfully stabilised prices, but now everybody is stuck with wildly fluctuating wealth (due to algorithm-driven girations in V). So not very helpful. Anyway, nice to ponder all this.