Inflating Away US Debt
Three lessons from history
for printing up money...
May 19, 2008
"We can pay anybody by
running a printing press, frankly," said Thomas Gale Moore,
one of Ronald Reagan's economic advisors, when the United States
became a net debtor to its foreign investors in 1986.
"[So] it's not clear to
me how bad [being a net debtor] is," he added. And for the
next two decades or so, owning fewer assets overseas than foreigners
laid claim to inside the United States didn't seem so bad at
The long boom delivered by
a steady inflow of foreign credit and cash delivered the greatest
stock market gains ever enjoyed by US investors. When they topped
out, the party switched straight into real estate - adding more
than one-third to America's household wealth on the Federal Reserve's
So what if non-US claims on
that surging wealth rose faster still? Now the party's over,
inflating away the value of America's debt will worked just as
beautifully as it always before. Right?
"In my view," says
John H.Makin - a visiting scholar at the American Enterprise
Institute writing in the Wall Street Journal - "the
least bad option [in fixing the financial crisis] is for the
Federal Reserve to print money to help stabilize housing prices
and financial markets."
"America is a country
that owes money," agrees Philippa Malmgren, a former Bush
advisor and now head of a risk consultancy in London. "It
is natural when you are a debtor that you lean in the direction
of inflation, because it makes paying it back so much easier."
The logic is simple: inflate
the number of Dollars in issue, and you'll shrink the real value
of each outstanding Dollar you owe. But if escaping your debts
really could prove that easy, how come history is littered with
the mischief that inflation causes instead...?
Restoration England, 1668
Charles II - still playing
his "divine right" as king some 20 years after Parliament
cut off his father's head - steps up the issue of new bonds.
Then called "stocks", they let the King raise cash
for yet another losing war against the Dutch.
Charles side-steps Parliamentary
approval for these new debts, and starts selling stocks against
the promise of future tax receipts (the same wheeze adopted by
governments worldwide today, of course). Come 1671, however,
all the new money raised went straight to paying interest on
the outstanding loans. So Charles opted to default, wiping out
11 of London's 14 biggest goldsmiths - those early banks who'd
first lent the Crown money - and destroying his credit with England's
The upshot? The King strikes
a secret deal with France, promising to stay out of its war against
the Dutch in return for regular cash pay-offs. But the deal -
uncovered amid a rash of anti-Catholic panics in London - undermines
all support for the Stuart royal family. Fifteen years later,
and with the English crown bankrupt once more, his brother James
II is overthrown in a popular and (pretty much) bloodless coup.
He's replaced by William of
Orange... head of the Dutch Republic!
Revolutionary America, 1775
Lacking a mandate to tax its
population while fighting a war, the second Continental Congress
authorizes the "limited" issue of paper money. The
new notes, known as Continentals, are backed by neither Gold
nor silver, but by the expectation of future tax receipts.
Effectively acting as tradable
bonds - but exchangeable for goods and services amongst the Patriots,
rather than hard currency - the Continentals will only be redeemed
when the Colonies win their independence from Great Britain.
But long before that happy day, they race towards zero, becoming
progressively worth less as their supply increases.
During the first six months,
the supply of Continentals goes from $2 million to $6m. By 1779,
the total supply reaches $242m on one estimate - more than twenty
times the volume of gold & silver money in circulation before
the war began.
"A wagonload of currency
will hardly purchase a wagonload of provisions," complains
George Washington. In March 1780, Congress announces a plan to
redeem the Continentals at one-fortieth of their face value,
effectively stuffing the American people and taxing the new citizenry
more aggressively than George III ever did.
"So much for Congress's
honor," notes Thomas E.Woods for Mises
today. But for once, at least, these un-backed and over-inflated
notes don't end with political or military defeat. Other than
for the Patriots' cry for lower taxation, that is.
Weimar Germany, 1920
Besides losing 13% of its territory
and 10% of its population under the Versailles Treaty after World
War One, Germany also owes "reparations" to the Allied
victors worth almost 37,000 tonnes of gold - around one-third
of the world's entire above-ground supplies at the time.
Expected to settle the final
payment seven decades later, the German government opts instead
to pay early by printing money. The volume of Reichsnotes in
issue rises 35 billion times over between 1918 and 1924 - and
"the young and quick-witted did well," as the German
journalist Sebastian Haffner will record, fifteen years later.
Equity prices in Berlin rose
some 2,772,164% by the time a loaf of bread cost a wheel barrow-full
of banknotes. The value of those Reichsnotes, however, went the
other way - sinking from 8.0 per US Dollar to 4.2 billion per
The resulting chaos, now regularly
blamed for the rise of Hitler during the Great Depression of
the early 1930s, saw "wages paid twice a day and promptly
and completely spent within the hour," notes Glyn Davis
in his History of Money.
"Large sections of society,
including the middle classes, became impoverished; food riots
were common; there was a complete flight from money, which had
clearly become worthless to hold."
A more honorable legacy, perhaps,
was the inflation-fighting Bundesbank of the 1970s and '80s.
Staffed by bankers and academics who'd lived through both the
Weimar inflation and its World War Two replay - which saw worthless
coupons issued as money to Nazi citizens, Wehrmacht troops and
even concentration camp victims - the West German central bank
refused to devalue the Deutsche Mark alongside the Dollar, British
Pound and French Franc by setting interest rates low.
The Bundesbank kept inflation
far below the double-digit rates suffered by UK and US households
Prices rose 20 times over against the Dollar. It finally
bit the bullet with the birth of the Euro in 1999.
The new European Central Bank
has since let slip its money-supply growth target of 4.5% per
year. At last count, the supply of Euros was expanding by 10.3%
per year, just below 2007's three-decade record for Europe monetary
The Global Banking Crisis, 2008
"US money supply growth
is running at a 47-year high," notes Bedlam Asset Management,
"as the authorities seek to inflate away the debt bubble
and prop up house prices.
"Clearly printing such
huge amounts of money is not great for the exchange rate. A weak
Dollar has forced the hand of other central banks as they try
and keep their currencies competitive with it."
But might the scam work? Not
if China, Japan and the big Dollar-holders of the Arab oil kingdoms
can help it. Will they really let their own currencies rise...just
so the United States stuffs them by paying its debts with devalued
Inflation, it's claimed, eases
the burden of settling your debts. But for government and private
debtors alike, that's only true if your income rises faster than
your on-going cost of expenditure. Otherwise, you end up struggling
to make ends meet today, only to leave yesterday's debts for
repayment tomorrow again.
Middle-class families and savers
looking to get ahead of the game - both inside and outside the
Federal Reserve's fast-inflating currency zone - might want to
Gold as defense. Because however this latest attempt to inflate
away debt pans out in the long run, it's sure to make history.
And history says - time and
again - that solid Gold
Bullion holds its value whenever man-made currencies are
forced to lose value.
19 May, 2008
Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events - and must be verified elsewhere - should you choose to act on it.
Contact the author regarding this article.
Adrian Ash runs the research desk at BullionVault, the world's #1 private investor gold service. Formerly head of editorial at Fleet Street Publications - London's top publisher of financial advice for private investors - he was City correspondent for The Daily Reckoning for four years, and is now a regular contributor to 321gold, FinancialSense, GoldSeek, Prudent Bear, SafeHaven and Whiskey & Gunpowder among many other leading investment websites. Adrian's views on the Gold Market have been sought by leading news organizations including the Financial Times, Bloomberg and Der Stern in Germany.
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