These are seemingly isolated events, reports and essays published, all within the last nine months:
- Government admits it actually committed more than six times what Congress authorized it to commit of our tax dollars in the TARP legislation -- $4.3 trillion laid on the line, rather than $700 billion. Inescapable conclusion: no one is in charge. Each branch of government now does whatever it deems necessary or advisable on its own, regardless of the other branches. Checks and balances have all but vanished.
- Wall Street is back to business as usual, where "bonuses" are part of every employee's base pay.
- The financial sector as a whole has seen its earnings nearly triple, from an average 16% of total business profits during 1973-1985 to a high of 41% in the current decade. Compensation in the financial sector as a percentage of average U.S. compensation likewise grew phenomenally, from between 99%-108% of the average all during 1948-1982, to 181% of the average in 2007 (the latest year for which statistics are available).
- The monetary base has reached stratospheric heights where the Fed has never been before.
- The dollar is sinking against other currencies (the headline "Dollar Sinks to Low for Year" keeps having to be repeated, as it establishes ever lower lows). The Fed is keeping interest rates low in an attempt to prevent the dollar from rising, because the Administration (foolishly) believes a cheap dollar will stimulate our exports, by making them less expensive to foreigners.
- But the banks, flush with government funds lent to them at near-zero rates, find it more profitable to lend the money back to the government at a nice profit than to lend it to the private sector amid such economic uncertainty. Consequently, there is little new investment, and no permanent growth in infrastructure that creates real wealth. Instead, all the growth being lately reported is -- you guessed it -- the result of increased lending to (borrowing / spending by) the government! (Think "Cash for Clunkers", at a cost to taxpayers of $24,000 per new vehicle sold.)
- Other countries, seeing the value of their dollar holdings diminish with each passing week, are talking about establishing a new reserve currency to replace the dollar.
- And a socialist economist connected with a new think tank being put together by George Soros publishes an essay called "Death Cometh for the Greenback", which argues that a different reserve currency already exists, in the form of Special Drawing Rights (SDRs), managed by the International Monetary Fund (IMF). He points out that the IMF needs only to secure the agreement to a Bretton-Woods-II type of arrangement to implement such a plan.
Can anything be concluded from these various happenings? Is there a common thread among them?
I submit that there is a common thread, and that it has to do with the inherent risks and disconnections from risk that accompany an economy based on nothing more solid than fiat (paper) money. The only thing that has held the system together since the first Bretton Woods agreement is the restraint of the United States in printing paper dollars. When that restraint was first relaxed, the United States was forced by the amount of paper money it had created to close down the gold window in 1971, making the dollar a completely fiat currency for the first time. With the irrational panic ensuing after last year's threatened collapse of the whole house of cards, even the last vestiges of restraint on the creation of more and more fiat money have now entirely disappeared.
What little restraint remained has been thrown to the winds of political megalomania, which conceives that simply by printing ever more and more money, the economy will eventually take heart and recover. In the meantime, however, the only sector which recovers is the financial one -- because it gets to play with all that money, and receive compensation for playing. Washington sends the money (in the form of bailouts and guarantees) to Wall Street, which takes its cut and then ships the money back to Washington for another round. Meanwhile, precious little money is making its way to Main Street (which is why inflation has not grown to be serious yet).
The printing of money to pay for political schemes has always had a side benefit for the politicians who dream up the schemes, and who pitch them to the unsuspecting public as programs for reform. (Let us remember that the much touted Stimulus Bill, rushed through a Congress which did not read it, and now proven an utter failure, was given the official title of "the American Recovery and Reinvestment Act of 2009.") The bills are now so long and complex that no one reads them before voting to pass them, and no one person knows all that is in any bill. The process allows politicians to stick in many little hidden rewards to the special interests represented by the faithful lobbyists. Those specially benefited reward the politicians by returning generous contributions to their political campaigns.
And so the vicious circle goes round and round. Certain sectors receive special handouts and rewards, which do nothing to stimulate the economy as a whole, because there is no overall coordination, but only a stuffing of the particular hands which offer to pay something back so the politicians can get re-elected. Then the politicians come to the "rescue" of the wrecked economy yet one more time, and vote more rewards and special handouts, and on and on. We truly have, and have had now for a long time before Mark Twain ever said it, "the finest government that money can buy."
But the game has to come to a crashing end once the printing presses are made to run without stopping. For the cycle feeds on itself. The more that is handed out, the more that is paid back to the politicians, and the more they are in hock to meet ever higher demands as the economy continues to sink. Think of the old fairy tale of the magic porridge pot: the image of the entire village being drowned in a sea of never-ending porridge is a perfect analogy to our current economy awash in paper dollars. Or, to use another image from fable, the sorcerer (the one who can bring things under control) is away, and the apprentices are in charge.
The chief apprentice, by the name of Ben Bernanke, assures us that all will be well, and that when the time comes he will magically be able to suck back in all those dollars that are floating around the economy before inflation takes over. But the talk of a new reserve currency demonstrates that Mr. Bernanke's promise is an empty one. Once the dollar stops being the world's preferred medium of exchange, not even Mr. Bernanke's figuratively cavernous vaults will be able to accept back all the dollars that people will be trying to dump in a flight to a more sound currency. The inflation that most people are anticipating is the slow, insidiously building kind, which the Fed admittedly has tools to fight. No one seems to be preparing, however, for how to handle the consequences of the dollar losing its reserve status when so many dollars are being printed. If raising interest rates or reserve requirements at that point does manage to curb runaway inflation, it will do so only at the cost of an economic collapse that is even worse than the current one.
