Article and photo originally published at The Weekly Standard
August 1, 2011
As the truth-or-dare battle over raising the debt ceiling moves toward a resolution of some sort, we are witnessing a unique political moment, with attention finally riveted on our nation’s fiscal future. We are about to learn whether there is such a thing as fiscal responsibility in a democracy where 45 percent of households don’t pay income taxes. Or whether any sense of moral obligation still attaches to paying your own way as a citizen. Chronic budget deficits are evidence of endemic political cowardice when it comes to reconciling government revenues with government expenditures. And our elected officials keep choosing the coward’s way: They “fund” excessive spending through borrowing.
Government borrowing is a convenient ploy for putting off financial inevitability for another generation—except for one huge problem. You can’t have sound money if you don’t have sound finances. If we fail to get a handle on government expenses under our current dire circumstances, the dollar is doomed.
Now some folks around the world might be happy enough about that. The dollar has been at the core of global finance since the end of World War II, as the preferred global currency for trade and capital transactions. One major benefit: It has enabled America to more easily borrow. Debt obligations issued by the U.S. government offer built-in appeal as the repository for dollars accumulated by foreigners. If you are China, say, and you sell much more to Americans than they buy from you, where better to stow that future purchasing power than in risk-free Treasury bonds issued by the United States? The dollar’s prominent role in global financial affairs makes it the most vital nonmilitary instrument of American power; it figures in 85 percent of foreign-exchange transactions, and dollar assets account for roughly two-thirds of the reserve assets of industrialized and developing countries. Of course, not everyone appreciates all those perks going to the United States—even when they realize that a diminishing dollar hurts the value of their own portfolios.
Still, this much is true for those who hold dollars, both U.S. citizens and central bankers around the world. Whether it’s the cash distributed to community banks by the Federal Reserve or the trillions in Treasury obligations peddled at home and abroad—it’s all U.S. government IOUs. Everyone who holds dollars is hurt when the U.S. government debases its currency.
People take dollars in the expectation they will be able to use them in the future to obtain something of comparable worth. They place their faith not so much in the “credit of the U.S. government” as in the eventual capacity of America’s economy to yield productive output. As government-issued claims against our country’s future output accumulate, there is a hollowing-out effect, with financial capital drawn away from the real economy. Real economic growth happens when private investors take their chances on innovative entrepreneurs—not when they are induced to purchase “safe” government securities.
Since the resources needed to pay for current government expenditures are not available, the government is laying claim to future revenues. The notion of money as a claim on tangible assets is thus rendered abstract. Defining the value of money becomes a matter of government dictate. That’s why it’s called fiat money, from the Latin for “Let it be done.”
Fear of losing the dollar as a meaningful unit of account has lately forged a curious confluence of interest among unlikely parties. There are those, mostly U.S. citizens, who use the dollar because it is America’s official legal tender; among these people, we hear increased protests against the Federal Reserve’s abuse of its powers to debase the currency. Then there are those who rely on the dollar as the world’s reserve currency; within this conglomeration of global players there are decidedly mixed feelings about the continued monetary hegemony of the United States.
This makes for an unexpected coalition for monetary reform. The decline of the dollar is linking the economic anxieties of Americans—on Main Street and Wall Street—with profound concern elsewhere in the world over whether America will continue to exercise global leadership. And while these seemingly disparate factions may not readily perceive it, within their mutual monetary angst may also be discovered a shared agenda for saving the dollar.
The connection was made last November when former Alaska governor Sarah Palin called for a stable dollar to put our economy back on the right track. “The Fed’s pump priming addiction has got our small businesses running scared,” she noted, “and our allies worried.” Robert Zoellick, who heads the World Bank, lamented in a Financial Times op-ed that global consternation over the Fed’s quantitative easing was prompting talk of currency wars. Zoellick proposed that the global monetary regime be reformed to spur economic growth—and suggested that any new system should “consider employing gold as an international reference point.”
Though it’s odd to think that the objectives of the Tea Party conservatives for whom Palin speaks might coincide with the concerns of the global elite who read the Financial Times, there is a thread that unites them. It’s the realization that the world economy cannot take another devastating boom-and-bust cycle.
What gold brings to the monetary table is discipline. If individuals suspect that money is being issued in excess of levels warranted by legitimate economic needs and growth prospects, they can exchange their currency holdings for gold at a pre-established, fixed rate. Gold convertibility ensures that the money supply expands or contracts based on the collective assessment of market participants—as opposed to the less-than-omniscient hunches of central bankers. Gold provides a self-correcting mechanism for irrational exuberance; as credit begins to flow too freely, as equity values or commodity prices appear frothy, the astute observer at the margin cashes out in gold. Monetary central planning gives way to the aggregate wisdom of the free market.
