U.S. must restore faith in monetary system
Money is the root of all evil. But, according to Niall Ferguson in “The Ascent of Money,” it’s also the “root of most progress.” Woolgatherers from Rousseau to Marx have dreamed of a society that operated without money. Yet, money and its offspring — credit and debt — have been “as important as any technological innovation in the rise of civilization,” writes Ferguson.
Money in some form has been around since the beginning of time. Shells, beads, stone discs, cattle, gold and silver have performed its roles. But money got really interesting when someone figured out that paper backed by gold could serve as a medium of exchange. A unit of gold held in reserve could be multiplied by issuing units of paper money. It was a kind of magic, which dramatically stimulated economic activity and increased wealth. As long as people had faith that they could redeem their paper for gold, the magic worked.
At some point, however, the magicians created too much money. Excess liquidity drove prices up. Fear overcame euphoria. One day the gong of doom sounded and everyone wanted to exchange paper money for gold. But there wasn’t enough gold in the vaults to cover all the paper money afloat. A moment of epiphany arrived: The paper was worthless. The bubble burst. The financial system collapsed.
We’re living in a modern version of this eternally recurring tale. There are many competing explanations for the current economic meltdown. The web of mistakes and culprits was complex. But the ultimate cause was expansive monetary policy. Low interest rates and excess money supply inflated the bubble, driving up the price of real estate and oil, tempting investors to take outrageous risks and stoking the deadly sin, Greed. This should have been no surprise. Loose monetary policy makes booms and busts inevitable. Now, the government’s colossal bailout and stimulus schemes promise to inflate another bubble — while we’re still recovering from the last.
“Money is a matter of belief, even faith,” writes Ferguson. The word “credit” comes from the Latin “credo,” belief. But faith in money is being tested today. One problem is that money is no longer backed by gold or any other commodity. The dollar is a “fiat currency,” backed by nothing other than the nation’s credit. Too much borrowing and spending has made that credit look shaky. There’s even been talk of the United States losing its AAA credit rating.
For a long time, the dollar has been the world’s “reserve currency,” an immense advantage in the global market place. Like the British before us, we’ve abused that advantage. The day of reckoning may be at hand. Those who’ve funded our deficit spending and profligate consumption are getting nervous.
The Chinese fear that we may “monetize” our debt — that is, devalue the dollar so that we can repay them with cheaper money. China has recently expressed interest in some alternative international reserve currency. Loss of the dollar’s unique status “would have serious costs for America,” writes economist Nouriel Roubini. “Our ability to finance our budget and trade deficits cheaply would disappear.” The decline of the dollar might take more than a decade, “but it could happen even sooner if we do not get our financial house in order.”
What would it take to get our financial house in order? The United States must “rein in spending and borrowing, and pursue growth that is not based on asset and credit bubbles,” writes Roubini. By the same token, individual Americans must spend less and save more. Everyone would have to swallow bitter medicine and suffer some deprivation.
Entitlements would have to be cut. Restoring faith in the dollar would require more disciplined monetary policy. Failure to get our financial house in order means higher taxes and higher interest rates, more costly imports, less economic growth, a lower standard of living, fewer resources to fund our social and environmental agendas and a decline in the value of our savings.
Does anyone believe that our gerrymandered, earmark-addicted politicians have the moral courage and sense of responsibility to get our financial house in order? Even the president of the Dallas Federal Reserve is skeptical.
“Throughout history … the political class has … turned to the central bank to print their way out of an unfunded liability,” said Richard Fisher. He estimates the government’s unfunded obligations for retirement and health care at more than $99 trillion.
Other experts are gruffer yet.
“Quite frankly, we do not trust the government,” said fund manager Bob Rodriguez. “We will not lend long-term money to a borrower that capriciously erodes its balance sheet.” Monetary expert and Stanford professor John Taylor calls our government, “the most serious source of financial risk today.” Lenin is supposed to have predicted the death of capitalism on the basis of policies unfolding today: “There is no subtler, surer means of overturning the existing basis of society that to debauch the currency. By a continuing process of inflation, government can confiscate an important part of the wealth of its citizens.”
Roubini calls our current debacle “the biggest asset and credit bubble in human history. But our predicament is nothing new. In A.D. 64, the emperor Nero decreased the silver content in Roman coins and made them smaller. Two centuries later, there was virtually no silver in the coins and wheat was two hundred times more expensive.
In the early 20th century, German printing of paper money resulted in an annual inflation rate of 182 billion percent. Since 1957, the purchasing power of the dollar (relative to the consumer price index) has declined by 87 percent.
What to do? An area banker recently answered that question: “I pray.”