Politics Vs. Reality In Monetary Reform
October 1, 2015
(This item originally appeared at Forbes.com on October 1, 2015.)
http://www.forbes.com/sites/nathanlewis/2015/10/01/politics-vs-reality-in-monetary-reform/
Politics is like the weather. Every day something new. Economic principles, however, are more like the mountains. They don’t change much, even though they might be momentarily clouded by the weather.
I am an advocate of gold-based money. “Gold-based” means, specifically, a currency whose value is linked to gold. One way to do this is to literally make coins out of gold and silver, and that was common in the sixteenth century. However, since 1850 or so it has mostly meant banknotes with a value linked to gold, and other subsidiary instruments like bank deposit accounts. In U.S. history, the dollar was linked to gold at a ratio of 20.67 dollars per ounce of gold, from 1834 to 1933. It was just like any other fixed-value system, such as the one that links the Danish krone to the euro at a rate of 7.46038 krone per euro today.
The United States, and most every other developed country within the Bretton Woods arrangement, had gold-based money up until 1971. The countries whose currencies were most reliably gold-based — in other words, were not devalued and did not float — tended to be very successful economically, and also became world financial centers. This was true of the United States until 1971; Britain before a series of devaluations beginning in 1914; the Dutch between 1600 and 1800, and so on back about as far as you want to go, even to Babylon and Sumer around 2500 B.C.
Nevertheless, despite this multi-century global track record of success, for some reason people think this is a bad idea, and that the floating currency arrangement that appeared by accident in 1971 is a good idea. Even a brief look at the data shows that this has no support whatsoever. According to the U.S. government’s own laughably lipstick-applied statistics, the median full-time male income (chosen because it eliminates issues relating to increasing paid work by women, household size and other factors) is less today than it was in 1972, over forty years ago. This is probably the first time that income has fallen over a forty-year period in U.S. history.
Before 1971, incomes had a roughly 2%-per-year growth trend going back a century to 1870. Over forty years, this would have meant an increase in income of 121%. Getting paid double. Not a decline.
During our forty-plus-year experiment in floating currencies since 1971, we’ve had a decade of punishing inflation (1970s), a constant patter of currency blowups (Latin America in the 1980s, Mexico 1995, Asia, Brazil and Russia in 1997-98), and a string of asset bubbles (continuously since about 1998) followed inevitably by asset-bubble-busts. Alongside these more dramatic events, we’ve had a constant grind of debilitating monetary chaos, plus an economy that hasn’t been very healthy since about 2000.
Hardly anyone would disagree with this assessment, and yet people think I am silly and the floating currency people are smart. Obviously, this has nothing to do with economic reality. It is a matter of politics.
Whenever you have an environment of monetary instability, the overall economy suffers but some entities benefit. In an environment of rampant devaluation, for example, exporters of manufactured goods can often do well because they can take advantage of the collapse in worker’s salaries that accompanies a collapse in currency value. Domestic industries, however, dry up and blow away because the impoverished workers don’t have any money to spend on anything but bare necessities.
Thus, over time, the exporters become relatively wealthy and the domestic industries become poor or disappear altogether. With wealth comes influence, and the exporters are thus able to promote all kinds of arguments that what the country really needs is more devaluation, to keep afloat the export industries which, by that point, are the only healthy part of the economy.
Between 1990 and 2000, the value of the Russian ruble fell from about 4/dollar on the black market to about 25,000/dollar. (They eliminated three embarrassing zeros along the way.) And yet in 2001, after the ruble has enjoyed a bit of stability, many Russian exporters (and the academic economists in their thrall) complained that what they really needed was: more devaluation! Their business model depended on it.
I hope I don’t have to convince you that hyperinflation is a bad idea. That’s an economic principle. But the politics of the situation were that: Russia really, really needed more currency devaluation – according to some influential people. Even after they just had a lost decade of disastrous hyperinflation, this was still taken seriously.
The situation today is a little different. We haven’t had hyperinflation, but today’s floating currency environment tends to favor financial/speculative sectors and disfavor industrial production and domestic services. This is no surprise. Andrew Carnegie warned that such a thing would happen back in the 1890s, when there was a discussion about devaluing the dollar. Indeed, it was even noted in the De Moneta by Nicholas Oresme, written around 1375 A.D. – the first tract on monetary topics in the Western world.
Today, it’s not the exporters that are favored by monetary conditions, as it was in Germany in 1922 or Russia in 1994. It’s the financial sector, which is supposed to be a minor intermediary between saving and corporate investment, but has morphed into a giant parasite.
A lot of arrangements that date from the postwar period – Social Security, healthcare, pensions, the university, owning a 2500 square-foot suburban house with two cars – are in the process of falling apart. They were appropriate for the world of fifty years ago, but not for today. However, people today have a sort of death-grip on this sinking ship, because they don’t see an alternative. They want to get their Social Security payments, make the payments on their mortgages, car loans and student debt, and retire on their 401(k) plans stuffed full of junk-bond ETFs or their woefully-underfunded defined-benefit pension programs. They certainly don’t want government defaults and bank bail-ins.
As one asset bubble after another turns to bust, and sovereign governments everywhere creep closer to the brink of default, people see that central banks have had something to do with keeping this sinking ship afloat a little longer than would have otherwise been the case. True, the ship is sinking in the first place in part because of this funny-money environment, and the asset bubbles and stagnant incomes it has engendered. If people had stuck to the economic principles (including gold-based money) that made America great over two centuries, we might be sailing happily into a prosperous future.
And, if the “ship had sunk” on all these decrepit postwar arrangements, let’s say around 2012, accompanied by sovereign defaults and bank restructurings, we might be well on our way to creating new arrangements that are much more appropriate for today – to everyone’s benefit.
But that is a little too abstract. Just kick the can a little longer, please.
Obviously, this is short-term expediency for personal benefit — perhaps the single most common element of human affairs. But, most people have a hard time telling lies, so it is much easier for them to embrace the self-delusion that they are expressing great principles.
The result of all this is that, today, we have the European Central Bank “printing money” (expanding the monetary base) at a rate of about 60 billion euros per month (7.1% of GDP per year), while people are braying for more. The Bank of Japan has been expanding at a rate of 80 trillion yen per year (16.3% of GDP). Now the Federal Reserve, having declined a widely-expected rate hike in September, and after keeping the Fed funds rate target at essentially zero percent for nearly seven years, might be on its own path to a fourth round of “quantitative easing.”
Now, let me explain this: the Bank of Japan is now purchasing Japanese government bonds at a rate of 16.3% of GDP per year. Which is a good thing, because the Ministry of Finance has to sell 170 trillion (34.6% of GDP) in bonds this year, to finance rollovers and new deficit spending, without letting prices fall and yields rise. Other governments are doing much the same thing, or did, or are getting ready to do it again. Monkey-see-monkey-do has always been the first principle of government.
You can buy a heck of a lot of can-kicking for this kind of money. And, since the beginning of 2013 or so, there doesn’t seem to have been a lot of consequences. Measures of inflation are actually lower than many would like. So do more of it! That is the politics.
However, I don’t think this money-for-nothing environment is going to last too long. It has already lasted a lot longer than it should, in my opinion.
I could be wrong. Maybe the printing press really is the ultimate path to economic salvation and worldwide commercial dominance. Funny how no other government discovered this previously.
Eventually, the weather will change. I think that the old principles of economic management – like Stable Money linked to gold – will become a lot more popular. Maybe, popular enough to put into practice. This would probably be a little while after people lose hope that all of today’s unsustainable things can be sustained just long enough for it to be someone else’s problem.
