REPRINT WITH PERMISSION

WE HAVE BEEN HAD

Copyright 1997 J.N. Tlaga

Part - I

Between January 3 and April 18 of 1995, the value of US dollar in Japanese yen declined 20% from 100 to 80 yen. This 20% drop created automatic 20% price subsidy in Japan for American-made products, and corresponding 25% tariff in America on Japanese-made products.

To be sure, no one was subsidizing Chrysler to sell cars in Japan at 20% discount, and no one was imposing import duty on Mitsubishi cars to raise their prices in America by 25%. It was the shift in dollar-yen exchange rate that was responsible for this effect. The principle is very simple. When one dollar is worth 100 yen, a 20,000-dollar car costs 2,000,000 yen, and a 2,000,000-yen car costs 20,000 dollars. But when the price of one dollar goes down to 80 yen, the price of the same 20,000-dollar car goes down to 1,600,000 yen, and the price of the same 2,000,000-yen car goes up to 25,000 dollars.

It would be rational to expect that so dramatic a change in terms of trade between dollar-denominated and yen-denominated markets would arrest, if not reverse, the persistent negative balance of trade between United States and Japan, but in reality nothing of the sort was happening. Was it possible for the US dollar to be so overvalued that one-fifth decline was not big enough to reach the level of equilibrium?

The obvious place to look for credible explanation of this odd state of affairs was the newspaper data on dollar's past exchange rates. When plotted on paper, the old data ultimately disclosed that the dollar's decline against yen, and against other currencies as well, was not a recent, singular phenomenon, but a long process with twenty-five years of history behind it.

It began after Camp David conference of August 13-15, 1971, when President Nixon, upon advice of his Secretary of the Treasury John Connally, imposed 10% surcharge on all imports, and closed the "gold window" where the foreign central banks could exchange their dollars for gold bullion at $35 per troy ounce. On Friday, August 13, 1971, one dollar was worth three-hundred-sixty yen. Ever since that time, while floating up and down, or down and up to be exact, dollar was never worth more than 360 yen, and never worth less than 80 yen. In this broad perspective, the current 20% decline from 100 to 80 yen became a minuscule 6% on the scale of 78% decline from 360 to 80 yen.

Graphic rendition makes it very explicit. Before August 1971, the curve of dollar's value in terms of yen is horizontally straight at the level of 360 yen all the way back to May 11, 1953 when the yen's par value was officially set by the International Monetary Fund at 360, and beyond that to September 19, 1949, when the official rate of 360 yen was noted in the news the morning after the massive devaluation of sterling bloc currencies. After August 1971, the dollar curve begins to descend from 360-yen level, and, after long and erratic journey, reaches 80-yen level on April 18, 1995.

One does not need to graduate from the London School of Economics to figure out, that if the dollar was still overvalued in April 1995 at the rate of 80 yen, so all the more it had to be overvalued at the rate of 360 yen in August 1971 and all the way back to September 1949, and, for the same reason, it had to be overvalued on each and every one of the sixteen-thousand-six-hundred-forty-eight days that came and went between September 19, 1949 and April 18, 1995.

Overvaluation of our own currency against another usually originates from another currency's competitive devaluation or our own currency's corrective revaluation. Here, neither one of these usual origins would apply. Dollar was never reported revalued and yen was never reported devalued during the time period under consideration. (Swiss franc was not reported devalued during this period either, and dollar's overall decline against Swiss franc from 4.37 on August 13, 1971 to 1.12 on April 18, 1995, registers at 74%, only four points behind the yen's 78% lead.)

Furthermore, currency overvaluation episode should not last very long, for no rational person would expect any government worth its salt to tolerate so open a threat to the nation's economic survival. Here, the overvaluation continued unabated for generations!

It took miles of New York Times microfilm to trace the seeds of this overvaluation to January 31, 1934, when Franklin Delano Roosevelt officially devalued Gold Standard Dollar by raising the price of gold from $20.67 to $35.00 per fine troy ounce.

