A 2,000-word essay is not required to answer those two questions; I think any advocate for free markets and responsible fiscal policy must agree that the Federal Reserve requires a complete overhaul if not a mothballing, and that a return to a commodity-based monetary system is the surest way to protect us against unseen government spending and runaway inflation. (There, I just did it in 48 words!) In this essay, I'd like to address why these conclusions are appropriate and necessary.
First, let's review some basic assumptions. If humans lived alone on their own private islands with no outside contact, they would need to spend most of their days providing for their own sustenance, shelter, firewood, and makeshift clothing. They might be able to hunt or forage for multiple days' worth of food at once, but without refrigerators or even plastic wrap, it wouldn't keep for very long. If a small group of them could somehow get together, the opportunity to engage in specialization would sprout - the ones better at hunting or foraging could provide the sustenance for the group while the ones better at collecting firewood could procure enough for everyone, and this distribution of chores would take less time and effort than each person providing his/her own food and firewood. The extra leftover time could be used to further enrich the group members' lives, such as by getting more food or firewood (investing in commodities), fashioning better tools or weapons (investing in industry), or by engaging in recreational pastimes.
Like families or tribes, small groups don't necessarily need to keep score. If everyone feels that they are doing a reasonable amount of work as compared to the others and are getting more in return than they could provide for themselves, they should be reasonably content. Bear in mind that any of them could strike out on their own anytime, but would likely choose to live in the group because it would benefit them to do so. In real life, specialization works - my wife can effortlessly whip up a gourmet dinner for us in less than 30 minutes, whereas it would take me longer to scrape together something not nearly as healthy and delicious. She's happy to do it because she finds it easy (if not enjoyable), and it leaves me the time to do chores for which I have a greater interest and aptitude than she. Together we're wealthier as a result of being able to focus on the tasks at which we're more specialists.
As groups get larger and trading partners get more spread out, it becomes more necessary to keep score. Goods and services may be difficult to divide, or trades may be separated in time or along chains of transactions. For example, harvests may come in just once or twice a year, but a farmer may need fuel all year; a refiner may not need hundreds of bushels of wheat, but may prefer to trade fuel for finished bread. Should the baker then trade fuel to the farmer for the grain with which to make the bread for the refiner? It makes more sense to establish a "money" in which to store the interim value of these transactions. In regards to large transactions, rather than a shoemaker trading hundreds of shoes at once for a car, it's easier for him to sell shoes to various customers at his own pace and save up enough money to buy a car over time.
This concept of "saving up money" requires some medium in which to do so. Grain spoils, fuel vapors evaporate, and shoes go out of style, so the need for a proper currency becomes even more pronounced. Wiser men than I have made the case that good candidates for currency should be divisible into small-enough units for trade, should be easily portable, should not spoil over time, and should be difficult and costly to counterfeit. Throughout history, various commodities have served as "money," including seashells, foods, gemstones, and precious metals. In prisons, cigarettes often fill the role.
The difference between these hard currencies and today's fiat currencies is that when we trade for something with gold or cigarettes, tomorrow the recipient will still possess roughly the same percentage of all the gold or cigarettes that exist today. Fiat dollars are easier to "counterfeit," (simply by fiat) so if I trade for something with dollars today, and then more dollars are arbitrarily produced in the future, the recipient's dollars will have less purchasing power at that time.
Generating more fiat dollars is precisely one of the things the Federal Reserve System does, managing the nations' money supply through monetary policy. The Fed can also give or lend new fiat dollars to bail out failing enterprises or industries, to encourage lending and borrowing, or to support US interests and foreign affairs.
There is only a certain amount of fossil fuel on the Earth, its scarcity and our demand for it determines its value. If gasoline could be fabricated out of thin air, we wouldn't be paying nearly $4/gal for it today. Precious metals and gemstones work similarly - there are only so much of them available to satisfy demand for them. Fiat dollars, however, have no such limitation. Their number can be unceremoniously doubled in a short amount of time, making each one worth half as much in terms of their purchasing power in real goods and services. Every new one printed steals value from the ones already in our pockets and bank accounts.
The trillion dollars we've spent on the war on terror would be a difficult pill for taxpayers to swallow whole, but by simply printing more money, huge costs like that can silently pass, unnoticed. Over the years, as those bills are paid and those dollars then make their ways back to the US marketplace, they generate surfeit demand for an unchanged quantity of goods and services, reducing our wealth by quietly pushing up the prices of everything we buy. Since few people realized or understood this hidden force until recently, the government largely wasn't blamed for inflation - it was assumed by many average citizens to be a normal result of increasing wages and higher employment rates. Unexpectedly to them, though, it has persisted (with a vengeance) throughout our current recession, despite lower wages and lower employments rates. This may be in large part an impetus for the current battle cry to "Audit the Fed." (Higher employment actually creates more wealth, and higher wages are the fallout from inflation, not its cause.)
