Deflation or Runaway Inflation
Antal Fekete*
The Denouement of the Gold-in-Exile Saga
Abstract
Runaway inflation
is not a monetary phenomenon, the claims of monetarists notwithstanding.
It is an interest-rate phenomenon predicated on the linkage. The price level and the rate of interest resonate with the oscillating
money-flows between the bond and the commodity markets. This economic
resonance, under the concerted pounding by speculators, ultimately reaches
the state of runaway vibration. When the fragile confidence in the value
of irredeemable currency snaps, commodities are bought up and all bids
for bonds are withdrawn. The rate of interest, together with the price
level, reach astronomical heights. There is no scientific way to predict
whether the denouement of the present plight of the world will take
the form of a deflation or that of a runaway inflation.
Sinking of the
sinking fund
Bondholders
of old, typically widows and orphans, were buying the bond because they
wanted to earn interest income and, at the same time, they wanted to preserve
the value of their capital. They had no reason to be concerned about the
danger of their investment losing value due to a rise in the rate of interest.
There was no such danger. Issuers of bonds were required to make provision
for a sinking fund. The manager of the sinking fund would step in and
buy the bond every time it was offered below face value in the open market
- as much and as long as it was necessary in order to restore market value
to face value. Those were the happy days of the gold standard when interest
rates were stable. In today's environment it would be suicidal for issuers
of bonds to offer this protection to bondholders. Sinking funds would
be exhausted in no time, due to gyrations in the rate of interest, reflecting
the uncertain value of the currency in which the bond is denominated.
The exile
of the Constitutional Monarch, gold, also meant the sinking of the sinking
fund. No longer is a vehicle available to those who are in need of a steady
income and have no expertise in trading derivatives in order to protect
the value of their capital. Savers have been disenfranchised and left
out in the cold. The bond market no longer serves the interest of widows
and orphans. It serves exclusively that of the bond speculator - a new
parasitic species that did not exist under the regime of the gold standard.
In praise of speculation
It may come
as a surprise that the role of speculation is the same as that of engineering.
Both are responses to the presence of uncertainty in human affairs. The
engineer establishes safety standards for his projects. He is not designing
buildings that can withstand all earthquakes. His buildings are
designed to withstand earthquakes that have a high probability to occur.
Speculation
addresses uncertainty about the price of produce due to the fickleness
of nature, especially the weather. The speculator buys low during the
seven fat years, and tries to sell high during the seven lean years. He
may also sell short, that is, sell forward inventory he hasn't got but
hopes to get at a cheaper price before the date of delivery arrives. In
either case, the speculator is performing a useful public service. During
the fat years he is helping producers who, without the benefit of speculation,
would be forced to sell below cost. During the lean years he is helping
consumers who, without the benefit of speculation, would be forced to
pay outrageously high prices or do without. Of course, the speculator
can go wrong and lose his bet; this happens when he buys before the fall
(or he sells before the rise) in prices has run its course. However, it
is important to note that the benefits to producers and consumers are
not affected. Only the capital of the speculator is at stake, not the
welfare of the public. If he makes too many bad bets, then the speculator
will lose his entire capital. But this, too, is beneficial to the public:
capital is passed from less to more competent hands, to speculators who
are better at judging the future course of market conditions. Speculation
is beneficial to society as long as speculators address only nature-given
risks, use their own capital in their enterprise, and do not try to unload
their losses to the public.
It is important
to understand that speculation does not, nor can it ever, address risks
created artificially by man. In particular, speculation cannot address
successfully the risks created by government and the banks. When risks
are artificially created in order to enable venturesome people to place
bets in the hope of a large payoff, we talk about gambling. To
confuse it with speculation is a very common mistake. Unfortunately, the
confusion is not always due to ignorance. Often it is due to obfuscation.
Take the example of government and academic economists making a case for
the derivative business using the language of speculation. They speak
admiringly of the sophistication involved in trading financial futures,
and options on financial futures. However, derivatives: futures and options
on foreign exchange, bonds, and bills, interest rate swaps, and a host
of other derivatives of financial instruments that are invented almost
every day, this entire business, squarely belongs to the category of gambling.
