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Feature
Fight The Fiat
Papering over U.S. debts and trade imbalances will take more bills than we can print.
The Consequences of Disorder
The Economic Crisis We Endure Today is only the latest chapter in the century-long struggle to restore financial order in world markets — a struggle whose outcome is inextricably bound up with U.S. prosperity and the promise of the American way of life.
As we think through the consequences of financial disorder, what come to mind are the economic heresies of fascism and bolshevism, and the catastrophic world wars of the 20th century. These historical episodes compel us to remember that floating exchange rates and competitive currency wars became the occasion for violent social disorder and revolutionary civil strife in the first half of the 20th century. They remind us that natural resource rivalry, monetary depreciation, mercantilism, and war clouds have appeared together from time immemorial.
The monetary disorder and national currency wars of that era are now being repeated in our own time, and have again led to social disorder and pervasive civil strife. I cite only one example among legions. The recent “Arab spring,” a revolutionary upheaval of the suppressed Islamic poor and middle class, was triggered by a vast food and fuel inflation, transmitted to the dollarized world commodity markets by hyper-expansive Federal Reserve monetary policy during 2008-2011. Huge price increases for basic necessities penetrated into the heart of all subsistence economies — in this case, North Africa. Because the dollar is the official reserve currency of the world trading system, when the Fed creates excess credit to bail out the banks and the U.S. government deficit, it exports some of the excess liquidity abroad, igniting basic commodity inflation and the social strife this engenders. At home, the same rising prices of food, fuel, and other basic needs impoverish those on fixed incomes. Moreover, they lower the standard of living for the middle class, held back by wages and salaries that always lag rising prices.
Even more ominous, the surge of contemporary mercantilism and competitive currency depreciations — initiated by monetary authorities worldwide — brings to mind the national rivalries among the Great Powers between World War I and World War II. Amidst financial disorder, floating exchange rates, and beggar-thy-neighbor policies during the interwar period of 1918-1940, civilization witnessed the rise of imperial Japan, Mussolini, and Hitler. But the 1920s had begun with great hope, including overwhelming confidence in the primacy of central banking, led by Benjamin Strong of the Federal Reserve System and Montague Norman of the Bank of England. The unrestrained boom of the 1920s, rising on a flood tide of central bank credit — based on the reserve currency role of the dollar and the pound — led to the brief illusion of permanent prosperity. That “new era” ended in austerity, currency chaos, autarky, depression, and world war.
Thus, it becomes in creasing ly urgent, if we might learn from the past, to restore international monetary order now, with reforms to re-establish a stable dollar and stable exchange rates. The United States is still able to set the example for the world to emulate. Indeed, the major powers publicly endorse international monetary reform. All seem to sense that only with stable exchange rates can the world trading community rebuild global incentives for equitable, balanced, and growing world trade-and, with these incentives, create the conditions for global growth and rising standards of living.
NOW COMES THE PERENNIAL QUESTION: How, precisely, does the United States once again establish a stable dollar? How do the United States and other countries get from “here” to “there” — that is, from the anarchy of floating-paper currencies to stable exchange rates based on an impartial, nonnational monetary standard? These questions have been debated at crucial junctures over the last century: before and after the creation of the Federal Reserve System in 1913; after the catastrophe of World War I; after Franklin Roosevelt in 1933 expropriated and nationalized all American citizens’ gold holdings; after Richard Nixon severed the last weak link between the dollar and its gold backing in 1971.
Recently, the same debate intensified after the Great Recession of 2007-2009, marked as it was by wild exchange-rate and currency instability. But it was the vast, inequitable financial subsidies — provided by the Federal Reserve system and the United States Treasury to an irresponsible, often insolvent, and cartelized world banking system — that sparked national outrage. In free markets, with responsible agents, insolvency should entail bankruptcy. Those who earn the profits in a free market must themselves endure the losses. Without the discipline of bankruptcy, crony capitalism must result — with the taxpayer providing the subsidies.
