Bernanke’s “enrich-thy-neighbor” rhetoric ignored the neighbors in emerging markets such as China, Korea, Brazil, Thailand, and elsewhere whose currencies would have to appreciate (and their exports suffer) in order for Bernanke’s “stimulus” to work in the developed economies. In other words, Japanese exports might benefit, but this could come at the expense of Korea’s exports, and so on. It might not be a currency war of all against all, but it was still one that pitted the United States, the U.K., and Japan against the remaining G20 members.
Japan and the U.K. had another reason to support the money printing and resultant devaluation being urged by the Fed. Money printing was being done not only to promote exports but to increase import prices. These more expensive imports would cause inflation to offset deflation, which was a danger to the United States and the U.K. and had long existed in Japan. In Japan’s case, inflation would come primarily through higher prices for energy imports, and in the cases of the United States and the U.K., it would come from higher prices for clothing, electronics, and certain raw materials and foodstuffs.
The United States and the U.K. both have debt-to-GDP ratios of approximately 100 percent and rising, while Japan’s debt-to-GDP ratio is over 220 percent. These levels are historically high. The trend in these ratios is more important to investors than the absolute levels, and the trend is worsening. All three nations are moving toward a sovereign debt crisis if their policies cannot be adjusted to put these debt-to-GDP ratios on a declining path.
Debt-to-GDP ratios are calculated in nominal rather than real terms. Nominal debt needs to be repaid with nominal growth in income. Nominal growth equals real growth plus inflation. Since real growth is anemic, the central banks must cause inflation to have any hope of increasing nominal growth and reducing these debt-to-GDP ratios. When policy interest-rate cuts are no longer possible because the rates are effectively zero, quantitative easing, designed in part to import inflation through currency devaluation, is the central bankers’ preferred technique.
The Bank of England (BOE) has engaged in four rounds of quantitative easing (QE), beginning in March 2009. Subsequent rounds were launched in October 2011, February 2012, and July 2012. Increased asset purchases have ceased for the time being, but the BOE’s near-zero-interest-rate policy has continued. The BOE is refreshingly candid about the fact that it is targeting nominal rather than real growth, although it hopes that real growth might be a by-product. Its official explanation on the bond purchases to carry out QE states, “The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand. Despite this different means of implementing monetary policy, the objective remains unchanged—to meet the inflation target of 2 percent on the CPI measure of consumer prices.”
The situation in Japan differs. Japan has been in what may be described as a long depression since December 1989, when the 1980s stock and property bubbles collapsed. Japan relied primarily on fiscal stimulus through the 1990s to keep its economy afloat, but a more pernicious phase of the depression began in the late 1990s. Japan’s nominal GDP peaked in 1997, declining almost 12 percent by 2011. The Japanese consumer price index peaked in 1998 and has declined steadily since, with relatively few quarters of positive CPI readings. It is a truism, if not intuitive, that an economy with declining nominal GDP can still have real growth when inflation turns to deflation. But this type of real growth does nothing to help the government with debt, deficits, and tax collections since those functions are based on nominal growth.
The Bank of Japan’s (BOJ) relationship to QE, inflation, and nominal GDP targeting is more opaque than the Bank of England’s. The BOJ’s efforts at monetary ease prior to 2001 were desultory and controversial even within the BOJ. A modest QE program was begun in March 2001 but was too small to have much effect. A detailed IMF survey of the impact of QE in Japan from 2001 to 2011 concluded, “The impact on economic activity . . . was found to be limited.”
Suddenly on December 16, 2012, Japanese politics and monetary policy were transformed with Shinzo Abe’s election as prime minister, in a landslide victory for his Liberal Democratic Party. The election gave Abe’s party a supermajority in the Japanese Diet that could override vetoes by the Senate. Abe campaigned explicitly on a platform of money printing, including threats to amend the laws governing the Bank of Japan if it failed to print. “It’s very rare for monetary policy to be the focus of an election,” Abe said. “We campaigned on the need to beat deflation, and our argument has won strong support. I hope the Bank of Japan accepts the results and takes an appropriate decision.”
Even Abe’s election did not fully convince markets that the BOJ would actually take extraordinary measures, given the bank’s indifferent approach to monetary ease for the prior twenty years. On March 20, 2013, Abe’s handpicked candidate, Haruhiko Kuroda, became governor of the BOJ. Within days, Kuroda persuaded the BOJ’s policy board to implement the largest quantitative easing program the world had ever seen. The BOJ pledged to purchase $1.4 trillion of Japanese government bonds over the two-year period of 2013 and 2014 using printed money. Japan simultaneously announced a plan to lengthen the maturity structure of the bonds it purchased, comparable to the Fed’s “Operation Twist.” Relative to the size of the U.S. economy, Japan’s money-printing program was more than twice as large as the Fed’s QE3 program, announced in 2012. As was the case with the Bank of England, the Bank of Japan was explicit about its goal to increase inflation in order to increase nominal, if not real, GDP: “The Bank will achieve the . . . target of 2 percent in terms of the year-on-year rate of change in the consumer price index . . . at the earliest possible time.”
