The Gold Standard prevented Nations from Devaluing their Currency to Keep Trade Fair
You may have heard of the great gamble the Chairman of the Federal Reserve, Ben Bernanke, has been making. Quantitative easing (QE). The current program being QE3. The third round since the subprime mortgage crisis. It’s stimulus. Of the Keynesian variety. And in QE3 the Federal Reserve has been ‘printing’ $85 billion each month and using it to buy financial assets on the open market. Greatly increasing the money supply. But why? And how exactly is this supposed to stimulate the economy? To understand this we need to understand monetary policy.
Keynesians hate the gold standard. They do not like any restrictions on the government’s central bank’s ability to print money. Which the gold standard did. The gold standard pegged the U.S. dollar to gold. Other central banks could exchange their dollars for gold at the exchange rate of $40/ounce. This made international trade fair by keeping countries from devaluing their currency to gain a trade advantage. A devalued U.S. dollar gives the purchaser a lot more weaker dollars when they exchange their stronger currency for them. Allowing them to buy more U.S. goods than they can when they exchange their currency with a nation that has a stronger currency. So a nation with a strong export economy would like to weaken their currency to entice the buyers of exports to their export market. Giving them a trade advantage over countries that have stronger currencies.
The gold standard prevented nations from devaluing their currency and kept trade fair. In the 20th century the U.S. was the world’s reserve currency. And it was pegged to gold. Making the U.S. dollar as good as gold. But due to excessive government spending through the Sixties and into the Seventies the American central bank, the Federal Reserve, began to print money to pay for their ever growing spending obligations. Thus devaluing their currency. Giving them a trade advantage. But because of that convertibility of dollars into gold nations began to do just that. Exchange their U.S. dollars for gold. Because the dollar was no longer as good as gold. So nations opted to hold gold instead. Instead of the U.S. dollar as their reserve currency. Causing a great outflow of gold from the U.S. central bank.
Going off of the Gold Standard made the Seventies the Golden Age of Keynesian Economics
This gave President Richard Nixon quite the contrary. For no nation wants to lose all of their gold reserves. So what to do? Make the dollar stronger? By not only stopping the printing of new money but pulling existing money out of circulation. Raising interest rates. And forcing the government to make REAL spending cuts. Not cuts in future increases in spending. But REAL cuts in current spending. Something anathema to Big Government. So President Nixon chose another option. He slammed the gold window shut. Decoupling the dollar from gold. No longer exchanging gold for dollars. Known forever after as the Nixon Shock. Making a Keynesian dream come true. Finally giving the central bank the ability to print money at will.
The Keynesians said they could make recessions a thing of the past with their ability to control the size of the money supply. Because everything comes down to consumer spending. When the consumers spend the economy does well. When they don’t spend the economy goes into recession. So when the consumers don’t spend the government will print money (and borrow money) to spend to replace that lost consumer spending. And increase the amount of money in circulation to make more available to borrow. Which will lower interest rates. Encouraging people to borrow money to buy big ticket items. Like cars. And houses. Thus stimulating the economy out of recession.
The Seventies was the golden age of Keynesian economics. Freed from the responsible restraints of the gold standard the Keynesians could prove all their theories by creating robust economic activity with their control over the money supply. But it didn’t work. Their expansionary policies unleashed near hyperinflation. Destroying consumers’ purchasing power. As the greatly devalued dollar raised prices everywhere. As it took more of them to buy the things they once did before that massive inflation.
The only People Borrowing that QE Money are Very Rich People making Wall Street Investments
The Seventies proved that Keynesian stimulus did not work. But central bankers throughout the world still embrace it. For it allows them to spend money they don’t have. And governments, especially governments with large welfare states, love to spend money. So they keep playing their monetary policy games. And when recessions come they expand the money supply. Making it easy to borrow. Thus lowering interest rates. To stimulate those big ticket purchases. But following the subprime
mortgage crisis those near-zero interest rates did not spur the economic activity the Keynesians thought it would. People weren’t borrowing that money to buy new houses. Because of the collapse of the housing market leaving more houses on the market than people wanted to buy. So there was no need to build new houses. And, therefore, no need to borrow money.
So this is the problem Ben Bernanke faced. His expansionary monetary policy (increasing the money supply to lower interest rates) was not stimulating any economic activity. And with interest rates virtually at 0% there was little liquidity Bernanke could add to the economy. Resulting in a Keynesian liquidity trap. Interest rates so close to zero that they could not lower them any more to create economic activity. So they had to find another way. Some other way to stimulate economic activity. And that something else was quantitative easing. The buying of financial assets in the market place by the Federal Reserve. Pumping enormous amounts of money into the economy. In the hopes someone would use that money to buy something. To create that ever elusive economic activity that their previous monetary efforts failed to produce.
But just like their previous monetary efforts failed so has QE failed. For the only people borrowing that money were very rich people making Wall Street investments. Making rich people richer. While doing nothing (so far) for the working class. Which is why when Bernanke recently said they may start throttling back on that easy money (i.e., tapering) the stock market fell. As rich people anticipated a coming rise in interest rates. A rise in business costs. A fall in business profits. And a fall in stock prices. So they were getting out with their profits while the getting was good. But it gets worse.
The economy is not improving because of a host of other bad policy decisions. Higher taxes, more regulations on business, Obamacare, etc. And a massive devaluation of the dollar (by ‘printing’ all of that new money) just hasn’t overcome the current anti-business climate. But the potential inflation it may unleash worries some. A lot. For having a far greater amount of dollars chasing the same amount of goods can unleash the kind of inflation that we had in the Seventies. Or worse. And the way they got rid of the Seventies’ near hyperinflation was with a long, painful recession in the Eighties. This time, though, things can be worse. For we still haven’t really pulled out of the Great Recession. So we’ll be pretty much going from one recession into an even worse recession. Giving the expression ‘the worst recession since the Great Depression’ new meaning.
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