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Feature
Fight The Fiat
Papering over U.S. debts and trade imbalances will take more bills than we can print.
(Page 2 of 3)
Let us remind ourselves that after World War I, the reserve
currency system, based on the pound and the dollar, was liquidated
in total panic (1929- 1933) , turning a cyclical recession into the
Great Depression. Today we have relearned the lesson, as expansive
Federal Reserve money creation has combined with the official
reserve currency role of the dollar to cause massive credit,
commodity, and general price inflation worldwide. (The purchasing
power of the 1950 dollar adjusted by the CPI has declined over 90
percent.) But, like Banquo’s ghost, deflation and unemployment
still 
haunt
us, despite the Greenspan-Bernanke era of quantitative easing
(often known as money-printing). That is because as soon as Fed
money-printing slows down, prices tend to fall, with the threat of
deflation and unemployment (2007-2012) coming to preoccupy the
financial authorities. The inflation-deflation cycle is systemic,
caused by perennial budget deficits and unhinged Federal Reserve
stop-go monetary policies.
The scientific method and economic history teach us that under similar conditions, similar causes tend to produce similar effects. The saying makes the point: “History never repeats itself, but it often rhymes.” We know that reserve currency systems have been tested by the market, and that they have failed in the past (e.g., Sterling in 1931; the Bretton Woods dollar in 1971). And the timing of their collapse cannot be accurately predicted. But now is the moment to prepare a program of monetary reform.
How, therefore, may America now lead other nations toward an equitable world trading system based on a balanced monetary order, a disciplined Federal Reserve, balanced budgets, stable exchange rates, and reciprocal free trade inuring to the mutual benefit of all? How do leading nations stage the resumption of a modernized true gold standard, ruling out the escalating debt and leverage engendered by the perversities of floating exchange rates and official reserve currencies?
America at the Crossroads
FOR THE PURPOSE OF true monetary reform, we have an example from the only available laboratory of monetary policy: human history (surely a better source than abstract equations imported from the blackboards of Princeton or the University of Chicago). The empirical data show that the classical gold standard (1879-1914) had its imperfections, but was the least imperfect monetary system of the last two centuries, perhaps even of the past millennium. At the end of the entire period (1879-1914), the general price level was almost exactly where it began. Overall economic growth was the equal of any period since the birth of the Republic.
Given the gravity of world financial disorder, America must take one of two divergent roads. She may persist on the road of soft indulgence afforded by the unstable dollar’s official reserve currency role. It is true that the absolute dominance of the dollar has gradually diminished since World War II, given the rise of Asia and Europe. Still, the world dollar standard could continue for another generation because of the scale and liquidity of the dollarized markets across the globe. Consider the extraordinary fact that almost two-thirds of world trade, not including that of the United States, is still transacted in dollars. About 75 percent of world commodity markets are still settled primarily in dollars. U.S. dollar financial markets are the repositories for as much as 5 to 6 trillion of foreign reserves, not easily invested elsewhere. In the service of unrestrained U. S. politicians, the world reserve currency role of the dollar underwrites the twin budget and balanceof- payments deficits, as well as the exponential increase of United States debt — which must lead, in the absence of monetary reform, to national insolvency. This “exorbitant privilege” — that is, the dollar’s role as the world’s primary reserve currency — does mislead American authorities, policy makers, and academic economists to persist in rationalizing the reserve currency privilege of the dollar as a boon instead of a deadly economic malignancy.
On the other hand, far-seeing American leaders could acknowledge that the dollar’s official reserve currency role is an insupportable burden instead of a privilege. It is a burden because 50 years of supplying official reserves to the world necessarily entails the uncontrolled increase of dollar debt, ultimately financed by Federal Reserve credit expansion, foreign central banks, and the global banking system as a whole. Moreover, dollar deficits, monetized by the Fed and foreign banking authorities, are the fundamental cause of 50 years of global inflation. Let me repeat that the purchasing power of the post-World War II dollar has shriveled to less than a dime. Finally, the steady dissipation of the U.S. international investment position — assets and claims in other countries owned by the United States, minus foreign liabilities — has led to the decline in American international competitiveness.
