In 1819, England’s debt-to-GDP ratio reached 261%. Think about this number for a moment. And in particular, think about it through the prism of accepted economic wisdom today… It’s a reminder that when we focus on debt and deficits, we’re very distracted. It’s what we’re notthinking about that threatens us.
As an example of thinking the wrong things about debt and deficit, take Carmen Reinhart and Kenneth Rogoff, authors of This Time Is Different (which is the “Bible” of sorts for the debt- and deficit-obsessed)… According to their analysis, England’s gargantuan debt signaled looming economic and currency collapse for the global power. They claim that countries tend to tip toward decline once their debt/GDP ratios pass over the 100% line. England was, I repeat, at 261%.
Yet England’s economy soared in the 19th century. It was the country’s Golden Age. Good policy tends to have that kind of positive effect. England broadly pursued good ones. Rather than erect barriers to foreign goods and services, the political class shrunk them. Most notably, England abolished its Corn Laws in 1846 that had artificially propped up grain prices through barriers to foreign imports of the commodity. The economic impact of this wise policy decision was profound.
Indeed, when countries are open to the world’s plenty, it’s a sign that their people are availing themselves of the genius of divided labor. Most point to lower prices to make a case for free trade, but its greatest attribute is that it frees its beneficiaries to do the work that is most commensurate with their productive talents. The latter can be translated with “if you get to do what you do best, I’ll get to do what I do best.” Open country borders to goods and services elevate the workers on the open side whose enhanced production commands more abundance from outside the country. Raises and increased productivity beget more of the same.
After that, it cannot be stressed enough that investment is what powers economic growth – despite what consumption-focused economists tell you. And when investors put wealth to work, they are buying future currency income streams and future returns denominated in money. In England’s case, the pound was the world’s most trusted currency. The faith in the pound’s strength as a stable measure of value proved a magnet for devaluation-averse investors around the world, plus it arguably factored in England running up so much debt in the first place. (But that’s another column.)
For now, it should be said that whatever one’s views of government debt, it doesn’t automatically foretell economic and currency collapse. But what about Reinhart and Rogoff, some might ask? What about the 100% line? The answer is that it’s rather meaningless…
Economies aren’t singular machines turned on and off by central planners, rather they’re just collections of individuals. The individuals who comprise any economy tend to be better off economically when the penalties (taxes) levied on their work are low, when market forces as opposed to bureaucrats regulate their activities, when they’re actively dividing up work with individuals around the world (free trade), and when the money they earn in return for their work is not being devalued. Capitalism works… Freedom works… Insert your wise platitude here.
Quoting the great George Gilder on the matter, “History tells us that the threat to capitalism is not debt, but socialism.” What’s crucial about this is that currency devaluation is an embrace of socialism, and it’s one that England’s Chancellor of the Exchequer chose to avoid. The protection of the pound was a wise policy choice.
Which brings us to a brief but important digression into currency, or monetary policy. Economics would be much better understood by the various economic religions if congregation members grasped that no one exchanges money, is paid with it, invests with it, etc. Money is merely an agreement about value that facilitates the exchange of real things. It’s products for products when you, the reader, purchase a breakfast taco at Whataburger, a flat-screen TV at Best Buy, or a house in your favorite neighborhood. You’re exchanging your production, or the fruits of your labor, for food, appliances, and shelter.
The only thing is that most restaurants, retailers, and homeowners won’t accept your brilliance as a salesman, barista, or banker as payment for various market goods. The agreement about value that is money renders moot the previous problem. We work for “money,” but we’re really working for what money can be exchanged for. Just the same, we don’t save and invest “money” as much as we shift the economic resources that money can be exchanged for to others in return for more expansive resource access in the future when we choose saving and investment over immediate consumption.
All of which explains why currency devaluation is just another word for socialism. Paraphrasing the Robert Bartley quote that begins this piece, currency devaluation is wealth redistribution. Governments sometimes employ it to shrink the value of the debt they owe, or the cost of their spending in the first place. Sadly, the socialism doesn’t stop there. It redistributes wealth in society, too.
To see why, it’s useful to travel ahead in time almost exactly 100 years after England wisely chose to avoid socialism. Germany didn’t. It turns out policy matters…
In 1914, World War I began. That same year, German monetary officials decided to suspend the mark’s link to gold with an eye on sharing some of the war’s costs with the producers of armaments and other goods and services necessary to go to war. Arms producers (among others) would take a “haircut” for the alleged betterment of Germany. For those a bit slow on the uptake, German monetary officials chose to devalue the mark. It began slowly in the war years, only to pick up rapidly after the fighting ended.
Facing debt related to war costs, along with reparations owed to victor countries, Germany’s political class chose socialism. A massive devaluation of the mark began as a way of eviscerating all debts.
As Adam Fergusson explained it in his classic 1975 book, When Money Dies, the head of Germany’s Reichsbank (Dr. Rudolf Havenstein) held firmly to his view that rampant creation of marks “was unconnected with either price levels or exchange rates.” Germany owed, so it printed away its obligations. By 1923, $1 bought 4,200,000,000,000 units of Germany’s near-worthless currency. Which means German government debt was shifted to the people who suddenly saw their wealth vanish.
