[Edit: I’m not fully satisfied with this post, but it’s close to the mark.]
I used to wonder how it is that currencies change “value”. Why is a dollar worth “X” euro one day, and 1.1X the next?
The answer is really quite simple: values change acccording to the perceptions of institutional and other investors of the relative rate of inflation of one currency compared to another. People are holding a lot of dollars now. Why? The Europeans and Chinese seem to be pursuing even more inflationary policies than we are. We sank a ton of money into various financial groups to stabilize them, but that money simply served to refresh money they had lost in failed investments. Only slowly will it find its way back into the wider economy. Likewise, the so-called Stimulus was really not that large. A third of it is propping up Medicaid programs for various States that spent themselves into bankruptcy. A third of it is going to send “vote for me” checks to likely Democrats, with some reserved for corporate tax cuts, which really isn’t spending at all. And only a third of it–roughly $250 billion in all–is getting spent. Of that, only about $148 billion has been spent in the last two fiscal years.
This brings to mind a fundamental fact about the Great Depression. We all know that a lot of banks failed, but not the reason. The reason was that our currency was attacked. First, some numbers with respect to the Great Depression:
Now, that piece is by the current Chairman of the Federal Reserve Board. I have posted that link elsewhere, but only just now read it all the way through. The gist of his explanatin of the cause of the Great Depression was, in essence, that the Fed pursued inflationary policies in the 1920’s, and then tightened the money supply, causing first the Crash of 1929, and then the following failure of roughly half the banks in the United States. They protected–through extensions of credit–banks within the system, but did nothing at all to protect those outside the system.
This contraction, combined with banking failures–which caused net losses in the money supply, since the money they held simply vanished into thin air (the same way most of it was created)–caused deflation. Deflation decreases lending, since if you borrow $1, and have to pay back $2, you are paying back more than the nominal interest rate you commited to. This means that there is no money for borrowing, and what money there is, most people don’t want.
He blames the gold standard for the deflation. Let’s think about that. What the gold standard is designed to do is prevent inflation. It is designed to protect the value of the money, by limiting how much you can print. In theory, if $1 is worth 1/10th of an ounce of gold, you can go to a bank and ask for the gold instead of the money. You can then take that gold to another country, and exchange it for their money.
Let us think about this, though. The United States in the 1920’s held X amount of gold, let us say 10,000 tons. In THEORY, there would be only enough money in circulation to equal out the exchange rate. In theory, it should match to the penny and ounce. Let us say, for example, that $1=1/10th of an ounce of gold. Let us say there are 16 ounces in a pound (there are troy ounces but I don’t understand them, and it doesn’t matter enough to look it up). If my math is correct, that means no more than $200,000,000 could be in circulation.
If you look at my piece on Money Creation, though, what you realize is that printing money is a very unimportant part of how money is created, and that the Federal Reserve (and all central banks) have the ability to create essentially unlimited quantities, and did even when we were theoretically on the gold standard. This means that, for example, that if our reserves (the Federal Reserve of New York, btw, holds the largest gold reserve in the United States to this very day) would imply $200,000,000 in circulation, that there could easily be, following inflationary policies of the sort in place throughout the 1920’s, $1 BILLION in circulation. Our dollars would be worth 1/5th, in gold, what they should have been worth, but that they could be REDEEMED for full face value. Phrased another way, that you could get $1 Billion in gold, for a mere $200 million in cash.
Now, the amount in circulation is a function of many things, such as the required bank reserve requirements, and what the Fed is doing as far as their open market operations (described in my piece on Money Creation). Phrased another way, the relative trajectory of the value of money can be influenced by Fed policy. In point of fact, that is almost the only factor, in the end, that matters.
Bernanke, here, tells us that the policies the Fed pursued were, in effect, allowing the forest to burn to clear out the dead underbrush. Yet, they also had the effect of strengthening the power of Wall Street banks, and those within the Federal Reserve system. What we need to understand, is that those same banks COMPRISED the Federal Reserve System. The same man might literally sit on the Board of Directors of the Fed, and at a large multinational bank that stood to benefit from the policies the Fed pursued. This is patent–and UNREGULATED–conflict of interest. We are not even sure who owns all the “stock” in the Fed. This is patently ridiculous.
We need to remember, too, that the value of all the loans which the member banks of the Federal Reserve held increased substantially as a result of deflation. Deflation forces the debtor to pay not just the interest, but to use money whose worth is increasing to do so. This creates an added stress, over and above the normal stress of doing business, and of course for that reason is economically damaging.
Inflation is created when banks create money from nothing to loan. Deflation is created when they contract the money supply. Self evidently, the failure of half the banks in the US caused severe deflation. Those positioned correctly win in both directions.
Bernanke cites apparently empirical evidence that the longer nations stayed on the gold standard, the worse they fared. This is of course an argument in favor of Keynes flexible currency, and in favor of what he, as Federal Reserve Chairman, does. Let us suppose this is accurate (as proper propagandists never lie: they interpret, lest we draw the “wrong”–which is to say correct–conclusions.)
Why would this be? Gold makes it harder to inflate–at least in theory–which means less credit is available. Deflation further makes it harder to justify taking out loans for business expansion. Hitler, to use one example–one cited by Keynes as a good example of his policies at work–used his central bank (which had inflated away all debts in the early 20’s) for massive public spending program. How did he intend to pay them off? Simple: conquest. America did not have that option. Nor have we paid off the debts we incurred in that war, which was in fact inflationary.
