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I CONSIDER here a pair of technical problems that will be crucial for the transition of almost any modern mixed-economy into a job-market economy: How can a fair, even if provisional, exchange-rate between old and new crowns be established before transition commences? And, at the end of transition, how can the total supply of new money be adjusted-that is, diminished or augmented-to ensure its initial equilibrium with the national inventory? In other words, how can the new economy be turned over to the job market in an inflation-free state? The job market's future performance of its equilibration functions may depend critically on our starting it in a state of equilibrium. Among other things, this means finding technically sound ways of answering these two questions.
Let's consider the first one first.
1. How can a fair, even if provisional, exchange rate between old and new crowns be established before transition commences?
Dual-pricing requires that such an exchange rate be in place at the moment transition commences. But how can such a rate be computed fairly in advance? This question is, as we shall see, intimately related to the one about the equilibrium-creating adjustment to be made at the end of transition. They are indeed two halves of the same question. But let us treat them separately until they coalesce.
First, it is clear that there are certain things we must not do about exchange rates. A tempting solution to the exchange-rate problem-but one that will turn out badly-would be to measure the average hourly-compensation for work in the old economy (which before transition will be the whole economy) in old crowns and call this quantity H (for "Hourly pay"). Then 1/H seems a plausible rate at which to exchange new crowns for old ones. This is because wages paid in the new economy in new crowns will, as we know, always have an average hourly-value of 1. So the ratio of the average new compensation for an hour's work, namely 1, to the average old one for that much work, namely H, is 1/H. But H would increase as transition progressed...simply because some old sector employers would pay their employees higher and higher wages just to keep them from moving into the new sector. Toward the end of transition, H could be increasing fairly rapidly...maybe even astronomically. If it was, then our variable exchange-rate 1/H would be diminishing just as rapidly.
To take a concrete example, suppose H started out at 20 OC (twenty old crowns) for an hour's work and reached 200 OC by the end of transition...a tenfold increase. If the exchange rate were based on the value of H alone, then 1/H would drop from 1/20 = 0.05 new crowns for one old one at the beginning of transition to 1/200 = 0.005 NC/OC at the end. This would punish late movers rather severely. In fact it would impose grievous financial charges on those firms and wealthy persons who were most reluctant to move. This is what our evenhanded government is determined not to do...presumably in compliance with its mandate from a politically serene, or at least unvengeful, people (see chapter 14 for more on this.) Besides, there is no good theoretical reason to suppose that, with old crowns changing into new ones at a steeply declining rate, the economy would be anywhere near equilibrium at the end of transition. Just because old crowns are being exchanged for new ones at what is likely to be a fear-driven rate doesn't mean that the mathematical requirements of equilibration are being served in some mysterious way by this essentially emotional process.
So let's abandon this idea. Or rather, let's learn from its failure that the dual-currency system we install should employ the same exchange rate throughout transition if it is indeed to be evenhanded. So let's redefine our mathematical objectives. Using Mo and Mn respectively for old and new values of the money supply M, and Io and In for old and new values of the national inventory I, it would appear that the nation should try to conduct its currency exchange transactions in such a way that, by the end of transition, the new money supply Mn and the new national inventory In, when both are being measured in new crowns (which is what the subscript 'n' is meant to suggest), will be reasonably close to one another, that is, in equilibrium. This means trying to predict the most likely value of Mn before transition begins, and then attempting to achieve that value by using an exchange rate during transition that is most likely to make M approach Mn as transition ends. That's the first step in what turns out to be a two-step process. The second step will be to make an adjustment in the final value of Mn-the value we actually end up with-that will make it equal to In. Obviously we can only do that when we know the actual values of these two quantities at the end of transition.
Returning to Step 1, what is the most promising value of Mn to aim for? We can do no better, I believe-at least at this distance; given an actual case we might find a way to improve the following algorithm-than to take the pre-transition values of the money supply Mo and the inventory Io, both measured in old crowns-as the basis of our estimation of the final value of Mn in new money. Comparing the pre-transition values Mo and Io with one another will give us a rough assessment of the current state of inflation. If, now, we remove at least that much inflationary pressure from the economy while transition is taking place, then we are likely to be closer to an equilibrium value of Mn at the end of it than we would be if we aimed at any other target I've been able to think of.
Pre-transition Mo is the total number of old crowns in circulation at the beginning of transition: in bank accounts, both domestic and foreign; hidden in cookie jars, behind loose bricks, or under floorboards; plus the cash value of any collectibles the citizens decide to turn in for new money during transition. In short, pre-transition Mo is not an easy sum to estimate. But, with a little sleuthing and some statistical ingenuity, a fair estimation can probably be made of Mo by the nation's economists.
Pre-transition Io, in contrast, is a more readily accessible figure. It is the total value of the "purchasables" that the economy has on its shelves, warehouses, or shop floors when transition begins. By this I mean the total value of its finished goods, its goods in production, its services in preparation, and the unconsumed portions of all its productive assets, that is to say, the unamortized value of all capital goods like factory buildings, typewriters, punch-presses, and production jigs.
