James Grant Wants to Know: Who Will Buy Our Greenbacks?

If you are unfamiliar with James Grant, do yourself a favor and read his latest missive in yesterday’s Wall Street Journal. It is overly long and probably attempts to cover too much, but still it is vintage Grant.

Basically, he asserts that the Fed approach at this point in time is destined to fail simply because the world is not going to keep on buying dollars.

Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, “continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth. Economic commentators praised the central bank’s determination to fight deflation — that is, to reinstate inflation. All hands, including President-elect Obama, seemed to agree that wholesale money-printing was the answer to the nation’s prayers.

One market, only, registered a protest. The Fed’s declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, “Tell me, again, now that the dollar yields so little, why do we own it?”

It was on Oct. 6, 1979, that then-Fed Chairman Paul A. Volcker vowed to print less money to bring down inflation. So doing, he closed one monetary era and opened another. With Tuesday’s promise to print much more money, the Federal Reserve of Ben S. Bernanke has opened its own new era. Whether Mr. Bernanke’s policy of debasement will lead to as happy an outcome as that which crowned the Volcker anti-inflation initiative is, however, doubtful. Whatever the road to riches might be paved with, it isn’t little green pieces of paper stamped “legal tender.”

Had he stopped there, or at least used that as the central thesis of the article, he would have been spot on. Grant, however, is one who believes that the biggest mistake the U.S. ever made was to abandon the gold standard. So he uses the opportunity to launch into a very entertaining-- though in the end, at least to me, not persuasive -- argument in favor of that regime. Along the way he presents an entertaining history of the migration away from the gold standard and a riveting quote from Elihu Root, a Republican senator who had strong misgivings about the establishment of the Federal Reserve in 1913.

Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community.

“Bankers are not free from it,” Mr. Root went on. “They are human. The members of the Federal Reserve board will not be free of it. They are human….Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure.

“That, sir,” Mr. Root concluded, “is no dream. That is the history of every movement of inflation since the world’s business began, and it is the history of many a period in our own country. That is what happened to greater or less degree before the panic of 1837, of 1857, of 1873, of 1893 and of 1907. The precise formula which the students of economic movements have evolved to describe the reason for the crash following the universal process is that when credit exceeds the legitimate demands of the country the currency becomes suspected and gold leaves the country.”

I am always amazed at how prescient people were many years ago and how little we tend to learn from them.

I may be wrong, but I can’t come down on Grant’s side of the gold argument. For all of the elegance and simplicity inherent in a hard currency, it is also a straight jacket. There is much to be said for the modern method. If the people who we choose to administer that system showed more wisdom and harked back to the Roots and others who spoke a great deal of truth then, we might not find ourselves in the sort of predicament we now face.

Comments

[Greg Pinelli:]

A trillion here..a trillion there..pretty soon we're talking real money..or in a couple of years..maybe not. Grants article is brilliant in that it both recalls the past concerns and justifications for leaving a gold standard behind and the present profligacy that a stand alone paper system allows. With much humor!
The problem with pure paper systems is that they ALWAYS lead down the same road. Since 1913 the inflation of the money supply has lead, as we are often reminded, to a dollar being worth only a few cents. 2009 might well mark the year it began to even lose its medium of exchange value.
Gold didn't (and wouldn't) provide a "straightjacket." Growth would be measured and very even...and prices would fall continuously by increment.
While the US and Europeans justify limitless monetary pumping that they promise they'll deal with later the real leadership in gold backed currency could come from the Arab oil countries. The first step in this process is the accumulation by those governments of gold...its also the first step for every Alpha reader. When it hits $2000 next Fall the rush will be on.
The reason Mr. Grant didn't stop halfway thru his article and went on to broach the notion of a gold standard is without it we are left helpless before Greenspans and Bernankes of this world without one...Why wail about the present if one has no solution??

