December 28, 2009

Money: Debauched, Debased, and Destroyed

By Jon N. Hall

Years ago, I was having a beer in the bar of a restaurant with an academic when he said something to the effect of "Money isn't real." On the contrary, he insisted, money's real because we agree that it's real. Money exists in an agreed-upon structure of trust, just as do contracts, ownership, and other abstractions, including the abstraction of value.

But money's big problem is its tendency to suffer loss of value, a.k.a. inflation.

One can think of inflation as either a decrease in the value of money or as an increase in the value of what money buys. But however one thinks of it, inflation is The Supreme Economic Evil. (Inflation in the Weimar Republic paved the way for Hitler.) And since government creates money and therefore controls the money supply, government is the main culprit where inflation is concerned.

We're talking about the Federal Reserve. Some contend that the Fed prolonged the Great Depression and caused the inflation of the late 1970s. Some contend that the Fed is unconstitutional and should be abolished. The late economist Milton Friedman thought we could replace the Fed with a computer. The Fed's main duty is to maintain the value of the U.S. dollar, and to do this, the Fed must fight inflation.

Rather than focusing on maintaining the value of our money, the Fed has lately had other fish to fry, like propping up the financial system. Now they've moved on to fighting the recession, a role prescribed by law. George Will writes about the problem:

Rep. Paul Ryan, R-Wisc., has, as usual, a better idea: Repeal the Humphrey-Hawkins Full Employment Act of 1978 that, he says, "dangerously diverted the Fed from its most important job: price stability." For 65 years after its creation in 1913, the Fed's principal duty was to preserve the currency as a store of value by preventing inflation from undermining price stability. Humphrey-Hawkins gave it the second duty of superintending economic growth.

"Superintending economic growth," the Fed has recently created trillions of dollars. The Fed does this by simply typing: One dollar becomes a trillion by typing twelve zeros.

It remains a mystery whether Fed Chairman Ben Bernanke types in those zeros all by himself or has his secretary do it. But we do know this: The more money in circulation, the less its value per dollar.

So when does inflation hit, and how bad will it be? If Bernanke can spare America from crippling inflation with his exit strategy, he'll be remembered as a great Fed chairman. But that's a big if, according to Dr. Doom, a.k.a. Nouriel Roubini. Timing is verything.

Bernanke's re-nomination as Fed Chairman has been approved by the Senate Banking Committee, but no less than Larry Kudlow has suggested that for the Fed's coming war on inflation, Paul Volcker might be the man for the job. As Fed chairman in the 1980s, Volcker killed inflation, helping to unleash a quarter-century of prosperity. (On his nightly TV program The Kudlow Report, Larry has been a voice crying in the wilderness for a sound and stable currency: King Dollar. Kudlow article archives are here and here and here.)

Because Congress created the Fed and allows the Fed to continue to exist, Congress is ultimately responsible for the inflation caused by the Fed's creation of money. But Congress itself creates money, too.

Now, Congress has embarked on history's wildest spending spree. And because Congress is running the largest budget deficits in history, its new spending must be financed through even more debt. Congress's debt instruments (U.S. treasuries) are essentially newly minted money, backed up by nothing more than the willingness of future taxpayers to redeem them. (But it's Congress that needs redemption.)

The Fed may be able to execute an "exit strategy," but how can Congress undo its improvident spending? In February, Congress raised the debt ceiling to $12T. Already they must raise it again, to $14T, just to get through 2010.

Where's Congress's "exit strategy"?

Some things are priceless -- there isn't enough money on earth to buy them. Is there enough money on this planet to purchase your eyes? Legend has it that Odin paid an eye for wisdom. The wisdom he received: Look with both eyes.

Life would be immeasurably diminished without those things valuated as priceless. But for everything else, there's money. And much of everything else, while not priceless, is nonetheless quite important. Everything else includes food, shelter, medicine, education, airline tickets, opera tickets, etc. So for a better life, what's needed is money.

But by its mindless spending, Congress is undermining the trust demanded by that agreement called "money." That's why business and the consumer are holding back: They don't know what's coming. When trust is destroyed, the party's over.

And when a nation's currency is destroyed, a people must start over.

Happy New Year.

Jon N. Hall is a programmer/analyst from Kansas City.