Obama has defended the Fed's use of quantitative easing to inject liquidity into the US economy1. This process involves the Fed creating money which is backed by no assets and using it to purchase government debt from private banks, who hopefully lend the money at low interest rates for domestic investment, creating jobs and stimulating the economy. The Fed, with a government appointed chairman and board of directors, monetizes the government's debt, and in the process the government funds its own spending with money that was created “out of thin air.” Therefore, the benefits of inflation accrue entirely in the hands of the government at the expense of the holders of the government's currency and debt, since there is an increased supply of currency in relation to the assets which back up that currency and the purchasing power of that currency goes down.
The international acceptability of the US dollar as a medium of exchange has resulted in its use as a reserve currency, an anchor currency, and even as an official currency in some countries. In addition, the US government's bonds are considered one of the most secure investments on the market. Universal ownership of US currency and debt means that these notes are backed by foreign-owned assets as well as Americans' assets, which allows the Fed to effectively mobilize the resources of non-citizens in order to make improvements inside the country. A large portion of the loss of US purchasing power is offset onto other currencies and economies, and as a result the US economy is able to realize a net gain from inflation. The removal of the US dollar's convertibility to gold has thankfully allowed for flexibility and autonomy of monetary policy in dealing with temporary crises, but if the Fed continues to rely on inflation to stimulate the economy, an increasingly vigilant and adaptive financial system will reduce the benefits of this policy. *As the international use and acceptability of US currency is a result of its stable exchange rate and the US economy's capital mobility and security, the US government must surrender some of its autonomy to manipulate its currency by removing the Fed's central banking privileges and moving to a currency that is fully backed by assets if it wishes to remain market leader as the top currency. Otherwise, increased fear of inflation will drive the international market to look for inflation protected investments or even to switch to more solidly backed reserve currencies, and the US economy will cease to benefit much from inflation.
As a result of globalization, networking, and interconnectedness, competition among currencies is increasing, and the reduced transactions costs provided by computers and the internet would allow investors to flee from the dollar quickly and efficiently in case of any lack of confidence in the stability of the exchange rate. In an ongoing process called currency deterritorialization, national currency systems have been unable to maintain a monopoly of money use within a territory2. Typically, this takes the form of currency followership, in which a country with a weak national currency adopts a stronger, more internationally acceptable national currency, such as the US dollar or the Euro. There are, however, also examples of interpenetration by complementary currencies such as elderly “caring relationship tickets” in Japan3 and business to business credit in Latin America4, which is modeled after the Swiss Wir bank. Due to the fact that "currency choice is becoming less restricted, and cross-border competition is once again becoming the rule,"5 the American government must maintain anti-inflationary monetary policy if it wishes to keep the advantages that are provided by the current universal acceptability of the US dollar.
This will not always be the case, however, if America enacts policies which decrease confidence in the value of the dollar and upset the international community enough to evoke a reaction, as consistent inflationary monetary policy would cause a flight from the US dollar. The German finance minister and other foreign leaders have rebuked America for its policy of quantitative easing, calling it currency manipulation6. This is a problem due to the fact that “no government can afford to ignore the preferences of market actors when reckoning how to finance its expenditures."7 While Fed Chairman Ben Bernanke has assured the international community that he will not let US inflation rise above normal levels, there are still doubts about whether inflation can be capped at 2% if it becomes a tool that the government relies on to fund its spending8. America must not inflate the money supply if it wishes to control a top currency, which requires low inflation and capital certainty9.
There have already been market signals indicating doubt regarding the stability of the US dollar's exchange rate. Some investors believe that there will be so much inflation that they have begun to buy Treasury Inflation-Protected Securities (TRIPS) at a negative rate of return10. The increased responsiveness of financial markets has decreased the benefits of inflation, as "changes in central-bank policy are almost immediately priced by exchange rates and interest rates"11.
In addition to financial tools which protect investments from inflation, fractional reserve banking has also diminished the government's revenue from inflation. The private banks use their leverage to create much more bank credit than what was added to the currency supply, and as a result inflation benefits private banks the most, which have the choice not to lend the money domestically or to simply increase their currency reserves, resulting in a liquidity trap. One possible policy option is for the US government to significantly raise the reserve requirements for banks, allowing it to gain more revenue from inflation, but such a sweeping reform would be difficult for banks to implement since they have such low reserve requirements at the moment12.
In order for the US dollar to remain the top reserve currency, and for the US government to retain the advantages of being market leader, the US dollar must be fully backed by some sort of asset13. It is wise to reject a return to gold convertibility since this would severely limit the amount of money, credit, and trade (in the absence of free banking), yet there must be some sort of collateral that secures the US dollar note if it wishes to maintain a stable exchange rate and international acceptability. This structural change would involve severely limiting the Fed's flexibility in directing monetary policy, but it would allow the US government to retain the advantages of being top currency.
