“Exactly,” Ben said.
“So why does the world hold dollars now instead of yuan? What gives America the advantage?”
“In a word, Mr. President, confidence. Remember what I said about currencies being a Ponzi scheme? It’s a way for the government to get something for nothing. All those dollars are printed by us. Then others, be they American or foreign, are willing to take them in return for something tangible because they have faith that they will be able to use that piece of paper to buy something from someone else. That next person takes it because they also expect to be able to pass it on. The game ends when the last guy holding the piece of paper has nobody to pass it on to.
“Mr. President, you’ve probably seen pictures of people in Germany in the 1920s carting wheelbarrows full of paper money just to go shopping. Currencies decline in value. Not necessarily all at once, but by people demanding more and more pieces of paper for everything they sell. The faster confidence declines, the more pieces of paper are demanded. This creates a vicious cycle where everyone starts demanding more and more money for everything they sell.”
“Meaning inflation,” said the President.
“You’ve hit the nail on the head,” said Ben. “The trick is to keep the money game going as long as possible. Usually this means allowing a little more inflation every year. A little inflation doesn’t destroy peoples’ confidence. The extra money being printed again gives the government more money to spend.”
“So inflation is a way for the government to make ends meet?”
“Yes. The government can get money through taxing people, borrowing, or printing money. You might think of money as an interest-free loan to the government. People get interest from a bank because the bank can lend it to someone else. But the money has to be created in the first place. When it is, the person who gets it is making an interest free loan to Uncle Sam.
“The trick is to find the right amount of inflation that won’t destroy confidence. When congress passed the Federal Reserve Act, it said one of the missions of the Fed was price stability. Remember, however, it’s Congress that gets to spend that money. So we’ve always taken that mandate as being tongue in cheek. The Fed and most of the other central banks of the world decided that price stability meant two percent inflation. This meant the Fed often pursued a policy of trying to increase inflation in order to get to price stability. However, two percent inflation means the purchasing power of a dollar drops seventy-five percent during a person’s lifetime and about eighty-five percent in a century.”
“You mean,” said the President, “if we have price stability, then a dollar printed today will only be worth fifteen cents a hundred years from now?”
“Yes. And history is full of stories of governments doing exactly that. Back in Rome their money was called the denarius. It started out being almost all silver. Then they first began to make it a little bit smaller, still calling it one denarius. Then they began to mix bronze and lead in with the silver. By the end, there was almost no silver in the denarius.”
“Didn’t Gibbon mention in The Decline and Fall of the Roman Empire that inflation was one reason for the collapse of the Roman Empire?” the President asked.
“Economic historians argue that the real mystery is not why the Roman Empire fell, but why it took so long. Inflation was actually one of the ways they stretched it out. The money the government saved by debasing the denarius like that let them make more coins for the same amount of silver. Those coins were used to pay the army until the solders got wise to what was going on and started demanding more and more of these debased coins in return for their labor. That turned inflation into hyperinflation. The same thing happened to Germany’s Weimar Republic in the 1920s.
“But it wasn’t just Europeans who did that. When the Conquistadors took the silver from the Incas, about half went across the Atlantic to Spain, where it caused inflation. Most of the rest went to China.
“The Chinese invented paper money and ended up printing too much of it. Inflation turned into hyperinflation. To restart the economy and run the government, the Chinese began to circulate the silver the Conquistadors took from the Incas. Of course, they had to give the Spanish goods in return. To show how attractive inflation is, the Ming Dynasty went through that entire cycle twice while they ruled. They introduced paper money along with the silver, the silver began to disappear, so more paper was printed. They again had to import silver from Peru.”
“They never learned,” said the President.
“It’s a hard-learned and easily forgotten lesson, Mr. President. During our Revolution, each state printed its own money to pay the militias. These pieces of paper were called Continentals. By the end of the Revolution, the phrase ‘Not worth a Continental’ became commonplace. So Alexander Hamilton assumed all the states’ debts, including the Continentals, and put the country on a mixture of gold and silver. This was called specie, and Hamilton replaced paper with it like the Ming did.
“Since then it fell in and out of favor. During our Civil War, money was printed to pay the Union Army. Naturally, it caused inflation, so America went back to specie. Eventually, in 1913, Congress created the Federal Reserve to take us back to paper money. At first they were cautious. The Fed had to have forty cents in gold for every dollar that circulated. But during the Great Depression FDR’s economists wanted to create inflation, so his government forced people to sell all their gold to the government for $20.67 an ounce. If you didn’t, the government simply seized it. When they had control of all America’s gold, Roosevelt declared that each ounce of gold was now worth $35 an ounce, a seventy-five percent increase in the amount of money in circulation. Prices stopped falling and started rising.”
“He did that just by decree?” asked the President.
“That’s why they call it fiat currency,” Ben said. “Eventually President Ford, a guy with a lot of common sense, decided this was ridiculous and repealed the prohibition on Americans owning gold. We could print money freely once again.”
