Monthly Archives: October 2015

Why is Money Accepted as a Medium of Exchange?

A widely accepted medium of exchange is critical to the efficient economic functioning of any society. Money, in all of its forms, has performed this role for thousands of year. Indeed, acting as a medium of exchange is, without doubt, the most important of money’s “three functions” and, for many, defines what is money and what is not.

However, while economics textbook overflow with discussions regarding the role of money as a medium of exchange and the importance of that role, most textbooks are mute on much more important topic: “Why is money accepted as a medium of exchange?”

There is little controversy around the fact that money is useful as a medium of exchange, a store of value and unit of account. However, merely making this simple observation doesn’t expand our understanding of why money is able to perform these vital functions.

In this week’s post, we will attempt to explain why money can perform its functions and, more specifically, why it is accepted as a medium of exchange. In order to do this, it is important that we go back in history and think about why early money, “commodity money”, was able to perform these roles. Once this exercise is completed, we can think about how money has evolved and why it is still able to perform these functions today.

The view of The Money Enigma is that in order for any item to act as a medium of exchange, that item must be “valuable”. More specifically, it must possess the property of “market value” or what Adam Smith might have called “value in exchange”.

In the context of an ancient economy, it is relatively easy to understand why “commodity money”, such as gold and silver, had value and was, therefore, accepted as a medium of exchange. The much harder question, and a question that economics generally fails to provide sensible answers for, is why does the money that we use today, i.e. “fiat money” or “paper money”, possess value.

Avoiding the Difficult Question

If you open a typical economics textbook and flip to the section about “money”, you will find a whole list of standard questions about money accompanied by a familiar list of answers. Near the top of this list of questions you will find the question “What are the functions of money?”

Economists feel very comfortable answering this question because all of us have some have first-hand experience with the “functions of money”. All of us have some familiarity with money’s role as a medium of exchange, a store of value and a unit of account.

Economists also feel very comfortable talking about why these roles are important. For example, money allows us to avoid the inefficiencies created by a pure barter system.

So far, so good. The problem is that these are easy questions: questions that require a basic modicum of common sense to answer, not a PhD in economics.

The much more difficult question, a question that is avoided by most introductory economics textbooks, is “why can money perform its function?” More specifically, why is money accepted as a medium of exchange, why is money able to function as a unit of account and why is money a store of value?

If you think that I am being unfair, try a quick Google search on “what are the functions of money?” No doubt you will find thousands of responses returned. Now, do a Google search on the phrase “why can money perform its functions?” or the phrase “why is money accepted as a medium of exchange?” Good luck finding a clear answer to these questions that doesn’t just repeat what the functions of money are.

The view of The Money Enigma is that there is little point discussing what are the functions of money if you can’t explain why money can perform those functions. The “why” is a much more difficult question than the “what”, but the “why” is a question that is fundamental to the science of economics.

Avoiding the Temptation of Circular Logic

It is very easy when answering the question “why is money accepted as a medium of exchange?” to inadvertently fall into a logical fallacy.

At the most basic level, most people recognise that in order for money to perform its functions, money must have value.

For example, you would not accept money from me in exchange for your goods or services unless you believe it is valuable. If I offered you Monopoly dollars for your services, you would refuse my offer. Why? You would refuse because Monopoly dollars have no value (except in the context of the game itself). On the other hand, if I offered you US Dollars, you would probably be more than happy to accept them because they are recognized as something “of value”.

In more technical terms, we can say that an economic good can only act as a medium of exchange if it possesses the property of “market value”. Money is only accepted in exchange because it has value. In the words of Adam Smith, we might say that money can only perform its role as a medium of exchange if it has “value in exchange”.

Again, so far, so good. The problem comes when we ask the next obvious question, “why does money have value?” More specifically, why does fiat money, paper money with no “intrinsic” worth, have value?

One of the more common answers to this question is “money has value because it is widely accepted as a medium of exchange”.

Now, can you see the problem with this answer? We have just argued that money is accepted as a medium of exchange because it has value. Therefore, we can’t also argue that money has value because it is accepted as a medium of exchange. One of these answers can be right, but they can’t both be right. Maintaining that both of these answers are right creates a circular argument, a form of logical fallacy.

Where does that leave us? Well, we need to pick one answer that we believe must be correct and then find another solution for the second question.

The view of The Money Enigma is that our answer to the first question is correct: money can only act as a medium of exchange, unit of account and store of value because money has value. Therefore, the question for which we need a new answer is “why does money have value?”

A sensible answer this question needs to achieve two objectives. First, it needs to avoid invoking money’s role as a medium of exchange to explain why money has value. Second, it should provide us with a model that can explain why money has had value in all the various forms that it has taken over time.

Bearing this second point in mind, let’s consider how money evolved over time and why money, in its earliest forms, had value and was able to act as a medium of exchange.

Commodity Money as a Medium of Exchange

It is not hard to imagine how in early barter-based societies, one particular commodity, such as grain or cattle, emerged as the favorite among traders of goods. Indeed, historical records indicate that these basic commodities were used as money as early as 9,000 BC.

It seems likely that, in early societies, goods that were widely used by most people, could be stored for a reasonable period of time and that weren’t prone to wild fluctuations in their value would have become favored as “trading goods” within and between small communities.

All of these basic goods derived their “value in exchange” from their natural or physical properties. Grains and cattle could be eaten, while other materials such as copper and silver could be used to make tools or household equipment.

In modern-day parlance, all of these items had value because they were “real assets”, i.e. they derived their value from their physical properties. Similarly, each of these early forms of “commodity money” had value because they were real assets.

Over time, precious metals emerged as the most popular form of commodity money. There are many reasons for this, but the primary reason for their popularity was the relative invariability in the stock of these commodities. Gold is rare, it’s hard to find and it doesn’t get consumed. Therefore, its stock is relatively constant over time. Why would this make it attractive as a medium of exchange? Well, in simple terms, gold would have acted as constant in a sea of economic variables. While other commodities were subject to vast fluctuations in stock due to natural variations in supply and disease, a trader knew that there was not going to be a lot more nor a lot less gold available in the world one year from now than there was today. (Those who would like to read more about this subject should read an earlier post titled “What Determines the Price of Gold?”)

Whatever the reasons, gold and silver became the preferred forms of commodity money and remained so for many centuries. Importantly, both gold and silver are real assets that derive their value from their natural or physical properties.

