Currency Debasement (Pt I): Laying the Foundations

Introduction

Over the last 50 or so years, most people in Advanced Economies have not really thought about currency debasement when earning a salary or investing their savings. In reality, though, currency debasement has been occurring continuously in the background, and until recently, it’s been a slow drip feed, so populations have not really noticed its direct impact on their lives.

Over the last few years, many populations have for the first time experienced the pernicious effects of high inflation, which is the result of accelerated currency debasement, and this has had an immediate negative impact on their day-to-day finances.

The press has termed this inflation issue as a “cost of living” crisis, paying almost no attention to its cause, which is this accelerated currency debasement. This continuous currency debasement has significantly contributed to societal inequalities, especially in the housing market, where there has been a widening of the gap between renters and rentiers.

Most of the global population has not been aware that their currencies have been continuously debased. More importantly, they are not cognizant of the direct and indirect consequences of debasement and how it is shaping the future, their future.

These four articles attempt to explain currency debasement to people with little or no background in economics or financial accounting. They will allow readers to understand how successive governments, Central Banks and financial institutions have been continuously employing tools that debase currencies.

This explanation of currency debasement is not a theory, an opinion or a viewpoint, but simply a description of facts supported by accounting principles that are centuries old. Indeed, these articles explain a process that has taken place hundreds of times throughout history in many different countries, and which has been well documented by excellent historians. I have just read a book about Thomas Gresham, who was Queen Elisabeth I’s banker in the late 16th Century – the Tudors used currency debasement to great effect to reduce their government debt.

Economists in the finance industry rarely discuss the subject of Currency Debasement – I have seldom met one who fully comprehends the issue and its impact in shaping future economies. Whilst these 4 articles are based on fact, it remains an open question as to

1. whether politicians understand this crucial topic and whether they have knowingly allowed currency debasement to occur

2. whether Central Bankers want the public at large to fully comprehend currency debasement, and the impact that it has and will have on the future

After reading these articles, you will have a view on the above two questions. I will offer my own views in the final article.

What is “Currency”?

So what is £1, $1 or €1? What is this "currency" that is apparently being "debased"?

When people used to buy goods or services with bank notes and coins, they tended to think of currency as physical cash, made up of the total bank notes and coins in circulation. Now that purchases are rarely completed with physical cash, but with debit and credit cards as well as by phone, it’s easier to comprehend that currency is much more than physical cash.

For the purpose of these articles, currency is defined as a broader set of "liquid assets". It includes anything that can be easily converted into cash or a deposit at a bank, which can then be spent on buying a good or service (e.g. a car, a bus ticket, food, an insurance product or a house). Thus the term "liquid".

This broader definition of Currency is in effect the Money Supply of a country, that allows a readily available liquid and readily available float for people to spend their money. It includes:

• all the physical cash in circulation (bank notes & coins) as well as central bank reserves (defined later)

• deposits held by people and businesses at banks (both regular demand and savings accounts)

• liquid money market funds that invest in very short-term financial instruments that can be easily sold at short notice for cash to make purchases

This makes sense – you don’t buy a house or car with physical cash, but by transferring money from your deposit held at a bank to the seller’s deposit account at his/her bank.

The total amount of currency in circulation, or Money Supply, has ballooned over the last 55 years – see charts below for the US, Eurozone, UK and Japan, and note the scale of the axes.

For the time being, it’s just worth noting that there has been a gargantuan increase in the money in circulation (in physical cash, deposits in banks, money market instruments etc.). To put some real numbers to highlight this increase......:

• When I started work in 1987, there was only £ 290 billion of currency in the UK

• Today there is 12 times that amount, totalling £ 3,475 billion.

The second Article will explain how this money has been created, and the third will demonstrate how the increased money supply is impacting economies worldwide and shaping the future.   

What is Currency Debasement? The invisible elephant in the room that people should know about!

My starting annual salary on the NatWest Graduate program in 1987 was £8,500. This year Robbie, a friend’s son, started his graduate program on a much higher annual salary of £32,500.

Whilst there has been a huge development in phones, computers, cheap air travel and other items over the last 38 years, the reality is that Robbie’s salary can only buy roughly the same basket of basic goods and services as the basket that I could buy 40 years ago with my much smaller salary.

In other words, despite Robbie’s salary being 280% higher than my starting salary in 1987, our purchasing powers are pretty similar. Clearly the £1 that I earned in 1987 is not worth much today as it now buys next to nothing – over time it has been debased. 

The Antiques Roadshow television program features members of the public whose family heirlooms are valued by antiques experts. Invariably, the highlight of any show comes when an expert places a high value on an item that was purchased many years ago, which draws a huge audience gasp. Recently a clock that was bought in 1970 for £200 was valued at £1,450 (cue the “wows”!).

The reality is that today’s purchasing power of £1,450 is almost identical to the buying power of £200 in 1970 (assuming an average annual 4.5% inflation rate over the last 55 years). Indeed, no one is any “richer” – in other words, costing £200, that was an expensive clock back in 1970.

