Ever wonder why your dollar doesn’t seem to stretch as far as it used to? There is a simple explanation: It’s worth less. The reason for that is, the nation’s money supply is constantly being expanded.
Between 1783 and 1913, the U.S. dollar was a real store of wealth. Except during war-time periods, inflation within the U.S. was essentially zero. If you saved one dollar in 1800, a hundred years later you could still purchase approximately the same amount of goods with that dollar.
But then in 1913 something changed, and the U.S. dollar started down a long, steady road of dollar devaluations. Using the U.S. government’s own figures, to obtain the same amount of purchasing power of $100 in 1913, you would need $2,038.38 today.
In 1970, Herbert W. Armstrong wrote about how as a boy his mother asked him to “[g]o to the meat shop and get a dime’s worth of round-steak. And tell the butcher to put in plenty of suet.” Even then, he related, each person in his family didn’t get a 12-ounce steak, but each person did receive a small piece of meat, plus plenty of gravy for the potatoes.
In times past, the dollar certainly seemed to stretch further. Mr. Armstrong quoted the Labor Department’s figures for how much $5 would have purchased in 1913: 15 pounds of potatoes, 10 pounds of flour, 5 pounds of sugar, 5 pounds of chuck roast, 3 pounds of round steak, 3 pounds of rice, 2 pounds each of cheese and bacon, and a pound each of butter and coffee; that money would also get you two loaves of bread, 4 quarts of milk and a dozen eggs. “This would leave you with 2 cents for candy,” he wrote.
Wow. At most grocery stores today, with $5 you would be hard-pressed to buy a pound of round steak and a chocolate bar.
What changed in 1913? That was the year the Federal Reserve System was adopted by the U.S. government and the nation took its first steps toward abolishing the gold standard and instead adopting a banking system that allowed for unlimited paper money to be created.
As described by Alan Greenspan in 1966, the new system consisted of “regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. … But now, in addition to gold, credit extended by the Federal Reserve banks (‘paper reserves’) could serve as legal tender to pay depositors.” In other words, the dollar would only be partially backed by gold, and banks could create money by lending out money secured by credit from the Federal Reserve banks (even though the reserve banks did not necessarily have gold on deposit themselves). Thus the seeds of America’s first fiat (currency not backed by gold) dollar system were sown.
At that time, however, there were still restraints upon money supply growth, because the dollar was still convertible to gold upon demand. Anyone cashing in paper dollars was still legally entitled to its value in gold, so the money supply did not balloon completely out of control.
After World War ii, the U.S. dollar became the world’s reserve currency. Toward the end of the war, representatives of most of the world’s leading nations met to create a new international monetary system, later known as the Bretton Woods agreement. At this meeting, they decided that since the U.S. economy had come to dominate the globe, and because it held most of the world’s gold due to the war, they would tie their currencies to the dollar, which, in turn, would be convertible into gold at $35 per ounce.
However, under the Bretton Woods system, there were still limits on how much paper money a country could create. Each country had to police its own currency or be forced to revalue. The U.S. itself was constrained from overprinting money because the dollar remained fully convertible into gold.
However, this changed in 1967-68, when Congress authorized the U.S. Treasury to stop redeeming paper dollars for silver. By 1970, silver was removed from the production of coins. In 1971, Nixon closed the gold window, no longer allowing foreigners to exchange their dollars for gold and thus ending the Bretton Woods agreement. From that point on, America’s dollar became fiat, not backed by tangible assets. As the Federal Reserve Bank of Minneapolis explains, the U.S. dollar is fiat and is valuable only as long as “[p]eople are willing to accept fiat money in exchange for the goods and services they sell”—and only as long as “they are confident it will be honored when they buy goods and services.”
Since people were already in the habit of accepting paper backed by gold, people hardly noticed when the U.S. greenback became no longer backed by anything but faith. People just assumed that the government would make sure that too much was not printed. After a brief U.S. dollar sell-off, in which gold spiked up into the $800 range and the Federal Reserve jacked interest rates into the high teens, people decided they would trust the government and continued using the U.S. dollar.
The U.S. now operates on what many refer to as the Bretton Woods 2 system. Although there is no formal central bank agreement (as was the case with Bretton Woods 1), many of the world’s central banks, especially those of Asian countries, have more or less informally pegged their currencies to the dollar.
But this system is inherently more unstable than the previous precious-metal-based non-fiat system. Since the U.S. dollar is no longer convertible to gold, there is no theoretical limit to which the U.S. money base can be expanded—and the U.S. has been taking full advantage of this situation to increase its money supply.
Nevertheless, as one well-known economics saying goes, “There ain’t no such thing as a free lunch.” America’s monetary expansion has been a primary driver behind the massive and continual erosion in the U.S. dollar’s purchasing power. As the government has massively increased the money supply, those dollars have become less valuable.
America’s massive monetary expansion could be about to boomerang on itself. Increasing the money supply beyond demand can have short-term benefits like stimulating consumer spending; however, it also always results in longer term economic damage such as inflation and a falling dollar. Additionally, the larger consequence for America is that by persistently destroying the value of the dollar by overprinting, foreign nations are losing confidence in the dollar and its role as a reserve currency. ▪