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Can gold survive Jessica Cross AND gangsta rappers?
By Hans Sennholz
DailyReckoning.com
Tuesday, January 11, 2005
If the love of money is the root of all evil, the depreciation of
money must be the mainspring of all shams and frauds. It works
silently and covertly, impoverishes many while it enriches a few,
and thereby inflicts great harm on social cooperation and
international relations.
A few economists are sounding the alarm about the decline of the
U.S. dollar. In recent months, it fell visibly toward the euro and
Japanese yen and is likely to fall even lower. But most Americans
refuse to be alarmed, as they are unaware of exchange rates and
foreign exchange markets. Why should they be troubled about the
financial affairs of money traders and dealers?
We may not be able to see the future, but always can learn from the
past. Looking at the recent history of the dollar, this economist
perceives distinct stages with various characteristics, causes, and
consequences. One stage was from the end of World War II to 1971,
when the U.S. dollar was tied to a small anchor of gold. President
Nixon cut its ties and embarked on a wholly new road of fiat dollar
management. Many other countries readily accepted the new system
acclaiming its flexibility and manageability. At this time, the
world is still traveling this road, but several countries are making
preparations for leaving it and proceeding toward a multiple
standard system. It is not clear whether they will depart in an
orderly fashion or in crisis and contention.
Throughout the decades, some economists were always worried about
the magnitude of the trade deficits and the vulnerability of the
American dollar. But their fears proved to be unfounded because they
underestimated the worldwide demand for dollars and the willingness
of foreign investors and central bankers to trust and hold U.S.
dollars. After all, until recently, the deficits never exceeded
three percent of GDP and Americans still were net creditors in their
foreign accounts. By now, the dollar standard has reached a stage in
which not only a few economists, but also some foreign creditors are
beginning to question its future. The federal government is swimming
in an ocean of debt. In its first term, the Bush administration
increased the federal debt by $2.2 trillion. Congress raised the
Treasury debt ceiling three times, by $450 billion in 2002, by $984
billion in 2003, and by another $800 billion on November 19, 2004,
to $8 trillion 184 billion. The ready willingness of Congress to
finance such deficits is a clear indication of the political and
ideological mold and make of most members of Congress and the public
that elects them.
Foreign observers are drawing similar conclusions. The Bank of
Japan, with more than $800 billion in dollar obligations already
announced its reluctance to increase its holding. China, with dollar
reserves exceeding $500 billion, is laboring under "unsustainable
U.S. trade deficits." Asian banks altogether, holding more than $2
trillion in American obligations are suffering hundred billion
dollar losses in terms of purchasing power. It is not surprising
that the central banks of India and Russia, as well as some Middle
East investors, have begun to sell dollar obligations.
According to some estimates, foreign banks and investors are holding
some $9 trillion of U.S. paper assets. They own some 43 percent of
U.S. Treasuries, 25 percent of American corporate bonds, and 12
percent of U.S. corporate equities. They obviously are suffering
losses whenever the dollar falls against their respective
currencies; even if they are pegged to the dollar, they are
incurring losses against all others that are rising.
The dollar standard surely would enter its final phase of
disintegration if its holders would panic and start selling their
American paper investments - their U.S. Treasuries, U.S. agencies,
and corporate bonds and shares. The crash would be felt around the
world and neither foreign sellers, nor American authorities, could
be trusted to react rationally in the fear and noise of the crash.
The scene could be similar to the political bedlam of the early
1930s.
There always is the hope that the primary creditors will act in
concert and once again bail out the debtor. The European Central
Bank, the Bank of Japan, the Bank of China, and the Bank of England
may decide to avert the unthinkable and support the dollar by
mopping up huge quantities. The mopping would stabilize the
situation once again by inflating and depreciating their own
currencies; they would pass the depreciation losses on to their own
nationals. Optimists in our midst are hoping for this scenario; they
are convinced that the Bush administration will, in time, save the
situation by balancing its budget and the Federal Reserve will allow
interest rates to seek market levels. Such a policy would avert the
dollar dilemma, although it would lead to a painful recession,
forcing all economic factors to readjust to market conditions.
Pessimists in our midst cast doubt on such a scenario. They point
not only to the host of legislators and regulators who cherish their
position and power, but also to public opinion and ideology, which
call for government favors. They are prepared to proceed on the
present road and brace for the morrow. A few cynics even contend
that a government facing a financial crisis of such magnitude is
prone to divert public attention from its ominous path by embarking
upon foreign adventures.
This economist is ever mindful that debts do not fade or pass away.
Individuals must face them, deal with them, or renege in bankruptcy.
Governments have an additional option: As the issuers of their own
currencies, they may inflate and depreciate their debts away. The
United States government has done this ever since it cast aside the
gold standard and imposed the dollar standard. It undoubtedly will
continue to do so as far as the eye can see. It is an iniquitous
road, which individuals would soon be barred from traveling, but
governments love to take, shedding their debts one percent at a
time. It is a road of the dollar standard designed at Bretton Woods,
built by the U.S. government, managed by the Federal Reserve System,
and financed largely by creditor central banks in Europe and Asia.
It is a road on which the fall in dollar value has inflicted losses
on all foreign dollar holders each in proportion to the amount of
dollars held. It is the political road of debt default the magnitude
of which amounts to trillions of dollars, undoubtedly the largest in
the history of international relations. It will be remembered for
generations to come.
It is unlikely that the federal government and the Federal Reserve
will soon mend their ways, but it also is doubtful that foreign
creditors will continue their support indefinitely. The U.S. dollar
is bound to continue to depreciate and gradually surrender its role
as the world's primary reserve currency to a multiple reserve-
currency system resting on the euro, Japanese yen, Chinese renminbi,
and the American dollar. The multiple-standard system is likely to
perform more efficiently and equitably than the dollar standard.
Competition would avoid the abuses and inequities of a monopolistic
system. Confining the powers of the Federal Reserve System and
constraining the deficit aptitude of the U.S. Treasury, it would
ward off any further inundation of the world with U.S. dollars.
In idle reverie of years long past, this economist is tempted to
compare the gold standard with the dollar standard. Throughout the
long history of the gold standard, the balance of payments of gold-
producing countries was usually "unfavorable." Since the birth of
the dollar standard, the United States has assumed the position of
the gold-producing countries; its balance of payments usually is
unfavorable. Much capital and labor were spent to find, mine,
refine, and market gold; the United States bears minuscule expense
in the production of its money. Market forces limited the quantity
of gold coming to market; the quantity of dollars depends on the
judgment of Federal Reserve governors who are appointed by the
President. In times of turmoil and war, the quantity of gold mined
does decline; in such times the stock of fiat dollars tends to
multiply and its value depreciates quickly. The quantity of gold is
limited by nature and its value is enhanced by many nonmonetary
uses; fiat and fiduciary moneys have no such uses or limitations.
They are the sorry creation of politics.
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