Beware of President Obama's call for a doubling of U.S. exports over the next five years as a way to reduce the unemployment rate. The obvious quick route to export success for any nation is to depreciate its currency. Dollar depreciation is already being pushed by the Obama administration as the key solution for resolving our massive trade deficit with China.
Meanwhile, the president is tapping into widespread concern over our nation's future role as a global leader to justify even more spending by government. It hardly matters that proposed new outlays are cleverly branded as "investments" in training, research or infrastructure; it still amounts to increased government spending that can only worsen our perilous fiscal condition.
For the Obama administration, it all works conveniently together. The government will continue to run a large budget deficit, which must be financed by issuing more government debt. The debt is monetized when the Federal Reserve purchases it from the public. The effect is to increase the money supply. Inflationary monetary policy goes hand-in-hand with a falling dollar in foreign-exchange markets.
If you think the government makes better decisions on where to invest, how to innovate, or who to train, you may perhaps accept the consequences of inflation that inevitably result when the money supply is expanded to accommodate excessive government spending. But if you trust the private sector's ability to better discern the most promising avenues of research leading to productive future gains, it merely adds insult to injury to have your own purchasing power reduced as the dollar is diluted.
It can be hard to remember these days, but the International Monetary fund started out as an undeniable force for good. Even as World War II was raging in July 1944, delegates from dozens of nations convened at the remote mountain resort of Bretton Woods, New Hampshire, to hammer out an international monetary agreement. The goal was to provide hope to a world beset by war through a stable monetary foundation to support free trade and international capital flows.
Yesterday former French Finance Minister Christine Lagarde took the helm of the IMF, and the world now faces a different sort of crisis. The prospect of debt default by Greece threatens the euro currency union. While riots and tear gas in Athens are a far cry from the horrors of war, the scenes of unrest are disturbing nonetheless. The IMF's ostensible purpose remains to counter disillusionment and enhance economic opportunity. By all appearances of its ministrations in Europe, it is failing.
Financial stability can only arise from coherent monetary arrangements. But the IMF has strayed from its founding mission of supporting sound money—far enough that, when it comes to promoting the free flow of goods and optimal use of investment capital around the world, the IMF may be doing more harm than good.
The monetary stability inherent in the original Bretton Woods agreement arose from gold convertibility. The U.S. dollar was convertible into gold at $35 per ounce; the currencies of other nations were fixed to the dollar. The IMF was expressly charged with maintaining the integrity and viability of this fixed exchange-rate system. Unlike the beggar-thy-neighbor practices of competitive depreciation that thwarted financial recovery in the turbulent 1930s, the postwar monetary system was aimed at preventing governments from debasing their nations' currencies to gain artificial advantages for exports.
Unprecedented spending, unending fiscal deficits, unconscionable accumulations of government debt: These are the trends that are shaping America's financial future. And since loose monetary policy and a weak U.S. dollar are part of the mix, apparently, it's no wonder people around the world are searching for an alternative form of money in which to calculate and preserve their own wealth.
It may be too soon to dismiss the dollar as an utterly debauched currency. It still is the most used for international transactions and constitutes over 60% of other countries' official foreign-exchange reserves. But the reputation of our nation's money is being severely compromised.
Funny how words normally used to address issues of morality come to the fore when judging the qualities of the dollar. Perhaps it's because the U.S. has long represented the virtues of democratic capitalism. To be "sound as a dollar" is to be deemed trustworthy, dependable, and in good working condition.
It used to mean all that, anyway. But as the dollar is increasingly perceived as the default mechanism for out-of-control government spending, its role as a reliable standard of value is destined to fade. Who wants to accumulate assets denominated in a shrinking unit of account? Excess government spending leads to inflation, and inflation plays dollar savers for patsies—both at home and abroad.
A return to sound financial principles in Washington, D.C., would signal that America still believes it can restore the integrity of the dollar and provide leadership for the global economy. But for all the talk from the Obama administration about the need to exert fiscal discipline—the president's 10-year federal budget is subtitled "A New Era of Responsibility: Renewing America's Promise"—the projected budget numbers anticipate a permanent pattern of deficit spending and vastly higher levels of outstanding federal debt.
Let's go back to the gold standard.
If the very idea seems at odds with what is currently happening in our country -- with Congress preparing to pass a massive economic stimulus bill that will push the fiscal deficit to triple the size of last year's record budget gap -- it's because a gold standard stands in the way of runaway government spending.
Under a gold standard, if people think the paper money printed by government is losing value, they have the right to switch to gold. Fiat money -- i.e., currency with no intrinsic worth that government has decreed legal tender -- loses its value when government creates more than can be absorbed by the productive real economy. Too much fiat money results in inflation -- which pools in certain sectors at first, such as housing or financial assets, but ultimately raises prices in general.
Inflation is the enemy of capitalism, chiseling away at the foundation of free markets and the laws of supply and demand. It distorts price signals, making retailers look like profiteers and deceiving workers into thinking their wages have gone up. It pushes families into higher income tax brackets without increasing their real consumption opportunities.
In short, inflation undermines capitalism by destroying the rationale for dedicating a portion of today's earnings to savings. Accumulated savings provide the capital that finances projects that generate higher future returns; it's how an economy grows, how a society reaches higher levels of prosperity. But inflation makes suckers out of savers.
This is the way the world ends
-- T.S. Eliot
The world is not ending. Despite the wrenching turmoil in global financial markets and morbid allusions to the death throes of capitalism, it ain't over. Not until people quit believing in themselves, not until people quit believing in a better future.
But the whimpering is real, and justified, because it hurts to have your world come crashing down. And global financial markets are definitely crashing, even when the impact is momentarily softened through massive injections of artificial money -- "artificial" because the fiat money does not represent a store of genuine value but rather an airy government claim to future wealth yet to be created.
In the aftermath of this financial catastrophe, as we sort out causes and assign blame, with experts offering various solutions -- More regulation! Less complex financial instruments! -- let's not lose sight of the most fundamental component of finance. No credit-default swap, no exotic derivative, can be structured without stipulating the monetary unit of account in which its value is calculated. Money is the medium of exchange -- the measure, the standard, the store of value -- which defines the very substance of the economic contract between buyer and seller. It is the basic element, the atom of financial matter.
It is the money that is broken.
These days, we don't often refer to the validity of the money itself but rather to "monetary policy" and how the Federal Reserve has managed to calibrate the money supply to economic activity over the last two decades. There are plenty of critiques; the most pointed ones blame former Fed chief Alan Greenspan for keeping interest rates too low, too long.