All of this was explained long ago, by the Austrian economists -- chiefly Ludwig von Mises. Here is a concise summary of his business cycle theory, written back in 2001, but every bit as true as if it had been written yesterday:
Business cycle theories are legion and they come and go. But the only explanation that has stood the test of time was first advanced in 1912, in Ludwig von Mises’s masterwork, The Theory of Money and Credit. Elaborations on the theory, by Mises and his student Hayek in the 1930s, culminated in the Austrian theory of the trade cycle.
The theory begins by observing the profound effect that interest rates have on investment decisions. Left to the market, interest rates are determined by the supply of credit (a mirror of the savings rate) and the willingness to take risks in the market (a mirror of the return on capital). What throws this out of whack is manipulation by the central bank.
When the Fed feeds artificial credit into the economy by lowering interest rates, it spurs investments in projects that don’t eventually pan out. In this economic boom, the high-tech and dot com manias resulted from a decade of sustained money growth via lower interest rates. When the Fed stepped on the brakes to prevent prices from rising, it prompted a sell-off, and hence a downturn.
What’s tricky to understand is what can’t be seen. Just because prices aren’t going up doesn’t mean the money supply is in check. Just because people in some sectors are getting rich doesn’t mean that the prosperity is on solid ground. Just because the stock market is going up doesn’t mean that the architecture of investment (to use Jim Grant’s phrase) is in good working order.
This is not rocket science, and we can be sure that as a trained economist and financier, Ben Bernanke knows all this perfectly well. So what is behind the charade he is currently running? Let's review the basic facts one more time:
1. The monetary base is expanding beyond all limits, into unknown territory, while the Fed is lending money to banks at 0.25% interest or less.
2. Unemployment -- even the government's artificially limited "official" figures -- is headed into territory not seen since the Great Depression.
3. The value of the dollar is steadily sinking with respect to other currencies, giving rise to plans to replace it as a reserve currency.
4. The price of gold in dollars is as high as it ever has been historically, and is headed still higher.
The conclusions follow as does night the day. Fewer and fewer people are gainfully employed, and those who do have jobs are working for less and less in terms of real value. Those who have the ability to do so already demand ever more and more in terms of compensation, and pretty soon those who manufacture goods will be forced to start doing so as well. A massive inflation is inevitable, and cannot be stopped. The only question is when enough people will recognize that it has begun, and whether the result will be runaway inflation, as occured in Germany in 1923.
Remember: runaway inflation is possible only with fiat currency. Having a currency backed by gold acts as a natural brake on the printing of paper money -- print too much, and people will choose to hold gold, making the currency worthless. (It is the same phenomenon we are observing now in the gold futures market -- there are signs of a time coming when no amount of paper dollars will convince a person to part with any gold. As the article just linked puts it succinctly: "Gold is not available at any price quoted in Zimbabwe dollars.") Some people -- especially economists since Keynes -- think that the brake works too well, and keeps the economy from growing, as well as producing panics when there is not enough money to go around. But would you rather be riding in a car with some brakes than one with no brakes at all?
Why, then, would President Obama, Timothy Geithner and Ben Bernanke allow us to continue down the present path, when the place where it is taking us is so readily foreseeable? One has to ask that question, but that does not mean one can discover the actual answer. None of the possible answers, however, is comforting. (I reject, for the reasons already given, the possibility that the three of them are acting out of ignorance; it may be out of overconfidence that they can keep the lid on the situation, perhaps, but not ignorance. As I say, however, neither of those possibilities offers any comfort.)
One more possible answer is those SDRs from the IMF. As Mr. Stiglitz acknowledges toward the end of his essay, the United States is currently allocated the largest share of new issues under its rules. So perhaps the government expects still to run the show, with or without the dollar.
But SDRs are useless for purchasing groceries. Here at home we will be stuck with our paper dollars, until the world's bankers manage to propose a uniform currency which all major countries will agree to accept. Even Mr. Stiglitz does not see a world currency any time soon -- although the collapse of the U.S. economy, followed by chaos around the world as it tries to dump dollars, might hasten the time when it becomes a reality.
And note that a switch to a different world reserve currency, such as SDRs, would still keep the world on a paper money standard, where the money supply would still depend on the integrity of central bankers. (Is that an oxymoron? No, their integrity may in fact exist, but whether it does is irrelevant in the final analysis, because central bankers, as we see in the case of Mr. Bernanke, are ultimately no match against the tide of political forces that make prudent monetary policy impossible. And if you think those forces are unmanageable now, just wait until the whole world's economy is tied to one fiat currency.)
As I pointed out earlier, fiat money gave us Weimar Germany in 1923, and also Zimbabwe in 2007; there are a lot more examples in this Wikipedia article. No historical precedent for runaway inflation should ever again make one willing to go through the upheavals it brings. Unless--
Unless you were elected president with a hidden radical agenda (based on principles taught by your idol, a man with the name of Saul Alinsky), which you knew in advance would not be popular, and which might result in your serving only a single term. If, however, a general crash were to occur well before the next election, you might just conceive that with everyone on the bread lines, looking to the government for assistance, and with the economy in shambles (as it was in 1936), voters will not dare to think of switching horses midstream -- just as they did not do with Franklin Roosevelt. (As an added plus, you could always blame the crash on the failed policies of your predecessor.)
Then, just wait -- just wait until they see what's in store for them in your second term. But by then it will be too late.