Let's Get the Dollar's Value Under Control

The United States is headed into a very important election in November of 2010, if the political pollsters are to be believed. Americans, besieged by a weak dollar and an even weaker economy, are reassessing some of their most basic assumptions about how the country works. RealClearMarkets has recently published columns on the mistakes of the Bush Administration along with others calling for higher taxes to pay down the national debt. Important as these subjects may be, they are only symptoms of a much larger malady.

The public is really scratching its head as long held assumptions prove to be wrong. The Bush Administration of establishment Republicans let the dollar essentially collapse, although responsibility for its value does rest with the Federal Reserve and the Treasury. His administration was preceded by Bill Clinton's, a Democrat, who lost control of Congress to the Republicans. Ironically, he is credited with many positive economic developments coming out of Ronald Reagan's tax cuts, which may have had more to do with Alan Greenspan's Jekyll and Hyde monetary policy than anything emanating from the White House.

In the first ten years of his reign as Chairman of the Federal Reserve System, Alan Greenspan followed a sound money policy based on the price of gold averaging around $350 an ounce into the end of 1996, when he gave his "irrational exuberance" speech worrying about high stock market prices. Donald Luskin of TrendMacrolytics published a great chart of what happened, when the Fed stopped watching gold. Of course, were you to ask Mr. Greenspan, he would probably deny it. Be that as it may, after that the Federal Reserve entered into an extremely deflationary period, which saw the dollar rise from $350 to $250 an ounce into the beginning of the next decade.

In those two segments, we have a history of the American monetary/economic policy and the effects in the proverbial nutshell. Keep in mind that the United States government/economy sits upon a three-legged stool of monetary policy, fiscal policy and the rule of law. Most of the commentariat focus on the last as the protection of American constitutional rights, despite the fact that the rest of us have to live in the real world of prices, taxes and regulation. There is an argument as to whether Congress delegated too much of its power to agencies such as the Federal Reserve and the IRS, but that is best left for another time.

The question of monetary stability is one which has plagued civilization whenever governments take over the creation and management of money. For the average American, that is an abstract discussion, because he has to live with its symptoms, inflation and deflation, in daily life. When the Reagan tax cuts began to have an effect, first on the forward-looking financial markets in 1982 and, then, on the economy in general, the dollar became stronger with economic growth absorbing the inflation of the 1970's. It became possible to invest in financial assets, such as bonds, stocks and mortgages with some hope of predictability. Money poured into the U.S. from all over the world on top of domestic investment. The result was a boom, the creation of many things we take for granted, like the personal computer. The whole process lifted the country out of what President Carter called its "Malaise".

The lesson should have been learned at that point and institutionalized. For some reason, the Fed became worried about the stock market being too high and set about slowing it down. This is a decision, which is really emotional as opposed to economic. Sadly, too many in Washington confuse real growth with inflation. With the "tightening" came the stock market collapse of 1999 - 2000, as the widely accepted two-year lag between monetary action and obvious results came into play. After the attack on the World Trade Center in September, 2001, the Fed opened the flood gates and gold recently nudged $1,200.

Pick the one you want as descriptive of American monetary policy or realize that inflation and deflation (fighting a growing economy) have been that policy since 1913. Until Americans realize monetary policy is being run for the government's political benefit and not theirs, this will continue. Most recently former President Bush said "the markets will set the value of the dollar" and kept talking about exports, as if we never imported anything; Bill Clinton and Bush wanted to make home ownership more affordable, and we have seen where that led us.

Today, we face a serious change of direction, as severe as the Depression of the 1930's. The Fed's policy of inflation over decades made home ownership the saving vehicle of popular choice. Most of the American public has its savings in housing, which has now collapsed. The "middle-class tax shelter" turned into the "Roach Motel" for their earnings as values fell below what they owed. The question to be answered is obviously, what's next? But, even more important, is what do we do to prevent this again. Washington is making sure the barn door is securely bolted now that the horse is gone, basically fighting the last war as usual. You would almost think Congress believes it can go back in time and change things.

In this context of crisis, it is hard to say whether the Tea Party movement is the start of something big, a fundamental change of direction or simply a protest movement. We shall soon see which it is; but the election of representatives who put the people's rights first would be a fundamental and helpful transformation. Right now, all Washington wants is their vote. The only way to solve the monetary problem is to realize it is too important to be left to the politicians. The public decided precisely that in the presidential elections of 1896 and 1900, leading to the "Gold Standard Act" of 1900. William Jennings Bryan may not have wanted to "be crucified on a cross of gold", but most Americans wanted sound money.

The gold standard may be too much for a lot of people these days, but Washington has to get the value of its money under control, so the people can use it; this does require some sort convertibility as a "money-back guarantee", as the sign of confidence and support. There are many ways to do it, all of which revolve around holding a market price of the currency.

Somehow people have forgotten the definition of money: a medium of exchange, unit of account and store of value. Then again, the banks and brokers created money-fund money, so there is a real, commercial demand for something that does hold its value and we can use.