It does not belong to the category of speculation. The reason is simple:
the risks, whether it is a foreign-exchange risk, an interest-rate risk,
or a combination of the two, have been artificially created when the gold
standard was abolished.
Economists
blithely assume that, just as in the case of wheat, so also in the case
of bonds, price fluctuations can be smoothed out by allowing speculators
to buy low and sell high. However, this reasoning is fallacious, as we
shall see. Economists should know better and make the distinction between
speculation and gambling clear. If they don't, not only do they make a
serious theoretical mistake, but they also call the integrity of their
own profession into question. They should not be accomplices to a scheme
which exposes society as a whole to very great economic dangers.
Responsibility
of the economists
Why is it
unethical for an economist or a financial journalist to compromise standards
of precision in their language of communication? By wiping out the distinction
between speculation and gambling, they are lying to the public who rely
on them for correct information and interpretation. They pretend, for
example, that bond futures trading is just as essential to the welfare
of society as wheat futures trading is. The proof that this is false is
in the fact that there were no bond futures under the gold standard, while
wheat speculation goes back to the Genesis (see the story of Joseph deciphering
the Pharaoh's dream). The introduction of derivatives does not show that
our society has become more sophisticated. What it shows is that our society
is so far from being sophisticated that it does not even notice when it
is being victimized by the crudest of swindles. The destabilization of
foreign exchange and interest rates through the abolition of the gold
standard was not done in the interest of society. On the contrary, it
was done in order to benefit a small minority of people by enabling them
to milk the vast majority dry of its substance.
The speculator
is pitting his wit against the blind forces of nature. His profits, if
any, are well-deserved. In the case of foreign exchange or bond trading
the 'speculator' is pitting his wits against the wits of bureaucrats working
for the government. Those bureaucrats are not risking their own funds.
The bets they make are covered by the taxpayers. We may admit that, on
occasion, these bureaucrats make winning bets. But it would be a great
mistake to believe that the payoff from those bets would benefit the taxpayers
in any way, or that the profits and losses incurred by the government
even out in the long run. The evidence available shows that, in the long
run, there are consistent and very substantial losses which the taxpayer
is forced to make good. Incidentally, the fact that profits and losses
don't even out is not surprising: the bureaucrats making the bets on behalf
of the government work for fixed salaries. Even if they were paid a bonus,
it would never match the compensation of the foreign exchange or bond
'speculator'. The whole scheme is a fraud, with zero public benefit. The
public is plundered as it is made to underwrite the risks of a (for them)
completely unproductive gambling activity on private account. Take the
words of arch-speculator George Soros for it, who could, single-handed,
force the devaluation of the British pound.
If it wasn't
for the scientific obscurantism of the economist profession, an impartial
inquiry would have found that our present monetary arrangements involving
irredeemable currency are untenable. These arrangements are based upon
privileges granted without countervailing responsibilities. In more details,
unwarranted privileges have been extended to the treasury and the Federal
Reserve banks (which they ought not to have under the U.S. Constitution),
namely, the privilege to issue liabilities such as bonds, bills, and bank
notes without countervailing responsibilities, such as the obligation
to redeem (as opposed to 'rolling over') those liabilities at maturity.
This also involves an outrageous double juridical standard. If a private
party issued liabilities under the same pretenses, then it would be charged
with fraud and be dealt with according to the Criminal Code. The monetary
provisions of the Constitution of the United States (which, incidentally,
have never been repealed showing that, indeed, a coup d'etat has
taken place overthrowing Constitutional order) are very clear on the point
that the government has not been granted power to organize its bills of
credit into currency, or to pay its debt in any other manner than paying
specie. It is to the eternal shame of their profession that the economists
were not in the vanguard demanding such an impartial inquiry, on the contrary,
they were most prominent among those who wanted to stifle the budding
debate aiming at the clarification of the issues involved.
Responsibility
of the politicians
Why would
the government tolerate the plunder of the majority for the benefit of
a minority? Granted that not all politicians have the intellectual powers
to muster the technicalities of central banking, money creation, and the
derivative business, we may be sure that at least some have. It is surprising
that in the ranks of those few who have there have been no defections.
We can only guess that the potential defectors who were ready to denounce
the scheme of plunder and pilferage have been blackmailed. They must have
been told that they would be blamed for the 'systemic failure' of the
monetary system that would surely follow hard upon the heels of any unauthorized
disclosure.
