Monday, September 17, 2007

The Depreciating Dollar

The New York Sun, New York's best newspaper, has run a front page editorial concerning the dollar, which the Sun argues, should be called the "Greenspan" instead of the "greenback". The reasons are in part that Greenspan's biography the Age of Turbulence came out today; the Fed's Open Market Committee will meet tomorrow to discuss whether to lower interest rates (depreciating the dollar further); and the Sun is increasingly concerned about the depreciating gold value of the dollar. Over the past two years the Sun has editorialized that the dollar declined from 1/265th ounce of gold in 2000, when President George W. Bush took office, to 1/500th of an ounce of gold in December 2005, to 1/637th of an ounce of gold in November 2006 to, well Kitco reports at 3:17 that gold has risen to $717 in light of tomorrow's Fed meeting, so it's 1/717th of an oz. of gold per dollar.

The problem facing the dollar is in some ways like previous inflations, such as the German inflation of the 1920s. In some ways, though, it is unique because never before has a fiat currency both served as a worldwide medium of exchange and been subject to aggressive depreciation in value. There are a number of interesting ramifications of this story that my friend Howard S. Katz has exposed through the years in his book The Paper Aristocracy; through his blog and through his investment advisory services.

First, Katz has brought the effects of monetary expansion on income inequality to the attention of libertarian politicians such as Ron Paul and to the attention of all who will listen. The left's game plan, evidenced during the great depression, has been to use disruption caused by mismanagement of the money supply, such as the 1929 stock market crash, the depression of the 1930s and the concomitant political strains, to agitate for quack nostrums like extension of government regulation that does nothing to cure the monetary problem and instead cripples the economy and interferes with legitimate business. Once again, we see an increase in agitation concerning income inequality just as the past two decades' monetary expansion is peaking.

Second, the effects on income inequality this time, which Katz discusses in his blog, may be more extreme than in the past. Because the monetary expansion has not resulted in the same degree of inflation as it normally would, interest rates have been reduced to very low levels, corporate profits have been energized and stock markets boosted to high levels. This seems to have turned Keynesianism on its head. The traditional Keynesian model is that stimulation of economic activity would create new jobs (hence the Phillips curve's trade off between inflation and unemployment) and workers would not object to the erosion of their real wages, essentially because they are suckers.

Instead, in the late 20th century and early 21st century world, which is far more globalized than Keynes's world of the 1930s, monetary stimulus may have reduced demand for US labor even as real wages have fallen. It may have done so because executives have been granted stock options that motivate them to maximize shareholder value more aggressively than they did in the prior postwar period. Rather than risk a higher degree of innovation, the executives focused on cost cutting, i.e., moving plants and services, to include white collar ones, to lower wage countries. These steps had some effect on stock values, enhancing the income inequality that naturally occurs because of monetary expansion and that is part and parcel of what the Fed does. Thus, traditional Keynesian economics has become not only a kind of deception (relying as it does on monetary illusion) as it has always been, but also has become increasingly outdated because of globalization. Real wages are stagnant; the stock market increases; but high paying jobs flee the country, all due to the Fed's monetary policy combined with aggressive stock option programs.

Third, the Fed now functions like a casino manager. The US dollar does not function just as a traditional money supply that provides a store of value; a medium of exchange; a unit of account and a standard of deferred payment. Rather, the dollar has become a commodity that is held by investors all over the world as a form of speculation. This new function puts the Fed in the role of casino game manager that needs to determine whether enough "chips" have been manufactured---chips that have meaning only so long as there are gamblers to use them.

Although economists have meaningful credentials, there is no reason to believe that they understand how to market casino chips. I am sure that Ben Bernanke, like Alan Greenspan, is a brilliant guy, but he is no better at marketing than a layman. Should Americans have faith in an institution like the Fed, which claims to manage the money supply while quietly extending its role to facilitator of a global crap shoot? Isn't it time to rethink the Fed altogether?

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