In the long run, it is possible that the government's currency manipulation would drive financial markets to a supranational or de-nationalized currency14. Increased financial instability and uncertainty among nation states might increase the demand for a noninflationary reserve currency, which would be provided by a privately-issued currency that is fully backed by assets. From the perspective of international investors, it would be a wise policy to reduce reliance on the US dollar, which has the potential to be inflated and manipulated without sufficient restrictions. There is already a proposal for a “trade reference currency” called the Terra that is backed by a basket of the twelve most traded products and can be converted by request15. This would ensure a stable exchange rate and international acceptability with sufficient market penetration. Whether the markets go to a privately-issued or a nationally-issued currency, flight is the inevitable result of abusive monetary policy.
Increasing deterritorialization and competition among currencies will force governments to maintain a noninflationary monetary policy if they wish to retain their currency's international acceptability. Currency regionalization has often been proposed, but the international financial market needs an increased number of currencies rather than currency contraction to maintain flexibility. The reduced transactions costs of economies of scale do not reduce the need for increased currency competition, which prevents inflation and manipulation by currency providers16. Regionalization is unwise on a global scale because it would result in the centralization of currency control, and such a monopoly or oligopoly would allow for increased private gain at the public's expense.
As a result of the US government's policy of increasing the money supply, the international community should recognize the downsides of centralized currency control and increase its use of complementary currencies, providing competition which would deprive the US government of its hegemonic privileges and force it to maintain a stricter monetary policy. For the US dollar to remain market leader in the increasingly globalized world, the creation of US currency must be accompanied by a corresponding increase of goods and services in the US economy. Barring a major change in the basis of the US dollar, international actors should search for a more secure reserve currency. Instead of amassing US dollars to provide liquidity, international actors should encourage free banking and private issuance of money and credit. Governments should remove the legal tender privileges from their currencies and begin accepting alternative currencies in the payment of taxes. Public receivability of complementary currency, as is being experimented with in Uruguay, will increase currency competition, which is already accelerating rapidly as a result of digitalization. A larger number of acceptable currencies will provide macroeconomic flexibility and reduce reliance on the US dollar so that crises in the US economy do not universally restrict lending and damage purchasing power.
1Neil Irwin, “Obama defends Federal Reserve's $600 billion bid to boost economic recovery,” The Washington Post (http://www.washingtonpost.com/wp-dyn/content/article/2010/11/08/AR2010110806587.html, 2010).
2Benjamin J. Cohen, The Future of Money (New Jersey: Princeton University Press, 2004), 8.
3Bernard Lietaer, “Complementary Currencies in Japan Today,” International Journal of Community Currency Research, Vol. 8 (http://www.lietaer.com/2010/01/complementary-currencies-in-japan-today/, 2010), 5.
4Bernard Lietaer, “Commercial Credit Circuit (C3)” (http://www.lietaer.com/2010/01/commercial-credit-system-a-financial-innovation-2008/, 2010), 1.
5Benjamin J. Cohen, The Future of Money, 8.
6Howard Schneider and William Branigin, “As Obama arrives in Seoul, Fed decision clouds G-20 debate,” Washington Post (http://www.washingtonpost.com/wp-dyn/content/article/2010/11/09/AR2010110907512.html, 2010).
7Benjamin J. Cohen, The Future of Money, 22.
8Neil Irwin, “After big move, Fed looks in the mirror,” Washignton Post (http://www.washingtonpost.com/wp-dyn/content/article/2010/11/06/AR2010110604006.html, 2010).
9Benjamin J. Cohen, The Future of Money, 67.
10Christine Hauser, “In bond frenzy, investors bet on inflation,” The New York Times (http://www.nytimes.com/2010/10/26/business/26bond.html?_r=1&ref=todayspaper, 2010).
11Jeffrey Rogers Hummel, “Government's diminishing benefits from inflation,” The Freeman (http://www.thefreemanonline.org/featured/government%E2%80%99s-diminishing-benefits-from-inflation/, 2010).
12Jeffrey Rogers Hummel, “Government's diminishing benefits from inflation.”
13Clarence B. Carson, “Built-in pressures to inflation,” The Freeman (http://www.thefreemanonline.org/featured/built-in-pressures-to-inflation/, 1976).
14Benjamin J. Cohen, The Future of Money, 30.
15Bernard Lietaer, “The Terra TRC White Paper” (http://www.lietaer.com/2010/01/terra/, 2010), 5.
16Benjamin J. Cohen, The Future of Money, 51.
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