Negative real interest rates: good or bad?

[Wonk]

There's a discussion about gold and negative real interest rates in the gold forum, which made me think about the topic for a minute. 

I used to be a staunch Ron Paul "no-inflation" kind of guy, but I think I've changed my mind.  When you look at the general electorate in just about every country on earth, the majority vote in their own self interest.  That means entitlement programs and pork barrel projects of various kinds.  This benefits the majority at the expense of the minority (think social security, medicare, defense spending, etc).  The majority also tend to be financially illiterate.

Since negative real interest rates act as a tax and the majority do not protect themselves properly, the majority tends to pay for everything they've voted for.  They just don't know it.  Meanwhile, those who are hip to real interest rates can protect their purchasing power.  It may not be perfect, but it seems to satisfy everyone.

Advocating for a pro-inflation policy wasn't something I thought I'd do, but it seems to be the only pragmatic solution in an entitlement-oriented society where everyone wants something for nothing.

Thoughts?

[MediumTex]

That sounds like a very realistic approach to living in the world we actually inhabit.

Following your approach you could visualize a utopian economic system in your mind while minimizing future regret in your actual affairs.

[craigr]

No inflation is the best policy. Politicians can't handle the money printing power and it causes a ton of unintended consequences. It would be one thing if the people calling the shots were angels, but they never are. This power is also used to fund massive destructive wars of all kinds as well, not just giving out free cheese to people.

[craigr]

Why is it that you think such a "no inflation" policy will be both (i) free of unintended consequences and (ii) not be subject to the same laws of human (i.e. non-angel) nature that ultimately messes things up?

It may not have no unintended consequences, I just think they will be far less than keeping unlimited money creation power in the hands of pols. The country grew successfully for the first 130 years without any inflation, and even slight deflation over most of the time. The idea that you need inflation to have a successful economy is just not true.

[Pointedstick]

It may not have no unintended consequences, I just think they will be far less than keeping unlimited money creation power in the hands of pols. The country grew successfully for the first 130 years without any inflation, and even slight deflation over most of the time. The idea that you need inflation to have a successful economy is just not true.

You're absolutely right, but doesn't that also validate the experience of the last 100 years as well? The dollar has lost 95% of its value during the same time period that the standard of living has improved to an unimaginably high level. Is it possible that economic prosperity may be independent from the general price level so long as it doesn't hyperinflate or collapse?

[craigr]

Is it possible that economic prosperity may be independent from the general price level so long as it doesn't hyperinflate or collapse?

Maybe, but once again I am saying that deficit/inflationary money systems are always abused and usually for purposes like big wars, big government, and other destructive ends.

I don't care about the accounting wizardry associated with modern fiat money systems. I do care however in how the money is being spent and used. I also care about long-term probabilities of there being a serious problem eventually with the system as there has been in every country.

In sum:

• Every Hellfire missile being shot into some third-world country is paid for with deficit spending.
• Every body scanner and airport groping is paid for with deficit spending.
• Every dictator we've propped up around the globe has been paid for with deficit spending.
• Every new government program, entitlement handout, and other forms of payola that will compound the debt problem over time has been paid for with deficit spending.

It will catch up eventually. Always has and always will. Inflation and currency debasement is as old as the hills.

I'm big on probabilities and investing. That's why I don't make concentrated bets. The odds are never as sure as people believe, you see.

But I do know this about paper money and inflation: It usually ends badly.

Now I can't say for certain it will happen with the US Dollar. All I'm saying is, as a guy who is thinking in terms of probabilities, every other time paper money has been tried it has failed. It maybe happened fast, or took some time. But the result was always misery. So everyone is free to draw their own conclusions on the odds of the US dollar making it out successfully.

However my advice: Never bet on the outlier to keep being an outlier.

Long term consequences of inflation has always been very bad because the people in charge of the money are just not responsible in handling it.  

Yes I really wish we were on a gold standard. It may have problems, but I don't think it would be nearly as bad as what we have now. And as an aside, businesses like having stable money. It makes their life a lot easier so I do not believe it would hamper the economy in the slightest and would likely allow it to be much more stable.

[moda0306]

It seems to me that wars/genocide (via the draft, no less)and other far worse forms of government overreach than what we have today were very successful when we had monetary systems much more rooted in "sound money."