What lessons might we learn from American financial history? Consider the fact that from 1792 until 1971, the dollar was defined in law as a weight unit of gold (and/or silver). The last vestige of convertibility of the dollar into gold was abolished by President Nixon’s executive order on August 15, 1971. Since then, the dollar has depreciated dramatically, to the point that it is now worth a mere 15 pennies, adjusted by the CPI. After generations of manipulated paper- or credit-based floating currencies — which ignite the currency wars of our own era — it has become increasingly clear that free trade without stable exchange rates is a fantasy.
It is true that the post-World War II dollarized Bretton Woods system, inaugurated in 1944, gave rise to a new era of free trade; but it was free trade maintained and subsidized by the especially open market of the United States. After World War II, the United States controlled 50 percent of world output. Thus, the U.S. dollar became the sole acceptable reserve currency with which to conduct international trade — displacing gold by international agreement at Bretton Woods. The Bretton Woods system caused the dollar to become substantially overvalued as a result of worldwide excess dollar demand for transactions and foreign official reserve holdings. The overvaluation of the dollar was intensified by post-World War II currency depreciations and inflationary fiscal and monetary policies of other major countries.
The European currencies were finally stabilized and made convertible on current account in 1959 through the monetary reform of the European Payments Union. But the dollar remained overvalued as the sole official reserve currency of the Bretton Woods monetary regime (of 1944-1971). Overvaluation of the dollar was compounded by excessive Federal Reserve money expansion within the pegged currency system of Bretton Woods, thus systematically raising the cost and price level in America relative to other major countries. This happens because the Federal Reserve creates money to purchase Treasury debt securities, a process which finances the U.S. budget deficit. But the newly created money On behalf of Treasury spending is not associated with the production of new goods. Thus total demand exceeds total supply at prevailing prices. Prices rise (inflation), followed by rising costs. American goods thereby become increasingly uncompetitive in world markets. After the collapse of the dollar-based Bretton Woods system, floating-pegged exchange rates ensued (1973-2012).
Compared to the U.S., both developed and developing countries to this very day have aggressively protected their markets with undervalued currencies, quotas, high tariffs, and discriminatory regulations — China most egregiously in recent years, Japan earlier. This arrangement has characterized the world trading system not only under Bretton Woods but also amidst the floating-pegged currency arrangements of today. Successive American administrations, all committed to free trade, have made the U. S. open market an easy target for mercantilist nations worldwide. The good intentions of American free traders have never been fully reciprocated. As a result, developing countries have mobilized undervalued currencies with which to build growing export machines, and without giving commensurate trade reciprocity to the United States — the General Agreement on Tariffs and Trade (GATT) and World Trade Organization (WTO) notwithstanding.
The World Dollar Standard
THE DOLLAR’S ROLE AS an official reserve currency has enormously impacted the United States economy. Net U.S. investment abroad is the value of assets and claims held by U.S. residents and their government abroad, minus the assets and claims foreigners and their governments own in the U.S. In 1980, net United States international investment was 10 percent of GDP. In 2010, it was negative 20 percent of GDP. The empirical data show that the entire shift from positive to negative is accounted for by the official, accumulated, United States balance-of-payments deficit.
In a nutshell, since World War II, free trade has often been at the expense of United States business, manufacturing, and labor. The problem of dollar overvaluation was compounded not only by its reserve currency role, but also by the perennial United States budget deficit, increasingly financed by Federal Reserve money and credit creation. But the U.S. budget deficit is financed not only by the Federal Reserve and the banking system, but also by foreign government purchases of U.S. Treasury debt, which is held as official national reserves. China and Japan, two major beneficiaries of U.S. trade and budget deficits, hold official reserves equal to approximately $2 trillion of U. S. government related debt. The authorities, mesmerized by neo-Keynesian mythology, do not understand that the exponentially growing U.S. budget deficits absorb a huge fraction of domestic production, which would otherwise be available for export sales to the global market. Proceeds from these exports, growing faster than payments for imports, could then be used to settle U.S. balance of payments deficits, thereby reducing U.S. debt.
