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The Real Cost of Money

We have discussed several criticisms of our current monetary system. Among these is this idea that the currency is continually losing a portion of its value each year. It would be nice to instead have a currency that would better maintain its value.

Many of us were taught in our youth, if we would just put a little money away in savings each month, it would earn interest and grow. Maybe within 20 or 30 years, it would even have grown into something substantial.

In terms of the number of dollars we might accumulate, certainly this can be true. But what about the actual purchasing power of those dollars? Do your interest-bearing savings really get more valuable over time?

True, the interest you earn each year does increase the purchasing power of your savings. But as we discussed, annual inflation is working in the opposite direction, diminishing the true value of your money.

If you earn less interest than the inflation rate, your savings are actually getting weaker over time. If your interest rate is higher than inflation, you may still be getting ahead, but by less than you might think. Just pay your income tax on the interest you have earned and you may be back in the hole again.

A similar dynamic exists if you invest in a home or some similar long-term investment. Say, for example you bought a house decades ago when it only cost $50,000. Now, thanks to inflation, you can sell it for $500,000. Since capital gains taxes are not indexed for inflation, now you owe taxes on a gain of $450,000—let’s say $90,000 of tax. So you get to keep $410,000.

But that money will not buy as much house as the one you just sold. You would have to buy something a little smaller. Did you really earn any additional value by investing in the house? No, you actually lost value because you were taxed on gains that were artificial, due only to inflation.

As we have discussed, inflation is programmed into our current fractional reserve, central banking system. Because all money is lent into existence, and it always must be repaid with interest, the money supply must always be growing in order to remain solvent. While this does provide an incentive to spend money, stimulating liquidity, it is not very helpful for those who wish to save value for the future.

It would be nice if switching to a gold-backed currency could solve this problem and our money would then hold its value indefinitely. It is true, a gold-backed money would not suffer from programmed inflationary losses. But there are still some significant maintenance costs that would tend to also erode its value over time.

Much more significantly, gold is a commodity in very limited supply, and it is expensive to find and refine. So its value is more likely to be driven by its scarcity than by its underlying utility value.

When a commodity’s value is driven solely by demand, its price continues to go up as that demand increases. This favors those who manage to get into the game early, when values are significantly lower. Unfortunately, it also encourages them to hoard what they have, because the longer they can hold onto it, the more valuable it will become. This makes it much more expensive for those who want to buy in later.

This can form an artifical valuation, or bubble. But because the laws of economics are pretty good at compensating for artificial forces, bubbles don’t usually last for too long. Eventually they pop. In other words, values can go up but they can also fall back down.

In the case of a currency based on a scarce commodity like gold, this can happen when lots of new-comers need a way to facilitate their trades but there is insufficient liquidity to be found in the standard currency. People will eventually find a way to get their transactions done—even if they have to invent alternate ways to represent value. If this occurs in the midst of an overvalued gold-based currency, a correction is likely to take place.

So it would be nice if we could avoid artificial devaluation from things like programmed inflation. And it would also be good to avoid large fluctuations of value, whether up or down, based purely on speculation. But even an ideal currency like CHIP can not take 100% of the losses out of money. Entropy is a law of the universe and is as in-escapable as gravity and old age.

In any system we devise, there are bound to be some costs of operation and maintenance. So let us try to better understand these losses and explore how they should best be dealt with.

In our current monetary system, we have a system of banks. They hire employees, and those people need to be paid for the work they do.

The central bank, along with all its associated private banks, form a network, or clearing house for all our financial transactions. When we create money, by taking out a loan, the bank performs a service by certifying the value of our homes and our individual earning potential. Then they issue credit to us based on that financial strength.

As we have discussed, the bank guarantees to the rest of the world that the dollars you are about to spend are good. Those dollars will eventually be redeemed by the labor you perform at your job, and that value will flow out into the economy.

All this is worth something. You get dollars right away, available to spend now. And the ones you have to pay back, can be delivered later, over time. But there is a possibility that during that time, you might lose your job, get disabled, or even die.

If, for some reason, you stop paying back your loan, the bank may have to foreclose on your home, put it up for sale, and hope the proceeds are enough to cover the debt. If they are not, then in essence, the money the bank originally put out into the economy was not as good as everyone had hoped and believed. It will be like the goldsmiths who printed too many certificates, debasing all the legitimate ones. The result is a tiny entropic loss to the system.

If today, we were using gold-backed certificates as our currency, we would have to store our actual gold in a depository somewhere. Someone would have to operate that service to make sure our gold was kept safe and secure. We would need buildings and security, managers and employees—everyone would have to get paid. The point is, this service would not be free either.

If we don’t want to carry around physical gold or some other commodity to every transaction, we will need some kind of credit-based money. And in order to enjoy that convenience, we will have to pay for some kind of operational overhead. In our current system, these losses are hidden from view. We think banks pay us interest for the privilege of storing, and using our money. In reality, the net effect of fractional reserve interest and programmed inflation extracts its price, paying the banking system for the services it provides.

In fact, even if you were willing to conduct every transaction by trading commodities directly, you would still suffer some overhead losses. If you keep physical gold, someone may try to steal it. To keep it safe, you might have to hire a guard or buy an expensive vault to keep it in.

If you store your value in wheat, you may have to deal with mice or mold. No matter how you look at it, there are going to be entropic losses fighting against your efforts to store value. This Biblical passage in Matthew reminds us, our forebears also understood the principle:

Treasure not up to yourselves treasures on the earth, where moth and rust disfigure, and where thieves break through and steal... [source]

People are not perfect, the world is not perfect, and no monetary system will be perfect. But CHIPs are about as close as we can get.

CHIPs are honest money. They are backed by human work and productivity. Even the name tells you it is so. There are no hidden fees and no programmed losses. Everything is plain, clear, and out in the open.

Today, consumers and merchants happily pay a small service fee to credit card companies because of the convenience they offer in facilitating our purchases. Likewise, consumers will be willing to pay a fair price to the CHIP banks who will certify their credit and manage an even better currency.

So what is the real cost of money? By some estimates, we may pay as much as 10% of our total productivity just to support our monetary systems. This would include losses due to inflation, overhead, and servicing interest on the national debt, necessary in order to maintain current market liquidity.

By introducing multiple complementary currencies, we can harness the power of competition to deliver a superior currency at the absolute best price possible. Rather than a single, government sponsored monopoly managing our money, we can benefit from multiple monetary systems competing for a chance to win our business.

Current credit card companies operate comfortably on service fees in the 3% range. Some of these can still offer cash rebates to consumers on the order of 1% to 2%. This is good evidence that the private market can offer overhead rates as low as 1%.

This is much more efficient than our Federal Reserve system. There is no reason to think CHIP banks will not do even better.
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