by Rep. Ron Paul, Texas
(Adapted from remarks from Congressman Paul on February 2, 1999, at the opening of the first session of the 106th Congress. This is part of a longer speech that can be obtained by contacting F.R.E.E. Foundation. Please see below.)
A huge financial bubble distorts the world financial markets. This bubble has been developing for a long time but has gotten much larger in the last couple of years. Understanding this issue is critical to the economic security of all Americans that we in Congress strive to protect.
Credit expansion is the root cause of all financial bubbles. Fiat monetary systems inevitably cause unsustainable economic expansion that results in recession and/or depression. Recession must always result, with the degree and duration determined by government fiscal policy and central bank monetary policy. If wages and prices are not allowed to adjust (as they do through the mechanism of recession), and the correction is thwarted by invigorated monetary expansion, new and sustained economic growth will be delayed or prevented.
Financial dislocations caused by central banks in various countries will differ one from another due to political perceptions, military considerations, and reserve currency status. The U.S.'s ability to inflate has been dramatically enhanced by other countries' willingness to absorb our inflated currency, our dollar being the reserve currency of the world. Foreign central banks now hold in reserve over $600 billion, an amount significantly greater than that held by our own Federal Reserve. Our economic and military power give us additional license to inflate our currency, thus delaying the inevitable correction inherent in a paper monetary system. But this not only prolongs the inevitable, it allows for a larger bubble to develop, further jeopardizing our future economy.
Because of the significance of the dollar to the world economy, our inflation and the dollar-generated bubble is much more dangerous than single-country inflations such as occurred in Mexico, Brazil, South Korea, Japan, and elsewhere. The significance of those inflations, however, cannot be dismissed.
When the Dow was at 6500, Federal Reserve Board Chairman Alan Greenspan cautioned the nation about "irrational exuberance," and for a day or two the markets were subdued. But while openly worrying about an unsustainable stock-market boom, he nevertheless accelerated the very credit expansion that threatened the market and created the "irrational exuberance" in the first place.
From the time Greenspan made this statement in December 1996 until December 1998, the money supply soared. Over $1 trillion of new money (as measured by M3) was created by the Federal Reserve. Another monetary measurement, MZM (a new statistical gimmick that is a combination of MI and M2), is currently increasing at a 20% rate. This generous dose of credit has sparked even more "irrational exuberance," which has taken the DOW to over 9000 for a 30% increase in just two years. (It is interesting to note that in 1998, when the foreign-registered corporation LTCM, with its massive $1 trillion speculation in the derivatives markets, was threatened by the market's demanding a logical correction to its own "exuberance," Greenspan and company quickly came to LTCM's rescue with an even greater acceleration of credit expansion.)
The pain of market discipline is never acceptable when compared to the pleasure of postponing hard decisions and enjoying for a while longer the short-term benefits gained by keeping the financial bubble inflated. But the day when it's realized that exporting our inflation is not without limits is fast approaching. That's when the markets and Congress will have to deal with an attack on the dollar. A hint of what can happen when the world gets tired of holding too many of our dollars was experienced in the dollar crisis of 1979-1980.
There is abundant evidence warning of the impending danger. According to Federal Reserve statistics, household debt reached 81% of personal income. For twenty years prior to 1985, household debt averaged around 50% of personal income. Between 1985 and 1998, due to generous Federal Reserve credit, confident American consumers increased their debt 81%; now it's even higher. At the same time, our savings rate has dropped to 0%.
Conviction that stock prices will continue to provide extra cash and confidence in the economy have fueled wild consumer spending and accumulation of personal debt. The home-refinance index between 1997 and 1999 increased 700%. Secondary mortgages are offered for up to 120% of a home equity, with many of these funds finding their way into the stock market. Generous credit and quasi-government agencies make these mortgage-markets robust, but a correction will come when it's realized that the builders and the lenders have gotten ahead of themselves.
The willingness of foreign entities to take and hold our dollars has generated a huge current-account deficit for the United States. It's expected the $200 billion annual deficit that we're running now will accelerate to over $300 billion in 1999, unless the financial bubble bursts first. This trend has made us the greatest international debtor in the world, with a negative net International asset position of more than $1.7 trillion. A significantly weakened dollar will play havoc when this bill comes due and foreign debt holders demand payment.
