Thursday, January 16, 2014

The Incredible Dollar, II: The Number One Rule for a Reserve Currency


As we noted yesterday, we got an e-mail a short time back expressing concern over the declining “credibility” of the dollar, and the refusal of a currency exchange in a remote area of Brazil to accept U.S. dollars any more.  The response by Norman Kurland, president of CESJ, was pretty good, but we thought it left out a few things, so here goes:

Dear HH:

If we may add our 2¢ to what Norm said, the U.S. dollar is suffering from the same malaise that led to the disestablishment of the British pound sterling as the global reserve currency.  Per the dictates of Keynesian economics as applied in "Modern Monetary Theory" ("MMT"), the U.S. dollar is backed with government debt, not private sector hard assets as originally intended.

Yes, the Federal Reserve is holding some pseudo "private sector assets," but these are grossly overvalued and classed as "toxic" — which directly violates the provisions of the Federal Reserve Act of 1913 (as, for that matter, does using government debt to back the currency in the first place).  The British pound went downhill when the debt-backed paper pound could no longer be converted into gold after 1914, and the government lost all restraint in debt financing.  The U.S. dollar started its downward plunge when the New Deal removed all restraints from government debt, and after 1933 the Treasury no longer had to consider what would happen if too many paper dollars were presented for conversion into gold if the paper dollar started losing its value relative to gold.

The problem is not the lack of convertibility into gold (or silver), however.  The problem is that the U.S. dollar (and the Euro) are backed by government debt, which is in turn backed only by the government's ability to collect taxes in the future.  If ordinary people cannot be productive, and rely on "job creation" and welfare for their income (i.e., redistribution), the tax base erodes.  Yes, the stock market is booming, but can you eat or wear appreciated shares of overvalued corporate equity?

The number one rule for a reserve currency is that it must — not "should," must — be backed with hard assets.  You can have all the other currency you want, you can even back it with massive amounts of government debt if you want to mortgage the future, but if all forms of money are not convertible on demand at full value into a sound reserve currency, then the reserve currency is not fulfilling its proper function, which is to give stability to the entire money supply, whether the money supply is in the form of currency, or anything else that can be accepted in settlement of a debt.

By convincing the politicians that they could back the reserve currency with government debt instead of private sector hard assets, Keynes ensured that the U.S. dollar would eventually follow the British pound as the economy of ordinary people continues to go downhill.

The only solution is to reform the tax system to encourage widespread capital ownership, phase out all new money creation to finance government deficits, and eventually restrict all new money creation through the discount window to finance widespread capital ownership and limit open market operations to monetizing existing private sector inventories of marketable products.  (we would say "immediately," but debt financing is a worse drug than heroin for politicians.  Going cold turkey might not be politically feasible.)  This is what Capital Homesteading is designed, in part, to do.

#30#

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