About the Author
Lewis E. Lehrman is a senior partner at L. E. Lehrman & Co. and chairman of the Lehrman Institute.
Letter to the Editor View all comments (36) | Leave a comment
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aware| 8.10.12 @ 6:30AM
As long as we have a choice of continuing the can kicking or taking our medicine, the can kicking will continue. There will be no monetary reform this election.
To do the right thing now would involve much pain, while doing nothing means even more pain in the future. But the future, even if it's next week, is not now. This means in the minds of men there is a chance of avoiding pain. So there will be no doing the right thing until no choice is possible.
I seriously doubt either of the candidates even knows how money is "created" in a fractional reserve system.
Dodd2| 8.10.12 @ 7:28AM
I could not agree more with what Aware said.
TLP| 8.10.12 @ 8:16AM
He's absolutely right.
It'll never happen.
But, that is what needs to be done.
It's time Government started Playing by the Same Rules, as we have to, when it comes to Balancing our Financing.
Unfortunately, we're dealing with a Political Party that hasn't Passed a Budget, in 4 Years.
Tell me, again, why anyone with his head NOT up his Ass, would vote for Democrats.
But, we're supposed to believe No Budget Harry Ried, when he says he gets a phone call from some No Named Ex Employee at Romney's Ex Company?
Tell me, again, why anyone with his head NOT up his Ass, would vote for Democrats.
Bob Grant| 8.10.12 @ 9:46AM
TLP,
New fox poll: Obama 49 Romney 40
Apparently, more a more people are choosing their ass as home for their heads.
MK48| 8.10.12 @ 10:28AM
As Iv'e said polls are overrated......they lie just like "the one".
JD| 8.10.12 @ 1:38PM
I believe this poll. The Liar in Chief's lies are working. The public is focused on this Romney-is-the-devil image Obama has been crafting. The issues are long-forgotten.
TLP| 8.10.12 @ 4:51PM
If this is true, and enough of the people are as Stupid as The TV GUIDE says they are?
We will get the Government we deserve.
I'm still of the thought that GOD will not let this happen.
We'll see.
Von Mises Jr| 8.10.12 @ 8:08AM
I have seen Lewis Lehrman on Kudlow many times and he would be a great pick for Federal Reserve Chairman or Treasury Secretary along with John Taylor in a Romney Administration.
I would not even attempt to critique his analysis since I believe his general statements and conclusions are exactly true, and his detail is way beyond my pay grade.
I would simply point out that the United States government has not been innocent and exploited over the last century as he suggests. Especially since FDR, our government has engaged in etatist (intervention or socialism) in farming, manufacturing and other industries both with subsidies and tax policy. Moreover, they have done the same in jumping in bed with crony capitalist creating de facto monopolies that stifle economic growth and lead to war socialism.
It has been conducted by both parties and this central planning protecting their favored son in business always and everywhere leads to poverty, misery and war. Per Mises, this is what led to both World Wars: inefficient central planning and protectionism that necessarily follows.
Romney and Lehrman are men that could turn this ship around. Pray for their ascendency in November.
Jacob McCandles| 8.10.12 @ 10:27AM
I'm far from an economist, but it seems to me:
1. Our leaders are doing everything they can to cause inflation
2. The stock market loves it.
3. Our media is largely ignoring or in denial about it.
Mike G| 8.10.12 @ 11:03AM
I think the media is ignoring it because they don't understand it. There is no way for them to explain something they don't understand.
Von Mises Jr| 8.10.12 @ 11:32AM
All they need to know is it redistributes wealth.
By creating many more dollars, the real value (purchasing power) of the dollar plummets. Mr. Lehrman mentions this a couple times in his article that the value of the dollar since the creation of the Fed is pennies on the dollar.
So seniors are especially hurt by this as prices soar and their Social Security and interest payments lag way behind.
It is also a way to repudiate national debt owed to foreigners and seniors since inflation shifts real gains away from debtors and to creditors. If you borrow and then pay back in cheaper dollars, the person who loaned you the money gets hosed.
