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    Beard M. Beard

    I often think of one of Einstein’s thought-experiment elevators floating in the void. If we in the US elevator peep out our peephole and there’s Europe and China and Japan and the UK all pretty much in the same relative positions as before, are we rising? falling? floating? plummeting out of the galaxy? Hard to tell…

    According to one Georg Friedrich Knapp, writing in the late 19th century, doesn’t matter. Only one thing matters: Will the related governments accept their own currencies as payment in full of taxes? Classical economists such as Smith and Say had earlier pondered the same question and come away queasy. But Knapp thought that Fiat money was all to the good… to totalitarian governments, that is.

    Look out your peephole again. See those bright stars in the distance growing steadily fainter. That’s the Specie Constellation where the two main stars are gold and silver. The fact they are receding would indicate we’re falling, but if we’re in the same place as all the other money players, what difference does it make?

    How did we get to be a reserve currency?

    Following the Depression of 1920–21, the one that no one ever heard about because it was quickly over, the world decided it was time to get back on a gold standard to put an end to all the economic disruptions. And so was held the Genoa Conference (1922).

    Now, a gold standard is not ideal. Inflation is built-in whenever there is a significant gold or silver strike (rapid expansion of the money supply), and deflation is built-in whenever production keeps increasing despite no gold or silver strikes of import. And so, John Maynard Keynes, head of the British delegation, was successful at getting the convention to adopt a new scheme–a gold-exchange standard by promising the hybrid would make for a perfect balance.

    And well it might have except that he got away with two utter frauds of great magnitude. For reasons of British pride, the Pound sterling was to be restored to its pre-War value of $5.00 from the $3.50 it had been battered down to. Also, it was, along with the American dollar, to become a reserve currency, that is, a Gold certificate, a currency redeemable for gold as almost all currencies formerly had been–all other currencies would “float” against them. This despite the fact that Britain’s gold reserves were negligible, having been traded to the US for war materiel. To mask these deceits, the pound would be used only for government-to-government gold redemption, not ordinary consumer banking as would be the case in the US.

    We owe it all to J. M. Keynes

    The Great Depression is a misnomer. It was a recession followed by three depressions. The Genoa Conference plan was implemented started in 1926 and Keynes’s duplicity on the value of the pound started roiling markets soon after. By 1929, the US was in recession, which President Hoover helped none too much because as a progressive, he leaned toward the new Keynes school of economics. He immediately shored up wages, which had the effect of hampering the production cycle by limiting the capital stock available to finance it.

    The US already, being the world’s main reserve currency, was suffering from being a too-strong currency, a byproduct of Keynes’ new scheme he failed to foresee. Everybody wanted the world’s most secure currency, and this meant that it was cheap for Americans to buy goods produced overseas but expensive for them and everyone else to buy American goods. The recession exacerbated the problem, and the US responded in the summer of 1930 with the Smoot–Hawley Tariff Act, and immediately threw itself into a depression.

    Two years later, France, tired of British foot-dragging on payments, presented its reserve of 4 billion in pounds (=$20B then or $347B now) for redemption. Because of the Keynes fraud, Britain had no choice but to renege and renounce its reserve status, which event caused the whole world to join the US in the now Great Depression.

    Franklin D. Roosevelt talked a good fight, and on his assumption of office in 1933, the unemployment that had shot up from 5 to 9% with the Wall Street Crash of 1929 before settling down to 6+%, stood at its peak at a whopping 28%. From 6%, with passage of Smoot-Hawley it had skyrocketed to 14% in little more than a month and then on up to 17% by the time the British reneged on redeeming French-held pounds. Within a year, it peaked at 27.5% before diving sharply to 23 and then spiking to 28 coinciding with Roosevelt taking office.

    Note: I have seen a single source that stated unemployment for the Depression years was calculated similar to our U6 rate now rather than our reporting standard of U3 — Table A-15. Alternative measures of labor underutilization. I do not know for certain and would appreciate any insight that can be provided.

