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SPEAKING FREELY
Dollar, my
foot
By Antal E Fekete
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click
here
if you are interested in
contributing.
Recitativo
The United States
abandoned its policy of stabilizing gold prices
back in 1971. Since then the price of gold has
increased about 1,000%, while consumer prices have
increased only about 250% 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 default 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 price volatility that has been
plaguing the world ever since, causing ever
greater economic distress. Paul 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% -
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 current price of gold is
$420. Let us calculate the discount on the dollar.
At the time the US defaulted on its gold
obligation to foreign creditors in 1971, $35 was
the price of 1 ounce of gold . Therefore the gold
value of the dollar was 1/35 oz. If the gold price
is $420 per oz, then the current gold value of the
dollar is 1/420 oz. So in terms of gold, dollar
has lost: 1/35 - 1/420
Now,
1/420 = 1/(35 times 12)
= (1/35)(1/12). Therefore the
loss is
1/35
- 1/420 = 1/35 - (1/35)(1/12) = (1/35)(1 - 1/12) =
(1/35)(12/12 - 1/12) = (1/35)(11/12) =
(1/35)(0.9166)
In
percentage terms, the loss, also known as
discount, is 91.66%. Not yet 100, but close
enough. Small comfort, as the last 8.33% 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%, 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 an irredeemable currency,
although obviously approaching 100%, never does so
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 a 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 US, 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 1930s,
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 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 are hard to measure but they must be
significant.
Rondo
It is
disingenuous to say that in 1971 the US made the
dollar "freely floating". What the US 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 had 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% 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 re-established, 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, 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's 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 US 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 is
Professor Emeritus at the Memorial University of
Newfoundland
(Copyright 2005 Antal
E Fekete.)
Speaking Freely is an Asia
Times Online feature that allows guest writers to
have their say.
Please click
here
if you are interested in
contributing. |
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