Since the beginning of 2009, oil prices have almost tripled, gasoline prices are up about 50 percent, and basic food prices, such as corn, soybeans, and wheat, have almost doubled around the world. Cotton and copper prices have reached all time highs; major rises in sugar, spice, and wheat prices have been creating food riots in poor countries, where basic goods inflation is rampant. That inflation is in part financed by the flood abroad of excess dollars created over the last couple of years by the Federal Reserve.
Those dollars also made possible the emerging market equity boom of 2009-2010. But foreign authorities are now raising interest rates as growth shifts to the United States and Europe. The years 2011-2012 will witness a Fed-fueled expansion in the United States. Unless there is a major oil spike from here, growth for 2011 in the United States will be above the new consensus of 3.5 percent—perhaps as high as 5 percent this year, with about 8 percent unemployment at year-end.
At first, the enormous Fed credit creation of 2008-2010 could not be fully absorbed by a U.S. economy in recession. But much of this new Fed credit has flooded stocks, bonds, and commodities. The excess credit went abroad, too, causing a fall in the dollar and creating bull markets and booming economies in the developing world. At the same time, inflation intensified, with riots and political turmoil as a result.
There is little new in this latest postwar boom cycle, associated as it is with the world dollar standard we have been living under since the end of gold convertibility and the Bretton Woods monetary system in 1971. With expansive credit policy and Fed financing of the U.S. government deficit, every boom and bust cycle has been enabled by the Fed. At this moment, we are witnessing in the U.S. equity market, and once again in the decline of the dollar, the predictable effects of Federal Reserve money and credit creation. This latest Fed credit boom has begun with commodity inflation. The extraordinary Treasury deficit, financed by the Fed at home, is financed abroad by the official reserve currency status of the dollar. For example, in addition to the Fed purchases of U.S. government securities, foreign financial authorities have absorbed at least $4 trillion of U.S. government securities, against which foreign central banks have created their own domestic money. And the U.S. budget deficit can continue to expand so long as there is undisciplined Fed and foreign credit to finance it.
To finance the government deficit, the Treasury now sells bills and bonds at a rate of about $120 billion a month, or about $1.5 trillion per year. But this new Fed-created money, which finances the government deficit, is not associated with any production of new goods and services. Thus, total monetary demand, or purchasing power, exceeds the existing supply of goods, equities, and services at prevailing prices, with the predictable result that prices rise. But some of the excess dollars go abroad, creating booms and inflation in emerging markets. As prices rise faster than wages, profits rise. Production increases. A boom is underway.
But it’s a boom that turns into a bubble. And there are social effects, not only financial effects. This insidious international monetary and fiscal arrangement has been a primary cause of the increasing inequality of wealth in American society. At home, bankers and speculators have been and are the first in line, along with the Treasury, to get zero interest money and credit from the Fed. They are first to get bailed out. Then with new money, they finance stocks, bonds, and commodities, anticipating, as in the past, a Fed-created boom.
Prices rise first for the most volatile goods, especially stocks, commodities, and financial claims, because they are relatively liquid vehicles for speculators and banks. This is the story of the past two years, with stocks and commodities advancing amidst a sluggish U.S. economy. This is also the story of postwar Fed-created booms. Each cycle experiences an inflation boom, often in different assets, e.g., Internet stocks in the late ’90s and real estate in the last boom and bust.
Inflation at the consumer level has been muted by high unemployment and unused production facilities. But the social effects are already discernible. The near-zero interest rates maintained by the Fed have primarily benefited the large banks and their speculator clients. A nimble financial class, in possession of cheap credit, is able both to enrich itself and to protect itself against inflation.
But middle-income professionals and workers, on salaries and wages, and those on fixed incomes and pensions, are impoverished by the very same inflationary process that subsidizes speculators and bankers. Those on fixed incomes will likely earn very little or even a negative return on their savings. Thus, they save less. New investment then depends increasingly on bank debt, leverage, and speculation. The unequal access to Fed credit was everywhere apparent during the government bailout of favored brokers and bankers in 2008 and 2009, while millions of not so nimble citizens were forced into bankruptcy. This ugly chapter is only the most recent in the book of sixty years of financial disorder.
The inequality of wealth and privilege in American society is intensified by the Fed-induced inflationary process. The subsidized banking and financial community, along with the chaos of floating exchange rates and an overvalued dollar, underwritten by China and other undervalued currencies, has submerged the American manufacturing sector, dependent as it is on goods traded in a competitive world market. In a word, the government deficit and the Federal Reserve work hand in hand, perhaps unintentionally, to undermine the essential equity and comity necessary in a democratic society. Equal opportunity and the harmony of the American community cannot survive perennial inflation.
If the defect is inflation and an unstable dollar, what is the remedy?
A dollar convertible to gold would provide the necessary discipline to secure the long-term value of middle income savings, to backstop the drive for a balanced budget, and to end the dollar standard and the special access of the government and the financial class to limitless cheap Fed money. And the world trading community would benefit from a common currency, a nonnational, neutral, monetary standard that cannot be manipulated and created at will by the government of any one country.
That is to say, dollar convertibility to gold, a nonnational common currency, should be restored. And dollar convertibility to gold should become a cooperative project of the major powers. This historic common currency of civilization was, during the Industrial Revolution and until recent times, the indispensable guarantee of stable purchasing power, necessary for both long-term savings and long-term investment, not to mention its utility for preserving the long-term purchasing power of working people and pensioners. In a word, the gold standard puts control of the supply of money into the hands of the people, because excess creation of credit and paper money can be redeemed for gold at the fixed statutory price. The monetary authorities are thus required to limit the creation of new credit in order to preserve the legally guaranteed value of the currency.
To accomplish this reform, the United States can lead, first, by announcing future convertibility, on a date certain, of the U.S. dollar, to be defined in statute as a weight unit of gold, as the Constitution suggests; second, by convening a new Bretton Woods conference to establish mutual gold convertibility of the currencies of the major powers.
A dollar as good as gold is the way out. It is the way to restore real American savings and competitiveness. It is the way to restore economic growth and full employment without inflation. It is the way to restore America’s financial self-respect, and to regain its needful role as the legitimate and beneficent leader of the world.
Lewis E. Lehrman is chairman of the Lehrman Institute.