The fact
is that the trading of derivatives absorbs a huge amount of currency.
This currency is already in existence. It cannot be wished away. We are
talking about a high multiple of the amount needed in the real
economy (that is, money needed to produce and distribute goods and services
without which society cannot function). What will happen if all this currency,
from one day to the next, becomes surplus? If irredeemable currency is
outlawed, the derivative markets will fade away along with the drying
up of volatility. The casino is closed, hence the chips are worthless.
Many trillions of dollars would become superfluous and have to go begging.
The dollar would lose its value. Worse still, along with it, all wealth
denominated in dollars would also lose its value. People belonging to
the middle classes in America (and, for the stronger reason, also in the
rest of the world) would lose their life-savings, just as they did in
the Weimar Republic of Germany in 1923. By now it is recognized that runaway
inflation, more than any other factor, was responsible for the birth of
Hitler's Third Reich. The potential defectors from government, who would
have been willing to expose the regime of irredeemable currency for what
it is, shirked their responsibility and remained silent. They did not
want the stigma of having helped spawn latter-day-Hitlers all over the
world.
Resonance in economics
But even
if it is maintained through the 'conspiracy of silence', the regime cannot
endure. The issue is not just scientific obfuscation, or the fact of an
ongoing plunder of the majority by a minority. More serious still is the
fact that society is being exposed to very great dangers which one only
in a million can recognize. Great economic forces are at work that are
potentially very destructive and, when let loose, will cause very great
economic pain. (In what follows I shall drop the quotation marks ' ' when
referring to bond speculators).
Speculators
don't buy the bond because they want to earn the interest income. They
buy it because they want to ride the rising trend in bond prices (i.e.,
they want to profit from the expected fall in interest rates). Speculators
don't sell the bonds because they are ready to employ capital, thus raised,
in the real economy. They sell it because they want to capture the difference
between the higher rate of interest on the longer, and the lower rate
on the shorter term debt; or the difference between the higher yield in
one country and the lower in another. In the former case the bond speculators
want to ride the yield curve; in the latter, the bandwagon of the carry-trade.
The long and short legs with which they enter or exit the bond market
are not alternating randomly. Bond speculators march in lockstep.
Since Roman
times, manuals for military commanders have included the interdictum
that an infantry unit crossing a bridge must not march in lockstep. The
reason for this rule is that the periodic thrusts of pounding boots could
resonate with one of the harmonic frequencies of the bridge. This resonance
would then cause runaway vibration, culminating in the destruction of
the bridge.
Runaway vibration
The phenomenon
of vibration is studied in physics. The most common varieties are even
vibration (oscillation) and damped vibration, according as the amplitude
remains constant or it is decreasing exponentially. But there is also
a third variety, not as well known, called runaway vibration, where the
amplitude is increasing exponentially. The collapse of the Tacoma suspension
bridge in the State of Washington in 1940 was an example. Gusting winds
caused the bridge to vibrate at one of its harmonic frequencies. The increasing
amplitude of the runaway vibration ultimately caused the suspension cables
to snap, and the whole structure was plunged into the river. The event
has been preserved on film - it must be seen to be believed. In general,
the small parcels of energy represented by each thrust would get dissipated
harmlessly through damping. In the case of resonance, however, not only
are they not dissipated, they are allowed to be built up to a formidable
force capable of causing huge destruction.
Resonance
in economics, no less than in bridge design, is a problem to reckon with.
I have discussed linkage in my talk Kondratieff
Revisited. The price level and the rate of interest move together
up or down, as they resonate with huge oscillating speculative money flows
to and fro between the bond and commodity markets. Bond speculators try
to maximize their profits. For them the problem is correct timing: they
want to be the first to switch positions when the expected turn of the
flow of money materializes. This is just the point where the runaway vibrator
starts spinning out of control. As soon as speculators find that point,
the oscillating speculative money-flows will become too big and too destructive
for anybody to control, and they will drown the economy.
