Gold News

Bitcoin, Peso and Interstellar Kredits

Imagine a "virtual" Federal Reserve. Now picture the Mexican Peso...
THIS MORNING I was reading about some sort of online game, "EVE Online," which has a game-world currency called "Interstellar Kredits", writes Nathan Lewis at New World Economics.
Like any currency, this one needs to be managed. Here is how it was described by Yahoo! Games:
"The economy in EVE Online is a living thing. CCP, the game's developer, actually has an economist in-house who monitors the virtual world, working to curb inflation or introducing new types of technology to absorb currency. It's like a virtual Federal Reserve, selling bonds to shrink the money supply."
It's not a very difficult concept. Shrinking the supply of currency helps support its value. You sell something (typically a government bond, but perhaps a virtual spaceship), take the money received in payment, and effectively make it disappear. It is like "unprinting money".
Believe it or not, most central bankers today – people in charge of managing real currencies, in real life, with real-life consequences for millions of people – haven't figured this out.
Remember the "Tequila Crisis" of 1995? The Mexican Peso imploded, losing about two-thirds of its value in a few weeks. The Mexican central bank could have prevented this by simply reducing the supply of Pesos, thus supporting its value. It did not.
Some people tried to help. On January 11, 1995, soon after the devaluation, David Malpass, then the chief economist of the brokerage Bear Stearns, wrote an op-ed for the Wall Street Journal. It said:
"From a technical standpoint, this experiment in public choice economics is simple. The goal is to get President Zedillo to say the following words: 'the Mexican central bank will cease creating Pesos until the Peso returns to 3.5 [Pesos per Dollar]. The Pesos earned through Mexico's fiscal surplus will be removed from circulation, making Pesos scarce. The government undertakes to borrow through Dollar-indexed instruments, at any interest rate, the sum of $5 billion per week until the goal is reached. To speed this process, Mexico will use half of its $18 billion international line of credit to buy Pesos in the first week."
This plan was absurdly overaggressive. After the devaluation, the value of all Pesos in existence (the monetary base) was about $10 billion. Just the $9 billion from the "international line of credit" would have eliminated almost every Peso in existence in five working days. In practice, it probably wouldn't have been necessary to reduce the monetary base by more than 30% or so, which would have cost about $3 billion – chump change.
Malpass knew his plan was a little over-the-top. In the same op-ed, he explained:
"The Mexican government can credibly buy every Peso in existence in a matter of weeks. Once the Mexican government announces a full presidential commitment to a thorough Peso buyback, the financial markets will complete the process in about two nanoseconds. The profit potential for the Mexican government and the first Peso buyers is immense. The public choice experiment is worthwhile if only to find out exactly how many hours it will take from start to finish once President Zedillo makes the commitment."
Simple enough. Did Mexico do it?
Actually, the monetary base did contract a bit, but that was related to a normal seasonal pattern. In January 1995 – the month of Malpass' op-ed – the Peso monetary base was up 20% from a year earlier. In January 1996, it was up 13% from January 1995. The money-printing continued. In short, it was "business as usual" at the central bank. They did nothing. Either this was on purpose (currency devaluations can be quite profitable for some), or it was simply incompetence.
The same incompetence has been seen many times since then, in Thailand in 1997, Russia in 2008, and many other places.
It turns out the video-game central banker – and the Yahoo! Games journalist – has this figured out better than the real central bankers.
He also has it figured out better than the Bitcoin dreamers. The online world of EVE wouldn't work very well if the value of the currency was careening all over the place. That's why they hired the economist to keep the value of the online currency stable, by means of adjustment of supply.
After today's Keynesian silliness ends badly, we will need people who know how to build and maintain proper monetary systems. Maybe today's PhD hopefuls should do a little online gaming.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

Follow Us

Facebook Youtube Twitter LinkedIn



Market Fundamentals