Contributing to the bubble and dollar strength has been the fact that, even though the dollar has problems, other currencies are even weaker and thus make the dollar look strong in comparison.
Budgetary figures are frequently stated in a falsely optimistic manner. In 1969, when there was a surplus of approximately $3 billion, the national debt went down approximately the same amount. In 1998, however, with a so-called "surplus" of $70 billion, the national debt went up $113 billion. Instead of future surpluses (which aren't really surpluses) running "forever," the deficits will rise with a weaker economy and as a result of congressional plans to increase welfare and warfare spending.
Current government propaganda promotes the false notion that inflation is no longer a problem. Nothing could be further from the truth. The dangerous financial bubble is a result of the Federal Reserve's deliberate policy of inflation. The Fed's argument that there is no inflation, according to government-concocted CPI figures, is made to justify a continuing policy of monetary inflation, because they are terrified of the consequence of deflation.
The Federal Reserve may sincerely believe maintaining the status quo, preventing price inflation, and delaying deflation are possible, which is not true. The most astute money manager cannot balance inflation against deflation as long as there is continued credit expansion. The system inevitably collapses, as it finally did in Japan in the 1990s.
Even the lack of CPI inflation as reported by the Federal Reserve is suspect. A CPI of all consumer items measured by a private source shows an approximate 400% increase in prices since 1970. Most Americans realize their dollars are buying less each year and no chance exists for the purchasing power of the dollar to go up. Just because prices for TVs and computers may go down, the cost of medicine, food, stocks, and entertainment certainly can rise rapidly.
One characteristic of an economy that suffers from a constantly debased currency is sluggish or diminished growth in real income. In spite of our grand economic recovery, two-thirds of our U.S. workers have had stagnant or failing wages for the past 25 years. The demands for poverty relief from government agencies continues to increase. Last year alone, 678,000 jobs were lost due to downsizing. The new service-sector jobs found by many of those laid off rarely pay as well.
In the last year and a half, various countries have been hit hard with deflationary pressures. In spite of the IMF-led bailouts of nearly $200 billion, the danger of a world-wide depression remains. Even with the extra dollars sent to them courtesy of the American taxpayer, all countries hit experienced devaluation and significant price inflation in their home currency. Although helpful to banks lending overseas, these bailout efforts have clearly failed. It has cost a lot of money, and has prevented the true market correction of liquidation of bad debt that must eventually come. The longer the delay and the more dollars used, the greater the threat to the dollar down the road.
There are good reasons why we in the Congress should be concerned. A dollar crisis is an economic crisis that will threaten the standard of living for many Americans. An economic crisis frequently leads to political crisis -- this is now occurring in Indonesia.
Congress is responsible for the value of the dollar, and yet, as we have too often done in other areas, we have passed this responsibility to someone else -- in this case, the Federal Reserve.
The Constitution is clear that the Congress has responsibility for guaranteeing the value of the currency. No authority has ever been given to create a central bank. Creating money out of thin air is counterfeiting, even when done by a bank that the Congress tolerates.
With its own insatiable desire to spend money and perpetuate a welfare and military state, it is easy to see why Congress cooperates with such a system. A national debt of $5.6 trillion could not have developed without a Federal Reserve willing to monetize this debt and provide artificially low interest rates.
When the dollar crisis hits, and it becomes painfully evident that the short-term benefits weren't worth it, we will be forced to consider monetary reform. Reconsidering the directives given us in the Constitution with regard to money would go a long way toward developing a sound monetary system that best protects our economy and guides us away from casually going to war. Monetary reform is something that we ought to be thinking about -- now.
by Rep. Ron Paul, Texas
March 25, 1999
About the F.R.E.E. Foundation
The Foundation for Rational Economics and Education, Inc. is a 501 (c)(3) tax-exempt public foundation dedicated to individual liberty and free-market economics. It was founded by Congressman Ron Paul of Texas and publishes his Freedom Report. For more information, or to make a tax-deductible donation write: F.R.E.E., Inc., P.O. Box 1776, Lake Jackson, Texas 77566, or call 409-265-3034.