Paper Money and the “Real Asset/Financial Instrument” Paradigm

Whether it is cattle or grain or gold, it is easy to understand why something that derives an intrinsic value from its physical properties should be accepted as a medium of exchange. What is more difficult to comprehend is why “paper money”, money that is literally made of paper of little intrinsic worth, should have value.

However, it is easier to understand why paper money has value if we think about the evolution of money over time.

The first form of paper money, “representative money”, was nothing more than contract, written on a piece of paper, that promised some amount of gold or silver coin on request. Issuing these pieces of paper allowed the early kings and emperors to pay for wars and major public works without emptying the royal treasury of all its gold.

In effect, representative money was an early form of “creative financing”: it allowed the rulers and governments of the day to stretch their spending beyond the limits of what would have otherwise been imposed on them if they had to rely solely on using gold and/or silver to pay the workers and soldiers.

Interestingly, the issuers of this paper money didn’t need to have gold in the vault for every piece of paper that they issued. Rather, they just need to make sure that they had just enough that the promised of “gold on request” remained credible.

The reason that I mention the term “creative financing” is not to imply that paper money is somehow of poorer quality than commodity money. Rather, it is to highlight the point that the real function of paper money is to act as a financing tool. The early kings and emperors didn’t create paper money because their societies needed a new or better medium of exchange: gold and silver were doing just fine in that regard. Paper money was created to finance the expenditures of these early rules.

The fact that paper money was invented primarily as a financing tool should give us a big clue regarding why paper money has value. If paper money was created as a financing tool, then, by definition, it is a “financial instrument”.

Financial instruments are interesting because they derive their value in a completely different manner to real assets. As discussed earlier, real assets derive their value from their intrinsic or physical properties. In contrast, financial instruments derive little or no value from their physical properties. Rather, financial instruments derive their value from their contractual properties.

Every financial instrument is both an asset and a liability. By creating a liability against itself, the issuer of the financial instrument creates an asset for another party. In other words, a financial instrument is only valuable to the holder of that instrument because it creates a contractual obligation upon its issuer to deliver something of value.

Now, let’s think about this in the context of representative money.

Clearly, representative money, the first form of paper money, was a financial instrument. Representative money is, quite literally, a written contract that creates an obligation upon its issuer, normally the royal treasury, to deliver a certain amount of gold or silver on request.

Early paper money only had value because it represented an explicit contractual obligation between its issuer and the holder of that money. Paper money was an asset to its holder, because it was a liability to its issuer.

The key point is that the “real asset/financial instrument” paradigm allows us to explain why commodity money had value and was accepted as a medium of exchange and why representative money, the earliest form of paper money, had value and was accepted as a medium of exchange.

Fiat Money as a Financial Instrument

Given how easily both commodity money and representative money fit within the “real asset/financial instrument” paradigm, you would think that economists would have spent much time and effort attempting to extend this paradigm to fiat money.

Unfortunately, you would be wrong.

As soon as “fiat money” enters the room, most economists rush to throw out this basic and important paradigm regarding how assets derive their value. Rather, they spend enormous time and energy trying to invent an entirely new paradigm, a paradigm that can explain why one asset, “fiat money”, is so unique that it must derive its value in a completely different way from every other asset ever known.

The view of The Money Enigma is that fiat money is a financial instrument and, in common with all financial instruments, derives its value from its contractual properties.

In simple terms, when the gold standard was abandoned and the explicit contract that previously governed representative money was rendered null and void, it was replaced by a new implied-in-fact contract. This new implied contract, or what some might term a “social contract”, is what gives fiat money its value.

While it may be difficult to determine the exact nature of the implied contract that fiat money represents, the view of The Money Enigma is that, prima facie, this represents a far more productive line of theoretical enquiry than trying to create a new entirely paradigm solely to explain how one asset, an asset of relatively recent invention, derives its value.

Moreover, if we can unravel the terms of the implied-in-fact contract that governs fiat money, then not only will we have a sensible answer for why fiat money has value and, therefore, can act as a medium of exchange, but we will also have a better understanding regarding what determines the value of fiat money, i.e. what factors cause the value of fiat money to rise and fall.

So, what are the terms of the implied fiat money agreement?

Those who are regular readers of The Money Enigma will know that we have dedicated a significant amount of time to this issue in recent posts including “A New Theory of Fiat Money”, “What Factors Influence the Value of Money?” and an earlier post titled “Money as the Equity of Society” that reviews the parallels between fiat money and shares of common stock.

However, in simple terms, the view of The Money Enigma is that fiat money is a liability of society and represents a proportional claim on the future output of society. In other words, fiat money has value because we recognize it as a claim against our collective future output.

The amount of output that any unit of money can claim at a given time depends on a complicated set of factors, but the term “proportional” implies that it varies in proportion to the long-term expected size of the outstanding monetary base. All else remaining equal, the greater the expected size of the monetary base, the less valuable each unit of money is today. Conversely, the greater the expected growth in future real output, the more valuable each unit of money is today.

In summary, money, in all of its forms, can only perform its role as medium of exchange if it possesses the property of “market value” or “value in exchange”. The view of The Money Enigma is that assets can only derive their value from their physical properties (“real assets”) or their contractual properties (“financial instruments”).

Commodity money, the earliest form of money, derived its value from its physical or intrinsic properties. In contrast, paper money, whether it be asset-backed or fiat, derives its value from its contractual properties. Fiat money derives its value in exchange from its implied contractual properties and it this recognized value that allows fiat money to perform its primary role as a medium of exchange.

The Fiat Money Experiment: Will the Virtuous Cycle turn Vicious?

For most of us, fiat money is just “part of life”. Many of us have spent our entire lives using fiat money and have little experience with other forms of money. However, viewed from a historical perspective, the widespread use of fiat money represents part of a grand social and economic experiment.

While commodity money and commodity-backed money both have a history of use dating back thousands of years, the use of fiat money as the primary medium of exchange is an anomaly of the modern age.

Many economists might argue that the fiat money “experiment” was successfully concluded many years or even decades ago. Arguably, the fiat monetary system of the Western World has withstood many crises over the past several decades, during which time the major economies of the world have continued to grow. More impressively, inflation has remained relatively contained during this time, except for a brief period in the 1970s and early 1980s.

The problem with this rosy assessment is that the real test of our fiat money system may be yet to come. More specifically, the view of The Money Enigma is that the real test of our fiat monetary system will probably occur at the point that monetary base expansion can no longer drive private-sector credit growth.

