Monetary Issues Made Simple Part 5

Back to Basics

When last we examined the realm of Emperor Og his many monetary travails, he had managed to institute a number of reforms which had stabilized his wildly inflationary currency. There had been considerable economic cost to his inflation, but by revaluation and some austerity, he had, for the moment, managed to restore a stable currency.

That is until Emperor Og announces his intention to war with one of his neighbors. At first this is greeted with the usual patriotic outpourings and so on, but when Og finds himself short of funds to pay the military payroll, and quietly issues a small increase in currency, the public panics. Quickly all the old fears resurface, and despite the fact that the supply of currency increased less than 1%, prices soar 10% or more and interest rates skyrocket. And so, despite the revaluation and short respite it gave, Og finds himself again running printing presses day and night in a losing race with soaring prices.

Revaluation having failed, Og turns to his more radical advisors and tries the alternate solution of price controls and interest caps. Previously he had not concerned himself with prices and had tried to manipulate interest solely through monetary means, but as that failed to produce results, he sees no alternative. And so Og issues an edict, pegging prices for all consumer goods at the recorded market prices on the last day prior to his creation of the additional currency. Similarly, he pegs interest in consumer credit at the maximum rate charged on that day.

The interest cap has a simple effect, the disappearance of credit. At the capped interest rate there is simply no way to make a loan without losing money, so no one is willing to make a loan. A few work around this by resorting to subterfuges, such as charging “fees” on a loan, to drive up the interest rate, or writing contracts requiring repayment in tangible goods to avoid the fluctuating value of the currency, but by and large, interest caps simply cause what little capital remained available to disappear.

The consumer price caps have a more complex effect. By being applied solely to consumer goods, they make only those goods unprofitable, driving them out of production. Instead, all productive energy is poured into anything which has no price controls, mostly for the export market, in the hope of turning a reasonable profit. A few enterprising individuals try to work around the price caps, either by engaging in some sort of barter, or by creating bundled contracts where they sell consumer goods at the fixed price along with a token amount of producer goods at a hugely inflated price to make up the shortfall. But again, the primary impact of price controls is to destroy the controlled market.

Emperor Og is shocked at what he sees. Despite his controls, the economy continues to collapse as before. Produce good prices continue to skyrocket, telling him that the underlying problem remains, even while his price controls destroy the capital market and the consumer good industries.

Seeing all productive energy going into the production of goods for export, and all the revenues flowing into the import of consumer goods no longer produced at home, he decides that “profiteers” are to blame, that they are exporting all the nation’s wealth overseas and enriching foreign companies while his own people starve. And so he issues two more edicts. First, he extends his price controls to all manner of goods, again freezing prices, this time at levels set by a panel of experts, with a specific “fair” price determined for each good. Second, he places draconian restrictions on foreign trade to avoid the outflow of wealth.

All of which results in the final collapse of the economy. Without the foreign markets to provide consumer goods, and with producer goods now as unprofitable as consumer goods, there simply is nothing left for anyone to make. The large and medium sized firms just collapse. A few small firms stay in business by resorting to barter, engaging in some subterfuge to avoid price caps, or by simply ignoring price caps until the government eventually shuts them down. However, even those firms are eventually forced to shut their doors, as the caps and inflation make trade impossible. Most people are forced to resort to some sort of subsistence farming, hunting or scavenging. The entire economy ceases to function.

And we will break there, having reduced his economy to the most basic subsistence level, with only a few traces of the former complex economy that had existed prior to his attempts to curb the harmful effects of inflation. In our later installments we will pick up there and look at the many solutions Emperor Og attempts to drag his economy out of the depression he created. Perhaps we will even turn back the clock a bit, pick a point short of total collapse and see how he might proceed had he chosen an alternate approach.

Whatever we choose to examine, that will have to come later. For not let us draw a curtain on Emperor Og and his unfortunate subjects.

NOTE: This is a reprint of an old essay first published in the, now defunct, Random Notes blog, and later reprinted in the still extant  Ghost Squirrels blog. Typos have been corrected, some minor changes made to content and some reformatting has been done.

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About Andrew Sherrod 15 Articles
I believe government is not a "necessary evil", but rather a tool, just one that is very often misused. It should be kept small, and more importantly, local.