Question-The Dollar, Fiat currencies, and Gold

[HenryKnoxFineBooks]

OK, here's my question:

I understand the Fed, and it's ability to print money out of thin air, to arbitraily set interest rates, (and the new tricks its learned in the past week or so). And I understand Rep. Pauls position on Gold backed currency. I see how our dollar is falling, and how inflation is driving up prices (CPI, etc).

My question is, since all the world's nations use fiat currencies, is the US dollar being destroyed just because of the LEVEL of "printing" of new monies of the USA vs. the other nations? And if we were to balance the budget and begin reducing the National debt, would that stablilize the dollar? Or is it's decline inevitable? And will other nation's (i'm thinking first world nations here) currencies suffer the same fate? or is it just the amount of our over-printing that is the cause?

And , finally, if we do go back on the gold standard, would that destroy the rest of the world's currencies?

Sorry for the string of questions, they flowed one from the other.

 

[Cleaner44]

My question is, since all the world's nations use fiat currencies, is the US dollar being destroyed just because of the LEVEL of "printing" of new monies of the USA vs. the other nations?

Most of the world uses fiat but I do not think that all do. I believe the biggest threat to the dollar is the possible loss of being the world's reserve currency.

And if we were to balance the budget and begin reducing the National debt, would that stablilize the dollar?

No. If we printed $50 billion new dollars tomorrow we could pay off our debt but the dollar would be destroyed.

Or is it's decline inevitable? And will other nation's (i'm thinking first world nations here) currencies suffer the same fate? or is it just the amount of our over-printing that is the cause?

In my opinion, as long as we have the Fed and no backing to our currency, then yes, the decline is inevitable.

And , finally, if we do go back on the gold standard, would that destroy the rest of the world's currencies?

No. Pre 1971 we still had gold backing and the world's currencies were pegged to the dollar and relativly stable.

 

[ron_paul_silver_dollars]

Politicans like fiat money becuase there's basically no accountability to govt. mistakes when fiat dollars are blown... they just print more and add it to the debt.

A Gold backed currency backstops govt. waste... and thats bad for avg. pork ladden politician.

 

[bale002]

A Gold backed currency backstops govt. waste... and thats bad for avg. pork laden politician.

But there are ways for politicians to corrupt the gold standard as well. Besides modern examples, look at the Roman Empire in the Third Century.

In short, interest rates should be set at a point where domestic production is in balance with consumption, and increases in money supply should be commensurate with increases in productivity.

Over the past several years, US policymakers have kept interest rates low and increased the money supply to allocate resources to such endeavors as import consumption, the building of energy-inefficient housing, the manufacture of energy-inefficient cars, and an inefficient foreign energy war.

All hardly productive enterprises, not to mention waste in a whole host of other sectors, such as health care and education, to name a few.

In principle, policymakers can manage a fiat system well, and they can also corrupt a gold-standard system.

Now, it may be argued, even successfully, that politicians would have a more difficult time in corrupting a gold-standard system than a fiat-currency system, but history shows that they manage to corrupt both.

One of our goals is to restore sound money; i.e. the means of exchange, the unit of account, and the store of value. Most of all, US policymakers have grotesquely impaired the dollar as a store of value.

We need to focus on the most efficient way of restoring sound money, technically, politically, socially, morally.

 

[Ozwest]

OK, here's my question:

I understand the Fed, and it's ability to print money out of thin air, to arbitraily set interest rates, (and the new tricks its learned in the past week or so). And I understand Rep. Pauls position on Gold backed currency. I see how our dollar is falling, and how inflation is driving up prices (CPI, etc).

My question is, since all the world's nations use fiat currencies, is the US dollar being destroyed just because of the LEVEL of "printing" of new monies of the USA vs. the other nations? And if we were to balance the budget and begin reducing the National debt, would that stablilize the dollar? Or is it's decline inevitable? And will other nation's (i'm thinking first world nations here) currencies suffer the same fate? or is it just the amount of our over-printing that is the cause?

And , finally, if we do go back on the gold standard, would that destroy the rest of the world's currencies?

Sorry for the string of questions, they flowed one from the other.

