By Cam Mather
Contrary to the impression I might have given you with my last blog post, I don’t actually watch TV all of the time. I’ve finally had some time to get caught up on reading because the garden is under snow. It’s one of my favourite parts of winter and the holidays. While the rest of my family were reading novels I stuck with non-fiction including “Currency Wars” by James Rickards and “The Ascent of Money” by Niall Ferguson. I’ve been anxious to read these books because I’ve spent so much time lately thinking about the reality of the U.S. Dollar. The U.S. dollar is a “fiat” currency meaning it’s not backed by gold. It simply has value because the government says it does. As long as people believe this to be the case all is well. If, at some point, people suspect that it is no longer holding its value, well, that could have disastrous consequences.
Exciting stuff I know, but this is how my brain works. Oh sure, I think about other important stuff, like whether or not those hoarders I saw on A&E last night let the crap pile back up in their living room once the TV crews left, but a lot of what I think about right now is related to paper dollars. And I’m not just thinking about how I wish I had more of them.
In 1971 the Dow Jones Industrial Average was about 900. Today it’s about 12,000. In 1930 it was around 200, so it took 40 years to go from 200 to 900. But then in the next 40 years it got 12 times bigger.
So what happened? What am I missing? Sure the world population and the U.S. population grew, and along with it the world economy, but it just seems too big a leap. It seems even more implausible since the 1970s was kind of the beginning of the end of the middle class, manufacturing job dream. This is when Bruce Springsteen started singing about the tough times in the industrial north. And Billy Joel sang “Yea we’re waiting here in Allentown, where they’re closing all the factories down, out in Bethlehem they’re killing time, filling out forms, standing in line…”
In the past the U.S. dollar was desired around the world because of the strength of the U.S. economy, in particular its manufacturing. Americans made stuff. Good stuff. Great stuff. But then people in power allowed those corporations to chase the lowest cost labor and today we have a U.S. economy that’s 70% consumption. So the economy is based on people buying stuff and less and less on people making stuff.
In 1971 the U.S. dollar was still theoretically convertible to gold. So if another country had an I.O.U. from the U.S. it could ask for it in gold. But then Richard Nixon took the U.S. Dollar off the gold standard and said it would have value because he said it did. And if you wanted to trade oil, you needed U.S. dollars to do it. Now there was really nothing behind the U.S. dollar.
This was also the time when the U.S. Federal Reserve seemed to discover the printing press. Around this time the U.S. money supply was about a trillion dollars. In 2006 it had risen to 12 trillion. So did the U.S. economy grow 12 times bigger? Certainly its manufacturing sector, the sector that created decent high paying jobs didn’t. It shrank. Then in 2006 the Fed stopped publishing the M-3, which is the broadest definition of money supply. They still provide the M-1, which doesn’t include bank reserves, and the M2, which represents money and “close substitutes” for money, but not the M-3.
That makes me kind of suspicious. In the world of economics it is important to know how much money is floating around out there. It kind of affects everything, including inflation. Back in the 1970s when the Fed started printing money, they still needed a printing press. Today, can you image how easy it would be for them to create money? Just a few keystrokes. So really, how could you not be tempted to just create money out of thin air? Every government that ever could, has done just that.
So if you look back at the Dow graph which went up in value about 12 times at the same time that the money supply was growing by about 12 times, you’ve got to wonder, what’s behind it all? If the government was just creating money out of thin air, and it was ending up in people’s hands, they had to do something with it, and putting it in the stock market so it could grow would be a logical place. Back in 1896 Charles Dow created his index to include the largest “industrial” companies. These would have been companies that make stuff.
Now it includes American Express, Bank of America, The Home Depot, McDonalds, Wal-Mart and Walt Disney. These are just part of the consumer economy where people spend money on stuff as opposed to making stuff.
So I think the reason the Dow Jones is at 12,000 is because there was a massive inflow of liquidity to the market in the form of dollars that were created out of thin air. Like magic. And I think the incredibly great lifestyles many of us have been experiencing for the last 30 years have been an illusion. Someone just rubbed a magic lantern and we all ended up with monopoly money that we’ve been spending on “stuff” made in other countries. But I think a day of reckoning is coming. And I think when enough people realize that the emperor of the U.S. Dollar has no clothes; we will experience a jarring return to reality. A return to an economy where people make stuff and trade with other people who make stuff. But to get to that point there will be a pretty stark downsizing and a realignment of how the world works.
The people best positioned to handle this new world will be those who have the skills to make stuff, and grow stuff. Pushing pixels around a computer screen won’t make it anymore.
It will be a very difficult transition for many people. There will a massive reduction in all our wealth and people will be dazed and confused and depressed and frustrated about it. But there will only be one way out, and that’s when we all get back to making and trading stuff we make ourselves. How we exchange these goods may be based on something like a dollar, but it will have a much different definition than it has now. Many of us will want to trade with precious metals like gold and silver, which have always been used as money. Ultimately every paper currency returns to some reality based on its relationship to these precious metals.
I think of these things as I cut kindling to sell at the hardware store in town, or dig trees from my property to sell, or grow garlic and vegetables to sell. I’m not getting rich. In fact, my time would be far better spent chasing those paper dollars on my computer. But garlic and potatoes and firewood and kindling are all things that I can touch and feel and when I sell them I know I have added value to someone else’s life. I’ve filled their stomach and given their body fuel or helped make their house warmer.
I could be crazy. Economists will dispute my perception of the money supply and the massive ponzi scheme that’s resulted from creating dollar bills out of thin air with no relevance to any traditional definition of real economic activity. And I’m OK with that. Even if I’m wrong, turning some sun and rain and seed garlic into hundreds of pounds of garlic to sell is all I need to stay sane.