Other programs... maybe.  But when it comes to war, murder, etc, things were way worse back when countries were held to tougher monetary standards with gold... IMO anyway.

[craigr]

Other programs... maybe.  But when it comes to war, murder, etc, things were way worse back when countries were held to tougher monetary standards with gold... IMO anyway.

Gold is not perfect, but I am simply saying it is far less of a problem than not having it in terms of unfunded wars and other runaway spending.

WWI and onward were basically enabled by deficit spending. The Civil War was also funded by paper money printing and not gold. Lincoln de facto came off the gold standard to fund the Civil War for instance. That's why the dollar around that time lost value before recovering after the war ended when Congress went back to the gold standard.

So the major wars you are thinking about almost certainly happened because deficit spending without regard to the gold standard enabled them.

Wars where the gold standard was still in effect were far less brutal in terms of US history.

[Pointedstick]

Gold is not perfect, but I am simply saying it is far less of a problem than not having it in terms of unfunded wars and other runaway spending.

WWI and onward were basically enabled by deficit spending. The Civil War was also funded by paper money printing and not gold. Lincoln de facto came off the gold standard to fund the Civil War for instance. That's why the dollar around that time lost value before recovering after the war ended when Congress went back to the gold standard.

Isn't that a knock against the gold standard? I see your point, but if it's so easy for governments to abandon it and turn to the printing press whenever they need to pay a bunch of young men to murder foreigners (or each other, in the case of the civil war), then what use is it in restraining government from doing so? No government is powerful enough to devise shackles that it won't later be able to open.

[craigr]

No government is powerful enough to devise shackles that it won't later be able to open.

I don't disagree with you. I believe that John Adams will ultimately be proven right when he wrote:

"Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other."

Ultimately the constitution is just a piece of paper (to paraphrase George Bush). If people choose to ignore it then no it doesn't matter. Immoral leaders and immoral people respect nothing.

Which brings me to a point about societies and trust. I have been to New Zealand and know someone from New Zealand very well as discussed here before. That country is 100% fiat currency. In fact, the New Zealand central bank invented the idea of "inflation targeting" which is what most central banks try to do today. But New Zealand and the New Zealand government are not very corrupt (this is the part where I irritate Moda BTW) and that's why they will likely be able to keep it up for a while. For that matter, Switzerland and the Scandinavian countries fit in that mold also. Probably Singapore and Japan as well but I've not been there yet to assess them, just reputation. These countries are all very straight arrow places on the whole and their societies have strong mores against corruption and acting immorally.

However I don't get the same sanguine feeling from the government of the United States and it has gotten worse each year. I guess you'd say "less moral" or "more corrupt." It is my feeling that in general a fiat system may work for other countries that maintain a level of good government and strong moral cultures like New Zealand, Scandinavia, Singapore, Japan, etc. I do not believe it is workable at all for countries and cultures that are entirely corrupt, or heading the wrong way on the trajectory (as the US is). That system will fail because fundamentally fiat systems rely on the issuer to be trustworthy. Gold assumes the issuer is not trustworthy. If you are trustworthy maybe paper has the flexibility to be a good idea and I understand the benefits. But if the issuer is not trustworthy, you have to just use gold because it may have problems but it's better than alternatives.

The argument is too much for me to get into here. I should flush it out. I will just say that paper money can only work if you really think the government could be trusted. But I will say that the US is becoming far more like Mexico in terms of corruption than it is Norway. That is a big problem with the idea of fiat money. It simply can't be left in the hands of corrupt people.

[MediumTex]

I believe that John Adams will ultimately be proven right when he wrote:

"Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other."

Ultimately the constitution is just a piece of paper (to paraphrase George Bush). If people choose to ignore it then no it doesn't matter. Immoral leaders and immoral people respect nothing.
...
It is my feeling that in general a fiat system may work for other countries that maintain a level of good government and strong moral cultures like New Zealand, Scandinavia, Singapore, Japan, etc. I do not believe it is workable at all for countries and cultures that are entirely corrupt, or heading the wrong way on the trajectory (as the US is). That system will fail because fundamentally fiat systems rely on the issuer to be trustworthy. Gold assumes the issuer is not trustworthy. If you are trustworthy maybe paper has the flexibility to be a good idea and I understand the benefits. But if the issuer is not trustworthy, you have to just use gold because it may have problems but it's better than alternatives.