By 2014, it was as if the Federal Reserve, the BOJ, and the BOE were in a monetary poker game and had gone all in on their bet. All three central banks had used money printing and near-zero rates to create inflation in order to increase nominal GDP. Whether nominal GDP turned into real GDP was beside the point. In fact, real growth since 2009 was on a path characteristic of depression in all three countries. Inflation and nominal GDP were the explicit and primary goals of their respective monetary policies.
The U.S. dollar, the U.K. pound sterling, and the Japanese yen together comprise 70 percent of global allocated reserves and 65 percent of the SDR basket. If the Federal Reserve is the keystone of the international monetary system, the Bank of Japan and the Bank of England are adjacent arch stones. But all three central banks, now engaged in a monetary experiment on an unprecedented scale, face highly uncertain outcomes. Their announced goal is not real growth but inflation and nominal growth in order to pay their debts.
Creditors and reserve holders in the BRICS, the SCO, the GCC, and other emerging markets are watching this money-printing pageant with undisguised frustration and increasing determination to end an international monetary system that allows such economic free-riding at the cost of inflation, lost exports, and diminished wealth in their own countries. It remains to be seen whether the international monetary system collapses of its own weight or is overthrown by emerging-market losers in response to this crime of the century being perpetrated by the U.S., U.K., and Japanese central banks.
PART THREE
MONEY AND WEALTH
CHAPTER 7
DEBT, DEFICITS, AND THE DOLLAR
Forward guidance . . . should promise that monetary policy will not remove the punch bowl but allow the party to continue until very late in the evening to ensure that everyone has a good time.
Charles I. Plosser
President of the Federal Reserve Bank of Philadelphia
February 12, 2013
Adopting a nominal income . . . target is viewed as innovative only by those unfamiliar with the debate on the design of monetary policy of the past few decades. No one has yet designed a way to make it workable. . . . Rather, a . . . target would be perceived as a thinly disguised way of aiming for higher inflation.
Charles Goodhart
March 18, 2013
■ The Meaning of Money
What is a dollar? This question has no easy answer. Most people respond that a dollar is money, something they make, spend, or save. That raises another question: What is money? Experts recite the three-part definition of money as a medium of exchange, a store of value, and a unit of account. The unit of account part of the definition is useful but almost trivial. Bottle caps can be a unit of account; so can knots on a string. A unit of account is merely a way of adding or subtracting perceived value. Medium of exchange also refers indirectly to value, since each party to an exchange must perceive value in the unit being exchanged for goods or services. Two of the three parts of the definition implicitly reference value. The entire standard definition can thus be collapsed into the one remaining part, the store of value.
If, then, money is value, what is value? At this point, the analysis becomes philosophical and moral. Values can be held by individuals yet shared within a culture or community. Values can be subjective (as is the case with ethics) or absolute (as is the case with religion). Values can come into conflict when competing or contiguous groups have widely varied values.
Despite this breadth in the meaning of value, two facets stand out. The first is the idea of a metric: that there is a way of measuring the presence, absence, or degree of value. The second is the idea of trust: that when one ascribes values to an individual or group, one trusts that the individual or group will act consistently with those values. Trust embodies consistent behavior in the form of reciprocal or altruistic acts.
At heart, a dollar is money, money is value, and value is trust consistently honored. When one buys a bottle of Coca-Cola anywhere in the world, one trusts that the original formula is being used, and that the contents are not adulterated; in this respect, Coca-Cola does not disappoint. This is trust consistently honored, meaning that a bottle of Coke has value.
When a customer buys a bottle of Coke, he hands the seller a dollar. This is not mere barter, but rather a value exchange. What is the source of the dollar’s value? How does it hold up as an example of trust consistently honored?
To answer that question, one needs to dig deeper. The dollar itself, whether in paper or digital form, is a representational object. What does the dollar represent? To whom is the trust directed? When trust is required, Ronald Reagan’s dictum applies: Trust, but verify. The Federal Reserve System, owned by private banks, is the issuer of the dollar. The Fed asks for our trust, but how can one verify if the trust is being honored?
In a rule-of-law society, a customary way of verifying trust is the written contract. A first-year law student in contracts class immediately learns to “get it in writing.” The beliefs and expectations of the parties to a contract are written down and read by both parties. Assuming both parties agree, the contract is signed, and from then forward, the contract embodies the trust. At times, disputes arise about the meaning of words in the contract or the performance of its terms. Countries have courts to resolve those disputes. This system of contracts, courts, and decisions guided by a constitution is what is meant by a rule-of-law society.
How does the Federal Reserve fit into this system? On one level, the Fed follows the written contract model. One can begin by reading the fine print on a dollar bill. That is where one finds the written money contract. The parties to this contract are specified as “The Federal Reserve” and “The United States of America” on behalf of the people.