Hyper-inflation also leads to financial collapse. So the revolutionaries love it since it will destroy our Republic and give them the opportunity to usher in socialism in the chaos.
That is all “Pooper Scooper” Anderson or Wolfie Blitzed need to know.
Mike G| 8.10.12 @ 11:41AM
Agreed, but what you've said here is more than a sound bite, i.e., too much for them to comprehend and explain.
Pecos Pete| 8.10.12 @ 8:53AM
Lehrman would be an excellent choice for Treasury Secretary.
JimH| 8.10.12 @ 9:28AM
Of course the one GOP candidate who might actually have supported this position and done something about it in office has been regularly derided as at best, some sort of crazy uncle by many on this site.
Bob Grant| 8.10.12 @ 9:42AM
Jim,
The problem is Ron Paul is no leader. A great congressman but possesses zero leadership skills.
He would, however, make a great fed chairman under president Romney.
MK48| 8.10.12 @ 10:29AM
The jew hater..................RP ?
Kwan| 8.10.12 @ 9:58AM
Financial sanity will be absent from the United States until the electorate throws the Democrat-Communist bums out of office. Otherwise we remain on the road to national bankruptcy. The country cannot afford to finance an ever expanding underclass with trillion dollar deficits forever and ever just so Obama and the Democrats can have a guaranteed voting block in their back-pocket.
ElGordo| 8.10.12 @ 11:01AM
ROMNEY'S POLICY WILL BRING US PROSPERITY & STABILIZE THE DOLLAR
Romney would utilize our new energy resources, eliminate our dependence on mideast oil & bring an era of prosperity to the U.S. Even with onerous federal government rules, look at how prosperous No. Dakota has become with drilling for natural gas .
.
We are on the verge of an American energy opportunity that will liberate us from relying on the Middle East, create millions of new jobs in the United States, improve our balance of payments (strengthening the dollar) & lower the cost of energy for consumers & for businesses.
.
Further, as a leader in energy production, the U.S. could affect the world price of oil and indirectly control the international actions of Venezuala, Russia, Iran, Iraq, and other nations heavily dependent on income from oil.
Through tv ads & speeches, Romney should show the difference between a vibrant Romney economy based on our new energy resources versus the regressive economy of Obama under green energy.
Kingofthenet| 8.10.12 @ 11:18AM
Quick! Sell everything, buy Gold Bars and sleep on a park bench!
JD| 8.10.12 @ 1:39PM
Thank you for representing liberalism so well.
TLP| 8.10.12 @ 4:53PM
He's not Kingofthenuts for nothing.
Bob Grant| 8.10.12 @ 6:04PM
Empty, meaningless snark.
Who Knows?| 8.10.12 @ 11:21AM
Thanks for the wonderful history lesson, and dream of a future that SANE leaders would choose.
However, ask Uncle Miltie---is “Free To Choose”, the book, the blueprint for what HAS HAPPENED since it came out. No.
If there’s only one thing I’ve learned, after half a century as an adult who’s been increasingly aware of economics and politics, it’s that sanity is the one word NOT applicable to our top dogs. Why, it was just “yesterday”, 1967 or 68, that LBJ made guns & butter a famous phrase, as he spent wildly on his Great Society AND the Vietnam War.
In retrospect, that was just a template for further priming of the inflationary pump, so that today we have Obama literally going for broke by spending like there’s no tomorrow---and, for him and the USA the tipping point “tomorrow” gets closer and closer.
Hubris brings nemesis. Period.
In essence, those in charge of the dollar printing press only THINK they’re smarter than you or me, AND the market--- fooled by their mastery of econometrics and other high level “scientific” economics: PhD’s, piled higher and deeper.
Sanity is to work, save 10% or more, and invest this real wealth in real---physical---things, that have proven to hold value and even grow, over time. Got sanity?
There was the tulip mania, and now it’s the dollar mania.
“Mania”?
Maniacs!
