A currency, to be perfect, should be absolutely invariable in value.
—David Ricardo, Proposals for an Economical and Secure Currency
As their name suggests, Buffalo wings were invented in Buffalo, New York. Late one night in 1964, Teressa Bellissimo, the owner of the Anchor Bar, deep-fried and basted with hot sauce the part of the chicken that cooks had usually tossed. Fifty years later, Americans consume an estimated 1.25 billion wings on Super Bowl Sunday. Progress in a market economy is defined by the leap and the information gained (bad news can be as valuable as good) from the risk taken. Bellissimo made a major leap in 1964, and her discovery of what to do with chicken wings changed how Americans (and foreigners) eat.
Wings have become so popular that there is a National Buffalo Wing Festival in—you guessed it—Buffalo, New York, each Labor Day weekend. Matthew Reynolds and Ric Kealoha won the 2013 competition, a victory immortalized in the Hulu documentary The Great Chicken Wing Hunt. The Wall Street Journal described the preparation of their “medium-hot, crisp and tender wings.” Included in the blue-cheese dressing were two tablespoons of finely chopped onion, a quarter-cup of parsley, and one cup of mayonnaise. The Reynolds-Kealoha Buffalo sauce was made with one teaspoon of celery salt and one tablespoon of honey mustard, and the wings were fried in thirty-two ounces of vegetable oil. The sauce was cooked for three to four minutes over medium heat, sautéed for five minutes, left to simmer for fifteen minutes, then another fifteen minutes with the honey mustard. The wings were fried for eight to ten minutes in vegetable oil heated to 375 degrees.
The result of this cookery is surely tasty but hardly high cuisine.1 Still, the successful preparation of something as simple as wings requires precise measurements. Imagine what would have happened if Reynolds’ and Kealoha’s tablespoons and measuring cups constantly changed size or if the duration of a “minute” was elastic. Thanks to the standardization of the tablespoon, cup, ounce, and minute, we can reliably cook chicken wings and all the other things that make life worth living.
On a far more serious level of culinary art, Grant Achatz’s cooking lab would be reduced to chaos without unchanging units of measure. There would be no Alinea, and Achatz would be back in St. Clair “flipping eggs.” Without standard measures, one of the world’s greatest chefs would be like a Lamborghini without wheels.
The construction of a house or office building is possible because a foot is standard. Without exact measurements, there would be plenty of oddly shaped houses, doors wouldn’t fit in their door frames, and the leaning tower of Pisa wouldn’t be unusual.
In the NFL, scouts and coaches spend months each year preparing for the draft, stopwatches in hand, timing prospective players in the forty-yard dash. Here the difference between 4.43 seconds and 4.73 seconds is substantial. Millions of dollars in salaries are at stake, along with the coaches’ careers.
They say football is a game of inches, and those inches are won and lost by the speed, strength, and jumping ability of players scouted and drafted. In the NFL, a third of a second in the forty-yard dash determines whether a defensive end reaches a quarterback or a left tackle blocks an onrushing linebacker. A vertical inch determines whether a cornerback tips away a spiraling pass. The Seattle Seahawks made it to Super Bowl XLVIII thanks to cornerback Richard Sherman’s speed, but also because of his ability to leap high enough to tip Colin Kaepernick’s pass to Malcolm Smith as time was running down.
But if the second, pound, and inch weren’t fixed units of measure, NFL teams would frequently find themselves working with imperfect information about players and, as a result, on the losing side of matchups. As it is, the draft is an inexact science—in 1998, many scouts rated the number-two pick, Ryan Leaf, a better quarterback than number-one Peyton Manning. But if no one really knew how fast or big the players were, draft day would simply be a crap shoot.
If units of measure were variable, surely restaurants, football teams, and construction companies would adjust, but the cost would be immense. They could hire mathematicians to calculate the constant changes in the length of a minute, second, and foot in hopes of mitigating the uncertainty. But the absurdity of that scenario is obvious. A standardized minute, pound, and foot are essential to much that we do. Their invariability permits a great deal of productivity and innovation. George Gilder would refer to them as “low entropy” inputs that allow a lot of “high entropy” leaps to new economic information.
All this speculation about a world without fixed units of measure would be pointless if it weren’t for what President Richard Nixon did on August 15, 1971. On that infamous date, he foisted on the economy a dollar without a fixed value. Since then, the greenback has floated up and down every second of the day. The foolishness of this policy is hard to minimize.
In The Wealth of Nations—the masterpiece that laid the groundwork for the rise of modern capitalism—Adam Smith observed that the “sole use of money is to circulate consumable goods.”2 That was a throwaway line, for no serious thinker had ever considered money as anything but a measure. Money came into existence because men needed a way to measure the value both of their production and of the consumable goods they sought in exchange for the fruits of their labor. Smith was stating the obvious.
