Dollar, my foot

The United States abandoned its policy of stabilizing gold prices back
in 1971. Since then the price of gold has increased about 1,000%, while
consumer prices have increased only about 250% or, roughly, a quarter of
the increase in the gold price. If we had tried to keep the price of
gold from rising, this would have required a massive decline in the
prices of practically everything else - deflation on a scale not seen
since the Depression. This does not sound like a particularly good idea.

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*Recitativo*
The United States abandoned its policy of stabilizing gold prices back
in 1971. Since then the price of gold has increased about 1,000%, while
consumer prices have increased only about 250% or, roughly, a quarter of
the increase in the gold price. If we had tried to keep the price of
gold from rising, this would have required a massive decline in the
prices of practically everything else - deflation on a scale not seen
since the Depression. This does not sound like a particularly good idea.

*Rondo*
What the United States did in 1971 was default on its gold obligations
to foreign creditors, the biggest act of bad faith in history
theretofore. This default, and the making of the dishonored debt money,
was the cause of the destabilization of interest rates, as well as the
explosive growth price volatility that has been plaguing the world ever
since, causing ever greater economic distress. Paul Krugman's euphemism
in calling the greatest default ever "the abandoning of the
stabilization policy of the gold price", and calling the promotion of
the dishonored paper as money "a measure designed to prevent deflation
and the decline of prices" is doublespeak, the hallmark of dismal
monetary science. Krugman suggests that an equilibrium now obtains that
didn't before. What we have is not an equilibrium; rather, it is a
burgeoning disequilibrium, one that will continue its devastating
course. We must remember that the financial annals do not record a
single case in which a default has not been followed by a progressive
increase in the discount on the paper of the defaulting banker, until it
reached 100% - possibly several years or even decades later. Obviously,
the defaulting banker would try to slow down the process by hook or
crook. However, ultimately economic law was to prevail and the remaining
value of the dishonored paper would be wiped out. There is no reason to
believe that the dollar default will end differently.

Suppose that the current price of gold is $420. Let us calculate the
discount on the dollar. At the time the US defaulted on its gold
obligation to foreign creditors in 1971, $35 was the price of 1 ounce of
gold . Therefore the gold value of the dollar was 1/35 oz. If the gold
price is $420 per oz, then the current gold value of the dollar is 1/420
oz. So in terms of gold, dollar has lost: 1/35 - 1/420

Now,

1/420 = 1/(35 times 12) = (1/35)(1/12). Therefore the loss is

1/35 - 1/420 = 1/35 - (1/35)(1/12) = (1/35)(1 - 1/12) = (1/35)(12/12 -
1/12) = (1/35)(11/12) = (1/35)(0.9166)

In percentage terms, the loss, also known as discount, is 91.66%. Not
yet 100, but close enough. Small comfort, as the last 8.33% of the loss,
coincident with the death-throes of the dollar, is likely to be most
violent and painful, revealing the full extent of the devastation.
Remember, the loss affects not only cash holdings, but all
dollar-denominated assets, including bonds, annuities, pensions,
insurances, endowments, etc. As the discount on the dollar approaches
100%, the dollar price of gold will approach infinity. To assert that
the dollar is going to escape this fate is tantamount to asserting that
the laws of economics and logic have been turned upside down, and the
penalty for default has been replaced by reward in perpetuity.

*Rondo*
The discount as calculated above in terms of the price of gold is the
leading indicator of the depreciation of the dollar. It is pretty
accurate in registering the loss of purchasing power in terms of a wide
array of other goods as well. However, it is important to note that the
discount on an irredeemable currency, although obviously approaching
100%, never does so along a straight line. It goes through fits and
starts, sprinkled with ever more violent reversals.

Therein lies a great danger. Reversal confuses people and lulls them
into believing that the currency has reached the end of skid row, and is
now entering a respectable neighborhood. The explosive growth in the
volatility of interest rates and prices is finally over. More astute
observers will, however, realize that low interest rates and subsiding
volatility won't cure the malady, the cause of which, default, has not
been acknowledged, still less removed. Nor will asset bubbles cure it.
Volatility is bound to return with a vengeance. Like the wrecker's ball,
it will keep swinging until the whole financial structure is reduced to
rubble.

A reliable measure of destruction is the so-called "notional" size of
the derivatives market trading interest-rate futures, options, and
swaps. It now stands at a quarter of a quadrillion dollars and is
increasing at an accelerating pace. The word "notional" is a euphemism
suggesting that there is nothing to fear about it. As if it were a kind
of financial mirage. Well, there is plenty to fear about. It is real
enough as it measures the commitments of bond speculators, most of whom
are betting that the rate of interest will keep falling in the US, too,
as it has been in Japan. The bets are well grounded. They reflect
expectation that interest rates will be driven by the Fed into the
bargain basement. This is what the Fed did in the 1930s, causing the
First Great Depression. This is what it is doing now, causing the
second. The Fed buys bonds in the open market when it wants to combat
deflation and falling prices, and also buys them when it wants to combat
inflation and rising interest rates. If the Fed ever sells bonds, the
occasion is few and far in between and it is for window-dressing
purposes only. Speculators know this and think that they can't go wrong
if they try to preempt or emulate the Fed in buying bonds.

This raises the question: if the deflationary danger caused by the Fed's
open market operations is so great because it makes bull speculation in
bonds risk free, then why don't economists warn us about it? The answer
is that dismal monetary science blocks the free flow of information and
an impartial scientific debate of the threat (which is caused by the
regime of irredeemable currency alternating, as it does, between
inflationary followed by deflationary excesses). During the inflationary
excess, commodity speculation, and during the deflationary excess, bond
speculation is bleeding the economy white, but you are not supposed to
know.

