The Skeptical Optimist

Gold versus fiat dollars: Money-printing for dummies, part 2

My previous article about money-printing by the Fed has been drawing a lot of flak in several discussion forums; the flak is from the anti-Fed crowd. That tells me a follow-up post is in order.

It’s common knowledge that the dollar can buy a lot less gold today than it could, say, ten years ago. The anti-Fed crowd says that should infuriate me, because it’s supposedly irrefutable proof that the fiat dollar is approaching worthlessness – due, of course, to profligate, criminal, treasonous money-printing by the scoundrels at the Fed -- which, of course, could all be remedied simply by switching the USA to the gold standard.

But the inflation of the price of gold doesn’t infuriate me. Reason: There’s something far more important to main street consumers than the dollar price of gold. It’s the amount of day-to-day stuff we can purchase from others, using the money we earn by producing stuff for others.

The important question is “How much of the stuff I need and want can I buy with 40 hours of my labor?”. Note that neither the word “gold” nor the word “fiat money” is to be found anywhere in that question. That’s because the “real economy” is about the real things we produce, exchange, and consume; money is merely lubrication for the real economy. 

So let’s answer that important question. But first I’ll show the “common knowledge” aspect: How many ounces of gold 40 hours of labor can buy, 2011 versus 2001.




Wow, what a shocker! That 40 hours worth of fiat-dollar earnings buys 79% less gold today than it did ten years ago! Not only is that undeniable, that is also where most of the anti-Fed crowd stops their thinking process (...and where they’d like us to stop ours).

But it’s mentally lazy to stop thinking at that point, so let’s proceed with the important question, which also happens to be the well-kept secret: The amount of day-to-day stuff 40 hours of labor can buy, 2011 versus 2001.




Wow, that’s a much different story, isn’t it? In spite of the fiat dollar system we’ve chosen, one week’s labor can purchase 5% more real stuff now than it could ten years ago. Even though the dreaded “fiat dollar” can’t buy nearly as much gold any more, a week’s worth of labor can buy more of the stuff we really need. The real economy has become more productive.

The whole truth is this: The “money” we Americans earn and spend can be whatever our society chooses: gold coins, diamonds, bushels of wheat, seashells, packs of Marlboros, fifths of Jack Daniels, or – last but not least – fiat dollars. The problems we are having today are problems with the real economy, not with the monetary system we’ve chosen. We are not inventing, producing, exchanging, and consuming real goods and services in sufficient quantities -- that is our real problem.

The debate about gold versus fiat dollars is a counterproductive diversion. Our national debate should be about which policies would kick the real economy into higher gear (and why) – but for some crazy reason, we are wasting time debating which brand of lube would be better for the real economy: fiat dollars controlled ("printed") by the Fed, or gold (or seashells, or Marlboros) controlled by who knows who.

It’s like we're standing around a car with four flat tires and arguing which country's brand of oil to use in the engine. To me, the answer is simple: We should choose our own oil, made right here in the USA; and then we should immediately turn our attention to fixing the four flat tires. 

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End notes:
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The United States of America currently defines money as “fiat dollars” supplied by its own central bank. That gives us monopoly control over the supply of those dollars -- control we do not have over the supply of gold, diamonds, or seashells. No other nation can produce U.S. fiat dollars; many other nations can produce gold, diamonds, or seashells. How well we manage that monopoly is completely up to us.

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Links to the data used to generate the charts above:

• Consumer price inflation

• Wages & benefits inflation

• Gold price inflation

Money-printing for dummies

News flash:

Ben Bernanke and the Fed
have been "printing money."

That’s supposed to be counterfeiting, according to politician Ron Paul. It’s supposedly treasonous, according to politician Rick Perry (...yes, he actually said that; see this link). But I disagree; I think it’s a laudable, praiseworthy effort in monetary policy by non-politician Ben Bernanke to protect main street from the hardships of stagnation and deflation – in the absence of any help in the way of growth-friendly fiscal leadership from our politicians.  

If you have any friends who think printing money is always inflationary, this post is for them. They are only hearing half of the real story from our politicians, and I bet they’d like to hear the other half.

Here are several several facts grouped under the two headings “common knowledge” and “well-kept secrets.”

Common knowledge:

• The Fed can print money rapidly.

• Inflation is too much money chasing too few goods and services. [Keyword: “chasing.”]

• Unanticipated inflation is bad; it hurts lenders by forcing them to accept money of lower value as payback for previous loans.

Well-kept secrets:

• Printing money is the Fed’s tool to fight deflation.

