David J. Bean
David J. Bean is a freelance writer living in California.
In March 2008 the Federal Reserve Bank began to dramatically increase the amount of dollars in circulation. The Fed does this by permitting the big Wall Street investment banking firms to borrow from the Fed at very low rates and then count these funds as part of their reserve. Because of our fractional banking laws a regular bank can lend out about ten times the amount it has on reserve, but the much larger Wall Street investment banks usually can lend out as much as 30 times the amount of their reserves. By packaging real estate loans and selling them, they increased their reserves and thus could loan out more money. The result is that when the loans started to go bad it created the mess our credit system is in now. The cure the Fed has embarked upon is exactly the wrong cure for the country's financial problems. The value of a dollar has already tanked because of previous Fed actions that created too many dollars, and the increase in liquidity they have recently initiated will only exacerbate the problem.
The housing problem has been attributed to the overextension of credit, especially to high-risk customers, but this in itself would not have become the problem it has had it not been for the loss of faith in the dollar. Our foreign investors have finally decided that our spending was not going to be trimmed, and looking at the resulting increase in our debt they have decided that inflation would soon be rampant. Inflation is the politicians' way of repudiating debt. Politicians, compliant economists, and a sympathetic press have all accepted some low figure for inflation as being acceptable, but whatever the figure is, it is a direct assault on the value of a debt. Any inflation reduces the value of a debt to the holder of that debt.
The investing public reminds one of the children's game where they all march around a set of chairs that are fewer than the marchers. When the music stops they all dive for a chair and those who don't make it are out of the game. The investors are looking desperately for a store of value and are scrambling from oil to gold to commodities trying to find something they feel comfortable with. Many have gone to euro-priced investments but the euro is not even backed by gold or a national government. Today no country's currency is backed by gold or any other tangible thing; the only force keeping the value of any currency up is faith, and many people have lost that for the U.S. dollar.
As Reuven Brenner pointed out in a recent Wall Street Journal article, "There is much talk about restoring trust in the financial markets but you cannot restore trust while taking no steps to halt the further fall of the dollar." He thinks that U.S. real estate value will languish as long as the Federal Reserve and the government do not take action to fix monetary policy. Even Fed Board members have been recently quoted as saying the Fed must now give priority to the liquidity problem in spite of the fact that too much liquidity has caused the problem. The vast expanse of credit could not have happened if the Fed had concentrated on a more stable dollar. Any currency designated as a "reserve" currency, as the dollar has been, needs an independent organization to keep it stable to keep global credit expansion under control. The Fed could have filled this function by keeping the dollar stable compared to gold or other commodities.
It is important for trade for countries to have a stable unit of exchange, especially for contractual reasons. Today, with the dollar at such a low regard, investors are somewhat paralyzed in trying to determine how to trade with the U.S. We need a stable unit of trade to ensure long-term wealth-producing employment. When the Fed finally starts concentrating on the proper cure it is going to be very painful for everyone, but until then the present course is taking us further down the road to tremendous inflation.
"One may smile and smile and be a villain." --William Shakespeare (Hamlet)