by Steve Forbes
Politicians and pundits worldwide have all sorts of explanations for the crises and malaise: greed, reckless speculation in dangerous currency markets, excess debt, inequality, and American capitalism itself. But the true cause is the ignorance of policy makers, whose ideas about money have been handed down from the mercantilists of the Middle Ages. These officials have been unable or unwilling to grasp a simple truth: money is not wealth. It is like a scale or a ruler—a measure of value.
Few people would see any advantage in constantly changing the number of inches in a foot or the number of minutes in an hour. Imagine the disruption that would cause. Nor does anyone think that each of America’s 50 states should have its own currency or that each one should fluctuate against all the others. Think of how hard it would be for Americans in different states to buy and sell to each other. How hard would it be to travel if you weren’t sure what your Wisconsin dollars would be worth in Florida? Most people would consider such a system uselessly complicated and chaotic. Yet this is what happens daily between nations as a result of our global monetary system of fluctuating exchange rates.
The End of the Gold Standard Ushers in Currency Chaos
Astonishingly, bureaucrats and officials understand less about money today than they did a century ago. This basic ignorance has given us not only the disasters of the last decade but also the Great Depression and the Great Inflation of the 1970s. More than 40 years ago, it led to the end of the gold standard and the destruction of the U.S. dollar as a vital anchor of value for the world’s currencies and the global economy.
The dollar had been linked to gold since George Washington was president. Near the end of World War II, with much of the global economy and monetary infrastructure in ruins as a result of that conflict and the Great Depression, Allied nations met in Bretton Woods, New Hampshire. Their objective: to devise a new international monetary system. It was agreed that the dollar would remain linked directly to gold at $35 an ounce. Other nations would fix their currencies to the dollar.
The Bretton Woods gold standard lasted from 1944 to 1971. Then, for reasons we will discuss, Richard Nixon abandoned it. Ever since, the value of the dollar and the rest of the world’s currencies have been at the mercy of the U.S. Federal Reserve (the Fed) and other central banks, whose policies reflect the political whims of governments.
This ever-fluctuating system of “fiat money,” with its gradual weakening of the dollar, has produced four decades of slow-motion wealth destruction. Since 1971 the dollar’s purchasing power has declined by more than 80%. Much of that slide has been recent: since the year 2000, according to the consumer price index (CPI), the dollar’s value has declined by about 26%.
This has major implications for the world economy. The dollar is the leading global currency. Commodities such as oil, copper, and wheat are priced in dollars. Other nations transact much of their business using the U.S. dollar or denominating contracts in dollars. The policy decisions of the U.S. Federal Reserve therefore are critical to the worldwide flow of capital and set the monetary agenda for other nations.
Studies show that since the 1971 end of the Bretton Woods gold standard system, the world has experienced more frequent crises and downturns. Fiat money is behind the many market eruptions erroneously viewed as an inevitable feature of free-market capitalism—the financial equivalents of hurricanes or monsoons.
We saw the toxic, disruptive effects of unstable money in 2013 when the Fed announced that it would begin “the taper,” the scaling back of its gargantuan quantitative easing. The yield on 10-year Treasuries increased to almost 3%, about twice their 1.6% low during the period of quantitative easing (QE). These newly attractive interest rates caused global capital to flow back into the United States, causing a drop in demand and a sell-off of the bonds and currencies of the emerging nations known as the “Fragile Five” (Indonesia, South Africa, Brazil, India, and Turkey), whose currency values dramatically weakened on the global markets.
This is only one example of the chaos wrought by the fluctuations of the fiat dollar. Unfortunately it is among way too many.
More and More of the Same Bad Medicine
The correlation between unstable money and an unstable global economy would seem obvious. But it has been largely lost on our policy makers. The failure to understand money is shared by all nations, and this failure transcends politics and parties. The destructive monetary expansion undertaken during the Democratic administration of Barack Obama by then Federal Reserve chairman Ben Bernanke began in a Republican administration under Bernanke’s predecessor, Alan Greenspan. Republican Richard Nixon’s historic ending of the gold standard was a response to forces set in motion by the weak dollar policy of Democrat Lyndon Johnson.
For more than 40 years, one policy mistake has followed the next. Each one has made things worse. We will later detail how the Fed’s loose money policies of the early 2000s led to the momentous worldwide panic and global recession that began in 2008. The remedy for that disaster? Quantitative easing—the largest monetary expansion in history.
Quantitative easing did not just fail as a stimulus. It prevented recovery by causing a destructive misallocation of credit. Perhaps even worse, it caused, in its early stages, spikes in the prices of commodities that raised the cost of food and fuel, inflaming political divisions and unrest in many developing nations.
Most of the supposed stimulus money never made it into the economy. One of the reasons was a distortionary bond-buying strategy that was part of QE known as “Operation Twist.” The Fed traditionally expands the monetary base by buying short-term Treasuries from financial institutions. Banks then turn around and make short-term loans to those businesses that are the economy’s main job creators. But QE’s Operation Twist focused on buying long-term Treasuries and mortgage-backed securities. This meant that instead of going to the entrepreneurial job creators, loans went primarily to large corporations and to the government itself. It was a form of credit allocation.
