|
Ron Paul's Freedom Report
A publication of the Foundation for Rational Economics and Education
Volume 7, No. 7 October 1999
The erosion of constitutional principle in the 20th Century has led to frequent war, recessions, inflations, depressions, ever dimishing respect for law and life,
and a dangerous explosion of national police powers.
An Economic Update
Former Federal Reserve Chairman Paul Volcker is no friend of the hard-money movement, nor is he a proponent of the bubble theory as explained by the Austrian economists. Nevertheless, a few months ago he said: "The economy of the world is dependent on the US stock market. The US stock market is dependent on 50 stocks, half of which had no earnings."
When establishment central bankers such as Volcker express concern over the financial bubble existing today, everyone should take notice.
The release of last June's trade figures sent shudders through the financial markets. The monthly $24.6 billion trade deficit was a record. In addition, the more important current-account deficit, which includes not only goods and services but unilateral transfers and earnings on US investments overseas, also continued to set records. We are now the greatest debtor in the history of the world, with a foreign debt of well over a trillion dollars.
The trillions of dollars of derivative speculation, as well as the ongoing crisis in Russia and a likelihood that the Asian crisis will spread to China, should cause us deep concern. Latin America is also experiencing difficulties. In a few months we will find out just how big of a problem Y2K really is. It turns out that last year's crisis over Long Term Capital Management was a mere drop in the bucket compared to what is likely to happen to the entire financial system once confidence is lost.
We in this country have an insatiable appetite for foreign imports. The relative strength in the dollar has allowed us to satisfy our desire for foreign goods without hesitation by buying on credit. In spite of the doubling of oil prices as our trade deficit explodes, there seems to be no hesitation among foreigners to continue to accept our dollars - the U.S. dollar being the reserve currency of the world.
Confidence in the dollar, which will not prove to be permanent, has permitted both this imbalance in trade and our current-account deficit to persist much longer than they otherwise would. Smaller countries and weaker currencies have to face reality much sooner, but because of our political and economic strength, foreigners are willing to accept our "promise to pay" in nothing for much longer periods of time.
The Case for Gold
Under a gold standard, a negative trade balance of this sort would have self-corrected years ago. A gold standard would require that a deficit nation suffer from a consequent gold loss, thus driving down prices and forcing renewed savings and a general reassessment of economic policy. Higher interest rates would then attract capital and restore balance by inviting capital back into the deficit nation.
Under a fiat system of money, distortions can go on for many years, and great deficits can accumulate, which finally prompt devaluations, higher interest rates, and domestic price inflation. We have seen this in recent years in South America and Mexico, and more recently in Asia. We even experienced it in the United States in the 1979-1980 crisis with rampant inflation, soaring interest rates, and a global dollar crisis.
These adjustments always bring suffering to many innocent victims who lose their jobs or get disproportionately penalized as the cost of living increases. Low middle-income people suffer the most. Statistics now bear this out even for the current booming 1990s.
A reserve-currency nation - and the U.S. is now the only one - has a great short-term advantage in being able to live beyond its means for many years. Foreigners willingly accept our fiat dollars, and then, they finance our deficits by loaning these same dollars back to us.
This process has given us a virtually unlimited benefit through inflating our currency, exporting that inflated currency by buying foreign products, and borrowing back the money from overseas. Our monetary policy and political perceptions have generated conditions where foreign holders of dollars perpetuate the financial bubble. They do so by not only financing our government debt (when they let us borrow back the money we have exported to them by buying their goods and services), but also by contributing to the stock market bubble.
The resulting increase in paper value of our stock market has encouraged consumers to spend like never before. An illusion of great wealth results because rising stock values continue and bloat the cycle of borrowing and spending - especially on imported cheaper products.
These events have led to a record-low negative savings rate, along with a record-high consumer-debt accumulation rate, as well as records in margin debt, real estate debt, corporate debt, and security loans.
What for nearly a decade has been seen as a seemingly perfect system of creating wealth and prosperity for many Americans, we now find to be based on an illusion of wealth generated by monetary inflation, excessive debt, and a giant financial bubble feeding consumer excesses.
Yikes!
Historically, current account deficits end badly, especially if they run for a considerable period as ours has. Economic law indicates that eventually the excess dollars overseas must return home. There's no way foreigners will forever accept our fiat money created out of thin air. After all, those dollars are used primarily to increase our standard of living at their expense.
