September 6, 2001
Congress has a constitutional responsibility to maintain the value of the dollar by making only gold and silver legal tender and not to "emit bills of credit."
This responsibility was performed relatively well in the 19th Century, despite the abuse the dollar suffered during the Civil War and despite repeated efforts to form a central bank. This policy served to maintain relatively stable prices, and the shortcomings came only when the rules of the gold standard were ignored or abused.
In the 20th Century, however we saw the systematic undermining of sound money, with the establishment of the Federal Reserve System in 1913, and the outright rejection of gold, with the collapse of the Bretton Woods Agreement in 1971.
We are now witnessing the effects of the accumulated problems of thirty years of fiat money-not only the dollar but also all the world currencies-something the world has never before experienced. Exactly how it plays out is yet unknown. Its severity will be determined by future monetary management- especially by the Federal Reserve. The likelihood of quickly resolving the deeply ingrained and worldwide imbalances built up over thirty years is remote. Yielding to the addiction of credit creation (as has been the case with every market correction over the past thirty years) remains irresistible to the central bankers of the world. Central planners, who occupy the seats of power in every central bank around the world, refuse to accept the fact that markets are more powerful and smarter than they are.
The people of the United States, including the US Congress, are far too complacent about the seriousness of the current economic crisis. They remain oblivious to the significance of the US dollar's fiat status. Discussions about the dollar are usually limited to the question of whether the dollar is now too strong or too weak. When money is defined as a precise weight of a precious metal, this type of discussion doesn't exist. The only thing that matters under that circumstance is whether an honest government will maintain convertibility.
Exporters always want a weak dollar, importers a strong one. But no one demands a stable sound dollar, as they should. Manipulation of foreign trade through competitive currency devaluations has become commonplace and is used as a form of protectionism. This has been going on ever since the worldwide acceptance of fiat money thirty years ago. Although some short-term advantage may be gained for certain manufacturers and some countries by such currency manipulation, it only adds fuel to the economic and financial instability inherent in a system of paper money.
Paper money helps the strong and hurts the weak before it self-destructs and undermines international trade. The US dollar, with its reserve-currency status, provides a much greater benefit to American citizens than that which occurs in other countries that follow a similar monetary policy. It allows us to export our inflation by buying cheap goods from overseas, while our dollars are then lent back to us to finance our current account deficit. We further benefit from the confidence bestowed on the dollar by our being the economic and military powerhouse of the world, thus postponing the day of reckoning. This permits our extravagant living to last longer than would have otherwise occurred under a gold standard.
Some may argue that a good deal like that shouldn't be denied, but unfortunately the piper must eventually be paid. Inevitably the distortions, such as our current account deficit and foreign debt, will come to an end with more suffering than anyone has anticipated.
The monetary inflation of the 1900s produced welcomed profits of $145 billion for the NASDAQ companies over the five years between 1996 and 2000. Astoundingly this entire amount was lost in the past year. This doesn't even address the trillions of dollars of paper losses in stock values from its peak in early 2000. Congress has expressed concern about the staggering stock-market losses but fails to see the connection between the bubble economy and the monetary inflation generated by the Federal Reserve.
Instead, Congress chooses to blame the analysts for misleading investors. The analysts may not be entirely blameless, but their role in creating the bubble is minimal compared to the misleading information that the Federal Reserve has provided, with artificially low interest rates and a financial market made flush with generous new credit at every sign of a correction over the past ten years.
By preventing the liquidation of bad debt and the elimination of mal-investment and overcapacity, the Federal Reserve's actions have kept the financial bubble inflated. Of course it's an easy choice on the short run. Who would deliberately allow the market tendency to deflate back to stability? That would be politically unacceptable.
Talk of sound money and balanced budgets is just that. When the economy sinks, the rhetoric for sound policy and a strong dollar may continue but all actions by the Congress and the Fed will be directed toward re-inflation and a congressional spending policy oblivious to all the promises regarding a balanced budget and the preservation of the Social Security and Medicare trust funds.
But if the Fed and its chairman, Alan Greenspan, have been able to guide us out of every potential crisis all the way back to the stock market crash of 1987, why shouldn't we expect the same to happen once again? Mainly because there's a limit to how long the monetary charade can be perpetuated. Now it looks like the international financial system built on paper money is coming to an end.
Modern-day globalism, since gold's demise thirty years ago, has been based on a purely fiat US dollar, with all other currencies tied to the dollar. International redistribution and management of wealth through the IMF, the World Bank, and the WTO have promoted this new version of globalism. This type of globalism depends on trusting central bankers to maintain currency values and the international institutions to manage trade equitably, while bailing out weak economies with dollar inflation. This, of course, has only been possible because the dollar strength is perceived to be greater than it really is.
Modern-day globalists would like us to believe they invented globalism. Yet all they are offering is an unprecedented plan for global power to be placed in the hands of a few powerful special interests.