Yes, to all of the above.

Last ghasp time!

 

[Ozwest]

No, to some of the above.

 

[Ozwest]

Inflation, is the "decider."

Act appropriately.

 

[Acala]

Good question

The dollar is being destroyed through inflation and deficit spending.

The exchange value of money is determined by supply and demand just like the exchange value of any other commodity. If the supply goes up and demand stays the same, the exchange value goes down. If supply stays the same and demand goes down, the exchange value goes down. Both of these things are happening to the dollar right now.

By creating excess money, the Fed increases the money supply beyond demand and the dollar loses value. Much of this inflation over the last few decades has been hidden by the growth in the US economy AND by the growth in the world economy - because the world has used the dollar as its reserve currency and as the main currency of world trade. This international use has created a demand that has sucked up much of the extra dollars and most countries have pegged their currencies to the dollar so they don't get priced out of the US market. In this way, the Fed's inflation of the dollar drives world inflation.

But because countries like China have not followed dollar inflation in lockstep, their goods have been cheap compared to ours and have driven our industry off-shore to take advantage of the currency differential. So the Fed's inflationary monetary policy has had a lot to do with the loss of US industry.

The value of the US dollar depends heavily on its continued use by the world. But that is in jeopardy now. Our massive debt and programmatic obligations (SS and Medicare) that we have NO WAY to meet except by more inflation, are scaring people away from the dollar. Countries holding an inflating currency as a reserve get screwed. So the world is moving away from the dollar. That means reduced demand. Reduced demand means more inflation. As more countries move away from the dollar, the demand goes down, increasing inflation, inducing more countries to move away from the dollar, reducing demand, increasing inflation. Rinse and repeat. Eventually we will have a mad rush by the world to unload dollars. And several countries are waiting in the wings to introduce their currencies as the new world currency.

At the same time as the world is starting to reduce demand for dollars, the Fed is churning out new dollars to try and keep the US credit bubble inflated and to bail out failing banks. Additionally, as government revenues fall due to recession and obligations increase due to retiring baby boomers and new government promises and programs, the government will have only two choices - create massive amounts of money to cover its obligations and to pay off special interests OR bite the bullet and cut spending, balance the budget, let the recession happen, and start over with a program of fiscal and monetary responsibility. If it chooses the former road (and I think it will) we will end up with hyper-inflation. Falling demand internationally and increasing supply to keep the Federal leviathan moving. Bye bye dollar.

A prior poster has suggested that a low level of inflation is desirable. This Keynesian/monetarist theory has been completely debunked by capital-based macroeconomics (Austrian macroeconomics). The reason the Keynesians and Monetarists think it is good to have a little inflation is because they do not recognize the distortion inflation causes to capital structure. In other words, inflation at any level cause malinvestment because business is mislead about people's actual willingness to postpone consumption. So industry over-invests in long-term projects that don't come to fruition. Continued inflation fills the economy with this malinvestment, based on fractional reserve debt-based currency, until something happens to trigger a pull-back and then the market tries to correct the malinvestment creating a recession. Even low levels of inflation lead to the boom/bust of the business cycle. And only increased rates of inflation will prevent the bust. SO an inflationary monetary policy leads to distortions in capital structure and either cyclic booms and busts OR continuously increasing rates of inflation that ultimately destroy the currency. And that is where we are now.

A prior poster also suggested that government should set interest rates at a particular level. First of all, it is not possible for government to know what the interest rate should be. The interest rate is a measure of people's time preference for consumption. The interest rate reflects to what extent people are willing to postpone spending their money today in exchange for getting more at a later date. Based on the interest rate, business borrows the saved money and makes changes to production to produce more at a later date to satisfy the postponed - but increased - demand. It is IMPOSSIBLE for government to know what people's aggregate willingness to postpone consumption is. Therefore, government will always just be taking a stab in the dark when it sets interest rates. Second, there is no reason for government to set interest rates even if it could. Absent government manipulation and fractional reserve banking, the market will set interest rates right where they need to be.

