The Least Imperfect Monetary System

10/04/2013 10:00

   by Lewis E. Lehrman

Those who really apply themselves to the subject of money will ultimately come out believing the least imperfect monetary system by which civilized nations can conduct their business is the classical gold standard.

That is a system in which every major nation defines its currency as a weight unit of gold. As a result, you would have a multilateral currency system, instead of a single country being subsidized the way a reserve currency country like the United States and its dollar is, or the British Empire during the period when sterling was a reserve currency.

All countries would exist on an equitable trading basis. Just as working people wouldn't have any advantages over the financial class on Wall Street, no nation would have an "exorbitant privilege" of issuing its own currency to pay debts that are never settled.

Today, with floating exchange rates and the central bank issuing money directly to the banks through the process of quantitative easing and direct bailouts, the financial class is in a position of getting the money first. It puts the financial class in a position to borrow money at 1% and buy commodities, speculate in stocks and front-run the Fed on buying bonds.  As a result, they accrue all of the profitability in the economy long before this money reaches the working people.

The exorbitant privilege under the reserve currency -- a role of the dollar -- is an exorbitant right for the financial and speculator class, who are the supplicants of the Federal Reserve System. They borrow money at virtually zero cost compared with you. They have to pay 12%, 15%, 20% on their credit card balance, and much higher rates for their mortgages.

The reserve currency role of the dollar -- that is to say the unique means of payment worldwide whereby only the United States' payors are given the privilege of paying in dollars, both internally and abroad -- was referred to by French President Valery Giscard d'Estaing as an exorbitant privilege. What is meant by the exorbitant privilege? It's a way of describing a situation that we read about every day in the United States. Why is it that for 35 years, every Congress of the United States has attempted to curb the budget deficit and failed?

There was the Gramm-Latta budget deficit control. There were 15 legislative attempts in the last 20 years to control the budget deficit. Why have they been unsuccessful? These are serious men; these are serious congressmen and senators who want to control the budget deficit.

The reason is that there is no institutional restraint on Congress. Congress can run deficits, President Obama can present programs that require debt financing, and this debt financing can be financed abroad by the Federal Reserve issuing new dollars to finance the deficit directly. That's what they're doing now with quantitative easing. That's not the end of the role of the reserve currency of the dollar.

When we run balance of payments deficits abroad, we can issue dollars in order to settle them. This was referred to not only as the exorbitant privilege, but as the twin evils.

There are two principal reasons for the endurance of the reserve currency role of the dollar. First, approximately 65% of all invoicing of international trade -- not including the trade of the United States itself -- is done in dollars. And about 75-80% of the commodities market is invoiced in dollars. So reserves are collected worldwide in the currency that everybody makes payments in.

There are approximately $10 trillion of reserves globally. There is no markets in the world with the scale, the financial assets both liquid and in their amplitude, that can contain such an enormous level of reserves. The reserves themselves are in general a product of the U.S. budget deficits and U.S. balance of payments deficits, so the endurance is underwritten by the fact that the U.S. market -- ironically, even perversely -- is the only market which can contain all of the deficits it is issuing abroad.

This exorbitant privilege exists because the United States wants it to exist. It's satisfied to have foreigners, among others, finance the budget deficit and its balance of payments deficit and its uninhibited spending inclinations. No one wants to take away the United States' unrestrained credit card. The United States most of all doesn't wish this to happen.

Second, those nations that absorb these reserves want a place where they can deposit them and then quickly sell them if they have to, and that kind of liquidity is available only in the U.S. markets.

The obverse of that privilege is that in order to maintain the dollar's reserve currency role, and in order for the foreign countries to accept it, they've had to accept the decline in the value of the dollar. Over the 40-year period since Nixon ended the gold standard, the purchasing power of the dollar has fallen drastically.

The purchasing power of real goods and services today is worth about 12-15 cents compared with then. That shows that the enormous issuance of dollars to finance our deficits may look like the system is continuing, but its price has been paid by the U.S. consumer. Imagine if you saved a dollar in the bank in 1971 and planned to hold it for the future.


2013 Agora Financial, LLC.  Lewis E. Lehrman is an investment banker who actively supports the ongoing study of American history from a conservative perspective. He was presented the National Humanities Medal at the White House in 2005 for his scholarly contributions.