One-dollar contracts are entered into by each of the Fed’s twelve regional reserve banks. Some of these written contracts are entered by the Dallas Fed, some by the Philadelphia Fed, and so on. Larger denominations such as twenty-dollar contracts are entered into by the “System.” These contracts are all signed by an agent, the U.S. secretary of the Treasury, on behalf of the people.
The most important clause in the written dollar contract appears on the front at the top of each bill. It is the phrase “Federal Reserve Note.” A note is an obligation, a form of debt. Indeed, this is how the Fed reports money issued on its balance sheet. Balance sheets show assets on the left-hand side, liabilities on the right-hand side, and capital, which is assets minus liabilities, at the bottom. Notes issued by the Fed are reported on the right-hand side of the balance sheet, as a liability, exactly where one would place debt.
Fed notes are an unusual form of debt because they bear no interest and have no maturity. Another way to describe a dollar, using the contract theory, is that it is a perpetual, non-interest-bearing note issued by the Fed. Any borrower will attest that perpetual, non-interest-bearing debt is the best kind of debt because one never pays it back, and it costs nothing in the meantime. Still, it is a debt.
So the dollar is money, money is value, value is trust, trust is a contract, and the contract is debt. By application of the transitive law of arithmetic, the dollar is debt owed by the Fed to the people in contractual form. This view may be called the contract theory of money, or contractism. As applied to the dollar, one way to understand the theory is to substitute the word debt every time one sees the word money. Then the world looks like a different place; it is a world in debt.
This approach to money through the lens of contract is one of many monetary theories. The most influential of these is the quantity theory of money, or monetarism, advocated in the twentieth century by Irving Fisher and Milton Friedman. Monetarism is one of the Fed’s chosen guides to money creation, although the original formulation advocated by Friedman is no longer in vogue.
Another approach is the state theory of money, which posits that unbacked paper money has value since the state may demand such money as tax payments. The state may use coercion unto death to collect taxes; therefore citizens work for and value money because it can satisfy the state. This relationship of money and state means paper money has extrinsic value in excess of its intrinsic value due to the medium of state power. This type of money is known as chartal money, and chartalism is another name for the state theory of money. In the 1920s John Maynard Keynes adopted chartalism in his calls for the abolition of gold standards. More recent acolytes of the theory of money as an arm of state power are Paul McCulley, former executive at bond giant PIMCO, and Stephanie Kelton, economist at the University of Missouri, who marches under the banner of modern monetary theory.
A new entrant in the money theory sweepstakes is the quantity theory of credit. This theory, advanced by Richard Duncan, is a variant of the quantity theory of money. Duncan proposes that credit creation has become so prolific and pervasive that the idea of money is now subsumed in the idea of credit, and that credit creation is the proper focus of monetary study and policy. Duncan brings impressive statistical and forensic analyses of government data to the study of credit expansion. His work could properly be called creditism, although it is really a twenty-first-century version of a nineteenth-century view of money called the British Banking School.
Monetarism, chartalism, and creditism all have one idea in common: a belief in fiat money. The word fiat has a Latin origin that means “let it be done.” As applied to money, fiat refers to the case where the state orders that a particular form of money serve as currency and be treated as legal tender. All three theories agree that money does not have to have intrinsic value as long as it possesses extrinsic value supplied by the state. When fiat money opponents say money “is not backed by anything,” these theorists answer, “So what?” In their view, money has value because the state dictates it be so, and nothing else is required to give money its value.
A theory is useful only to the extent it accords with real-world phenomena and helps observers to understand and anticipate events in that world. Theories of money that rely on state power are a thin reed on which to lean because the application of state power is changeable. In that sense, these competing theories of money may be said to be contingent.
R
eturning to where we started, the contract theory of money focuses on money’s intrinsic value. The money may be paper, but the paper has writing, and the writing is a legal contract. A citizen may deem the contract valuable for her own reasons independent of state dictates. The citizen may value contract performance rather than fiat. This theory is useful for understanding not only the dollar but also whether the dollar contract is being honored, both now and in the future.
Although the dollar as debt bears no interest and has no maturity, the dollar still involves duties of performance on the parts of both the Fed and the Treasury, the two named parties on the contract. This performance is made manifest in the economy. If the economy is doing well, the dollar is useful, and contract performance is satisfactory or valuable. If the economy is dysfunctional, performance may be thought poor to the point of default under the contract.
A gold standard is a way to enforce the money contract. Advocates for gold insist that all paper money has no intrinsic value, which can be supplied only by tangible precious metal in the form of gold, or perhaps silver. This view misapprehends the role of gold in a gold standard, but for the few who insist that coins or bullion be the sole medium of exchange—a highly impractical state of affairs. All gold standards involve a relationship between physical gold and paper representations of gold, whether these representations are called notes, shares, or receipts. Once this relationship is accepted, one is quickly back to the world of contract.
The Death of Money Page 19