Yes, a gold or silver based currency can be corrupted - through the trickery of fractional reserve banking or through physical debasement of the coinage. You can even have accidental inflation of metal currencies as when the massive amounts of gold stolen from the New World by Europeans went into circulation or when the Comstock silver vein in Colorado was extracted. But there have been many instances where gold and silver coinage have remained stable for centuries. There is no instance of a paper currency remaining stable for even a few years. Repeating history is a bitch!

 

[bale002]

Excellent post by Acala.

Two points are worth special highlighting.


1) the Fed's inflationary monetary policy has had a lot to do with the loss of US industry.

2) Our massive debt and programmatic obligations (SS and Medicare) that we have NO WAY to meet except by more inflation

And a third point needs clarification.

3) A prior poster also suggested that government should set interest rates at a particular level. First of all, it is not possible for government to know what the interest rate should be.

Assuming you were referring to my post, I did not write that the government should set interest rates. I wrote

interest rates should be set at a point where domestic production is in balance with consumption, and increases in money supply should be commensurate with increases in productivity.

The sentence is in the passive voice, the subject is vague. To put it in very formal terms, the IS-LM curve should set interest rates, and I wish someone would hit Bernanke over the head with it.

In other words, we agree that the market should set interest rates, the equilibrium level at which demand/supply for saving/investment meets demand/supply for cash and money market instruments.

 

[Acala]

Cool

Thanks for the clarification Bale002. When you hit Bernanke over the head, I will hold him.

But I think it is only fair to point out that he didn't create the problem, he inherited it. He is making it worse and he probably WOULD have created the problem if he had been Fed chairman instead of Greenspan. But if Bernanke should be hit over the head, Greenspan should be tarred and feathered.

As long as I am on here blabbing again instead of working in the yard, I should add that another problem with even low levels of inflation that the Monetarists and Keynesians don't recognize is that inflated currency doesn't just appear in the economy in a uniform manner - it spreads out from certain sectors creating different effects depending on where you sit relative to the source of the expanding currency. If you are close to the source, you get more money to use against prices still based on the previous lower money supply. Just the opposite happens at the far end - higher prices with lower wages. This is why real wages (adjusted for inflation) have been in decline since the 70s. This is why it now takes two average incomes to raise a family. This is why the middle class and working poor are being eaten alive while Wall Street and the Bankers get rich. As Ron Paul points out, it is a secret tax and very anti-progressive in the sense that it impacts the poor and middle class disproportionately. It is in this way that the financial elite have slowly and steadily sucked the wealth out of the country. There is a special place being warmed up in Hell . . .

 

[freedominnumbers]

It should be noted as well that any "setting of rates" by the fed is a problem for the market. This is because what that means is the fed is giving it's printed money out at a rate which is less than private investors who are investing their own money would demand. This is inflationary, creates less efficiency in economic development and discourages savings (private investment) as well as having many other negative impacts.

 

[scooter]

Thanks for the clarification Bale002. When you hit Bernanke over the head, I will hold him.

But I think it is only fair to point out that he didn't create the problem, he inherited it. He is making it worse and he probably WOULD have created the problem if he had been Fed chairman instead of Greenspan. But if Bernanke should be hit over the head, Greenspan should be tarred and feathered.

As long as I am on here blabbing again instead of working in the yard, I should add that another problem with even low levels of inflation that the Monetarists and Keynesians don't recognize is that inflated currency doesn't just appear in the economy in a uniform manner - it spreads out from certain sectors creating different effects depending on where you sit relative to the source of the expanding currency. If you are close to the source, you get more money to use against prices still based on the previous lower money supply. Just the opposite happens at the far end - higher prices with lower wages. This is why real wages (adjusted for inflation) have been in decline since the 70s. This is why it now takes two average incomes to raise a family. This is why the middle class and working poor are being eaten alive while Wall Street and the Bankers get rich. As Ron Paul points out, it is a secret tax and very anti-progressive in the sense that it impacts the poor and middle class disproportionately. It is in this way that the financial elite have slowly and steadily sucked the wealth out of the country. There is a special place being warmed up in Hell . . .

That is a false statement. Milton Friedman is probably the most famous monetarist of all time and he was the one who originated the argument that those who get to the new money first benefit from it while those who get it last or not at all only receive a negative effect.

