Fiat Money and a Profligate Congress: A Bad Combination 20 comments
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Any discerning person must wonder how the U.S. has been able to run significant Federal deficits, on average, since the Johnson administration and not have extreme negative Economic affects. A government can run a deficit only if it prints money or engages in genuine borrowing. If it excessively prints money, the country gets significant inflation and the leaders will be voted out of power. If it engages excessively in genuine borrowing, the government will crowd out private borrowing, interest rates will rise, and debt service will consume the government tax take, and the leaders will again be voted out of power. So this leaves one to wonder how the U.S. has been able to run significant Federal deficits for 40 years and only have some bad inflation in the 70's and early 80's to show for it.
This week I read an article that connected the dots on the deficit conundrum. Some may object to the source of this article, but read it for its investment and economics value. If the authors' predictions were as good as they claimed (they may not have mentioned predictions that didn't work out so well) it behooves all investors to understand the way they think and what indicators they keep an eye on. Their predictions on commodities (OIL, GLD) and equities (represented by DIA, SPY, and VEU) were spectacular.
The main point of this article is that the adoption of the dollar as the Reserve currency since World War II has allowed the U.S. to deficit spend and not incur the normal bad economic affects from doing so, up to now. To get a handle on this consider China. Back in 1985 when people in China were wearing Mao suits, avoiding the Red Guards, and praising the Great Leader, they had little use for the U.S. greenback.
Fast forward to 2008 where China makes all the iPods and a lot of other things too. It has to hold a huge reserve of dollars to clear foreign exchange transactions and it also converts some of the country's savings into large purchases of U.S. Treasury securities. The United States printed pieces of paper and issued U.S. Treasury bonds to China, and received real goods and services in return. I would argue that the build up of dollars for reserves by China that is stable going forward represents money the U.S. Congress can spend "for free". Multiply this by all the other countries in the world that have to have the reserve currency and you begin to see how U.S. deficit spending can be sustained.
Lehrman and Meuller, the authors of this article, argue that the U.S. is going to have bad affects from being the Reserve currency and that it should give up that role. They recommend that the world adopt a new gold standard for all currencies. I am not a gold bug and certain parts of being the administrator of the Reserve currency seem attractive. Plus after a long time of receiving real goods and services for pieces of paper, it seems like giving up being the Reserve currency might be painful in the short run. I could envision other solutions like legal limits on Federal spending, and a strict computer algorithm that manages the money supply, that could allow the U.S. to continue to administer the Reserve currency in the world of a fiat dollar.
I want to end with an appeal that is related to, but different than the thrust of the article so far. I would argue that savvy people who believe in government of the people, by the people, for the people have to insist on one thing that is currently lacking in their government. We need a hard, mathematically defined, limit on how much the Federal government can spend in a given year. This limit should be a law and not rely only on the few members of Congress who understand that the Federal budget must balance. Obviously an exception could be made for wars where the entire nation is at risk.
When the Congress convenes at the beginning of the year, every Representative and Senator should have a number in his or her mind that represents the maximum total Federal spending for that year. This limit would be defined by Tax Revenues and some reasonable, limited, genuine borrowing. If a gold standard is the fastest, most direct way to accomplish this mathematically defined limit, so be it. Any person who has ever been responsible for a budget realizes that any budget must have its' limits, even the budget of the U.S. government.
Disclosure: Long DIA and SPY.
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This article has 20 comments:
What's lacking is the willpower of our leadership, which is focused on getting themselves re-elected, taking PAC-money from the special interests.
Volcker is the only guy (short of Graham and Rudman and maybe Bob Dole) who had the guts to take a stand. Volcker must be getting extremely nervous about this whole thing.
Obama will have his chance, but the preliminary indications are that he's going to spend like there's no tomorrow. Doesn't look good for the dollar (which is why I'm long on silver (and gold)).
I am told that silicon formed into something useful such as a solar cell or a chip can't have an easily pegged value because so much of its value is in the labor. We all know how much value labor has right now.
