I have been thinking for some time about the angry reaction I have received when I mention a commodity based currency (specifically gold, though I would be content with anything backing the dollar, or anything more than political promises -- see "Why Gold?"). Some obviously dislike commodity currencies because they would interfere with government spending. Others are probably true believers in Keynesian theories, or their nominally conservative "non-Keynesian" monetarist and Chicago School cousins, and so really think turning back to commodity currencies would leave us in a financial bind. And a few others probably have no clear idea why they dislike gold, but have bought into the heated rhetoric that declares gold will cause recessions while fiat currency will liberate us¹.

But I think some who react so violently are reacting not so much to my arguments in favor of gold, but to some other people who have taken those arguments and run to absurd conclusions. You know the ones, the people who send you emails telling you the dollar is collapsing and so you should buy gold now, or should invest in their newsletter, or should send them support for politician X. A lot of people have taken the, quite proper, worries about the stability of the dollar and used them to promote whatever cause they represent. And, so, I think many who oppose gold are not so much angered by gold as by the many incorrect arguments piggy backing on pro-gold sentiment.

So, in the interest of making myself quite clear, let me explain why I think many of those arguments are so absurd.

First, let me say all the stock plans in the world are pointless if the dollar is collapsing. If you really think the dollar will be valueless in the next one to five years, the solution is not to invest in gold, or even buy gold coins. If the dollar completely collapses, the chaos will be so total there will not even be enough economy left for gold coins to be exchanged. No, if you think the dollar will collapse very soon, then take out as many long term loans as you can (why not? The dollar will be valueless when time comes to pay them back) and buy things of concrete value, things you can barter after the collapse, as well as guns and ammunition, and maybe some land on which to store them. If you really see total collapse, that is the sensible approach, not buying a stock guide.

Of course, if you think the collapse will be less than total, maybe a Weimar type hyperinflation, or even just a Carter-like one, then you don't need a guide, invest in ANYTHING. Recall in the late 90's when every tech stock went up? When no one could predict from day to day what stock would mysteriously triple in value overnight? At that time you didn't need a guide, by the time they wrote to you the moment had passed. You were effectively just gambling in a casino, the only difference being that everyone won something, it was just a question of whether you won small or big. So, if you think that sort of inflation is coming, then just put money in any stock and wait. Of course, you need to get out before the crash comes. And that is the hard part, but, again, that is also the part where any newsletter will arrive too late. So, if you think we are going through a 1990's bubble and crash, no newsletter will help either.

But stock pitches aren't the only thing being sold with talk of economic collapse. Many people are selling political beliefs based on the collapse of the dollar. So, as this is basically a political blog, let me explain what I do and do not believe.

First, I don't think the dollar will collapse, at least no time soon, and certainly not in the sense of leaving us in Mad Max style wasteland. I know I have said the dollar is in bad shape, and it is, but the collapse is certain to eb slow, as it has been. Oh, with Obama's fondness for big spending, I would imagine we could easily see some 70's style inflationary pressures, but that would be more of a slow grind, coupled with economic stagnation, not a general collapse. More than likely any decline in the value of the dollar will take time, and in that time we and the rest of the world will adjust. Oh, it certainly could wipe out many individuals' savings, could do untold economic harm, and could generally be quite economically destructive, but I don't see any rapid collapse leading to general political breakdown.

Second, despite the fears of many conservatives, I don't see the dollar's collapse being used by other nations as a tool of economic warfare. Mainly because, being the largest customer of many nations, should the US currency collapse, most of the rest of the world will hurt as well. In addition, as other nations are inflating just as badly as the US, or at least to some degree, and almost every currency on earth is backed by nothing more than the promises of politicians, so if the dollar collapses, expect that every other currency on earth will be facing hard times as well. After all, if the largest, most circulated currency on earth proves unstable, don't you think locals in other nations might question the stability of their currency? (If you doubt this, just look at how our economic woes spread out throughout the world economy.)