As for the OP... Yes, the US dollar is declining in value because it is being inflated faster than other fiat currencies of the world.

And it is not feasible for us at the government level to return to a gold standard because the rest of the world is not on one. It would put us in a pretty tough competitive disadvantage.

Fiat money is not going anywhere. I don't see it as a major problem if it was allowed to be dictated by the free market. It's government spending and corruption that has destroyed the dollar under the fiat system. By the way, those things were pretty prevalent in the gold standard years as well.

 

[bale002]

Fiat money is not going anywhere. I don't see it as a major problem if it was allowed to be dictated by the free market. It's government spending and corruption that has destroyed the dollar under the fiat system. By the way, those things were pretty prevalent in the gold standard years as well.

I tend to agree.

I think we all agree that the goal is sound money. But I don't see how eliminating the Fed and going back to the gold standard are necessarily the most efficient and realistic means of achieving that goal.

It may be, but I would need to analyze a persuasive argument why.

I would argue in favor of firing the entire current Fed Board of Governors and changing the Fed's statute, taking away its mandate for growth and full employment, and having it concentrate on price stability and equilibrium between domestic production and consumption, perhaps at most setting a range for a target interest rate that envelops the equilibrium point on the IS-LM curve.

As mentioned, that is impossible for the government to figure out exactly, but some sort of range may be possible. In the past, some central banks in Europe had a target range, letting the market determine the actual interest rate within that range at their periodic money market auctions.

 

[Bryan]

Keep in mind, the only reason this matters is due to forced taxation- without that you could use whatever currency you wanted.

 

[Acala]

Citation please

Scooter, please provide a citation to Friedman's writings for this proposition:

"Milton Friedman is probably the most famous monetarist of all time and he was the one who originated the argument that those who get to the new money first benefit from it while those who get it last or not at all only receive a negative effect."

Actually it was Milton Friedman who was famous for talking about inflation using the "Angel Gabriel" fable where suddenly everybody has twice as much money in his pocket - a fable that ignores the important disparity in the movement of inflation through the economy.

Scooter, you also say :
"the US dollar is declining in value because it is being inflated faster than other fiat currencies of the world." That is not the whole picture. Even if other currencies were inflating faster than the dollar, the dollar would still be losing exchange value because it is increasing in supply. The inflation rate of other currencies impact trade but increasing the dollar supply causes dollar inflation without regard to other currencies.

Please explain:

"it is not feasible for us at the government level to return to a gold standard because the rest of the world is not on one. It would put us in a pretty tough competitive disadvantage."

How is a fiat currency an advantage? How is hard currency a disadvantage? How did the US do so well in international trade from the time of the civil war up until 1971 when the last tie to gold was severed? Many other countries had fiat currency at that time. Why would people NOT want to trade with an ultra-stable currency protected from government meddling?

Please explain:

"Fiat money is not going anywhere. I don't see it as a major problem if it was allowed to be dictated by the free market."

How can you have a free market fiat currency? The definition of a fiat currency is one that people are forced to accept by government fiat (meaning command). How can the market be free but with a compulsory currency created by government? A free market fiat currency is an oxymoron. And how can you have a compulsory currency controlled by government that is NOT subject ot political corruption?

 

[kyleAF]

That is a false statement. Milton Friedman is probably the most famous monetarist of all time and he was the one who originated the argument that those who get to the new money first benefit from it while those who get it last or not at all only receive a negative effect.

As for the OP... Yes, the US dollar is declining in value because it is being inflated faster than other fiat currencies of the world.

And it is not feasible for us at the government level to return to a gold standard because the rest of the world is not on one. It would put us in a pretty tough competitive disadvantage.

Fiat money is not going anywhere. I don't see it as a major problem if it was allowed to be dictated by the free market. It's government spending and corruption that has destroyed the dollar under the fiat system. By the way, those things were pretty prevalent in the gold standard years as well.

If spending and corruption were present under both a gold and a fiat standard, yet the currency is just now being destroyed, then wouldn't it make sense to first assume that the uncommon factor is to blame? I.e. the change in monetary standards? The corruption and spending are a common factor.

