{"id":597,"date":"2008-02-13T14:40:29","date_gmt":"2008-02-13T14:40:29","guid":{"rendered":"http:\/\/scientopia.org\/blogs\/goodmath\/2008\/02\/13\/why-does-currency-value-change\/"},"modified":"2008-02-13T14:40:29","modified_gmt":"2008-02-13T14:40:29","slug":"why-does-currency-value-change","status":"publish","type":"post","link":"http:\/\/www.goodmath.org\/blog\/2008\/02\/13\/why-does-currency-value-change\/","title":{"rendered":"Why does currency value change?"},"content":{"rendered":"

After yesterday’s article about conversion between the value of
\nbritish pounds in the ’70s versus british pounds today, someone sent me a link to
\nan article at the National Review Online<\/a>, which just about had me rolling on the floor laughing. The problem is, it’s dead serious.<\/p>\n

It’s written by an “engineer” named Louis Woodhill, who argues from what he calls
\nan “engineering viewpoint” that the whole idea of fluctuating currency value is total nonsense, and we’d all be better off if we just assigned a fixed value to our currency, and never allowed it to change.<\/p>\n

\n

The U.S. dollar is in a scary slide. Gold and oil are hitting record highs,
\nwhile the dollar is hitting record lows. To get how strange this all seems to an engineer
\nlike me, imagine the following headline: “Foot Falls against Meter for Fifth Straight Day.”<\/p>\n

The accompanying article would breathlessly report that after the U.S. abandoned its “antiquated” fixed-exchange-rate system (one foot equals 0.3048 meters), our beloved foot began plunging in length. A “length trader” would predict that if the foot fell below the “psychologically important 0.2800 meter support level,” it could fall as low as 0.2500 meters. But an economist would say that as long as the foot didn’t fall more than 10 percent, everything would be okay.<\/p>\n

The story would then describe the plight of a homeowner whose garage was no longer within
\nhis lot lines. Then another economist would argue that the falling length of the foot was
\nactually a good thing, because it caused people to be taller, which reduced their “body mass
\nindexes,” thus fighting obesity. The head of the U.S. Bureau of Standards would be quoted as
\nsaying the bureau is committed to “a strong foot,” although, “given that imports are longer
\nthan exports, there is only so much we can do.” The story would conclude with Paul Krugman
\nblaming the falling foot on “Bush’s tax cuts for the rich.”<\/p>\n

What is going on with the dollar right now is every bit as ridiculous as the fictional story above. Here’s how an engineer would explain the problem.<\/p>\n

Economic transactions involve the exchange of “something” for “money.” The “something” is specified in terms of number (1, 2, 3, etc.); length\/area\/volume (“the foot”); weight (“the pound”); and\/or time (“the second”). “Money” is specified in terms of “the dollar.”<\/p>\n

The problem with this scheme is that the magnitude of our fundamental unit of market value, “the dollar,” is not defined. Being undefined, the value of the dollar can change. This fact gives rise to huge economic costs and risks for which there are no offsetting benefits.<\/p>\n<\/blockquote>\n

Sorry, Mr. Woodhill, but that’s not how an engineer<\/em> would explain the problem. It’s how a pig-ignorant idiot<\/em> would explain the problem. The explanation of why<\/em> is beneath the fold.<\/p>\n

<\/p>\n

It’s really quite astonishing that this kind of crap still continually pops up. It’s based on a fundamental ignorance of very basic economic issues. It’s especially
\namusing that this kind of nonsense generally seems to be printed in things like NRO – an extremely conservative, pro-free-market rag.<\/p>\n

Why does currency fluctuate? Because the relative values of different valuables fluctuate<\/em>. Peg the currency to any one, and it will stay constant relative to that
\none, but it will vary dramatically compared to others. There’s no way around that: it’s all about supply and demand. Take things in limited supply that people want\/need, and their value
\nwill increase. The whole concept of value is intrinsically variable – value describes
\na variable relation between different quantities. What Woodhill wants to do is to somehow
\ndeclare that the variable relation can no longer change. But you can’t do that – you can’t
\nsimply declare<\/em> that a variable will stop changing. The derivative of currency value relative to goods isn’t 0, and you can’t make it be.<\/p>\n

For example, oil is currently incredibly expensive. 10 years ago it was comparatively
\nextremely cheap. If we’d pegged our currency to the value of gold ten years ago, then the
\npurchasing power – the effective value – of the dollar would be significantly less today that it would have been when it was pegged.<\/p>\n

In response to this, America has started pumping lots of money into ethanol production. As a result, supplies of some agricultural products, like corn, have had their demand increase rather dramatically – and so their prices have risen. And that in turn is increasing the price of other things that rely on corn – like many foods. So if we pegged our currency to gold, we’d still have seen an effective change in the price of a huge swath of consumer goods, caused by the change in the value of oil relative to the value of gold.<\/p>\n

