Currency Plurality and Menu Prices
If there is anything to be learned from MMT, it is that fixed exchange is death: bank runs and public debt crises are two examples of the bad results of fixed exchange.
Simply put, fixed exchange is bad financial engineering. Like a non-earthquake-proof building, fixed exchange offers no flex until it breaks. Your reserves run out trying to honor deposits or maintain a foreign currency peg.
Even today, we see well intentioned financial efforts fall into this trap. This was the fate of cryptocoin NuBits.
NuBits promised a 1 to 1 peg to the U.S. dollar. We already have a dollar. We don’t need another dollar. That is the wrong way to engineer asset price stability.
NuBits could have stabilized their asset price without targeting a fixed peg — with some flex in it. If you try to target a fixed price you can easily drain your reserves and fail to meet the desired price. If you dynamically adapt your price target, you can dampen the ride going over the bumps and potholes while never completely depleting your reserves(depleting reserves completely would require the prices to go to zero). Targeting a fixed price is like a car’s suspension system trying to guarantee a specific altitude as opposed to a smooth ride over altitude changes.
As an asset issuer, it’s not difficult to design an asset buying program where you never have a net loss of a different reserve asset whenever the exchange rate returns to a previous price. You can even design your buying program such that your reserves are guaranteed to increase with price fluctuations, though as an asset issuer that should not be your goal.
Hypothetical Example: FlexCoin
Pretend you issue an asset called FlexCoin and you use U.S. dollars as reserves to help stabilize prices. You have an initial level of dollar reserves, an initial amount of circulating FlexCoin, and an initial price level.
Let’s say you have $10 million of initial dollar reserves, 25 million in circulating FlexCoin, and you start trading FlexCoin at a price level of $1.00.
Instead of targeting a specific exchange price, you specify a target reserve level directly proportional to the current price. If the price of FlexCoin doubles, you want your amount of dollar reserves to double as well, for example, which you can achieve by issuing and selling more FlexCoins for dollars. If the price of FlexCoin halves, you may use up half of your reserves buying back FlexCoins to stabilize the price.
In this construction, the price of your asset and the amount of reserves always correspond exactly, while the circulation level and price correlate less precisely, but still have the same limit behavior. Price, circulation, and reserve levels are all guaranteed to approach zero together. You never deplete your reserves without the price going to zero and also buying back all circulating flexcoin.
Full reserve banking can make these same guarantees, but this more flexible program allows for price changes, interacts smoothly with markets, and still works if you happen to lose a portion of your reserves.
More sophisticated asset exchange programs can be designed using optimal control theory. While the mathematical details can get quite complex, the basic principles are not. You need to be smart and savvy, you need to conserve your resources carefully, but not be afraid to use them to reach your goals.
Pegs Are Bad, Stability Is Good
MMT explains why pegs are terrible, and the amazing powers you get as an asset issuer when you be yourself and stop trying to pretend to be someone else.
At the same time, there are HUGE social benefits that come with price stability. Because finance is social and not physical, the units have no fixed representation in the physical world, unlike units of distance or mass. (You could tie it to energy like oil, but that’s a bad idea)
As I explained before, prices are social costs, so as prices change, your social relationships must change as well. If the prices of rents and goods change, wage prices need to adapt as well.
Prices that don’t reflect the physical costs of resource use aren’t sustainable. One of the fundamental purposes of our political social groups is to survive by adapting to changes in our environment. A changing environment leads to changing physical resource costs.
If we pursue the right priorities, price stability isn’t hard, and is related to social stability. Imagine a tribe of nomadic people. As the seasons change, their activities will change and they will move to better use the resources of their environment. One way to describe such essential adaptations is the pursuit of price stability. By shifting your resource use you can still meet the same goals as before. Some price change is unavoidable, but the adaptations minimize them, permitting survival.
Menu Costs, Many Currencies
A currency is an asset used to denominate prices and accepted for purchasing products or services.
Currency plurality is attractive for a lot of reasons. It creates a diverse environment of political entities that can exercise the immediate spending powers available to currency issuers. It creates checks and balances and empowers peers with knowledge through transparent political relationships. If one issuer uses their powers improperly, it is easy to transition to another currency standard, and price changes reveal problems.
But the menu costs that come with many currencies are exponentially greater. Relative prices change, advantaging some and disadvantaging others, and potentially requiring renegotiation. Menus need to be longer and specify the different prices in all the accepted currencies. Users must deal with more challenging mental math to know if they are getting a good deal or not.
Having a single stable standardized unit is nice for most menus, but this can lead to mental pegs that don’t accurately reflect the political relationships involved involved in resource use. Certain products might have stable prices in one currency but not the other, because of the way that changing prices reflect changes in social and political relationships and environment.
If an asset isn’t currency, it’s only used for savings, and probably a less preferred savings asset because it is less liquid. The distinction between a currency and savings asset isn’t black and white but rather a continuum. I could potentially buy something on craigslist with a walmart gift card, but I might get a less favorable price.
Perhaps there are good ways of making these asset dynamics transparent without overwhelming users with a plethora of currencies and listed prices. Prices should be denominated in the most relevant assets to minimize menu costs and price fluctuations.
The problem with menu costs is not merely publishing new prices, but renegotiating and adapting to new relationships. Continuity and stability are good things here.
Credit cards can seamlessly facilitate spending using whatever assets the buyer has which the seller wants. They offer easy use at point of sale, but less transparency.
Prices should be denominated in assets that are the most relevant politically and socially to the resources required for a product. For example, you might pay for housing using state or local currency, while you would pay for a happy meal with federal currency.
This is how you can best achieve price stability and reveal the political and social factors behind prices transparently.