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Stupid TrilemmaThere is an interesting economic problem in mainstream economics called the Impossible Trininty or Trilemma. It is a "problem" that has not only puzzled economists since it was first postulated but it has been so far not only verified but blamed for several economic busts.

INTRO

The Trilemma simply states that it is impossible to achieve simultaneously the following three goals:

  1. Stable Exchange Rates
  2. Free Capital Flow
  3. Independent Monetary Policy

Only two of them can be achieved at any given time. The rationale goes more or less like this.

If a Central Bank wishes to impose interest rates different from global ones, people will either sell or buy local currency depending of said interest rates. If the Central Bank sets the rates lower than the international ones, people will sell local currency and buy foreign one in order to get higher interest rates. If the rates are higher, the opposite will happen. But either event will trigger either a depreciation or appreciation of the local currency because of simple supply and demand. If people are selling, the exchange rate of the domestic currency drops. If people are buying, the exchange rate of the domestic currency soars. Bam! No stable exchange rates are possible.

If the Central Bank wishes prevent this, they can do so by imposing Capital Controls, which means no Free Capital Flow. Bam!

Another way in which Central Banks may attempt to control this phenomenon is by selling or buying foreign currency. To prevent domestic currency from depreciating, they can sell foreign currency (its reserves) and buy domestic. But reserves are limited. Bam! If they want to prevent the opposite, they can print domestic currency but then inflation will go up. No Independent Monetary Policy. Bam!

The Trilemma states that Central Banks must choose which two parameters they want to control. They can have either:

  1. Stable Exchange Rates and Free Capital Flow
  2. Independent Monetary Policy and Free Capital Flow
  3. Stable Exchange Rates and Independent Monetary Policy

So much for the capability of "managing" the economy!

WHY IS THIS IMPORTANT

This is important because of how mainstream economists (i.e. Keynesians) perceive the economy and how their masters the politicians attempt to use such perception to perpetuate themselves in their cushy (uselessly destructive) jobs. Let's take a look at one parameter at the time.

Why would politicians attempt to control Exchange Rates? Because Exchange Rates are critical to voters. Low exchange rates favor exports (good for large companies with deep pockets for political contributions) but bad for people (voters) because their imports soar in price. Politicians are always attempting to manipulate Exchange Rates depending from which direction the wind is blowing and screwing either one, the other or both groups of people in the process.

Why would politicians attempt to control Capital Flow? Because incoming capital typically produces investments which create jobs and this is favoured by the people (voters). But incoming capital is not good for local companies because this typically means more competition.

Why would politicians attempt to control Monetary Policy? Because in order to stay in their jobs they need to buy votes. Being able to print without affecting the exchange rate and/or imports/exports is the holy grail.

WHY THIS IS SHOCKING

Yet again we need to point out the obvious. Modern economic theory (i.e. Monetarism) is garbage at best and a dangerous tool at worse. The Trilemma was a theoretical curiosity up to the 80's. After that and as globalization began to take hold, it became a reality to the point that modern Open Economy Macroeconomics is based on it.

Let's pause for a minute here and consider the last statement. An entire branch of modern economics (arguably the most important) is based on the idea of what Central Banks (and by extension politicians) cannot do. In other words, the economic conditions that will be imposed upon us are dictated by what Central Banks are unable to control. Considering that the idea of the necessity of Central Banking was sold to people under the guise of actually controlling the economy for the "greater good", this is truly mindboggling.

WHY THIS IS STUPID

Let's now go back for a second and analyze the Trilemma from a different point of view. The point of view of common sense and peoples' needs. Let's begin.

Stable Exchange Rates

Within modern economics lies the idea that prices should be stable. There is no reason why a screw today should not sell for the same price as yesterday. This concept stems from the theory of valuation which states that somehow and for some reason the "value" of a thing can be determined. If a value of a thing can indeed be determined then this value has no reason to change over time, all things being equal. If you buy that screw today in the hardware store and all the elements of screw production and retail conditions remain constant, there is no reason why that screw should cost more tomorrow. The only exception to the rule is inflation, which is, of course, unleashed on you for your benefit. To "reactivate" the economy, you know?

And what is the relation of prices with exchange rates? Simple. Exchange rates are the prices we pay for other currencies. Exchange rates are prices, thus the idea that they should be "stable" applies.

Now consider this. Do you believe that retailers base their pricing solely on manufacturing and retailing conditions? If that would be the case, it would be a no-brainer to forecast prices! The whole point of "price discovery" is to actually discover prices! As you know, retailers change prices in an attempt to maximize profits, even when all conditions remain the same. Yet, modern economics cannot explain this phenomenon. On the other hand, Austrian Economics does.

The Austrians explain that prices (or values) are deeply subjective, personal and thus infinitively variable, even when all manufacturing and retail conditions remain the same (see for example Austrian Economics For Dummies - Scale of Values). Thus, the idea that prices should be "stable" is revealed to be idiotic and nonsensical.

If we look into the distant past when physical items were used as money (e.g. gold and silver), we notice that prices did fluctuate considerably, even though the amount of gold and silver remained roughly the same!

Thus, the idea that exchange rates must be kept "stable" is in and by itself idiotic and nonsensical! We do not need to keep exchange rates stable and attempting to do so goes against basic economic principles!

But then again, all socialist actions are based on trying to impose theoretical ideas on real markets (Central Banks' manipulations are socialistic by definition because they "manage" markets). There is no reason why current governments should not attempt to do so when they are based on theoretical economic and social theories that have very little to no connection to the real world.

The bottom line is simple, the demand for Stable Exchange Rates is artificial at best and destructive at worse.

But let's get a step further. Why exactly is that we need about 150 or so currencies? Before the 1800's the world was doing just fine on gold and silver. The reality is that fiat currencies are artificial impositions of artificial entities called Central Banks operating based on artificial theories. None of it is necessary, required or, for that matter, desirable!

Note: please see the Glossary if you are unfamiliar with certain words.

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