It is clear
that elementary principles of resonance were completely ignored by the
designers of the world's present monetary system. Following Keynes, they
blindly assumed that speculative buying and selling bonds and foreign
exchange takes place at random (as does the thrust of pounding boots on
the bridge if the infantry unit obeys the rules) and, on average, speculative
buying and selling balance out one another. It is true that speculators
do act randomly in markets where risks are nature-given. But this is no
longer true when risks are man-made. As pointed out above, in that case
speculators march in lockstep. They are either net long or net short,
according to the prevailing market trend which they all want to ride and
amplify. As a consequence, speculators periodically cause great damage.
In the worst-case scenario, they could destroy foreign exchange values.
Every episode of a currency devaluation (of which we had hundreds in the
20th century) is a proof of that. They could also wipe out bond values.
Every episode of a runaway inflation (of which we had dozens in the 20th
century) is a proof of that. But the danger has never been so great as
it is today, when the entire world has embraced irredeemable currency
uncritically. The linkage may turn the inflation/deflation cycle of Kondratieff
into a runaway vibrator. The ever wider fluctuations in the rate of interest
and price level threaten the entire world economy with destruction. This
is the threat of runaway inflation on a global scale, something that
the world has never before experienced.
Yet the calamity
is entirely preventable - given the proper monetary system that takes
the phenomena of economic resonance and runaway vibration fully into account.
The gold standard was such a monetary system before the banks and the
government started sabotaging it. It stabilized the economy by stabilizing
foreign exchange and interest rates. This eliminated fluctuations in the
foreign exchange and bond market without which speculators could not operate.
A runaway vibrator in prices and interest rates was forestalled. A gold
standard, if re-introduced, would do it again.
The mechanism of
runaway inflation
Virtually
all historic runaway inflations have taken place in the wake of wars or
revolutions, in an economic setting that involved physical shortages of
consumer goods or the physical destruction of production facilities. This
confused the issue, and made it possible to explain the phenomenon in
terms of linear models such as the quantity theory of money. It has also
provided grounds for optimism that, with prudent monetary policy and strict
controls over the rate of increase in the stock of money, runaway inflations
in the future can, at least in peacetime, be avoided.
Unfortunately,
the optimism is not well-founded. The explanation of the phenomenon of
runaway inflation in terms of linear models is fallacious. Nor can the
proposition that runaway inflations may not occur in peacetime be established
inductively. The historic runaway inflations were all confined to individual
countries engaged in experiments with irredeemable currency, while most
other countries remained on a metallic monetary standard. For this reason
explanations of past episodes of runaway inflations in terms of the quantity
theory of money are irrelevant.
The fact
is that linear models are useless in studying runaway inflations. The
phenomenon itself is non-linear in nature, as it is the culmination of
a runaway vibration. Keynes was a keen observer of the 1922-23 episode
of runaway inflation in Germany. He was so convinced that the process
was cyclical rather than linear that he reportedly risked large sums of
money in order to convert his insight into cash. He was betting that every
time the Reichsmark was oversold, there would be a bounce-back. For a
time, indeed, he was making money on the long side. But disaster struck
as he placed one bet too many. When Keynes bought Reichsmarks the last
time, the bounce-back came to an end so swiftly that he had no time to
exit. He was trapped in a losing position. The collapse that followed
was so complete that Keynes reportedly lost all the capital he had committed
to the venture.
A deeper
theoretical understanding of the phenomenon of runaway inflation shows
that destruction on that scale is not possible except in the case of runaway
vibration. The quantity theory of money (and, more generally, monetarist
precepts) are entirely inadequate and can't deal with the problem. Runaway
inflation is not a monetary phenomenon. It is an interest-rate phenomenon,
more precisely, an economic resonance phenomenon involving the rate of
interest. Recall that the linkage is responsible for tying the price level
and the rate of interest together. The bond speculator rushes in like
an elephant into the china-shop and starts causing great damage. The bond
speculators' concerted action causes the oscillation in the money-flows
between the commodity and bond markets to get out of control. The vibration
is no longer damped (as it would be under a gold standard). Instead, it
follows the pattern of a runaway vibrator characterized by an amplitude
increasing exponentially. The energy-level of such a runaway vibrator
also increases exponentially. At one point during the inflationary spiral
it will exceed the centripetal forces that keep the economy together.
The financial system snaps. The price level and the rate of interest reach
astronomical heights, destroying currency and bond values.
