One of the little realised curiosities about an economic system is that it needs at least two sources of flexibility in order to function without rapid price fluctuations due to currency shortage or surplus. Currently we operate with two – the interest rate, which accounts for the cost of capital – the preference to save rather than to invest. The other is the amount of currency in circulation. This is less visible and certainly not reported on to any extent. But the RBA flexes the amount of money in the system on a continuous basis.
The chart shows annual fluctuations – at Christmas and Easter – which serve to provide the liquidity needed in the market when more demand is being made for goods and services. Otherwise we’d start to find notes in shorter supply and see temporary inflation and deflation occurring.
You can also see the longer term gradual increase, which shows the inflation of the monetary supply over that period – it has more than tripled in 15 years. If you’re ever wondering why things cost more over time… maybe this is a place to start digging.
But here’s an interesting question – how was this dealt with back in the days before currency was printed into existence upon the whim of the Reserve Bank? Obviously there are small and ongoing increases in the supply of monetary commodities like gold and silver, but these certainly couldn’t be ‘printed’ at whim.
There were two things that made the old system work. First of all, there existed what was known as the ‘discount rate’ – the rate at which circulating capital was preferred to shelf stock. It was quite a different thing to the interest rate, with a different rate and a shorter time frame. It was controlled by the rate of consumption, not the rate of saving. Looking at the current graph, you would see the rate jump at Christmas and Easter, rather than the supply. The higher rate would draw more coin into circulation for that period.
The second was that far more money sat quietly. Today, because the RBA consistently injects new, free, money into the system, we are biased as a society towards debt rather than savings. This shortens our time focus, and dramatically lessens the benefits obtained from saving. Previously, we kept far more in reserve, and this reserve allowed the market to flex in volume and velocity very quickly with a change in rates.