Free Markets and the Problem of Debt
James Duvall, M. A.
Big Bone University
“I have lifted salt, and I have lifted lead,
and it was not heavier than debt.”
Ahiqar, 500 B. C.
The gold standard which was in use by most of the world before World War I was not very economically efficient. Anyone who tries to tell you that doesn’t deserve much of your time and attention. It did do something very important, however, that was well worth that inefficiency: it kept government from creating credit. From the point of view of the market, the gold standard made the market supreme over the industrial system, and more importantly, at least from the free market standpoint, it prevented the government from encroaching on that system.
Political government was balanced with political freedom, at least in the sense that money and credit were determined by market forces, not by the government. In the United States the gold standard acted as a barrier in the economic sphere. The gold standard was a Constitutional barrier to government creation of credit. This barrier between government and the market was not absolute; but there was at least an area, a kind of no-man’s land, if you will, that promoted and gave scope to free markets. Government by majority rule is particularly prone to interfere in the market system; this interference was called its proper name by the Frenchman Fredric Bastiat, who saw it explode during the revolution there: “legal plunder”. The use of gold meant that except relatively small amounts for tariffs and such protection, gain for special interest groups was minimal; there were no “bail-outs” at public expense.
This no-man’s land, the frontier in which the market operated, was basically acquired by the government in 1918, and the market as a separate society collapsed. This control of the market was even more stringent in 1931, in the wake of the great contraction of money and credit we call the Depression. This greater control of the market was the major step taken to combat this contraction; that is, the government chose to harness the economy to solve the problems of social integration caused by industrialism and loss of traditional security due to loss of community. This socialism caused greater dislocations and inequalities than if the government had simply let these difficulties work themselves out, it is likely that recovery would have come sooner; but politicians find it difficult to wait and do nothing.
Government control of the economic system — especially the ability to create credit, allowed greater social control — if time is money, it is even more true that money is people. That is, control of people. In other words, the government used money to create social obligations, also known as political debt. Charles Henry Carey, who came highly recommended — he was considered by Karl Marx to be America’s greatest economist — wrote “Money is to society what fuel is to the locomotive and food to the man — the cause of motion, whence results power.” Economists and bankers tend to focus on the negative side of the equation, that is, on money. And this is what the government did after it captured the economy: it tried to make money the motive force in the economy.
The truth is much nearer the opposite. Charles Franklin Kettering, the inventor, made a remark that is much more profound than Carey’s. He said: “A dollar isn’t anything but a receipt for a service performed.” For that receipt, of course, you get another service; but this puts the emphasis on the positive side. It is the services and the goods produced by that service that drives the economy, the money is just the paper work, how we keep track of whose turn it is. Nothing is created by banking and paper operations, and no actual wealth is generated except the service of keeping track; but the emphasis on the negative aspect of money means some people and institutions get rich by it. The government could harness the system only by seizing the money part of the economy, but it could not create incentives by the receipt method; all it could do was start a new “market” determined by political and social objectives, that in itself had nothing to do with private initiative.
The gold standard had been abandoned by nearly every country at the end of World War II. The Bretton Woods conference in 1944 gave a measure of stability by setting a fixed rate of exchange for all of the various currencies, and this system stayed in place until August of 1971, during the Nixon administration. This meant that each country could generally manage its domestic economy — as we did through our Federal Reserve — without much affecting imports and exports — at least in the short run. When Nixon floated the dollar (they called it “managed float”) it created what was essentially a free market for the dollar against the other world currencies.
This free floating dollar was very nearly the opposite of the gold standard, at least in one very important sense — it was very economically efficient; but it did something, whether anyone anticipated it or not, that was like the gold standard: it once again makes the market supreme over the economic system, regardless of any government, including ours. The significant difference between the old system of exchange rates and the new floating system for America is that the dollar’s central place in the system went from being a legal obligation, to a matter of actually that was not necessarily permanent. That means than the security underlying this system is no better than the soundness of the dollar.
Because the Federal Reserve prints dollars it can lend to debtors whose failure threatens the system; and it is only the soundness of the American economy that allows this to happen, for it is effective only if the currency used is acceptable to the borrower or their creditors. There are limits to the effectiveness of loaning dollars in any case. As Benjamin Friedman says: “The Federal Reserve’s ability to create dollars and place them in the right hands helps in a crisis only if too few dollars in those hands produced the crisis in the first place.” (p. 63) The other limit is the unsoundness of the American economy, for if another currency, such as the euro, were to replace the dollar, then our creditors could demand we repay in that currency. The creation of money and credit is so easy in this floating system (just as easy is the creation of debt, two sides of the same coin), that it makes government spending binges, such as the bail-out, not only tempting, but possible.