Why is a
gold standard an effective brake on economic resonance, capable of preventing
runaway vibration? Because under a gold standard bond values or the rate
of interest cannot go to zero. Compare that with the regime of irredeemable
currency where both can occur. A government bond is merely a promise to
replace one piece of paper with another at maturity. What is there is
to stop the value of bonds or the rate of interest from going to zero,
once the runaway vibrator starts spinning? The pious wishes of central
bankers? Or the altruism of bond speculators?
The debt incubus
Milton Friedman
insists that the 1930 Great Depression in America was caused by the 'collapse
of the stock of money'. He says that it could have been prevented by a
more adept monetary policy: the Federal Reserve banks should have put
more money into circulation through open market purchases of government
bonds. Our position is diametrically opposed to that of the monetarists.
The long-wave inflation/deflation cycle is not a monetary phenomenon.
It is an interest-rate phenomenon. The Great Depression was an instance
of debt-explosion, caused by the vanishing of the rate of interest.
Several authors
have pointed out that, as a matter of record, the Federal Reserve banks
did in fact create money through open market operations in the 1930's.
However, the money so created was not used in a way consistent with monetarist
precepts. It was not used in commodity speculation that would have met
with the approval of the monetarists. Instead, it was used in bond speculation.
Businessmen were lethargic and did not see any profit potential in building
up inventory. They refused to take the loans offered by the banks. By
contrast, bond speculators were frenetic. They were full of exuberance
(which in retrospect was not so irrational after all). They saw enormous
profit opportunities in what amounted to risk-free, government-subsidized
bull market in bonds. Speculators correctly diagnosed the meaning of Roosevelt's
monetary tinkering: the policeman on duty to keep the rate of interest
away from zero has been fired. Now the sky is the limit for bond prices!
You can take
the proverbial horse to water, but you cannot make him drink. Likewise,
the Federal Reserve banks can put all the money in the world into circulation,
but still have no control over the direction in which the new money will
flow. In the 1930's newly created money flowed to the bond market. This
deepened the crisis in pushing bond prices ever higher and the rate of
interest - together with the price level - ever lower.
What Friedman
calls a 'collapsing stock of money' was, in fact, the irresistible whirlpool
of the bond market sucking up money from the remotest corners of the economy.
The bond market acted like a giant vacuum cleaner running amok. The more
money the Federal Reserve banks created, the more destructive the sucking-effect
became in draining money away from the real economy. Interest rates kept
declining throughout the 1930's. The consequences were devastating.
Every
time the rate of interest falls, the present value of the outstanding
debt rises (because a larger capital sum can now be amortized by the
same stream of money payments, as shown by the increase in bond values).
Even though the outstanding debt in the 1930's may look to us paltry by
today's standards, as the rate of interest goes to zero, its present value
will still go to infinity (because there is 0 discount on the stream of
interest payments).. And as it did, debt and inventory liquidation swept
through the country. The pressure on business to liquidate debt and inventory
became unbearable. Those firms that could not reduce debt and inventory
fast enough were mercilessly forced into bankruptcy. The same was true
of households and mortgages on homes. The deflationary spiral, acting
like a giant twister, uprooted fortunes, farms, firms, and families.
The dangers
facing the world economy in the opening decade of the new century and
millennium are even greater than those of the 1930's. Indebtedness in
the world is greater and more widespread. The rate of interest started
its descent from a much higher level, making the bull market in bonds
that much more ferocious. Government leaders and captains of the economy
see no great danger in the decline of the rate of interest. They congratulate
themselves on their success in 'having licked inflation'. But the prolonged
decline in the rate of interest has its own dangers, very different from
the dangers of inflation. The debt burden on the world economy is very
great already, but it could still grow if the decline in the rate of interest
resumed its previous course. Should this modern Tower of Babel, the debt-structure
of the world, crash, it would bury the prosperity of the world under the
rubble.
Floating or sinking?
