Originally posted on Thursday, July 17th, 2014

The Federal Reserve System’s James Narron and David Skeie, career officials with the Federal Reserve System, are two eminent historically erudite figures.

Writing in the New York Federal Reserve Bank’s online publication, Liberty Street Economics, they recently provided a continuation of their valuable historical “revue,” Crisis Chronicles: The Collapse of the French Assignat and Its Link to Virtual Currencies Today:

In the late 1700s, France ran a persistent deficit and by the late 1780s struggled with how to balance the budget and pay down the debt. After heated debate, the National Assembly elected to issue a paper currency bearing an attractive 3 percent interest rate, secured by the finest French real estate to be confiscated from the clergy. Assignats were first issued in December 1789 and initially were a boon to the economy. Yet while the first issues brought prosperity, subsequent issues led to stagnation and misery. In this edition of Crisis Chronicles, we review how fiat money inflation in France caused the collapse of the French assignat (subscription required) and describe some interesting parallels between the politics of French government finance (subscription required) in the late 1700s and more recent fiscal crises.

As our colleagues point out in a recent San Francisco Fed Economic Letter, recovery from a recession triggered by a financial crisis is greatly influenced by the government’s fiscal position. Because of France’s poor fiscal status, the country was plunged into financial ruin for years. The assignats have taken their place in history as another paper money made worthless by over-issuance, with disastrous results. But others have been able to break the cycle of over-issuance and hyperinflation. And in one incredible example, Brazil did it with a virtual currency.

Unit of Real Value
Brazil had experienced heightened inflation as far back as the 1950s as its government spent massively on infrastructure, including a new capital in Brasilia. That inflation persisted for nearly five decades. Early attempts to break the cycle of inflation followed the same failed tactics seen in the assignat episode, such as price freezes and confiscated assets, with the same failed results. Brazil understood that it needed to stop the printing presses, but the country also recognized that it had to reestablish faith in money. And the government decided to try doing so through a virtual currency—the unit of real value or URV.

The idea, conceived by behavioral economists, was to create a stable URV that would be indexed to the local currency—the cruzeiro—with prices quoted in URVs alongside prices in cruzeiros. Each night, the central bank would publish the exchange rate between the URV and cruzeiro. While the prices of goods might continue to go up in cruzeiros, they would remain relatively constant in URVs. It worked. Brazilians started thinking in URVs and hyperinflation began subsiding. The people went from having absolutely no faith in their currency to having absolute faith in a virtual one. Brazil is now the eighth largest economy in the world.

Those engaged, in practice as well as in theory, in matters of monetary integrity might fairly draw at least two lessons from the history presented.

First, although issues of paper fiduciary currency demonstrate an inherent propensity to lose value — quickly or slowly.  Specie — money made of precious metals, particularly gold, demonstrate inherent stability as does currency defined by and convertible into specie.  Whatever the theoretical quality of fiduciary money, one may speculate that both technical challenges and a lurking moral hazard make paper money inherently inferior.

Second, to serve its purpose as an agent of equitable prosperity the nominal and real value of money must be kept rigorously aligned.  This was a point made by no less than Copernicus, in his 1525 essay On The Minting of Money.

I think that the relevant measure here is the valuation [Latin aestimatio] of the money as such,
and, although this is founded in the quality of the metal it is made of, nevertheless, money’s material or metallic value [Latin valor] must be distinguished from its valuation as money [aestimatio]; for money can be valued more in itself than the material it is composed of and vice versa [i.e., its material value may be more than its actual valuation].

[Copernicus, Essay on Money, Laissez Faire Books, 2013, translation by Gerald Malsbary, edited by Ralph Benko and Charles Kadlec, Foreword by Lewis E. Lehrman]

The fundamental things don’t change as time goes by.