To understand the scope of our economic crisis, we must understand the degree of departure from sound money. The American economy was founded upon the idea of natural law, actually, where the free exchange of goods and services occurred in the marketplace. The father of capitalism, Adam Smith, called this the “obvious and simple system of natural liberty.” An obvious and simple economic system requires an obvious and simple currency; I generally believe precious metals are ordained as currency, as these elements have little industrial superiority over others, other than their perceived inherent value. All Western empires grew based on sound currency - the US Dollar, the British Pound (and silver Sterling), and the Roman Aureus (and silver Denarius) - and subsequently died when they departed from the set standard.
Like the British and Roman empires, America departed from an obvious and simple system, adopted a fiat currency, and embarked on a journey which placed democracy before freedom. In all things, spreading the costs and minimizing the risks dampens rewards, as profits are smaller, and produces little incentive to succeed; social democratization of our institutions undermines natural liberty. Our monetary system and our fiscal policy are not exempt from the laws of nature.
History of the Crisis
Business cycles in the market are as normal as the consumer trends – or “animal spirits” – that keep it afloat. Realizing this, our founders established a dollar as equal to 371.25 grains of fine silver; this economic law was adopted by the Continental Congress in 1787 and formally signed into law as the Mint Act of 1792 by President George Washington. This effectively tied the hands of the US Mint by prohibiting the printing of money not backed by silver.
Over time, this law was altered to accept gold – and occasionally, foreign currency – in place of silver, effectively providing currency competition within our borders. America went completely off a precious metal standard from 1863 to 1878 to accommodate spending for the Civil War; we fully instated the Gold Standard in 1900.
But it didn’t last long. Although more destructive business cycles began with the conception of the Federal Reserve (1913), our modern fiscal crisis began with the Bretton Woods agreement (1944), which established a nominally gold-backed US Dollar as an international monetary standard, managed by the International Monetary Fund. I say “nominally,” for this standard was susceptible to manipulation: In 1933, FDR issued Executive Order 6102, which made the possession of gold bullion illegal until 1974. This confiscation obscured the actual effects a global monetary system - defined at the Mount Washington Hotel in Bretton Woods, New Hampshire – had on the Dollar.
It cannot be emphasized enough how important the Bretton Woods agreement was to world history, and not just for monetary reasons. Empire status was, for the most part, thrust upon us as a repayment for the blood we shed for our Allied partners in World War II. Deferring to the International Monetary Fund for control of the Dollar, however, has not aided these partners, as our ignorance of the IMF has allowed for the clandestine support of military dictatorships worldwide with our printing of fiat currency.
From its inception, the Bretton Woods system was doomed to fail: Over time, the global use of the US Dollar stressed the Gold Standard to the point where we had to abandon it for fiat currency in 1971, which began the Nixon Shocks, and allowed the Treasury to print as much money as it needed, therefore increasing the magnitude of the booms and busts created by the artificially low interest rates held by the Federal Reserve. Consider the fact that when Nixon announced our departure from the Gold Standard, gold was $40/oz; today it is near $1,700/oz. Gold is not up; the dollar is down, as a result our debt. Today, the US Dollar has lost 95% of its purchasing power since the Fed’s inception; that is, a dollar today buys what 5 cents bought in 1913.
Since Bretton Woods, America has assumed the risks of the world: Through wide-scale cost-cutting business practices, we have relied on foreign nations, first for labor, and then for capital by monetizing debt, thereby slowly gutting the workforce, and the the economy. With our new-found – albeit temporary – wealth, our government approved unsustainable – and untouchable - welfare and warfare states. Through the maintenance of these empirical federal programs, we are forfeiting the greatest experiment in freedom the world had ever seen.
Mechanics of the Crisis
Because our government has been uwilling to rein in spending, and unable to raise taxes any further on American productivity, it has relied on the Federal Reserve to distribute more money and push interest rates lower for borrowing purposes. Interest rate manipulation leads to destruction of the economy, in which good people get hurt. Artificially low interest rates promote banks to lower lending standards, creating malinvestment in the market, which creates a moral hazard for both parties of the transaction. When the market exposes these investments as flawed, the entire society experiences the bust – that is, the consequences of the actions of a few. Therefore, through market interference, the Federal Reserve violates the economic liberty of all Americans.
We are taught that prices should slowly rise in a “normal” economy, at a low single-digit annual rate; we are also taught deflation is a bad thing, as if falling prices is harmful. The price of a particular good should fall until it is improved upon, the way flat screen televisions and Smartphones do. New products entering the market are priced high and then fall, until they either reach a level of sustainment or exit the market, with annual inflation for the entire economy equal to zero.
