Money: We CAN Have Too Much of It

Christmas is coming, the goose is getting fat, and our checking account balances are getting lean.  We could all use more money, right?  Wrong.

We could all use more income and more assets – even Bill and Melissa Gates, who do such a good job of giving it away.  But money?  There’s already too much of it.

If you were worth $50 million, you’d never keep it all in cash, or all in your checkbook, would you?  Of course not.  You’d buy a McMansion, with multiple bathrooms and a Jacuzzi or two.  You’d get a new sports car or three.  How about a vacation home in the Hamptons and box seats at the playoffs?  The point is, there’s only so much of your assets you’d want to hold as money.

If we want to avoid inflation, we must “grow” the money supply at the same rate we grow the economy.  That’s because the only way we can end up with the right amount of money if we start with too much is to reduce the value of what we have, and we do so by raising price levels.

Courtesy of ShadowStats.com

Money can be defined in many ways.  Here, we’ll just look at M1, the narrowest of the official measures.   In the graph above, M1’s light gray trajectory tells a dark and scary story: double-digit growth while the economy’s contracting.  Inflation, here we come.  Even worse may be the negative growth right before the recession.  Could this have caused or aggravated the economy’s severe downturn?

Why is M1 growing so fast?  Partly to help our economy out of the recession.  Mostly to monetize the debt as stimulus packages and automatic stabilizers[1] combine to create record deficit levels.  The Federal Reserve paid for some of our $1.42 trillion deficit by buying the addition IOUs our government had to issue.  How did it buy them?  It simply printed money.

Money is cheap to produce, but producing too much is costly in many other ways.  The world is losing faith in the “greenback”.  European allies, oil-producing nations, Chinese and Russians talk about moving away from the dollar and towards a “basket of currencies”.  Investors flee to commodities like gold and silver.  If the oil trade is conducted in “petro-euros” instead of “petro-dollars”, the flight from the dollar as the world’s reserve currency will accelerate. The Brazilian supermodel Giselle Bundchen has already announced that she will no longer accept payments in dollars, but only in Euros.  Ahead of the pack, she made this decision more than two years ago.

In June, US Treasury Secretary Timothy Geithner was laughed at in China when he sought to assure students that China’s investment of more than $800 billion in America was secure.  In November, when President Obama toured Asia, he got a surly lecture from the Chinese on the irresponsibility of the Administration’s growing deficits and the Fed’s loose monetary policy.  Imagine, a lecture to the bastion of capitalism from the largest foreign holder of our government debt, communist China. The U.S. can expect more lectures and more pressure to get our fiscal house in order from our unhappy Chinese banker.  They may be followed by a call that our “Chinese line of credit” is going to be cut.

The supply of dollars cannot continue its double-digit growth without inflation. In 1980, this resulted in prime mortgage interest rates of 20.5% and a very slow and sticky economy.  Thirty years later, we must be attentive to international  consequences of domestic inflation as well.    If other countries have more sober monetary policies, they can predict that the dollar will be worth less in the terms that matter most to them: their own currency.  And they will get rid of the dollar.  Or, rather, dollars: they’ve been holding roughly one-third of all American M1.

American consumption has been the growth engine not only for the United States but also for much of the rest of the world.  We have been consuming more than we produce, and our extra consumption has fueled world growth as we import more than we export.  Domestic investment hasn’t really suffered: the world has sent many of those dollars back to America by investing in us.  They’ve also kept interest rates on the government debt from rising by buying t-bills and government bonds.

The United States and the rest of the world are in this mess together. They need our consumption demand, we need their savings and investments. If  “In God We Can Trust” money loses the trust of other nations, its exchange rate will fall.  The cost of  imported goods will rise, and the carrying costs of our national debt, already the fourth biggest item in our spending, will climb right along with them. Foreigners will suffer exchange-rate losses in the value of all the assets they hold in American dollars. We’ll cut back on imports and they’ll cut back on investments and savings in the US.  We’ll hurt them, and they’ll hurt us.  It’s this mutuality that may prevent sudden calamity. It’s only the unexpected that causes the crashes. As long as people can predict this future, the changes will be gradual.  But the cumulative effect could be substantial – and negative for all concerned.

With this future so easy to see and so hard to stomach, why haven’t we already changed course?  The two main reasons are both based on the fact that the money supply is increasing too fast largely because we’re monetizing debt that’s also increasing too fast.

First, although the honest ways to reduce debt are to spend less and tax more, reducing the real debt by unexpected inflation has substantial, if sneaky and short-term, appeal.[2] Second, for years what’s been truly bipartisan is cowardice. Politicians never want to say no to special interests or yes to tax increases.  After all, special interests are key to re-election and the always-important campaign contributions, and tax increases enrage voters. So our representatives have been dodging the tough choices, settling for partial and temporary fixes to our deficits. “Kicking the can further down the road”, they hope our problems will somehow disappear. This is the kind of “magical thinking” psychiatrists characterize as “adolescent.”  Time to grow up.  Now.

[2]The stealth stops when people realize the game, anticipate inflation, and demand higher interests to compensate for the loss in purchasing power.