Supporters insisted that Operation Twist’s lowering of long-term rates would stimulate the economy by encouraging people to buy homes and make business investments. In reality this credit allocating is cronyism, an all-too-frequent consequence of fiat money. Fed-created inflation results in undeserved windfalls to some while others struggle.
Because of the widespread misconceptions about money, policy makers and economists have largely failed to perceive these and other failures. In fact there are movements afoot to give the Fed and central banks in other nations even more power.
Unstable Money: Odorless and Colorless
Unstable money is a little bit like carbon monoxide: it’s odorless and colorless. Most people don’t realize the damage it’s doing until it’s very nearly too late. A fundamental principle is that when money is weakened, people seek to preserve their wealth by investing in commodities and hard assets. Prices of things like housing, food, and fuel start to rise, and we are often slow to realize what’s happening.
For example, few connected the housing bubble of the mid-2000s with the Fed’s weak dollar. All they knew was that loans were cheap. Many rushed to buy homes in a housing market in which it seemed prices could only go up. When the Fed finally raised rates, the market collapsed.
The weak dollar was not the only factor, but there would have been no bubble without the Fed’s flooding of the subprime mortgage market with cheap dollars. Yet to this day the housing meltdown and the events that followed are misconstrued as the products of regulatory failure and of greed. Or they are blamed on affordable housing laws and the role of the government-created mortgage enterprises Fannie Mae and Freddie Mac. The latter two factors definitely played a role. Yet the push for affordable housing existed in the 1990s, and we didn’t get such a housing mania. Why did it happen in the 2000s and not in the previous decade?
The answer is that the 1990s was not a period of loose money. The housing bubble inflated after Alan Greenspan lowered interest rates to stimulate the economy after
the 2001–2002 recession. Greenspan kept rates too low for too long.
The bursting of the subprime bubble put in motion a collapse of dominoes that started with the U.S. financial sector and European banks and led to the sovereign debt crisis in Europe, the Greek bankruptcy crisis, and the banking disasters in Iceland and Cyprus.
Other Problems Caused by the Weak Dollar
Many may not realize it, but the weakening of the dollar is at the heart of many other problems today:
High Food and Fuel Prices
As with the subprime bubble, the oil price rises of the mid-2000s (as well as the 1970s) were widely blamed on greed. Yet here too no one bothers to ask why oil companies suddenly became greedier starting in the 2000s. Oil prices averaged a little over $21 a barrel from the mid-1980s until the early part of the last decade when there was a stronger dollar, compared with around $95 a barrel these days.
Rising commodity prices spurred by the declining dollar have also driven up the cost of food. Many shoppers have noticed that the prices of beef and chicken have reached record highs. This is especially devastating to developing countries where food takes up a greater portion of people’s incomes. Since the Fed and other central banks began their monetary expansion in the mid-2000s, high food prices wrongly blamed on climate shocks and rising demand have caused riots in countries from Haiti to Bangladesh to Egypt.
Declining Mobility, Greater Inequality, and the Destruction of Personal Wealth
The destruction of the dollar is the reason that two incomes are now necessary for a middle-class family that lived on one income in the 1950s and 1960s. To see why, one need only look at the numbers from the U.S. Bureau of Labor Statistics. What a dollar could buy in 1971 costs $5.78 in 2014. In other words, you need almost six times more money today than you did 40 years ago to buy the equivalent goods and services. Say you had a 2014 dollar and traveled back in time to 1971. That dollar would be worth, according to the CPI calculator, a mere 17 cents.
What has this meant for salaries? According to statistics from the U.S. Census Bureau, a man in his thirties or forties who earned $54,163 in 1972 today earns around $45,224 in inflation adjusted dollars—a 17% cut in pay. Women have entered the workforce in much larger numbers since then, and women’s incomes have made up the difference for families. As Mark Gimein of Bloomberg.com points out, “The bottom line is that as two-income families have replaced single-earner ones, the median family has barely moved forward. And the single-earner family has fallen behind.”
This drop in real incomes is a key reason why people feel they can’t get ahead, creating fertile soil for resentment against the rich. Of course there are other contributing causes responsible for the increasing pressure on the middle class, the foremost being taxes. But the weak dollar has been the primary cause.
Increased Volatility and Currency Crises
The 2014 currency turmoil in emerging countries is just the latest in a succession of needless crises that have occurred over the past several decades as a consequence of unstable money. Today’s huge and often-violent global markets, in which a nation’s currency can come under attack, did not exist before the dollar was taken off the gold standard. They are a direct response to the risks created by floating exchange rates. The crises for most of the Bretton Woods era were mild and infrequent. It was the refusal of the United States to abide by the restrictions of the system that brought it down.