Over the past few decades, the fiat monetary base has expanded at a rate far in excess of real output. Basic monetary theory would suggest that this should have led to high levels of inflation. But this hasn’t occurred. Why is this case? Well, in simple terms, inflation is a “confidence game”. More specifically, the value of fiat money is primarily determined by confidence in the long-term economic prospects of society.

So far, monetary base expansion by the central banks has driven a “virtuous cycle”. Low interest rates, banking bailouts and deposit guarantees have all encouraged private-sector credit growth and this growth in credit has fueled economic growth. Strong economic growth boosts confidence in the long-term economic prospects of society, thereby putting a floor under the value of fiat money and, in effect, putting a lid on prices as measured in fiat money terms. The end result is an environment of stable prices that justifies further monetary base expansion!

The key question that we should be asking is what happens if this virtuous cycle breaks down? For example, what happens if our economy reaches the point of “credit saturation”, i.e. the point where monetary policy can no longer stimulate credit growth?

At this point, the “virtuous cycle” may become a “vicious cycle”. If economic growth fails to respond to expansionary monetary policy, then people may begin to question the structural health of the economy and the markets may begin to lose faith in the long-term economic prospects of our society.

If this occurs, then the value of the fiat money that we use every day could suddenly be eroded, leading to a sharp rise in prices. Once prices begin to rise, central bankers may be forced to tighten monetary policy, leading to further declines in credit, economic activity and long-term economic confidence, further damaging the value of fiat money. The vicious cycle, once started, may be one that is hard to stop.

The Virtuous Cycle of Monetary Expansion, Credit Growth and Confidence

Many economic historians might argue that the late 20^th century and early 21^st century represent a period of unparalleled global economic growth and prosperity. During that time, most developed and developing economies experienced a period of robust economic growth and relatively low levels of inflation.

In many ways, it seems that we finally got the “secret sauce” right. Policy makers finally figured out how to manage the tools at their disposal to create and sustain the “goldilocks scenario”.

Indeed, if it wasn’t for the 2008 financial crisis and the lingering effects of that crisis, I suspect that many in our society would believe that economists and central bankers finally have it all figured out.

But have economists really been able to create a new paradigm? Have central bankers been able to perfect the fiat monetary system that we use today? Or have we all just been really lucky… at least, so far?

Let’s consider the alternative proposition: rather than becoming the masters of fiat money, the fiat money regime has become the master of our central bankers.

In essence, central bankers have become trapped in a “virtuous cycle”: a cycle of monetary expansion and economic growth that requires continued and ever greater levels of monetary expansion in order to sustain itself.

How does the virtuous cycle work? Well, let’s think about the events of the past few decades and how they have impacted our expectations.

The view of The Money Enigma is that a significant part of the world’s economic success over recent years can be attributed to an extraordinary expansion in the level of global private-sector credit. This growth in private credit has been enabled by the expansionary monetary-policy bias of the major central banks.

The growth in private-sector credit has, not surprisingly, fueled both consumer spending and corporate investment and has underwritten the growth of the global economy over the past 20-30 years.

This extended period of economic prosperity has had an important impact on our expectations for the long-term future of our society. Decades of growth and reasonably mild recessions, at least by historical standards, have fed the expectation that this will be the pattern that we will see over the next few decades.

The view of The Money Enigma is that this confidence in the long-term economic future of our society has had an important impact on containing the debasement of fiat money, despite the rapid historical growth in the monetary base. In turn, this support for the value of fiat money has kept a lid on prices as expressed in money terms.

Why does long-term confidence matter to the value of fiat money? And why does the value of fiat money matter to inflation? These are both issues that we shall address in detail in the last section of this post. But, in simple terms, the view of The Money Enigma is that fiat money is a proportional claim on the output of society. Therefore, the value of fiat money is positively correlated to confidence in the long-term economic prospects of our society.

Moreover, the price of a good in money terms depends upon both the value of the good and the value of money: all else remaining equal, as the value of money falls, the price of the good rises. If the market value of fiat money is relatively stable, as it has been over the past decade or so, then the price level should, all else remaining equal, remain relatively stable.

Anyway, let’s close the loop, as it were, on our discussion regarding the nature of the “virtuous cycle” that has been created.

The view of The Money Enigma is that the suppression of interest rates and monetary base expansion by the central banks has fueled a cycle of confidence that has underwritten economic growth and kept inflation at bay. However, this virtuous cycle will only sustain itself if expansionary monetary policy can continue to generate credit growth and economic growth and, perhaps most importantly, sustain market confidence in the long-term future of our society.

So, what might happen if we reach the point of “credit saturation”? What happens if expansionary monetary policy no longer has any significant impact on economic growth? Alternatively, what happens if aggressive monetary policy actually begins to undermine market confidence in our long-term economic future?

The Vicious Cycle of Credit Saturation, Falling Confidence and Rising Prices

Over the past fifty years, there has been an explosion in the level of private-sector credit, as measured against GDP, in almost every major developed and developing economy. However, over the past ten years, the growth in private-sector credit has slowed in many of those countries, despite record low interest rates.

While it may be too early to call at this stage, it does seem plausible that we are approaching a point of “credit saturation”, particularly in the United States, Europe and Japan.

What is the point of credit saturation? For the purposes of this discussion, it is the point at which additional monetary stimulus does not generate growth in private-sector credit.

Why might we be reaching the point of credit saturation? Well, there are a few reasons why this might be the case. First, demographics in many of these countries suggest that the consumer, in aggregate, should be moving into a deleveraging phase. Second, private debt levels are already very high by historical standards and common sense suggests that there is some natural limit on these levels.

However, the most compelling reason to believe that we are nearing the point of credit saturation is the most obvious: interest rates can’t get much lower than this. Admittedly, someone could have made a similar observation to this nearly ten years ago and would have been proven wrong. But, with short-end rates now at zero and long-end rates near record lows, it is hard to see how interest rates can take another big step down.

Why does reaching the point of credit saturation matter?

The reason it matters is because the point of credit saturation could represent the monetary policy “tipping point”, i.e. the point at which monetary base expansion stops having a positive net impact on the economy and begins to have a negative net impact.

Moreover, and perhaps more importantly, it may be the point at which the “virtuous cycle” becomes a “vicious cycle”.

How does the vicious cycle work? Let’s start near the top of the diagram above and assume that we have reached the point of credit saturation.