    Primarily because Roosevelt talked a good fight and rapidly started implementing his plans, unemployment steadily dropped to 20% in a year and then started to climb again. It had returned to 24% in the late summer of ’34 when a Republican undersecretary of Agriculture caught FDR’s ear and turned the Depression around. He pointed out that the US, as the world’s reserve currency, had had to print sufficient dollars to meet the demand of foreign governments for dollars with which to conduct trade–enough dollars that the overseas reserve alone exceeded the amount of gold in Fort Knox. Should our enemies conspire against us, not only could we be facing steep inflation with all those overseas dollars returning home, our gold reserves could be wiped out making the dollars already home worthless.

    Over the strenuous objections of Bernard Baruch and his other advisors, FDR repegged the dollar to gold. Throughout US history to that point a dollar bought 1.5 grams of gold. Per FDR, it would now purchase 0.85 grams. Everyone who held dollars had just received a 43% haircut, but honesty had been restored to the system with the dollar no longer overly strong. The resulting inflow of gold because of the higher price (from $20.67 to $35.00 per troy ounce) increased the money supply, and for the next three years unemployment zigged and zagged its way back down to 14%, where it had been in the wake of passage of Smoot-Hawley seven years earlier.

    Unfortunately, in 1936 Keynes forwarded Roosevelt a gift copy of his new book, The General Theory of Employment, Interest and Money, which extended his economic thinking into even more seriously bogus realms. “General theory” because he wanted to imply that all of liberal economics (Smith, Say, Ricardo, etc.) was really only a special theory, applicable in times of low unemployment. His general theory would work all the time and would be good for preventing or arresting recessions. He expressed this infamously as “money doesn’t matter,” that is, increasing the capital stock available to industrialists to get production going again was no longer the way to go. Better was for politicians to take charge and use fiscal (rather than monetary) methods–tax increases, wage protections and so on in order to increase demand for goods rather than the supply of goods.

    Despite the expansion of the money supply caused by the monetization of gold, the Federal Reserve System misread interest-rate signals and steadily increased banking reserve requirements, soaking up much of the money supply. When Roosevelt in ’36 pushed a Keynesian-style corporate undistributed profits tax, it caused great uncertainty about the future in the business world, and we were swiftly in the Recession of 1937–38, also known as the “Roosevelt recession,” the third of the depressions of the Great Depression. We were also back up over 20% unemployment and stayed at high levels until our participation in World War II started.

    Lesson: The depression of ’20-21 had larger starting metrics than the one that came along in 1930. It was over quickly because the US dollar was not then strong–it took a beating and adjusted–and because Harding and Coolidge were not fans of Mr Keynes.

    We owe it all to J. M. Keynes, Part II

    As with WWI, in WWII leading governments used inflation to wipe away the costs of war. In the last months of the war, another monetary conference was held, the Bretton Woods Conference, again with J. M. Keynes playing the role of “the smartest guy in the room.” The conference resulted in the Bretton Woods system of international monetary management. Again the US dollar would be the world’s reserve currency, no pretense about Britain any longer, but, in order to prevent damage to the US from an overly strong dollar, the US committed to a fixed rate of foreign aid and to overseas military bases and a role as the world’s policeman. It was thought these appreciable expenses would weaken the dollar offsettingly.

    And so started what is sometimes referred to as The Golden Quarter (Why has human progress ground to a halt? – Michael Hanlon – Aeon), the boom years from 1945 to 1971. By 1971, Nixon was clued in the same way Roosevelt had been. Not only did it cost forty cents to make a quarter, the amount of reserve dollars around the world was more than enough to wipe out our gold reserve. And so we got the Nixon Shock, as Richard “We are all Keynesians now” Nixon abandoned the gold standard and turned the dollar into a fiat currency backed by our “full faith and credit” but nothing more.

    And so where are we? The dollar that when my dad was in junior high would buy 1.5 grams of gold and when I was in college would buy 0.85 grams of gold now buys 0.025 grams, a 34-fold drop in value in 43 years!

    What is the reserve risk?

