A Modern Dilemma

Given the lack of control over how much fiat money is placed in circulation – after all, it is based on nothing – we can only expect that the currency will continue to lose value over time. Addison Wiggins shares the grim truth about the U.S. dollar…

The Great Dollar Standard Era is a direct result of the removal of gold as the underpinning of the world’s currencies. The vast overprinting of currency will inevitably debase the value of the U.S. dollar and, because so many foreign currencies are pegged to the dollar, the currency of those nations as well. Fiat money, simply put, is created out of nothing. A future promise to pay has never supported monetary value for long and the United States is so overextended today that it is doubtful it could ever honor its overall real debts.

Counting obligations under Medicare and Social Security, the real debt of the United States is more than 10 times the reported national debt:

"Taking present values as of fiscal year end 2002 and interpreting the policies in the federal budget for fiscal year 2004 as current policies, the federal government’s total fiscal imbalance is equal to $44.2 trillion."

The Fiat Money System: The Argument in Favor

The argument favoring the current fiat system is that the demand for it grew out of barter, the need to facilitate ever-higher volumes of trade. If this were true, there would be a reasonable expectation that a system of paper drafts would make sense. But the reality is that fiat money has not grown out of barter, but from the previous gold standard. Given the lack of control over how much fiat money is placed in circulation – after all, it is based on nothing – we can only expect that the currency will continue to lose value over time. The model of fiat money is supported and defended with arguments that consumption is good for the economy, even with the use of vacant monetary systems. But there is a problem:

"The predictions of these models are at odds with the historical evidence. Fiat money did not in fact evolve . . . by means of a great leap forward from barter. Nor did fiat monies ever emerge out of thin air. Instead, fiat monies have always developed out of some previously existing money."

Can we equate the problems inherent in fiat money with the effects of inflation? We have all heard that saving for retirement today is problematical because, by the time we retire, we will need more dollars to pay for the things we will need. By definition, this sounds like the consequences of inflation. But inflation is not simply higher prices; it has another aspect, which is devalued currency. We have to pay higher prices in the future because the currency is worth less relative to other currencies. That is the real inflation. Higher prices are only symptoms following the debasement of currency. If we examine why those prices go up, we discover that the reason is not necessarily corporate greed, inefficiency, or foreign price gouging. At the end of the day, it is the gradual loss of purchasing power, the need for more dollars to buy the same things. That’s inflation. And fiat money is at the root of the problem.

The intrinsic problem with fiat money systems is how it unravels the basic economic reality. We know that it requires work to create real wealth. We labor and we are paid. We save and we earn interest. Government, however, produces nothing to create wealth so it does so out of an arbitrary system: fiat money. The problem is described well in the following passage:

"It takes work to create wealth. ‘Dollars’ are created without any work -how much more work is involved in printing a $100 bill as compared to a $1 bill? Not only are ordinary people at home being deceived, but foreigners who accept and save our "dollars" in exchange for their goods and services are also being cheated."

The Fiat Money System: Are We Being Cheated?

So are we "cheated" by the fiat money system? Under one interpretation, we have to contend with the reality that the dollar is not backed by anything of value. But as long as we all agree to assign value to the dollar, and as long as foreign central banks do the same, isn’t it okay to use a fiat money system?

The problem becomes severe when, unavoidably, the system finally collapses. At some point, the Federal Reserve – with blessings of the Congress and the administration – prints and places so much money into circulation that its perceived value just evaporates. Can this happen? It has always happened in the past when fiat money systems were put into use. We have to wonder whether FDR was sincere when, in 1933, he declared that the currency had adequate backing. It wasn’t until the following year that the president raised the ounce value of gold from $20.67 to $35. He explained his own monetary policy in 1933 after declaring the government’s sole right to possess gold:

"More liberal provision has been made for banks to borrow on these assets at the Reserve Banks and more liberal provision has also been made for issuing currency on the security of those good assets. This currency is not fiat currency. It is issued on adequate security, and every good bank has an abundance of such security."

It was the plan of the day. First, the law required that all citizens turn over their gold to the government. Second, the value of that gold was raised nearly 70 percent to $35 per ounce (after collecting it from the people, of course). Third, the president declared that currency printing was being liberalized – but it is backed by gold, so it’s not a fiat system. This may have been true in 1933, but since then – having removed ourselves from the gold standard – the presses are printing money late into the night. The gold standard has been long forgotten in Congress, the Federal Reserve, and the executive branch.