For some reason, we don’t expect a gallon of gas, a gallon of milk, a carton of eggs, or a loaf of bread to behave similarly; we somehow expect annual inflation. Therein the Federal Reserve has perpetrated the greatest conspiracy – unknown to most Americans – that inflation is necessary, when indeed, it is not. But inflation has a purpose for the political class, for it allows them to spend without limit.
While the American public is focused on rates of taxation, they fail to recognize that overspending is a tax itself. It does not matter what the tax rate is. Whether our government taxes, borrows, or inflates the monetary base, the public will pay for its government’s overspending eventually. By delaying the inevitable, and not addressing our debt drivers – Defense, Social Security, and Medicare – our correction is going to be sharp, and will hurt the savings and investments of millions of good people, while rewarding those in control.
Investment research expert Charles Biderman offers this:
“Debt has to be reckoned with one way or another. It either has to be repaid, or someone has to bear the losses on what cannot be repaid, either through default or inflation and currency debasement. If it were otherwise, everyone could be rich.”
Similarly, but from another angle, the now infamous economist John Maynard Keynes:
“By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some.”
Is it any wonder we now have billionaire career politicians, considering it is they who write the rules for banking, the stock market, and the economy largesse. In his controversial new book, Throw Them All Out, Peter Schweizer reports on how the median speculator loses in the options market, while industry insiders beat the market by 5%, hedge fund managers by 8%, and US Senators, astonishingly, by 12%.
With inflation, politicians have fleeced the citizenry of their covert actions; this period of American history may be ending. Through what psychologists call the normalcy bias, our society believes since an occurrence has not yet occurred, it will never occur. This fallacy is rampant across demographics: Our large elder generation – “Baby Boomers” – long ago voted themselves welfare-state benefit, is now seeking retirement, and expects to reap their just rewards. The next generation is riddled with protesters – or protester sympathizers – who demand their generation be shackled with more debt.
So, like the empires before us, we are slowly committing national suicide, with a debt-laden poison pill.
Scope of the Crisis
Both America and the world are buried in debt: just as America’s debt reached 100% of GDP at $15 trillion last month, the world did the same, at $195 trillion of debt. To put this in perspective, Carmen Reinhart and Ken Rogoff, the authors of This Time It’s Different (2009), found (by studying 22 global economic crises) that when government debt-to-GDP ratio rises above 90%, it lowers the future potential GDP of a country by at least 1%, and begets a slow-growth, high unemployment economy; our unemployment rate is stuck at the socialist nations’ average of 9%. After a crisis, public debt soars to an average of 86%, whereas our is, as stated, currently over 100% of GDP. Nations that cannot pull out of the debt crisis often experience sovereign debt default. An American default would lead to a collapse of the global currency system.
The source of our debt concerns, deficit-spending, is now an epidemic. Our last budget surplus occurred during the Clinton Administration, with ballooning debt spiraling out-of-control during the Bush Administration. Today, a wholesale abandonment of fiscal responsibility has allowed President Obama to run monthly deficits greater than Bush’s annual deficits. Artificially-low interest rates beget loose lending standards, incentivizing people to make money during the boom, before the “necessary bust” punishes everyone.
We have avoided this bust with Federal Reserve policy, but we are merely delaying the effects, and intensifying the pain to come. Through “Quantitative Easing” - QE1 and QE2 - the Federal Reserve surpassed China as the majority owner of our Treasury Bonds. Through a money-laundering scheme, we are both debtor and lender.
With the imminent collapse of the Euro, the world is painfully realizing the facts: the world economy is bankrupt, and the IMF looks to the U.S. to bail out Greece, when, in fact, the U.S. is only one to two decades from becoming Greece.
Conventional wisdom says that when – not if – the Euro collapses, it will strengthen the US Dollar as the world’s reserve currency, as there will be no other global alternative. I believe the opposite, that the Euro collapse expose the US Dollar as being just as weak as the Euro, as our debt is at similar levels; the bond rates will go up, credit will dry up, business will fail, and prices will rise, thus commencing the global currency crisis some have been predicting for years.
Future of the Crisis
History shows what awaits if we don’t get our debt under control: First, a sharp period of hyperinflation, and then, a sovereign debt default. With the facade gone, we will also experience a currency collapse, followed by a painful, deliberate return to a precious metal standard. How this will happen, and who will be controlling it, is yet to be seen.