All this
raises very serious questions about the future of the regime of irredeemable
currencies. Milton Friedman admits that the present international monetary
system, based on nothing more substantial than the irredeemable promises
of spendthrift governments with a penchant for default, has no historical
precedent. He also grants that the ultimate outcome of this experiment
is shrouded in uncertainty. Yet at the same time he takes an optimistic
outlook as he asserts: "It is not possible to say that Irving Fisher's
1911 generalization that 'irredeemable paper money has almost invariably
proved a curse to the country employing it' will hold true in the coming
decades" (Money Mischief, New York: Harcourt-Brace, 1994, p 254.)
Well, it is possible to say it, and someone should!
Friedman's
optimism concerning the future of the regime of irredeemable currencies
(provided that monetarist stratagems for controlling the rate of increase
in the stock of money are adopted) is not well-founded. The rate of increase
in the stock of money cannot be controlled by the central bank or the
government, because of the fragility of the line separating irredeemable
currency from debt. When that line breaks, speculators will threaten to
overwhelm the central bank as they start dumping debt instruments. The
central bank is helpless. It cannot allow the credit of the government
be ruined by a collapsing bond market. But in supporting bond prices the
central bank will cause the stock of money to snowball.
Friedman
is the godfather of floating. He advocated the abandonment of the regime
of fixed exchange rates long before the word floating could be
uttered in polite company. In retrospect, it would be more appropriate
to call Friedman's a system of sinking exchange rates as countries, one
after another, succumb to the temptation to engage in competitive currency
debasement. Indeed, it is hard to see how economists still find it possible
to defend this destructive system, in view of the immense damage it has
already done to the world economy.
Friedman's
main argument in favor of floating (as he presented it in the 1950's)
was that it would furnish an automatic adjustment mechanism to correct
trade imbalances. As trade deficits emerged, he argued, the currency of
the net importing country would depreciate against that of the net exporting
country. The rising cost of imports to the former and the falling cost
of imports to the latter would then eliminate the trade imbalance and
wipe out the deficit. There is no need to deny that Friedman's argument
is intellectually seductive; let's see what actually has happened in practice.
The American
dollar was in a steady decline against the Japanese yen for a 25 year-period
starting in 1970, when the exchange rate was 360 yen to the dollar and
the annual trade deficit of the U.S. with Japan was $1.2 billion. A quarter
of a century later, in March 1995, the yen was worth four times
as much in dollars (at 90 yen to the dollar) and the U.S. trade deficit
with Japan was fifty times as great (at $66 billion). Trade figures
with Germany tell a similar story. This raises the question: how much
more beating would the dollar have had to take before Friedman's adjustment
mechanism had kicked in and corrected the adverse trade imbalance?
Debasement of the
currency is self-mutilation
It should
be abundantly clear that the debasement of the dollar undermined the productivity
of the American producers, causing the U.S. trade deficit to grow. To
understand this you must look at the currency in the hands of the exporter,
not as a weapon with which you can beggar your neighbor, but as a sharp
tool with which you can outproduce him. If you want to do the latter,
you don't blunt the edge of your tool. To use another simile, debasement
of the currency is self-mutilation. You don't mutilate yourself before
the race you want to win. It is preposterous to suggest that one can become
more competitive by debasing one's currency. The practice of crying down
the value of the dollar is every bit as corrosive and addictive for the
American economy as narcotic drug is for the human organism. It may produce
a euphoric sense of well-being, but this effect is ephemeral. Not only
can it not solve problems, it indeed will compound them.
A stable
currency is a major tool in the hands of those producers who are lucky
enough to have it, making them more productive as against producers laboring
under the yoke of a depreciating currency. Producers with a stable currency
cannot be driven to the wall by a depreciating currency in the hands of
their competitors. For one thing, the interest-rate structure is lower
in the country with a stable currency, spelling higher and more stable
capital values. Moreover, producers armed with a stable currency retain
their ability to control costs, because the danger is reduced that the
imported components of their products will get dearer. By contrast, their
competitors with a depreciating currency are bound to lose control over
costs as the price of the imported components of their products will steadily
rise. In today's global economy to assert that a weakening currency is
a deficit-remedy and a weapon in the trade-war is nothing but Orwellian
doublespeak.
