Destabilizing the Dollar, 3/17
There are many hidden costs
Neither the Chinese RMB, gold, or Bitcoin is prepared to play anything like the role that the dollar currently plays in the global financial system.
Right. But neither is the dollar prepared to play anything like the role that the dollar has played up until recently. First, the promiscuous use of sanctions means that the dollar is no longer a safe haven. It used to be that if you were a wealthy Russian, a wealthy Chinese, or a wealthy Iranian, you wanted to have dollars in American banks, “just in case.” Now, you have to wonder if and when those funds will be frozen or confiscated. I think you even have to wonder about it if you are a Canadian or an American with dissenting opinions.
Second, the promiscuous use of debt financing by the American government has finally unleashed inflation that is rapid and unpredictable. This undermines the usefulness of the dollar as a measure of value. Undertaking long-term contracts and investments in such an environment is like trying to build a house with odd-shaped boards or trying to coordinate meetings between people whose clocks are not set to the same time.
To hedge against future price increases, Elaine Bell Catering has started to include an inflation rider in new contracts. “We’re giving them the best price we can if they were having their event today,” Mr. Merritt added. “But where we are booking things 18 months out commonly, we have to price this more like a long-term labor contract that has a CPI adjustment.”
In order to engage in economic activity, we need reliable measures of value. When inflation becomes high and variable, we no longer have that. In 2023, what will inflation be? As of a few years ago, most people were certain that it would be less than 3 percent. Now, many people may still believe that. But I think it will be more than 7 percent.
It’s not that I know better than the crowd where inflation is headed. The point is that no one knows. Inflation has become unpredictable. This raises the cognitive load for you in trying to evaluate how much to save and in what assets, when to buy a house, or whether you need to look for a better-paying job.
In information theory, one measures signals by looking at surprise relative to a stable medium. In the context of markets, the stable medium is a reliable currency. Neither Bitcoin, gold, nor the RMB are stable media. The dollar is no longer a stable medium, either. Our economic environment is now filled with noise, making it harder to extract signals. The harms that this causes will never be calculated. The process of calculation itself is what has been damaged.
An incisive blogpost about a contested issue in economics. Part of what makes Arnold Kling a most reliable public intellectual is his sure grasp of 'knowledge problems' in society.
Compare Bryan Caplan's recent blogpost about inflation:
"What’s so bad about inflation, anyway? Economists have struggled to come up with a good answer. The best story, in my view, is that inflation causes recessions via politics: Voters hate inflation so much that politicians willingly endure severe recessions to get it under control. So while there’s a long-run trade-off between inflation and unemployment at low inflation rates, high inflation is a leading cause of high unemployment."
Link: https://betonit.blog/2022/03/15/inflationary-austerity/
I find persuasive Arnold Kling's answer to the question, What's so bad about inflation?:
"Our economic environment is now filled with noise, making it harder to extract signals. The harms that this causes will never be calculated. The process of calculation itself is what has been damaged."
Arnold Kling harnesses the economics of information. Bryan Caplan appeals to behavioral political economy: rational, self-interested politicians adapt to irrational beliefs of voters about inflation.
To accommodate “a wealthy Russian, a wealthy Chinese, or a wealthy Iranian, [who] want[s] to have dollars in American banks, ‘just in case’,” are there not banks in other countries that offer dollar accounts? The American government tries to impose its sanctions on foreign countries, too, but there must be some with a history of resisting—perhaps Luxemburg, the Cayman Islands, or Singapore would be small enough to fly under the U.S. radar.