Smith would laugh at all the commentary in the media today about the need for a “strong dollar” or a “weaker dollar to boost exports” or the importance of convincing the Chinese to “boost” the value of the yuan. To Smith, that would be the equivalent of saying “increase the length of a meter” or “shorten the minute” or, because Kim Jong-Un is bothered by his diminutive five-foot-six-inch stature, there is a need to “devalue the foot” so the North Korean dictator can stand ten feet tall. Just as the foot is never long or short, money should be neither strong nor weak. The foot is a standardized tool to measure actual things, and money should have the same constancy.
The vintner makes wine, and the baker bakes bread, and while the vintner might want bread, the baker might not want wine in exchange. This asymmetry in trade gives money its purpose. If the baker were a teetotaler, he could still trade with the vintner, who would offer money for the bread. Money is an acceptable medium of exchange. The baker can take the money he receives from the vintner to the butcher in order to buy meat. Trade is the exchange of products for products. But money permits different people with different wants to trade easily with one another.
I work as an editor and as a writer, and while the McDonald’s on Wisconsin Avenue in Washington, D.C., does not want my writing and editing, Forbes and RealClearMarkets do. They pay me in dollars for my work as a writer and editor, and as those dollars are an accepted medium of exchange, I am able to exchange my work as a writer and editor for all the Quarter Pounders and fries that I can afford.
Money is not wealth. It is a measure of wealth. The salaries that my employers pay me in dollars are their measure of my worth to them. My work is my demand for money, but as the chapters on trade made clear, people produce in order to consume. The supply of work enables the consumption of the work product of others. So while my work is my demand for money, what it really represents is my demand for all the things I do not have.
My ability to specialize in the kind of work I’m good at—one of the benefits of free trade—makes me more productive, so my employers’ measurement of the worth of my work is higher. I would struggle if I had to work in the high-tech business. I would end up as a gofer for the geniuses at Dell or Apple and would languish at the low end of the pay scale. But thanks to open markets, I get to focus on writing and editing, for which my employers pay me a good salary, and with those dollars I am able to buy my computers and phones from Dell and Apple.
If I had to add a shower to my apartment, I’d be in trouble. Thanks to money, I can trade my writing and editing skills for the shower that I want; even if my contractor has no interest in my work at Forbes and RealClearMarkets. Now, let’s say a contractor tells me the new shower will cost ten thousand dollars, and because of a busy schedule, he can’t complete the job for six months. Let’s then say that I agree to those terms, but to make sure he finishes the job, I offer five thousand dollars up front and five thousand upon completion of the work. This deal would make sense except for one problem.
Until 1971, the dollar’s value was defined by gold. Specifically, a dollar was worth one thirty-fifth of an ounce of gold. To be sure, there were variations in the gold standard during the U.S. dollar’s first two centuries. But the United States stuck to the gold standard because the only good money is money that is a constant measure of value, just as a foot and minute are constant measures of length and time. The obvious question, then, is why gold?
That question is easy to answer. Gold has had the most stable value of any commodity in history. It was not an accident that a world in need of “money” for the purpose of exchange settled upon gold. Other commodities, including seashells and cigarettes, have been tried, but since perfect money is that which is invariable in value, the sovereigns of the world have always gravitated to gold.
John Stuart Mill stated in his Principles of Political Economy, “As it is much easier to compare different lengths by expressing them in a common language of feet and inches, so is it much easier to compare values by means of a common language of pounds, shillings, and pence.”3 But if the baker is going to have enough faith in that “language” to rely on it in exchanging his bread, it must be stable. Gold provided money with credibility precisely because it was, and is, so stable. Gold, said Mill, is “among the least influenced by any of the causes which produce fluctuations of value.”4 More recently, the economist and investor Nathan Lewis wrote in his masterly book Gold: The Monetary Polaris:
A gold standard system has a specific purpose: to achieve, as closely as possible in an imperfect world, the Classical ideal of a currency that is stable in value, neutral, free of government manipulation, precise in its definition, and which can serve as a universal standard of value, in much the manner in which kilograms or meters serve as standards of weights and measures.5
Lewis, like Mill, acknowledges that gold is not perfectly invariable in value in the way that a foot is always a foot. But after many centuries of effort to find the most stable definer of money, he says, “nobody has found a better way” to provide money with a stable value than gold.6
In recent years, gold has been especially volatile. But its gyrating and mostly rising price is measured in dollars that are themselves without definition. A rise in gold signals a decline in the value of the dollar, and a decline in gold signals a rising dollar. Until 1971, the supply of dollars was managed by pegging the price of an ounce of gold at thirty-five dollars. There were some wiggles in that price, particularly during the Johnson and Nixon administrations, but generally the dollar’s value was maintained at one thirty-fifth of an ounce of gold. A market commodity known for its stability, as opposed to government bureaucrats, managed the supply of dollars.
