I’m pretty much an optimist when it comes to long term economic outlooks for the US. I assume that we will do what we need to do to be competitive in the world wide market. With any luck that will involve some things like implementing a flat tax, reducing the corporate tax, and going to a private social security plan. Yeah, I know, but I’m thinking really long term:-) Many countries have done these things, or are about to, especially eastern European countries.
In any case, Im pretty confidant that we will do what we need to in order to “Keep up with the Joneses.” I do have some worries though. No, it’s not about income disparity or environmental issues, it’s about monetary policy. There has not been a world wide monetary standard in a long time. All countries used to be on the gold standard, but I don’t think that there are any that do that now. It used to be that every denomination of currency was backed by a certain amount of gold (or silver). This means that the government could only print or circulate as much currency as it had in reserves. Today, we have what is called “Fiat” money, the government could print as much of it as it likes. The value of the currency is determined by simple(!) supply and demand. The more money the Fed puts into the system, the less any particular bill will be worth. The opposite is also true. The nice thing about the gold standard is that it restricted what the government could do with monetary policy. They couldn’t intentionally deflate the currency or even just screw it up. By having the currency backed by something, it limited the government’s impact and allowed the actual economy to do its thing.
Why does this matter? Since the entire world is using fiat money, it isn’t out of the realm of possibility to have a world wide currency crisis. If America’s dollar value really melts down, they are going to take a bunch of other countries with them. Many other countries have either pegged their currency to the dollar (like Yemen) or have just started to use US dollars as the local currency. Additionally, if the US dollar tanks, and I mean really tanks, we would no longer be able to afford the products from China or Europe. So their economies would feel it as well… We gotta hope that the Fed keeps their head and doesn’t allow that to happen…
There are a handful of practical issues with going back to the gold standard, not least of which is that the government doesn’t want to give up any control. Milton Freidman had some alternative ideas about stabilizing the currency. He suggested 100% reserve banking and an automatic, rules based mechanism (as opposed to using the discretion of the Federal Reserve) as possible remedies. I’m not really sure how they work, but he was pretty bright when it comes to things like this. In any case, I would eventually like to see some sort of stabilizing mechanism introduced. The recent weakness of the dollar brought this to my mind, I can only hope that our “leaders” get their financial act together before I really have to start worrying about monetary issues…