The weak dollar has also been the cause of banking crises that have been blamed on the U.S. system of fractional reserve banking. Traditionally, banks have made their money by lending out deposits while keeping reserves to cover normal withdrawals and loan losses. The rule of thumb is that banks have $1 of reserves for every $10 of deposits. In the past, fractional reserve banking has been criticized for making these institutions unnecessarily fragile and jeopardizing the entire economy. Indeed, history is replete with examples of banks that made bad loans and went bust.
Historically, the real problems have been bad banking regulations. In the post–Bretton Woods era, however, the cause has most often been unstable money. Misdirected lending is characteristic of the asset bubbles that result when prices are distorted by inflation. This has been true of past booms in oil, housing, agriculture, and other traditional havens for weak money.
The Weak Recovery
This bears repeating: the Federal Reserve’s quantitative easing, the biggest monetary stimulus ever, has produced the weakest recovery from a major downturn in American history. The monetary expansion of the European Central Bank (ECB) produced even more feeble results in the euro zone, whose economy has long been impeded by suffocatingly high taxes and regulatory obstacles. The region is finally beginning to grow again, but barely.
QE’s Operation Twist has not been the only constraint on loans to small and new businesses. Regulators have also compounded the problem by pressuring banks to reduce lending to riskier customers, which by definition are smaller enterprises. In 2014 the Wall Street Journal reported that this credit drought had caused many small businesses, from restaurants to nail salons, to turn in desperation to nonbank lenders—from short-term capital firms to hedge funds—that provide loans at breathtakingly high rates of interest. Interest rates for short-term loans can exceed 50%. Little wonder there are still so many empty storefronts during this period of supposed recovery.
Monetary instability encourages a vicious cycle of stagnation: the damage it causes is usually blamed on financial sector greed. The scapegoating and finger-pointing bring regulatory constraints that strangle growth and capital creation. That has long been the case in countries with chronic monetary instability, such as Argentina. Increased regulation is now hobbling capital creation in the United States as well as in Europe, where there is growing regulatory emphasis on preventing “systemic risk.”
Regulators, the Wall Street Journal noted, “are increasingly telling banks which lines of business they can operate in and cautioning them to steer clear of certain areas or face potential supervisory or enforcement action.”
In Europe, this disturbing trend toward “macroprudential regulation” is turning central banks into financial regulators with sweeping arbitrary powers. The problem is that entrepreneurial success stories like Apple, Google, and Home Depot—fast-growing companies that provide the lion’s share of growth and job creation—all began as “risky” investments.
Not surprisingly, we’re now seeing growing public discomfort with this increasing control by central banks. A 2013 Rasmussen poll found that an astounding 74% of American adults are in favor of auditing the Federal Reserve, and a substantial number think the chairman of the Fed has too much power.
Slower Long-Term Growth and Higher Unemployment
Even taking into account the economic boom during the relatively stable money years of the mid-1980s to late 1990s, overall the U.S. economy has grown more slowly during the last 40 years than in previous decades. From the end of World War II to the late 1960s, when the U.S. dollar had a fixed standard of value, the economy grew at an average annual rate of nearly 4%. Since that time it has grown at an average rate of around 3%. Forbes.com contributor Louis Woodhill explains that this 1% drop means a lot. Had the economy continued to grow at pre-1971 levels, gross domestic product (GDP) in the late 2000s would have been 56% higher than it actually was. What does that mean? Woodhill writes: “Our economy would have been more than three times as big as China’s, rather than just over twice as large. And, at the same level of spending, the federal government would have run a $0.5 trillion budget surplus, instead of a $1.3 trillion deficit.”
And what if the United States had never had a stable dollar? If America had grown for all of its history at the lower post–Bretton Woods rate, its economy would be about one-quarter of the size of China’s. The United States would have ended up much smaller, less affluent, and less powerful.
Unemployment has also been higher as a consequence of the declining dollar. During the World War II gold standard era, f
rom 1947 to 1970, unemployment averaged less than 5%. Even with the economy’s ups and downs, it never rose above 7%. Since Nixon gave us the fiat dollar it has averaged over 6%: it averaged 8.5% in 1975, almost 10% in 1982, and around 8% since 2008. The rate would have been higher had millions not left the workforce.
The rest of the world has also suffered from slower growth, in addition to higher inflation, since the end of the Bretton Woods system. After the 1970s, world economic growth has been a full percentage point lower; inflation, 1.5% higher.
Larger Government with Higher Debt
By enabling endless monetary expansion, the post–Bretton Woods system of fiat money has helped propel the unchecked growth of government. In 1971 the total U.S. federal debt stood at $436 billion. Today it is more than $17 trillion. It’s no coincidence that the federal debt has doubled since 2008, the same year that the Fed started implementing QE.
In 2011, three years after the Fed started quantitative easing, the United States’ credit rating was downgraded by Standard & Poor’s to below AAA. The picture is even worse in the euro zone, where the ECB has also been easing and which underwent a sovereign debt crisis, with nine nations receiving downgrades on their bonds.
