by Steve Forbes
THE NUGGET
When it comes to investing, emotions are your enemy.
CHAPTER 8
Looking Ahead
We cannot predict the value of our homes or prices on the stock market from day to day. We cannot anticipate illness or automobile accidents, the behavior of our children, or the incomes of our parents. . . . We are almost entirely incapable of predicting the future.
Yet economics purports to be strangely exempt from this fact of life.
—GEORGE GILDER, Knowledge and Power
WHERE DO WE GO FROM HERE? THE GLOBAL OUT-look is mixed. If the Federal Reserve continues pulling back from its disastrous experiment in interest rate manipulation known as quantitative easing, more credit should flow to small and new businesses. America’s recovery should gain momentum. This will not only be good for the United States but also for the European Union—where there have been slight signs of growth—and the rest of the world’s nations. Regardless of forecasts by the naysayers, the United States, at least for the time being, continues to be the engine for the world’s economies.
At the same time, the currency crises that have roiled emerging nations in response to the Fed’s taper underscore the perils of a fiat monetary system. Throughout this book we’ve explained how money brings together strangers throughout the world, enabling them to work together and conduct transactions that meet the needs of people in the global marketplace. Currency crises resulting from the taper show how easily misguided monetary policies can cause this global cooperation and enterprise rapidly to unravel.
The woes in emerging countries remind us that, while the darkest days of 2008–2009 may have passed, the conditions that caused the catastrophe remain with us. The world will continue to lurch from one crisis to the next until we finally understand that the way to growth and a more prosperous future is not through weak money or tight money—but through sound money.
A monetary system based on sound and stable currencies is our best hope of finally achieving a genuine recovery, one that would usher in a new era of material progress that would lift living standards to unheard-of heights. We got a taste of the possibilities in the global economic expansion of the 1980s and 1990s when the United States had a somewhat stable dollar. The world experienced growth and prosperity that nearly rivaled that of the classical gold standard era of 1870–1914.
Bill Gates once predicted that by 2035 there would no longer be poor nations. For his prediction to come true—and for us to finally vanquish the malaise that we mistakenly call “the new normal”—the world monetary system must be anchored by a stable global currency.
The British pound performed that role in the nineteenth and early twentieth centuries. Since then the de facto world currency has been the U.S. dollar. Its destruction after 1971 has hurt the United States and the world economically and politically. This cannot be allowed to go on or we will face new and ever more turmoil that will imperil free markets and ultimately democracy itself.
Many of the major problems that plague us today, from anemic growth to high food and fuel prices to sovereign debt, have roots in distortions and volatility that are the by-products of fiat money. People instinctively sense that there’s something wrong with our present system. The challenge is to convert this unease into knowledge, debate, and a demand for change. For too long, our thinking about money has been needlessly clouded by jargon, bad ideas, and political agendas.
Restoring Monetary Sanity
If we are to overcome the obstacles that face us, we, the people in the United States and around the world, must learn more about money. Such an understanding requires knowledge of some simple fundamental principles. Here’s a recap of some key precepts:
1. The foremost objective of monetary policy must be to maintain currency stability. The only justification for central bank manipulation of the monetary base is to maintain fixed currency values. This is achieved most easily when there is a gold standard.
2. Trade itself has nothing directly to do with the value of a currency; balance of payment deficits have no impact on an economy if money has a fixed value. Media coverage of the emerging markets crisis in early 2014 was littered with numerous commentaries about the need for countries with a current account deficit to take corrective action. The obsession with the balance of payments deficit has for decades led to needless monetary devaluations, capital controls, and protectionist trade restrictions that have wreaked havoc around the world. This wrongheaded focus on the current account and the overall balance of payments helped to give us the disaster of fiat money.
Adam Smith’s fundamental insight about the mutual benefits of trade continues to be ignored. If a central bank correctly uses open market operations to maintain monetary stability, trade deficits would have no effect whatsoever on currency values or an economy.
When Turkey’s lira came under speculative assault, the problem wasn’t the current account; it was political turmoil and a loose monetary policy. Turkey responded by more than doubling its interest rates, a move that slowed its domestic economy. This would not have occurred had Turkey adjusted its monetary base to keep the lira at a stable level.
What about so-called hot money pouring into a country—or, conversely, large amounts pouring out? Again, the right countervailing monetary policy should be able to deal with the problem. If a central bank adjusts the monetary base, it can maintain stability. Remember our story about Switzerland. When enormous amounts of money—primarily euros, but also dollars—flooded the country to buy the Swiss franc during the euro and sovereign debt crises, the Swiss responded by putting a ceiling on how high the franc could increase in value against the euro. A relatively stable value was maintained and Swiss exporters avoided further harm.
3. Printing money is not creating wealth. Had mercantilist monarchs succeeded in turning lead into gold, they still would have failed to create wealth. Gold would have become so plentiful that it would have lost its value. Enough said.