Ever since the breakdown of the Bretton Woods Agreement in 1971, the dollar has steadily slipped on world currency markets with many ups and downs in between. We are currently ending a recent up-trend for the dollar (and down for gold), and are seeing the early stages of the dollar once again resuming its downward spiral.
The huge surge in the June trade figures indicates how seriously out of balance the world financial markets are. However, in the last several months, dollar weakness has emerged which has a moderating influence on trade imbalances. This weakness in the dollar will continue. The surprise in the June report was the minimal increase in our exports, which indicates that the supposed recovery in Asia is not yet reflected in our trade figures and that Europe and South America are still not enjoying economic growth. It is highly likely that these trends will lead to a lower-than-projected GDP growth rate in the near future.
This pattern cannot continue. The dollar will adjust downward against many other currencies, and the gold price in dollars will rise along with interest rates and many consumer prices. This will all be made worse as the stock market falls in value and the stock-market wealth effect is revised. Oil prices have already doubled this year. This will play havoc with the unrealistic projections of budget surpluses that the politicians in Washington are depending on to expand the welfare state and continue the warfare state with irrational military spending. Perpetual war requires ever-increasing expenditures in the military budget, something we will not be able to afford in the next decade.
Treasury's Slush Fund
Meanwhile, Congress keeps in place all the statist tools that can be used to bail out the entire system. No serious effort is afoot to curb foreign aid or the influence of the military-industrial complex. Financing for the World Bank, the IMF, and the United Nations will continue along with funding for the Export/Import Bank and the Overseas Private Investment Corporation.
The Congress is not yet interested in challenging the Fed's secret operation through which it manages the dollar's fiat system. The Fed assists special friends, such as foreign dictators who owe plenty to the New York Banks and friends in domestic enterprises, like Long Term Capital Management, who get in over their head.
An effort to curtail Treasury's special slush fund, the Exchange Stabilization Fund, failed on the House floor. The ESF, set up by the Roosevelt Administration with profits gained from confiscating gold and reevaluation of the dollar in 1934, has been off limits to congressional control ever since. Today the ESF - this "government" unto itself - has accumulated over $34 billion. This fund has a direct line of credit to the Fed, and it can be used at will to satisfy the special needs of the world financial markets, just as it was, extensively, in the 1995 Mexico/Peso bank bailout.
Through all the various domestic and international agencies, almost any bailout can be carried out by creating unlimited dollar-denominated credit - that is, until the market decides there are too many dollars being created, and the dollar's value is driven down on foreign exchange markets.
The Exchange Stabilization Fund should never have been created. It's unconstitutional, it exists to serve special interests, and it promotes dangerous economic policies. In fact, it should be abolished. Nevertheless, when a few of us in the House tried to force even token oversight by requiring congressional approval of loans of anything over $1 billion to foreign nations, the notion was soundly rejected. That shows how powerfully the special interests who benefit can influence Congress.
The original purpose of the ESF has been ignored by all recent administrations. It was originally set up to protect the dollar's value on international exchange markets - a much more justifiable goal than what it currently is employed to achieve. Today, instead of being used to protect the dollar, it's used to prop up weak, foreign, mismanaged, and indebted countries - to shore up their economies and their currencies. It exposes the U.S. taxpayers by loaning dollars and actually weakening the dollar by encouraging monetary inflation by the Fed. Bailouts from the ESF are encouraged by the banks that have made unwise loans in these economically unsound, unstable countries, and stand to lose if the United States government doesn't come to their rescue.
Obviously, under a constitutional system of sound money, the Exchange Stabilization Fund would never exist. But needless to say, it's still around and available for the next bailout.
Probably only a weak and discredited dollar will bring this process to an end. In recent months, the dollar has shown signs of weakness. While, in the scheme of things, this has been minimal, it may well be the beginning of a trend. Interest rates, likewise, have risen, and the markets are rightfully jittery. The stock and bond markets abhor rising interest rates; all eyes are on the Fed.
The Wizard of Rates
The moment after the Fed announces interest-rate policy at one meeting, all attention immediately turns to the next Federal Open Market Committee meeting six weeks later. Expectations and speculations as to what the Fed might do with interest rates occupy a tremendous amount of time and energy on Wall Street.
Trying to read Alan Greenspan's mind, since he is the Fed, is crucial to every investor. It's rather bizarre to have this man, who was once a free-market, gold-standard capitalist, dictating monetary policy to all Americans - and for that matter, to the entire world. This one man decides the proper amount of money and credit to be put into circulation, as well as where short-term interest rates should be pegged.
