How Depreciating Money Is Making Your Services Cheaper


By Anand Gangadharan

Around 2013 the Reserve Bank of India decided to let the Rupee depreciate. I like many other common man of this country observed the event in equal apathy and ignorance. As I was contemplating with idea of money itself losing its value and its implications I came across a wonderful book “The Death of Money” by James Rickards. The book talks about acquiring real assets like gold or art instead of paper money or government debts.

Slowly I woke up to the reality of our government undermining the value of assets I acquired in Rupee terms to be reduced in value by about 50 percent. Of course this was due to the countries mounting trade deficit which in turn was due to increase in oil prices. Nonetheless it was not my fault, I did not suddenly start consuming so many high priced imported goods. Some wealthy men thought of indulging in their new found wealth and people like me are suffering.

Then I realized as a common man my options of protecting wealth are really limited. By the way ”The Death of money” talks many ponzi schemes used by wealthy Chinese to move their asset out of their country and preserve its value in vineyards of Australia. None of these will work for an average middle class Indian. Now I need to understand how money itself is working, before thinking of an alternative or if an alternative exist in the first place. Not willing to go through any serious economics course I could think of simple analogies and stories to give life and structure to my thoughts.

History of Money – My Version

Think about an ancient village where people were living without money. The used to exchange or barter goods and services and the society progressed slowly. The richest man of the village was their governor, the most shrewd and hardworking fellow. He owned lot of land, gold, and silver and had armed men to protect his interests.

One day the village farmer came to the governor's house, trying to sell his produce of the year. He had 100 kg rice to sell and was looking for about hundred silver coins for it. The governor got an idea and he said, instead of 100 silver coins I would give you 100 paper pieces each of which says that I owe you a silver coin. The farmer was not impressed, but then the governor whispered something into his ears and all of a sudden he accepted the deal.

The farmer went home and he had plans to get some nice clothes for his wife. He approached the weaver, told the whole story. He wanted to get a coat for which the weaver normally take 2 kg rice or 2 silver coin or varying quantity of whatever he needs. The farmer gives 2 paper chits which said that the governor owes 2 silver coins and return home with the coat. Those days everyone knew everybody else and the weaver did not doubt the farmer or the governor and he always know that the immensely wealthy governor would have two silver pieces any day and he can collect it at his leisure.

Money Value Proposition

So what was the magic by which the governor convinced the farmer to accept worthless paper for his hard earned rice? For the farmer to buy the coat there are many pre conditions

• Someone should be willing to sell a coat.
• Seller should need rice at the moment.
• The buyer and seller need to assess their respective commodity value, which is, how much rice for a coat.
• The buyer should have rice (perishable and seasonally available item) at hand when he needs coat.


With the introduction of the paper money, the farmer has a lot of flexibility in all but the first precondition. He can preserve the value of his rice in 100 paper pieces, knows how much a coat cost by doing simple calculations, and doesn't have to wait till the weaver runs out of rice to buy his coat.

The Problem

Fast forward to modern day and we have banks, loans and multi-million dollar businesses (farmer, weaver) and our central banks (governor) so everything is fine right? Wait, something is not correct. Let us go back in time and check the governor. Ideally he should print money for which he had gold or silver to back up with. If all the people come back with all the paper pieces he should be able to honor his promise. But such an event never happens.

Even on first day he did not lose a single silver piece and got 100 kg of rice. Technically he is simply richer without doing anything. To make thing worse he can think he is richer by having 100kg of rice plus all his existing wealth. May be can mint more money, all his gold and silver worth plus 100 more due to the 100 kg of rice in his kitchen.

He is limited only by the amount of money transactions that his village performs, beyond that there will be inflation as people no longer needs his paper and it loses its purchasing power. This is not silly, he may be rich, but his wealth is nothing compared to the total value of transactions happening in his village. So he can go a long way before any real inflation kicks in. And he ferociously attacks anyone who do not accept his money or come up with an alternative.

This is simple to understand, you accept 100 Rupee bill from your employer not to exchange it for gold from your central bank. You accept it because the friend grocer will exchange it for food that you can eat. This is what our central banks are doing to us in our country. United States of America is doing to the entire world at a different and larger scale.

Solution?

So where did it all go wrong. When the farmer wanted to exchange his produce with weaver, a medium called money was definitely useful. The trouble was that it had to be ratified and printed by the governor. This unwanted link gave an unfair advantage to the governor.

What they wanted was a secure accounting system which recorded the sale. After the first sale the governor really owed goods or service worth 100 bit coin to the farmer or anyone who happened to have one of those bills. He is in debt not richer as he initially thought. This hypothetical accountant who doesn’t report to governor or village should have made an entry only if governor entrust the accountant with 100 silver coin. This transaction can be verified by anyone in the village and weaver would happily accept two bit coin for a coat from the farmer. Of Course the accountant doesn't own any bit currency himself. He should have obtained it magically on demand when he sees real asset and no one should be able to do this at home or tamper with his accounts. He can charge a small commission for his service rendered.

A money transaction is just half of that of barter transaction. Money exchanged for some goods or service. The loop is complete when the farmer collects goods or service worth 100 bit coin from many different people of the village. The accountant need to keep track of the initial transaction securely till the loop is complete. The total money in the village equals the sum of all goods and services that the entire village possess and that is distributed in the entire village. No one including the accountant has the right to invent money. It is created when people make goods or services that is needed by another person. The weaver and farmer are the real people who created wealth in the system.

When the governor finish selling the rice to all needy people in the village, check the accountant's record. Either the governor would have got all his silver back or may be couple of more silvers if he sold it at a higher price. Here he added a service to the system which is reflected as an increase in his personal wealth.

Money itself cannot be created and it has no intrinsic value. It can but be destroyed. Let us say the rice is spoiled at the governor's place. He still need to provide goods or service to each and every person with whom the farmer traded his bit coins.

Bitcoin

Without computers and cryptographic techniques we could not create such a benevolent, secure, truthful accountant. But now we can and it is called bit coin. This is a crypto currency created by very complex mathematical operation that is not easy to counterfeit. The accounts are kept by an open community of computer programs. The value of the currency against any goods or services will really be guided by demand supply pattern of those commodity.

Conclusion

Going back to my original problem, the central bank will not be able to undervalue the currency on demand has we used bit coin. India imports lot of gold and oil. The price of these commodities in bit coin rate will increase. You might argue this is exactly the result of reducing the value of rupee. But in the case of a market controlled currency I have the power to fight back. I could say the price of oil has increased, now you need to pay more for my services. This freedom is indirectly taken away by the central bank who by reducing the value of our currency, is declaring that my services are essentially cheaper. I need to work harder to make up for the loss of value of my services and work longer to acquire the costlier oil!

Tags:bit coin,understanding how money works

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