Returning to a gold standard is feasible. Of course, if you're thinking of returning to a gold standard at the level that we left it, then of course it isn't feasible. If we freeze the gold market at, say, $40,000.00 per ounce, and make that our new standard, then the currency will stabilize. (Yes, it's more complicated than that, since a great deleveraging and deflation would have to occur...oh wait, it is) All it would do to us in relation to the rest of the world is reaffirm our currency's reserve status. Many political changes would be needed here at home, too. This assumes we actually have our gold in Fort Knox still.

Milton Friedman would likely agree with what Bernanke is doing right now, if not how.

 

[Acala]

Ludwig von Mises

Scooter,

Ludwig von Mises introduced the idea of inflation moving through the economy impacting different sectors differently in his great book "The Theory of Money and Credit"(pg. 497). It was published in 1912. Milton Friedman's comment at the time was purportedly "goo goo" since that was the year he was born.

 

[scooter]

Scooter, please provide a citation to Friedman's writings for this proposition:

"Milton Friedman is probably the most famous monetarist of all time and he was the one who originated the argument that those who get to the new money first benefit from it while those who get it last or not at all only receive a negative effect."

Actually it was Milton Friedman who was famous for talking about inflation using the "Angel Gabriel" fable where suddenly everybody has twice as much money in his pocket - a fable that ignores the important disparity in the movement of inflation through the economy.

Okay, I'll admit, "originated" is a poor word choice. However, it was Friedman who popularized these ideals. Read chapter 2 of his book "Money Mischief." I do not have it in front of me, so I can't give any quotes, but he discusses the fable you mention thoroughly. And he specifically discusses the "money helicopter" where it drops money to instantly double the paper in the system. However, he also discusses at length how in this theoretical scenario, certain people get to the dropping point and pick up more money than others do, while some do not get any of the new money. He concludes that this is the problem with inflating the money. If everyone got an equal chunk of the new supply, then there would be no net change. People would save twice as much and prices would double. However, because it is uneven in distribution, that is where you have the widening gap between haves and have nots.

Please explain:

"it is not feasible for us at the government level to return to a gold standard because the rest of the world is not on one. It would put us in a pretty tough competitive disadvantage."

How is a fiat currency an advantage? How is hard currency a disadvantage? How did the US do so well in international trade from the time of the civil war up until 1971 when the last tie to gold was severed? Many other countries had fiat currency at that time. Why would people NOT want to trade with an ultra-stable currency protected from government meddling?

Do some research on the massive deflation that took place in the late 1800s as the United States went back to a metal standard from the greenback era. There was practically a 20-year depression because the government was determined to deflate prices and reduce money so that they could resume transferability with gold. In fact, this era culminated with William Jennings Bryan's rise to fame merely because he was fighting on the side of the free-silver movement. That movement was a challenge to the gold standard because it's massive deflation was terrible for the economy. Bryan was only silenced by the fact that new gold discoveries in South Africa and a new extraction process caused a significant amount of gold to come onto the market and inflated the money supply enough to finally keep up with growth.

Please explain:

"Fiat money is not going anywhere. I don't see it as a major problem if it was allowed to be dictated by the free market."

How can you have a free market fiat currency? The definition of a fiat currency is one that people are forced to accept by government fiat (meaning command). How can the market be free but with a compulsory currency created by government? A free market fiat currency is an oxymoron. And how can you have a compulsory currency controlled by government that is NOT subject ot political corruption?

Sadly, fiat money is here to stay. I think that competing currencies is an excellent idea, but the government is in too deep to swtich from their paper standard now. I don't think anyone wants to go back to the wild fluctuations of Bryan's time where disturbances in the metals market could cause so many economic problems. Of course, metals markets are much more stable now, but who can say that it will remain that way. I will say, though, that the bimetallic standard of gold and silver before the Civil War was an outstanding system. The monometallic standard of gold after that was not nearly as "sound" as you claim it was.

What I meant by fiat money dictated by free markets was to allow the free markets to set interest rates. Having a money supply that freely fluctuates with the demand for money through the loan process is much better than the artificial demand that the Fed generates.

