Tuesday, June 4, 2013

Day of Reckoning

The present article is based on Ron Paul’s paper about “The U. S. Dollar and the World Economy” written on September 6, 2001. In dealing with various economic issues throughout the paper, Dr. Paul keeps on mentioning about the “day of reckoning.” We will find this expression as the Congressman discussed about constitutional duty to maintain sound money, global economic crisis, advantage of the US dollar, new globalism, real estate bubble, and economic solution. Intentionally, I omit other topics, which are too difficult for me.
Global Economic Crisis
Constitutional Duty
Comparing the July 20, 1979 speech of Dr. Paul to his speech in September 6, 2001, it surprises me knowing that the former speech talks about the US government destroying the dollar, while the latter speech indicates the constitutional responsibility of the Congress to protect the value of the dollar. Dr. Paul talks about this constitutional duty “to maintain the value of the dollar by making only gold and silver legal tender…” (p. 214). This is a strange concept for most people today. But if Ron Paul is right that monetary history and economic law support the soundness of this concept, it is to our own peril that we keep ignoring it.
1913 and 1971 are two important dates in financial history. The Federal Reserve System was established in 1913 and President Nixon disconnected the US dollar from gold in 1971. Our present day economic woes can all be traced from these two serious mistakes.
Global economic crisis is here to stay as long as those who are responsible to provide solution remain in the dark as to what is really going on. Dr. Paul describes this blindness of the US Congress as inability to realize the relationship between inflation and the bubble economy. As a result of such blindness, the US Congress wrongly identifies the root cause of the crisis. Due to wrong diagnosis, inflating the money supply is the only solution given ignoring the serious warning from Austrian economists that such action would lead to far deeper economic crisis.
Economic Crisis
For Dr. Paul, the worsening crisis was a product of several decades of disregard of sound money that started in 1971. In his mind, the world was already suffering recession in 2001 while the mainstream hesitatingly accepted this fact only in 2008 due to obvious visibility of real estate bubble. This is the reason why Ron Paul was not surprised seeing the collapse of real estate industry while most “professional economists” were caught unprepared.
In this crisis, Dr. Paul describes the dangerous status not only of the dollar, but including all the currencies of the world. It is a danger that the world has never experienced before due to its scope. Its severity depends primarily on the nature and the time of response of both the Federal Reserve and the US Congress. If the response is the usual creation of fiat money, the collapse will be more catastrophic and the time for recovery will be prolonged.
Advantage of the US Dollar
For citizens outside the US, the analysis of Dr. Paul as to the status of the US dollar deserves careful attention. He claims that the dollar as reserve currency of the world is more advantageous for American citizens than citizens of other countries that follow the US in her monetary policy. It is because the US is permitted to export their inflation by purchasing goods from other countries and at the same time lending back the dollars to finance American deficit.
New Globalism
Dr. Paul mentions an alarming truth that most people consider as delusional. This truth is connected to the dominance of fiat currency. Dr. Paul talks about a new form of globalism.
Unlike in ancient time where the goal of globalism “was honest trade and the currency was gold” (p. 217), the goal of this new form of globalism is world government through fiat currency and international organizations like IMF, WB, and WTO. The connection of the US dollar to other currencies of the world is critical in the success or failure of this goal. For Dr. Paul this goal is nothing but a socialist dream that will certainly collapse along with the destruction of fiat money. The existence of fiat money, international organizations intensely engaged in nations’ economies, and new globalism confirms that the final end of the worsening economic crisis will be far all-encompassing than the Great Depression in the 1930s.
Real Estate Bubble
Among numerous insights in this congressional speech, I find that the information on real estate bubble invaluable. Mainstream media misleads the public as to the primary source of the 2008 crisis. It never touches the primary role of the Federal Reserve in the expansion and explosion of the bubble. I will just restate here ideas that are comprehensible to me.
It all started with Federal Reserve credit expansion. Huge size of the credit went into real estate, stirred up by the “$3.2 trillion of debt maintained by the GSEs” (p. 219). The GSEs by the way, was composed of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. The GSEs received a special treatment through low interest rates and the Federal Reserve monetizing them “just as if they were U. S. Treasury bills” (p. 220). This action of the Federal Reserve sent an attractive message to foreign central banks causing these banks to purchase great quantity of GSEs.
At this point, the details that follow concerning real estate bubble are too intricate for me. For fear of distorting the Congressman’s message, let me just select three relevant paragraphs from the report.
About the relationship between the collapse of NASDAQ in 2000 and the boom in real state:
“After the NASDAQ collapsed last year, the flow of funds into real estate accelerated. The GSEs accommodated by borrowing without restraint to subsidize new mortgages, record sales, and refinancing. It’s no wonder the price of houses are rising to record levels” (p. 220).
About the direction of new money supply into real estate industry:
“Refinancing especially helped the consumers to continue spending even in a slowing economy. It isn’t surprising for high credit card debt to be frequently rolled into second mortgages, since interest on mortgage debt has the additional advantage of being tax deductible. When financial conditions warrant it, leaving financial instruments (such as paper assets), and looking for hard assets (such as houses), is commonplace and is not a new phenomenon. Instead of the newly inflated money being directed toward the stock market, it now finds its way into the rapidly expanding real estate bubble” (ibid.).
About possible dumping of GSEs: 
“A weak dollar will prompt dumping of GSE securities before Treasuries, despite the Treasury’s and the Fed’s attempt to equate them with government securities. This will threaten the whole GSE system of finance, because the challenge to the dollar and the GSEs will hit just when the housing market turns down and defaults rise. Also a major accident can occur in the derivatives markets where Fannie Mae and Freddie Mac are deeply involved in hedging their interest rate bets” (p. 221).
Among the above three paragraphs, I find the last one familiar. It has been clearly reported in the news. However, the information provided by the first two paragraphs appears to me that it fails to reach public awareness most especially the role of inflation in expanding the real estate industry.
Economic Solution
For Congressman Paul, the solution to global economic crisis must first start with the change in mind that created the crisis in the first place. This would mean an end to Keynesian-monetarist mindset. This would also mean exposure of the powerful identities behind oil corporations, international banking, and the military-industrial complex that serve as the driving force to perpetuate the warfare state. In concrete terms, this tells us to do everything we can to stop the following: regulating the prices of goods, giving artificial low interest rates, centralized economic planning, and manipulating money and credit.
Dr. Paul argues that the above economic and monetary policies are unconstitutional and destructive to the economy not only of the US, but of also of the world. There must be change in these policies if we want to see lasting peace and economic growth.
However, Dr. Paul after several decades of experience in advocating monetary reform is realistic that such change is not easily accomplished. It is hard to change the way both the government and the people think. On the part of the Congress, it is difficult to surrender the monopoly on the supply of money. On the part of the people, it is also difficult to give up the welfare programs of the government. Other sectors of society are also unwilling to give up the benefits they receive from inflating the money supply.
Providing genuine solution to global crisis, the US must give up the obsession to police the world and the constant interfering with free market activity. The Congress must take its responsibility to restore honest monetary system. This would mean an end to the power of the Federal Reserve.
Source: Paul, Ron. (2008). Pillars of Prosperity: Free Markets, Honest Money, Private Property. Auburn, Alabama: Ludwig von Mises Institute.