    With the demise of a dollar backed by gold, we are now in the world foretold by G. F. Knapp long ago, a world in which money is a very plastic tool of the political class to whom we have no choice but to give our “full faith and credit.” As Knapp pointed out, governments do not have to tax to get money; they can simply print it and use the resulting inflation as a tax. (He did not advocate giving up on taxing; he thought governments should do both.)

    And so we’ve had a four-fold growth of the adjusted Monetary base since the arrival of an administration that thinks that such far-left economics are the way to go.

    Yet, our published rate of inflation is less than a tidy 2.0% these days (that is, right in the sweet spot governments shoot for). But there are many ways to calculate inflation, and many ways to be deceptive in doing so. A growing number of voices say that we are being lied to (Shadow Government Statistics – Home Page); some say the lie is major: I’ve seen a plausible argument that the dollar now has a four-year half-life, which would mean inflation of around 16%, and that seems closest to my own rough calculations.

    One way to disguise the inflation from the flood of printed money is to offshore it, that is, to put it in the portion used in international commerce by using it for overseas debts and purchases. Another way is to have people look out the peephole and see the euro and the yen and the yuan, et cetera, in roughly the same relative position.

    There is no fundamental reason the dollar should remain the world’s primary reserve currency. Indeed, several currencies have been much stronger than the dollar of late, but these have been in countries like Switzerland and Singapore with an insufficient monetary base to use as a world reserve. (We had the surreal experience summer before last of a visit from a couple of Swiss misses, a secretary and a housewife. We took them to some of Fort Worth’s more chi-chi western stores, where I urged them to try on cowboy boots, which they were admiring at a distance. I completely understood when they said, no, they’d been spending money like crazy and such beautiful boots would be too expensive. Then one walked up and looked at a price tag and was astonished, “Only $650 for a pair! Let’s each get a pair and then look at the accessories.” Those gals were playing in a different league from me. The Swiss flying elevator is in a different orbit from ours.)

    We seem to be in a place where a lot of economic brinksmanship is going on. Should inflation become more visible, a lot of money will need to be carefully vacuumed from the base. Having the dollar remain the reserve currency has been enabling for managing our debt and being able to borrow more, but maybe not in a good way– Paying Down The Debt Is Now Almost Mathematically Impossible.

    A decade ago the euro seemed like a sure bet to replace the dollar as the reserve currency, then we got the PIGS (economics). Before that, the yen had been a candidate. But Japan now has a debt-to-GDP ratio of 250%. China too makes noises about bumping the dollar out of the reserve status, but they keep devaluing the yuan (renminbi) to keep it from appreciating against the dollar so as to protect their export base, the engine of their economy (but to the detriment of the Chinese people themselves as consumers).

    In the old economy before the First World War, the nations of the world were a train of linked cars pulling in lockstep. From there, they were more like race cars on a track, jockeying for position and advantage. And now we find ourselves hurtling along in space. Who knows what’s in store? How sage was the German totalitarian on whom all this hangs? But one thing is for sure, if the wings start to come off at this speed, it’ll get ugly fast.

    Beard M. Beard

    Just as the British Pound was replaced by the US dollar, the dollar will be replaced by something else. Quite probably it will be an international unit determined by averaging the value of a basket of major currencies.

    The US position as the dominant economic power is an historical fluke produced by the devastation of all of the other major powers in the Second World War. The US was the last man standing and domestically unscathed by the conflict. US GNP amounted to 50% of the world economy after the war but is now less than 25% and declining steadily as China and others grow at a faster rate. The US has been able to use its position to control the IMF, World Bank, WTO and other institutions to support the dominance of the dollar. Having the world oil markets denominated in dollars helps, too.

    The deteriorating financial position of the United States and and its shrinking share of the global economy will eventually lead to the end of the dollar as a reserve currency. The US will use every possible device to retain its position and other countries will hesitate to challenge the dollar’s position until a clear alternative is presented. In the meantime, the overvaluation of the dollar is distorting international markets and has become in some ways a liability, but everyone is afraid of the possible consequences the fall of the dollar might have on the stability of the world economy.

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