The Engine's Lubricant Thins Out

by William Palumbo

What specific distinction does tobacco, cattle, and gold share?  The answer, obvious to few, ignorant to most through no fault of their own, is that they have all been used as money.   They also share some other qualities, in varying degrees, relating to their status as money: they are commodities (i.e., they are measured by weight); they are easily divisible; they are commonly desired; and, importantly, they have high economic utility relative to their weight.  Now, ask yourself whether paper, currently the money medium for this country and all the industrialized world, shares these qualities.  No, it does not; it lacks, critically, a high economic utility.  If, in fact, another piece of paper such as an eatery napkin said “one dollar” it would pretty much be worthless.  “So what?,” you say, “it seems to work most of the time just fine.”

Under our current monetary system, economic problems relating to monetary policy arise when it’s not “most of the time.”

          None of this would amount to much more than an academic hill of beans to anyone if weren’t critical to their wellbeing.  Money and the nature of its supply cut deep into the heart of the capitalist free-market system so that when bad policies are enacted the consequences can be near lethal.   For example, a sudden increase in the money supply by fiat results in future price inflation, a destabilizing fore.  This is one of those laws that seems banal once understood, but is apparently forgotten or disabused by the federal government.  Significant enough inflation causes economic chaos that leads to recession on par with, possibly worse than, the present.  How did our officials forget this critical fact?

          In response to economic crisis earlier last century, John Maynard Keynes, a Cambridge economist and public policy advisor in England, developed a theory supporting deficit spending to end recession.  His rationale was inconsistent and essentially rejected classical economics, yet such policies were enacted by English and American governments in the 1930s.  In one respect, the prescription realized some success through lowering unemployment.  It did this by inducing inflation, hence reducing real wage rates; the public, unsurprisingly, was not sold on this deceptive solution.  Keynesianism went out of fashion in name only through the decades when the name Monetarism, a University of Chicago invention associated with the libertarian (and Reaganite) Milton Friedman, was applied.  Both schools implicitly advocate government counterfeiting, which is tantamount to advocating inflation.

The consequences of inflation still exist and always will.  Here are some of the biggies.

In the short term, the extra money put into the system benefits those who receive it first, before prices adjust upward – put another way, the result is a transfer of wealth.  Pursuing this policy is oxymoronic, if not immoral as well, and does nothing to spur new wealth creation in the private sector.  Yet we routinely accomplish this task byway of our government’s banker, the Federal Reserve, buying government treasury bills from private banks with newly created money.  This not only inflates the money supply in an arbitrary manner but in a noxious one as well: the banks then loan the new money out at market rates too low for the market to accommodate in reality.  That the banks lower interest rates and lend again is no adverse side effect – “tightening credit,” after all, is the justification for the new money in the first place.  Consequently, projects are evaluated with poorly forecasted inflationary numbers, then miss budget when prices react to supply and demand changes, and then are cancelled.  These ripples, if numerous enough, can form economic tidal waves, exploding financial instruments and toppling banks.

Our housing bubble was driven by bad loans, formerly counted as part of the asset base from which banks could lend.  Nefarious, government-directed reasons exist for some; regardless, their finance could not have reached near these proportions had not the Federal Reserve increased the money supply after the mini-recession shortly after 9/11.  We may have cut that market correction short only by agreeing to endure worse later.

In theory at least, you can have a paper currency managed by government that will function perfectly well and indefinitely.  The addition of the characteristic of high utility – of actual worth – to the list that defines good money seems to be out of practical wisdom rather than strict economic necessity.  While the revival of the classical gold standard is a political non-plus to most voters, the public should be aware that the Federal Reserve must act within strict boundaries if we are to avoid destabilizing boom-busts.  That economic instability often leads to war is gleaned by a cursory study at history, and should increase our urgency in drawing attention to this systemic menace.