Let’s go back to my agreement with the contractor, who will get the other five thousand dollars when he finishes installing my shower in six months. I am hardly driving a hard bargain, but since the dollar is no longer defined by gold, it is possible that six months from now the dollar will be worth less, maybe a lot less. If so, the weaker dollar will turn our voluntary and mutually enhancing exchange into a good deal for me but a bad one for him.
On the other hand, what happens if the dollar rises in value during those six months? It has happened before. When the 1980s began a dollar bought as little as 1/875 of an ounce of gold.7 By 1982, a much stronger dollar bought one three hundredth of an ounce. If there’s a big jump in the dollar’s value over the six months that the contractor is adding the shower, then I’ll be paying more than I had intended. Now you can see why gold has been used to define money for so many centuries and for much of American history. Allowing money to fluctuate undermines what makes it useful in the first place.
This is not to say that people stopped producing and consuming once the dollar was set afloat back in 1971. But this monetary mistake has prevented a great deal of economic progress. When the dollar—and by extension all other currencies—lost its gold-based stability, it was as if someone broke into Alinea’s kitchen just before the dinner rush, removed the temperature dials from the ovens, smashed every timer, and left with every measuring cup and measuring spoon. Suddenly contracts written in dollars, pounds, and yen were left with wildly fluctuating values. Wages once carefully measured in those currencies became less certain, as did investments and returns on investment. Money, which had been a “low-entropy” measure of value, lost its purpose. They do not call the 1970s the “malaise decade” for nothing. The global economy had to start cooking without a thermometer, timer, and teaspoons. Clever minds have come up with ways to mitigate the problems of the floating dollar, but the economic costs have nevertheless been enormous.
Wall Street, in lower Manhattan, where investment banks were once concentrated, is a symbol for the financial business that now takes place all over the country. In many ways, Wall Street is a positive symbol because its firms provide important services. But Wall Street changed substantially after 1971, and the change wasn’t for the better. When the U.S. dollar was pegged to gold, most of the world’s currencies were pegged to the dollar, so they too were on the gold standard. When President Nixon severed the dollar from gold, currencies around the world began to fluctuate. If one day a “minute” was fifty-one seconds, thirty seconds the next, and forty-five seconds the following day, there would be chaos in Grant Achatz’s cooking lab, where precise timing is essential. That’s what happened in the world economy when the value of money began changing every day.
Nobody stopped producing or trading. Human needs and desires and the urge to produce and consume are too powerful. Instead, Wall Street came up with a way to work around the new elasticity of its standards of measure: currency trading.
As the Wall Street Journal’s Craig Karmin noted in his 2008 book, Biography of the Dollar, “the currency market is the biggest market in the world, with a daily trading volume of $3.2 trillion.”8 More importantly, it is “also one of the newest.”9 He explains, “Throughout the nineteenth and first half of the twentieth century, the world’s major currencies were tied to a gold standard, rather than trading directly against one another in an open market.”10 Until 1971 there “was no need for a foreign exchange market because all major currencies were pegged to a dollar rate and could only be changed in unusual circumstances.”11
Toyota wants to sell cars in the United States, but since it sells those cars for constantly fluctuating dollars, it must hedge against changes in the greenback’s value. Apple, Dell, and Microsoft sell their products globally for yen, pounds, and Australian dollars, and as all three are also floating currencies, they must protect their earnings in those currencies against a decline in their value. People are still trading products for products, and currency remains the facilitator of the exchange, but the foreign exchange market has exploded with activity meant to subdue the chaos bred by currency’s constant fluctuation.
When I worked in Goldman Sachs’s Private Client Services division, a client of mine, along with his partners, sold a business to a Japanese buyer in 2001. The payment was in yen and was spread over five years. If the transaction had taken place in 1970, when the yen was pegged to the dollar at 360 to one, my client would have done nothing further. But since the value of the yen was fluctuating, my client and his partners needed to protect themselves from such fluctuations over the five years of the sale. We were able to hedge the five-year yen payout against any declines, but the transaction took weeks to complete. The loss of productivity for all involved was astounding, and it should have been completely unnecessary.