Given the value in old crowns of both these pre-transition quantities, we can now estimate the amount of "inflationary pressure" that was in the economy when transition began. If Mo = Io, there was no inflationary pressure; the economy happened to be in equilibrium on this dimension. Evidently there was exactly as much money in people's pockets as there were purchasable items for them to buy. If Mo > Io, then Io/Mo < 1 and there was some inflationary pressure; and its strength can be gauged by the amount the ratio Io/Mo falls below 1. If Mo < Io, then Io /Mo > 1 and there was some deflationary pressure; and its strength can be gauged by the amount the ratio Io/Mo rises above 1. So we can evidently use the initial ratio Io/Mo as a correction factor.
Suppose we find that Io/Mo = 0.8 just before transition begins. That would mean that only 80% of the nation's old money is matched by goods or unconsumed productive assets on its shelves. Somehow we've got to get rid of that other 20% by the end of the transition period. We can do so very simply. We need only underpay the people converting old crowns into new ones by 20%. To explain to the public why we're "discounting" old crowns in this way, we can tell them that because the old money was inflated, only 80% of it is "entitled" to be converted into the new money...which, as we trust they'll know by this time, can only grow in value. To do this we could calculate for each customer what he or she would have received in new crowns in exchange for the quantity of old crowns he or she wishes to exchange, had there been no inflation. To make this calculation we would need to know H again, the average pre-transition hourly compensation in old crowns.
In other words, to approximate equilibrium by the end of transition, we can "trim the fat" from the old currency at the same time that we convert any quantity of it into new currency. In practice, of course, we won't need to bother with discounts. All we'll need to do is multiply the unadjusted exchange rate 1/H by the correction factor Io/Mo to get an adjusted exchange rate, which, if used throughout transition, will not only be non-punitive but will have removed the estimated quantity of inflationary pressure from the new money-supply by the time transition is over. The desired, inflation-reducing exchange rate to be used throughout transition is, therefore, Io/Mo x 1/H.
Please note that to make this figure represent a truly nationwide average, H = 20 OC/hr must include the compensation, as reduced to an hourly basis, of literally all the workers in the pre-transition economy, whether they are wage earners, salaried managers, self-employed professionals, chief executive officers of large corporations, or entertainment luminaries-like footballers and movie stars-who may possibly be earning even higher figures per hour than the CEOs for the few hours they spend, annually, earning their large incomes. Such data is not easy to obtain. But it can be obtained; and the government must be given the legal right to obtain this elusive information if it is to calculate a fair exchange-rate between the two currencies that will be in use during the transition period.
Reviewing briefly what we have done, we start with the raw exchange rate 1/H, which we assumed was 0.05 NC for each old crown, or 50 NC for each 1,000 OC brought in to be exchanged. Then, to remove inflation from the new money that is arriving in the economy in this way, we multiply this preliminary figure by the correction factor Io/Mo. This, we assumed, had a value of 0.8, which is an estimate of the amount of inflation initially in the transition economy. Multiplying 0.05 by 0.8 gives 0.04 NC/OC as the adjusted exchange rate. Thus there would be only 40 NC for each 1,000 OC a citizen brought in for exchange instead of the 50 NC he or she would have received had we done nothing at all about inflation.
Applying this adjustment throughout the transition period will give us the 20% reduction in the new money supply that we wish to effect in order to compensate for the inflation that we suspected was in the economy when transition began. By this relatively simple and readily understood maneuver, we can remove little by little-and virtually painlessly-whatever amount of inflationary pressure we know about beforehand.
We can now address our second question:
2. How can the supply of new crowns at the end of transition (Mn) be adjusted to assure its final equilibrium with the national inventory (In) at that time?
How, in other words, can the economy be turned over to the job market in an equilibrated state? This question is conceptually a good deal easier to answer than the one we've just considered. We need just two post-transition quantities, Mn and In. This time, of course, money and inventory will both be measured in new crowns, so they'll be easier to assess. In addition, to make this adjustment in the money supply, we'll need a list of all the citizens who exchanged old crowns for new ones during transition-a list that will, presumably, include all the citizens-as well as the total amount of old money that each one exchanged. With this information in hand, we need only compare Mn with In and decide what must be done to Mn at the end of transition to make it equal In. If Mn is greater than In, then we must reduce Mn by the Mn - In difference to bring it into equilibrium; if smaller, we must increase Mn by the In - Mn difference.
Very likely Mn will still be greater than In. That is, the economy will still be inflationary but less so than at the beginning of transition. Once we discover what adjustment is needed to equilibriate the post-transition economy, we can execute that adjustment by either adding to or subtracting from each citizen's bank account-assuming that all citizens exchanged some old crowns for new ones during transition and that each citizen has a bank account-an amount that is that citizen's a pro rata share of the total adjustment to be made, that is, an amount proportional to that particular citizen's share of the total funds that have been exchanged.
This final adjustment is likely to be very small...perhaps even negligible from the points of view of most citizens. But its sum will not be negligible from the country's point of view, nor from those of its richest citizens. In effect, the national bank will be recalculating the exchange rate retroactively, applying small adjustments across the board by making a one-time deposit to, or withdrawal from, each money-exchanger's bank account, and so bringing the money supply of the new economy into equilibrium with its inventory.
At that point, the transition to the new job-market economy can be said to be fiscally complete.
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