If credit growth slows to stall speed, or worse, credit balances begin to significantly decline, then this is likely to have a negative impact on the rate of growth that the major developed economies can sustain. Just as importantly, slower baseline economic growth will lead to sharper and more severe recessions. After all, if you assume that growth in the economy oscillates around some baseline or trend level of growth, a lower baseline will lead to lower highs and lower lows.

Clearly, such a change in dynamic, if sustained over any extended period of time, would begin to chip away at long-term economic confidence. If economic growth is anemic and recessions are more frequent and more severe, then market confidence in our long-term economic future will be eroded.

Now, we get to the critical point. If people begin to lose faith in the long-term economic future of our society, then the fiat money issued by our society will begin to decline in value. All else remaining equal, this decline in the value of fiat money will trigger a widespread rise in prices.

If this scenario occurs, then central banks could quickly find themselves trapped in a vicious cycle.

Declining economic confidence leads to a fall in the value of fiat money that, in turn, leads to a rise in prices. Central banks are forced to tighten monetary policy, which triggers a decline in credit balances and an extended period of economic malaise further eroding long-term economic confidence and the value of money. The end result is that inflation continues to accelerate, economic conditions worsen and people begin to wonder where it will end.

No doubt, there are many economists who would argue that this sequence of events is impossible. The narrow view of many economists trained in the Keynesian school of thought is that if the economy is weak, then prices must decline. In simple terms, their argument is that is less aggregate demand equals lower prices.

Intuitively, this idea seems plausible. After all, in microeconomics we are all taught that, all else remaining equal, less demand for a product will lead to a lower price for that product. Unfortunately, that represents a very simplistic view of the way the prices are determined, particularly at a macroeconomic level

What many economists don’t seem to appreciate is that every price is a relative measurement of market value. More specifically, the price of a good in money terms is a relative measure of both the market value of the good itself and the market value of money. If the market value of the good, as measured in absolute terms, is constant and the market value of money falls, then the price of that good will rise. (See “A New Economic Theory of Price Determination” for an extended discussion of this point.)

At a macroeconomic level, the price level can be considered to be a ratio of two market values. More specifically, the price level is determined by both the market value of the basket of goods (the numerator) and the market value of money (the denominator).

In a weak economy, it is likely that there will be pressure on the numerator in our equation above: if there is less demand, then the basket of goods becomes “less valuable” in an absolute sense.

However, this does not mean that price must decline in a weak economy. Why? Prices may rise and rise significantly in a weak economy if the market value of money, the denominator in our price level equation, declines by a greater degree than the decline in the market value of goods, the numerator in our equation. (See “Will Inflation Rise or Fall in the Next Recession?” for an extended discussion of this point.)

In summary, if credit and economic growth stalls and this damages long-term economic confidence, then the value of fiat money could decline sharply, leading to a sudden acceleration in inflation.

The Value of Money and Long-Term Economic Confidence

This discussion raises a couple of obvious questions about the relationship between economic expectations and the value of money. First, what factors influence the value of fiat money? Second, why is the value of fiat money tied to long-term economic confidence?

These are topics that we have discussed in many recent posts, but we shall address them both briefly here.

The first question is discussed at length in two posts that should be read together titled “The Evolution of Money: Why Does Fiat Money Have Value?” and “What Factors Influence the Value of Fiat Money?”

In essence, the view of The Money Enigma is that fiat money is a financial instrument and derives its value from its implied contractual properties. Representative money (money backed by gold) derived its value from an explicit contract that promised a certain amount of gold on request. When we abandoned the gold standard, this explicit contract was rendered null and void.

So, why did paper money retain any value at that point? The view of The Money Enigma is that paper money retained its value because the explicit contract that governed paper money was replaced by an implied-in-fact contract.

Fiat money is a financial instrument. A financial instrument, by definition, only has value to one party because it is a liability of another. From an economic perspective, fiat money is a liability of society. More specifically, fiat money represents a proportional claim against the future output of society.

This theory allows us to begin to answer the second question raised above, namely “why is the value of fiat money tied to long-term economic confidence?

If fiat money is a proportional claim on the future output of society, then its value will be primarily determined by two variables.

The first variable is the expected rate of long-term real output growth. If fiat money is a claim to future output, then a higher expected long-term growth rate of output will make fiat money more valuable today.

The second variable is the expected long-term path of the monetary base. If every unit of the monetary base represents a proportional claim (or “share”) of future output, then expectations of higher levels of future money creation will lead to a lower value for each unit of money today.

The alternative way to state this is to say that the present value of fiat money primarily depends upon the expected long-term path of the “real output/monetary base” ratio. What determines the expected path of the “output/money” ratio? The answer is confidence in the long-term economic future of society.

If people are optimistic about society, then they should reasonably expect solid real output growth and constrained growth in the monetary base. However, if people become pessimistic about the economic future of society, then they may well expect low levels of output growth that are supported by high levels of monetary base growth. If people move from a state of long-term optimism to a state of long-term pessimism in a short period of time, then the value of fiat money will decline sharply.

In simple terms, the view of The Money Enigma is that “fiat money is only as good as the society that issues it”. What this really means is that the value of any fiat currency, and hence the price level of any fiat currency regime, is intimately tied to confidence regarding the economic future of that society. We have seen this simple principle demonstrated repeatedly. For example, think Zimbabwe in the 1990-2010 period.

While it is very unlikely that the Western World will follow a similar path to Zimbabwe, for a whole host of reasons, it does seem possible that the real test of our fiat monetary system is yet to come. If economic growth stalls as we reach the point of system-wide credit saturation, we may see the virtuous economic cycle that we have enjoyed turn into a vicious cycle of economic misery.

Why Do Prices Rise Over Time?

Since 1950, prices in the United States have risen roughly tenfold. Given this history, it would be easy for one to believe that inflation is just a natural part of economic life. But there have been many extended periods in human history where prices were either stable or even declined.

For example, prices in the United States fell at a rate of 1 per cent a year from 1879 to 1897 and then rose at a rate of little more than 2 per cent a year from 1897 to 1914 (Friedman & Schwartz, “A Monetary History of the United States”, page 91).

This begs some obvious questions. Why do prices rise over some extended periods of time and not others? More specifically, why did prices remain relatively stable while the United States adhered to a strict gold standard pre-WWI? In contrast, why did prices rise dramatically in the later half of the 20^th century as the United States abandoned the gold standard?