Who Knows?| 8.10.12 @ 11:36AM
Furthermore, we might rehabilitate another hoary economic term---soft landing.
Lehrman, in my reading of this great article, recognizes that it’s too late for such a future to happen. He is saying, IMHO, it’s either gold or not.
And, as a longtime gold bug myself, who revels in either-or simplicity, this is THE monetary true or false moment. It’s fiat currencies or not!
“Fiat”—let it be!
You see, Bernanke and his types over time are playing God, trying to mimic the “Let there be light” biblical creation myth, when it comes to money. However, THEY can’t create gold----it just IS!
They are gold diggers, in the fooling-you sense! Carnival con men, moving the pea around, tricking the rubes.
Remember “momentum trading”, at the peak of the dotcom bubble? Why, I do! Those who were making money hand over fist, as the price of stocks of companies who had yet to even make a profit, doubled, and doubled, again, said you’d be stupid to fight the trend.
The end of the dollar trend won’t be your friend---buy gold!
TLP| 8.10.12 @ 4:55PM
Can I buy some Meth from you?
Who Knows?| 8.10.12 @ 7:48PM
Poor TLP.
Johnny one note.
axbucxdu| 8.10.12 @ 12:46PM
The old gold standard was just another form of government fiat. While it imposed more discipline on fiscal policy, whenever the going got tough, the USG pulled the plug on it, either through confiscation by FDR, or by stealth with Nixon closing the gold window.
Privatise the damn note issue, let those notes compete freely against the FRN, and then we'll see how many prog pipe dreams can pay for themselves.
JD| 8.10.12 @ 1:32PM
Inflation is redistribution. That's all you need to know. That's why Democrats love it. That's why they love their monetary system.
That, and the fact that they've trained the public and their media to believe that any problem caused by "complicated financial mumbo jumbo" must be Republicans' fault!
Drunken Sailor| 8.10.12 @ 3:09PM
Interesting how the trolls avoid this subject but are all over the other ones today. Nothing like cold, hard, facts to make them run away I guess.
Rhoetus| 8.11.12 @ 11:50PM
Henry Hazlitt warn us about the Bretton Woods agreement when it was adopted. Both the Republican and Democrat parties have run from the truth preferring to kick the can down the road in order to stay "politically viable". Now we have a world drowning in toxic debt.
BackToBasics| 8.12.12 @ 12:14AM
from the article - "In a word, the official reserve currency role of the dollar enables America to buy without paying."
Ironic how what seems like a strength, dollar-reserve currency, is sowing the seeds of a future fall.
Lehrman makes sense with the arguments he gives for establishing a gold standard. Others disagree and think the current system of fiat-money is the most advantageous for worldwide wealth-creation.
But if the current fiat-money system crashes what will it be replaced with; a gold standard, worldwide debt forgiveness, steep decline and another 500 years of the dark ages? It just seems like the current system is destined to fail. Smart and more traditional economic thinkers, like Lehrman, may have some answers to consider.
JamesDrouin| 8.12.12 @ 11:00AM
A scholarly article that fails to address THE fundamental problem of US debt:
Unrestrained spending by political class.
Basing the dollar on gold, or silver, or pork bellies for that matter, won't change those spending patterns.
Rhoetus| 8.12.12 @ 9:07PM
Leaving the gold standard enabled the congress to spend freely with the Fed as their conspirator expanding the currency without limits.
Rex| 8.13.12 @ 9:39AM
Romney and Ryan are fiat money politicians.
Why would they "take the hit" on change?
LOL
Rex| 8.13.12 @ 9:51AM
You can take these nuggets to the bank:
(1)The election will bring no changes in monetary policy
(2)Furthermore,there will be no change until economic conditions give us no choice.
(3)LL is a brilliant guy,but he has absolutely no influence.
Rex| 8.13.12 @ 12:25PM
21 individuals respond to a major article by Professor L,what a joke.
I have been trying to discuss these issues since Nixon ordered us to be paper trained,no one cares.
LOL