Throughout the 1920’s, Benjamin Strong, who was the Federal Reserve Chairman, worked in close collaboration with his counterpart at the Bank of England, Montagu Norman. When Churchill–a bit out of his depth, I think, economically–put England back on the gold standard, they set the price of the pound a bit high. In the course of implementing Labor (Socialist) policies, they had created problems for themselves in affording all it, particularly when their war debts were added to the mix. [Edit: this is written from memory. I may be wrong in part on this part, with respect to the details, although I think the larger picture is correct.]
What does this mean? Let us say that one pound ought to have been worth 1 ounce of gold, based on the amount of gold they held, and the quantity of pounds in circulation. They set it at, say, 2 pounds, such that they immediately created money for themselves. This sort of thing is exceedingly difficult to measure. Only very few would have grasped this. They then pursued ostensible fiscal tightening, in the form of tighter monetary policy relative to the United States.
For his part, Strong–a pronounced Anglophile–kept interest rates (here, we are talking mainly about the Discount Window, which was much more important, prior to the Fed getting unlimited freedom for their open market operations, although open market operations were pursued then, in the form of buying the securities of member banks, and thus providing them money to lend) lower than they should have been. This made our money weaker than it ought to have been relative to the pound, and thus made holding pounds relatively more attractive to international investors than the dollar. It allowed them to buy more, domestically and abroad, than they ought to have been able to afford.
At a certain point, the scheme collapsed, and people who had held pounds, asked for gold instead. This led to England abandoning the gold standard. Then, as Bernanke put it: With the collapse of the pound, speculators turned their attention to the U.S. dollar, which (given the economic difficulties the United States was experiencing in the fall of 1931) looked to many to be the next currency in line for devaluation.
If my understanding is correct, this is fundamentally disingenuous. The value of money has nothing to do with economic circumstances, and everything to do with monetary policy, specifically the extent to which Federal Reserve policy has enabled the overvaluation of our currency to begin with. Put another way, it only makes sense to “buy” money if that money is undervalued, and it makes sense to “sell” it when it is overvalued. Both terms are best understood with reference to gold. If there are too many dollars relative to the gold we have, it makes sense to get the gold, and dump the dollars; or, alternatively, to buy some other currency, like marks or yen.
Let me think out loud for a moment. Once large scale deflation set in, it would have made sense to hold dollars again, provided other currencies were not deflating faster than us. The fear of devaluation that Bernanke says led to the panics that closed so many banks would have been the fear that international markets would recognize that we had inflated far past our ability to redeem our money in gold. This would have led to dumping dollars in favor of other currencies. Why did money not flow back in, though? Maybe it did. Maybe international banks DID hold dollars, and simply didn’t spend them. We did not see widespread transfer of ownership of our economic assets to foreign interests, though. Perhaps members of the Federal Reserve system held them themselves, for later use. This is plausible. If you can create money at will, then getting cash is never a problem. Sometimes you might just want to sit on your money. In deflationary times, that amounts to an investment.
As I have argued in my series on economics inflation is a means by which to transfer ownership of real property through leveraging a protected position in the economic system, without thereby creating anything of real value. It is anti-Capitalist. If Capitalism is harnessing the powers of motivation and creativity to create wealth, our financial system in large measure, as currently constituted, acts to reallocate the fruits of that system to people who have added nothing of value. This process is quite similar to the process portrayed by Marx, in which people who sit in the right place get richer, at the expense of everyone else. To be redundant to emphasize the point: THIS IS NOT CAPITALISM.
What happened, then, is that our currency was made less valuable throughout the 1920’s, during which process people creating the money attached de facto liens to our means of production, and then it was devalued through a financial disruption in which half of the banks in the United States failed, and as a result of which all outstanding loans increased in value. Competition was destroyed, and existing loan “assets” went up in value.
Given that the same people created the policy and benefited from it, it is exceedingly hard not to see this as the result of planning. How would we know what happened in the meetings at the Fed? We don’t even know with certainty who the members are. The meetings are closed to the public. At that time, they did not even announced their targeted Federal Fund rate, as they do now (this is what creates the Prime Rate).
Then we add Keynes (who by the way was a member for some time of the Board of Governors of the Bank of England). What was the proposed solution to deflation? Deficit spending by the Federal Government. Who financed that spending? The same Wall Street banks that constitute the Federal Reserve. Funding deficits is a primary function of central banks the world over, although we are unique in having one that is accountable to no one. They use open market operations to buy Treasury bonds, which are interest bearing.
Now, I don’t think Keynes was on the same page as Wall Street. With his pal, Soviet agent Harry Dexter White, he tried to nationalize the Federal Reserve, presumably to get precise control over this process. They failed. But they did succeed in creating a de facto World Central Bank, in the IMF and World Bank.
In politics, economics is everything. Hitler only came to power because of the economic dislocations of the Great Depression. Lenin was only able to seize power in the aftermath of World War 1, and the generalized economic problems that caused. Mao seized power in the aftermath of World War 2, facing a financially depleted government.
Given the foregoing, consider the recent news that global financial chiefs reached new rules on reserve requirements. It is all the central banks–the Federal Reserves of the world–reaching an agreement to require all banks to keep more money in the proverbial safe. This is categorically going to have deflationary consequences. It will pull money out of circulation. It will make banks more stable, but it will likely push some over the edge, and it will tighten credit.
Consider, too, the INSANITY of the Fed making policy internationally, when it is not accountable to anyone. There will be no Senate hearing on this. We are in effect entering into a treaty that will be signed by someone who was appointed, but who can do ANYTHING he wants after that.
This system is utter and complete lunacy. Here, again, is my solution.