Milton Friedman famously remarked, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

The long-term economic data clearly supports Friedman’s contention. But, Friedman never adequately explained why this is the case. Why should growth in the monetary base that is in excess of growth in real output lead to rising prices over extended periods of time?

The view of The Money Enigma is that the primary reason that prices rise over time is because growth in the monetary base that is greater than growth in real output acts to reduce the value of money.

The value of money acts as the denominator of the price level: as the value of money falls, prices as measured in money terms rise. If the value of money is relatively stable over time, as it generally was under a strict gold standard, then the price level is relatively stable. However, if the value of money declines significantly over time, as it has tended to do under fiat regimes, then the price will rise significantly.

Why does fiat money tend to lose value over extended periods of time? The simple answer to this question is that maintaining the value of fiat money relies on restricting the growth in the fiat monetary base and, under fiat regimes, the temptation to expand the monetary base is simply too great.

In more technical terms, fiat money is a long-duration, special-form equity instrument and represents a proportional claim on the future output of society. Measured over long periods of time, growth in the monetary base that is in excess of growth in real output will reduce the value of a proportional claim on future output, i.e. it will lead to a decline in the value of money. It is this sustained decline in the value of money that is the primary driver of inflation over long periods of time.

Every Price is a Relative Measurement of Market Value

In most of our daily life, we measure things using “standard units” of measurement. For example, we measure height in inches and weight in pounds. Inches and pounds are useful tools for measurement because they are invariable in the property that they are trying to measure. One inch is exactly the same length as it was yesterday and as it will be one year from now.

In this sense, most of the measurements that we make in our daily can be considered to be “absolute” measurements: they are made using a standard unit of measurement that is invariable in the property being measured.

However, in our economic interactions, the way we measure things is quite different.

The price of a good in money terms is a measure of the market value of that good. For example, if we know that an apple costs one dollar, then that tells us something about the value of apples.

However, while the price of a good is a measure of the market value of that good, it is not an absolute measure of the market value of that good. Why? Price is not an absolute measure of market value because our unit of measurement, “money”, is not invariable in the property that is being measured.

Unlike inches and pounds, which are both invariable in the property they are measuring, money is not invariable in the property of market value.

Therefore, the price of a good is always a relative, as opposed to an absolute, measure of market value.

What does this mean in practice?

If the price of apples in money terms is a relative measure of market value, then this means that the price of apples can rise for one of two reasons. Either (a) the market value of apples rises (each apple becomes “more valuable”), or (b) the market value of money falls (each dollar becomes “less valuable”).

The way that economics is taught today creates the temptation to ignore the second element outlined above. Traditional supply and demand theory focuses on how changes in the supply and demand for a good impact the market value of that good and, therefore, the price of that good.

What is often overlooked in this analysis is that the price of a good in money terms depends just as much on the market value of money as it does on the market value of the good itself. While it may be useful for classroom demonstrations to assume that the value of money is constant, this is not the way the world actually works.

This is particularly the case when we consider what drives prices over extended periods of time. For example, in 1950 apples in Florida cost roughly 20 cents per pound. Today, apples sell for approximately $1.50-2 per pound.

Why did apple prices increase roughly tenfold over the last sixty years? Was there “too much demand” for apples or “too little supply?” Or did something else happen? Maybe the market value of apples, as measured in absolute terms, hasn’t changed that much over that period of time. Maybe, the price of apples has risen tenfold because the value of money (the value of one US Dollar) has fallen by roughly 90% over that same period!

Arguably, the price of apples in money terms has risen tenfold over the past sixty years not because of any significant change in the value of apples per se, but because a dramatic fall in the value of our unit of measurement, i.e. a dramatic fall in the value of money.

Ratio Theory: The Price Level is a Relative Measure of Market Value

So far, we have focused only on the price of one good, the price of apples. The price of apples in money terms measures the market value of apples in terms of the market value of money. Therefore, the price of apples can rise either because (a) apples become more valuable, or (b) money becomes less valuable.

In this sense, the market value of money acts as the denominator of the price of apples. All else remaining equal, if the market value of money falls, the price of apples, as measured in money terms, will rise.

If this observation is true for the price of apples, then it is also true the price of every other good in the economy, i.e. the market value of money is the denominator of every money price in the economy.

The price of apples, the price of bananas, the price of milk… all of these prices, as expressed in money terms, are determined by both the market value of the good itself (apples/bananas/milk) and the market value of money. All else remaining equal, if the market value of money falls, then the price of all these goods, as measured in money terms, will rise.

Now, let’s think about what determines the price of a typical basket of goods, or what is often known as “the price level”.

Clearly, if the value of money is the denominator of the every money price in the economy, then the value of money is also the denominator of the price level. All else remaining equal, as the value of money falls, the price of the basket of goods will rise.

The price level is a relative measure of market value. The price level measures the market value of the basket of goods in terms of the market value of money. In this sense, we can think of the price level as a ratio of two values. The price level is determined by the ratio of the market value of the basket of goods (the numerator) divided by the market value of money (the denominator).

The key to “Ratio Theory”, as illustrated in the slide above, is isolating the market value of goods from the market value of money by measuring both in terms of a “standard unit” for the measurement of market value. Just as we measure height and weight in terms of a standard unit, so we can, at least theoretically, measure the property of market value in terms of standard unit, i.e. a unit that is invariable in the property of market value. For more on this topic please read “The Measurement of Market Value: Absolute, Relative and Real”.

In simple terms, the Ratio Theory of the Price Level implies that the price level can rise for one of two basic reasons. Either (a) the basket of good and services becomes more valuable, or (b) money becomes less valuable.

Now let’s return to original question. Why do prices rise over some periods of time and not others? More specifically, why were prices relatively stable under a gold standard and why did prices rise dramatically once the gold standard was abandoned?

The Gold Standard and Price Stability

Speaking in general terms, history indicates that prices tend to more stable, when measured over long periods of time, under a gold standard than they are under fiat monetary regimes. This is not to say that prices don’t fluctuate under a gold standard nor that there is no inflation under a gold standard, but it is true, as a general rule, that inflation has been systematically lower under true gold standard regimes than it has been under fiat money regimes.

So, why do prices tend be stable over long periods of time under a gold standard?

The view of The Money Enigma is that the main difference between a fiat money regime and a gold standard system is that, under the gold standard, the value of money is relatively constant as its value is tied to gold. Therefore, the denominator in our price level equation tends to be stable over long periods of time and the price level itself is relatively stable.