• The Fed can also “unprint” money rapidly.

• Unprinting money is the Fed’s tool to fight inflation.

• Deflation can be triggered or fueled by insufficient money to support the potential production of goods and services.

• When newly-printed money is just sitting there not “chasing” anything, it doesn’t cause inflation or cure deflation.

• Deflation is bad; it hurts borrowers, frequently forcing them to default on their loans – which in turn hurts lenders as well.

 How the Fed prints and unprints money

The Fed “prints money” by purchasing U.S. Treasury securities from the public (i.e., from banks) – but instead of printing paper money to buy them, it simply bumps up the balances in the banks’ checking accounts at the Fed. Conversely, it “unprints” money by doing the reverse. The money isn’t “printed” or “unprinted”; the Fed simply changes numbers on a spreadsheet. That’s why “unprinting” money is just as fast and easy as “printing” money.

Wishful thinking

Wouldn’t it be a big step forward if our politicians started revealing some of the well-kept secrets above? For example, wouldn’t it be nice to hear one of them admit that the Fed’s job is not only to protect bankers from inflation, but also to protect main streeters from deflation? It would lead to a less-dogmatic, more substantive debate about what the Federal Reserve is doing. Hint: The Fed isn’t counterfeiting, it isn’t playing politics, it isn’t committing treason, and (for anyone who defines inflation in terms of the general price level, as opposed to the price of gold) it isn’t inflating the currency.

And if our politicians can’t find the courage to open up the debate like that, our journalists should call them on it instead of continuing to let them get away with it.

Pie chart of who owns the national debt: mid-2011

My pie chart has been copied all over the web for several years, so I guess that means it's a hit. But the data got stale since the last time I published it, so it's time for an update.

Here's who owns the U.S. national debt as of mid-2011.




Data sources:

• Foreign holdings

• Treasury debt reports

China loves U.S. debt; never mind the bluster

I enjoy a good laugh, and the New York Times provided one a few days ago in the article titled "China Tells U.S. It Must ‘Cure Its Addiction to Debt’" at this link.

Here's an excerpt:

“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” read the commentary, which was published in Chinese newspapers.

What's so funny about that is the irony: For many years, China has been selling their goods and services into our market in order to obtain US dollars; they want our dollars, we want their goods and services at bargain prices. Why do they want U.S. dollars? So they can give them back to us in return for U.S. Treasury securities. We get the dollars back, they get Treasury securities. What do we use the dollars for? Among other things, we use them to buy spy satellites and other national security assets to keep better tabs on ... China.

Here's the (ironic) sequence of events in the cycle:

1. China decides that exporting to the USA is how they want to keep many of their workers employed;
2. China's workers make things, then China sells them to us to obtain our dollars;
3. We get the goods and services, China gets non-interest-bearing U.S. dollars that sit in their checking account at the U.S. Federal Reserve;
4. China pays those dollars back to the USA, in return for interest-bearing U.S. Treasury securities that sit in their savings account at the U.S. Federal Reserve;
5. The U.S. Treasury uses a portion of those returned dollars to buy spy satellites, Aegis cruisers, and other national security assets to help us keep tabs on China.

Bottom line: China gets the U.S. Treasury securities they want as a reward for their nineteenth-century mercantilist economic policies, and the USA gets beefed-up capabilities in intelligence-gathering and other military assets, financed at rock-bottom interest rates. Everyone is happy.

How will we ever "pay China back"?

That question is irrelevant. The real question is, Why does China keep refusing to let us "pay them back" no matter how hard we try? Whether or not we "pay China back" is completely under China's control; they can choose to get "paid back" every time any one of their T-securities matures -- but instead of keeping the dollars we try to pay them back with, they choose to exchange those dollars for new T-bonds, T-bills, and T-notes.

The answer is obvious. China doesn't want their U.S. dollars back; they'd rather have U.S. Treasury securities, and it's their choice. Why should they want non-interest bearing dollars instead of interest-bearing T-notes?

As long as China chooses to have an economy based on exports, the US market will be their biggest opportunity for selling their stuff -- and the U.S. dollar will be currency they'll receive for the stuff they sell us. What they buy with those dollars is their choice, and their track record is telling us they prefer to save those dollars by investing in U.S. Treasury securities. If China, all of a sudden, has some kind of problem with U.S. Treasury securities -- why don't they just sit on all those non-interest-bearing U.S. dollars we keep trying to give them?