The collapse of the Roman Empire was predicated by inflation; to combat the effects, Rome used price controls to drive prices below their market value, sapping all profit and killing the economy. Similarly, the US has monetized and securitized the debt, auctioning cheap Treasury Bonds to overseas bidders to prevent inflationary effects.
Here’s the kicker: Treasury Bonds, seen as assets on multiple nations’ balance sheets, are essentially worthless, for if they were to be leveraged as capital during the collapse, it would further undermine the unit of currency upon which it rests, quickening the collapse.
Contrary to popular belief, the Federal Reserve does not print money to make up the balance; rather, it transfers it electronically, and accordingly, has been able to covertly manipulate markets – both foreign and domestic – for years. These actions are finally catching up to us. While Congress approved a $700 billion Bank Bailout, followed by a $700 billion Stimulus, the Federal Reserve was delivering 10 times that amount of cash - $7.77 trillion – to the financial industry through the back door, all in an eight month period. The total amount of cash lent in the financial crisis was $16 trillion, a truly inconceivable amount of money. In perspective, $7.77 trillion is more than half the US production capacity last year; GDP in 2011 was a little bit shy of $15 trillion. I believe this action will be remembered as the “nail-in-the-coffin” for the US Dollar.
What will a currency crisis look like? As the US Dollar crumbles, we will export our inflation to other nations (as it is the reserve currency of the world), destroy their economies, and create a “Weimar Republic” situation around the world. How the world will reckon with this is uncertain, but America will receive much of the blame from the rest of the world for its woes. How will these nations react? What coalitions will be formed to fill the power vacuum?
Ask yourself: What happened to the British and Roman Empires when their currency collapsed? The end of the British Empire brought the First World War in Europe, which eventually precipitated into the Second World War at the end of Germany’s currency crisis. When the Roman Empire collapsed, the world plunged into a 600-year economic doldrum known as the Dark Ages. Of course, America wouldn’t let that happen; no, I’m sure we’d go out with a bang.
Alternate History
This could unfurl differently.
By restoring the US Dollar as sound currency, on a precious metal standard, combined with a laissez-faire economic approach – that is, a severe downsizing of our federal government – would let a correction take place, and would be the quickest way to spur innovation in the private sector and unveil a new economy, dependent on individual action, and not the collective.
Of course, a sharp self-correction of this type, like that of 1920-21, would mean a number of firms that could not survive without federal injections of cash would go bankrupt. A positive externality of wide-scale bankruptcy would mean an influx of skilled labor entering the job force, creating the new economy. Restoring the US Dollar to a precious metal standard would, in turn, restore confidence in the American monetary system, and would no longer allow our government to destroy the economy and our standards of living with inflation.
As only an extremely slim minority would favor this sharp self-correction, the status quo decides there are only two ways out of this: war or inflation. I disagree. Restoring the fundamentals would allow the nation to find the new economy, while allowing competing currencies in the marketplace as not to burden the US Dollar and worsen the impact of recession.
If left alone, the market would rebound and define itself, the way it has centuries before. From 1750 to 1850, America was an agricultural society; 1850 to 1950 marked the industrial society; and 1950 until now, America has been a technological society. Our wholesale abandonment of the agricultural and industrial sectors for the technological sector has left us vulnerable, as we are unable sustain our own demand for food or manufacturing. This situation undermines our national security. We need to leverage our new technologies into these antiquated sectors, the way oil companies have with oil exploration, or BMW has with automobile production.
Demand is there for new innovations and new approaches, shrouded beneath layers of government intervention and stimuli. In attempts to choose winners and losers in a market, government destroys entire sectors, a fact I discussed back in October. The green movement comes to mind: Considering the fact that food travels an average of 1500 miles to get to your plate, and that food travels away from you before it travels toward you, it’s high time to overhaul inefficient supply chains, before the currency crisis empties store shelves faster than they can be restocked.
Ending this mess begins with reinstating sound currency, and ensuring the rest of the world the US Dollar can be trusted again. Although we haphazardly began our empire with Dollar hegemony, it will take deliberate steps to end it and restore the republic.
That is the choice we now face, as we did in September of 1787: republic or empire. It’s important to remember the ominous nature of the answer given when Ms. Powell of Philadelphia asked Benjamin Franklin, exiting the Constitutional Convention, “Well Doctor what have we got, a republic or a monarchy?”
Dr Franklin replied: “A republic, if you can keep it.”
It is now ours to restore.
