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Recitativo
The United States
abandoned its policy of stabilizing gold prices back in 1971. Since then the
price of gold has increased about 1000 percent while consumer prices have
increased only about 250 percent or, roughly, a quarter of the increase in
the gold price. If we had tried to keep the price of gold from rising, this
would have required a massive decline in the prices of practically
everything else — deflation on a scale not seen since the Depression.
This does not sound like a particularly good idea.
Rondo
What the United
States did in 1971 was defaulting on its gold obligations to foreign
creditors, the biggest act of bad faith in history theretofore. This default,
and the making of the dishonored debt money, was the cause of the
destabilization of interest rates, as well as the explosive growth in the
volatility of prices that have been plaguing the world ever since and
causing ever greater economic distress. Krugman’s euphemism in calling
the greatest default ever “the abandoning of the stabilization policy
of the gold price”, and calling the promotion of the dishonored paper
as money “a measure designed to prevent deflation and the decline of
prices” is doublespeak, the hallmark of dismal monetary science.
Krugman suggests that an equilibrium now obtains that didn’t before.
What we have is not an equilibrium; rather, it is a burgeoning
disequilibrium, one that will continue its devastating course.
We must remember
that the financial annals do not record a single case in which a default has
not been followed by a progressive increase in the discount on the paper of
the defaulting banker, until it reached 100 percent — possibly
several years or even decades later. Obviously, the defaulting banker would
try to slow down the process by hook or crook. However, ultimately economic
law was to prevail and the remaining value of the dishonored paper would be
wiped out.
There is no
reason to believe that the dollar default will end differently. Suppose that
the price of gold is $420. Let us calculate the discount on the dollar.The
gold value of the dollar has been reduced from 1/35 to 1/420 = 1/12×35.
Therefore the loss is
(1/35)(1 ! 1/12) =
(1/35)(11/12) = (1/35)0.9166...
In percentage
terms the loss, also known as discount, is 91.66 percent. Not yet 100, but
close enough. Small comfort, as the last 8.33 percent of the loss, coincident
with the death-throes of the dollar, is likely to be most violent and
painful, revealing the full extent of the devastation. Remember, the loss
affects not only cash holdings, but all dollar-denominated assets,
including bonds, annuities, pensions, insurances, endowments, etc. As the
discount on the dollar approaches 100 percent, the dollar price of gold will
approach infinity. To assert that the dollar is going to escape this fate is
tantamount to asserting that the laws of economics and logic have been turned
upside down, and the penalty for default has been replaced by reward in
perpetuity.
Rondo
The discount as
calculated above in terms of the price of gold is the leading indicator of the
depreciation of the dollar. It is pretty accurate in registering the loss of
purchasing power in terms of a wide array of other goods as well. However, it
is important to note that the discount on irredeemable currency, although
obviously going to 100 percent, is never doing it along a straight
line. It goes through fits and starts, sprinkled with ever more violent
reversals.
Therein lies a
great danger. Reversal confuses people and lulls them into believing that the
currency has reached the end of skid-row, and is now entering respectable
neighborhood. The explosive growth in the volatility of interest rates and
prices is finally over. More astute observers will, however, realize that low
interest rates and subsiding volatility won’t cure the malady the cause
of which, default, has not been acknowledged, still less removed. Nor will
asset bubbles cure it. Volatility is bound to return with a vengeance. Like
the wrecker’s ball, it will keep swinging until the whole financial
structure is reduced to rubble.
A reliable
measure of destruction is the so-called “notional” size of the
derivatives market trading interest-rate futures, options, and swaps. It now
stands at a quarter of a quadrillion dollars and is increasing at an
accelerating pace. The word “notional” is a euphemism
suggesting that there is nothing to fear about it. As if it were a kind of
financial mirage. Well, there is plenty to fear about. It is real enough as
it measures the commitments of bond speculators, most of whom are betting that
the rate of interest will keep falling in the U.S., too, as it has been in
Japan. The bets are well-grounded. They reflect expectation that interest
rates will be driven by the Fed into the bargain basement. This is what the
Fed did in the 1930's, causing the First Great Depression. This is what it is
doing now, causing the second. The Fed buys bonds in the open market
when it wants to combat deflation and falling prices, and also buys
them when it wants to combat inflation and rising interest rates. If the Fed ever
sells bonds, the occasion is few and far in between and it is for
window-dressing purposes only. Speculators know this and think that they
can’t go wrong if they try to preempt or emulate the Fed in buying
the bonds.
This raises the
question: if the deflationary danger caused by the Fed’s open market
operations is so great, because it makes bull speculation in bonds risk free,
then why don’t economists warn us about it? The answer is that dismal
monetary science blocks the free flow of information and an impartial
scientific debate of the threat (which is caused by the regime of
irredeemable currency alternating, as it does, between inflationary followed
by deflationary excesses). During the inflationary excess commodity
speculation, and during the deflationary excess bond speculation is bleeding
the economy white, but you are not supposed to know.
Recitativo
It is true that a
freely floating national money can create uncertainties for international
traders and investors. Over a period of five years between 1991 and 1996 the
dollar has been worth as much as 120 yen and as little as 80. The costs of
this volatility is hard to measure but they must be significant.
Rondo
It is
disingenuous to say that in 1971 the United States made the dollar
“freely floating”. What the United States did was nothing less
than throwing away the yardstick measuring value.
