Money, Gold, and the American Way

EVERY day, billions of people wake up with unique expectations for what their day – and the days to follow – will bring. Then they set off in pursuit of their personal callings, striving in direct proportion to 1.) how well they will be rewarded for their efforts; 2) how well they can protect and preserve their rewards; and 3.) how readily they can exchange what they earn for the stuff of their dreams. If their society’s monetary system is strong, people will literally create miracles. But if their money’s no good, they may not even bother getting out of bed….

Before the Industrial Revolution (1760-1850), the world’s population and the amount of goods and services that people produced each year barely changed. So the size of the world’s money supply didn’t need to change much either... This made gold an excellent choice as the world’s common currency because its supply was pretty constant; it didn’t decay, was relatively scarce, and could be pounded into foil or melted into standard sizes for exchange.

Eventually, when economic growth began rising in earnest, some countries boosted their money supplies with silver so they could facilitate the “circulation” of all the new goods, services, and people that were being added to their economies. And with added prosperity came a growing appetite for additional money to spend, save, and invest.

In the 19th century, gold’s luster began to dull:  accelerating growth and economic shocks such as the American Civil War exposed the vulnerabilities of a purely metallic monetary system. When faced with paying usurious lending rates for gold, President Lincoln decided instead to pay his wartime vendors with “Greenbacks,” America’s first successful fiat currency – “successful,” because Greenbacks held their advertised values pretty well (something that could not be said for how “Continentals” fared during the American Revolution).

After the War, Greenbacks were gradually retired from circulation and America reduced its money supply so it could rejoin the gold standard. But changes in worldwide ore stocks have nothing to do with changes in a particular country’s economic output.  And just when U.S. immigration was booming and national productivity was growing logarithmically, U.S. money supply was dawdling… The “Great Depression” caused by this imbalance (1873-1879) was later renamed the “Long Depression” after another dramatic period of inadequate money supply struck the world six decades later.

[Whenever GDP grows substantially faster than the money supply, deflation will occur – wages and prices will fall. Deflation is bad because money borrowed last year becomes unexpectedly difficult to repay this year. Businesses fail…households fail. Conversely, if money supply growth significantly outpaces GDP growth, then consumer prices will mysteriously rise (inflation), and asset “bubbles” will appear, typically in sectors such as art, equities (stock markets), real estate, and government (Treasury Bonds).]

During the 20th century – after a good run lasting more than two millennia – gold-based currency systems met their demise. Great wars and vastly expanded governmental responsibilities demanded far more monetary agility than precious metals could possibly deliver. Arms races and global trade redefined what was required to “provide for the common defense”…and governments began stringing massive social safety nets too – not only for their poor, but also for their middle- and upper- income folks as well. They became glorified insurance companies with militaries (see RM#3).

But safety nets certainly have their place, because the “creative destruction” that pure-form capitalism delivers sometimes knocks people down so hard they can’t get back up… The trick lies in finding the social support “sweet spot,” where people are assisted just enough to get “back in the fight,” but not so much that they lose their desire to compete.

The Value of Money

Money is an instrument that nations use to manage their wealth; it isn't the wealth itself. Successful monetary policy makes the money supply a geometric function of a country’s underlying wealth and its level of monetary transactions. The fact that gold is shiny and actually has some intrinsic commercial value is actually a distraction, because the fashion sensibilities of women in India and their rising or ebbing attraction to gold – a major factor in its price – should have nothing to do with its value as a currency.

No longer tied to gold, the U.S. dollar is now determined instead in a “money market,” where buyers and sellers haggle over the cost of entering the Dollar Economy. “Ticket prices” are based upon the following:

1. U.S. goods and Services being more attractive than foreign goods and services (strengthens $)

2. U.S. Rule of Law (fair, universal, and enforceable) and adherence to Property Rights (Example of what NOT to do:  Allow government to move labor union claims ahead of shareholder claims when restructuring  GM during its bailout)

3. Price Stability, i.e. avoid inflation over 2%/year, by avoiding:

a. Excessive governmental borrowing that’s paid for by “key-stroking” new money into existence instead of raising taxes and reducing spending (weakens $)

b. Extended periods of artificially low borrowing costs combined with governmental guarantees to cover losses, which creates “moral hazard” and incentivizes gambling and “malinvestment” (weakens $)

4. Competitive Returns on U.S. Savings (strengthens $)

5. Hearty U.S. Culture:  Strong work ethic and globally competitive levels of educational attainment (strengthens $)

6. Superior Market Information leading to transparently created and properly rated (risk-adjusted) dollar-based financial products (strengthens $)

7. Exports or Imports Focused:  Purposely weakening the dollar to boost export-driven industries or doing the opposite to support U.S. consumers and lower the costs for U.S. businesses that import raw materials

8. U.S. Economic Shocks from weather, accidents, mortgage defaults, Baby Boomer retirement costs, persistently high unemployment, infrastructure crises, pension crises, student loan defaults, political dysfunction, and military interventions, etc. (weakens $)

9. U.S. Economic Boons from scientific breakthroughs, domestic energy exploitation, healthcare reform, intellectual property law reform, getting regulation right, admitting more high-skilled immigrants each year, and establishing a legal means for other productive and entrepreneurial ones currently hiding in the shadows to enter the mainstream, i.e. taxable, economy, etc. (strengthens $)

10. Foreign Currencies  faring better with the above than the U.S. (weakens $) or worse (strengthens $)

Many look solely to the Federal Reserve to protect the U.S. dollar… But we play a huge role in the soundness of our money. And anyway: the conditions that may one day precipitate the dollar’s crash on global currency markets are the very same ones that would have also caused a run on U.S. gold reserves – “gold flight” – if we were still on the gold standard….

So let’s set off today in pursuit of what we can do to help the U.S. dollar ourselves… We can consider what the Federal Reserve and Wall Street should do next time....