Protection from Inflation¶
Offset moves the power of issuing money from the state to the market participants. Therefore, Offset credits are protected from inflation.
What is inflation?¶
Imagine living in 1970, having 1000 US dollars in your bank account. Now imagine you fell asleep for 50 years, waking up in the year 2020.
After the first moments of cultural shock, witnessing all the new roads, cars, skyscrapers and mobile phones, at some point you will (unhappily) notice that your 1000 US dollars you have in the bank have became much less valuable than they used to be. An item that costs 10 US dollars in 2020 probably costed only 1.5 US dollars back in 1970!
How can the value of the currency be measured? One way to do it is to track, over a long period of time, how much it costs to buy an average basket of goods, and see how it changes over time. We deduce that money loses its value over time, if the price of goods generally increases over time.
Money depreciation is not special to US dollars. People in most countries of the world experience a similar phenomenon. Money depreciates in value as time passes. This phenomenon is called inflation.
Control over money supply¶
Governments in modern countries usually have control over the money supply 1. This means that governments can create new money and insert it into the market. Inflation is usually caused by the state, inserting money into the market faster than the market produces new goods. In small doses, inflation is considered to be a healthy enabler of long term market growth.
By handing the government the power of creating money, we trust our governments to use this power wisely, helping create healthy economic markets. Unfortunately, along the history, governments again and again abused their power of controlling the money supply for short term, and sometimes corrupt motives.
Assume for a moment that you were the king of a country, wanting to wage war over some other country. Wars are very expensive, and you find that you do not have enough money to fund the war. What could you do to get more money?
One way would be to ask for higher taxes from your citizens, but then the citizens of the country could protest against the high taxes. In fact, finding out about the high costs of the war, some citizens might prefer to not start a war at all.
A much easier way to collect the money is to use your control over the money supply, and just print it. You could print many new bills, and use those bills to pay for the war 2. This is a stealthy way to tax all the citizens of the country.
At first the citizens will not notice that they were taxed. As the new money bills enter the market (faster than the market grows), the prices of all the goods in the market will start rising, causing inflation. By the time inflation hits enough time have passed. The citizens of the country might not be able to connect between the money printing and the inflation.
Except for wars, printing new money could also be used as a band aid for overspending of the government, or for dealing with unexpected disasters.
Dangers of inflation¶
High inflation rates distort the value of money and damage the ability to trade.
Let’s look at an example. Consider two merchants, Bob and Charli, living in the same community. Bob owns a bakery, and Charli is a chocolate artist, selling her famous chocolate bars.
Suppose that one loaf of bread at Bob’s bakery costs 1USD, and one chocolate bar at Charli’s shop costs 2USD.
As part of party preparations, Bob buys 50 units of Charli’s chocolate bars, 2USD each, for a total of 100USD. Charli now has extra 100USD, which she could spend to buy anything. For example: Charli could use those 100USD to buy 100 loafs of bread from Bob’s bakery. Charli keeps those extra 100USD to be used later.
One week later, for reasons absolutely unrelated to bread and chocolate bars, the government of Bob and Charli’s country experienced economical difficulty. This could be due to over spending of the government during the last year, changes in the prices of oil around the world, a fast spreading epidemic or a war with a neighboring country.
In attempt to rescue itself from the economic difficulties, the government decides to create new money, and use it to pay its debts. As a result, new money enters the market. Suppose for the sake of simplicity that the government has created money worth 100% of all the previous money circulating in the market. In other words, the amount of money circulating in the market has doubled.
The total amount of goods in the market hasn’t changed, but the amount of money cirulating in the market has doubled. This means that every new USD has half the value of an old USD.
We now go back to Bob and Charli. As the money changed its value, but the value of one loaf of bread, or of one chocolate bar hasn’t changed, Bob and Charli decide to double the price of everything in the store. So now Bob sells one loaf of bread for 2USD, and Charli sells one chocolate bar for 4USD.
Remember that Charli saved an extra 100USD? Before the government created new money, Charli could use those 100USD to buy 100 loafs of bread. But now, as the price of bread at Bob’s bakery doubled from 1USD to 2USD, Charli can use the same 100USD to buy only 50 loafs of bread!
In the short term, the government bailed itself from debt, but Charli’s business was severely impacted.
By creating new money, the government has distorted the value of money. If such events happen very often in Bob’s and Charli’s country, people might conclude that holding to money is very risky. Lending money also becomes risky, as the value of the currency might change from the time of issuing the loan to the time of when the loan is repaid.
Protection from inflation¶
Money created using Offset is protected from inflation.
Distortion of value of money happens when the amount of money circulating in the market changes disproportionally to the amount of goods produced in the market. If the amount of money in the market doubles, and the amount of goods in the market also doubles at the same time, the value of money should not change. Problems arise when new money enters the market, but the amount of goods created in the market do not change.
In traditional money systems, only the state can create money. However, the state does not offer goods or services in return for the money created. In other words, the state is not an active participant in the market. As a result, new money can enter the market, without extra goods to back it up.
Offset moves the power of issuing money from the state to the market participants. In Offset, new money is created when Charli (the chocolate artisan) buys the cocoa powder and milk required to create chocolate bars, and money is destroyed when Charli finally sells her chocolate bars.
Consider the example discussed in the previous section: Money printed by the state distorts Charli’s savings. Let’s review this example, and see what happens if Bob and Charli used Offset to maintain their economic relationship.
Bob and Charli create Offset friendship, having an initial balance of 0. Bob and Charli use a currency they call OUSD (Offset USD). This is a currency that has the value of one USD at the time the relationship between Bob and Charli was established. Bob sells one loaf of bread for 1 OUSD or 1 USD, and Charli sells one chocolate bar for 2 OUSD or 2 USD.
Bob buys 50 of Charli’s chocolate bars, for a total of 100 OUSD. The balance between Bob and Charli is now -100 OUSD. (Bob owes Charli 100 OUSD).
Bob’s and Charli’s government prints 100% more USD, which makes one USD twice less valuable. This means now 1 OUSD = 2 USD. Bob now sells 1 loaf of bread for 1 OUSD or 2 USD, and Charli sells one chocolate bar for 2 OUSD or 4 USD.
Although the value of the USD has decreased, Charli can still use her mutual Offset balance with Bob of +100 OUSD to buy 100 loafs of bread.
If the whole community where Bob and Charli live used Offset, they will all be protected from the effect of inflation created by money printed by the state.