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The golden rule of fiscal discipline

The solution to the looming federal funding crisis could hardly be simpler. America has a credit card. What it sorely needs is a debit card.

Imagine a super-premium platinum credit card with no preset spending limits; no membership fee; low, low interest rates; and no requirement ever to repay the outstanding balance. You spend to your heart’s content, the only limit being a statutory debt ceiling that Congress dutifully raises whenever you bump up against it.

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In monetary jargon, this magic credit card is the “reserve currency” privilege, and it belongs to the United States. Among the nations of the world, we alone pay our bills in the currency that only we may lawfully print. This prerogative is ours because the dollar is the king of currencies. We spend as we do because our dollar enables us.

Before the dollar, the British pound ruled the monetary roost. From Waterloo to the Great Depression, it was the world’s money. But the holders of sterling had to trust only so far. If they didn’t like the looks of British finances, they could exchange their pound notes for the gold coins that stood behind them. There were only so many notes, because there was only so much gold.

It’s easy to forget that the dollar, too, was once convertible into something besides nickels, dimes and quarters. From Alexander Hamilton until Richard Nixon, with a long time out for the Civil War, American money was defined as a weight of precious metal. Present a wad of bills to the Treasury and you got gold or silver at the lawful rate. To the Founders, and generations of conservative financiers who followed, the logic of convertibility was self-evident. An improvident government could simply print paper currencies. Gold and silver you had to dig up out of the ground.

It’s the digging that jars modern sensibilities. There’s no need for it, the PhDs argue. Let the Federal Reserve print — or conjure or whatever — the mathematically correct volume of dollars, and noninflationary prosperity will be ours.

Here’s how it works without the digging: Americans buy more from abroad than we sell abroad. We have for all but two of the past 39 years. We pay in dollars — but we don’t really pay. We send dollars west to our Asian creditors. Our creditors obligingly send those dollars back east in the shape of investments in U.S. Treasury bonds. It’s as if the money never left the 50 states. Nobody forces our creditors to hoard dollars, of course — they have their own reasons. But in so hoarding, they goad congressional incontinence. “Deficits without tears,” the French economist Jacques Rueff called these seductive arrangements.

Under the gold standard, a deficit country pays its bills in coins, bars and ingots. It holds no magic credit card but instead operates with a kind of debit card. The gold it remits to its creditors is gone. The loss may or may not elicit tears — by making the necessary economic adjustments, a deficit country can certainly restore its competitive position in the world. But, in the manner of a shopper with a check card, it pays its bills on the spot, so countries know where they stand.

A gold standard of a kind existed between World War II and 1971. It wasn’t much of a gold standard — you had to be a government to get the gold — but it did allow a measure of convertibility. Foreign central banks could exchange their unwanted dollars for bullion at $35 to the ounce. Starting in the 1960s, France exercised that option with gusto. There’s no gainsaying the prescience of its decision — the United States was spending itself into the great inflation of the 1970s. Rather than commending its monetary critics, however, Washington cut them off. On Aug. 15, 1971, President Nixon announced that this country would no longer exchange gold for dollars and vice versa. The greenback would henceforth be faith-based.

America’s credit card has served us no better as a nation than our personal home equity lines did as individuals. We borrow and spend as if our bankers will never foreclose. From 1940 to 1971, when foreign holders of dollars could exert some wholesome monetary discipline, federal debt in the hands of the public grew at a compound annual rate of 6.5 percent. Since 1972, however, following the activation of our paper-dollar credit card, federal debt in the hands of the public has grown at an annual compound rate of 9.2 percent. Last month Reuters quoted an adviser to China’s central bank as saying that, in contemplating even a technical default on its federal debt, the United States was “playing with fire.”

Neither revenue-raising Democrats nor outlay-
chopping Republicans seem to grasp the essential point. The U.S. government runs up titanic debts because it can. Sooner or later, someone will take steps to ensure that it can’t. Better that that conscientious party be America now rather than its creditors later.

Once upon a time, the dollar was as good as gold. It should be made so again.

James Grant, the editor of Grant’s Interest Rate Observer, is the author, most recently, of “Mr Speaker! The Life and Times of Thomas B. Reed, the Man who Broke the Filibuster.”

 
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