In spite of Greenspan's god-like image on Wall Street and in Washington, when push comes to shove, he will receive plenty of blame. At present, Banking Committee members, both Republicans and Democrats, fawn over Greenspan when he appears before our committee. They sang high praises and even endorsed immediate reappointment by Clinton a full year ahead of schedule to try to ensure that no loss of confidence in the Fed would creep into the market. At the same time we have the conservative, pseudo-gold standard supply-siders, as well as the left-wing liberals, continuing to criticize Greenspan for even thinking about raising interest rates ... ever.
Nowhere do we hear, except from yours truly, that the real question is not whether Greenspan should raise or lower interest rates at any particular time, but how Greenspan (or anyone else on earth) could ever know the "proper" interest rates or the correct growth rate for money and credit.
The ability to know those numbers is nothing more than a central planner's dream, a fiction; it's money socialism and entirely foreign to the concept of free-market capitalism.
Since the only complaint we hear regarding Greenspan's policy is that he's not inflating the currency fast enough to keep rates down and the economy perking, we can be quite certain that with any downturn in the economy, the demands for lower interest rates will be very loud.
The tradeoff Greenspan will face in trying to maintain a reasonably sound dollar, once the current-account deficit problem manifests itself, will be in allowing interest rates to rise and accepting consumer price increases in the U.S. The truth of the matter is the Fed, even with its tremendous power to run the economy through monetary mischief, will ultimately be subject to market forces.
Those who actually express a concern for future price "inflation" wrongly believe that future policy will determine the prices of commodities and services. That is why we are forever hearing the pundits and federal officials express plans to "head off" inflation. This is utter nonsense. The only tools they have to deal with the consequence of previously engaged-in monetary inflation (the byproduct of previous policy) are: 1) to reduce the money-supply growth; 2) raise interest rates; and, 3) cause a recession and hope a weak economy will reduce prices.
The dilemma is that increasing interest rates in themselves can contribute to generally higher prices (option 1). Furthermore, the politicians are demanding that the economy be kept moving, and that will preclude a return to market interest rates (option 2), because they would be condemned as being too high. And finally, we experienced stagflation in the 1970s with a serious recession (option 3) and still experienced significant price inflation in goods and services at the same time.
Third-world countries not infrequently experience runaway inflation and depression at the same time. The 70s stagflation phenomenon in the United States was blamed on the Arabs raising oil prices in order to distract us from the inflationary Fed policy of earlier years, which financed the Vietnam War and Johnson's Great Society welfare programs.
The big challenge to Greenspan and Company is to preserve the dollar's value. Meeting that challenge will be construed as promoting a policy of economic slowdown, high interest rates, and stock-market weakness - a policy that is politically unacceptable to Washington. Someday, if Greenspan is indeed reappointed as everyone expects, he may remember my admonishing him when he was before the Banking Committee that maybe instead of reappointment he ought to be thinking about "getting out while the getting's good."
We must remember the business cycle is not a natural consequence of capitalism and sound money - it comes from central bankers inflating the currency either to stimulate the economy, monetize government debt, or both.
Keynesian economics dictates that a fiat standard of money accommodates the politician's desire to spend the central-banker's efforts to charm the economy. Some who promote this system seriously believe it's best for everyone, and especially helpful to the poor who need welfare benefits. Others more correctly see this system of money and economic planning as beneficial to their own special interests. In the later category, we would place bankers, internationalists, and promoters of intervention through militarism. Members of these groups may talk themselves into believing the trickle-down effect will help the masses through jobs and cheap services.
Although all these justifications are true to some degree for periods of time, the great harm done and the moral injustice of such a system should preclude ever promoting it. The eventual consequences are far different from the delusions of the promoters:
1. All planned economies eventually fail.
2. The working poor are notoriously the greatest victims of inflation and job losses.
3. Wealth is transferred from the middle class to both the wealthy and the welfare beneficiaries.
4. Financial crises produce political crises and frequently lead to war.
5. But the ultimate and most serious consequence of a program of big government financed with fiat money is loss of personal liberty.
In this century we have had steady erosion of constitutional principles and sound money. In association with this, we have experienced frequent war, recessions, inflations, depressions, erosion of respect for law and life, and a dangerous explosion of national police powers.
Only a determined effort to return to the basic American principles of liberty, as expounded by our Founders, will permit our nation to thrive in peace in the 21st Century. Our challenge will be more clear-cut than ever as we witness the disintegration of the financial markets.
|