This doesn't mean it is free money. In fact it is very expensive, and can lead to financial ruin. Government irresponsibility (both our own and that of other countries) has caused currency prices to fluctuate widely, and sometimes wildly, since 1971. Governments have discovered they can enjoy short term popularity through long-term economic costs; spending to get them through the next election. It makes no difference which party is in power, the temptation to spend against the future is almost irresistible, as the consequences must usually be dealt with by someone else — a subsequent congress, or another administration.
The instability of exchange rates is not caused simply by debt; that is merely a contributing factor. Instability is greater now due to the greatly increased mobility of capital. This mobility has serious consequences for all countries in both short term and intermediate term economic growth and development. However, there is a factor in the equation that is even larger than this, though it is related: Instability of exchange rates is caused for the most part by the simple reality that the majority of foreign exchange transactions are speculative.
Today billions can be transferred from one currency into another with a few keystrokes. This has created a new kind of virtual money, which does not exist as a currency. Probably the easiest way to understand it is what happens when you write a check: You create a piece of paper worth $100, but this exists only as virtual money until the transaction when it is finally cashed. Now the transactions are much faster. Instead of existing as an uncashed value, this virtual money exists as the difference between transactions; essentially you have created money, even if for a short time. The currency held is cashed in for a currency with a differing value, and the virtual money is nothing other than the traders profit, which will be realized with the next trade, and so on; it is created by transfer. It is in fact gigantic, and though the money is not real, the power generated by it is. This is because it is totally mobile; even a slight rise or fall in any given currency starts frantic trading activity all over the world, and the market is almost instantaneous.
In one day as much virtual money may be traded as the world actually needs for a year's worth of trade and investment. This means most of the money is totally speculative, and serves no economic function whatever, such as driving economic growth and development. This system is extremely volatile, and can easily be panicked; unexpected events, disasters, political upheavals, or even rumors of such events, can set off violent market reactions; there are no safeguards, like the old fixed exchange rates, with the dollar always there to bail out countries in trouble. It is a free market.
This news, how ever bad it may sound, is not all bad, for this free market global economy is forcing governments to be more fiscally responsible, or shortly they will risk completely wrecking their economy. The U. S. recently saw its bonds downgraded due to failure to adopt a debt ceiling. In 1995 Clinton, poised to spend, as usual, was forced to abandon this and adopt a “balanced budget” instead, because of a huge drop in the dollar against other currencies. It has become too risky for any government to depend on short term, volatile world money to cover its debts. It is now a fact that due to the free market, brought into existence by floating world currency exchanges, governments are in a similar position as when they were under the gold standard. They had then, and have now, almost no control over the free market. Only a responsible fiscal and monetary policy can keep a country from dependence on this volatile new money.
As long as foreigners are willing we as a country can continue to borrow. We can finance this, as we have been doing since the eighties, by selling our assets, and borrowing to pay the interest. Remember a dollar is a receipt for a service rendered; but a borrowed dollar is a receipt for one that hasn’t been performed yet; a dollar borrowed from a foreigner, whether a person, company, or government, means higher exports. It must lead to a lower standard of living in the not-too-distant future. As Dr. Friedman writes:
Foreign lenders will not continue indefinitely to accumulate our IOUs, without growing fears that we will not pay or that when we do it will be in inflated dollars. Foreign investors will not continue indefinitely to accumulate stocks and real estate and other assets in America, when the incomes and prices that matter for their own standard of living are those of their home countries.