2008 Dec 22 09:57 AM

[socrateazz:]

I say the problem seen today in the US is a wealth balance problem. The problem in 1980 was wealth balance problem. They are the opposite. the 1930,s problem was similar to today's difficulties as many folk have pointed out. The supply and demand is out of balance. Too many goods with too few folk with wealth to buy those goods. In 1980 the problem was too many folk wanted goods and the demand forced up the prices. Somehow a balance between supply and demand needs to be encouraged before the economy actually moves too drastically any one direction. Hard to change things when everything appears great. But that is what is needed. I think a new macro economic profession may need to be developed that looks at the major forces on the economy and recomends changes in ecomomic policies for the future. What could have been changed in the 1990's that could have made today's downturn less. Most of the changes made during that time actually made things worse today although for the short term things got better

2008 Dec 22 10:22 AM

[Tony Towers:]

Mr. Grant is absolutely correct. The dollar will continue to weaken as the Fed continues on the course it's on. I'm hedging against the dollar by investing in the etf, BWX.

2008 Dec 22 10:24 AM

[tom007:]

"For all of the elegance and simplicity inherent in a hard currency, it is also a straight jacket. There is much to be said for the modern method. If the people who we choose to administer that system showed more wisdom and harked back to the Roots and others who spoke a great deal of truth then, we might not find ourselves in the sort of predicament we now face."

There is the truth of the matter and the difficulty of it as well.

The central bank needs to have almost superhuman men and women running it, free, or at least constrained, from common human weaknesses, like greed and pride.

2008 Dec 22 10:41 AM

[Think-About-It:]

"For all of the elegance and simplicity inherent in a hard currency, it is also a straight jacket. There is much to be said for the modern method. If the people who we choose to administer that system showed more wisdom..."

Tom, you are dreaming. Wake up!! Human nature is what it is, not what you wish it to be. Therefore, the best system is the one that works best when people blunder and the human element is minimized. There is only one system that does this and has stood the test of time -- a hard (usually Gold) currency system. End of story.

2008 Dec 22 01:57 PM

[NOWHEREMAN:]

Mr. Grant is correct in his view regarding the Sea Change which occurred when Paul Volcker came into office. And his view that an Equally strong Sea Change occurred when Bernanke made his recent comments is on the Mark as well.

It took Volcker 2 1/2 Years to start unravelling the previous situation, I do not see Bernanke being able to go from a Deflationary environment to an Inflationary one within 6 months.

The new year will bring more deflation as commercial properties go into Bankruptcy. a Lot of Malls will lose their Anchors. Failures in the small Insurance and small bank sectors will light up the sky. 2 million homes will be saved from foreclosure but 4 million more will dot the landscape.

It is fanciful to believe that inflation will begin to hyperventilate any time soon. IMO

2008 Dec 22 02:57 PM

[xpatUSA:]

I think that Professor Antal Fekete has it just about right. He lets the dollar go it's merry way, complete with the Fed, Banks large and small, Forex, the whole shmear. He proposes a concurrent gold-based system, the which makes quite a bit of sense to me. The dollar would soon atrophy and die, methinks, and good riddance.

Meanwhile, GoldMoney offers a good alternative to fiat currency - goldgrams. Maybe they'll catch on!

T.C.

2008 Dec 22 03:10 PM

[lance sjogren:]

We need to sell our treasury bills to Martians.

Greenbacks, green men. They should enjoy US dollars.


If we can't find Martians to buy our dollars, we're in big trouble.

2008 Dec 22 04:19 PM

[lance sjogren:]

One thing about the gold standard: Look at how Roosevelt used it in the 30's.

He was able to do an overnight devaluation of the dollar by simply changing the exchange rate between the dollar and gold.

So even a gold standard can be corrupted.


Bottom line is I don't think there is any way to keep governments from debasing currencies over time. And as the dollar has rotted away we have had decades of prosperity.

If a fiat money system means you have decades of prosperity, and then make an occasional reset back to the stone age (as we are probably going to in the next several years), I can't say that fiat money is necessarily a non-viable economic system.

2008 Dec 22 04:24 PM

[lance sjogren:]

People have pointed out that all fiat money systems in history have failed.

