The monopoly over the provision of money that governments have appropriated to themselves and their central banks is the ultimate source of the government failures rippling around the world today, threatening to destroy many national economies.
In view of the central role performed by money in the economy, the Foundation takes a keen interest in monetary policy and the activities of the South African Reserve Bank. FMF publications on monetary policy include Chronically large federal budget deficits: The American experience by Roger W Garrison, who visited South Africa in 1998.
In the monograph, Professor Garrison made the following observation: “If you are a conservative investor having neither the time nor the stomach for second guessing the US treasury and the Federal Reserve, then stay out of the market. Refinance your home at the current low interest rate and put the monthly savings into Treasury bills. The low thirty-year fixed-rate mortgages now available will virtually insure another savings-and-loan crisis down the road, when interest rates rise in the face of monetary and fiscal realities. And the Treasury bills that will protect you from default risks will allow the government to postpone a little longer its own day of reckoning.” This monograph was published ten years before reality struck home in the US and refutes the contention that no one saw the home loan crisis coming.
Unfortunately, central banks have proved to be untrustworthy custodians of their nations’ currencies. This is especially true of the United States Federal Reserve, which has debased the US dollar so badly that it is in danger of losing its role as the world’s reserve currency.
When a currency becomes widely trusted, which the dollar was after World War II, it is used outside its country’s borders as the basis for transactions. Trust in the US dollar has, in recent years, been badly harmed by its excessive issue, especially as part of the so-called ‘stimulation’ packages of the past two years.
Governments have become used to spending more than they collect in taxes and to using a process called deficit financing. They generally finance debt by issuing government bonds, which are IOUs to pay the debt later, thus making future generations of taxpayers pay for benefits provided to today’s generation and for paying off political debts to supporters.
Frequently, new bonds are issued to provide the funds to pay for old bonds falling due for repayment, thus shunting the debt forward. Perpetuation of this process of burdening future generations has been made possible by the conviction that governments will not renege on their debts, after all governments cannot become insolvent.
All central banks, including those that are supposedly independent, have great difficulty avoiding being dragged into politically-created crises because when a government struggles to find purchasers for its debts, it turns to its central bank.
A central bank takes its government’s bond, credits its government’s account, and thus gives its government the go-ahead to start writing more cheques. Every unit of extra currency created in this way reduces the purchasing power of all existing units of the currency. In truth, it is imposing a stealth tax – invisible to the masses because it is understood by too few people. So, in the final analysis, it is the taxpayers who pay, including those whose investments have been deeply eroded by inflation.
We must constantly be aware of what is happening in the US, the world’s largest economy, because what happens there will affect all of us. In the last three years, the US monetary base has increased through government borrowing by an astonishing $1,835.5bn, from $848.3bn to $2,683.8bn. Even more astonishing, is that the decision-makers in Washington proclaim that they are borrowing and spending these huge amounts in order to solve the problems created by the previous borrowing to cover budget deficits.
In January 1966, the US monetary base was $60.5bn. The figures for January by decade thereafter were: 1970 $76.4bn, 1980 $156.2bn, 1990 $292.1bn, 2000 605.1bn, 2010 $1,994.9bn and then for July 2011 $2,648.0bn. The monetary base multiplied 43.8 times in 45.5 years. According to the US Bureau of Labour Statistics, the purchasing power of the dollar has declined from $1 in 1913 (when the Federal Reserve was established) to $0.05 in 1913 dollars today.
In January 1966, the South African monetary base was R512 million. The figures for January by decade thereafter were: 1970 R753 million, 1980 R2.1bn, 1990 R10.9bn, 2000 R25.0bn, 2010 R123.4bn and for June 2011 R140.8bn. The monetary base multiplied 275 times in 45.5 years.
This means that SA has debased the rand more rapidly than the US has debased the dollar, which helps to explain the severe decline in the exchange value of the rand against the dollar over the period.
In Feb 1961, $1 equalled R0.714, Dec 1971 R0.7134, June 1975 R0.8676, Feb 1983 R1.8520 and Aug 2011 R7.20. The rand has lost 90.08 per cent of its purchasing power against the dollar since Feb 1961 and 74.28 per cent since Feb 1983.
Given that the purchasing power of the dollar was also declining rapidly, albeit more slowly than the rand, the figures tell us that there is something radically wrong with the management of the rand and the dollar. It tells us that the holders of both currencies have lost heavily over the years.
What has happened to the purchasing power that has apparently disappeared? The answer is that it has been appropriated by the central banks, the supposed custodians of these currencies in a willful process of debasement. Debasement is occurring to a greater or lesser extent in all countries, making currency reform essential. The only feasible option is to use gold as a means of preventing debasement. It is clear from a glance at purchasing power graphs of currencies that when they were on the gold standard, purchasing power remained relatively stable over long periods.
A least disruptive method of controlling currency debasement has been put forward in articles published by the FMF. It is suggested that the rand be backed one hundred per cent by gold at a fixed quantity of gold per rand, preferably based on the rand price of gold at the time the system is introduced. It is further proposed that the currency be managed by a Currency Board that has the sole task of ensuring that the correct quantity of gold is held to fully back the rands in issue. The Board will not convert paper rands into gold but will purchase gold with all new paper rands issued, except those issued to replace damaged or soiled notes. A Currency Board functioning on this basis would stop the debasement of the currency, stabilise the internal and external purchasing power of the currency, and stop the “race to the bottom” in competitive currency weakening.
Improved stability in the purchasing power of a currency is the most important reason for halting perpetual currency debasement. Currency stability facilitates long term economic planning, protects savings and fixed incomes, and brings about accelerated growth.
South Africa should not emulate the errors of others but should build on its yellow metal to develop an alternative monetary system that will make the country a preferred investment destination in the difficult times that lie ahead.
AUTHOR Dr Brian Benfield is the Chairman of the Free Market Foundation and this article is an excerpt from his address to the Annual General Meeting of the Foundation on 24 August 2011. The article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.
FMF Feature Article / 23 August 2011