4. Beware of the false growth that comes from monetary stimulus. Not all growth is what it appears. The Great Inflation of the 1970s did have periods of seemingly good GDP expansions, but they were false advances. The debasement of the dollar led to massive investments in energy, commodities, farmland, and commercial real estate. All experienced horrific downturns in the 1980s when inflation was conquered and the malinvestments were liquidated. We see the same phenomenon at work today. Commodity-oriented economies such as Brazil, Russia, and South Africa have similarly experienced false booms.
In the early part of the 2000s, excess liquidity created by the Fed and other central banks enabled otherwise less-than-prime creditors like Greece and Turkey as well as millions of home buyers in the United States to borrow vast amounts of money. Manipulating or devaluing the currency, or, for that matter, boosting government spending, might raise GDP in the short term. But this activity is a response to distorted market signals and is always false and unsustainable.
5. Loose money can damage an economy without a big, immediate rise in the cost of living. In the popular mind and in the minds of most economists, inflation means rising prices as reflected by the Consumer Price Index (CPI). As we have painfully learned from the housing meltdown, loose money can produce destructive asset bubbles without a big across-the-board rise in the CPI and 1970s-style inflation. Debasing money always leads to unpleasant consequences, although the symptoms are not always the same.
6. There is no such thing as price stability. Even when there is stable money, prices for goods and services will always change because of supply and demand fluctuations that have nothing to do with money. Recall what happened to the price of cell phones—the original one 30 years ago cost $3,995, and the price of handhelds has plunged since their debut because of constant increases in productivity. If money were stable, in fact, such productivity increases would lead to a decline in the cost of living. Keynesians would scream, “deflation!” But, as in most things, they would be wrong.
7. The cent
ral bank shouldn’t manipulate interest rates except in a crisis. Since World War II, monetary policy has been geared to setting short-term rates on the supposition that this helps guide activities of the economy and influences GDP. For example, interest rates have been used to “cool down” a “hot” economy. The idea that economies get cold or overheated is ridiculous.
Because interest is the price of borrowing money, artificially setting interest rates is a form of price control, which means rationing and shortages. Price controls on interest are one reason for the misallocation of credit that has slowed the economic recovery in the past several years.
Central banks should spur an economy by maintaining currency stability through open market operations. Domestically that means buying or selling bonds to increase or decrease the monetary base. Internationally, it means using foreign exchange reserves to buy or sell a currency. We don’t need a central bank manipulating interest rates. If we had stable money, rates would naturally be lower.
8. The euro would do fine if European policy makers maintained stable money. The euro was launched in the early part of the 2000s, around the same time the Federal Reserve started to weaken the dollar. When the Fed misbehaves, it sucks in its wake most other central banks. The European Central Bank followed the lead of the United States and ended up creating too much money, although not on the scale of the Fed.
Even with today’s problems, the euro has indeed succeeded in making intra-European trade easier. The euro also provided a refuge from the volatility of floating exchange rates.
Some Keynesian commentators trash the euro for the same reason they reject gold: they see its fixed exchange rate system as too rigid. One of their biggest delusions is that the euro has prevented nations of Southern Europe from recovering by keeping them from devaluing their monies. The truth is, had these countries continued with their own currencies, things would have been far worse. Many would have experienced a terrible inflation—in Greece, a hyperinflation—and a lower standard of living than they have today. The euro, if anything, saved these countries from themselves. The real problem with Southern Europe and France is not the euro but domestic antigrowth restraints like rigid labor markets and high taxes.
9. If there were stable money, the price of gold would not fluctuate. The precious yellow metal is often misperceived as being too volatile to anchor the dollar effectively. Today’s gold prices, however, are not driven by changes in supply. Remember, gold itself has a stable intrinsic value, which is why it’s called the monetary Polaris. It is a refuge for investors during periods of weak or unstable money. The huge upsurges in the dollar price of gold in 1980 and 2011 reflected fears that the dollar’s worth would rapidly decline. If there were a stable gold-based dollar, people would not seek to invest in gold to protect their money. Its price would fluctuate very little.
10. In an ideal world the head of the Federal Reserve would be no more important than the director of the Office of Weights and Measures inside the Commerce Department. The Federal Reserve must stop trying to run the banking system and the economy.
It’s Not Only the Money
We have said this before: getting the economy right starts with getting money right. But other things also have to be gotten right. Money is simply a facilitator of transactions. A return to prosperity that leads to a better future requires a thriving, entrepreneurial society that encourages transactions to take place. The only way to get there is with a system based on fiscally responsible government, reasonable regulation and taxation, and a political environment founded on rule of law.
Stable money fosters these conditions. But policy makers must also be committed to promoting, rather than discouraging, commerce. We need government. But the only way realistically to be able to pay for it is through a growing free economy that meets the needs of its people.
Unfortunately, too few policy makers today grasp the bigger picture. As a result too many nations, including the United States, have been mired in stagnation and instability.
The Global Outlook
The following are thoughts and recommendations concerning the broader challenges faced by nations and regions around the world, and what’s needed to get their economies and money right.