In contrast, under a fiat money system, the value of money tends to decline over time for reasons that we shall discuss shortly. As the denominator in our price level equation declines, sometimes precipitously, the price level rises.

The key principle of a gold standard is that each dollar is exchangeable for some fixed amount of gold. Under a gold standard, paper money has value because the issuing authority has made an explicit promise that paper notes are convertible into a fixed amount of gold on request.

Therefore, the value of each note is tied directly to the value of the gold. As the value of gold rises, the value of money rises. As the value of gold falls, the value of money falls.

Measured over long periods of time, the value of gold tends to be relatively stable. There are good reasons for this, as discussed in a recent post titled “What Determines the Price of Gold?”

In simple terms, gold acts a constant in sea of economic variables. More specifically, the stock of gold is relatively constant over time and, perhaps more importantly, its growth is very predictable. While the value of gold does fluctuate, gold is still the closest thing that we can find to an economic constant, especially when considered over long periods of time.

The value of gold is susceptible to sudden increases in supply, i.e. new discoveries. For example, when the New World was discovered, a large influx of gold and silver into Europe led to the “Price Revolution”. The new supply of gold and silver led to a gradual fall in the value of gold and prices, as measured in gold terms, rose roughly six-fold over a 150 year period. Nevertheless, that rate of inflation only amounted to 1-1.5% per year!

The point is that prices tend to be stable under a gold standard because the value of gold tends to be stable and, therefore, the value of money tends to be stable. If the value of money, the denominator in our price level equation, is relatively stable over time, then the price level itself is relatively stable. Economic cycles of excess demand and excess supply may lead to variations in the value of the basket of goods, the numerator in our equation, but it is the value of money, the denominator in our equation, that is the key determinant of inflation when measured over long periods of time.

Fiat Money Regimes and Inflation

If prices are relatively stable under a gold standard, then why do prices tend to rise under fiat money regimes?

Almost universally, fiat money regimes have experienced levels of inflation that are far above long-term historical averages. For example, prices in the United States pre-WWI were relatively stable, but then exploded higher in the second half of the 20^th century.

But why is this the case?

Once again, I would encourage readers to look at the price level equation below and think about what is likely to be the key difference between a gold standard system and a fiat money system.

Does seem reasonable to believe that the key difference between periods of low inflation and high inflation is the numerator in our equation? Was the value of the basket of goods relatively stable pre-WWI, but then, for some reason, broke with history and exploded higher in the second half of the 20^th century?

Or is it more plausible to believe that the difference between the two periods was the denominator in our equation, the value of money?

The view of The Money Enigma is that it is the denominator, not the numerator, which is the key driver of the price level as measured over long periods of time. More specifically, it was the collapse in the value of fiat money in the second half of the 20^th century that led to inflation well above historical averages.

Under a strict gold standard, the value of money is tied to the value of a gold and, consequently, its value tends to be relatively stable. In contrast, the value of fiat money is not pegged to the value of any real asset. Indeed, fiat money is, at least superficially, just a piece of paper.

So why does fiat money have any value and why does that value tend to decline over time?

The first part of that question is an issue that we have addressed in detail on several occasions. I would encourage people who are genuinely interested in this topic to read two recent posts, “Why Does Money Exist? Why Does Money Have Value?” and “The Evolution of Money: Why Does Fiat Money Have Value?”

In simple terms, under a gold standard, paper money represented an explicit contract that promised that it could be exchanged for gold. When the gold standard was abandoned, the explicit contract that governed paper money was rendered null and void.

So, why did paper money retain any value? It retained value because the explicit contract was replaced by an implied-in-fact contract, or “social contract”, between the holders of money and the issuer of money.

What is the nature of the implied contract that governs fiat money?

Again, this is a lengthy subject that is discussed in the “Theory of Money” section of this website. But, in simple terms, fiat money is a financial instrument: it has value as an asset to one party because it represents a liability to another party. More specifically, fiat money is a liability of society and a proportional claim on the future output of society.

This is a complicated idea, but there is a simple analogy that we can use to help us think about what determines the value of fiat money.

In many ways, fiat money is like shares of common stock. A share of common stock represents a proportional claim on the future residual cash flows of a company. In contrast, one of fiat money represents a proportional claim on the future output of society.

Over an extended period of time, if a company grows its earnings faster than it grows shares outstanding, then the value of the stock will rise. Conversely, if over a lengthy period, a company grows it shares outstanding faster than it grows its earnings, then the value of its shares will fall. Why? Each share is a claim on earnings and, ultimately, the value of each share depends on the earnings per share.

Similarly, if over an extended period of time, a society grows its real output faster than it grows its monetary base, then the value of each unit of the monetary base will rise, i.e. the value of money will rise and, all else equal, the price level will fall.

This doesn’t happen very often, especially under fiat money regimes. Rather, most of us are more familiar with the alternative scenario.

If over a long period of time, a society grows its monetary base faster than real output, then the value of money will fall. Why? The value of money falls because money, the monetary base, derives its value from an implied-in-fact contract. More specifically, money represents a proportional claim on future output. In general terms, as real output per unit of money falls, the value of money falls and, all else remaining equal, the price level rises.

In summary, the primary reason that prices tend to rise under fiat money regimes is that, over long periods of time, fiat money regimes tend to grow the monetary base at a rate that is faster than the growth in real output. Fiat money is a financial instrument and represents a proportional claim on future output. All else remaining equal, as the “real output/base money” ratio declines over time, the value of fiat money declines.

The key difference between a gold standard regime and a fiat money system is the behavior of the value of money over long periods of time.

Under a gold standard, the value of money is relatively stable because it is tied to the value of gold. In a fiat money system, the value of money is heavily influenced by political process and the “needs/wants” of our society. Inevitably, as central bankers acquiesce to the needs of the people, the monetary base grows at much faster rates than real output, leading to a decline in the value of money and a rise in the general price level.

Author: Gervaise Heddle

Is Money a Short-Duration or Long-Duration Asset?

Is the value of money more sensitive to changes in short-term expectations or long-term expectations? Is what happens in the economy today the key driver of the value of money and the price level, or are both the value of money and the price level driven primarily by confidence about the long-term economic future of society?