Then there are the claims that "resource rich" nations would take advantage of economic collapse to seize power. That is fine and good except for two things. First, the US IS a resource rich nation. We forget it because environmental laws and unionization make it hard to extract those resources, or make it easier to import than produce raw materials, but in the face of collapse, I doubt environmental laws would survive popular demand for goods. Second, the USSR was a resource rich nation, but their political system made it hard for them to efficiently extract them. Similarly, despite the fear propaganda, the slave economy of China, and kleptocratic government, even after reforms, makes it very inefficient as well. Yes, at the moment, thanks to bad laws in the US, and favorable trade deals, they have an advantage in commerce, but that does not make their system anywhere close to efficient. And while, in a collapse, I can see the US shedding all the feel-good laws that are the result of our great wealth², I don't see China or other nations reforming their politics. So even if there were some general collapse, we would probably benefit more than anyone else³.

No, I do not think our current fiat currency will end up causing any of the nightmare scenarios that have been bandied about on the internet. Such panic mongering has been common on the internet for some time, but just because it has a hint of truth, in blaming fiat currency for some of our woes, does not make the overall message more acceptable.

On the other hand, I do think things will get worse in the short term, though not as bad as some. And, to show I am not just engaging in Obama bashing or idle speculation, let me explain why, and why I think the present differs for the past near century since the founding of the Federal Reserve.

First, I do not think fractional reserve banking in itself is bad. many gold advocates want a statutory 100% reserve ratio, but I think that is insane. Fractional reserve, when controlled by individual banks, based on business rationales by the individual bank owners, and when held in check by bankruptcy laws with 100% shareholder liability, tends to work well. Yes, there is usually a multiple of notes piled on each unit of specie, but as there is no general rush for redemption, especially if the banks are sensibly run, that is not a problem, nor is it "inflationary". Inflation across the boards is only an issue when we either centralize currency issue, as the Fed does, or pyramid reserves, using reserves in one bank to count as reserves in another, effectively allowing the same currency to support multiple issues of notes, as the system preceding the Fed did.

However, as I said above, fractional reserve banking can be a problem under two circumstances. First, when note issue is centralized, as in the Federal Reserve, and when notes are backed with government debt, or other goods with no market value which can be easily increased in number, allowing for rapid expansion of the money supply. Under a system of independent banks, it is unlikely they will all make the wrong decision at once and inflate the money supply too much. When you centralize note issue, there IS only one decision, and if wrong, it does inflate the entire economy too much. So, the checks inherent in a decentralized system do not apply, allowing the money supply to grow too large. And, with currency backed by intangibles such as government debt, it is also easier to inflate without changing the reserve ratio, allowing the system to look stable on paper while in reality it is expanding dangerously. The government can easily issue debt, they cannot easily create gold. The former simply makes it too easy to create currency out of thin air.

The reason I mention all this is that the situation which troubles me has existed a long time. There were notes backed with government debt as far back as the 1860's. And even if it requires a central bank, the Federal Reserve has been in existence since 1913. So, why do I think that the present situation is likely to be worse than the past century?

Well, first, let me say the past century has had a serious number of economic woes, so predicting more is not that unprecedented. After all, since the founding of the Fed we have the collapse of 1929, the depression from 1932 - 1941. We had a postwar slump for 1945-1948. We had a slump in the early 1970's. We had the "stagflation" of the late 1970's. The recession of 1981-1982. We had the dot-com bubble and bust of the late 1990's. The recession of 2001, and the current recession. So, looking back over the Fed's existence, the only period which did not experience serious economic turmoil was the stretch from the end of the Korean War until the Vietnam War, and the Reagan-Bush era following the early 80's contraction. Every other period experienced some form of economic slowdown, or excessive growth⁴. Granted, there were some slumps prior tot he Federal Reserve, but my point is central banking did not result in the promised stability, and so predicting future recessions and instability is actually predicting simply more of what we already experienced.

However, the situation today actually is different from the period from 1913-1973. The first 60 years of the Federal Reserve there was one check on the system. Even after FDR denied citizens the right to hold monetary gold in 1934, foreign individuals, or late rjust foreign banks and governments, could demand gold, sot eh Fed had to keep currency issue within some limits. Admittedly the governemtn could bring pressure on other nations to not ask for redemption in specie, but only to a point. If the Fed went too far, no government pressure could keep banks from demanding gold when their confidence in the dollar got too low. So, until 1971-1973, when the gold window snapped shut,. the Fed had a check on it that has not existed since.

