Imagine 2030: The dusk of fiat money?

Source: Deutsche Bank, the original author: Jim Reid

Source: Fintech Research (WeChat public account id: fintechstudy)

Compilation: Wang Zhezhu

Editor's note: On December 4, 2019, Deutsche Bank's research department released Konzept's special edition "Imagine 2030", predicting possible developments and changes in the world in the "next decade". "Dusk of Fiat Currency? "In the first section, we discussed the macro issues of inflation and imagined the possible development of fiat currencies in 2030.

Since the 1970s, we have entered the era of fiat currencies. The value of almost all currency in circulation is based solely on credit, with national government credit as the most common guarantee. Prior to that, most of the currency that existed in history was a commodity currency, whose value relied on precious metals such as gold or silver. When the value of money relies on physical value, inflation tends to accelerate (usually rises sharply), and when its value relies on physical value, inflation slows. We believe that under the same conditions, the fiat currency system is inherently unstable and prone to high inflation. The reason may be that the printing of banknotes without physical value is a very attractive monetary policy tool for policy makers. The current fiat currency system has existed for a long time because the impact of inflation has been offset by a series of accidental and powerful global anti-inflation natural forces over the past decades.

This power to maintain the stability of the fiat currency system now appears to be fragile and may disintegrate in the 1920s. If this force breaks down, fiat currencies will suffer a strong impact, and demand for gold or alternative currencies may surge.

The development of inflation in the twentieth century was abnormal. In the early 1970s, the collapse of the gold-based Bretton Woods system caused global inflation to rise sharply in the next 10 years. In addition to the oil crisis, the collapse of the Bretton Woods system and the ability of countries to borrow more freely and find ways to financially liberalize and credit are also the reasons for the surge in inflation. In the 1970s, the annual nominal yield of gold was 32%, which is much higher than the long-term average of 2% since 1800. By the end of the 1970s, some people believed that anti-inflation would be difficult to achieve. But a miracle happened. Inflation began a 40-year structural decline and continues to this day, and concerns about fiat currencies are virtually gone.

The traditional view is that this success is largely due to the central bank's management of inflation. This may include that in the early 1980s, when Volcker led the Federal Reserve to introduce austerity monetary policy for the first time, central banks became more independent, or the global inflation target was generally set at a level close to 2%.

In fact, fortune is indeed more important than strength this time. Convincing arguments point out that a global force has played a far greater role in controlling inflation than policy makers.

China saves fiat money

In the late 1970s, global inflation peaked, and demographic and geopolitical developments ushered in the largest transformation in decades: China's accidental accession as a member of the global economy, and the demographic structure of developed countries and China Once-in-a-lifetime changes-these can no doubt be regarded as the biggest inhibitors of global inflation in the past 40 years. In the late 1970s, when economic globalization and global economic controls were relaxed, global labor supply surged. So strictly speaking, over the past 40 years, downward pressure on wages, prices and the accompanying inflation has always existed and has nothing to do with central bank or government policies.

The following table reflects changes in the working-age population in more developed regions and China. Among them, the light blue pillars also show changes in the age-appropriate labor force population, but before 1980, due to the closure of the Chinese economy, the age-appropriate labor population in China was calculated as zero. After 1980, after the opening of the Chinese economy, the bar graph reflected the global labor force Integration and effective growth of supply.

More developed regions and China's labor force

Source: Deutsche Bank, United Nations Population Division

Obviously, the diagram is highly simplified. And with the development of globalization, in addition to China, many countries with cheap labor have changed from relatively closed low-income countries to more open developed countries. But these countries are too small compared to China. The graph also simplifies the growth of all working-age population in China every ten years, and does not reflect the cumulative increase in the number of people over a period of time.

Although the information above is simplified, the course of anti-inflation will not change much. At the level of developed countries, it is widely acknowledged that the labor force's share of GDP has declined over the past few decades.

Wage data also support this view. Since the reform and opening up in the 1980s, China ’s real wage growth has outpaced that of many developed countries, while real wages in advanced economies have stagnated compared to previous decades.

The turning point for workers , inflation and fiat money?

As can be seen from the chart, the peak of the “age-appropriate working population” in developed countries and China has occurred in the past decade. In the next decade, the total labor supply in major global regions will begin to decline.

Although the decline in labor supply will not be rapid, it will inevitably have an impact on labor costs as it will no longer grow as fast as in the past 40 years. The rise of anti-globalization and populism is one of the effects of this change. In the past ten years, more and more governments have been selected by workers who have felt the pressure of real wage decline for decades (or that the rise in these government support rates comes from these workers).

Therefore, the government's attitude towards labor is likely to change. Policies will increasingly favor low-income workers who have been left behind by globalization. This could mean higher fiscal spending than monetary policy that has been overemphasized in the past decade. The beneficiaries of active monetary policy are owners of capital and assets, not workers. For this reason, inflation is common in asset prices. Fiscal policies that favour workers may reverse this trend.

If labor's share of GDP reverses, can fiat money still exist?  

It is undoubtedly good to raise wages to address the widening gap between capital and labor. However, the problem facing the current global monetary system is that over the past 45 to 50 years, its stability has depended on the stimulating economic policies implemented by governments and central banks as soon as the crisis hits. This allows each crisis to be tackled and turned into safety by increasing leverage rather than creatively disruptive policies. But the stimulating policy of increasing leverage may bring inflation, and this effect must be offset. Fortunately (and unfortunately if you think of this as an endogenous unstable equilibrium), external downward pressure on global labor costs offsets this effect.

If the trend in labor costs in the past 40 years reverses, what will happen to the global monetary system? If the central banks' current task is to maintain inflation at around 2%, then regardless of the external environment, they have a responsibility to adopt tightening policies more frequently. However, considering the global debt level, such a result is unrealistic. Governments will certainly change their directives to the central bank first, allowing inflation to rise or reducing the independence of the central bank, rather than allowing rising interest rates to worsen the debt situation. In the end, if labor costs continue to rise, policy makers will face a more difficult situation, and inflation governance will likely become a pain point and key when politicians run for elections.

Higher inflation trends will mean that bond yields are becoming extremely fragile, especially for yields that are currently approaching (for centuries) historical lows. Given that global debt burdens have almost reached new highs, central banks may be forced to buy more securities to ensure that yields remain below nominal GDP (see article "How the Government Will Deal with Record Debt"). As a result, negative real yields will emerge, locking in higher inflation, which will lead to a more relaxed financial environment and higher wages.

Eventually inflation may become more deeply embedded in the monetary system, and people will increasingly doubt the sustainability of fiat currencies. Can the fiat currency survive the policy dilemma when the government tries to strike a balance between high yields and debt levels? This is a trillion-dollar issue over the next decade.

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