In last week’s post, we explored the idea that “money is only as good as the society that issues it”. More specifically, the value of any given fiat currency depends primarily upon expectations regarding the future economic prospects of the society that issues it. But is the value of money more sensitive to expectations regarding the near-term economic prospects of society or the long-term economic prospects of society?

We can state this question another way: “Is fiat money a short-duration or long-duration asset?” This may seem like a strange question to ask about money. After all, most people associate the concept of duration with fixed income securities, not “cash” (the monetary base).

However, every financial instrument, including fiat money, can be considered to possess the property of “duration”. Moreover, the duration of an asset is a critical determinant of how that asset behaves in response to changes in expectations.

The view of The Money Enigma is that fiat money is a financial instrument and a proportional claim on the future output of society. More specifically, fiat money is a long-duration instrument.

While there are a couple of ways to demonstrate that money is a long-duration asset, the simplest method is to apply what I call the “benefits-cut-off” test, i.e. imagine if it was announced that money would be no longer accepted in exchange for goods and services in one year from now or five years from now, or twenty years from now etc. and imagine what would happen to the current value of money in each of those circumstances.

Why does the duration of money matter? Well, if we understand the duration of fiat money, then we can create better models for the value of money and, consequently, the price level. More specifically, if money is long-duration asset, then we can argue that both the value of money and the price level are far more responsive to changes in confidence regarding the long-term economic future of society than they are to any change near-term economic conditions.

The Concept of Duration

The duration of an asset is the weighted average time that it will take to receive the present value of the benefits generated by that asset. The term is most commonly applied to fixed income securities. A 5-year, interest-bearing government bond is a “short-duration” asset, while a 30-year zero-coupon bond is a “long-duration” asset.

From a practical perspective, if an asset is a “short-duration asset”, then most of its value relates to benefits that will be received in the near future. Short-duration assets are highly sensitive to changes in current conditions and expectations regarding the near future, i.e. the next 2-3 years. However, short-duration assets are, as a general rule, completely insensitive to changes in long-term expectations.

In contrast, the value of a “long-duration asset” depends primarily on benefits to be received in the distant future, i.e. 10-20 years from now. The value of a long-duration asset is highly sensitive to changes in long-term expectations, but relatively insensitive to changes in expectations regarding short-term conditions.

While the concept of duration is most commonly applied to fixed income securities, it can be applied to any financial instrument. After all, the value of every financial instrument depends upon benefits that we expect to receive from that financial instrument in the future. “Duration” simply provides with a measure of the average time taken to receive the present value of those benefits.

Indeed, every financial instrument can be considered to possess the property of “duration”. For example, John Hussman often discusses the idea that equities are a very long-duration asset. In theory, the stock market should be far more sensitive to changes in expectations regarding long-term earnings growth than changes in current economic conditions and earnings.

If every financial instrument possesses the property of duration, then this raises two interesting question relating to the nature of money. Is fiat money a financial instrument? And if it is, then what is the duration of fiat money?

Fiat Money as a Financial Instrument

The view of The Money Enigma is that fiat money is a financial instrument. Every asset can be classified as either a real asset or a financial instrument. Fiat money is not a real asset and, therefore, must be a financial instrument.

The classification of assets into real assets and financial instruments is important because it relates to how an asset derives it value. Assets can only derive their value in two ways: either they derive their value from their physical properties or they derive their value from their contractual properties.

A real asset is an asset that is tangible or physical in nature. More importantly, it is an asset that derives its value from these tangible or physical properties.

In contrast, a financial instrument is, by definition, both an asset and a liability. A financial instrument derives its value as an asset from the liability that it represents to another. In this sense, the value of a financial instrument can be considered to be an artificial creation of a contract entered into by economic agents.

In simple terms, if something doesn’t derive any value from its natural or intrinsic properties, then the only way it can derive value is if it creates an obligation on a third party to deliver something of value. Indeed, this paradigm is so fundamental that it is used as the basis of classification of assets for accounting purposes.

So, where does fiat money fit in this simple paradigm? Does fiat money derive its value from its physical nature or does it derive its value from the liability that it represents to its issuer?

The view of The Money Enigma is that fiat money is a financial instrument and derives its value solely from the nature of the liability that it represents. Money is an asset to one party because it is a liability to another. More specifically, money is a liability of society and represents a proportional claim on the future output of society.

In simple terms, the cash in your pocket has value to you today because you believe that you will be able to exchange that cash for goods and services in the future. The money in your pocket represents a claim against the future output of society. This is the essence of the social contract that fiat money represents.

So, if fiat money is a financial instrument and every financial instrument possesses the property of duration, then what is the duration of fiat money?

The Duration of Fiat Money

One of the aspects of fiat money that makes it rather unique as a financial instrument is that it doesn’t entitle us to a stream of future benefits. Rather, it entitles us to a slice of future benefits. In simple terms, we can only spend the dollar in our pocket once. We can spend it today, tomorrow, one year from now or twenty years from now.

Since most of us are in the habit of spending the dollars in our pocket within a week or two, this would suggest that money is a short-duration asset. However, this simplistic form of analysis is wrong. Just because we don’t typically hold the same cash in our pockets for a long period of time, doesn’t mean that fiat money is a short-duration asset.

There are two much better ways to think about the duration of money. The first is relatively simple and involves the application of a basic test. The second is more complex and requires an appreciation of the economic concept of “intertemporal equilibrium”.

Let’s begin by discussing the first, relatively simple approach.

There is an easy test for duration of any asset. For lack of a better term, we can call this test the “benefits cut-off test”.

As discussed, a financial instrument only has value because it creates an obligation on the issuer of that instrument to deliver something of value in the future.

The benefits cut-off test involves imagining a scenario in which the issuer of that financial instrument announces that it will not to honor the liability starting x years from now and thinking about the impact that announcement would have on the current value of the security.

For example, if the government announced that, starting five years from today, it would stop paying interest and principal on all government debt, what would be the impact on the value of its debt?

Clearly, it depends on the duration of the debt. The announcement should have no impact on one-year government debt, after all, the interest and principal will be repaid well before the government stops honoring its commitments.

But what about recently issued 30-year debt? Clearly, the value of such debt would collapse. Why? Because it is a long-duration asset: most of its value is associated with payments that will be made well beyond five years from now.

Now, let’s apply the benefits cut-off test to fiat money.

As mentioned, the view of The Money Enigma is that money is a financial instrument that represents a proportional claim on the output of society. In short, fiat money is a liability of society and its value depends on society honoring its obligation to deliver output in exchange for little pieces of paper.

