We hear today about "a race to the bottom" by central banks.
If you have bought gold coins, you probably expect to see them appreciate in relationship to the United States dollar. If not, then you at least expect the gold to appreciate in relationship to other assets that you might choose to buy in a time of price deflation. You assume that the value of the gold in relationship to other goods and services will still appreciate, even in a situation in which there might be falling consumer prices.
You may regard gold as a hedge against inflation. But if you expected the price of gold and all other commodities to fall, and you had the opportunity to convert the gold coins into dollar bills, you might consider doing this. That is because the value of other goods in relationship to dollar bills will be falling. This could actually happen in a time of massive bank failures. This is not just hypothetical.
If you held dollars, and other prices went down, you would certainly profit from this. Furthermore, you would not be subjected to any federal income tax, because the profits would not be in the form of an increased number of dollars. The profits would be in the form of an increased amount of goods and services that you could buy with your existing dollars. So, price deflation would be a tremendous benefit to you if you held dollars.
If it is a benefit for you as an investor to hold dollars in a time of price deflation, why would it be unwise for Americans in general to hold dollars rather than foreign currencies in a time in which the international value of foreign currencies is falling? When the dollar buys more foreign currencies as time passes, this is deflation (falling prices) for the items being purchased: foreign currencies. Why would it be a disadvantage for Americans if they are owners of dollars rather than foreign currencies if the foreign central banks continue to inflate?
We are now in a situation in which central banks around the world are expanding their holdings of government debt. They are doing this by creating money out of nothing. That is what central banks do. So, there is the so-called race to the bottom. All the nations are inflating, so that their exporters will not suffer from an appreciating currency. Central bankers regard appreciating currency as a disaster. They are mercantilists.
Yet we know that, as individuals, to hold onto an appreciating currency is a great thing. Why is it a great thing for individuals to hold an appreciating currency, yet it is also a good policy for a central bank to expand the money supply, so as to decrease the international value of the currency? There seems to be something wrong here. There seems to be cognitive dissonance.
What is good for an individual is good for the nation. If it is good for an individual to be the owner of an appreciating currency, then it is good for an entire nation to have an appreciating currency. How can we possibly say that it is a good thing for individuals to hang onto an appreciating currency, and at the same time say that the nation should instruct its central bank to inflate the currency, so as not to allow the currency to appreciate?
We live in a mercantilist era. Those few corporations and businesses that export to foreign nations want to see the value of the domestic currencies race to the bottom along with all the other currencies. In other words, they do not want free-market pricing. They want the central bank to intervene, so as to create price inflation, so as to drive down the international value of the domestic currency. So, what is good for individuals is supposedly bad for the nation as a whole. But what is the nation as a whole, other than the aggregate of all the individuals?
There is no question that we have entered into an era of competitive depreciation of national currencies. Historically, this has been called devaluation, but when there is a free market in money, the term devaluation is confusing. It sounds as though there is an overnight change in the exchange rate announced by government officials. Instead, the market establishes the exchange value of one currency to another. If both nations' central banks inflate at about same rate, there will tend to be approximately the same exchange rate over time. But in relationship to goods and services, the domestic currencies are depreciating.
When you hear somebody tell you that the dollar ought to fall in value, or least hold its own with other depreciating currencies, you are in the presence of a mercantilist. This is a person who probably would not buy gold coins. It is someone who thinks that monetary inflation, and therefore a little price inflation, is a good thing. He thinks so because it subsidizes the export sectors of the market. But it should be obvious, when we extrapolate from what is good for an individual American to what is good for most Americans, that the appreciation of the dollar in relation to foreign currencies is a positive thing. It indicates that the central bank is not inflating, and that central banks around the world are inflating. It means that the Federal Reserve is maintaining a sound dollar. A sound dollar is an appreciating dollar. But this is not how Congress thinks. This is also not how Federal Reserve economists think.
What matters most are not the exchange rates among currencies. What matters most are exchange rates domestically between the currency and other goods and services. You want to hold on to an appreciating asset domestically. If you like products that are produced abroad, you also like to have an appreciating currency domestically. Only exporters are upset with an appreciating currency, and very few people in the economy work for exporters.
I think the central banks of the world are now trapped. I do not think they can go back to anything like the conditions in 2007 or earlier without creating a huge recession. I really do think there is what appears to be a race to the bottom. I also think that, before the bottom is reached in industrial countries, central banks will cease inflating. That is when we will get the Great Default. But, for the moment, the race is on.
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