It is truly
unbelievable that, in our scientific day and age when the material and
therapeutic well-being of billions of people depends on the increasing accuracy
of measurement in physics and chemistry, dismal monetary science has been
allowed to push the world into the Dark Ages by abolishing the possibility of
accurate measurement of value. We no longer have a reliable yardstick to
measure value. There was no open debate of the wisdom, or the lack of it, to
run the economy without such a yardstick.
To throw away
gold, a rigid yardstick, and to replace it with a shrinking and elastic
yardstick, the dollar, idiotic as though it is, does nevertheless have a rationale
as well as a precedent. In less enlightened times the length of the
“foot”, as the name of this particular yardstick suggests, was
adjusted every time the king died. If the new king’s foot was smaller,
then the new official unit of length was made shorter. This allowed
rope-makers, spinners, and weavers to sell a smaller amount of merchandise
for the same amount of money. In this way inefficient producers were favored
at the expense of the consumers who were legally short-changed.
The floating dollar
does exactly the same. It shelters the inefficient producer who is enabled to
sell the same quantity of products at progressively higher prices, to the
detriment of the consumer at large.
Interlude
During the course
of his travels to many strange lands Gulliver also visited the Country of the
Mad Scientists. A government spokesman took him on a guided tour in order to
acquaint him with the marvelous achievements and great projects of that land.
Among others Gulliver was shown a new procedure under development whereby the
erection of buildings would start with the construction of the roof rather
than the foundations and proceed from top down. In this way shelter was
provided for construction workers in inclement weather.
In another part
of Science City, the capital, Gulliver visited an experimental farm where
research scientists were simultaneously breeding woolless sheep and milkless
cows. They were motivated by the idea that the output of sheep milk could be
increased greatly through the elimination of wool growing, thus making
cow’s milk redundant. Wool for clothing could then be replaced by the
sturdier cows’ hair, that could also be shorn more efficiently.
There was one
invention in particular that fascinated Gulliver more than any other. They
called it “floating time”. At the Institute of Horology the
director explained that the idea of fixity of time is old-fashioned, even
reactionary. In this respect musicians have been more progressive than
scientists. They had long ago overthrown constant time, leaving its variation
to the discretion of the conductor. Now he could set free the emotive energy
implicitly present in the music, the release of which was forbidden by an
earlier narrow-minded and reactionary age.
Floating time was
implemented by connecting Big Ben in one tower of Parliament Building to Big
Barb, the weather vane, in the other. Every time the direction of the wind
changed, turning Big Barb one way or another, so did time, as indicated by a
slow or a fast Big Ben. The director proudly pointed out that in this way
their timepiece was imbued with cosmic power present in the universe,
including sun spots and sun flares that have so far been foolishly ignored by
clockmakers, but not by the wind.
The director was
going to let Gulliver inspect the ingenious mechanism that made floating time
possible. It would allow the Chairman of the Board of Time Reserve to
overrule the prevailing wind whenever justified. At the Parliament Building
they ran into the picket line of workers demanding higher wages. At that
moment the town clerk announced that the direction of the wind has just
turned Westerly, meaning that Big Ben would run fast, cutting the hour down
from 60 minutes to 50. The workers burst into joyous cheering. They
understood that the working day has been instantaneously shortened 16 percent
by the change of the wind, without reduction in pay. The strike was called
off. The director turned to Gulliver and winked: “See what I mean? Floating time is
helpful even in settling labor disputes!”
Finale
The great 20th
century economist Ludwig von Mises famously predicted, shortly after the
consolidation of Bolshevik power that, unless private ownership of the means
of production was reestablished, the economy of Russia would collapse. Without
valid market prices for the means of production businessmen could not do the
necessary economic calculations as to what, when, and where to produce, and
how much to invest in production facilities, so rational allocation of scarce
resources was no longer possible. For a while the economy could limp along
but, eventually, the compounding of bad economic decisions would lead to so
great an economic distortion that sudden death would become inevitable. Well,
it took three and a half score of years to reach the threshold beyond which
economic abuse caused by bad decisions could no longer be tolerated, and the
prophecy was duly fulfilled.
Mises made
another famous prediction. If the United States left the gold standard, and
failed to stabilize the dollar in terms of gold soon thereafter, then a
“crack-up boom” would follow and the dollar would lose all its
purchasing power, first internationally, then domestically. This prophecy has
not yet been fulfilled but, as the Soviet example shows, sometimes you have
to be patient when waiting for Mises’ predictions to come true.
Unfortunately,
Mises justified his prophecy about the dollar in terms of the Quantity Theory
of Money, which is a linear model and is not applicable in a non-linear world
such as ours. He should have argued in exactly the same way as he did in
predicting the demise of the Soviet Union. If the United States threw away
the yardstick measuring value, namely the gold dollar, then businessmen could
not do the necessary economic calculations as to what, when, and where to
produce, and how much to invest in production facilities, so rational
allocation of scarce resources would no longer be possible. For a while the
economy could limp along but, eventually, the compounding of bad decisions
would lead to so great an economic distortion that sudden death would, in the
fullness of time, become inevitable. We don’t know where the threshold
is beyond which the economic abuse caused by bad decisions can no longer be
tolerated. What we do know, however, is that economic abuse cannot continue
indefinitely, as the Soviet example so convincingly demonstrates.
Antal
E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
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Copyright © 2002-2008 by Antal E. Fekete - All rights reserved
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