Now, what would happen to the value of money and, conversely, the price level, if it were announced that society would not honor money’s claim on output starting one year from now?

Think about this for a moment. What would your immediate reaction be if the government announced that cash would no longer be accepted in commercial exchange one year from now? My guess is that you would try get rid of all your cash and cash-related securities, i.e. bank deposits, as fast as possible!

The problem is that everyone else would try to do the same thing. What would happen to the value of money if everyone wants to get rid of it and no one wants to accept it? It would collapse.

If the government announced that money would no longer be accepted one year from now, then it seems reasonable to believe that there would be panic and the value of money would collapse, not in one year, but today, right now. What would happen to prices in this scenario? Prices would soar. You can imagine the scene: people offering $100,000 for a jar of peanut butter and the grocer refusing to accept it.

Let’s try a different scenario. What if it was announced that the cut off was 5 years from now? In other words, what would be the reaction if everyone learnt that money would not be recognized as a claim on output starting five years from now?

In this scenario, there might not be panic, but there probably would be an immediate drop of in the demand for money. Again, money would lose a substantial portion of its value very quickly and prices, as expressed in money terms, would skyrocket.

What about if the cut off was 10 years from now? Maybe a smaller drop in value, but still a drop in value.

Now, apply a 30-year test. Would there be a significant drop in the value of money today? Probably not. Why? Well, 30 years is a long time from now. Arguably, money could function for at least another ten years before people really start to worry about the end point.

Clearly, this exercise involves a large degree of speculation, so we won’t belabor the point. Nevertheless, it does give some credence to the view that money is a long-duration asset. The value of money is highly dependent upon the expectation of benefits, in the form of goods and services, that can be claimed with money not just months but years from now.

So, how is it possible for money to be a long-duration asset? After all, we tend to think of money as something that we can spend now or at any time we wish.

The benefits cut-off test provides a hint as to the answer: the value of money today depends upon a long chain of expected future values.

In very simple terms, I accept money from you because I think I will be able to acquire goods of value from the next person. In turn, the person who accepts that money from me does so because they think that the next person will accept it as something of value. And so a chain develops: money has value now because we believe it will have value to each successive person in the chain.

Fiat Money and Intertemporal Equilibrium

What our very basic example highlights is that the equilibrium value of money incorporates a chain of expected future values for money. More specifically, the present value of money depends largely upon the expected variable entitlement of money in distant future periods. If, as in our example, the entitlement of money drops to zero in future periods, then this has a big impact on the current equilibrium value of money.

In theory, the economy should always be in or adjusting towards a state of intertemporal equilibrium. If it is announced that society will no longer recognize money as a claim on output beginning next year, then it will lose all, or nearly all, of its value today. In essence, a state of intertemporal equilibrium is disrupted by the announcement: everyone tries to spend the money today with the result that no one can spend the money, or only at a massively reduced value.

In our simple one-year cut-off example, equilibrium is only restored once the value of money has fallen to such a degree that someone is prepared to accept it in exchange for goods or services. The price level may well have to rise by a 1000% or more in order to restore a state of intertemporal equilibrium.

Interestingly, there is another way we can leverage the concept of intertemporal equilibrium to demonstrate that fiat money is a long-duration asset. More specifically, we can use the concept of intertemporal equilibrium to demonstrate that the expected value of money in distant future periods does impact the value that we put on money today.

This process starts by investigating one of the key differences between fiat money and shares of common stock.

One of the most obvious differences between money and a traditional equity instrument is that one unit of money provides its holder with a claim to a slice, not a stream, of future economic benefits. A share of common stock provides its holder with a proportional claim to a stream of future cash flows. In contrast, one unit of money provides its holder with a one-time claim on the output of society, or a “slice” of future output.

If a financial instrument entitles its holder to a stream of future benefits, then we can create a valuation model for that asset by simply adding the present value of each of the expected future benefits in that stream.

However, if a financial instrument entitles its holder to a slice of some set of possible future benefits, then we face a different challenge: the present value of that instrument could equal one future benefit or another or another.

In essence, we are left with a question of probability: what is the probability that the holder of that financial instrument will claim any one of n different future benefits? If we know the probability of each slice being claimed (i.e. the probability of when the money will be spent), then we can calculate the present value of the asset.

So, how do we create a probability function to weight each of the possible future values of money and, thereby, determine the current equilibrium value of money? The key to the answer lies in the question itself: the concept of “equilibrium”.

Equilibrium can be thought of in one period terms, “static equilibrium”, or in multi-period terms, “intertemporal equilibrium”. It is the view of The Enigma Series that in order for the economy to be in a state of intertemporal equilibrium, the marginal holder of money must be indifferent between spending the marginal unit of money at any point in their future-spending horizon.

Think about it this way: if you would much prefer to spend the marginal dollar you receive in five years, than spend it today, then you haven’t maximized your utility and the economy is not in a state of equilibrium. In simple terms, you have an incentive to act and, by definition, the economy is not a “state of rest”.

If you have n years remaining in your life, then technically, for the economy to be a state of general equilibrium, you should be indifferent between spending money now versus spending money in any one of those future n years. Moreover, you will also be indifferent as to which of those future periods you spend the money in. For example, you will be indifferent as to whether you spend the marginal dollar in 5 years, 10 years or 20 years.

[Geeks note: Mathematically, if you are indifferent between A (spending money now) and B (spending money in 5 years) and indifferent between A (now) and C (10 years), then you are also indifferent between B (5 years) and C (10 years)].

Now, we can use this idea to create our probability distribution. If the marginal holder of money must be indifferent between spending the marginal unit of money at any point in the future n period spending horizon, then the probability that the marginal unit of money is spent in any one of the future n periods is 1/n.

At least theoretically, the probability that we spend the marginal dollar twenty years from now is the same as the probability that we spend it one year from now. Therefore, the value we put on money today will incorporate not only expectations about the value of money one year from now, but the value of money thirty or even forty years from now.

This application of equilibrium theory casts new light on the duration of money. The value of money doesn’t just depend on what we expect we might get for it one or two years from now. Rather, the value of money also depends heavily on what we might expect to get for that money many years, if not decades, from now.

In summary, the value of money depends upon long-term expectations. Fiat money is a long-duration asset and the value of fiat money is highly sensitive to changes in expectations regarding the long-term (20-30 year) economic future of society.

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