James Grant Wants To Know Who Will Buy Our Greenbacks

If you are unfamiliar with James Grant, do yourself a favor and read his latest missive in yesterday’s Wall Street Journal. It is overly long and probably attempts to cover too much but still it is vintage Grant.

Basically, he asserts that the Fed approach at this point in time is destined to fail simply because the world is not going to keep on buying Dollars.

Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, “continue to consider ways of using its balance sheet to further support credit markets and economic activity.”

Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth. Economic commentators praised the central bank’s determination to fight deflation — that is, to reinstate inflation. All hands, including President-elect Obama, seemed to agree that wholesale money-printing was the answer to the nation’s prayers.

One market, only, registered a protest. The Fed’s declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, “Tell me, again, now that the dollar yields so little, why do we own it?”

It was on Oct. 6, 1979, that then-Fed Chairman Paul A. Volcker vowed to print less money to bring down inflation. So doing, he closed one monetary era and opened another. With Tuesday’s promise to print much more money, the Federal Reserve of Ben S. Bernanke has opened its own new era. Whether Mr. Bernanke’s policy of debasement will lead to as happy an outcome as that which crowned the Volcker anti-inflation initiative is, however, doubtful. Whatever the road to riches might be paved with, it isn’t little green pieces of paper stamped “legal tender.”

Had he stopped there, or at least used that as the central thesis of the article, he would have been spot on. Grant, however, is one who believes that the biggest mistake the U.S. ever made was to abandon the gold standard. So he uses the opportunity to launch into a very entertaining though in the end, at least to me, not persuasive argument in favor of that regime. Along the way he presents an entertaining history of the migration away from the gold standard and a riveting quote from Elihu Root, a Republican senator who had strong misgivings about the establishment of the Federal Reserve in 1913.

Little by little, business is enlarged with easy money. With the exhaustless reservoir of the Government of the United States furnishing easy money, the sales increase, the businesses enlarge, more new enterprises are started, the spirit of optimism pervades the community.

“Bankers are not free from it,” Mr. Root went on. “They are human. The members of the Federal Reserve board will not be free of it. They are human….Everyone is making money. Everyone is growing rich. It goes up and up, the margin between costs and sales continually growing smaller as a result of the operation of inevitable laws, until finally someone whose judgment was bad, someone whose capacity for business was small, breaks; and as he falls he hits the next brick in the row, and then another, and then another, and down comes the whole structure.

“That, sir,” Mr. Root concluded, “is no dream. That is the history of every movement of inflation since the world’s business began, and it is the history of many a period in our own country. That is what happened to greater or less degree before the panic of 1837, of 1857, of 1873, of 1893 and of 1907. The precise formula which the students of economic movements have evolved to describe the reason for the crash following the universal process is that when credit exceeds the legitimate demands of the country the currency becomes suspected and gold leaves the country.”

I am always amazed at how prescient people were many years ago and how little we tend to learn from them.

I may be wrong, but I can’t come down on Grant’s side of the gold argument. For all of the elegance and simplicity inherent in a hard currency, it is also a straight jacket. There is much to be said for the modern method. Now if the people that we choose to administer that system showed more wisdom and harked back to the Roots and others who spoke a great deal of truth then we might not find ourselves in the sort of predicament we now face.

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