Once foreigners accumulate enough American holdings so that they are unwilling to increase their net investments in the United States except to the extent of collecting the interest, dividends, and other returns that they earn on their American assets, the dollar will finally fall by enough to bring our imports and exports into balance. Any continuing excess of imports over exports at that point will just send more dollars abroad than the amount that foreigners want to put into additional holdings of American assets. As foreign investors collectively try to sell their extra dollars in the foreign exchange market, with no one to whom to sell except each other, they will only drive the dollar still lower. (Friedman, p. 34)
Neither the Federal Reserve or any system of central banks can bolster such a currency. The Japanese banks lost trillions trying to bolster their currency some years ago. The international currency market is simply too gigantic for any such government intervention; it is almost as futile for a government to print money in such a situation as to try to create gold. As the strength of our economy has, since 1971, been the only reason the dollar is the standard world currency, a continued unsound domestic and monetary policy will have an extremely high price, both in the United States, and around the world. As Friedman remarks: “We are simply mortgaging our future living standard.” (p. 39)
Our foreign policy has been conducted by means of U. S. economic clout. We don’t give away “free money”: for every dollar sent overseas someone here has profited. The companies selling the goods for which these dollars were spent were basically hand-picked. We continued our foreign aid after 1971, but in addition we added a new dimension of force to coerce “third world” countries to increase their debt to the U. S., whether any very considerable body of people in those countries wanted the debt or not. The U. S. insured that that money was spent here; in fact most of the money loaned never left the country, simply moving from a bank in Washington to one in Dallas, San Francisco, or Seattle. Huge engineering companies, such as Bechel and Halliburton, contracted, often by means of force, brokered by the CIA, for massive engineering projects: hydroelectric dams, bunkers for Saddam Hussein, and new cities for Saudi Arabia. (See Perkins) Among other results of these misdeeds, was to bloat the construction sector of our own economy at the expense of the economies of the third world, and of our own economy as well.
The enormous loans outstanding to the U. S. from these countries can probably never be repaid. In some of these countries, among the poorest, half the gross national product goes to pay the yearly interest on U. S. loans. The only reason we can finance these kinds of loans is that they were made in dollars, and we (that is the Federal Reserve) control the supply (though we, that is, the Reserve, is not doing a very good job of it). If the standard world currency were anything other than dollars, say euros, which is a distinct possibility in a few years, then these loans would be worthless to us for paying back our own debts. Any attempt to turn these billions of dollars we were trying to pay with into another world currency would drive the price of that currency so high that the dollar would be completely devalued, worthless.
If our creditors, China, Japan, Germany, refused dollars (they have billions of them now), and they loaned the worthless ones they had on hand to our debtors in the third world, they could buy that debt for a song. These dollars would come home to roost, bringing nothing but trouble with them; we could have a confetti party bigger than anything seen in Weimar Germany. This is a very real possibility; our leadership, if it can be called that, is playing with fire in a paper house.
We must demand a balanced budget and the elimination, or at least steady reduction of debt. One of the definitions of debtor in the dictionary is “sinner”, and that is exactly the right concept in this case, as we must repent and reform. There is now a great market incentive to get our fiscal house in shape before we totally wreck our economy. We claim to believe in free markets, now the global free market is demanding that governments shape up, to become fiscally responsible. Governments who cannot compete responsibly in that market will be forced out of business.
The real issue now is not go back to the gold standard — it would be nice to do so in some ways, but it is probably an impossible dream, and too costly to obtain at this point. Many in the Arab countries feel that a gold standard would be religiously more acceptable them. One Arab writer has written: “In the past when people were free to choose, they chose gold and silver. If we are again allowed to choose most probably we will choose gold and silver. The important thing is that paper money cannot be imposed on us.” (Vadillo, p. 42) He points out quite logically: “Because all national currencies — even the ‘mighty’ US dollar — are simply pieces of paper. Their value is as strong, or as weak, as the country which stands behind them. Which paper currency would you choose as a refuge from a shaky dollar?” (Ibid., p. 52)
This does not mean the Arab countries will move to the gold standard; but it certainly makes the point that when they no longer trust the dollar they will have no hesitation in forsaking it for money which is, for the moment at least, more trustworthy, whether gold, or paper. The real issue for us is not the gold standard, but the fiscal responsibility it stood for. What is now necessary is for ordinary citizens like you and me to join in forcing our government to accept the new reality of the global market, and to come up with a plan that will make our country strong, and allow us to compete and prosper by becoming fiscally sound. The sooner this happens the better.
29 Sep 2011. edited 30 Sep 2011. J. D.
Bibliography
Peter F. Drucker. Managing in the Next Society. New York: Truman Talley Books/ St. Martin’s, 2002.
Thomas Sowell. Basic Economics: A Common Sense Guide to the Economy. New York: Basic Books, 2007.
John Perkins. Confessions of an Economic Hit Man. San Francisco: Berrett-Koehler Publishers, 2004.
Benjamin M. Friedman. Day of Reckoning: The Consequences of American Economic Policy. New York: Vintage, 1989.
‘Umar Ibrahim Vadillo. The Return of the Gold Dinar: A Study of Money in Islamic Law. Cape Town, South Africa: Madinah Press, 1996.
