I wonder what would happen....to the drum!

Jan 9th 2004

Just testing a theory here. What would happen if the contents of the drum remained static, no shrinkage. This thought process is the ultimate in lateral contrarian thinking. 

The way currencies are traded today forces Central Banks to print money to cater for the influx of funds. This benefits consumers and impoverishes producers. Now, say that there was no way a Central Bank could print money. It does not need to be a gold standard, it just requires something that is lacking by Central Banks and Governments, prudence and honesty. 

In today's world there is a flight of money from consumption type nations, the USA, into productive type nations....... NZ, Aust, SA, Can. Now suppose those wanting to buy the NZ dollar had to purchase it off a producer who had a product to sell. There would be an auction, the one who would pay the most would get New Zealand currency in the trade. The producer who sold product in exchange for US currency would be the beneficiary of foreign currency, not the Central Bank. This is only fair as it is the producer who has to bear the costs implicit with a strengthening currency. It would be the producer who deploys the funds. 

Now lets go back to the drum of money. Under the present system the Central Bank has to print money in order to trade the currency. The drum remains the same size, to put more money in the contents need to shrink. Inflation. Those on fixed incomes have an increase in spending power out of proportion to their share of the contents of the drum in relation to the producer. In New Zealand that spending power has gone up as the dollar appreciated. From US38c to US64c, or 60%. Spending power increases velocity which increases inflation. So hypothetically, if the drum started with 45% productive money and 55% consumptive money, and the consumptive money supply goes up 60%, then the share of the drum occupied by the consumptive sector goes up to 88%. That leaves only 12% of the drum for the producer. No wonder there is financial pain in the provinces. There is no money to add to or maintain productive ability.  

If it was the producer who sold New Zealand currency in exchange for US currency then the share of the contents of the drum would not alter by such a huge margin. The producer would then go to the Central Bank via domestic banking institutions and exchange for New Zealand currency. The money is earned, not created out of fresh air. The Central Bank would then be the holder of foreign currency reserves which importers could access. This would lead to the minimizing of national current account deficits as only what is in reserve could be spent. The producer would then be able to spend on production without risk of inflation generated by the Central Bank. The producer would also benefit directly from the commodity markets appreciation, the very reason for the pain in the first place. 

Because there would be very little inflation and the balances inside the drum would be not so blatantly altered, the liquidity driven retail and housing markets would not begin and demand continual feeding. 

I think the result would be a stable currency. 

I will leave you to ponder the contents of the drum.

Allie Oop 8th Jan 2004