Why Study Economic Theory & History?

Thursday 9/27/12

Tonight I read some in “Basic Economics” by Thomas Sowell as I sipped some chai tea as a way to wind down from a long and exhausting day of studying Greek grammar.  I had logged about 14 hours the last two days on Greek and I often find that reading something completely different – political philosophy, economics, or history – helps revive me.

I purchased “Basic Economics” this summer, but I had my eye on it for some time.  Sowell is an excellent and accurate economist who is able to state complex economic theories, concepts, and models in everyday, ordinary language that the common person and non-economist like me can understand and make sense of.  I’m in Part V of the book that talks about the national economy, and specifically chapter 16 on the money and banking system.  I’ve been reading about inflation, its causes and effects, and it has been eye-opening and very timely.

Inflation is a general rise in prices (p. 389), which means that goods are in higher demand than supply.  The more money in a given national economy, the higher the prices of goods.  This correlation has been well documented and is not disputed (increase money supply, higher prices; decrease money supply, lower prices).  Gold and other precious metals have often been the currency used by nations because its supply is limited and it cannot be easily manufactured.  So gold acts as a restraint on governments that would seek to increase the money supply in order to spend more.  As Sowell puts it, gold “is a way of depriving governments of the power to expand the money supply to inflationary levels” (p. 390).

We often hear about how the American dollar used to be “backed up” by gold (which it no longer is).  This type of language can be deceiving because it causes us to think that the value of gold is somehow transferrable to the dollar, which it is not.  The value of having gold back a paper currency is that gold limits the amount of paper money that can be printed and circulated.  The U.S. dollar came off a 100% backed gold standard in 1913 when the Federal Reserve Bank (U.S. Central Bank) was created under the Wilson administration.  Since then, the dollar has been increasingly backed by less and less gold: first by FDR in 1933, and then finally the gold-backed dollar was ended in 1971 under President Nixon.  Since that time the dollar has not been redeemable for any precious metal; the only thing giving it value is the trust placed in it by American citizens and people around the world.  Today the dollar is worth only 2% of what it was worth in 1913; in other words, it has lost 98% of its value.  This is why we stand amazed when we hear our parents or grandparents talk about filling up their car’s gas tank for 50 cents back in the day.  This is also why it is so critically important that we maintain a strong dollar and high credit score, otherwise when Americans or citizens of other nations lose faith in the purchasing power of the dollar, our currency will crash and we’ll find ourselves with worthless greenbacks.  Then it’s back to bartering (which has been witnessed in Latin American countries in the 21st century) until a new money system can be set up.

One of the best indicators of inflation in any given society is the price of gold.  During the economic crisis in the 1980s, the price of gold in the United States rose to $800 an ounce (p. 392).  When this crisis passed, gold fell back to $250 an ounce during the 1990s.  Today, the price of gold is more than $1,735 an ounce.  This is a sure sign that we are currently experiencing a high level of inflation.

What’s the big deal with inflation, you say?  Well, not only does inflation increase prices, but it devalues the currency, which means it loses purchasing power.  This necessitates that you have more money in your bank account or in your wallet in order to make the same purchase on the same kind and quality goods as before.  Governments often turn to inflating the money supply in an effort to squeeze more bang out of every buck, and they prefer this to taxation, which is very unpopular with the general public.  However, what most people do not realize is that inflation of the money supply by a government (via printing or borrowing money) is hurting them just as much as if the government levied a high tax.  Frankly put, inflation is theft.  Sowell states, “inflation is in effect a hidden tax.  The money that people have saved is robbed of part of its purchasing power, which is quietly transferred to the government that issues new money” (p. 393).  Today we see this happening before our very eyes: the U.S. government borrows billions of dollars a year from China and Japan, and has engaged in what’s called “quantitative easing” where the government prints money and buys assets in a certain market in the hopes of driving down interest rates and sparking people’s desire to invest in that market in order to revive it.  The third round of quantitative easing was announced this month (September 2012) by the Federal Reserve overseen by Chairmen Ben Bernanke.  Unbeknownst to you, the federal government just stole part of the value and purchasing power of your hard-earned money without your consent.

