The Falling Dollar Through the Eyes of John Maynard Keynes

“In the last conversation I had with [Keynes in 1945] I asked him if he wasn’t getting alarmed at what some of his pupils were doing with his ideas. And he said, ‘Oh, they’re just fools ...’ I’m sure that in the post-war period Keynes would have become one of the greatest fighters against inflation.”

~ Friedrich von Hayek, interviewed by Thomas Hazlett in Reason Magazine, May 1977.

Those not familiar with the adjective “Keynesian” were likely given a crash course in the word’s meaning this past month with Congress’s passage of a bi-partisan economic “stimulus” package. Owing to fears on the part of politicians that a fall in “aggregate demand” might lead to a recession, Congress passed legislation that effectively takes money already collected from one set of taxpayers, and shifts it into the hands of those who’ve paid little or no taxes at all.

Thanks to the Keynesian shape of the above policy, not to mention the failure of similar policies to resurrect post-World War II economies, the ideas of John Maynard Keynes are increasingly seen in a pejorative light. And well they should. Still, Keynes knew money, and he knew it well. To read his Tract on Monetary Reform is to believe that if he were alive today, he would clearly understand the negative sentiment that holds sway over the U.S. economy. Indeed, his Tract in many ways predicted what we’ve experienced amidst the dollar’s fall.

While there are varying views on the present health of the economy, polls show that Americans as a whole are unhappy and feel uncomfortable about the economic outlook. According to Keynes, economies “cannot work properly if the money, which they assume as a stable measuring-rod, is undependable.” Keynes went on to write that, “the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer—all proceed, in large measure, from the instability of the standard of value.”

Be it a strong dollar or a weak dollar, changes in the value of money enervate the citizenry most by redistributing wealth. Keynes wrote that “when the value of money changes, it does not change equally for all persons or for all purposes.” Sure enough the falling dollar of recent years has enriched those long on land, precious objects and commodities all at the expense of the saver and to a high degree, the investor.

Stocks have certainly done well in stretches since the summer of 2001 (when the dollar began its decline), but the annualized total return on the S&P 500 since that time has been unimpressive to say the least. When we look at the dollar’s impressive fall versus currencies and gold over the same timeframe, we see that investors have actually lost quite a lot in real terms.

Keynes asked if the public could work around currency debasement and noted that “It has only one remedy, to change its habits in the use of money.” As he found, individuals eventually “discover that it is the holders of notes who suffer taxation,” so rather than hoarding currency that is declining “they spend this money on durable objects, jewelry or household goods.” And as we’ve seen in recent years, rich and poor alike have hedged their dollar wealth with purchases of homes, art (Sotheby’s shares are up over 100% since 2001) and jewels, and have borrowed against the commodity-like rise in the prices of their homes to fund all manner of improvements to same.

Keynes added that individuals “can reduce the amount of till-money and pocket-money that they keep and the average length of time for which they keep it,” and that of course helps to explain the heavy consumption versus saving that we’ve witnessed. Lastly, “they can employ foreign money in many transactions where it would have been more natural and convenient to use their own.” Supermodel Gisele Bundchen’s primary address is New York City, but in response to dollar weakness she’s asked that her modeling fees be paid in euros.

Currency weakness as mentioned benefits those who hold commodities such as homes, and as Keynes found, when money is losing value, “anyone who can borrow money and is not exceptionally unlucky must make a profit.” Rising prices often lead to expectations of further gains in these scenarios, so as Keynes noted, the “practice of borrowing from banks is extended beyond what is normal.” Much as we saw the rise of “day traders” during the strong-dollar driven equity boom of the late ‘90s, in more modern times we’ve seen the rise of part-time real-estate investors who rode the property boom of this decade.

And while broad measures of home prices such as the Ofheo Index continue to register yearly gains, the aforementioned property boom of recent years has seemingly ground to a halt. This likely wouldn’t have surprised Keynes given his view that the “increasing money value of the community’s capital goods obscures temporarily (my emphasis) a diminution in the real quantity of the stock.” Markets eventually adjusted to the money illusion driving up home prices, and with their continued appreciation not so certain, banks have understandably pulled back.

When it comes to conducting business, the changing value of money naturally affects commercial health, and as will become apparent, the reputation of businesses seeking profits. First, while there is some dispute as to the rising dollar’s role in the 2001-02 recession, it can safely be said that businesses holding debts found themselves paying back dollars that were more valuable than those they borrowed.

On declining money values, Keynes wrote that when “the value of money falls, it is evident that those persons who have engaged to pay fixed sums of money must benefit, since their fixed money outgoings will bear a smaller proportion than formerly to their money turnover.” That’s the good part, and stocks certainly showed strength (aided by timely cuts in dividend/capital gains taxes) for a time in the aftermath of the dollar’s decline that began earlier in this decade.

Where problems arise is that only monetary disturbance can change the broad price level, and with the dollar’s fall, profits, particularly those earned by companies that would more likely benefit from a falling currency, were called into question. Keynes witnessed this in the inflationary aftermath of World War I in England, and his insight was that falling money values not only discourage investment, but the money debasement “also discredits enterprise.”

His words ring true when we consider the reputational hit that U.S. oil companies have experienced alongside the dollar’s fall and oil’s rise. Just as they were forced to do in the ’70s when the dollar was weak, oil-company executives have twice been brought before Congress to explain their allegedly ill-gotten gains.

Keynes added that various remedies are thought up “to cure the evils of the day” wrought by cheap money, and he listed “subsidies, price and rent fixing, profiteer hunting, and excess profits duties.” Sure enough, Congress has passed the aforementioned stimulus package to subsidize the earnings of low-income Americans, the Treasury has foisted a “voluntary” rate freeze on “predatory” lenders, ExxonMobil executives remarkably seek to downplay the company’s profits, and Congress has resurrected the “windfall profits tax” from the failed policy playbooks of the 1970s.

And when we scrutinize the price of oil more closely, we ask why it is that producers don’t flood the markets with more oil to capture dollar profits while the price remains high. At first glance their actions (or lack thereof) may seem odd, but with the price of oil very much driven by the value of the dollar, we better understand why oil producers are reluctant. As Keynes wrote, “a general fear of falling prices may prohibit the productive process altogether.” Looked at in oil terms, producers are well aware that the dollar’s fall could eventually be arrested, and if so, they might hold oil that would have to be sold at a loss.

Keynes went on to write that “entrepreneurs will be reluctant to embark on lengthy productive processes involving a money outlay long in advance of money recoupment.” About oil we can say that the exploration process is long, very expensive, and the payoff from investment often occurs years down the line. U.S. politicians rail against OPEC and the major oil companies stateside for not bringing more oil to market, but as we’ve seen since 1971, periods of dollar weakness have frequently been followed by periods of dollar strength. With the dollar’s future value unknowable, should we be surprised in the least at the reluctance of oil producers to fix the supply side of the oil-price equation?

If Keynes were alive today, but unaware of the dollar’s direction, he might ask why President Bush suffers such low approval ratings, why Americans are so downcast about the economy, and why markets are so uncertain despite tax rates that are historically low, trade that is mostly free, and a war that, while unfortunate as all are, is being conducted continents away from us. His curiosity would be well placed, but easily explained by him once made aware of the falling dollar.

As Keynes so famously wrote, “There is no subtler, surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and it does it in a manner which not one man in a million is able to diagnose.” We know what ails us, and it’s the falling dollar. If we halt its decline, spirits will improve as they always do when we strengthen and stabilize the value of the money we earn.