Ebb and Flow; How Currencies Function

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.



About Neocolonial

Ideas. Dreams. Collector of alternative perspectives. Engineering. Education. Politics. Photography. Whatever else catches my attention.
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2 Responses to Ebb and Flow; How Currencies Function

  1. Bron Suchecki says:

    “how was this dealt with back in the days before currency was printed into existence upon the whim of the Reserve Bank”

    Australia operated on a free banking basis. See this from George Selgin’s “The Theory of Free Banking: Money Supply under Competitive Note Issue” Quote:

    “Before 1910 Australia had several note-issuing banks all adhering to a gold standard. The banks settled clearings with one another in specie, since this was the only form of high powered money in the system at the time. Under this arrangement prices were fairly stable, and the principle of adverse clearings insured that no single bank could step out of line with its competitors. If by chance the entire system went out of line, adjustment would come as a consequence of gold losses abroad.

    In 1910 the Australian government passed a law authorizing a limited issue of legal tender Australian government notes, and a year later the Commonwealth Bank was set up as an agent for issuing these notes. Soon afterwards a prohibitive 10 percent tax was imposed on all private bank note issues, and restrictions on the issue of legal tender notes were relaxed. This gave the Australian government and its agent, the Commonwealth Bank, a virtual monopoly in note issue. The result was that the Australian notes became a new kind of high-powered money. Almost immediately the government increased its issues, and a general expansion of credit followed. So as to thwart the corrective influence of the international price-specie-flow mechanism, the
    government declared a gold export embargo. In the space of two or three years what had been an open system with plural note issuers was transformed into a closed system with monopolized note issue.

    More consequences, all in accord with the predictions of theory, followed. In September 1914, the private banks formally abandoned their regular procedure of settling clearings in specie, giving priority to acquisition of notes from the monopoly bank of issue. By this time Australian credit expansion was entirely unleashed from normal sources of control. … The result was a dramatic rise in Australian prices that continued throughout the course of the war, and for some time thereafter.”

  2. Similarly, the issue of ‘bills of exchange’ was curtailed at that time through legislative means, leaving us the situation we have today where a bill may not be issued that is both ‘payable to bearer’ and ‘designed to circulate’. I’d have to go back to my assignment (on the potential for the reintroduction of real bills) to pick out the exact timeframes.

    The same or similar thing was was happening in many places around the world at that time, largely in preparation for WWI. Inflation as a means of paying for war.. and income taxes introduced to pay for the consequences of war.

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