Externally, the "Roosevelt dollars" that resulted from this devaluation were "as good as gold" because foreigners could exchange them for gold bullion at $35 per ounce, but internally, they were as bad as any other fiat currency because US nationals could not exchange them for gold. As their circulation doubled in eight years from $5,317,000,000 in February 1934 to $11,339,000,000 in February 1942, and then re-doubled in just two years to $21,396,000,000 in April 1944, the external, gold-convertible dollar kept its value, while the internal, fiat dollar was loosing few cents every year.

To place our calculations on very firm, unimpeachable ground, we must begin in the years when the Gold Standard Dollar reigned supreme before the Federal Reserve Act became the law on December 23, 1913, and the solid currency of our nation was debased by massive counterfeiting.

As of the date of Gold Standard Act of March 14, 1900, this country had all kinds of money in circulation, but only gold coins were recognized as unconditional legal tender. Five coins, made of standard gold 0.900 (9/10) fine, were in circulation:

• One Dollar ($1), made of 25.80 grains,
  
  
• Quarter Eagle ($2.50), made of 64.50 grains,
  
  
• Half Eagle ($5.00), made of 129 grains,
  
  
• Eagle ($10.00), made of 258 grains, and
  
  
• Double Eagle ($20.00) made of 516 grains.
  
  
• One troy ounce of fine gold, not less than
  
  
• 0.999 fine, was worth $20.67.
  

Standard silver dollars, made of 412.50 grains 0.900 fine, also enjoyed the status of legal tender, but could be excluded by express stipulation in the contract. Subsidiary silver (halves, quarters and dimes) had to be accepted in payment only up to the amount of $10, and token coins (nickels and pennies) up to the amount of 25 cents.

United States Notes, originally introduced by President Lincoln to finance the Civil War, were recognized as legal tender for all debts public and private, except for duties on imports and interest on the public debt, which had to be settled in gold.

Treasury Notes of 1890 had the same status as silver dollars (full legal tender except where otherwise stipulated in the contract). Authorized by the "Sherman Silver Purchase Act", these notes represented silver bullion in US Treasury, and were gradually displaced by newly coined silver dollars, or the more convenient silver certificates. Only in the Western states, silver dollars, known as "cartwheels", were broadly used in daily commerce. Rest of the country was satisfied with "paper dollars". Minting of gold One Dollar coin was discontinued in 1890, and even Quarter Eagle was later displaced with one-dollar and two-dollar silver certificates, which became the "workhorses of daily circulation". The $5 Half Eagle, $10 Eagle, and $20 Double Eagle, remained in open circulation until 1933, when all monetary gold was nationalized.

Gold and silver certificates, which represented gold and silver coin on deposit in US Treasury, were not legal tender but were receivable for all taxes, customs and public dues. Unlike the US notes, they circulated in lieu of equal amount of coin, and thus did not expand the overall amount of money in circulation. For every gold or silver certificate of say $20 face value, twenty silver dollars or two golden Eagles to be withdrawn from circulation and deposited in the US Treasury .

National Bank Notes were not legal tender either but were receivable for all public dues, except duties on imports, and US government could not use them to pay interest on public debt or to redeem US notes. Even though they were issued by Controller of the Currency against deposit of US bonds (not to be confused with US notes), they were still required to be redeemed in gold coins on demand, for gold coins were the legal tender and bank notes were not.

When Gold Standard Act became law, the overall supply of money in circulation had just passed the two billion dollar mark. Rounded off by category to the nearest half a million dollars, it consisted of the following:

• $322.5 million in US notes, secured by redemption fund of $150 million in gold coins;
  
  
• $257.0 million in national bank notes, secured by deposits at the Treasury ($219 million in US bonds, the balance in lawful money);
  
  
• $410.5 million in silver certificates;
  
  
• $210.5 million in gold certificates;
  
  
• $84.0 million in Treasury notes;
  
  
• $715.5 million in gold coins.
  

Under monetary system, where gold was the only legal tender without limitations, and all forms of "paper money" were redeemable in gold on demand (silver certificates in silver or in gold at the Treasury's option), the supply of money was finite, and the only money the bankers could possibly have at their disposal was that which they have earned previously or currently attracted on deposit. Unlike their British counterparts, American bankers could not increase supply of money at will, for they could not increase supply of gold at will. To acquire the magic power of creating money out of thin air, American bankers had to establish their own central bank.

Next Week Part - II (What is central bank?)