If spending and corruption were present under both a gold and a fiat standard, yet the currency is just now being destroyed, then wouldn't it make sense to first assume that the uncommon factor is to blame? I.e. the change in monetary standards? The corruption and spending are a common factor.

Returning to a gold standard is feasible. Of course, if you're thinking of returning to a gold standard at the level that we left it, then of course it isn't feasible. If we freeze the gold market at, say, $40,000.00 per ounce, and make that our new standard, then the currency will stabilize. (Yes, it's more complicated than that, since a great deleveraging and deflation would have to occur...oh wait, it is) All it would do to us in relation to the rest of the world is reaffirm our currency's reserve status. Many political changes would be needed here at home, too. This assumes we actually have our gold in Fort Knox still.

Again, do some historical research on money. There were many cases of depressions and turmoil in markets because of currency problems. You are right that the currencies weren't "destroyed," but you ignore the extreme problems caused by the deflationary depressions of the 1890s and 1920s. Also, it is important to remember that a gold standard wasn't present until 1879. Before that we were on a bimetallic standard where silver was the preferred metal.

The last part of your comment is good. Returning to a gold standard under previous conditions is not possible following the massive growth in output and money that has occured since then. It would have to be done under new ratios and would need to be handled differently. If you think "a great deleveraging and deflation" would be a fun time, then I suggest you read a little bit of William Jennings Bryan's speeches and writings from before his 1896 presidential bid. Most of the working class was NOT happy with this very same effort that was undertaken to restore gold after the Civil War.

It's called closing the barn door after the horse has already been stolen.

 

[jon_perez]

My question is, since all the world's nations use fiat currencies, is the US dollar being destroyed just because of the LEVEL of "printing" of new monies of the USA vs. the other nations?

It's more to do with interest rates rather than "printing" money per se. Low interest rates result in two things: Exchanging of the currency with the lower interest rate to buy currencies with relatively higher ones (so-called covered interest-rate parity arbitrage). The lower interest rate also encourages higher supply or faster creation/injection of that currency into the economy since it tends to be easier to borrow from the central bank (who creates the new money out of nothing).

Remember that central banks lending money into the economy is the only means, afaik, that money is created. Although I was wondering, why can't central banks, by paying interest on money deposited with them, perform the same money creation role?

And if we were to balance the budget and begin reducing the National debt, would that stablilize the dollar?

Sure, but remember that if you do it at the expense of having a recession and US productivity slows down as a result, it might not necessarily strengthen the dollar (or it might as Japan has paradoxically shown). You also have to realize that there is a high price to pay for recession because you will get unemployment. Seems that the political will to tolerate unemployment is always in short supply (blame you and me for that...).

Or is it's decline inevitable? And will other nation's (i'm thinking first world nations here) currencies suffer the same fate? or is it just the amount of our over-printing that is the cause?

Well, to listen to some analysts, what is going on today is that many countries are pressured to devalue their currencies as well in order for their exports to remain competitive with US ones. Because they also do this by lowering their interest rates, global inflation is the result.

And , finally, if we do go back on the gold standard, would that destroy the rest of the world's currencies?

I don't think so. What backs a currency is not necessarily gold, but rather the assets it can buy or the quality of debt behind it. (hmmm.... maybe we should start shorting the yen... but not against the USD...)

If country X issuing currency cX produces widgets wX that the rest of the world needs, then demand for cX would in some way be tied to the demand for wX. Gold is not the only commodity around you know...

While gold has a lot of practical utility as money and "store of value", there is nothing mystical about it. On the other hand it, together with silver and other precious metals (and even other commodities) often serves as a good barometer of the quality and supply (especially oversupply) of fiat currencies.

 

[jon_perez]

A prior poster also suggested that government should set interest rates at a particular level. First of all, it is not possible for government to know what the interest rate should be. The interest rate is a measure of people's time preference for consumption.

Of course, the main interest rate that the central banks have influence over are short term ones only. Long term interest rates are set by the market. But that, on the other hand, does not mean their levels are not influenced or distorted by the short term ones that central banks set.