Recently, as much as 60 percent of the United States budget deficit has been financed by money and credit conjured into existence by the Federal Reserve. But these newly created dollars are not associated with new production of real goods and services. Under such market circumstances, total demand must exceed total supply, expressed by price increases in one sector of the world economy, such as oil and commodities (2003-2011), Internet stocks (1995-2000), or real estate (2004-2007). Fed credit expansion unassociated with the production of new goods and services — that is, the creation of demand without supply — is the hidden inflationary mechanism behind the world dollar disease. However, when the Fed tightens credit abruptly and substantially, as in 2006, the process is reversed with deflationary consequences (2007-2009).
Moreover, some Fed-created excess dollars flood abroad, sustaining the perennial United States balance- of-payments deficit. But the excess dollars going abroad are not inert. They are purchased by foreign central banks against the issue of their newly created domestic money, most prominently today by China in the form of new yuan. Global purchasing power is thereby augmented in this case by new issues of yuan — also unassociated with the production of new goods. The Chinese and other foreign central banks promptly reinvest the accumulated dollar reserves in U. S. Treasuries, financing the U.S. budget deficit; these foreign dollar reserves also finance the U.S. balance- of-payments deficit and the inordinate personal consumption debt of U.S. residents.
Because of the official reserve currency role of the dollar, everything carries on as if there were no United States deficits. There is little compelling incentive for the U.S. government — or its congressional budget masters, or the consumer holding the ubiquitous credit card — to adjust. In a word, the official reserve currency role of the dollar enables America to buy without paying. Worse yet, the necessary adjustment mechanism needed to rebalance world trade has been permanently jammed, immobilized.
If American leaders continue to choose rising debt and deficits financed by the Fed, the reservecurrency dream world in the United States may carry on for many years before its collapse. But collapse is inevitable.
Monetary Reconstruction
THE CHOICE IS OURS. Indeed, this election may be our last chance. If American leaders embrace true monetary reform, they will reject the siren song of the reserve currency’s exorbitant privilege. They will acknowledge the insupportable burden of the dollar’s official reserve currency role. They will Plan now for the termination and windup of the dollar’s reserve currency role. They will plan to restore dollar convertibility, defining the dollar by statute as a certain weight of gold, and then propose gold as the missing and impartial global balance wheel by which to settle residual balance-of-payments deficits among nations and currency areas. A balanced budget amendment to the American Constitution should follow.
Moreover, such a monetary order, based on convertibility of the dollar to gold, free of government manipulation, provides an indispensable rule for the conduct of the Federal Reserve System — bringing to bear rule-based market discipline to stabilize the Fed’s monetary policy. Domestically, the institutional discipline of dollar convertibility would limit the Fed’s unrestrained discretion to print money, finance the government budget deficit, and bail out the cartelized banking system. Under dollar convertibility, if the Fed creates too much money, causing inflation, the people are free to redeem currency for gold at a price set by law. Too great a loss of gold would threaten the solvency of the banks. Thus, the Fed and the banking system would be forced to reduce the growth of money and credit, thereby maintaining convertibility and containing inflation. Conversely, deflationary tendencies could be contained by Federal Reserve credit — made available at market rates on high-quality collateral — without threatening currency convertibility.
To choose true monetary reform and balanced budgets is to embrace not only the American Constitution, but also the nation’s historic financial policy that led to world leadership. Article I, Sections 8 and 10 of the United States Constitution enabled the monetary reconstruction of the American Republic at the founding on the bedrock of a gold dollar. The Constitution mandates that only Congress has the power “to coin money and regulate the value thereof.” The Constitution prohibits the states from making anything but “gold and silver a legal tender.” Shorn of the crushing weight of trade disadvantages caused by inflation and the accumulating debt and deficits — originating in budgetary excess and the reserve currency role of the dollar — America could again become Prometheus unbound.
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