It may be the view of some people that a perfect monetary system may include changes in value based on purchasing power and on the demand for money itself. Thus, rich nations would become richer and control the cost of goods, while poor nations would remain poor. In spite of the best efforts under the Bretton Woods Agreement, it has proven impossible to simply let money find its own level of value. Unlike stocks and real estate, the free market does not work well with monetary value because each country has its own selfinterests. Furthermore, today’s post-Bretton Woods monetary system has no method available to prevent or mitigate trade imbalances. Thus, trade surplus versus deficit continues to expand out of control. The United States ended up accumulating current account deficits totaling more than $3 trillion between 1980 and 2000.This perverse twist on world money has had a strange effect:

"These deficits have acted as an economic subsidy to the rest of the world, but they have also flooded the world with dollars, which have replaced gold as the new international reserve asset. These deficits have, in effect, become the font of a new global money supply."

This is what occurs when international money supplies become unregulated. We need a firmly controlled world banking system if only to stop the unending printing of money. If, indeed, U.S. deficits continue as a form of subsidy to the rest of the world, that can only lead to a worldwide economic collapse like the one seen in the 1920s and 1930s.

If it were possible to create a controlled international monetary unit, its effectiveness would demand ongoing regulation to prevent the disparities between nations with varying resources and reserves. Ludwig von Mises wrote that:

"The idea of a money with an exchange value that is not subject to variations due to changes in the ratio between the supply of money and the need for it . . . demands the intervention of a regulatory authority in the determination of the value of money; and its continued intervention."

Mises concluded that this need for intervention was itself a problem. It is unlikely that any government would be trustworthy enough to property ensure a fair valuation of money, were it left up to them; instead, governments are more likely than not to fall into the common fiat trap. Without limitations on how much money can be printed, it is human and governmental nature to print as much as possible. Mises observed that fiat money leads to monetary policy designed to achieve political aims. Mises:

"The state should at least refrain from exerting any sort of influence on the value of money. A metallic money, the augmentation or diminution of the quantity of metal available which is independent of deliberate human intervention, is becoming the modern monetary ideal."

The Fiat Money System: Politically Motivated or Political Tool

To an extent, the enactment of a fiat money system is likely either to be politically motivated or to soon become a political tool in the hands of government. We have to see how government attempts to influence economic health through a variety of means and in tandem with Federal Reserve policy: raising and lowering interest rates, enacting tax incentives for certain groups, legislating tax cuts or tax increases, and imposing or reducing trade restrictions or tariffs. All of these moves invariably have a pro and con argued politically rather than economically. The argument in modern-day U.S. politics is between Republican desires to reduce taxes as a means of stimulating growth versus Democratic views that we cannot afford tax cuts and such cuts are given to favored upper-income taxpayers. The arguments are complex and endless, but they are not just political tools; they are part of overall monetary and economic policy trends as well.

This has become our modern entry in the history of money. The belief on the part of government, rooted in an arrogant thinking that power extends even to the valuation of goods and services and monetary exchange, has led to a monetary policy that makes utterly no sense in historical perspective. Having gone over entirely to a fiat standard, government has chosen to ignore history and those market forces that ultimately decide the question of valuation, in spite of anything government does. This has always been true, as Jeffrey M. Herbener observed:

"The use of the precious metals was historically the choice of the market. Without interference from governments, traders adopted the parallel standard using gold and silver as money."

If monetary policy were left alone and allowed to function in the free market, what would happen? Perhaps governments ultimately do follow the market by adopting the gold standard, as we have seen repeatedly in history: going on the gold standard, moving to fiat money, experiencing a debasement, and then returning to the gold standard. Herbener continued by observing,

"The fly in the ointment of the classical gold standard was precisely that since it was created and maintained by governments, it could be abandoned and destroyed by them. As the ideological tide turned against laissez-faire in favor of statism, governments intent upon expanding the scope of their interference in and control of the market economy found it necessary to eliminate the gold standard."

Today, we live with that legacy. While historians marvel at the "end of history" and the triumph of free market economics, the Fed maintains "price controls" on the very symbol of economic freedom – the U.S. dollar itself.


