Stickiness

In my previous post, I proposed a thought experiment: If all the debts denominated in New Zealand Dollars suddenly halved, and half of all the New Zealand Dollars in each person or organization’s possession suddenly disappeared, would the value of the dollar double? Today, let’s consider what it might mean if the answer is “no”; what could we conclude about what determines the value of the dollar?

Recall that this unlikely scenario was compared with a scenario where New Zealand decided to switch to the New Zealand Pound, worth two New Zealand Dollars. One possibly significant difference is that legislation and regulations still specify some things in dollars.

For example, the adult minimum wage is currently $13.50 per hour. If we switched to the pound, the minimum wage would presumably be automatically set at £6.75 per hour. But in our halve-every-debt-etc scenario, this wouldn’t happen. But the minimum wage attempts to put a lower limit on the value of labour in New Zealand Dollars; this seems equivalent to trying to put an upper limit on the value of the dollar, in terms of the cheapest labour. I can’t see how a minimum wage would put a lower limit on the value of the dollar, and in particular, I can’t see how it would ensure that the dollar has any value at all.

So yes, a minimum wage might prevent the value of the dollar from fully doubling, but this fact is actually a distraction from the purpose of this thought experiment, which is to try to discover what determines the value of fiat currencies. So let’s assume that New Zealand is one of those countries that doesn’t have a compulsory minimum wage (and they all use fiat currencies, too).

Similarly, I could imagine (but not necessarily believe) an argument that social welfare payments put an upper limit on the value of the dollar, but I struggle to see how they would ensure that the dollar has any value in the first place, so for now, let’s not worry too much about their effect on the value of the dollar.

So, we’ll have to look somewhere else. Certain fines and fees are set by legislation and regulation, too. Perhaps these give the dollar its value. This is really an argument that the dollar is actually a hard currency disguised as a fiat currency, and that it’s backed by marriage licences, or passports, or the right to be absolved of a speeding ticket. I don’t find this a particularly convincing idea; when the government announced (some time last decade) that New Zealand passports would be issued for only five years instead of ten, and that the cost of a passport would not be lowered, did we see a big jump in inflation? We ought to have, if passports were the basis of the value of our currency.

So it seems that the only remaining significant difference between the two scenarios is that in one, we’re told to value the pound twice as much as the old dollars, so everyone halves their prices and replaces the dollar symbol with a pound symbol, and in the other scenario, no-one tells us to value the dollar twice as much, so prices stay the same.

Now economists do have the idea of stickiness in prices, and I think that monetarists would argue that stickiness does influence prices in the short term, but that in the long term, prices adjust to the underlying value of the currency (whatever that is). So perhaps our halve-all-the-debts scenario wouldn’t result in an immediate doubling of the value of the dollar, but the value of the dollar would tend towards doubling sooner or later, as a result.

For now, since we’re considering a possible “no” answer to the question, let’s assume that the answer is “no” even in the long term, and that the value of the dollar is unaffected by halving all the debts and all the currency in circulation. What we’re left to conclude, then, is that the only thing that would make the pound twice as valuable as the dollar is that everyone would be told that it’s twice as valuable, and that they would believe it.

Essentially, we have to believe that the value of the dollar is purely a collective illusion, and that it is solely determined by prices that workers and merchants charge for goods and services. This turns notions about prices upside down.

If you were giving someone milk in exchange for flour, you would consider the value to yourself of each commodity, and only agree to the exchange if you thought you ended up with flour at least as valuable to you as the milk you parted with (unless you were being philanthropic, or exchanging with a friend, and you were exchanging with them for the purpose of improving their welfare, even at the expense of your own). Similarly, the other person would only part with their flour if the milk you gave them was at at least as valuable to them. In this situation, the relative values of the milk and flour determine the ratio at which they’re exchanged (that is, the price).

But now we’re trying to convince ourselves that in the case of money, value doesn’t determine prices, but prices determine the value of the money.

And if the value of the dollar is a collective illusion, then why do we expect the Reserve Bank to be able to influence its value? And why do they seem to be somewhat successful? Do they really have that much influence over our irrational beliefs?

In summary, I don’t think I can believe that the answer to our original question is “no”. At least, not a pure, long-term “no”. I think that the answer must be at least that the value would tend towards doubling as a result of the halving-everything shock, but that stickiness might slow it down, and minimum wages and social welfare payments (as well as the Reserve Bank and expectations of it) might stop it from getting all the way to double its old value.

So in a later post, I intend to investigate what this might tell us about what really determines the value of fiat currencies.

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2 thoughts on “Stickiness

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