Money_How the Destruction of the Dollar Threatens the Global Economy - and What We Can Do About It

by Steve Forbes

  Equilibrium is the pipe dream of academicians. In real life, the economy is not an engine, but a dynamic, serendipitous stew of human actions, needs, and desires. Unpredictable events constantly arise to thwart the earnest intentions of bureaucrats. The Fed—indeed, any government bureaucracy—is no more capable of successfully orchestrating the economic activities of millions of people than it would be to control the weather.

  THE NUGGET

  To paraphrase Ron Paul: if printing money created wealth, there’d be no poverty left on earth.

  CHAPTER 5

  Money and Morality

  How Debasing Money Debases Society

  Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

  —JOHN MAYNARD KEYNES

  A MONG THE GREAT IRONIES IS THAT LORD KEYNES, THE foremost proponent of monetary stimulus, penned one of the most famous and powerful summations of the societal disarray that occurs when money is destroyed. Keynes wrote these words in 1919, shortly before Germany’s inflation flared up into the Great Disorder, the hyperinflation and social breakdown that preceded the rise of Adolf Hitler. He was convinced that there was a distinction between extreme inflation and more moderate levels, which he believed would stimulate an economy. History soon proved him tragically wrong.

  By providing a common standard of value that facilitates trade among total strangers, money promotes the cooperation and trust vital to commerce. Unstable money that can’t be trusted undermines the market’s common perception of value, creating distortions and uncertainty that disrupt transactions, making trust harder to establish. Transactions become more difficult or cannot take place. Or they appear to be unfair. In the most extreme situations, people eventually lose faith in the system—and in each other.

  A Classic Scenario of Malaise

  Noted investment strategist Dylan Grice points out: “History is replete with Great Disorders in which social cohesion has been undermined by currency debasements.” The destruction of money has always brought with it social malaise. From the decline of Rome to the French Revolution to the German hyperinflation to—more recently—the U.S. stagflation of the 1970s and Argentina in the present day, the scenario has been the same. It has been marked by scapegoating, corruption, social unrest, and increasingly coercive government. In the worst cases, such as in Weimar Germany, the destruction of money has led to political extremism and the rise of dictators.

  Because developed nations have not recently experienced Weimar-level inflation, most people consider the possibility of a Great Disorder to be extremely remote. But that has also been true of past disasters caused by the destruction of money. People are slow to recognize what is taking place. Monetary blogger Paul Hein compares the gradual breakdown to the heating of water in the pot containing the frog. Sooner or later, he says, “the situation becomes unbearable.”

  Given the bloating of the world’s monetary base over the past decade, nothing can be ruled out. Indeed, some observers today fear that the water may be reaching a boil. They point to the global financial crisis, largely overlooked hyperinflations of close to Weimar magnitude that have recently occurred in Zimbabwe and Syria, and the general unrest throughout the Middle East as being part of a four-decade worldwide decline of trust that has resulted from the shift to fiat money and the Fed’s weakening of the dollar.

  A Fissure at Society’s Core

  Locke observed centuries ago that the debasement of money drives a fissure into the core of society by defrauding both lender and borrower. Not only economic but social trust unravels when this fundamental relationship is destroyed. The financial crisis was very much a Lockean betrayal of trust that started when the Fed pulled out the rug from under borrowers by raising artificially low interest rates. Homeowners who could no longer afford their homes stiffed lenders, producing a wave of foreclosures. The resulting collapse of major financial institutions took the wealth of millions down with them. This in turn triggered the stock market panic of 2008 that set off a worldwide destruction of trust that ricocheted from one continent to the next. In Europe, bank failures and bailouts shook the confidence of global investors, helping bring on the EU’s sovereign debt crisis.

  This worldwide loss of faith swiftly turned to rage: riots and street protests rolled across the world—from Latvia, Germany, Turkey, France, and Austria to Great Britain, Ireland, Italy, Spain, and Greece. Anger in the United States erupted in the form of Occupy Wall Street protests.

  By fueling inflation, the Fed’s weak dollar also contributed to a meltdown of trust in the Middle East, where Tunisian protests over soaring food prices led to the mass unrest of the Arab Spring.

  ETM Analytics, a South African investment advisory house, has issued reports called Riot Alerts, which predict the world’s most likely trouble spots. The firm is able to forecast unrest based on nations’ rates of “monetary abuse.” Syria, suffering nearly 200% hyperinflation, topped the list in February 2013, followed by Argentina, South Africa, Egypt, India, and Turkey.

  In the case of Syria, hyperinflation has been caused by its civil war. ETM’s analyst Chris Becker explains, however, that monetary malfeasance is generally “the catalyst or trigger for the ultimate flare-up of unrest and violence.”

  Turning Society Against Itself

  Weak, unstable money inflames perceptions of unfairness. People with fixed incomes struggling with rising prices in an uncertain economy become enraged when they see others appear to get rich through speculation or crony capitalism, not honest effort.