“How does all this relate to what the Chinese are up to?” said the President.
“Confidence,” Ben said. “The Chinese plan to bring the dollar down and have yuan take its place by destroying confidence in the U.S. dollar.”
“How?”
“If I put myself in Governor Li’s shoes, I would force the American economy to inflate. I think the Chinese are going to dump one and a half trillion dollars’ worth of U.S. government bonds onto the market.”
“How did we get to this point?” asked Steinway.
Ben said, “For nearly three-quarters of a century, the U.S. government spent more money than it took in, so it had to borrow to cover the shortfall. So the U.S. Treasury issues bonds to raise the money. The bond promises the lender that he or she will be paid back at a certain point in the future and the government will pay them interest in the meantime. Some of these bonds, technically called bills, last only three months. Long-dated bonds can be outstanding for as many as thirty years. Usually the markets demand less interest when they are going to be paid back in the short term than if repayment is many years in the future.
“Sometimes the Federal Reserve buys those bonds. It is often said that the Fed simply prints money, and in a sense they do. But each of those dollars they print is backed by U.S. Treasury bonds. So paper money buys something that pays interest, and at the end of the year, the Fed gives all of the interest it received back to the government after covering its cost of operations. Money is not backed by gold. It is backed by government debt.
“Sometimes foreign governments and banks buy U.S. bonds as an investment. When a country like China runs a trade surplus with the U.S., when they sell more to us than we buy from them, they end up holding more dollars. Like anyone, they want to earn interest on those dollars. The best way to do it is buying U.S. Treasuries. Foreign banks may choose to hold U.S. Treasuries as an investment because they might pay a higher interest rate than bonds issued by their own country. That’s why nearly a thir
d of all U.S. government bonds are owned by foreigners.
“In responding to such a dump, we would have two choices. We could let interest rates rise to entice others to buy those bonds. The problem is the much higher interest rates would knock our economy into a recession. Or we could print money to buy the bonds. In fact, when I was asked about this possibility in my confirmation hearings, I said what I would do is ask the Chinese whether they wanted large bills or small.”
“You’re recommending a policy of deliberate inflation?” The President gave him a hard look.
“It’s the lesser of two evils,” said Ben.
The President took a deep breath. “So much for my chances of reelection. Ben, when I appointed you, I thought having a smart guy as chairman was the politically shrewd thing to do. I guess I was wrong.”
“Mr. President, I am not a politician—”
“Bullshit, Ben!”
“Sorry, Mr. President. But history has put both a challenge and an opportunity in your hands. If we play our cards right, you will be the man who derailed China’s march to superpower status. That should not just reelect you, it’ll give you a great place in the history of America.”
The President smiled. “You butter me up like that and wonder why I called bullshit when you said you weren’t a politician. So how do we get from here to there?”
“Mr. President, remember—knocking down confidence in the dollar is just one of the things the Chinese have to do. They also have to create confidence in the yuan. And, well, nobody has confidence in a little piece of paper issued by a communist dictatorship. But they do have confidence in us.
“The way the Chinese are going to build confidence is age-old. They are going to back the yuan with gold, at least partially. When I asked Governor Li why they were accumulating so much gold, he said he wanted the Chinese to treasure the yuan as much as they treasure gold.
“Right now, they’re having a bank run because their people don’t have confidence in the yuan or the Chinese banking system. If the people get their money out of the banks, the banks will have to call in their loans. That will wreck the Chinese economy.”
“Why doesn’t their government print the money and give it to the banks?” asked the President.
“They could,” said Ben, “but that would totally destroy confidence in the yuan. Instead, they’re going to use their gold stockpile to create public confidence in the yuan, and by extension, their banking system.”
“So it all comes down to gold.”
“Yes, Mr. President, it does. China has been accumulating gold for several decades. If its price keeps going up, in probably five years, they will have enough gold to cover sixty to seventy percent of the yuan they have printed. That will be more than enough to restore confidence in the yuan and make it a plausible alternative to the dollar.”
“That’s how they’ll wreck us economically and become the world’s only superpower,” said the President. “We can’t let that happen, can we?”
“No, we can’t.” said Ben. “And there are things we can do to stop it. Our biggest hope is the impatience of the Chinese leadership. Governor Li said something very interesting. He said politicians think desperate times require desperate measures, but to a central banker, desperate times require calming measures. Li knows that today is not the time to implement this plan. It is five years from now. But what I saw in the bank run were troops shooting people in the middle of Beijing. That sounds like a desperate measure to me. And the Chinese long-term plan seems a lot less desperate than shooting people.”
“So your hunch is that they’ll act too soon.”
Hector Lopez joined the conversation. “Our intelligence indicates that may be a possibility. But frankly, our analysts are divided over the situation.”
“Hector,” said the President, “you’re doing a great job, but frankly, this wouldn’t be the first time the CIA has not come to a definitive judgment.”
“You’re right, Mr. President,” said Hector. “Our best guess is that if these bank runs continue, they will have to make a move in the next six months to a year.”
