In my previous essay I explained how over time the US abused its
responsibility to control the supply of dollars, the world's premier reserve
currency for settling international trade accounts among nations. This
abrogation of its duties is leading to the likely adoption of a new reserve
currency, commodity based and controlled not by one nation but by members, all
watchful that the currency is not inflated.
Let us continue the analogy of an individual receiving a "magic
checkbook" which allows him to write as many checks for as much money as
he desires. Receivers of these checks could only pass them along to others
through the normal course of trade. Over time the owner of the magic checkbook
becomes increasingly irresponsible. He funds all kinds of welfare and warfare
initiatives. Naturally dollar reserves build to levels completely unnecessary
for peaceful exchange. Prices start to rise at a faster and faster rate. Then a
reform consortium assembles a team to offer an alternative currency. Why, one
may ask, is that such a problem for the dollar and dollar users?
A
Lesson in Supply and Demand from the Weimar Republic
A successful alternative reserve currency would dilute demand to hold
dollars. When demand for dollars drops, its price must drop unless and until
its supply drops. (A drop in the dollar's "price" is just another way
of stating that its purchasing power falls; i.e., more dollars are required to
buy the same goods and services.) Through irresponsible use of the magic
checkbook you have obligated yourself to funding a free-for-all of entitlements;
i.e., Social Security, Medicare, and the military-industrial complex being the
largest by far. Politically, it may be almost impossible to cut any of these
three categories of spending to the extent necessary to arrest the dollar's
drop in purchasing power.
The world has seen all this before, and not just in less developed
nations like Zimbabwe. The US will find itself in the same trap as experienced
by Germany's Weimar Republic following World War I. The Reichsbank, Germany's
central bank, printed papiermarks in order to placate powerful constituencies
within Germany. As the Reichsbank printed more money, the purchasing power of
papiermarks dropped. And herein lay the trap. Rising prices led powerful
constituencies to demand increases in pay and benefits. Industrial labor
unions, government civil servants, welfare recipients, old age pensioners whose
life savings were being decimated--all demanded more money. Strikes and violence
became endemic. So the Reichsbank printed more money...which, of course, simply
led to higher prices and another round of payment increases...which led to even
higher prices, etc., etc. until the papiermark became worth more as wallpaper
than money.
Why did the Weimar Republic government continue to increase payments,
and why did the Reichsbank continue to print papiermarks? Many sophisticated
answers have been advanced, such as that the government and the Reichsbank
deliberately destroyed the papiermark in some kind of roundabout plot to thwart
the financial terms of the Versailles Treaty in which a defeated Germany was
ordered to pay reparations to the Allied powers. But the simplest answer is
that both believed that there was no other choice than to increase payments and
print money in a crisis. It was felt that powerful constituencies must be
placated in the short run. But short run tactics just made things worse. There
was neither the political will nor the economic understanding of the need to
end excessive spending and currency debasement and endure the pain thereby
induced.
The
Lack of Both Political Will and Economic Understanding in the US and the UK
I fear that the same is true today. In fact the seeming lack of adverse
consequences (all in the long term) and advantages of money printing in the
short term have led to a knee-jerk response by the US Treasury and the Federal
Reserve Bank to increase the money supply and lower interest rates in the face
of any economic problem, even higher prices themselves. As a example, just look
to Britain. Its energy shortages have caused prices to rise. The government's
response has been to pledge payouts to households! That's right. No pledge to
dismantle barriers to increased energy production...just a pledge to increase
the government's deficit, which requires more money printing! As the saying
goes, you can't make this stuff up.
One thing is certain though. What Britain can do, the US can and will
do in spades. Hyperinflation is a real possibility. Remember, the Reichsbank in
Weimar Republic Germany actually had to print physical money. The US Federal
Reserve Bank need only click a few buttons on a computer. As prices rise,
powerful groups demand more money. Police, firemen, road workers, etc. demand
that they not suffer a lowering of their lifestyle. Since government is spending
someone else's money, it accedes to these demands.
Back to our British example. The exchange value of the pound has been
plummeting in currency markets, leading to serious consequences. The Bank of
England was forced to raise interest rates and now government debt has become
unaffordable. So the Bank, as handmaiden to the government, has applied the
only politically permissible remedy that it knows: its computers' money-printer
is forced into overdrive, just to keep up.
What
Happens on the Ground
Where in reality does government get its money? State and local
governments get money from state and local taxes. So captive property owners
get increased tax bills to pay for maintaining public school teachers, police,
etc. Social Security recipients must be compensated, of course, so payroll
taxes are increased, which depresses business. American products become less
competitive on the national and world market. The price spirals continue to
destroy all in their path until the dollar loses all purchasing power and
society descends into chaos. And not one politician in a thousand understands
what happened or, if he did understand, did not have to political will to do
anything about it; i.e., reduce public spending, liquidate the Fed, and tie the
dollar to our still significant gold reserves. It can be done.
Posts