Just like the case of increasing salaries over time, this example demonstrates that the “£1 of old” was worth far more than the “£1 of today”. In 1970 you needed 200 of the then £1 notes to buy an expensive clock – now you would need 1,450 of £1 coins to buy that same expensive clock. In summary, the £1 of 1970 has been debased, you need 7 ¼ times more money now to buy this same clock as you did back then.

Defining Currency Debasement

Chat GPT defines “Currency Debasement” as “the process of reducing the value of a currency, typically through excessive currency growth. This results in a decline in the purchasing power of the currency, often leading to inflation”

Voila’! My two previous examples (that show how £1 today buys less than it did in the past) describe the two blue statements within this dull Chat GPT definition. This is the easy bit to understand - most people have direct experience of a £10 note no longer buying a round of drinks in the pub. The remainder of this article and the subsequent articles will focus on the two phrases in red:

• excessive currency growth is the cause of currency debasement (covered in the next article)

• inflation is the consequence of the debasement.

What is “Inflation”?

Most people think of inflation as the change in the price of a good or service. If the price of my favourite egg and cress sandwich rises from £4.00 to 4.20, then I might say that inflation is 5% [20p divided by £4]. Similarly, if my annual car insurance rises from £530 to £593, then the eyewatering insurance inflation is close to a ridiculous 12% [£63/£530] – hard to justify given my 9 year+ no claims bonus.

The increase in the price of a good or service is one way to think about inflation. But what is “price”? It is the amount of money required to buy a good (egg sandwich) or service (insurance contract). Defining inflation as the “change of money required to buy THE SAME good or service” helps to understand currency debasement.

Inflation is the extra amount of currency required to buy the same good or service over time.

If an egg sandwich bought today is identical to the one bought last year, or the insurance contract has not been amended in 12 months, then if their prices rise, I need more Pounds and Pence today (compared to last year) to buy the same identical product. Therefore, I will need more coins to buy the same sandwich or will need to write a cheque for 12% more money to buy the same insurance contract.

It is key to consider inflation in this way, calculating the change in money to buy the SAME good or service.

Looking back at the example of the clock, only £200 was required to buy it back in 1970, whilst far more money, £1,250 more to be exact, would be required to buy it in 2025. Buying that clock today requires 625% more of today’s money compared to the money required in 1970. 625% is therefore the total inflation rate of the money required to buy the clock over this period [(£1,450/£200) – 1].

There are 2 different types of Inflation.

1.                  Consumer Price Inflation (CPI)

When you read about “inflation” in the news, or discuss inflation amongst friends or work colleagues, you are probably discussing “Consumer Price Inflation” (CPI). Central Bankers the world over focus on CPI and are mandated to keep it at a certain target (commonly around 2% per year).

To calculate CPI, a government’s statistics agency

1. starts by creating a typical “basket” of goods and services that a consumer might purchase every month

2. estimates how much a consumer will spend on each item as a percentage of the consumer’s total spend, thereby placing a weight against each product. For example, if they estimate the average person has a monthly spend of £100 and on average, they spend £11 on food, then the Food component will have a weight of 11%.

3. collects the change in price for each item every month. It can then determine the monthly change in price (%month on month, or "mom") or the change in price over the last 12 months (%year on year, or "yoy")

4. finally calculates the average weighted inflation rate of that basket of goods and services – this is the average annual Consumer Price Inflation rate for the whole basket (full example in the Appendix).

The table below shows the main expenditure components of the UK CPI basket and their individual inflation rates, as well as the weights or importance of each component in the left-hand column.

• In December, the UK’s annual Consumer Price Inflation (CPI) rate was 3.0%.

• There was a significant disparity in the annual inflation rates of the various components in the basket, ranging from a high 8.1% for housing rents to a negative 9.9% for electricity, gas and fuels (i.e. these prices declined over the 12 month period).

In summary, the UK’s annual 3.0% CPI rate means that in 2024 a typical UK householder needed to spend 3.0% more money (currency) to purchase exactly the same goods and products that were purchased a year earlier in December 2023.

2.                  Asset price Inflation (API)

With friends and work colleagues, you might also discuss the housing market, the stock market, bitcoin, or other costly assets that do not appear in the CPI inflation basket.

Whilst the CPI basket estimates the difference in the annual cost of having a roof over your head, which takes into account the increases or decreases in rent or mortgage payments, these are very different to the change in the price of the flat or house that you live in. Likewise, the CPI basket does not include the change in the value of investments (equity, bonds, private equity, mutual funds etc) or other assets (art, classic cars etc).

These assets that are not included in the CPI basket have invariably seen huge price increases over the last 50 years. Much more money is now required to buy a house in Wimbledon, to purchase 1 Apple equity share, 1 Bitcoin, a Picasso painting or a Porsche 911! Whilst the inflation rate of each specific asset can be calculated, there is no widely publicized single index that represents the change in money required to buy a basket of these assets.

