Steve Bain

What is Debasement of Currency?

Debasement of currency is the term applied to the undermining of the purchasing power of a currency by various means. Typically, in modern times, this occurs via the effects of monetary inflation and consequent rising of the price level.

Historically, debasement was a common problem for most of human civilization because the currencies in circulation usually had something inside them that was of intrinsic value. Usually that was a precious metal such as gold, and that meant that there was always a temptation to somehow debase the currency by clipping tiny fragments off the coinage before spending it.

This, of course, can be construed as simple theft. That being the case the penalty for anyone engaging in such activity would be extremely harsh. That is, of course, unless it was done by a Monarch or other head of state.

The most famous debasement of currency in history occurred in Roman times, and it is one of the main reasons given for the fall of the Roman empire. You might wonder why the authorities would conduct such a self-destructive policy; the answer is the same as always - too much government spending and not enough taxes to pay for it all.

In this article I will explain how currency debasement affects the economy, and I will relate it to modern experiences of incompetent handling of monetary policy in the form of seigniorage.

John Maynard Keynes on Currency Debasement

The key to understanding the difference between historical currency debasement and its modern version comes down to the difference between commodity money and fiat money. Unlike the commodity money of previous eras, modern fiat currency has no intrinsically valuable element inside it. In fact, it usually takes digital form of some sort, in which case there is no physical component at all.

The way in which debasement works with fiat currency is via the creation of inflation. The meaning of the word inflation, in its original form, simply meant an increase in the money-supply, and whilst that is impossible to manipulate with something real like gold, it is child's play for the Federal Reserve to create as many dollars as it desires.

However, inflation of the money-supply just creates extra dollars without creating any extra goods and services, meaning that extra competition to purchase the existing supply of goods and services will result. In the end the competitive process will always work itself out with rising prices the inevitable consequence. 

“The process (of currency debasement) engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
John Maynard Keynes

The quote above by John Maynard Keynes is exactly right; he doesn't mean that rising prices are impossible to diagnose as a result of money-printing, he means that the costs of those rising prices will fall disproportionately on society in ways that are very hard to account for. One thing that you can rely on, however, is that the poor and middle-classes will suffer most. The rich can often avoid most of the costs, and the political elites often profit heavily - especially if they are corrupt!

Debasement of Fiat Currency

Debasement of fiat currency does not have to come from excessive deficit spending by the government funded by Federal Reserve money-printing (a process termed 'monetizing the debt'), in most cases it occurs when the fractional reserve banking system creates too much credit.

Excessive credit creation increases spending without  a proportionate increase in the production of goods and services, and that again leads to rising prices in just the same way as monetizing the deficit-spending by the government. Usually this creates the typical boom-bust business cycle as consumers borrow excessive amounts of money, at ridiculously cheap interest rates, in order to buy into a housing bubble.

House prices then rise to an unsustainable level and, when they turn the corner and start to decline, people stop buying. As spending in the economy falls, a recession begins. There are, of course, many more dynamics involved in this process, but the key to understanding all of them is the detachment of interest rates from the supply and demand of/for money.

With a fiat monetary system, fractional reserve banking, and a central bank managing base money via interest rate policy, you have all the ingredients for markets to miss-allocate resources in such a way that causes a boom-bust cycle. What's worse, each recession puts extra demands on governments to increase spending even further, and to pay for it by running up the national debt. Ultimately this creates the long-term debt cycle.

Debauch the Currency

"The best way to destroy the capitalist system (is) to debauch the currency."
Vladimir Illyich Lenin

Regular readers of my site may have gathered that I am no socialist, but that doesn't mean that there is nothing about socialist doctrine that makes sense. Marx and Lenin understood a great deal about the weaknesses and injustices of capitalism, and almost 100 years since the death of Lenin the quote above seems more pertinent today than ever before.

The high inflation (rising prices) seen in the west since 2021 appear to many economists, particularly the proponents of free-market economics, to be the start of a secular inflation that will persist for many years to come.

While it would be lazy to attribute all the blame for this on excessive deficit-spending by our governments, incompetent Federal Reserve interest rate policy, or irresponsible commercial banks that are 'too big to fail', it is hard to imagine how the our economies could have gotten into the mess that they are in if we had not spent the last 50+ years debauching the currency with grossly excessive money creation.

Keynesians would argue against free-market solutions, and have a different theory of interest rates to that of Austrian economists, but there's little doubt that Keynes himself would turn in his grave if he could see the way in which his brand of economics has been perverted by perpetual deficit-spending spending, funding by an ever-growing mountain of debt.

The debasement of currency in the western world could be about to get much worse in the near future. At the start of 2023, a severe recession looks imminent and, when it becomes apparent, look out for government deficit-spending to take off to new highs and CPI inflation to reach levels never before seen in the US or the UK.


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