What Is It About a Stable Dollar That Paul Krugman Doesn't Understand?

Liberals don't seem to favor the Republican Party platform calling for the establishment of a commission to study "possible ways to set a fixed value for the dollar." Over the last 41 years we have had a discretionary monetary system favored by progressives, but the results haven't been pretty.

Louis Woodhill
8/29/2012 @ 5:32PM

It’s not surprising that liberals are apoplectic over a provision in the draft Republican Party platform calling for the establishment of a commission to study “possible ways to set a fixed value for the dollar”. After all, this amounts to a “right to life” plank for the dollar, the economy, and the American middle class.

We have now had the discretionary monetary system that the progressives advocate for 41 years. We have seen the results. The numbers aren’t pretty.

During the 180 years that we had one form or another of “a fixed value for the dollar” (1790 – 1970), the U.S. economy grew at an average annual real rate of 3.94%. During the past 41 years of fiat money (1970 – 2011), our real GDP grew at 2.81%.

The difference between these two growth rates is staggering.

If the U.S. economy had continued to expand at 3.94% real over the past 41 years, 2011 GDP would have been $23.6 trillion, 56% higher than it actually was. Our economy would have been more than three times as big as China’s, rather than just over twice as large. And, at the same level of spending, the federal government would have run a $0.5 trillion budget surplus, instead of a $1.3 trillion deficit.

On the other hand, if our real GDP had grown at our fiat-dollar 2.81% annual rate for all 221 years, 2011 GDP would have been only $2.1 trillion, or about a quarter of the size of China’s economy.

But wait, there’s more.

Progressives don’t just want a fiat dollar, they want a weak dollar. Liberal economists believe that “a falling currency boosts exports”. Both Bush 43 and Obama bought into this notion, and ran “weak dollar” policies. During the first 11 years of the Bush 43 – Obama era, the dollar lost 81% of its value in terms of gold.

How has this been working for us?

Real economic growth during the 11 Bush 43/Obama years (2000 – 2011) averaged 1.57%. If the U.S. had grown at this meager rate its entire history, 2011 GDP would have been only $144 billion, and America would be begging for foreign aid from Somalia and the Sudan.

Given the numbers, which are available to anyone via a few mouse clicks, it is truly bizarre that anyone can be in favor of a weak dollar.

The Bureau of Economic Analysis (BEA) publishes quarterly GDP numbers going back to 1950. Since then, there have been six presidential terms with a falling dollar (the value of the dollar was down by more than 10% against gold), one with a rising dollar (up by more than 10% against gold), and eight with a stable dollar. Here are the average real GDP growth rates for those periods:

Rising dollar: 3.21%

Stable dollar: 3.58%

Falling dollar: 2.23%

What is it about these numbers that Paul Krugman does not understand?

Progressives decry “rising inequality”, but the data shows that it was breaking the link between the dollar and gold that caused the rising income inequality that we have seen over the past 40 years.

From the end of WWII to 1973, “real GDP per worker” and the “real weekly wages of production and non-supervisory workers” rose in lockstep. If you graph the two lines, there is a sharp inflection point at 1973. From that point on, real GDP per worker continued to rise (albeit more slowly than before), but real wages declined.

What happened in 1973? Having abrogated the Bretton Woods gold standard system in 1971, in 1973 President Nixon abandoned the pretext that the suspension of gold convertibility was “only temporary”. And, at that point, nations went to fully floating exchange rates.

How does a fiat dollar suppress economic growth and increase income inequality? It does so by creating an additional risk for those considering investing capital in the real economy.

For the past 60 years, the U.S. economy has reliably produced $0.07 of GDP per dollar of residential assets, and $0.46 of GDP per dollar of nonresidential assets. If business invests $200,000 in nonresidential assets, GDP will go up by $92,000 per year, and one average job will be created.

Our weak, unstable dollar has made fools of everyone that invested capital to create jobs during the past 11 years. At the end of 2011, the people who simply bought gold in 2000 were sitting on an average annual compounded return of 17.0%. They more than quintupled their money. There are very, very few investments in productive assets that matched gold during this period.

The progressive economists mocking the idea of a return to stable money must think that investors haven’t noticed that they would have been better off putting their capital into gold.

Higher risks for capital investment result in a higher required return on capital. Capital and labor basically split the sales dollar. If the cost of capital goes up, workers must either accept lower wages, or lose their jobs and get no wages.

During the Bush 43/Obama weak dollar era, workers have gotten some of both: falling real wages combined with a true unemployment rate (adjusted for falling labor force participation) of 11.2% (July 2012).

Unstable money worsens the problem that Austrian economists call “malinvestment”. Malinvestment occurs when, deceived by the price distortions caused by unstable money, businesses invest in the wrong assets.

One massive example of malinvestment was the housing bubble that occurred during 2004 – 2006. Hundreds of billions of dollars of capital was spent to build housing units that now stand empty. If this money had been invested in appropriate nonresidential assets, that capital would have produced hundreds of billions of dollars of real GDP and millions of jobs.

Quantitatively, the malinvestment problem shows up in “Line 43: Real holding gains or losses” of “Table 5.9. Changes in Net Stock of Produced Assets”, which is published by the BEA once a year.

During the Bretton Woods gold standard period, the yearly real gains and losses (as a percent of GDP) ranged from +4.00% to -5.46%.

The move to a fiat dollar made real asset values much less stable. Over the past 40 years, the yearly real gains and losses have ranged from +11.42% of GDP to -11.79% of GDP.

Obviously this kind of chaos is discouraging to people and businesses looking to invest in the real economy.

And, speaking of chaos, our fiat dollar has spawned “the chaos industry”. The economy has tried to adapt to unstable money by creating a profusion of complex financial futures and derivatives, the deep purpose of which is to try to spread the pain caused by a fluctuating dollar. Collectively, these instruments provide a type of insurance.

As we saw in 2008, futures and derivatives can create problems of their own. The truth is that it is not possible to have a stable economy and stable financial markets without a stable dollar. No amount of regulation can substitute for stable money.

However, the economy’s attempt to cope with an unstable, fiat dollar has had the side effect of transferring 4% of GDP, or about $600 billion a year, from workers (“the 99%”) to the chaos industry (“the 1%”). This phenomenon has been a huge contributor to rising income inequality over the past 40 years.

Get a grip, liberal economists, and get out of the way. “A fixed value for the dollar” has become a matter of economic life and death for the American middle class.

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