How would a system based on gold protect against moral deficiency or untrustworthiness?

It does seem to be a bit more difficult to wage large scale war when you're on a gold standard.

[Pointedstick]

It does seem to be a bit more difficult to wage large scale war when you're on a gold standard.

Unfortunately, it seems all too simple to suspend it when you want to wage a large scale war. As long as the government is the originator of its gold standard monetary system, how could that possibly tie its hands? It could (and as we've seen, has) made whatever alterations it wished for when the killing times rolled around.

If we wish to prevent war, it seems like we need to abolish government itself, not fiat currency.

[MachineGhost]

It does seem to be a bit more difficult to wage large scale war when you're on a gold standard.

A bit more difficult just isn't good enough.  What we need is strict legal controls on Congress like term limits and a balanced budget amendment.  Once that happens, we can all use p2p cryptoanarchist XXXXcoins.

[craigr]

This is what I was thinking too.  Paraphrasing melveyr... "Gold [the metal] doesn't make any promises.  It just sits there, being gold."  But a gold standard is indeed a promise.  Why wouldn't the promisors simply break it in an emergency?

Again it's not a panacea. Ultimately if you live in place where the government is going to do things that are immoral as a matter of course, then nothing is going to protect you outside of simply leaving for greener pastures. I do think that gold, along with other constitutional protections initially built in, provided a layered defense. But over time the fail-safes have each been gradually disarmed. However I certainly do think we'd have less problems with a gold standard than without.

[MediumTex]

It does seem to be a bit more difficult to wage large scale war when you're on a gold standard.

A bit more difficult just isn't good enough.  What we need is strict legal controls on Congress like term limits and a balanced budget amendment.  Once that happens, we can all use p2p cryptoanarchist XXXXcoins.

We should amend the Constitution so that the only branch of government that could actually declare war was Congress, and knowing how difficult it is to get Congress to do anything, this would put a serious damper on the ability of the government to wage war on other countries in any but the most extreme circumstances. 

It seems like such an elegant solution to the problem of king-like executive branch leaders waging war as a form of regal sport.

Does anyone else think that something like this would be a good idea? 

[Tortoise]

Gold-based money doesn't have to be defined and managed by the government.

Privately defined and managed gold-based money--i.e., a free market for money--is entirely possible and would avoid the problem of relying on the government to keep its promise regarding a fixed exchange rate between dollars and gold.

Just allow private money systems to compete freely with the government's money, and let the consumers decide.

[craigr]

Just allow private money systems to compete freely with the government's money, and let the consumers decide.

I completely agree, but Uncle Sam doesn't. They put the collectibles tax on gold almost certainly to keep it from playing in the market squarely. If paper money and inflation were so much better, surely this tax could be removed without any worry, right?

[Pointedstick]

Just allow private money systems to compete freely with the government's money, and let the consumers decide.

They already sort of do, don't they? Take a look at Bitcoin: it's a purely private money system that you can use to buy many many things, and the feds haven't shut it down or made it illegal. Just about the only thing you can't use it to pay is your taxes!

[Tortoise]

Just allow private money systems to compete freely with the government's money, and let the consumers decide.

They already sort of do, don't they? Take a look at Bitcoin: it's a purely private money system that you can use to buy many many things, and the feds haven't shut it down or made it illegal. Just about the only thing you can't use it to pay is your taxes!

There's much more to it than that. The government also needs to enforce contracts denominated in any currency agreed upon by both sides of the contract. Currently it only enforces U.S. dollar contracts.

Also, free competition in currency would mean the government needs to let private companies define and manage their own gold-backed currencies if they want to, without those gold-specific taxes. That is not currently the case.

[craigr]

They already sort of do, don't they? Take a look at Bitcoin: it's a purely private money system that you can use to buy many many things, and the feds haven't shut it down or made it illegal. Just about the only thing you can't use it to pay is your taxes!

They will make it illegal if it gets too big if history is any guide. Trust me. They will claim it is used by criminals, terrorists, etc. (never mind that cash is used for the same thing). The people printing the money don't want competition.

[Pointedstick]

I have no doubt that they will. But it will be awfully hard for them to actually shut it down!

I get your point though. I want competing, private currencies as well.