In a political emergency in Kenya, phone cards were currency, at least briefly. Maybe they still are.
As U.S. dollars seem unavailable in the U.S. largely, actual U.S. persons are going to be coming up with other ways to trade. Trade is both a necessity and a form of entertainment here, an entitlement not to be denied for long.
Personally I just don't care much about gold, and I live in the Upper Left Coast where today a wetsuit would appeal more than gold, but maybe that would not be true for me if I were in Miami.
Humans do seem to universally like energy. As a tree-hugging sort of person, I am concerned for trees in some places because they are an alternative when there is an interruption in the supply of energy from acts of man of Whomever.
If currencies become useless, peoples around the world will come up with other ways to trade. Governors will be talking about whatever and imbibing whatever, and re-naming things (except for the governors who are locked up--I believe we now have at least two in that category).
Meanwhile, private persons, sometimes even on the dime of their insurance companies, are flying around the globe to get new body parts, or whatever other new thing they want that is prohibited or too expensive in the U.S.
Meanwhile, out in the U.S. boonies, things are going to change.
In the South, for example, a recent on-line conjecture was that kudzu, a leafy plant that can cover a junk car in no time flat, might save NASCAR because they can make ethynol out of it.
Things will change out in the hinterlands. If Obama can stay alive long enough, he can then claim to have made the changes that regions make on their own. Better still, as he seems a consummate politician, he can have his supporters say this, or he can acknowledge that the people did it themselves.
If I were he, I would give their work back to the people and applaud their new, improved, rainbow ingenuity, and then I'd do a photo-op with Jennie-Sue, the daycare provider and Jim-Bob, the electrician, et al.
Is this an American politician's dream or what?
Also worth noting: every episode of fiat currencies deployment, historically speaking, has ended in massive economic dislocation. In France, in the late 18th century, it ended in the guillotine being put to good use. Perhaps they were on to something...
I would be in favour of such spending limitations. It seems like most states are going bankrupt at the moment and they are raising local taxes like there is no tomorrow...
The government use of fiat money allows arbitraries and complications to be introduced into the federal budget as has been done for the last 100 years. Who is to say a there is a real threat to our national security? Iraq was never a threat to our security. Neither was North Vietnam nor North Korea, but our federal government decided to carry out those wars and spend our money on them.
Now we are in an economic crisis and various elements of our government want to give money to private companies that have made poor business decisions in the past and are suffering now because of those decisions. Where does it stop? Deciding who to give all this bailout money to involves more arbitrary decisions allowed with our fiat currency. No computer algorithm is going to stop the Federal Reserve's printing presses from printing more money.
The very idea that every Congressman could come up with a budget figure and then all 535 of them work it out is absurd. The complications and arbitraries are overwhelming, evidenced by the limitless budget we now have. Who is to say we need government healthcare or that the government should support our schools? Who is to say which government programs need support? Of course, these questions are solved by looking at the US Constituion, but the federal government hasn't paid any attention to that for some time. These are all arbitrary decisions that no computer algorithm is going to regulate.
The only solution to this is a gold standard. A gold standard removes all the arbitraries and complications. On a gold standard, when the government wants more money, they get more gold to back up printing more money. No more gold = no more printing of money. If the federal government want to print more money, they need to get the gold to back it up. No arbitraries or complications can be allowed. If the federal government wants to spend money on healthcare or education or a war or corporate bailouts, they have to have the gold to do it. Gold can't be created on a printing press like the money we have now. Someone has to dig into the ground and get it and that takes real work. Then there are no arbitraries involved. Either you have the gold or you don't. Real simple.
Fed's Chairman Burns tried to fight inflation and excessive money supply but Nixon stopped him dead.
So, indeed Paul Volcker did a good job but it was Ronald Reagan who allowed him to do so. Without Regan's consent, Volcker would not be able to stay on his inflation-fighting course since too many people and politicians wanted him out.
Do you remember as much Democrats blamed Reagan for running budget deficits? Somehow now, they do not care at all about deficits.