Suppose we pegged it to oil instead – so a dollar was fixed as the price of one gallon
\nof refined gasoline. The dollar would be worth significantly more now than it was 10 years ago – because oil is worth so much more. But because people are paid in dollars, that would effectively make US labor dramatically more expensive, which would make it very hard for us to export goods to other countries – the production cost of American goods would be so much more expensive relative to goods produced elsewhere.<\/p>\n

Try a different tack: suppose we set the dollar to something like a stock index: a dollar
\nis the combined value of 1\/50th of an ounce of gold, 1\/10th of a gallon of gas, 1\/2 a bushel of corn, etc.<\/p>\n

What happens then is that the dollar becomes an effective exchange medium: if oil becomes
\nmore scarce, then its value relative to other goods should increase. But the fixed exchange
\nof the indexed dollar would mean that you could use it to “trade” corn for oil at a fixed
\nrate. How do you make the dollar work when people are gaming it like that? You need to infuse a huge amount of capital into the system to cover what people are pulling out via the exchange system.<\/p>\n

No matter what you do, currency is going to fluctuate. The only way to stop it from
\nfluctuating is to stop the entire world from changing in any way. No unusual weather, no
\nconsumable resources, no changes in population, no changes in fashion, no changes in
\ntechnology, no changes in medical care, no changes in childbirth rates – no changes of any
\nkind. Because the moment you allow change of any kind into the economic system, it’s going
\nto produce changes in the relative values of different goods. And the instant that different things have shifting relative values, you cannot possible have a currency whose value is fixed relative to all of them. Pick any one, and you wind up in basically exactly the same situation that we have today with our floating exchangeable currency.<\/p>\n

What’s Woodhill’s argument that you can<\/em> fix the value of currency? Basically,
\nhe differentiates between currency<\/em> and capital<\/em> – two different, but related, economic concepts:<\/p>\n

\n

Why would the Fed employ a monetary-control approach that is both indeterminate and dangerous? I believe the underlying problem is an intellectual confusion between “money” and “capital.”<\/p>\n

“Capital” is measured in terms of money (dollars), is mobilized by money, but is not money. Capital represents real economic resources. The Fed cannot create capital. All it can do is create money and use that money to commandeer capital. Unfortunately, this can cause inflation.<\/p>\n

Once inflation gets going it tends to run away, with rapidly rising prices and escalating inflationary expectations. Ultimately this must be stopped. Unfortunately, raising the fed funds rate in order to halt inflation can cause an economy to “overshoot” into recession. Then, to fight the recession, the Fed will cut its fed funds target, thus starting the next oscillation of the business cycle.<\/p>\n<\/blockquote>\n

This is fairly typical ignorant, poorly thought out rubbish. What is capital? Capital is,
\nto put it simply, stuff which is invested in the production of other valuable stuff<\/em>.
\nAnd what is money? Money is an abstract representation of a fixed amount of stuff, which is
\nexchangeable for other stuff.<\/p>\n

As Mr. Woodhill admits, capital is measured in terms of money<\/em>. In fact,
\ncapital is exchangeable for<\/em> money – when you invest in a company, what you’re
\nbasically doing is exchanging a bit of currency for a bit of capital.<\/p>\n

So how does differentiating between currency and capital accomplish anything? Frankly, it doesn’t. It doesn’t avoid the fundamental problem – that there is no fixed unit of value, because the relative value of different things varies. It’s just handwaving nonsense. What he’s effectively saying is that there needs to be two kinds of money – a floating money supply for capital, and another one for regular currency. But that solves nothing – the two will float relative to each other, and relative the values of other goods.<\/p>\n

You can’t turn a variable quantity into a fixed one.<\/p>\n

As an aside, it’s interesting to me – particularly in light of my recent career change from full-time research to software engineering – that articles like this are almost always written by engineers, who always flout their engineering knowledge as the<\/em> reason why they should be believed. But when you read pretty much any<\/em> article about math or science where the author touts the fact that they’re an engineer, it’s almost always total crackpot nonsense. I don’t quite understand it.<\/p>\n

(And for the people who’ve been criticizing my spelling: this article was spell-checked by emacs.)<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"

After yesterday’s article about conversion between the value of british pounds in the ’70s versus british pounds today, someone sent me a link to an article at the National Review Online, which just about had me rolling on the floor laughing. The problem is, it’s dead serious. It’s written by an “engineer” named Louis Woodhill, […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"jetpack_post_was_ever_published":false,"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":false,"jetpack_social_options":{"image_generator_settings":{"template":"highway","default_image_id":0,"font":"","enabled":false},"version":2}},"categories":[71],"tags":[],"class_list":["post-597","post","type-post","status-publish","format-standard","hentry","category-bad-economics"],"jetpack_publicize_connections":[],"jetpack_featured_media_url":"","jetpack_shortlink":"https:\/\/wp.me\/p4lzZS-9D","jetpack_sharing_enabled":true,"jetpack_likes_enabled":true,"_links":{"self":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts\/597","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/comments?post=597"}],"version-history":[{"count":0,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/posts\/597\/revisions"}],"wp:attachment":[{"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/media?parent=597"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/categories?post=597"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/www.goodmath.org\/blog\/wp-json\/wp\/v2\/tags?post=597"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}