Early in WWI, the French were urged to turn in their gold in exchange for paper bank notes. They would not lose “any part of their savings,” they were told. Nor would they have to “pay any more for anything they wished to buy.”
The war over, France was unable to keep its commitments. But what did you expect?
More recently, we recall visiting Argentine president Carlos Menem in the 1990s. At the time, Argentina had boldly solved its inflation problem by fixing the peso to the dollar, one to one. This stability gave the Argentine economy a boost. Foreign investors felt they could invest safely. Lenders felt they could place money down on the pampas, collect high yields, and still get back money of more or less the same value as the money they lent.
Still, there was some doubt about whether Argentina could maintain the fixed- rate exchange policy. So, we put the question directly to the head of state: “Will the peso/dollar exchange rate hold” we wanted to know.
“Yes,” he replied.
About two years later, Argentina abandoned the dollar peg, defaulted on its debt and the peso lost two-thirds of its value.
Now, this past weekend, Henry Paulson, told a crowd in India that the US is “strongly committed to a strong dollar.”
According press reports, the U.S, Treasury secretary neither smiled nor waited for laughter. Instead, he continued speaking, just as though he had not just told one of the biggest whoppers in financial history.
If there has been any progress in central banking it is surely this: the authorities don’t have to lie as much as they did in the past. French officials in 1915 had to separate the public from its money. In 2007, the public and its money have already been parted. Now, we all have bank notes, and plenty of them.
Today, anyone who is a dollar bull (or on the pound or the euro, for that matter) has to be a bull on human nature… and on economics too. Economics is merely the study of man and his money. But reported in the International Herald Tribune was the curious finding that people who had studied economics for 6 months scored no better on tests of basic economic principles than people who had never opened an economics book. The researchers were too timid, in our opinion. A follow-up study will show that those who go on to study economics at an advanced level will actually score lower than those who never studied it at all. It is a value-subtracting discipline. The longer you study it, the less you know.
Still, last week, the whole world seemed to hold its breath, wondering what a committee of economists would say. Would the US central bank lower rates? Or raise them. Economics itself has been in a bull market for many years. Now, economists control our money and get their faces on our news magazines.
But we live in a world of remarkable wonders. Improbably, even the Iraqi currency – the dinar – is going up against the US dollar. In January, 2004, it took 1,480 dinars to buy a dollar. Now, Iraqis willing to stand in line in a public place can buy them for just 1,240. While the inflation rate was recently clocked at 30% per year, the Iraqi central bank nevertheless lends out money at 20%. Last week, at an auction in Texas, a bookstore owner reported paid $100,000 for a lock of Che Guevara’s hair. And in Argentina, this past April, it rained spiders.
We don’t know what to make of it all. So, we will draw only the most obvious conclusion: there’s no telling what nature – even in its human form – might get up to.
In the past, one did not need so much faith in human nature to stock up on dollars, pounds, francs or deutschemarks. Behind every one of them, until fairly recently, was a fixed quantity of something that man did not make; and neither could he duplicate it, destroy it or diddle with it – gold. Ultimately, everyone who held a franc or a dollar could count on exchanging it for gold, at a stated rate. Only in the case of an extreme emergency – such as World War I – would the central banks renege. And even then, the default would be only partial…tentative…and shameful.
But the man who walks the street with a pocket full of paper money today is a man walking on air. A public official may tow the dollar bull line and tell him that his dollars are ’strong,’ but what does that mean? Against other major currencies, the dollar has lost nearly 10% of its value this year alone. Measured in oil, gold, or wheat the damage has been even greater. Meanwhile, the supply of dollars is increasing at 15% per year – 5 times faster than America’s output of the goods and services the dollar is supposed to buy. And the Financial Times tells us that the world market in credit derivatives, almost entirely in dollars, grew 32% in the first half and increased 75% over the year to the end of June.
A dollar bull has nothing solid beneath his feet. He only has faith. He has to have confidence in modern economists. He must not worry that members of Congress will spend too much. When the Treasury secretary says we will have ’strong dollar,’ he must believe him. And he must believe that the American president will show restraint and prudence. And, most importantly, he has to think the folks at the Fed, America’s central bankers, will exercise their authority with foresight and intelligence.
Do we need to say any thing more? We didn’t think so.
Markets and Money