Fight The Fiat

Papering over U.S. debts and trade imbalances will take more bills than we can print.

By From the July - Aug 2012 issue

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.

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?


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About the Author

Lewis E. Lehrman is a senior partner at L. E. Lehrman & Co. and chairman of the Lehrman Institute.