The President looked to Ben. “Is that your time frame?”
“Sir, I don’t think it’s my place to question the CIA on its ability to guess the behavior of a foreign government.”
“Again, bullshit. That’s a political answer. It is not the answer of someone with a reputation as a straight shooter.”
“Mr. President,” Ben said, “I don’t think anyone knows when the Chinese government is going to act. I saw a lot of desperation in that bank run. And that was happening in the middle of Beijing, the most pampered city in all of China. When bank runs start, they rarely go on for six to twelve months. Weeks, maybe?”
The President nodded. “That’s my instinct too. From my days in business, I know what you have to worry about is your stock price. Once the selling starts and you don’t have good news to give the market, the selling accelerates.”
“As long as America wins this fight in the end,” Ben said, “confidence in the dollar and in the U.S. government will surge. I think once the Chinese initiate their action, we will be in desperate times. Central bankers have one big calming measure. It doesn’t last forever. In fact, it’s a dumb thing to do forever. But it works in the short run, and I think this crisis, when it happens, is going to be a quick one.
“So as cynical as I am about the history of monetary policy, I think the best thing for us to do would be to buy all of the bonds the Chinese dump on the market and hint that we’ll do the same if there’s trouble in the treasury market. If people think we’re credible, Wall Street is not going to take us on. We don’t have to buy all the bonds for very long. But for a while Wall Street will never fight the Fed. They know it’s a battle they’re going to lose.”
“Well, Ben,” said the President, “I appointed you chairman, so I am going to trust your judgment. But there’s an old story about why politicians don’t interfere with the Fed. It’s the great narrative that it’s an independent institution. If we didn’t have you to blame, what would we do?
“As the writer said, with great power comes great responsibility.” He smiled at that. “So the ball is in your court. But if you fuck it up, it’s going to be your head on the chopping block, not mine.”
“Fair enough, Mr. President. Let’s all hope that this crisis doesn’t happen anytime soon.”
The others nodded in agreement.
The President rose from his chair, signaling that the meeting was over. The other three followed the President’s lead as he led them to the exit. The President put his hand on Ben’s shoulder.
“I’d like to have a quick word with you before you go.”
“Certainly, Mr. President.”
Steinway and Lopez took the hint and the President closed the door behind them.
“Ben, the First Lady and I would like to have you and Bernadette over for dinner tomorrow night up in the residence.”
Ben knew what a rare honor this was, and said, “Of course, Mr. President.” But he could only think, Something is up.
Opening the door, the President said, “Great. We’ll see you tomorrow night at six-thirty.”
* * *
Ben’s first impulse was to call Bernadette about the White House dinner as soon as he got in his car. Then he remembered he was springing something on her at the last minute. There would be the inevitable complaint about not having anything to wear. She’d get over it, but there was a trade-off. A few extra minutes of preparation versus the possible miscommunication inherent in using the phone. Ultimately, he opted to do it in person since after Beijing his goodwill with her was still a little thin.
So it was when Ben walked in the door and accepted the glass of wine she had waiting, he broke the news and waited for the reaction.
“Darling, I love you, but why didn’t you call me from the car? You know I need time to prepare.”
“I wanted to see the look on your face,” he offered.
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br /> “Well, this is the look of a woman who has less than twenty-four hours to prepare for one of the biggest events that can happen to anyone in Washington.”
“You’re going to be fine.” He sipped the wine. “And beautiful.” I got that one wrong, he thought. Or would I have been wrong no matter which decision I made?
“Easy for you to say. You don’t have to get your hair and nails done. You can throw on a blue pinstripe, spend forty seconds picking out a tie, and you’re done. I don’t have anything to wear.”
Ben held back a smile. Her accent even added charm to her complaining. Besides, it made it exponentially easier for him to decipher if he was in trouble, and if so, how much.
“And shoes. Shoes. Dammit, Ben, this is the President and First Lady we’re talking about and I will never be able to find anything to wear on such short notice.”
Despite the accent, the message was clear. She was trying to make him feel that he was in big trouble. Deep inside the flattery of the invitation was taking hold. But she wasn’t going to let him off the hook that easily.
“You’ll find something perfect,” Ben said. “I have no doubt. And don’t worry about your hair—”
“Wipe that stupid grin off your face,” Bernadette said, a little too quickly. “This is no laughing matter.”
Ben tried to swallow his smile. Between the accent and the way she became flustered at times like this, he couldn’t take her seriously. To him it was adorable. When he showed such obvious signs of amusement, it angered Bernadette even further, because her facade was fading.
“Well,” Ben said, trying to maintain a serious look. “The President is going to fall for you no matter what. But if he falls too hard—”
“Then I will have to assault him in a manner and place so embarrassing that he won’t be reporting it to anyone.”
“Nobody is more capable of that than you. But I don’t think that will be necessary. My suspicion is that he is after your mind, not your body, although he doubtless wouldn’t mind that either if he thought it was available.”
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