Saturday, August 13, 2011

Prospects for a U.S. monetary collapse

My understanding of the debt crisis has led me to believe that the United States, and, indeed, much of the world, is on the short track to economic disaster. I base this primarily on the insight of the Austrian school: that since accumulating too much debt caused the problem, attempts to incur more debt will only exacerbate matters. Secondarily, our political class seems incapable of doing anything to address this problem; I expect economic conditions to worsen until either the currency is rendered worthless by too much inflation, or austerity measures are adopted, whereupon we shall find ourselves in the midst of a depression.

Thus I read with interest a piece which claims that things might be less dire. The author attempts to refute some of the myths of the doom and gloom crowd. Alas, I remain unpersuaded. His debunking shall thus be subsequently debunked.

Purported Myth: "Printing Money Does Not Create Wealth"

Explanation: "The example I like to give is that the Sovereign US Government can start this totally useless agency, yet the money will eventually flow to those who create wealth. Therefore, printing can eventually lead to wealth creation...

If the new ear pickers go into their communities and spend it at local businesses, the printed money goes from useless employees, into the accounts of productive businesses..."

Rebuttal: As one of the commenters has pointed out, this is a classic example of what Frederic Bastiat calls the broken window fallacy. It's true that any money which the government prints will go into the economy, but it only adds to wealth creation by simultaneously subtracting from wealth creation. If a government worked spends a dollar, he may pay a producer, but he has taken that dollar from the citizenry who would have spent it on something else. One could similarly argue that thieves participate in wealth creation by robbing from the rich so as to spend on themselves, which is actually reasonable shorthand for most government spending.

Wealth is created through production. Redistributing the currency--which is what inflation does--can alter the productive process by ensuring that different goods are produced, but it cannot increase the amount of goods provided.

Purported Myth: "Businesses and Foreigners Will Stop Accepting US Dollars"

Explanation: For some reason it is just assumed that the marketplace will all of a sudden stop accepting paper US dollars...

The US Government has determined that taxes are to be levied on owners of property and services, and those taxes will only become extinguished in the form of paper dollars. Failure to submit to this monster will require time in prison. So under the motivation to not spend time in jail, citizens work tirelessly, offering labor and goods in exchange for paper dollars so they can feed the tax monster."

Rebuttal: While it is true that the government monopoly on money ensures that people will use the dollar even when they would prefer to use something else, this ignores the potential for a black market to arise when the currency depreciates sufficiently. Excessive taxation and regulation actually make it more likely that a black market will develop, because in addition to dealing with that which cannot be devalued through inflation, one will also be able to avoid paying government for the privilege of engaging in mutually beneficial exchanges.

Purported Myth: "America Will Soon Not Be Able to Afford the Interest on the National Debt"

Explanation: "Burkett prophesied that America, by the turn of the century, would have so much debt that they could not afford the interest on the debt. Since his book made this claim, the debt has doubled. Now the current doom and gloom crowd is saying, yet again, that we will not be able to afford the interest on the debt."

Rebuttal: No one knows how long extend and pretend will last. What is clear, however, is that the more indebted a nation becomes, the higher the interest rate the market will demand. In a matter of months, Greece went from a nation which was seemingly economically sound to one which could only take on more debt at ever increasing rates of interest. The speed at which this occurred was astounding, even to economic pessimists.

Momentarily, the United States is better positioned than Greece, partially because our debt levels are smaller, and partially because we've been able to suppress interest rates thanks to a Federal Reserve which has made a habit of monetizing the debt.

We are probably still a fair ways from Greece, though ultimately no one knows. What is clear, however, is that a nation which refuses to reduce its insatiable appetite for debt will find it harder and harder to find willing borrowers. I think it likely that the current monetary system will collapse before we reach this stage, but the pessimists are correct in their reasoning, and right to be concerned.

Purported Myth: "Paper Dollars Are Worthless and Backed By Nothing"

Explanation: "Dollars are just worthless pieces of paper. It has no value by itself and is today backed by nothing. I agree with this argument. Consider this though: Oil in and of itself is also worthless. It is just sticky goo that could ruin the environment if it ends up in the wrong place...

The event that causes worthless oil to be in demand is when a company turns it into gasoline. The event that causes worthless paper dollars to be in demand is the prosecution process for failing to pay taxes."

Rebuttal: The first paragraph is basically sound. The error shows up in the next paragraph. It's preposterous to pretend that a nation can jail the citizenry for failing to pay taxes without destroying itself in the process. America, like any other nation, functions because of a relatively small group of people who produce goods and provide them for others. These are the same people who are taxed by the government, and maligned for failing to do more for the country. Jailing these citizens is the height of idiocy, for it turns a producer into someone who acts as a drain on the economy.

It is true that the government can force citizens to use their currency, giving superficial support to the dollar. But it can only do so if it is willing to wage war against the productive class. Expect to see an increase in tax evasion in the next few years, in which case it will be very interesting to see what the IRS decides to do to such "criminals." It is difficult to envision a response that would strengthen the regime.

There is another point which our author misses. If the dollar cannot buy as much, it will become less attractive to work as an agent of the IRS. Thus in late Rome, the soldiers refused to tolerate the currency which had been mixed with base metals; so the wise emperor paid them in coins which had not been debased. Without employees willing to accept the government's money, the government has no one with which to force the citizens to accept that same money.

Purported Myth: "Every Fiat Currency System Eventually Fails"

Explanation: "I hear (and used to believe myself), that the fiat currency system is about to collapse because all fiat currency systems in history have collapsed...