Globalism has existed ever since international trade started thousands of years ago. Whether it was during the Byzantine Empire or the more recent British Empire, it worked rather well when the goal was honest trade and the currency was gold. Today, however, world government is the goal. Its tools are fiat money and international agencies that believe they can plan globally, just as many others over the centuries believed they could plan domestically, ignoring the fact that all efforts at socialism have failed.
The day of reckoning for all this mischief is now at hand. The dollar is weakening, in spite of all the arguments for its continued strength. Economic law is overruling political edicts. Just how long will the US dollar and the US taxpayer be able to bail out every failed third-world economy and pay the bills for policing the world with US troops now in 140 nations around the world? The answer is certainly not forever and probably not much longer, since the world economies are readjusting to the dislocations of the past thirty years of mismanagement and misallocation of capital, characteristic of fiat money.
Fiat money has been around for a long time off and on throughout history. But never has the world been so enthralled with the world economy being artificially structured with paper money and with a total rejection of the anchor that gold provided for thousands of years. Let there be no doubt, we live in unprecedented times, and we are just beginning to reap what has been sown the past thirty years. Our government and Federal Reserve officials have grossly underestimated this danger.
Current concerns are expressed by worries about meeting the criteria for a government-declared recession and whether a weaker dollar would help. The first is merely academic, because if you are one of the many thousands who have been laid off, you're already in a recession. The second doesn't make a lot of sense unless one asks "compared to what?" The dollar has been on a steady course of devaluation for thirty years, against most major currencies and against gold. Its purchasing power in general has been steadily eroded. The fact that the dollar has been strong against third-world currencies and against most major currencies for the past decade doesn't cancel out the fact that the Federal Reserve has systematically eroded the dollar's value by steadily expanding the money supply. Recent reports of a weakening dollar on international exchange markets have investment implications but do not reflect a new policy designed to weaken the dollar. This is merely the market adjusting to thirty years of systematic monetary inflation.
Regardless of whether the experts demand a weak dollar or a strong dollar, each inevitably demands lower interest rates, hoping to spur the economy and save the stock market from crashing. But one must remember that the only way the Federal Reserve can lower interest rates is to inflate the currency by increasing the money supply and by further debasing the currency. In the long term, the dollar is always weakened, even if the economy is occasionally stimulated on a short-run basis.
Economic growth can hide the ill effects of monetary inflation by holding some prices in check. But it can't prevent the over-capacity and mal-investment which causes the economic downturn. Of course, the central bankers cling to the belief that they can somehow prevent the ugly corrections known as recessions. Economic growth, when artificially stimulated by monetary growth and low interest rates, generates the speculation we've seen in the stock, bond and real estate markets, along with excessive debt. Once the need for rectifying the over-capacity is recognized by the market, these imbalances are destined to be wiped out. Prolonging the correction phase with the Fed's efforts to re-inflate by diligently working for a soft landing, or even to prevent a recession, only postpones the day the economy can return to sustained growth. This is a problem the United States had in the 1930s and one that Japan has experienced for more than a decade, with no end in sight.
The next recession, from which I'm sure we're already suffering, will be even more pervasive worldwide than the one in the 1930s due to the artificial nature of modern globalism, with world paper money and international agencies deeply involved in the economy of every nation. We have witnessed the current and recent bailouts in Mexico, Argentina, Brazil, Turkey and the Far East. While resisting the market's tendency for correction, faith in government deficits and belief in paper money inflation will surely prolong the coming worldwide crisis.
Alan Greenspan made a concerted effort to stave off the 1991-1992 recession with numerous reductions in the Fed funds rate to no avail. The recession hit, and most people believe it led to George Bush's defeat in the 1992 election. It wasn't that Greenspan didn't try, and in many ways the Bush people's criticism of Greenspan's effort is not justified. Greenspan, the politician, would have liked to please the elder Bush, but was unable to control events as he had wished. This time around, however, he's been much more aggressive with the half-point cuts along with seven cuts in just eight months, for a total of a three-point cut in the Fed funds rate. But guess what? So far it hasn't helped. Stocks continue to slide, and the economy is still in the doldrums. It is now safe to say that Greenspan is pushing on a string. In the year 2000, bank loans and commercial paper were growing at an annualized rate of 23%. In less than a year, in spite of this massive influx of new credit, these loans have crashed to a rate of minus 5%.
But where is the money going? Some of it probably has helped to prop up the staggering stock market, but that can't last forever. Plenty went into consumption and to finance extravagant living.
The special nature of the dollar, as the reserve currency of the world, has permitted the bubble to last longer and to be especially beneficial to American consumers. But in the meantime, understandable market and political forces have steadily eroded our industrial base, while our service sector has thrived. Consumers enjoyed having even more funds to spend as the dollars left manufacturing. In a little over a year, one million industrial production jobs were lost while saving rates sank to zero and capital investments plummeted. Foreigners continue to grab our dollars, permitting us to raise our standard of living, but unfortunately it's built on endless printing of fiat money and self -limiting personal debt.