And look at the results. In terms of gold, prices rose sixfold from 1971-1981. Since 1973 we have experienced a pretty consistent 3-5% erosion in the value of the dollar. And, during that period, there was not a year when we did not experience either strong inflation or slow growth, or both⁵⁶. Most of the problem is because, quite simply, with no checks on monetary growth, the pressure is always to increase the money supply. The monetarists want it because money supply growth must equal economic growth. The Keynesians want it, as their doctrine requires increased money supply to hold off unemployment. Big spending politicians want it because it creates a market for their debt. Populist politicians want it because debtors always outnumber creditors, and increasing the money supply erodes debt. And those aspiring to the presidency want it because farmers carry debt, and Iowa has a lot of farmers.

And so, since 1973, we have had pretty constant growth of the money supply, and not just growth, but big growth. The monetary wonks try to justify it by creating new M's, M2, M3 ML, MLB, 3M⁷ and so on. But the truth is, the pressure has always been to increase the money supply as much as possible, to fulfill political goals, pulling back only when prices rise too fast or when it seems the economy is about to collapse.  But, such as policy is untenable, as we have seen time and again. And once confidence flags, we get the general contraction we are in today.

Of course, politicians, being politicians, don't want to have people suffer any hardship, and so rather than sit through the recession to allow the economy to correct itself (with the exception of 1981-2, see "The Reagan Lesson", "Bad Economics Part 3"), they inflate more, to try to get us out of the slump, and push our final accounting a few years into the future (See "Hair of the Dog? ", "The Single Greatest Weakness",  "Don't Blame the Politicians", "From Bad to Worse", "Doing Something", ""Doing Something" Revisited") And so, not only do we get such slumps, but they come at accelerating rates, with each worse than the preceding.

And that is why I predict a bad collapse. Because we already have a congress and a president trying to spend us out of this recession. So, either we will inflate our way out, and get a worse slump in a few years ("A Thought on the Clinton Surpluses", "Cause or Symptom? or, Who's to Blame?", "Partial Solutions", "How To Resolve Our Current Problems"), or we will get "stagflation", mixing rising prices will slowing growth ("Economic Resistance to Recovery"). Either way, the specific details of today bode ill for the economy of the next few years.

But, having said that, they do not bode as ill as many of the scare stories I mentioned above. Likely what they will bring about will be the dreadful economic conditions of the  late 1970's. At worst, maybe some sort of hyperinflation. But many nations have experienced just such circumstances and not collapsed into total anarchy. In fact, Argentina experienced decades of economic problems far worse than I predict for us, and, while their politics was a bit wonky, nothing close to anarchy took place. So, though I predict economic problems, and think that moving to gold will not only solve our problems, but also prevent future occurrences of the same issues, I do not believe we will sink into anarchy any time soon, whether we keep our current banking system or not.

Hopefully that cleared things up a bit. There are problems, the economy is damaged by the choice to use a managed currency backed by nothing but debt, but the damage is of the "sluggish economy" and "eroding savings" kind, which is painful but not fatal. We are not about to face roving packs of Road Warrior style bandits in Topeka or Austin (though you might in downtown Baltimore, but that has nothing to do with the economy). The US is not about to turn into the set of a 1980's Italian post-Apocalypse film. Nor are we about to be purchased as a nation by China or Russia. (Any more than the Japanese fulfilled the 1980's-era worries that they would buy the US in its entirety.)

In short, many things are wrong, but those who predict the absolute worst are taking things too far. The world isn't ending, just slowly slipping downhill a little way. So, if you were worried by the doom sayers, be of good cheer, things aren't as bad as you thought. Enjoy your holidays, whatever they might be, the world won't end as soon as you thought.

Then again, if this is the first you are hearing of the matter, I suppose things are worse than you thought. Sorry to ruin your holidays.