Funding wars and bailing out automakers, banks, brokerages, and even foreign nations are all within the possible uses of such quietly-printed fiat dollars. Control of them is the ability to cripple or hyper inflate our economy, and it's too much power for one entity to wield. Any sort of currency that isn't tied to a hard commodity is simply too easy to corrupt. As a child, I used to believe that our dollars were backed by gold, so I was understandably surprised when it was explained to me that a five dollar note was worth five bucks solely because it was generally accepted in exchange for five dollars worth of goods. More exactly, it's because the government will accept it towards five dollars' worth of an entity's tax obligation. Only more recently did I learn that commodities, when priced in other commodities, haven't experienced the same inflation as our dollar has. In 1960, an ounce of silver cost around 90¢, and a gallon of gasoline cost around 30¢, thus an ounce of silver would buy about three gallons of gas. Today, although you can only get only about one-tenth as much gas for that same 90¢, the same ounce of silver today would actually buy about ten gallons. Effectively, gas has gotten much less expensive in terms of silver, but both are significantly more expensive in fiat dollars. Silver and fuel production are severely limited as compared to simply turning on a printing press to produce more dollars, and in this context, the Fed's lack of restraint becomes obvious.
So what should we do about it? As countless civilizations have found throughout time, gold and silver are some of the best candidates for currency media. They are portable, divisible, durable, and limited in supply. They even have uses outside of just serving as money. While mining operations can produce more of them, it's a much slower and more costly endeavor than a printer just flipping a switch on a machine. Gold and silver coins and bars are an easy way to store value and could be used to pay for goods and services. Checks and money orders could continue to serve as demands for funds, but could be denominated in weights of metals. Credit cards, loans, and mortgages could continue to serve as debts to lenders who paid out gold or silver on borrowers' behalves, and could be repaid over time in quantities of metal plus interest.
One minor nuance of a bi-metal currency system would be the relative value of the two metals. We're used to a system in the US whereby one dollar is fixed as being equal to 100 cents, but that wouldn't work for exchanges between gold and silver. The market would have to determine that ratio fluidly, as supplies and demands fluctuated, and as each participant set his/her own personal exchange rate. A car might cost 10 ounces of gold or 550 ounces of silver; an hour of my time might be worth 3.5 ounces of silver or 25 grains of gold. Gresham's law would encourage efficient exchanges, ensuring that any businesses or government offices that got their individual exchange rates out of line with the market would find themselves at the short end of the stick.
Taxes would be payable in gold or silver, and government echelons would use that collected gold and silver to pay their expenses and debts. Just as instruments such as checks, money orders, and credit card slips could represent stored metal, so, too, our government would probably create paper notes of currency to represent their stored metal. If we've learned our lesson from the ills of the current Federal Reserve System, this must be a carefully monitored practice, ensuring that notes are only issued for quantities of metal actually on hand. A policy of convertibility and periodic auditing should prevent runaway printing of unbacked notes.
There are still opportunities for governments, businesses, and individuals to borrow more metal to spend more than they've earned, but inflation is mitigated by the lenders being temporarily required to spend less than they earned - until their notes are repaid.
In conclusion, I think it's obvious that our present system is broken, and since it is based on the flawed Keynesian assumption that government can better control the economy than could a free market, I see no reason to put bandages on it. It is easier and more appropriate to start over with better assumptions and design a new system. Decentralized control of money is safer and permits unfettered markets to do what they do best - find and adjust for the true values of goods and services - without the covert effects of inflation. If government's role is to represent us and to serve our best interests, rather than hide expenses in our future, let them tell us what it costs to wage a war or to build a bridge. If they can get the support for such projects through increased taxes, referendums, or bond sales, the public must want them; otherwise, there's no reason to force them and their costs upon us without our consent. The ability to arbitrarily print fiat money wrests control of government expenditures out of the hands of the people who are subsequently asked to pay the bills. We can no longer afford such a policy.
About the Author:
Brian Blum is the founder, president, and chief consultant at Maverick Solutions IT, Inc. Maverick Solutions provides technology consulting and support services, primarily to schools, NFPs, and SO/HOs in the New York Metro Area. Maverick Solutions helps clients get more value from their technology budgets. Visit our Website to learn about the services we offer, or read our blog, Maverick Ramblings, for assorted tips, tricks, and information of technology interest.
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