The Federal Reserve credit created during the last eight months has not stimulated economic growth in technology or the industrial sector, but a lot of it ended up in the expanding real-estate bubble, churned by the $3.2 trillion of debt maintained by the GSEs.
The GSEs, made up of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank, have managed to keep the housing market afloat, in contrast to the more logical slowdown in hotel and office construction. This spending through the GSEs has also served as a vehicle for consumption spending. This should be no surprise, considering the special status that GSEs enjoy, since their implied line of credit to the US Treasury keeps interest rates artificially low. The Clinton administration encouraged growth in housing loans that were financed through this system.
In addition, the Federal Reserve treats GSE securities with special consideration. Ever since the fall of 1999, the Fed has monetized GSE securities, just as if they were US Treasury bills. This message has not been lost by foreign central banks, which took their cue from the Fed and now hold more than $130 billion of United States GSE securities. The Fed holds only $20 billion worth, but the implication is clear. Not only will the Treasury loan to the GSEs if necessary, since the line of credit is already in place, but, if necessary, Congress will surely accommodate with appropriations as well, just as it did during the Savings and Loan crisis. But the Fed has indicated to the world that the GSEs are equivalent to US Treasury bills, and foreign central banks have enthusiastically accommodated, sometimes by purchasing more than $10 billion of these securities in one week alone. They are merely recycling the dollars we so generously print and spend overseas.
After the NASDAQ collapsed last year, the flow of funds into real estate accelerated. The GSEs accommodated by borrowing without restraint to subsidize new mortgages, record sales and refinancing. It's no wonder the price of houses are rising to record levels.
Refinancing especially helped the consumers to continue spending even in a slowing economy. It isn't surprising for high credit-card debt to be frequently rolled into second mortgages, since interest on mortgage debt has the additional advantage of being tax-deductible. When financial conditions warrant it, leaving financial instruments (such as paper assets), and looking for hard assets (such as houses), is commonplace and is not a new phenomenon. Instead of the newly inflated money being directed toward the stock market, it now finds its way into the rapidly expanding real-estate bubble. This, too, will burst as all bubbles do. The Fed, the Congress, or even foreign investors can't prevent the collapse of this bubble, any more than the incestuous Japanese banks were able to keep the Japanese "miracle" of the 1980s going forever.
Concerned Federal Reserve economists are struggling to understand how the wealth effect of the stock market and real estate bubble affect economic activity and consumer spending. It should be no mystery, but it would be too much to expect the Fed to look to itself and its monetary policy for an explanation and assume responsibility for engineering the entire financial mess we're in.
A major problem still remains. Ultimately the market determines all value including all currencies. With the current direction of the dollar certainly downward, the day of reckoning is fast approaching. A weak dollar will prompt dumping of GSE securities before treasuries, despite the Treasury's and the Fed's attempt to equate them with government securities. This will threaten the whole GSE system of finance, because the challenge to the dollar and the GSEs will hit just when the housing market turns down and defaults rise. Also a major accident can occur in the derivatives markets where Fannie Mae and Freddie Mac are deeply involved in hedging their interest-rate bets. Rising interest rates that are inherent with a weak currency will worsen the crisis.
The weakening dollar will usher in an age of challenge to the whole worldwide financial system. The dollar has been the linchpin of economic activity, and a severe downturn in its value will not go unnoticed and will compound the already weakening economies of the world. More monetary inflation, even if it's a concerted worldwide effort, cannot solve the approaching crisis. The coming crisis will result from fiat money and monetary inflation; therefore, more of the same cannot be the solution.
Pseudo-free trade, managed poorly and driven by fiat money, is no substitute for true free trade in a world with a stable commodity currency, such as gold. Managed trade and fiat money, historically, have led to trade wars, which the international planners pretend to abhor. Yet the trade war is already gearing up. The WTO, purported to exist to lower tariffs, is actually the agency that grants permission for tariffs to be applied when complaints of dumping are levied. We are in the midst of banana, textile, steel, lumber, and tax wars, all managed by the WTO. When cheap imports hit our markets, it's a good deal for consumers, but our manufacturers are the first to demand permission to place protective tariffs on imports. If this is already occurring in an economy that has been doing quite well, one can imagine how strong the protectionists' sentiments will be in a worldwide slowdown.
Congress is starting to realize that the budget forecast based on an overly optimistic growth rate of 3% is way off target, and even the pseudo-surpluses are soon to be eliminated. Remember the national debt never went down with the "surpluses." The national debt is currently rising at more than $120 billion at an annualized rate and is destined to get worse.