  It is no accident that income inequality was an emotional issue in the United States even before the financial crisis—since the Fed started weakening the dollar. In 2012, a poll by the Pew Research Center found Americans to be more polarized than at any time during the past 25 years. “Nearly all of the increases have occurred,” the study reported, “during the presidencies of George W. Bush and Barack Obama.”

  In the words of Dylan Grice, during times of monetary expansion “the 99% blame the 1%; the 1% blame the 47%; the private sector blames the public sector, the public sector returns the sentiment—the young blame the old, everyone blames the rich—yet few question the ideas behind government or central banks.”

  He warns: “What we’ve effectively done with this . . . money printing exercise is to turn society against itself.”

  The Symbiosis of Money and Trust

  Money promotes trust by providing a stable unit of measurement people in the market can agree upon, that is the basis of transactions between strangers. But it’s not just that money is the foundation of trust. The converse is equally true: social trust depends on stable money.

  George Mason University economist Bruce Yandle tells us:

  Practically all market transactions depend on some degree of trust. . . . Consider some simple actions. I fill the tank of my car with fluid from a pump at a 7-Eleven store I have never visited, trusting that the fluid passing through the hose is gasoline. I walk into a large TESCO superstore in Prague, a store and company I have never patronized, and buy a supply of groceries, including fresh fruit, soups, and coffee. I consume the items without a second’s concern about their safety. I e-mail my broker and tell him I want to buy a thousand shares of stock . . . [though] I have never checked the firm’s financial strength. . . .

  Trust is somehow rooted in individuals. Within all these examples, truth telling and promise keeping are typical features of ordinary commercial life. The marketplace is infused with trust.

  Economist and political philosopher Francis Fukuyama defines trust as “the expectation that arises within a community of regular, honest, and cooperative behavior, based on commonly shared norms, on the part of other members of that community.”

  Fukuyama notes that societies with high trust tend to be be
tter wealth creators. What he calls “high trust societies” (examples include Germany, Japan, and the United States) tend to be better at forming corporations and have prospered more rapidly than lower trust societies that have relied more heavily on smaller family businesses.

  Money promotes trust not only by acting as a common measure of value, but also through the mechanism of credit. After all, what is credit—a loan based on a promise of future repayment—but the financial expression of trust?

  To see the interrelationship between money, credit, and social trust, one need only compare various nations’ benchmark interest rates. They tend to be higher for troubled economies. Contrast the rates in 2014 for high-inflation Argentina (15.0%), Belarus (26.0%), and Myanmar (11.3% and more recently 10.0%) to those in nations with lower inflation and higher trust such as Norway (1.5%) and Australia (2.5%). Or better still, contrast them to the 3% yields on long-term bonds that prevailed in the nineteenth century during the global economic boom that took place during the classical gold standard era, a time when money was considered as good as gold.

  Unfortunately, the relation of money to social trust is seldom fully appreciated. This has been especially true since the financial crisis, during which money and finance have become almost synonymous with greed.

  There is a strong correlation between periods of social unrest and periods of monetary volatility. The four-decade destruction of the dollar is also a story about the destruction of trust. More than one study has shown an overall decline of faith in the system since the early to mid-1960s, even before the destruction of the Bretton Woods standard. Various factors have contributed to this slide, including assassinations, the Vietnam War, and the rise of the counterculture.

  Social trust has taken especially sharp dives during the double-digit inflation of the late 1970s and during the weak dollar expansion of the last decade that culminated in the financial crisis. In addition to being an economic catastrophe, that worldwide event was a destruction of trust from which we have yet to recover.

  How the Financial Crisis Exemplifies the Corruption of Trust

  The financial crisis that began in the United States and tore through the global economy began with the corruption of fundamental mechanisms of money and credit that are part of what Bruce Yandle calls the market’s “trust technology.” Instruments like credit ratings, he explains, are “assurance mechanisms” vital to the “truth telling and promise keeping” that establish trust and allow the economy to function.

  The Fed’s lowering of interest rates and the monetary expansion of the early 2000s, combined with pressures from affordable housing regulations, he tells us, impaired the market’s trust-assuring capabilities by damaging this critical infrastructure. As a result, loans were made to people who would not normally have received them. This in turn led to financial institutions bundling tainted loans in the mortgage-backed securities they sold to investors.

  Trust-assurance mechanisms like bond credit ratings were also compromised by the politicized environment. Finally, when the Fed raised interest rates, Yandle writes, “politically distorted assurance devices failed to function,” setting off a wave of foreclosures.

  The reinstatement of mark-to-market accounting regulations, which forced banks artificially to undervalue their loan portfolios, provided a tipping point. The return of this toxic regulation caused banks holding subprime mortgages to look more financially precarious than they were in reality. Attacks by short sellers sent bank stocks into a death spiral, setting off the Panic of 2008–2009 and the crisis of confidence in the financial system.

  The painful memory remains with us: several of the nation’s largest financial institutions that were supposedly “too big to fail” collapsed, merged, or, in the case of Citigroup and AIG, were temporarily taken over by the government, which seized most of their equity. The Dow Jones Industrial Average lost 7,600 points, or 54% of its value, in 17 months.