The European Union. Along with being plagued by sovereign debt crises, most European nations have been punching below their weight economically because of major structural barriers: high taxes, bloated public sectors, and restrictive labor laws that make companies very reluctant to hire. The result has been that the continent has dramatically lagged in economic growth. To cite one example, despite its varied cultures and a population of nearly 500 million people, the region trails tiny Israel (with a population of barely 8 million) in high-tech innovation.
The European Union’s highly bureaucratic officialdom persists in believing that the answers to its woes are monetary expansion, lower interest rates, and so-called austerity—their euphemism for piling still more taxes on the heavily burdened private sector. Germany, whose relatively robust economy has made it the effective paymaster of the European Union, helping bail out countries such as Greece, has demanded higher taxes. Spain raised its top income tax rate to 52%. Italy and Portugal boosted their value-added taxes and other levies. France effectively raised its top rate on salaries to 75%. Greece hiked every conceivable levy, sending its economy into a bone-crunching recession. Meanwhile, the public sectors in these countries have largely been spared.
The global lack of understanding about money can be seen in commentaries bemoaning the fact that, because of the euro, countries cannot devalue their currencies to spark recovery. Monetary policy cannot overcome the obstacles to wealth creation created by excessive taxation, government spending, and job-killing labor laws. The key to resurgence in the European Union is structural reforms like lowering tax rates. Privatization—spinning off parts of the massive government bureaucracies—is also an easy source of needed cash.
Since 2008 Poland has privatized over 1,000 companies, large and small, raising billions in euros. Unfortunately the government took a step backward when it confiscated, Argentina-style, a portion of Polish citizens’ pension funds.
The real problem is the devotion of Europe’s political culture to the care and feeding of the welfare state. Germany made some internal reforms under chancellor Gerhard Schrölder, a Social Democrat, in the early part of the 2000s that involved reforming welfare payments and tightening unemployment rules. The changes cost Schroder his job, but they enabled Germany to weather the crisis of 2008–2009 better than the rest of Western Europe. Nonetheless, the German government under Schroder’s successor, Angela Merkel, has been whittling away at those reforms.
Other countries, though, are seeing the light. Sweden has cut taxes, with good effect. During the Great Recession, Estonia resisted the temptation to engage in a Keynesian spending binge. Its spending cuts earned the government a rebuke from Keynesian scold Paul Krugman, but the country’s economic success speaks for itself: Estonia has become a leading high-tech center (Skype was developed there). It is growing, whereas most of the rest of the European Union is barely breathing.
China. The country’s economic success, like Japan’s and Germany’s before, has aroused charges in Congress of currency manipulation. Observers also point to the ghost cities built to keep the economy humming during the financial crisis—including one with full replicas of Paris’s Eiffel Tower and the Champs-Elysées—as proof that China’s rapid expansion has been built on the sands of misallocated credit and artificial stimulus. There are definitely white elephants. But the reason for China’s economic miracle is that the Chinese make products that people want. Its success has also been based on the fact that, until recently, it’s had a better record than many countries for maintaining a relatively stable currency.
In the mid-1990s, when the dollar was fairly sound, Beijing pegged the yuan to the dollar at a fixed rate, believing that currency stability would spur trade. It did. China’s global trade has since expanded
more than 15-fold. In its monetary policies, China has taken its cue from Hong Kong, which similarly tied its dollar to the U.S. dollar in the early 1980s. The commitment of both Hong Kong and China to monetary stability enabled both to successfully defend their economies against the fierce speculative attacks that took place during the Asian Contagion in 1997–1998.
The question is, what does China do now? One big problem is its capital markets. The major banks cater to state-owned companies, but the bulk of the Chinese economy is made up of approximately 43 million small private companies, many operating in a legal and financial twilight zone. They borrow, at stiff rates of interest, from so-called shadow banks.
Investment has also been hampered by the fact that China’s state-owned banks pay interest rates less than the rate of inflation. This has turned off many Chinese investors, who have sought investments with higher yields. The state-owned banks responded by setting up so-called trust companies that would lend to private companies at high yields. But many of these loans went bad. China’s government has had to bail out many of these firms.
If China is to continue leading the world in economic growth, it must encourage a system of capital creation that better meets the needs of both its entrepreneurs and investors. Beijing is taking some steps in this direction, such as moving toward market-set interest rates over the next couple of years. Unfortunately it has also adopted a bad habit from the West—let us hope temporarily—of weakening its currency and letting it gyrate against the dollar more than it has in the past.
Japan. This country has been stuck in a rut for over 20 years. Its economic mistakes are legion. Its national debt is approaching a breathtaking 250% of GDP. That’s even higher than Greece, whose debt/GDP ratio is 170%, and the United States, whose ratio is a little over 100%.
Over the past two decades rampant government spending, including more than 20 big stimulus packages, has dissipated Japan’s immense wealth. The misunderstanding of money on the part of the nation’s policy makers is monumental. In the late 1980s, the country underwent a frenzied real estate boom. As in the United States, it was the result of loose money, as well as a response to a tax code that rewarded companies for buying and holding on to real estate. Building codes and regulations also added costs and encouraged inefficient use of precious land.