Strong-dollar policy
The weak-dollar
policy was in fact abandoned in March, 1995, in favor of a strong-dollar
policy. At the same time, all pretenses were given up that American producers
ought to be competing in the world market. Let the trade deficit go to
outer space if it must, thereafter the paper mill on the Potomac river,
not the exporters, will take care of the import bill. The paper mill alias
Federal Reserve System will also finance the globalization (read: Americanization)
of the world economy. American multinational companies no longer compete
in the world market with products made in U.S.A. They compete in every
domestic market with products made in the same country by them. The capital
spending of large American companies no longer benefits American production
facilities at home: it benefits American production facilities abroad.
American workers and foreign manufacturers are victimized by this policy.
It is amazing that both acquiesced in the plan to globalize the world
economy at their expense, by jeopardizing their most vital interests.
American jobs are exported, while foreigners are forced to give up ownership
of their industry in exchange for confetti money. There is no rational
explanation for this irrational behavior other than assuming that neither
the American workers nor the foreign industrialists understand the concept
of 'globalization'. Nobody wants to expose the mendacity of the strong-dollar
policy, just as nobody wanted to expose the mendacity of the earlier weak-dollar
policy. Actually, both make the dollar weaker as both carry the seeds
of self-destruction within.
Only a
stable-dollar policy has a chance of success.
Between Scylla
and Charybdis
We have two
scenarios to choose from: global deflation and global runaway inflation.
It is impossible to say which one is uglier, Scylla or Charybdis. Perhaps
it is a mistake to formulate the problem in terms of these alternatives
because, really, there is only one problem: the debt incubus saddling
the world and sapping the vitality its economy. Deflation and runaway
inflation are different only in form; they are identical in substance
which is the threat of shaking off the debt incubus. The former does it
by wiping out the value of debt through defaults, the latter, through
debasement. Both threats are wrought with danger for the world population
at large. It is not possible to predict which of the two will actually
occur. The only certainty is that the debt incubus will be shaken off
by hook or crook, at the cost of immense economic suffering - unless world
leaders take proper measures in time to fend off the impending disaster.
Luckily, the measure that will fend off one will also fend off the other.
And this measure is the restoration of the gold standard.
The proposition
that the gold standard is deflation-prone cannot stand scientific scrutiny.
It is often charged that there is not enough gold to back all the bonds
that the world needs to finance itself. But this statement leaves out
of purview the gold price which determines how much credit can be built
on each ounce of the precious metal, and also how much of the mines' ore-reserves
are payable. It also confuses the concepts of stocks and flows by assuming,
wrongly, that the backing for all the outstanding gold bonds has to be
available and in hand at all times. The truth is that the world needs
only so much gold in any given year as is needed to meet the demand for
the retirement of gold bonds maturing in that same year. Another charge
is the chimaera of gold hoarding. But the assumption that gold hoarding
would sooner or later wreck the gold standard if one was established leaves
out of purview the rate of interest. We know that gold hoarding is just
a protest vote against the loose credit policies of banks. There was a
saying in London during the halcyon days of the gold standard to the effect
that "the Bank of England could pull in gold from the moon" provided that
it raised its rate of interest high enough. The gold standard is not deflation-prone
- it just demands that promises be kept. Whenever banks and the government
break their promises to pay gold, and then pat themselves on the back
for being shrewd in outsmarting their creditors, gold grows nervous and
goes into hiding. Looking back to the 20th century, we can see lots of
reasons for gold to be nervous. The governments of the world still owe
an apology for acting in such bad faith for so long, where promises to
their citizens and creditors are concerned.
The right
question to ask is not whether we should combat the danger of deflation
or that of runaway inflation. The
right question to ask is this: how can we restore honorable dealings between
the government and its citizens, and how can we restore faith in the promises
of the government, after a century of chicanery at the highest level?
13 July 2001
* Professor
Emeritus, Memorial University of Newfoundland, Canada; recipient of the
1996 International Currency Prize awarded by Bank Lips, Zürich, Switzerland,
for his essay Whither Gold? This paper is a follow-up to a talk
Kondratieff Revisited given at the Babes-Bolyai University, School
of Business Administration, in Sf. Gheorghe, Romania on May 2, 2001. It
is based on a Chapter of the author's projected 3-volume treatise entitled
Credit. E-mail: fekete@math.mun.ca
and/or: aefekete@hotmail.com
Dr. Antal E. Fekete
fekete@math.mun.ca
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