Germans who owned bonds and stocks that returned marks were wiped out so that the debts incurred by Germany’s political class could be erased via devaluation. As one German remarked about the evaporation of her savings…
A housewife who has had no experience of the horrors of currency depreciation has no idea what a blessing stable money is, and how glorious it is to be able to buy with the note in one’s purse the article one had intended to buy at the price one had intended to pay.
And the wealth redistribution didn’t just stop there…
When governments devalue, they don’t just shrink their own debts on the backs of businesses and citizens who see the value of their savings shrink. The massive tax that is devaluation also redirects precious capital away from investments in wealth that doesn’t yet exist (think stocks and bonds), and into wealth that already exists. Yes, socialism logically fosters economic stasis as savers and investors seek certainty over the progress that is a consequence of intrepid investing. Writing about post-WWI Germany, Fergusson noted that the citizenry sought to insure themselves against paper currency losses through the purchase of “assets which would maintain their value: houses, real estate, manufactured goods, raw materials and so forth.”
Germany’s tragic lurch toward redistributionist policies isn’t just useful as a way of explaining why currency devaluation is a particularly odious form of socialism. The story of post-WWI Germany is also useful as a reminder that devaluations don’t just happen. They’re not a consequence of debt/GDP ratios, sunspots, or anything else thought up by the philosophers who populate the economics profession. They’re a choice. Germany is instructive on the matter.
As Fergusson observed, Havenstein’s successor as Reichsbank president, Dr. Hjalmar Schacht, managed with U.S. support to transform “the German financial system from chaos to stability in less than a week” after waving the “magical wand of currency stability.” Monetary authorities who believed devaluation was the path to economic nirvana were replaced by individuals with an actual clue. Just as devaluation was a choice, so was a return to stable money. A focus on government debt as the catalyst for economic and currency collapse misses the point. U.S. history is instructive in this regard.
To see why, let’s now travel ahead in time to the U.S. in 1933, a little less than a decade after Germany’s tragic blunders. Franklin Delano Roosevelt had just replaced Herbert Hoover in the White House after Hoover chose policy that was inimical to economic growth. You guessed it! Taxes went up, so did regulation, and tariffs on 20,000-plus foreign goods were raised to record levels.
The problem was that rather than learn from Hoover’s mistakes, FDR doubled down on them while committing new ones. One of his most egregious occurred during his first year in office. It was a substantial dollar devaluation. A dollar formerly exchangeable for 1/20th of an ounce of gold would now be worth 1/35th. Government debt that had been soaring (FDR himself promised deficits of $7 billion-plus) would be shrunken by the president, and the bill would be left at the doorstep of American individuals and businesses, along with investors whose capital commitments are the drivers of growth.
Then Federal Reserve Chairman Eugene Meyer was so incensed by FDR’s decision that he resigned. Reinhart and Rogoff described what happened as “a restricting of nearly all the government’s domestic debt.”
No doubt some who should know better correlate soaring government debt with devaluation, but they’re mistaking causation. Sometimes governments choose socialism whereby they transfer their borrowing to workers, businesses, and savers. That’s devaluation in a nutshell. But what requires stress is that there’s no logical chronology that begins with debt incurrence and ends with socialistic devaluation.
We know this because U.S. federal debt soared well above 100% of GDP during WWII, but this in no way led to a falling greenback. In truth, U.S. Treasury officials traveled to Bretton Woods, New Hampshire in 1944 to participate in what became the Bretton Woods Agreement. The latter was a currency system that the dollar was at the center of. The dollar would be defined as 1/35th of a gold ounce, and currencies around the world would peg to the dollar. With massive amounts of debt to pay back as WWII was nearing its end, the U.S. chose currency stability over socialism. The post-war U.S. economy predictably boomed…
Which brings us to modern times. In 1980, total U.S. federal debt was $900 billion. At the same time, the 10-year Treasury note yielded 11%. Forty years later, total U.S. debt is $27 trillion-plus, but the 10-year yields just 0.9%. Translated for the half-asleep, the cost of borrowing for the U.S. has plummeted amid soaring total debt.
Despite how the dollar has endured stretches of weakness that had a Nixonian (Richard Nixon severed the dollar’s link to gold in 1971 – an explicit, economy-wrecking devaluation), 1970s quality to them (see Jimmy Carter, see George W. Bush), it remains the world’s de facto currency. This wouldn’t be true if the U.S. had chosen socialism, which is all currency devaluation is.
So while it’s accepted wisdom among self-styled “deficit hawks” that the bill for excessive government borrowing is inflation and recession, there’s really no “there” behind all the emotional ranting. More realistically, it’s much easier for governments to borrow if the country currency is trusted. Wait a second… what? That can’t be! Actually, it can. And it is. But that’s another column…
John Tamny is editor of RealClearMarkets