THE PERILS OF SUCCESS
by Bill Bonner
Last month, Alan Greenspan spoke to the N.Y. Economic Club
and sounded, for a while, like his old self.
"Although the gold standard could hardly be portrayed as
having produced a period of price tranquility," he
conceded, "it was the case that the price level in 1929 was
not much different, on net, from what it had been in 1800.
But, in the two decades following the abandonment of the
gold standard in 1933, the consumer price index in the
United States nearly doubled. And, in the four decades
after that, prices quintupled. Monetary policy, unleashed
from the constraint of domestic gold convertibility, had
allowed a persistent over-issuance of money. As recently as
a decade ago, central bankers, having witnessed more than a
half-century of chronic inflation, appeared to confirm that
a fiat currency was inherently subject to excess."
Mr. Greenspan was setting the stage. He might have added
that no central banker in all of history had ever succeeded
in proving the contrary. Every fiat currency the world had
ever seen had shown itself 'subject to excess' and then
subject to destruction.
Against this epic background, the new Mr. Greenspan
strutted out, front and center.
Today's essay is not about Mr. Greenspan, per se, but
rather about his trade. Each métier comes with its own
hazards. The baker burns fingers...the psychiatrist soon
needs to have his own head examined. The moral hazard of
banking is well documented. Given the power to create money
out of thin air, the central banker almost always goes too
far. And if one resists, his successor will almost
certainly succumb.
There are some things, dear reader, for which success is
more dangerous than failure. Running a central bank - like
robbing one - is an example. The more successful the
central banker, that is, the more people come to believe in
the stability of his paper money, the more hazardous the
situation becomes.
Warren Buffett's father, a congressman from Nebraska,
warned in a 1948 speech:
"The paper money disease has been a pleasant habit thus far
and will not be dropped voluntarily, any more than a dope
user will without a struggle give up narcotics...I find no
evidence to support a hope that our fiat paper money
venture will fare better ultimately than such experiments
in other lands...."
In all other lands, in all other times...the story was the
same. Paper money had not worked; the moral hazard was too
great. Central bankers could not resist; when it suited
them, they overdid it, increasing the money supply far
faster than the growth in goods and services that the money
could buy.
Asked to produce a list of the world's defunct paper money,
Addison was soon overwhelmed.
"I don't think you want all these," he replied, "looking at
his screen. They're in alphabetical order. But there are
318 of them and I'm still in the B's. And every one of them
worthless."
Against this sorry record of managed currencies is the
exemplary one of gold itself. No matter whose face adorns
the coin...nor what inscription it bears...nor when it was
minted...an unmanaged gold coin today is still worth at
least the value of its gold content, and will generally buy
as much in goods and services today as it did the day it
was struck.
Gold is found on earth in only very limited amounts - only
3.5 parts per billion. Had God been less niggardly with the
stuff, gold might be more ubiquitous and less expensive.
But it is precisely the fact that the earth yields up its
gold so grudgingly that makes it valuable. Paper money, on
the other hand, can be produced in almost infinite
quantities. When the limits of modern printing technology
are reached, the designers have only to add a zero...and
they've increased the speed at which they inflate by a
factor of 10. In today's electronic world, a man no longer
measures his wealth in stacks of paper money. It is now
just 'information.' A central banker doesn't even have to
turn the crank on the printing press; electronically
registered zeros can be added at the speed of light.
Given the ease with which new 'paper' money is created, is
it any wonder the old paper money loses its value?
But for a while, Mr. Greenspan seemed to have a light
shining on him. Standing there, center stage of the world
economy like Moses in front of the Red Sea, he believed he
had found the promised land of managed currencies - for his
paper dollars rose in value against gold for two decades,
when they ought to have gone down.
Mr. Greenspan explains how this Exodus came about:
"But the adverse consequences of excessive money growth for
financial stability and economic performance provoked a
backlash. Central banks were finally pressed to rein in
overissuance of money even at the cost of considerable
temporary economic disruption. By 1979, the need for
drastic measures had become painfully evident in the United
States. The Federal Reserve, under the leadership of Paul
Volcker and with the support of both the Carter and the
Reagan Administrations, dramatically slowed the growth of
money. Initially, the economy fell into recession and
inflation receded.
"However, most important, when activity staged a vigorous
recovery, the progress made in reducing inflation was
largely preserved. By the end of the 1980s, the inflation
climate was being altered dramatically.
"The record of the past twenty years appears to underscore
the observation that, although pressures for excess
issuance of fiat money are chronic, a prudent monetary
policy maintained over a protracted period can contain the
forces of inflation."
Until recently, Mr. Greenspan's genius was universally
acclaimed. Central banking looked, at long last, like a
great success. But then the bubble burst. People began to
wonder what kind of central bank would do such a dumb
thing.
"Evidence of history suggests that allowing an asset bubble
to develop is the greatest mistake that a central bank can
make," wrote Andrew Smithers and Stephen Wright in "Valuing
Wall Street," in 2000. "Over the past five years or so the
Federal Reserve has knowingly permitted the development of
the greatest asset bubble of the 20th century."
When the stock market collapsed, Mr. Greenspan's policies
began to look less prudent. During his tour of duty at the
Fed, the monetary base tripled, at a time when the GDP rose
only 50%. More new money came into being than under all
previous Fed chairmen - $6,250 for every new ounce of gold.
All this new money created by the Greenspan Fed had the
defect of all excess paper money; it had no resources
behind it. Though taken up by shopkeepers and dog-groomers
as if it were the real thing, it represented no increase in
actual wealth. The retailer and the dogwasher thought they
had more 'money', but there was really nothing of real
value to back it up.
The new money was issued, light on value but heavy on
consequences. It helped lure the lumpeninvestoriat into
their own moral hazard; they no longer needed to save -
because the Greenspan Fed always seemed to make money
available, at more and more attractive rates. And it misled
suppliers into believing there was more demand than there
really was. Consumers were buying; there was no doubt about
that. But how long could they continue to spend more than
they actually earned?
Encouraged by what seemed like almost unlimited buying from
America, foreigners - notably, first in Japan in the '80s,
then in China in the '90s - constructed new factories on a
monumental scale. They sold their products to
Americans...and then invested the proceeds, either in more
capacity at home, or in more assets in the U.S. As
mentioned above, by the end of 2002, U.S. manufacturing was
in still in a 30-year slump...and foreigners owned nearly
20% of the U.S. stock market...42% of the treasury bonds
market...and total dollar assets of as much as $9 trillion.
The effects of this moral hazard are just now being felt.
The consumer is more heavily in debt than ever before - and
seems to need increased credit just to stay in the same
place. State and Federal governments have gone from modest
surplus to flagrant deficit. Where was the money going to
come from? Americans have very little in savings; it must
be imported from abroad. But the current account is already
in deficit by $450 billion annually. Stephen Roach
estimates that the new capital demands will push the
deficit to $600 billion - or $2.5 billion every working
day.
Foreigners may be willing to finance the new U.S. spending
binge. Then again, with the dollar already falling, they
may not. We cannot know what will happen, but we can take a
guess: they won't be willing to do so at the same dollar
price. The dollar ought to fall against gold...and against
foreign currencies. It probably will.
Bill Bonner
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