Our dollar problem, which affects our financial and budgetary decisions, originated at the Fed with our country's acceptance of paper money thirty years ago. Federal Reserve officials and other government leaders purposely continue to mislead the people by spouting the nonsense that there is no evidence of inflation, as measured by government-rigged price indices. Even though significant price increases need not exist for monetary inflation to place a hardship on the economy, stock prices, housing prices, costs of medical care and education, and the cost of government have all been rising at very rapid rates. But the true inflation, measured by the money supply, is rising at a rate of greater than 20%, as measured by MZM. This fact is ignored.
The deception regarding price increases is supposed to reassure us and may do so for a while. The Fed never admits it, and the Congress disregards it out of ignorance, but the serious harm done by artificially low interest rates--leading to mal-investment, overcapacity, excessive debt and speculation causes the distortions that always guarantee the next recession.
Serious problems lie ahead. If the Fed continues with the same monetary policy of perpetual inflation, and the Congress responds with more spending and regulations, real solutions will be indefinitely delayed.
The current problems, hopefully, will cause us as a nation and, in particular, Congress to reassess the policies that have allowed the imbalances to develop over the last thirty years.
Someday, stable money based on the gold standard must be reconsidered. Stable money is a constitutional responsibility of Congress. The Federal Reserve Board's goal of stable prices, economic growth and low interest rates, through centralized economic planning by manipulating money and credit, is a concoction of 20th Century Keynesian economics. These efforts are not authorized by the Constitution, and are economically detrimental.
Economic adjustments wouldn't be so bad, as many mild recessions have proven, except that wealth is inexorably and unfairly transferred from middle class and poor to the rich. Job losses and the rising cost of living hurt some more than others. If our course is not changed, the entire middle-class prosperity can be endangered, as has happened all too often in other societies that pursued a false belief that paper money could be satisfactorily managed.
Even the serious economic problems generated by a flawed monetary system could be tolerated, except for the inevitable loss of personal liberty that accompanies government's efforts to centrally plan the economy through a paper monetary policy and ever-growing welfare state.
Likewise, an imperialistic foreign policy can only be supported by inflation and high taxation. This policy compounds the threat to liberty, because all too often our leaders get us involved in overseas military adventurism in which we should have no part. Today that danger is greater than ever before, as we send our dollars and troops hither and yon to areas of the world most Americans have no knowledge or interest in. But the driving force behind our foreign policy comes from our oil corporations, international banking interests and the military-industrial complex, which have high-stake interests in the places our troops and foreign aid, are sent.
If, heaven forbid, the economy sinks as low and for as long as many free market economists believe, what policy changes must we consider? Certainly the number one change ought to be to reject the ideas that created the crisis. But rejecting old ways that Congress and the people are addicted to is not easy. Many people believe that government programs are free. The clamor for low interest rates, (more monetary inflation) by virtually all public officials and prominent business and banking leaders is endless. And, the expectation for government to do something for every economic malady-even if ill-advised government policy has created the problem-drives this seductive system of centralized planning that ultimately undermines prosperity. A realization that we cannot continue our old ways may well be upon us, and, the inflating, taxing, regulating, and centralized planning programs of the last thirty years must come to an end.
Only reining in the welfare-warfare state will suffice. This eliminates the need for the Fed to monetize the debt that politicians depend on to please their constituents and secure their reelection. We must reject our obsession with policing the world by our endless foreign commitments and entanglements. This would reduce the need for greater expenditures while enhancing our national security. It would also remove pressure on the Federal Reserve to continue a flawed monetary policy of monetizing endless government debt.
But we must also reject the notion that one man, Alan Greenspan, or any other chairman of the Federal Reserve Board, can know what the proper money supply and interest rates ought to be- only the market can determine that. This must happen if we ever expect to avoid continuous and deeper recessions and to get the economy growing in a healthy and sustainable fashion. It also must happen if we want to preserve free-market capitalism and personal liberty.
The longer the delay in establishing a free market and a commodity currency, even with interrupted blips of growth, the more unstable the economy and the moredifficult the task becomes. Instead it will result in what no one wants- more poverty and political turmoil.
There are no other options if we hope to remain a free and prosperous nation. Economic and monetary meddling undermines the principles of a free society. A free society and sound money maximize production and minimize poverty. The responsibility of Congress is clear: avoid the meddling so engrained in our system and assume the responsibility, all but forgotten, to maintain a free society while making the dollar once again as good as gold.
In the words of James Madison in The Federalist Papers:
The extension of the prohibition to bills of credit must give pleasure to every citizen in proportion to his love of justice and his knowledge of the true springs of public prosperity. The loss which America has sustained since the peace, from the pestilent effects of paper money on the necessary confidence between man and man, on the necessary confidence in the public councils, on the industry and morals of the people, and on the character of republican government, constitutes an enormous debt against the States chargeable with this unadvised measure.