The problem is, these proponents are comparing apples with oranges. Never in history has the entire world been on a coordinated, floating exchange-rate, fiat-currency, system. Therefore, do they really have anything with which to compare today's situation?"

Rebuttal: To answer the question, yes, we do: we have the graveyard of fiat currencies. Countless times in the past, governments have debased their currencies until the populace escapes to anything and everything else. Traditionally, this has been gold and silver, but it could be alcohol, or ammunition, or canned food, or diesel fuel. It does not matter. When the government is printing money so quickly that one cannot make money fast enough to spend it, people will no longer use it; at this point, the currency has been destroyed.

Part of the confusion from which our author suffers is that he assumes that because every central bank is inflating its currency, people have nowhere to turn. Now, it's true that historically, when the British, say, inflated, people could fly to the dollar, thereby checking the British bankers. But the absence of this check--that is, any currency backed by gold--actually makes it far likelier that people will abandon the dollar. The confusion comes because he thinks people have to begin to use something that is already a currency; on the contrary, whatever good people begin to acquire will take hold as the new currency.

Now Bernanke has a good deal of inflating to do until we reach this point, but history is very clear about what happens when we do reach it.

Purported Myth: "Printing Money Will Cause the US Dollar to Lose Reserve-Currency Status"

Explanation: "The US economy is still the biggest in the world by a large margin. The military, which we are not afraid to use, is the most powerful. Until another country holds title to either one of these claims, our reserve currency status will likely remain intact."

Rebuttal: At this point, the dollars status as a reserve currency is only tangentially connected to our economic and military power. In fact, it was not long ago that the U.S. dollar was, at least theoretically, backed by gold. Other countries value the dollar because they know they can turn around and get something else for it. As that something else diminishes, countries will begin to look elsewhere to sell their products. Moreover, while the U.S. will probably remain the nation's largest economy, its diminished purchasing power will further incentivize sellers to look elsewhere for customers.

I suspect that in the next several decades, we will see a world without a reserve currency per se. Regional currencies will develop, regions which will not correspond exactly to the present boundaries of maps. This will greatly reduce international trade--though piracy will see a boost--and thus diminish the goods available to the average consumer. This is unfortunate, but if black market activity reduces the scope in which governments may interfere, I see it as an essentially inevitable result. Moreover, while the interim period will be rife with bloody conflict, a world of small, homogeneous regions should prove more stable than have our gargantuan nation states.

Purported Myth: "If Money Printing is Good, Then Just Print Enough To Give Everyone $1 Million"

Explanation: "If printing is not a big deal, then why not just print away? The doom and gloomers jump to the conclusion that if I think printing won't cause the collapse of America, it must be a good thing. So why not seek more of that good thing? The answer is simple...

There is a limit to the productive capacity of the economy."

Rebuttal: The author insists he is not a Keynesian, so I'll take him at his word, but I do note a curious resemblance. I suppose I see all inflationary systems as similar in nature: printing money is good, but only to a certain point; that point cannot be clearly delineated, and any inflation which does not produce the desired effect will be decried as too small, but a theoretical upper limit is recognized.

Of course, if the government did give everyone one million dollars, every one of the myths above would come true virtually overnight, but setting that aside, I want to focus on the last sentence of his explanation. For while this statement is undoubtedly true, it essentially undermines his entire argument.

Earlier, we learned that printing money can create wealth. Here we learn that wealth is not limited by money, but by something else entirely. As I have said, this is correct, but if it is correct, then printing money can do nothing whatsoever to increase wealth. It can only, as I have said, alter the distribution of that wealth.

If inflationists wish to be taken seriously, they need to explain how much inflation is needed to salvage a depressed economy. Typically, the response is to demand more inflation when a jolt of easy money fails to awaken the sleeping patient. But until we can be told with certitude that we are not inflating too much, I am far from certain that it can be safe to inflate at all.

Purported Myth: "The US Dollar Has Lost 96% of its Purchasing Power - Thus Printing Makes Us Poorer"

Explanation: "Instead of looking at how many dollars it takes to buy a candy bar today compared to 30 years ago, I would challenge you to instead value the candy bar in hours of labor to obtain it. While it might take many more dollars to buy that candy bar, you get many more dollars for each 60 minutes of work. So even though the candy bar costs 1000% more, it may take you 30% less work now to buy it. Therefore, you are in fact richer, even though the value of your dollar does not go as far."

Rebuttal: This is a curious way of looking at the debasement of the currency. The issue at hand is not whether we are richer than our ancestors were decades ago, for this is undoubtedly true, but whether or not inflation has made us poorer than we would have been had the Fed left the money supply alone.

It should be obvious that the Fed has stuck it to the American people, or at least some of them. I've covered this before, but inflation is a tax on savers; the beneficiaries of inflation are debtors, as well as anyone who is politically connected, for they receive the newly printed money before its debasement has been discovered by the market.

Savers provide the capital with which producers make the things which we can then buy. Our tax code attacks producers, while our central bank attacks savers; a more idiotic system would be hard to implement. The establishment class in Washington, as well as their friends from the banks and corporations, have benefited tremendously from the wealth redistribution that occurs courtesy of the Fed. Concomitantly, the people have been harmed. While it is true that, in general, and excepting the present, we have been getting richer as a society, this should not distract us from the real wrongs the people have suffered through inflation. It is the height of absurdity to suggest that the people should be happy that they are a little richer than before, while the banks make money hand over fist, courtesy of a central bank which takes wealth from the people.

In short, things look very bad indeed. Much can change, and the pessimists may be wrong about the timeline, but a sober reading of the tea leaves demands concern. It wouldn't hurt to have some precious metals lying around, either.

1 comment:

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