5 - Seigniorage versus hyperinflation

Summary

As either coinage or paper, the history of metallic-based monetary regimes shows that such money remains convertible to its respective metal until it is debased too far. The issuance of paper money can herald the beginning of debasement. Money lives on as a means of exchange when its value is stable or declining at an acceptable rate. Its second life occurs when people begin to stop using the money and seek alternative means of exchange at a rapid rate. Substituting a nation's unstable currency for another nation's more stable currency can lead to increasingly high inflation, or even hyperinflation. This second phase bodes the end of the life of the currency, when its practical use for exchange diminishes.

Once people anticipate that a monetary regime is nearing collapse, its money becomes increasingly worthless. This hastens the end of the regime and increases the speed at which the system collapses. The only positive action becomes ending the monetary regime and establishing a new one that citizens respect and accept as a means of exchange.

During this life cycle of money, monetary regimes continue to evolve. The common thread is that, whenever the government supplies a stable form of money, it yields revenue for the government Treasury as long as the economy grows. A stable money with a growing economy in turn means a growing demand for the stable money, and an economy grows more readily when the price level is stable. To achieve a stable price level with a growing demand for the money, a government debases the money at the rate of growth of the economy and reaps the revenue from the debasement. This is the original meaning of natural seigniorage.

When a government begins to debase the money at a faster rate than the economy is growing, the price level in terms of the money begins rising, causing inflation. People tolerate moderate inflation, albeit with a decreased demand for the money in real terms. Deflating the money by dividing the stock of money by the price level gives the real money stock. This real money falls as the price of holding money rises. The inflation rate, plus the real return on capital, constitute the price of holding money instead of investing it.