Is this the end of fiat money?

Fiat money is paper money that comes into existence by government law. It is not valued to any ‘objective standard’ like gold or silver, so governments can produce as much money as they like. When you hear the expression ‘printing money’, that’s what is being referred to.

The widely held view amongst economists is that if you increase money supply too much you get high inflation. In practice, it’s playing out differently. The increase in money supply has poured into assets like shares and real estate causing a massive rise in asset price (but this isn’t considered inflation). It is not translating into prices for general goods and services.

I personally think the length of time we’ve had in this low rate environment is worrying. It feels like we have adapted to, and almost become dependent on, low rates.

House prices cannot increase faster than economic growth indefinitely. Increasing leverage and external capital (creating money) are the only two things that drive house price growth above economic growth. The main driver over the past two decades has been leverage. With Kiwis owing over $200 billion in residential mortgages it won’t take much of an increase in interest rates to constrain consumer spending. We’re also running out of capacity to borrow more, even at low interest rates.

It is challenging to find a healthy yield on any form of investment, and so in pursuit of yield, the markets are mispricing risk. How do we deal with an aging population coming out of the work-force and low yielding income?

We have all of this printed money pouring into assets like shares, bonds and real estate that is causing no generalised inflation.

We then have investors chasing lower and lower yielding (or riskier) assets. We have retirees sitting on a combination of over-inflated assets and low yields.
Then those of us working collectively have more debt than during the Global Financial Crisis.

As I’ve said, growing our debt bubble is not the answer. By borrowing to consume today, we are stealing from the future and looking increasingly likely to stall economic growth.

House of cards anyone?

The final piece of the picture is technology-led deflation. It seems like a lifetime ago but the first smart phone was only launched in 2007. Mobile phones as a category only became commercially available in the mid 1980s. By 2023 a smart phone is predicted to have more computation power than the human brain.

Technology is going to have a profound impact on labour market. Most jobs we have today will not exist in 30 years’ time – how on earth do we transition an economy through that at the same time as dealing with extraordinarily high debt-levels and asset bubbles?

The biggest issue facing the world today is that our systems of government and our economics and markets cannot keep pace with the speed of change. I have a sneaky suspicion that our current monetary system (and possibly the way governments work) will not survive what’s coming. Is it that time again? Is fiat money coming to an end?