Many moons ago, I started using the generic term Asset Price Inflation (API) to describe the increasing amounts of money required to buy large ticket assets that were not included in the CPI basket, be they a house, stocks and shares, classic cars and so on. To fully comprehend a country’s economic development, you need to be informed of API and understand what is driving the inflation rate of these different assets. By doing so, you will then also be fully aware of any developing financial imbalances.

As I will show in the next articles, all major recessions in the last 30 years have been caused by financial imbalances derived from high Asset Price Inflation, and which were preceded by and followed by periods of largescale currency debasement. What should surprise you is that Central bankers very rarely discuss API, focusing almost exclusively on CPI.

The chart below gives an example of the difference between CPI and API, in this case looking at American residential housing data:

• You would have to spend $212 today to buy a CPI basket of goods and services that would have cost you $100 in 1995 (black line).

• Within that CPI basket is the cost of “Shelter” (i.e. your rent or mortgage payment). Today you would have to spend $251 to have the same equivalent housing that would have cost you $100 in 1995 (green line). So mortgage/rental costs have increased by 151% from 1995 to today.

• But look at what happened to house prices during this period. If in 1995 you had bought a house for $100 (or more likely $100,000), you would have to spend $405 today ($405,000) to have exactly the same house.

  
  

So, whilst in the last 30 years the cost of the goods and services in the CPI basket has risen by a cumulative 112% and the cost of shelter has risen by 151%, House API has increased by 305%, almost 3 times more than the CPI. The same has occurred for the API of stocks and shares, Bonds, Classic Cars and so on.

Conclusion

In this first article I have outlined some basic fundamentals, and shown some important trends

• Currency is not physical cash; it is the total money in circulation (money supply)

• Currency is defined more broadly. It includes anything that can be easily converted into cash or a bank deposit that can be used to purchase a good, a service or an asset (e.g. sandwich, insurance contract or house)

• Currency includes physical cash, bank deposits and liquid short-term investments (e.g. money market funds)

• In the last 50 years there has been a huge, vast, enormous increase in the currency, or money supply, in all developed countries

• Many more £s are required today to buy the same good or service compared to 20 years ago (£1,450 vs. £200 for that clock)

• A much higher salary is required today to buy a similar basket of goods and services, compared to 30 years ago.

• Currency debasement is the process of reducing the value of a currency, resulting in a decline in the purchasing power of the currency

• Consumer Price Inflation shows the change in money required to buy the same amount of goods and services over a period of time

• Central Banks monitor CPI, and work to ensure that it stays close to its target, which is generally set at 2% per year

  
  

• Asset Price Inflation, instead, shows the change in money required to buy a house or an asset that is not included in the everyday items in the CPI basket.

• Central banks rarely discuss API

  
  

• Over the last few decades, API has increased significantly more than CPI. 

…..next time

In the next article I will show how money is “created”, both in the “good boom” times” and in the “bad bust” times. It will then become clear in the third article why API has increased so much, leading to imbalances that have then impacted whole economies and multiple populations. Again, this will be pure fact supported by hard data.

The final concluding article will bring us up to date, highlighting current economic conditions as well as existing imbalances. It will tie currency debasement together with API and the terrible state of government finances, which for many countries are the worst they have been since World War 2. This will expose the driver of rising inequalities and explain why many electorates are now voting for radical change. Finally, I will speculate on future fiscal and monetary policies, based on historical precedent.

Feedback

Agree or disagree with the content? Has this been helpful or is there something that needs clarifying? Do feel free to call me or to send feedback to edward@thegreyfirehorse.com

APPENDIX: The Office for National Statistics calculates the CPI rate in the following way.

1. It creates a typical “basket” of goods and services that a consumer might purchase every month. Below are the 15 subcomponents of the UK CPI basket. Each subcomponent might have many items (e.g. Food will have eggs, meat, salad, etc.)

   
   

2. It will estimate how much a consumer will spend on each item as a percentage of the consumer’s total spend, thereby placing a weighting against each product. For example, if the average person spends £100 on average each month, and they spend £11.30 on food, then the Food component will have a weighting of 11.3%.

   
   

3. Each month, the agency collects the change in price of each item. It then determines the monthly change in price (%mom) and the change in price over the last 12 month period (%yoy). In the example below, it has been determined that the price of “Food and (Non-Alcoholic) Drink” has risen by 3.3% in the last 12 months

   
   

4. The ONS can then calculate each component’s inflation contribution to the overall basket inflation. In the case of food, the contribution is the 3.3% inflation multiplied by the 11.3% weighting, i.e. 0.4%

5. Finally, it adds the inflation contributions of all the components together. The sum is the total CPI of the whole basket.

6. The contribution column shows which components are impacting inflation. For example, Rents, at 0.6%, contribute 20% of UK inflation.