QE3: The Funny Money Team Has Crossed the Monetary Rubicon


September 24, 2012

(This item originally appeared at Forbes.com on September 24, 2012.)

http://www.forbes.com/sites/nathanlewis/2012/09/24/qe3-the-funny-money-team-has-officially-crossed-the-rubicon/


Now they’ve gone and done it.

Humans’ natural pattern-recognition habits usually work something like this: the first time is a fluke. The second time is a coincidence. The third time is a pattern or trend. At that point, people begin to accept the twice-confirmed event as a new part of their environment. They may also tend to extrapolate the new trend or pattern into the indefinite future.

This, arguably, was one purpose of the Federal Reserve’s newest “QE3”: as Paul Krugman puts it, the promise to be “credibly irresponsible” for years ahead. According to the Keynesians’ Bizarro World logic, this is a good thing.

What happens next? The investing mainstream, which has mostly acted as if the dollar is stable in value even as it has been declining for a decade due to the Fed’s “easy money” stance, may begin to see things in a new way.

We may begin to see a decline in dollar demand, with inflationary consequences. This was the main reason for the inflation of the 1970s, not an expansion in supply. The dollar’s monetary base – the total number of dollars in existence – was $68.361 billion in August 1971, the month the dollar left the Bretton Woods gold standard parity at $35/oz. In January 1980, the month the dollar hit its nadir around $850/oz. and Paul Volcker decided that enough was enough, the monetary base was $132.831 billion, an increase of 93%. This came nowhere close to the 2,328% increase in the dollar price of gold (i.e. a decline of the dollar by 96%). During the 1990s, when the dollar actually rose in value, the monetary base increased by 121%, reflecting economic expansion for the most part.

If we start to see this kind of 1970s-style revulsion in demand, on top of the Fed’s eager increase in supply and promises of zero percent rates for years ahead, things could get really interesting.

The funny-money guys have begun the process of destroying themselves. This is what has always happened eventually. The temptation of using the printing press to solve every sort of economic difficulty – here, it is supposedly a cure for unemployment; in Europe it is a way to avoid sovereign default — eventually becomes an incurable addiction.

Ideally, as I chronicled in my book Gold: the Once and Future Money, this results in a political migration towards the Classical ideal of a currency that is as stable and reliable as possible, and free of human intervention. In practice, the best real-world way to achieve this goal is a gold standard system.

Already this has begun to happen, illustrated by the Republican Party’s suggestion of a commission to study the gold standard alternative. That rather mild step is appropriate for this time. We still have five or ten years, before replacing the imploding fiat currency system becomes a political imperative. At that point there will be no “debate” with the Keynesians, because it is hard to have a debate with someone who has already been tarred and feathered.

Before that happy day, there is a lot of work to do. First, we have to become very clear about what we are trying to accomplish, and why. We want a currency that is stable in value, a universal constant of commerce, and a neutral medium of business, not a fiat abstraction whose value depends on Ben Bernanke’s latest press conference. In practice, the best way to achieve this goal is a gold standard system.

Those who adhere to the principles of stable money gain a lot of benefits. In the middle of the 20th century, the United States was the world’s premier defender of the gold standard system. The former champion, Britain, disappointed its fans by devaluing in 1931, 1949 and 1967. Not surprisingly, the United States also became the world’s financial center, had the world’s dominant international currency, became the center of a gentle global empire, and had a middle class that reached a level of prosperity never seen before (or since).

When Britain was the world’s premier champion of the gold standard system, during the 19th century (the U.S. was an emerging market then), it too became the world’s financial center, had the world’s dominant international currency, had an empire that spanned the globe, and became a hotbed of industrial innovation and capitalist wealth-creation.

But perhaps a better example of the power of sound money is provided by Holland. In the 17th century, while Britain was still in the Mercantilist age of unreliable currencies, the Dutch had fully embraced the principle of stable, gold-linked money. Amsterdam became the world’s financial center, and the Dutch guilder was the world’s dominant international currency. Holland became a hotbed of industry and world commerce. The middle class became wealthy enough to finance an artist class whose works fill museums today.

This little nation of two million, on some of the worst land in Europe, eventually gained its own global empire, which included all or part of today’s: Indonesia, Brazil, Australia, India, Iran, Iraq, Pakistan, Yemen, Bangladesh, Oman, Burma, Sri Lanka, Taiwan, Thailand, Malaysia, Cambodia, Vietnam, China, Japan, South Africa, Suriname, Guyana, Colombia, Chile, and Ghana.

And, let’s not forget, an outpost at the mouth of the Hudson River, then known as “New Amsterdam.”

The gold standard works.

Unemployment can still be a problem, but you don’t try to solve it with funny money manipulation. Instead, a combination of economy-positive policies such as tax reform or regulatory reform, plus welfare as necessary to relieve the immediate suffering, is the preferred strategy. Fundamental problems get fundamental solutions, not a temporary jolt of currency meth.

There are many potential ways to design a gold standard system, some of which require no gold reserves at all. Gold is simply “the standard,” a basis of measurement. We can navigate by Polaris, the North Star, and get excellent results without having to actually own the star itself. Historically, however, gold standard systems have had the most longevity when the currency issuers are subject to the requirement of “redeemability,” to deliver gold bullion on demand. We should have a long and intelligent discussion about the pros and cons of the various ways to run a proper gold standard system, which will also help to dispel a lot of the fatuous nonsense on the topic that is floating around out there.

I think the funny money team has crossed the monetary Rubicon. No turning back for them now. The old era is past; the wheels of history have begun to turn. The new era, if it is to be a happy era, will also be an era where the Classical ideal of a currency as stable and neutral as possible becomes prominent. We now have to build that monetary system in our minds, in all of its exacting and meticulous detail, so that we can wheel it out, shiny and perfect like a new Mercedes, when the time comes.