Economic growth is about matching human capital with investment. Fluctuating money has led a great deal of human capital to migrate to Wall Street in order to trade the chaos. The work done to mitigate the economic uncertainty caused by floating exchange rates is necessary: global trade and investment would not occur nearly as frequently without it. But floating money has redirected many of our best financial minds to jobs that, while highly paid, amount to facilitator work. It’s a tragic waste. The “seen” is bright and hard-working traders making good money at banks, investment banks, and hedge funds. The “unseen” is what these people could have accomplished if their talents hadn’t been diverted to compensating for the instability of our currency. How many advances in medicine or technology did we forego because of the useless necessity of currency trading?
* * *
The most important commodity in the world is probably oil. It’s at the root of much of the world’s turmoil, and people all over the world watch breathlessly as its rising or falling price changes the geopolitical balance of power. And the instability of the all-important price of a barrel of oil is almost entirely a result of the floating dollar. Remember: despite what you read in the paper, there have never been “oil shocks.” Since 1971, an ounce of gold has fairly consistently bought about fifteen barrels of oil. Gold is the constant. A rise in its price does not signal greater scarcity but a falling dollar. When gold falls, it signals a rising dollar. When the dollar weakens and gold rises, the price of oil goes up.
As Steve Forbes has observed, “When the dollar was fixed to gold between the mid-1940s and 1971, the price of oil barely fluctuated.”12 Which is exactly what you’d expect. With a stable dollar, oil was stable and cheap. Just as there was no need for a currency trading market before 1971, there was little need to hedge against volatility in commodities that were priced in dollars.
When the dollar started floating, commodity trading took off alongside currency trading. Leo Melamed, the former chairman of the Chicago Mercantile Exchange, wrote in 2007 that the breakdown of the postwar Bretton Woods gold standard “provided the rationale for the launch of financial futures by the Chicago Mercantile Exchange.”13 Much as floating money lured many bright minds into the currency trading market, it lured others into the commodity pits, and the economy lost even more talent to a business whose only purpose was to tame the chaos stirred up by a floating dollar.
While oil, soybean, wheat, and meat prices were fairly flat under a gold-defined dollar, commodities went on a wild ride once the dollar lost its anchor. It is popular today to demonize hedge funds and other products of financial wizardry, but a drifting dollar made the complicated evolution of finance inevitable. To offer one example, airlines need certainty about fuel prices. A floating dollar has taken jet fuel on a turbulent path, and airlines have had to divert precious resources from serving customers to working with traders in order to stay on the right side of the fuel market.
Historians of the U.S. automobile industry will trace its long-term decline to the early 1970s. American carmakers were best at producing big, air-conditioned, gas-guzzling cars. That was their comparative advantage. When the dollar lost its link to gold in ’71 and went into a free-fall, oil prices soared. Suddenly the big cars that GM, Ford, and Chrysler were adept at manufacturing were not so attractive to buyers. For a sense of how the price of a gallon of gas has changed, watch The Last Picture Show, set in the 1950s. Be sure to notice the posted price for gasoline. There are many authors of the American auto industry’s struggles, but a large if usually ignored factor is hiding in plain sight. The industry’s sickest periods were in the 1970s and the 2000s, when the dollar weakened and oil spiked.
Some argue, against all the evidence, that a weak dollar has helped U.S. carmakers export their products. But as Douglas Irwin of Dartmouth College has pointed out, American car producers have to import much of what they need to build those cars:
. . . 30 percent of the car’s value is due to assembly in Korea, 17.5 percent due to components from Japan, 7.5 percent due to design from Germany, 4 percent due to parts from Taiwan and Singapore, 2.5 percent due to advertising and marketing services from Britain, and 1.5 percent due to data processing in Ireland. In the end, 37 percent of the production value of this American car comes from the United States.14
A cheaper dollar means more expensive imports. Remember, no consumer good is made by one person or one company. Everything we enjoy is the result of cooperation among myriad individuals around the world. If the dollar is weakened, moreover, American workers—including auto workers—will demand more pay. Finally, all American companies are in the business of earning dollars. How then is a weaker dollar good for them, and how do they attract investment if investors know those dollars will be devalued?
It’s the American consumer who suffers most of all from a floating dollar. Businesses can at least work with traders to mitigate the damage of corrupted money, but not the average consumer. A dollar that bought 1/250 of an ounce of gold in 2001 now buys less than 1/1200, but with most Americans lacking the means or sophistication to protect themselves from a falling dollar, they have had to endure nosebleed gasoline prices, not to mention rising grocery bills. And that’s only part of a tragic story.
Inflation is nothing more than a falling dollar, and gold is the most reliably objective measure of its health. In the next chapter we’ll see how the meanings of inflation and deflation have become so perverted as to obscure the monetary errors of these last thirteen years. Then we’ll look at the devastating and widespread economic consequences of a falling dollar. The floating currency is one of the most damning indictments of the economics profession and the political class that ought to have protected the dollar.