A gold standard brakes runaway government spending. It allows individuals to defeat governments that dilute the value of money. A gold standard provides citizens with “a form of protection against spendthrift governments,” as the economist Ludwig von Mises put it. “If, under the gold standard, a government is asked to spend money for something new, the minister of finance can say: ‘And where do I get the money? Tell me, first, how I will find the money for this additional expenditure.’ ”
Under a gold standard, money regains its primary purpose as a vital tool of free markets instead of serving as a corrupted instrument of government policy. Genuine economic growth—as opposed to the money illusion of artificial wealth reflected in bloated equities or housing prices—is no longer sacrificed to monetary policy encumbered by the fiscal failures of government.
We have learned from the European Union’s experience with the euro this past decade that major benefits can be derived from eliminating price distortions caused by fluctuating currencies; unfortunately, the lack of fiscal discipline among participating eurozone nations now threatens the entire system. As with the dollar, the ability of eurozone governments to borrow money to cover nonproductive deficit spending—and then convert government-issued debt obligations into a component of the monetary base—undermines the credibility of the currency. Robert Mundell, the Nobel laureate in economics who laid the theoretical groundwork for the euro, suggested recently that the world could move forward to a better monetary system by tying the U.S. dollar and the euro to each other and also to gold. “Gold is nobody’s liability and it can’t be printed,” Mundell told Bloomberg. “So it has a strength and confidence that people trust.”
Mundell was the intellectual god-father of supply-side economics, usually remembered as advocacy of low taxes but equally a movement that favored hard money. He also mentored Jack Kemp, the pro-growth Republican congressman and vice-presidential candidate who championed the cause of making the dollar “as good as gold.” Kemp made the case for restoring sound money an integral part of his policy agenda; even as he extolled the benefits of international exchange-rate stability as the logical underpinning for free trade, he was able to bring home its relevance for the American public. “Let’s not forget that what is true of nations is also true of individual workers, savers, investors, businesses, and families.”
Kemp’s initiative to establish a new international gold standard was financially sophisticated—far more so than Nixon’s blunt decision in 1971 to renege on America’s historic commitment to redeem dollars for gold. Yet Kemp also insisted that “honest, sound, stable money is a popular, blue-collar, bread-and-butter, winning political issue.” The 1984 Republican platform referred to gold as a “useful mechanism” for aligning Federal Reserve monetary policy decisions with the goal of price stability. Citing the domestic need for “real economic growth without inflation” and the benefits of a stable dollar internationally (“commodity prices which change only when real production changes”), the plank combined political appeal with sound economic reasoning.
Could such a proposal find resonance with voters today? Americans are more cognizant now than in the 1980s of the inverse relationship between the spot price of gold and the perceived value of the dollar. Far from inclining toward naïve provincialism or embracing rigid dogma, the growing number of citizens who purchase gold—in physical form, or through exchange-traded funds—testifies to increasing savvy. Tired of falling for the ruse of putting dollars into savings accounts at near-zero rates of interest, many opt to purchase Treasury Inflation-Protected Securities to avoid getting burned by dollar debasement.
Which raises the question: Why should we have to game the future value of our own currency? Why can’t we just have money that works?
Frustration over the arrogance—and ultimate price tag—of fiscal stimulus is now spilling over into its monetary counterpart. The passive role originally stipulated for the Fed has morphed into one of overwhelming dominance of the economy, even as the Fed’s fundamental mission of preserving the purchasing power of the dollar has been subordinated to papering over fiscal failure. The fact that legislation has been introduced in 13 states to allow gold and silver to function as legal tender indicates broad dissatisfaction with the Fed’s stewardship of the dollar.
Anyone who believes that the effort to reaffirm a gold link for the dollar is politically quixotic was not paying attention when Senator Jim DeMint questioned Fed chairman Ben Bernanke at a hearing earlier this year. Making reference to a 1981 proposal by Alan Greenspan, published in the Wall Street Journal, that the Treasury issue five-year notes payable in gold or dollars, at the option of the holder, DeMint asked: “Have you given any thought to the idea of issuing bonds payable in gold that would begin to create some standard for our currency?” Bernanke demurred, observing that a gold standard was no “panacea” yet also conceding that “it did deliver price stability over very long periods of time.”
One could say, of course, that a balanced budget is no panacea either—but it imposes needed discipline on fiscal decision-making. In the same way, monetary policy needs some discipline to prevent the dollar from being the default mechanism for enabling government mismanagement. Gold convertibility would signal that we intend to maintain the integrity of our currency. It’s all about trajectory and confidence; sound money makes it real.
Judy Shelton, author of Money Meltdown: Restoring Order to the Global Currency System, is a senior fellow at the Atlas Economic Research Foundation and co-director of the Sound Money Project.