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Friday, April 21, 2000

Quatlus

[A letter]

I've often pondered at the question of Cash -- how and when should new Dollars come into existence to keep pace with the increasing net-worth of any growing economy? And in particular, how can you introduce new cash without effectively taxing everyone in the process? (Let's assume for the sake of discussion that we also would like there to be One nation-wide currency, so every merchant doesn't have to keep daily tables of exchange rates and such...)

This morning, before my brain could engage, I contemplated the obvious solution -- a solution so obvious it's been discarded out of hand any time I've heard it remotely approached in conversation. But now, in this mental purgatory between the Hawaiian morning and the Californian afternoon, my flailing brain can't find any problems with the approach, so I'm curious to hear your comments:

What if the number of monetary units -- let's call them Quatlus -- were simply fixed? I.e., there are and always will be exactly N Quatlus in the world. Always.

What does this mean? Let's say you're working your butt off, and saving Quatlus in your floor safe for twenty years and then one day decide to retire. What are you really holding there, in all those Quatlus? Effectively, they're shares in the national economy -- for all of the extra work you did above and beyond what you spent, for all the extra product you created beyond what you consumed, you own a corresponding portion of all of the net worth currently in the country (and that portion is exactly M/N, where M is the number of Quatlus you hold). Which means as the economy grows, they'll be worth more and more -- just like you were holding shares in, precisely, the ultimate index fund. Not a bad investment strategy, eh?

This in turn implies an obvious solution to the original question: You simply split the shares. Or, more usefully, you (the government or any central monetary body) create a new unit with a new name which is equal to one half of the current unit, and you exchange them two-for-one (destroy one of the old for every two new you print; likewise for any electronic cash). In practice what you would be creating at any given time would be the "pennies" (probably worth more like a current quarter) which would become more and more valuable with time, eventually becoming the dollars, twenties, hundreds, and some day investment certificates sitting in your safe (or bank) worth quite a lot. And in the same way that we have different names for pennies, nickles, quarters, and dollars, you'd have different names for currency all the way up to Quatlus, which would eventually leave circulation all together.

In this economy, you'd probably pay your bank a trivial fee to keep your Quatlus in a vault for you (or simply to convert them to and from electronic currency) rather than them paying you interest. And if you took or gave a loan, the interest rates would be tiny -- 1% maybe? -- since there is no cost to you in loaning out your Quatlus (other than the risk of not getting them back -- which is what you make up for by charging interest).

Note that everyone, by default, would be owners in a truly no-load index fund, eliminating a great deal of bureaucratic cost currently associated with simply keeping your spare cash invested in a broad index funds...

So, this is a deflationary economy -- usually considered a very bad sign. Why? What are the pitfalls of the above strategy?

Would it be possible/desirable to start a new electronic currency that worked this way? (The one issue that's still a little confusing is how you would exchange Quatlus for other currencies, as in between countries, or between Quatlus and dollars in the new electronic currency case.)

-Simon

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