The other problem with inflation as a hidden tax is that it is broad-based and unequal.  Inflation transfers wealth from everyone who has money to those who have less money.  From a simplistic and uninformed view, this might seem like a good thing.  However, the rich aren’t stupid; they have invested their money in stocks and bonds, real estate, and other assets that rise in value as inflation rises.  Thus, they escape this transfer of money and become wealthier while the poorer classes who are unable to invest in such ways suffer.

History has many examples of the negative impact that inflation creates.  In Russia after WWI, the Russian government issued lots of currency, so much so that by 1921 prices had risen to thousands of times that of their pre-war 1913 levels (much of this was due to the war itself as inflation is a natural by-product of wars.  Governments would rather inflate the money supply to pay for a war than tax the citizens.  This is happening currently with the Iraq and Afghanistan wars).  Again in Russia in 1991, during the fall of the USSR, the value of the ruble plunged – due to both increased money supply and rapid circulation – so that people were using it as wallpaper and toilet paper because it was so worthless.  When a currency reaches this dilapidated state, people spend it as quickly as possible because they know its value won’t last long and they don’t want to be stuck with worthless money.  (Examples taken from p. 394).

One of the most striking and frightening examples of the result of inflation occurred in Germany during the interwar years.  A government known as the Weimar Republic, which lasted from 1919-1933, oversaw the recovering German nation.  It pursued an inflationary monetary policy which saw the mark’s value spiral out of control: “40 marks were worth one dollar in July 1920 but it took more than 4 trillion marks to be worth one dollar by November 1923.  People discovered that their life’s savings were not enough to buy a pack of cigarettes” (395).  By printing vast amounts of money (sound familiar?) the German government essentially stole everything of value that the German people owned.  Such a monetary disaster leads to chaos in a society, and it would not be an overstatement to say that the German people were desperate.  And we all know what happened next.  A persuasive, dominant, and narcissistic individual by the name of Adolf Hitler rose to power and became chancellor of Germany in 1933.  World War II began six years later.  While many factors played a role in Hitler’s rise to power, it is very plausible and almost certain that the economic chaos and insecurity from the 1920s played a major role.  It is also possible that the German people were willing to accept such an extreme and dangerous ruler like Hitler because he offered security, leadership, and the promise of revival when the world seemed to be falling apart.

I am deeply concerned that America might one day soon find herself in a similar situation.  I’m not saying that another Hitler will arise out of our midst, but if we fail to understand economic theory and monetary policy, and we doubly fail to study recent history of nations where foolish economic and inflationary models were pursued, we could easily become the next Weimar Republic, Zimbabwe, or Russia.  Our government has showed little will or ability to enact prudent and responsible monetary and fiscal policies, but has instead resorted to deficit spending, increased welfare entitlements, numerous wars, and so much more.  Annual deficits have surged under President Obama to over $1 trillion a year, more than $500 billion more than the highest deficit under President Bush (which was still way too high).  The national debt has leaped to over $15 trillion dollars and the unfunded liabilities of Social Security, Medicare, and Medicaid surpass $200 trillion.  This is ridiculous and simply unsustainable.  One day soon it will all come crashing down and the American people who have worked so hard, saved much, and invested in businesses and families, will have it all ripped out from underneath them and find it worthless.  This will result in economic chaos, which could easily lead to a charismatic, domineering, and totalitarian leader rising to take control (of course with the justification of a “national emergency”).  This is not some far-flung conspiracy theory on my part; this is 20th century history.  And those who fail to learn from history are destined to repeat it.

Please do yourself and your country a favor: read about history, economics, and political philosophy; find out what it means to be an American and what values our country was founded on (fiscal responsibility was one of them); and educate those around you and become politically involved in constructive ways that will change people’s minds and force our elected representatives in Washington to do something meaningful to prevent a monetary and economic collapse, which would likely be the end of our country as we know it.

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