It’s obviously no mystery that the only reason the U.S. Dollar, and most of the world’s currencies, have any value is because the central banks and governments say it does. After we left the gold standard, there was no commodity to back the money or regulate the money supply.
Now, it was no mistake that we left the gold standard. As our economy would continue to grow and grow, the money supply would not grow to accommodate. Larger amounts of transactions would be done with the same money supply. This leads to deflation. Deflation obviously ruins an economy.
Sidenote: Deflation is NOT deleveraging. Those are two different things entirely. Deleveraging is the common viewpoint of deflation: when prices of goods fall. Deflation is entirely different.
The Federal Reserve created the fiat money system. This monetary system is tied to no commodity and provides floating exchange rates. While floating exchange rates is a plus for foreign trade, it is only a plus when the Federal Reserve (or any central bank) is responsible. When the Fed prints money like crazy, the value of our currency will decrease. It’s like any good: when supply increases, value is lost.
The bond bubble is fueled by this.
Now let me explain. The Fed created the fiat money system so the public sector could keep the market regulated as it saw fit; it tried to do what was in the well-being of the people. The middle-class of America was created by the ability to finance purchases with loans, mortgages, etc. Interest rates to the debtors was what mattered. The only reason the middle-class was able to be built the way it was was due to low interest rates. These same low interest rates were artificially created by the government.
Foreign countries would buy our bonds (IOUs of sorts) and wait for us to repay. Well, the way we would repay was through the private sector. The money given to us by others, like China, buying our debt went to keeping all interest rates low so people could finance and save. The microeconomy would adapt and spend more on foreign goods. These foreign goods would create huge revenue for the countries buying our debt. So with the money cycling back to them, they re-buy debt.
Bonds, the debt certificates, have maturities so that huge amounts of interest do not accumulate. Mostly they have long-term (30-year) maturities, but a lot of the times they have only 5 year maturities. The maturities are the set dates of when we must pay the debt back by.
Well as investing in our currency increased, we could keep fueling the debt-fueled economies. But to make payments, the Fed realized they could printtheir way out. They eventually had to with the short-term maturities. This was horrible for the economy. Since leaving the gold-standard, the dollar has lost near 98% of its purchasing power. $25,000 in 1929 would be over $300,000 today. We ruined the dollar.
But here is where this system falls further: other countries are decreasing investment in our currency and increasing in others (such as the Rupee). So as our dollar loses value from printing and our debt increases, our need to sell off bonds increases. But less are being bought. Foreign countries can’t keep up with our expenditures on everything. On top of the decrease in investment, structural deficits sky-rocketed. This is shown in the figure below:
Now with an increase in the deficit, a greater issuance of bonds must be met. Foreign countries did buy more securities, but not enough. See the below chart (link is here if it’s too small):
We can see investment in our debt go up a few hundred billion. Now compare that number to the $1.6 trillion budget deficit. There is no comparing. Again, they can’t keep up. And the fact that investment is occurring short-term rather than long-term expresses their doubt about us. They’re just holding money with us instead of investing; they don’t see a prospering nation anymore. And again, with the excess of printing and lack of investment, we’re heading down hill. But what will come?
A huge increase in interest rates and massive inflation. Floating exchange rates, because of irresponsibility, made our dollar fall entirely. The bond bubble is bursting. And the only way we fueled this failure was fiat money.
Fiat money and the government doing what it saw to be in the best interests of the people led to this, and we’re going to have to help ourselves when the huge inflation comes. The fiat system in America needs to end; we again need commodity back currency. And it needs to be a commodity that can expand with the economy.
A better possible solution? Competing Currencies.