Finally, Reagan administration did not use their deficits bailing out failed companies but rather used it for investments in high-tech, science and defense.
PS
Note that Reagan was not perfect. His immigration policies and budget compromises with the Congress were not excusable. However, nobody can argue with his many achievements.
Relly..are you as naieve and ignorant as this article suggests??? Federal spending is about survival..political survival..and the Fed is off the books...they'll spend WHATEVER is necessary..and then some to move the economy along and keep the people happy......
coppernickle coins. copper coated tincoins, silver coatedcoppernickle coins, and paper. You name it it has been used for money. One accepts money for payment of goods or service or for a gift expecting to be able to excange it for something of value. The big problem is accumulating it as it's real value tends to fluctuate, particularly as more is printed. The real trick is trying to accumulate things that will increase in value as time passes. Sometime it maybe antiques, but alas their values fluctuate up and down, maybe paintings same problem, maybe oil wells same problem. The only constant is change,when the weather changes a good sailor trims his sails. If we are to accumulate wealth we must adopt to an everchanging financial landscape. There isn't any auto pilot here and very few safe harbors. A segment of the population decides what is in and what is out the rest of just go along. last ones in and last ones get burned the most. I think it would be a prudent thing to have 10% of your investable cash in gold shares (GLD) or some form of solid gold for the forseeable future. With paper being printed like crazy these day in many different countries I suspect the financial trend setters will begin to take liking to the shinny stuff.
Merry Christmas, Bob
B. Goode: I made the comments about the algorthm because I'm pretty sure Milton Friedman once said the fed could be replaced by a computer. Obviously I meant an algorthm and the will to stick with the algorthm. FOMC sets their growth rate, the Fed buy Treasuries from banks (increasing the money supply) or sells Treasuries to banks (decreasing the money supply). And you have to take into account the "Reserve" currency aspects of the global market that Lehrman and Meuller were talking about. I'll write the code if someone gives me the formula. If you had the will to stick with the algorthm then Treasury borrowing would be "genuine" and would put constraints on Congress.
nova: interesting comments. The fed chairman has the bad end of the bargain when the president/congress overspends. One can see politically why they don't complain openly, but you seem to know of some cases where the fed chairman did push back.
general: Many people on this board felt I was naive for suggesting a balanced budget law. When our side gets it's next Reagan I would argue that a balanced budget amendment to the Constitution should be their primary strategic objective. If they accomplish this they help their own time and all future times. I don't mind if Obama wants to subsidize GM's corporate jets and highly paid workers for the next five years, or give everyone who currently doesn't have health insurance the same health insurance gov't workers have, if he's willing to give up something else to get it. The current budget environment in Washington seems to say that there's no limit, and that's scary. The federal budget was already in a deficit before all these bailout's and yet almost no one in Washington is saying "we can't afford this". On the other hand people don't really seem to vote for people if they promise to balance the budget, and that's a big part of the problem too.
Thanks for bringing Lehrman & Muller's writings to our attention once again.
Even if a new gold standard was the right solution how could it be implemented short of a worldwide economic breakdown and chaos? It seems democracies are incapable of important structural changes without a crisis.
Jack
show up in mainstream outlets. A few comments from recent events:
Iraq under Saddam Hussein made the first moves away from US currency as world currency. That was the deepest "real" reason they were invaded and occupied.
China, in the past two years, has ramped down their accumulation of US currency and obligations. So has Japan. It should be obvious where the new borrowing is coming from even though you won't be able to read it anywhere for awhile longer.
There is not enough gold in the whole planet to use it as world currency. For that to work, a single one-ounze gold coin would have to have the equivalent value of about one year of service from a typical middle-class worker. How do you make change?
The most likely scenario I can see, going forward, is that crude oil becomes the new world currency. That still leaves the United States so deep in debt
that it will never be able to pay. Voting out the scoundrels does not seem
to work, they seem to be as inexhaustible as the paper coming out of the Bureau of Minting and Engraving. I fear armed insurrection.
Interesting times ....