The counterargument is that all sound money systems in history have failed as well.

Of course, that is a bit facile because the reason all fiat money systems in history has failed is that they are self-destroying. The reason all sound money systems have failed is that people in authority have always recognized that sound money prevents those in power from manipulating the economy for their own self-interest.


So, saying that sound money systems has always failed is sort of like saying that the rule of law is inherently a flawed concept, because there will always be people who break the law.

So where was I.

Anyway, my point is I don't know the answer but I do know that individuals that are in a position to buffer themselves from the effects of promiscuous money-printing and have the good judgement to do so are liable to be a lot better off than those who do not.

2008 Dec 22 04:31 PM

[Moon Kil Woong:]

Right now Asia is buying as they have been. This is a double edged sword. While we reap the rewards of cheap goods we slowly loose our financial independence. We are already tied very close to them right now in a somewhat symbiotic relationship. The question remains as the US keeps running roughshod over it's own finances will this relationship become parasitic.

This can occur either by the US essentially getting everything for nothing (debasing their currency so much their dollars become worthless), or by foreign debt holders forcing the US into a Wold Bank type austerity program with payments to foreign countries higher than Germany paid as a percent of GDP to the Allies after WWI? Of course if the US debases like this it will be a cold day in hell before anyone else starts accumulating US treasuries again. And if the second case occurs, it will be the end of Asia's export fueled expansion.

In order to keep our balance we need some level of fiscal restraint and de-leveraging. How much is healthy and if we can control it is the question. I think James Grant is right in the fact Bernake and the current administration have no real control which bodes very ill. However, that is not to say Volker or another person is unable to right the ship with some amount of pain. I'm sure they can. All is not lost.

2008 Dec 23 04:25 AM

[unwired:]

"I may be wrong, but I can’t come down on Grant’s side of the gold argument. For all of the elegance and simplicity inherent in a hard currency, it is also a straight jacket. There is much to be said for the modern method. If the people who we choose to administer that system showed more wisdom and harked back to the Roots and others who spoke a great deal of truth then, we might not find ourselves in the sort of predicament we now face."

As others have also said... this is the crux of the matter. Human beings are in fact incapable administering any monetary system over time. The gold standard is the only self-regulating system that will obey natural economic laws in the long run. Of course human beings can't even understand this simple truth and will....over time corrupt it as well. Then...after corrupting the gold standard with intervention...blame it as the problem. Give me the discipline of a gold standard any day. Sure it would mean a simplier life without nearly as much 'stuff'...but we'd be living in a self sustaining economy and our years of accumulated weath would have far less chance of being wiped out. Many think this is deflation we are going through.... because true deflation would in fact have similar symptoms. What we are witnessing is in fact the economic destruction and loss of confidence brought about by years of monetary inflation, gross mismanagement and malinvestment on scales never before seen.

2008 Dec 23 09:07 AM

[Alex Stanczyk:]

"Tom, you are dreaming. Wake up!! Human nature is what it is, not what you wish it to be. Therefore, the best system is the one that works best when people blunder and the human element is minimized. There is only one system that does this and has stood the test of time -- a hard (usually Gold) currency system. End of story. "

Totally concur. Well said.

2008 Dec 23 09:36 AM

[applesauce:]

Let's use plutonium, at least we know where it is and it is cannot easily be moved or put in Swiss accounts.

2008 Dec 23 12:33 PM

[Jack Walker:]

Tom,

Thanks for bringing James Grant's artilce to our attention.

Here are two questions I would ask.

How would you compare the current situation with the 1930s when the US embarked upon a policy of massive fiscal stimulus and public works projects? If I recall correctly inflation was contained until the mid 60’s when the Vietnam war expenditures eventually forced the US to renounce the gold standard in the early 1970s. Was the difference due to the gold standard?

Secondly, as an investment class how did gold perform during the deflationary 1930s?