Doesn't make much sense, does it? Unless, of course, it's simply nationalistic political bluster designed to impress Chinese workers who make things for us instead of for themselves.

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End note:
This topic is perennial. See my previous article from two years ago, Poker with China.

Two choices for balancing the budget: pro-Reagan, and anti-Reagan

Take a look at the graphic below depicting two different ways of balancing the budget, then decide which of those two methods you prefer. (Full disclosure: My strong preference is for method 2, the pro-Reagan balanced budget.)




Note the big difference between the anti- and pro-Reagan methods of balancing the budget. The first one indiscriminately labels everything "government spending"; the budget it balances with tax receipts is the unified budget. The second one discriminates between two types of spending, just as Reagan did, and just as most state governments do: (a) immediate expenses, versus (b) investments in the future; the budget it balances  with tax receipts is the operating budget. The first one insists that no more money should be borrowed to fund any type of "government spending" whatsoever; the second one confirms the financial truth that it is perfectly sound financial practice to borrow money for good investments such as defense, infrastructure, and, as many argue, education. The first method fingers "borrowing" in general as the evil demon to be exorcised; the second fingers bad spending and bad investments as the culprits -- which are quite distinct from borrowing for good investments.

Reagan knew the difference between expenses versus investments. For example, he knew that beefing-up our defense and intelligence capabilities (backed by a stronger economy) would generate benefits not immediately, but in the future. That's why he steadfastly and unequivocally exempted national defense from budget-cutting, in spite of objections from all sides (including his own green-eyeshade employee, David Stockman). Exempting defense contributed immediately to the Reagan deficits; the benefits were not immediate, but  accrued a few years later with the end of the Cold War -- which ended the threat of a thermonuclear war between superpowers. It was a good investment, and borrowing money to fund it was sound financial practice. [And to those who are fond of saying "investment" is just a code word for "spending" I ask, Is there really no such thing as an "investment" by our government? Really?)

Unfortunately, the pro-Reagan method has apparently been forgotten by the very people who should be keeping it alive. One example is the ex-governors who tend to brag about having balanced their state budgets when they run for president: they also tend to omit the important detail that it was the operating budget they balanced while they were simultaneously utilizing debt financing to help fund their capital budgets. Another example: The Republicans, of all people, should understand the long-established private sector business lesson that debt is frequently the preferred way to help finance good investments in growth and security -- so why are those Republicans now acting as if that same truth does not apply to government?

In short, the anti-Reagan method (an indiscriminate ban on borrowing) has been gaining a lot of support, driven by, but not limited to, conservative freshmen in the House of Representatives. It's ironic that the message is being amplified by supposedly pro-Reagan voices such as Rush Limbaugh and Sarah Palin. All of them are making a mistake best articulated by Einstein: "Everything should be made as simple as possible, but not simpler."

Keeping the budget under control

The oversimplified, anti-Reagan method supposedly keeps the budget "under control" by way of a constitutional amendment that forbids borrowing for any kind of spending, except during a declared war; see the proposed wording at this link. (Oh well, at least the proposed wording acknowledges that winning a war is a good investment for the future, for which borrowing is permissible. But that begs the question, Why shouldn't it be permissible to borrow money to prevent a war? For example, was having a surplus in the late-90s that much more important than investing at least that much in the intelligence and counterforce capabilities it would have taken to prevent 911, Afghanistan, and Iraq?) Seems to me the anti-Reagan way of balancing the budget can end up saddling us with a heavier debt burden instead of a lighter one.

But the pro-Reagan method would need a control mechanism, too. Capital budgeting isn't a panacea; it is full of potential pitfalls, one of the first of which would be that politicians would scramble to get their pet spending programs labeled "capital investments." The pros and cons were analyzed in this excellent CBO paper in 2008.

The control mechanism

I favor a results-oriented control: the ratio of debt to GDP, because the longer-term results are what count more than the shorter-term debates about the definition of capital. Because good investments tend to foster real growth of the economy (...or to prevent destruction that would damage our economy), the size of our economy (GDP) should play a role in the measure. Higher GDP means higher tax receipts, which in turn mean increased ability to afford the debt it took to fund the investments. (Although other measures may be more to the point, such as Times Interest Taxed, the debt/GDP ratio is more widely recognized and therefore an easier sell.)

Bottom line: Controlling to a specified "ceiling" ratio of debt/GDP permits borrowing for good investments in defense, infrastructure (and education?), and would therefore be far superior to the anti-Reagan method of an outright ban on any type of borrowing. Why the anti-Reagan balanced budget has so much support is beyond me.