To Lower The Debt Ceiling, Fix The Monetary System

http://blogs.forbes.com/richdanker/2011/03/30/to-lower-the-debt-ceiling-fix-the-monetary-system/
To Lower The Debt Ceiling, Fix The Monetary System
Rich Danker - Next Economy, FORBES, Mar. 30 2011

The federal debt limit is supposed to be a political straightjacket on tough-talking Republicans in Congress like Marco Rubio. However, there is a way out of it that would allow them to reset the debate on government spending rather than punt on an issue that has come to a head.

For decades, Republicans have been struggling to implement the conservative philosophy of limited government. What began as an unexpected sideshow with the budget deficits of Ronald Reagan turned into deep disappointment with George W. Bush and Republican Congresses of recent past. The return of the GOP leadership that was in place when that happened has been accompanied with a mea culpa of “We’re sorry, we won’t do it again.”

Which is why the federal debt ceiling, in most years an obscure technical aspect of public finance, means something in 2011. Republicans must either agree to raise it when it approaches its statutory limit in May or risk a default that would trigger a financial crisis. The best they might be able to do in terms of a negotiation is extract some discretionary spending cuts from the White House as something to show for raising the amount of approved federal borrowing past $14.3 trillion. The inevitability of this outcome reveals that despite the justified outrage on the part of voters, the GOP still has little in the way of viable solutions to the perennial size-of-government problem.

The way out of the debt ceiling straightjacket is to show that flawed fiscal policy enabled a truly flawed monetary system. Consider that half of the Treasury securities used to fund the public debt is in the hands of foreigners. This is not an accident but the result of the world’s monetary order: U.S. government IOUs form the basis of foreign central banks’ reserve money supply.

The federal debt ceiling is but an arbitrary limit on the seemingly limitless potential for our debt to be absorbed around the world because it has the unique feature of reserve currency status. Likewise, U.S. dollars are debt-based instruments themselves without any independent value beyond more dollars, which the Federal Reserve can always inject into the banking system through its open market operations. It is as if the whole monetary system was set up to enable over-borrowing and big government in America.

The dollar was solidified as the world’s reserve currency at the Bretton Woods monetary conference near the end of World War II. It was chosen as a compromise over the bancor, a supranational currency proposed by John Maynard Keynes. There was a check on dollar creation in the form of the gold exchange standard, which allowed foreign central banks to convert their dollar holdings into gold.

But the resulting systematic buildup of dollars abroad compelled the U.S. to completely back out of Bretton Woods by 1971, only a decade after it was fully up and running. Since that breaking point U.S. government debt has grown from $436 billion to the $14.3 trillion figure we are approaching. Federal spending, which under Bretton Woods had settled at a postwar average of about 18 percent of GDP, is now 25 percent of economic output. The monetary system, more than interest groups, pork-barrel politics, public choice theory, or weak-kneed Republicans, deserves most of the blame for this outcome.

The only way to get around the use of reserve currencies and the over-borrowing they lead to is to use an international money that is no particular government’s liability. Gold has served this role throughout history, being a commodity easily identifiable as money and one with a relatively steady production rate that mirrors economic growth in the long run.

Gold lets governments settle international payments deficits rather than recycle them into the reserve currency debt of choice, which supports excessive government borrowing and transmits market bubbles. The international gold standard, fully operational from 1873-1913, is the best historical model for price stability, economic growth, and transparency.

The party of limited government has been gradually losing the size-of-government struggle for decades. Now, shortly after taking office, an insurgency elected to Congress with fervent enthusiasm for cutting spending finds itself pressed to approve increasing the already outrageously-high debt limit. Hard budget rules were adopted as part of the same debate in the late 1980s, yet such terms have come and gone as the growing debt has remained a fact of economic and political life.

The only way to swear off overspending is to upend the monetary system that promotes it. A gold standard world, in addition to supporting economic prosperity, would compel governments to plan their spending based on conventional taxation and borrowing. It would likely produce something conservatives have always talked about but failed to deliver on: balanced budgets. If the new Republicans could help make that happen, they really would be different this time around.

Rich Danker is Project Director for Economics at American Principles Project, a Washington policy organization