*Recitativo*
It is true that a freely floating national money can create
uncertainties for international traders and investors. Over a period of
five years between 1991 and 1996, the dollar has been worth as much as
120 yen and as little as 80. The costs of this volatility are hard to
measure but they must be significant.

*Rondo*
It is disingenuous to say that in 1971 the US made the dollar "freely
floating". What the US did was nothing less than throwing away the
yardstick measuring value. It is truly unbelievable that in our
scientific day and age when the material and therapeutic well-being of
billions of people depends on the increasing accuracy of measurement in
physics and chemistry, dismal monetary science has been allowed to push
the world into the Dark Ages by abolishing the possibility of accurate
measurement of value. We no longer have a reliable yardstick to measure
value. There was no open debate of the wisdom, or the lack of it, to run
the economy without such a yardstick.

To throw away gold, a rigid yardstick, and to replace it with a
shrinking and elastic yardstick, the dollar, idiotic as though it is,
does nevertheless have a rationale as well as a precedent. In less
enlightened times the length of the "foot", as the name of this
particular yardstick suggests, was adjusted every time the king died. If
the new king's foot was smaller, then the new official unit of length
was made shorter. This allowed rope-makers, spinners, and weavers to
sell a smaller amount of merchandise for the same amount of money. In
this way inefficient producers were favored at the expense of the
consumers who were legally short-changed. The floating dollar does
exactly the same. It shelters the inefficient producer who is enabled to
sell the same quantity of products at progressively higher prices, to
the detriment of the consumer at large.

Interlude
During the course of his travels to many strange lands, Gulliver also
visited the Country of the Mad Scientists. A government spokesman took
him on a guided tour in order to acquaint him with the marvelous
achievements and great projects of that land. Among others Gulliver was
shown a new procedure under development whereby the erection of
buildings would start with the construction of the roof rather than the
foundations and proceed from top down. In this way shelter was provided
for construction workers in inclement weather.

In another part of Science City, the capital, Gulliver visited an
experimental farm where research scientists were simultaneously breeding
woolless sheep and milkless cows. They were motivated by the idea that
the output of sheep milk could be increased greatly through the
elimination of wool growing, thus making cow's milk redundant. Wool for
clothing could then be replaced by the sturdier cows' hair, that could
also be shorn more efficiently.

There was one invention in particular that fascinated Gulliver more than
any other. They called it "floating time". At the Institute of Horology,
the director explained that the idea of fixity of time is old-fashioned,
even reactionary. In this respect, musicians have been more progressive
than scientists. They had long ago overthrown constant time, leaving its
variation to the discretion of the conductor. Now he could set free the
emotive energy implicitly present in the music, the release of which was
forbidden by an earlier narrow-minded and reactionary age.

Floating time was implemented by connecting Big Ben in one tower of
Parliament Building to Big Barb, the weather vane, in the other. Every
time the direction of the wind changed, turning Big Barb one way or
another, so did time, as indicated by a slow or a fast Big Ben. The
director proudly pointed out that in this way their timepiece was imbued
with cosmic power present in the universe, including sun spots and sun
flares that have so far been foolishly ignored by clockmakers, but not
by the wind.

The director was going to let Gulliver inspect the ingenious mechanism
that made floating time possible. It would allow the Chairman of the
Board of Time Reserve to overrule the prevailing wind whenever
justified. At the Parliament Building they ran into the picket line of
workers demanding higher wages. At that moment the town clerk announced
that the direction of the wind had just turned Westerly, meaning that
Big Ben would run fast, cutting the hour down from 60 minutes to 50. The
workers burst into joyous cheering. They understood that the working day
has been instantaneously shortened 16% by the change of the wind,
without reduction in pay. The strike was called off. The director turned
to Gulliver and winked: "See what I mean? Floating time is helpful even
in settling labor disputes!"

Finale
The great 20th century economist Ludwig von Mises famously predicted,
shortly after the consolidation of Bolshevik power, that unless private
ownership of the means of production was re-established, the economy of
Russia would collapse. Without valid market prices for the means of
production, businessmen could not do the necessary economic calculations
as to what, when, and where to produce, and how much to invest in
production facilities, so rational allocation of scarce resources was no
longer possible. For a while the economy could limp along but,
eventually, the compounding of bad economic decisions would lead to so
great an economic distortion that sudden death would become inevitable.
Well, it took three and a half score of years to reach the threshold
beyond which economic abuse caused by bad decisions could no longer be
tolerated, and the prophecy was duly fulfilled.

Mises made another famous prediction. If the United States left the gold
standard, and failed to stabilize the dollar in terms of gold soon
thereafter, a "crack-up boom" would follow and the dollar would lose all
its purchasing power, first internationally, then domestically. This
prophecy has not yet been fulfilled but, as the Soviet example shows,
sometimes you have to be patient when waiting for Mises's predictions to
come true.

Unfortunately, Mises justified his prophecy about the dollar in terms of
the Quantity Theory of Money, which is a linear model and is not
applicable in a non-linear world such as ours. He should have argued in
exactly the same way as he did in predicting the demise of the Soviet
Union. If the US threw away the yardstick measuring value, namely the
gold dollar, then businessmen could not do the necessary economic
calculations as to what, when, and where to produce, and how much to
invest in production facilities. So rational allocation of scarce
resources would no longer be possible. For a while the economy could
limp along but, eventually, the compounding of bad decisions would lead
to so great an economic distortion that sudden death would, in the
fullness of time, become inevitable. We don't know where the threshold
is, beyond which the economic abuse caused by bad decisions can no
longer be tolerated. What we do know, however, is that economic abuse
cannot continue indefinitely, as the Soviet example so convincingly
demonstrates.

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