Jack

2008 Dec 23 02:12 PM

[retired avi...:]

I don't think hard asset (such as gold) currency backing is as important as the discipline in printing fiat currency it engenders. We could have more printing discipline without any backing with just the same effect.

Seems highly remote that people will be widely distrustful of "Federal Reserve Notes" because they are not redeemable for gold or some hard asset any time soon.

2008 Dec 23 02:58 PM

[fran:]

i believe two things were wrought by l. johnson and r. nixon to hide their financial shenanigens--

1-decouple from gold
2-unified budget process to hide imbalances behind SSA surplusses

we've been off to the races since.


On Dec 23 02:12 PM Jack Walker wrote:

> Tom,
>
> Thanks for bringing James Grant's artilce to our attention.
>
> Here are two questions I would ask.
>
> How would you compare the current situation with the 1930s when the
> US embarked upon a policy of massive fiscal stimulus and public works
> projects? If I recall correctly inflation was contained until the
> mid 60’s when the Vietnam war expenditures eventually forced the
> US to renounce the gold standard in the early 1970s. Was the difference
> due to the gold standard?
>
> Secondly, as an investment class how did gold perform during the
> deflationary 1930s?
>
> Jack

2008 Dec 23 04:25 PM

[Kunst:]

The dollar has lost 23% of its purchasing power in the last 10 years.
The dollar has lost 45% of its purchasing power in the last 20 years.
The dollar has lost 71% of its purchasing power in the last 30 years.
The dollar has lost 84% of its purchasing power in the last 40 years.

There is really no limit to this.

2008 Dec 25 12:50 AM

[Gedankonomist:]

"I am always amazed at how prescient people were many years ago and how little we tend to learn from them."

You can blame the public schools for that.

2008 Dec 25 01:59 AM

[KIT:]

>The dollar has lost 23% of its purchasing power in the last 10 years.
>The dollar has lost 45% of its purchasing power in the last 20 years.
>The dollar has lost 71% of its purchasing power in the last 30 years.
>The dollar has lost 84% of its purchasing power in the last 40 years.

>There is really no limit to this.

But we make more of them so much for ½ sided arguement

Year WAGE

1951 2,799.16
1952 2,973.32
1953 3,139.44
1954 3,155.64
1955 3,301.44
1956 3,532.36
1957 3,641.72
1958 3,673.80
1959 3,855.80
1960 4,007.12
1961 4,086.76
1962 4,291.40
1963 4,396.64
1964 4,576.32
1965 4,658.72
1966 4,938.36
1967 5,213.44
1968 5,571.76
1969 5,893.76
1970 6,186.24
1971 6,497.08
1972 7,133.80
1973 7,580.16
1974 8,030.76
1975 8,630.92
1976 9,226.48
1977 9,779.44
1978 10,556.03
1979 11,479.46
1980 12,513.46
1981 13,773.10
1982 14,531.34
1983 15,239.24
1984 16,135.07
1985 16,822.51
1986 17,321.82
1987 18,426.51
1988 19,334.04
1989 20,099.55
1990 21,027.98
1991 21,811.60
1992 22,935.42
1993 23,132.67
1994 23,753.53
1995 24,705.66
1996 25,913.90
1997 27,426.00
1998 28,861.44
1999 30,469.84
2000 32,154.82
2001 32,921.92
2002 33,252.09
2003 34,064.95
2004 35,648.55
2005 36,952.94
2006 38,651.41
2007 40,405.48

There is really no limit to this.......... :>

If you took your 1951 full year wage and put in a box buried in your yard and pulled it out today your right “it lost value or purchasing power“

$2800 converted to gold in 1951 ( $34 oz ) would get you 83 oz at 2007s value that would be 650 X 83 = $53,950 mid 2007 or 800 X 83 = $66,400 Dec 2007

Wow looks like gold wins!

Put the same $2800 in DOW stocks and at 9% per year after 56 years you have $723,289.00

This divided by 83 is $8714 per oz to equal stock performance over near 60 years.

Gold does not look so good now.

Jan 01 04:29 PM