  For weeks, financial institutions were virtually paralyzed. Some people withdrew their money from banks and brokerages and many more wondered if they should. An incipient wholesale panic of withdrawals from money market funds was halted when the Fed temporarily guaranteed their values. But this crisis of trust was only just beginning.

  From Foreclosures to Sovereign Default

  The collapse of confidence in the system brought about by the weakening of the U.S. dollar set off a seismic reaction quickly felt around the world. Bailouts and bank seizures took place in countries from Great Britain to Germany to Ireland. The contagion helped trigger the sovereign debt crises in the euro zone that began months later in 2009.

  Many observed at the time that some banks were in better condition than was widely perceived. But this reality meant little. A Deutsche Bank economist told the New York Times, “In this day and age, a bank run spreads around the world, not around the block. Once a bank run is underway, it doesn’t matter anymore if you have good loans or bad loans. People lose confidence in you.”

  Greece, hit hard by the ensuing global recession, revealed that its government deficit was twice what was previously reported. The prospect of a Greek government default on its bonds—which were owned by global investors, especially European banks in general and French financial institutions in particular—terrified the financial markets, igniting doubts about the creditworthiness of other European governments—especially Portugal, Italy, Ireland, and Spain.

  Greece and other troubled nations suffered a series of downgrades on their bonds. Eventually Standard & Poor’s rated Greece an “SD”—a selective default, indicating the country was unable to meet all of its financial obligations. Shaken bond buyers caused interest rates to skyrocket throughout Europe. Greek 10-year bond yields reached an astonishing high of nearly 49% at the height of the crisis in March 2012. Soaring borrowing costs pushed the region’s troubled governments to the brink of insolvency. Greece eventually ended up in a bailout agreement engineered by the European Union, stiffing its bondholders for 50% of their loans.

  The global contagion that started with a crisis of trust in the U.S. subprime mortgage market created new antagonisms in the euro zone. Greece was blamed for out-of-control borrowing and spending. Germany was resented for refusing to bail out Greece and pushing a solution that relied on private bondholders. The United States was condemned as responsible for the crisis. China, with its growing economic strength and ownership of the debt of so many troubled governments, was feared by everybody.

  The Middle East: Weak Money Fuels the Fire

  The destruction of trust produced by the Fed’s tsunami of global liquidity did not end with Europe—it inflamed tensions in the Middle East as well. Remember, as the value of money declines, investors look to preserve their wealth. Money flows into commodities like oil and agricultural products, jacking up the price of essentials like fuel and food. In 2010 the United Nations Food and Agriculture Organization (FAO) Food Price Index reported a 25% surge in prices. People around the world blamed the jump on supply shocks from drought, poverty, and wars. But the real cause was the flood of loose money from the Fed.

  The 2010 Tunisian street demonstrations that set off the Arab Spring protests were largely over food prices. The unrest then spilled over into Egypt, where the consumer price index had jumped 18% in 2009, compared with 5% in 2006. The country has since seen the toppling of the Mubarak and the Morsi governments and remains in flux. Unrest also increased in Iran, where the inflation rate had surged to an official rate of 25% in 2009, nearly twice its level several years earlier. The real level was probably twice that.

  At the G-20 meeting in Paris in 2011, finance ministers expressed fears that U.S.-driven global inflation was threatening global stability. George Melloan was among those who made the connection between this unrest and QE. He acknowledged in the Wall Street Journal: “Probably few of the protesters in the streets connect their economic travail to Washington. But central bankers do.”

  To appreciate the depth of political upheaval created by
the 2008 financial crisis, just tally the power shifts that occurred in its wake. In addition to the turmoil in the Middle East, 13 out of 17 European governments changed over as a result of the initial financial crisis. In the United States, the stock market panic in September 2008 reversed the slight lead of John McCain and helped sweep the far-left Barack Obama into office.

  From Balance Sheets to the Streets

  Throughout history, an extreme loss of trust in money has often turned into a hunt for scapegoats. When things go wrong, loose money—or, for that matter, tight money—is rarely seen as the cause. People look for someone to blame. As Keynes observed, “Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations” become “the object of hatred” and are despised as “profiteers.”

  In his widely cited piece on great disorders, Dylan Grice reminds us that every inflationary period has been marked by vicious campaigns against supposed villains. The Romans in the third century blamed the Christians for the inflation caused by their own ruthless debasement of the denarius. Great Britain’s witch trials in the sixteenth and seventeenth centuries and the French Revolution’s Reign of Terror in which 17,000 people were slaughtered both coincided with periods of monetary debasement. And during its hyperinflation, Germany blamed the Jews.

  In the immediate aftermath of the 2008 financial crisis, people from all sides questioned the fairness of the government propping up the financial sector with taxpayer money while people were losing their homes, jobs, and savings. Almost daily, politicians excoriated Wall Street greed, predatory lenders, and speculators. Condemnations of “fat cats with corporate jets” became mainstays of the political rhetoric.