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1. I still don't understand how, in the midst of our second worst recession of the 20th century people can buy this claim. Citizens have been unable to use gold as currency since 1934 (though specific performance contracts specifying payment in gold were made legal again in 1977). Some form of government paper currency has been in use since 1913, and the government has encouraged wildly unsound fractional reserve practices, backed at least partly with government debt, since Salmon P. Chase pushed the idea following the Civil War. Not to mention that the federal government began passing banking regulations as soon as Jackson left office, and the states had been meddling in banking to some degree since colonial days. So, as there is but one recession of note during our brief Jacksonian hiatus, that very short period without significant state or federal banking regulation (in 1836, brought about by the end of the ill-conceived Second Bank of the US), and many more and much worse since the government began tinkering with what "money" means, how can anyone seriously argue gold is the source of recessions, and "managed" currency will prevent them? It certainly hasn't done so yet. Or is this one of those "we just didn't do it right yet" ("The Endless Cycle of Intervention") or "we just need the right people" ( "The Wrong People") arguments that support countless bad government programs? (cf "How To Blame the Free Market") I feel about managed currency the same way I feel about management of the rest of the economy, it is a task beyond the ability of humans to consciously manage, but also a topic which self-regulates quite well when left alone. ("The Limits of "Scientific" Management", "The Limits of Econometrics", "The Limits of Technocracy", "Technocrats") It also follows my second law of government intervention, government management will inevitably lead to inefficiency and political decisions. ("The Inevitability of Bureaucratic Management in Government Enterprises") But those topics should be the substance of another post, not the world's fourth longest footnote (losing the top position to Gibbon's Decline and Fall, Dalos' 1985 and the USCA).

2. I call them the result of wealth because they are. Basically, we are rich enough to afford environmental laws, aggressive unions, insanely restrictive workplace safety, aggressive tort laws, and so on. Poor nations adopting such laws would starve. We can afford to hamstring our productive capacity. Many other nations cannot.

3. I won't go into many other "economic warfare" arguments here. I dealt with them before in "Really Silly Fears" and "Our New Paranoia". See also "Protectionism", "Your Fellow Man" and "Revival of an Old Absurdity", which elaborate on specific aspects of those posts.

4. Obviously I might have missed some slump, as I am working from memory while doing my day job. Still, the point is valid, I think. The introduction of "managed currency" hardly resulted in a stable, prosperous economy without any recessions as many claimed.

5. I know modern macroeconomics argues you will either have slow growth or inflation, so you have to choose one, but history shows that is not true. During the 1880's we saw both growth and falling prices. Growth or inflation is not a real trade off inherent in the economy, but is the result of a "managed currency".

6. The Reagan era actually is a bit of an exception, as the slow growth during that time was not form monetary contraction, but because deficit spending was finance by borrowing on the market, rather than monetizing debt. So, the currency was relatively stable, but capital markets were gutted to fund federal spending. Had spending been kept under control during those years we would likely have seen strong growth without price increases. But as spending was not restrained, there is no way to confirm that prediction, so make of it what you will.

7. No corrections please. Some of those were jokes. Bad jokes, but jokes.

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POSTSCRIPT

I have written quite a bit about both inflation and banking, and any list would certainly leave out countless older articles. So, instead of my usual lengthy list, I will just provide a list of a few of the more interesting and more recent posts. If you want to find my older writing, there are enough links in these that it should be no problem tracking down my earlier thoughts.

So, for those curious about what I wrote in the past, I recommend the following:

Monetary Issues Made Simple Part I
The Free Market?
Monetary Issues Made Simple Part II
Not Entirely to Blame
Why"Negative" Economic Indicators Are A Good Thing
Explaining Past Crashes
Environmentalism For The Economy?
The Inflation Engine
Nation of Debtors
The Problem With Economic Debate
Alan Greenspan's Hubris
Planning For Imperfection
Weimar Republic Here We Come!
Inflation and Uncertainty
Derivatives and Other Investments
A Thought on the Clinton Surpluses
Place Blame Fairly, Regardless of Party
"Good People"
Subsidizing Irresponsibility and Poor Planning
Too Big To Fail
Why Gold?
Proof Keynes (and Krugman) Are Insane
Shopaholic Government
Treasury May Be Doing the Right Thing
Signs the Fed Is Not Getting It Right
Living Large During the Good Times
Now I Get It!
The Rubber Yardstick
Greed Versus Evil
Economic Resistance to Recovery
A Strange Wish
Interesting Article
Cause or Symptom? or, Who's to Blame?
Bad Economics Part 5
Your Government At Work
Our Variable Focus
From Bad to Worse

I could probably add a dozen more, but as the whole point was to keep the list manageable, I will stop at these.