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The Prospects for a Sound-Money Revolt against the Dollar and Euro

In the last decade, the combination of virulent asset price inflation and low reported consumer price inflation crippled sound money as a political force in the US and globally. In the new decade, a different balance between monetary inflation’s “terrible twins” — asset inflation and goods inflation — will create an opportunity for that force to regain strength. Crucial, however, will be how sound money advocacy evolves in the world of ideas and its success in forming an alliance with other causes that could win elections.

It is very likely that the deflationary nonmonetary influences of globalization and digitalization, which camouflaged the activity of the goods-inflation twin during the past decade, are already dissipating.

The pace of globalization may have already peaked, before the Xi-Trump tariff war. Inflation-fueled monetary malinvestment surely contributed to its prior speed. One channel here was the spread of highly speculative narratives about the wonders of global supply chains.

Digitalization’s potential to camouflage monetary inflation in goods and services markets, on the other hand, has come largely via its impact on the dynamics of wage determination. It has forged star firms with considerable monopoly power in each industrial sector. Obstacles preventing their technological and organizational know-how from seeping out to competitors means that wages are not bid higher across labor markets in similar fashion to earlier industrial revolutions. These obstacles reflect the fact that much investment is now in the form of firm-specific intangibles. Even so, such obstacles tend to lose their effectiveness over time.

As deflation fades, monetary repression taxes (collected for governments through central banks’ manipulation of rates to low levels so as to achieve 2 percent inflation despite disinflation as described) will undergo metamorphosis into open inflation taxes as the rate of consumer price inflation accelerates. Governments cannot forego revenue given their ailing finances. Simultaneously, asset inflation will proceed down a new stretch of highway where many crashes occur.

Historical Circumstances of Empowerment of Sound Money Forces

If the small sample size of monetary history is any guide, the combination of asset market crashes and high goods inflation empowers sound money forces in the political arena. Widespread public resentment against higher goods and services prices and wealth loss (whether by strong inflation or crash) is responsible for the shift.

By contrast, when the goods-inflation twin is camouflaged (as during the 2010s) and asset inflation is rife, unhappiness among some savers about the monetary repression tax is more than matched (in terms of electoral impact) by happiness among large segments of the population about rising wealth and the comforting performance of their pension funds.

If the asset inflation ends without the goods-inflation twin emerging from its camouflage, then most likely there would be a further triumph for unsound money, as was the case in the 1930s and again in the aftermath of the 2008 crash. The bankers, mortgage brokers, and securities salespersons would be blamed, not the money printers, though the latter’s political masters might suffer the consequences even without direct attribution.

The last time we had the combination of high goods inflation coupled with crash-prone asset markets was in the later stages of the great monetary inflation from the early 1960s to the 1970s. Sound money did become a political force both in Europe and the US despite the most effective groupings’ advancement of the flawed doctrines of monetarism.

The seriousness of the flaws and whether these could be lessened by various forms of financial system reconstruction were never put to the test. In the US, the Reagan administration by 1985 had decided on a new devaluation policy (highlighted by the Plaza Accord), endorsed at the start by then Fed chairman Paul Volcker. Earlier the same administration had undermined the original purpose of a commission to study a return to the gold standard (law signed by President Carter in 1980) by packing it with opponents. In Europe, the dollar devaluation of the mid-1980s created the political dynamics towards monetary union which proved fatal to discount margin (DM) monetarism.

After the waxing and waning of monetarism, the US adopted gradually the 2 percent inflation standard built on emperor’s-new-clothes econometrics and expectations inertia. The newly established European Monetary Union followed suit. This all occurred just as nonmonetary deflationary forces were gaining power. At first globalization was the strongest force; later it was digitalization and resource abundance (especially of shale oil and gas).

A Sound Money Resurgence?

As the camouflage of goods and services inflation now thins, a climb in consumer price inflation may undermine the equity market and lead to an early dose of asset deflation. Governments will then double down on money printing. If that asset deflation nonetheless leads to great depression, sound money advocacy will remain dead.

However, if there is no great depression and goods inflation picks up sharply into the next cycle beyond a normal recession, sound money will have its chance. The extent of malinvestment during the monetary inflation of the past decades will be revealed in the wake of asset price deflation. Effective capital shortage resulting from the obsolescence of malinvestment will mean that goods and services price inflation can pick up faster and earlier than much conventional macroeconomic modeling would suggest as the business cycle upswing gets under way.

In this case there will still be a problem for sound money advocacy in the political arena. We can count the number of US senators in favor of sound money on one hand — and less in European parliaments. There is no ready popular brand of ideology of sound money analogous to Friedman’s 1970s monetarism.

Popular branding is difficult. The fundamental prerequisite to monetary soundness is an anchoring of the monetary system, which is accomplished by designing a monetary base for which a broad and stable demand exists that is not hugely sensitive to small changes in interest rates. This is not an easy concept to popularize. Successful anchoring means that automatic mechanisms would keep money under control without any official setting or manipulation of interest rates or any targeting of the price level.

It is hard to imagine a brand “catching on” that does not include gold. which has potential and actual popular appeal. A natural ally of sound money forces promoting this brand could be antimonopolists, found on both sides of the aisle. Big Tech and Big Finance are joining with Big Government in pursuing the war against cash. While this rages, gold money and the little saver stand little chance.

In Europe the forces of sound money would have a natural base in Germany, Holland, Belgium, and Austria. These forces could build on resentment toward transfers to southern Europe and negative rates. The main counterforce for now are the Greens. Watch how European Central Bank chief Lagarde is playing to the Green Party in Germany, expecting it to be an equal partner to the Christian Democrats in the next government, probably at some point in 2020.

A gold-backed euro based in northern Europe seems like fantasy for now, but it is more plausible than a gold dollar as an outcome of this decade.

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Brendan Brown
Brendan Brown is senior fellow (non-resident) Hudson Institute. As an international monetary and financial economist, consultant, and author, his roles have included Head of Economic Research at Mitsubishi UFJ Financial Group.
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