Monetary Inflation is
December 4, 2006
financial press reported last week that the value of the U.S. dollar plummeted
to a 14-year low against the British pound, and weakened against the Euro and
Yen. Many financial analysts
predict continued rough times for the dollar in 2007, given reduced expectations
for economic growth at home and less enthusiasm among foreign central banks for
holding U.S. debt.
This decline in the value of the dollar is simple to explain. The dollar loses value as the direct result of the Federal Reserve and U.S. Treasury increasing the money supply. Inflation, as the late Milton Friedman explained, is always a monetary phenomenon. The federal government consistently wants to spend more than it can tax and borrow, so Congress turns to the Fed for help in covering the difference. The result is more dollars, both real and electronic-- which means the value of every existing dollar goes down.
Reserve Chairman Ben Bernanke faces two basic ongoing choices: raise interest
rates to prop up the dollar, but risk pushing the economy into a recession; or
lower interest rates to stimulate the economy, but risk further declines in the
dollar. This unfortunate dilemma is
inherent with a fiat currency, however.
course Mr. Bernanke inherited this tightrope act from his predecessor Alan
Greenspan. The Federal Reserve did
two things to artificially expand the economy during the Greenspan era.
First, it relentlessly lowered interest rates whenever growth slowed.
Interest rates should be set by the free market, with the availability of
savings determining the cost of borrowing money. In a healthy market economy,
more savings equals lower interest rates. When savings rates are low, capital
dries up and the cost of borrowing increases.
when the Fed sets interest rates artificially low, the cost of borrowing becomes
cheap. Individuals incur greater amounts of debt, while businesses overextend
themselves and grow without real gains in productivity. The bubble bursts
quickly once the credit dries up and the bills cannot be paid.
the Fed steadily increased the monetary supply throughout the 1990s by printing
money. Recent Fed numbers show
double-digit annual increases in the M2 money supply. These new dollars may make Americans feel richer, but the net
result of monetary inflation has to be the devaluation of savings and purchasing