Originally posted on Wednesday, August 22nd, 2012
“The restoration of sound money, that is to say, depoliticized and honest money, is a necessary step to a return to sustainable global prosperity. Specifically, a gold dollar that promotes the long-horizon investment that, almost by itself, leads to strong job creation at the same time as it restrains government profligacy, is an essential part of a brighter future for the entire world.”
Image creative commons licensed, Courtesy of digitalmoneyworld
So, a year ago, wrote John Allison, then teaching at Wake Forest University. Allison’s co-author, John Chapman, wrote as chief economist at Hill & Cutler Co. and an advisor to Alhambra Investment Partners. Given Cato’s importance and Allison’s prominence as its incoming president this thoughtful essay, originally published at year ago at AEI’s The American, entitled It’s Time for Pro-Growth Monetary Reform, merits renewed attention. It concludes:
By the 1960s this (gold-based international monetary) system broke down. Foreign governments announced periodic devaluations to promote exports and allow for domestic spending, and the U.S. ramped up “guns-and-butter” federal spending for both the Great Society and the Vietnam War. Inflation slowly crept into the U.S. economy, and gold redemption requests spiked by 1968.
President Nixon thus took his fateful decision in 1971, freeing the United States from any redemption obligations. This had two immediate effects: it amounted to an automatic, if stealthy, repudiation of U.S. debt in real terms, because it devalued all dollar-denominated assets and currency at once; and, it allowed the nominally independent Federal Reserve to manage the U.S. money supply for political ends.
The Predictable Aftermath of 1971 and the Fiat Dollar
An era of massive instability has been the result: a trenchant stagflation in the 1970s; banking and Savings and Loan crises in the 1980s; Latin American, Asian, and Russian banking crises in the 1980s-1990s; overleveraged financial institutions and bailouts of firms too-big-to-fail in the 1990s-2000s; and, since 2000, two Fed-induced bubbles and subsequent crashes, the second one based in the housing sector that went global thanks to implicit guarantees of U.S. mortgage debt.
Here’s the key policy insight: rather than being a source of macro-stability, central banks that manage fiat currencies are themselves the causal agents of repeated boom-and-bust business cycles. By increasing the base money supply costlessly, central banks not only encourage government spending, they also permit the pyramiding of credit that guarantees leverage-driven booms: interest rates fall below their natural rate, which induces private investment and a temporary expansion. But this boom, usually in interest-sensitive capital goods, is not based on real savings of individuals and institutions, but rather on artificially created credit. By definition, such a boom is inherently unstable, and must end in a bust and painful retrenchment. The greater and longer the creation of fiat money by the central bank, the larger the pyramiding of credit, and the harder and longer will be the ensuing recession.
Monetary policy has not been a dominating political issue since the presidential election of 1896, when the pro-inflation William Jennings Bryan railed against a “cross of gold,” only to lose to the sound money advocate William McKinley. But it must once again animate our national debates because the Great Recession and its ensuing torpor are the direct consequence of fiat money management by politicized central banking. The restoration of sound money, that is to say, depoliticized and honest money, is a necessary step to a return to sustainable global prosperity. Specifically, a gold dollar that promotes the long-horizon investment that, almost by itself, leads to strong job creation at the same time as it restrains government profligacy, is an essential part of a brighter future for the entire world.
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