Addison Wiggin
The Daily Reckoning

August 18, 2005

Addison Wiggin is the editorial director and publisher of The Daily Reckoning. Mr. Wiggin is also the author, with Bill Bonner, of the international bestseller Financial Reckoning Day and the upcoming thriller Empire of Debt. Mr. Wiggin is frequent guest on national radio and television programs.

When we left off yesterday, we were exploring how we got into our current jam. No one ever proposed that America become an empire, but it did anyway. No one ever suggested that the nation drown itself in debt, but it is up to its eyeballs already. Things happen that no one particularly wants or especially encourages. And the average man goes along with whatever humbug is popular – with no real idea where it leads or why he favors it.

Each person plays the role given to him; everyone believes what he needs to believe to play the part.

Alan Greenspan was famously against paper money un-backed by gold – when he was a libertarian intellectual. When he became a government functionary, his views conveniently changed. He came to believe what he had to believe in order to be the head of the American empire’s central bank – the Federal Reserve. The empire needs almost unlimited amounts of credit – to carry out its foreign wars…while making bread and circuses available at home. Alan Greenspan makes sure it gets what it needs.

Expensive foreign wars…expensive bread…expensive circuses – these are, of course, what bankrupted almost every empire from Rome to London. But that is just the point; institutions play their roles, too. One grows; another decays. One is young and dynamic; another is old and decrepit. One has to die to make way for the new one to take its place. One has to ruin itself so that another may flourish.

Americans could cut their military budget by 75% and still have the biggest, most advanced army in the world. They could trim their household spending by half…and still live well. They could drive less, in smaller cars…they could cease mortgaging their houses…they could "make do" with last year’s clothes and yesterday’s laptop. But how could they ruin themselves if they put on the brakes before getting to where they are going?

Alan Greenspan’s easy money policies – the Fed has been lending money at a rate at or below the level of consumer price inflation for more than two years – do not merely lure Americans to borrow and spend. They also grease the skids of history, permitting one empire to slip away while another slides in to take its place. The main beneficiaries of the present gush of globalization are the Asians. As American consumers turn to Wal-Mart to buy more and more things at Everyday Low Prices, they find products from China and Malaysia on the shelves. Were it not for Greenspan’s low lending rates, they would not have found it so tempting to borrow. Were it not for Greenspan’s low rates, they would not have found it so alluring to spend. Were it not for Greenspan’s low rates, they would not have bought so much from Asian manufacturers, the Asians would have made less money and would have built fewer new factories and trained fewer new workers. Were it not for Greenspan’s lending policies, in other words, Asia would not have grown so quickly and would not now pose such a competitive threat to the rest of the world’s industries…and Americans would not owe Asians so much money.

More news, from our team at The Rude Awakening…


Chris Mayer, reporting from Gaithersburg:

"Unfortunately, the values available in the REIT sector aren’t quite as fresh as they used to be…or ought to be."


Bill Bonner, back in Ouzilly…

*** Surprise, surprise – it’s expensive to live in California…

San Diego’s Union-Tribune reports that the Golden State dwellers have to stretch and contort their incomes, just to afford their homes.

A new study shows that those buying homes in San Diego aren’t rich newcomers to the market, but middle-class thirtysomethings who are willing to pay a ridiculous amount of money on their mortgages.

The percentage of recent California homebuyers spending half their monthly income on housing is twice the national average, said Hans Johnson, who co-authored the study.

"For moderate-income Californians – those earning $30,000 to $60,000 – almost a third are spending more than half their income on housing," he added.

Interestingly, DataQuick Information Systems says sales of California homes and condos slowed in July, even as homebuyers helped push prices to new records.

Hmmm…the end is coming…but not quite yet…

*** Americans also believe that houses always go up in price. No cobwebs grow over a real estate office door. No mortgage lender sits by the phone waiting for it to ring. And yet, it is impossible for real estate prices to exceed the rate of GDP growth for very long. This belief too will have to be crushed out…by a long, bear market in property. Prices in Rome began a downturn in the year 300AD or so (this we do not know for a fact, it is just a good guess). They did not stop going down until a 1000 years later…in the Renaissance…or maybe later. Even as late as the 18th century, sheep were grazing where the Forum used to be.

The belief in the American empire – in American cultural, political, social and economic superiority – must also be crushed out somehow. That is the likely next phase…the degenerate stage of empire…

More to come…

The Daily Reckoning