I’m concerned in regards to the long-term health of the US dollar and just about all other fiat currencies on the earth. Why? Due to low rates of interest, artificially inflated asset valuations and skyrocketing debt following the worldwide financial crisis (GFC).
How much has monetary policy modified for the reason that global financial crisis? In his book, Christopher Leonard notes that the Federal Reserve printed more cash between 2007 and 2017 than within the previous 500 years. And that was before those efforts were ramped up following the COVID-19 outbreak to combat weak economic growth and high unemployment. As we now have seen, printing more cash doesn’t increase wealth, but somewhat inevitably makes the cash less beneficial through higher inflation.
This grand monetary experiment has undermined the worldwide economic system and requires a radical solution.
The United States cannot overcome its current deficit simply through growth. Higher taxes and budget cuts are among the many only remaining tools available to policymakers, and while the previous could increase federal revenues within the short term, they might likely reduce economic growth in the long term. Significant and sustained budget cuts, however, are almost all the time unpopular and politicians have little incentive to make them. The negative effects of such measures will be felt relatively immediately, while high deficits only hurt a few years later, normally long after the responsible politicians have left the stage.
However, if the United States fails to bring its deficits under control, the US dollar could lose its status because the world reserve currency. Some countries are already trying to cut back their dependence on the dollar. Reserve currencies rise and fall as a part of long-term cycles, and any reserve currency is vulnerable to becoming non-reserve.
For these reasons, I consider we’d like to return to the gold standard in some form. President Richard Nixon ended the previous gold standard era in 1971 when he abolished fixed convertibility between the U.S. dollar and gold and made the dollar a fiat currency. While it’s unlikely that a rustic issuing fiat currency will ever default, it could actually and infrequently will print a lot money that the currency becomes worthless. In this case, the connection between paper money and gold or other material assets is usually restored. Today, the specter of debt restructuring and possible defaults could soon result in such a worldwide monetary policy reset.
I’m not only advocating a return to the gold standard; Like Milton Friedman, I consider that central banks should link money supply growth to GDP growth. Over the years, Keynesians have rightly noted that constraints on money supply growth don’t all the time affect the speed of cash. However, when the cash supply increases far beyond GDP growth, it destabilizes the economic system.
“Where is the understanding of history and common sense about the amount of money and credit and the level of inflation?” — Ray Dalio
Of course, Friedman’s monetarism just isn’t resistant to criticism. How to define the cash supply – for instance M1 vs. M2 – has never been clear. The rise of shadow banking and cryptocurrencies has not made the job any easier. Still, it makes intuitive sense that monetary growth should reflect economic growth. When more cash competes for a similar goods and services, that cash loses value. There isn’t any profit in printing massive amounts of paper money in excess of GDP growth, or incentivizing private banks to accomplish that through fractional reserves and government bailouts. Fed Chairman Jerome Powell may downplay the connection between monetary growth and inflation, but it surely was a policy mistake to print a lot money in 2020, long after conditions had stabilized.
For this reason, I consider that a partial gold standard needs to be complemented by linking money supply growth to GDP growth and introducing a full-reserve banking system. In 1933, a bunch of economists proposed such a full-reserve banking system as a part of the so-called Chicago Plan. They believed that the fractional reserve banking system that also exists today was answerable for the Great Depression. But in a full-reserve system with a loan-to-reserve ratio of 1:1, every dollar of loans is backed by a dollar of deposits. A monetary system structured along these lines would drastically reduce the danger of maximum boom-and-bust cycles.
We may never fully understand the impact of COVID-19 on the domestic and global economy or the aggressive monetary and monetary policies taken in response. But it’ll almost actually be rather more difficult for the United States to cut back national debt today than it was within the post-World War II era. Between 1945 and 1959, the U.S. government reduced its debt-to-GDP ratio by greater than half to about 50%, largely due to rapid economic growth and a population boom. U.S. GDP rose from $228 billion in 1945 to almost $1.7 trillion in 1975. Today, not even essentially the most optimistic scenario assumes economic growth will come anywhere near that level in the approaching years becomes. In terms of population, without major changes in immigration policy, the United States won’t grow fast enough to spur crucial economic growth given the low domestic birth rate.
Making matters worse, Social Security and Medicare spending accounted for 61% of federal spending in 2019, in comparison with about 30% in 1970. The United States has three options: It can raise taxes in the approaching years to cut back the national debt and to pay social spending, restructure or default on debt, or proceed to print large sums of cash. In my opinion, the primary option may be very likely. The second is extremely unlikely given the country’s status as an issuer of fiat currencies. This means the third option is all but inevitable. But given the state of the United States today, higher taxes and extra money printing will only further devalue the U.S. dollar.
Increasing global debt and the potential decline in fiat currencies increase the chance that U.S. Treasuries and other government securities can be devalued or reduced to zero. For most living today, such an idea could appear inconceivable. But Ray Dalio provides some helpful historical context:
“While people tend to think that currency is pretty much a permanent thing and that ‘cash’ is the safest asset to hold onto, that’s not true. All currencies devalue or die, and when that happens, cash and bonds (which are promises to receive money) are devalued or destroyed. This is because printing large amounts of currency and devaluing debt is the most expedient way to reduce or eliminate the debt burden.”
Those of us within the United States and other developed countries have only ever experienced stable national debt. Too many retirees have 80% of their total wealth invested in a single government’s debt, under the false assumption that it’ll never lose value. But we must always not confuse low price volatility with the absence of risk. Such considering is dangerous and ignores the history of public debt around the globe. We must also recognize that fiscal and monetary policies for the reason that global financial crisis and particularly post-COVID-19 have only made devaluation more likely.
“Of the approximately 750 currencies that have existed since 1700, only about 20 percent remain,” notes Dalio. A brand new monetary system along the lines I actually have described would help keep the dollar at that 20%.
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Photo credit: ©Getty Images / manassanant pamai
