Tuesday, August 9, 2011

The Maestro?

With the twin economic events of the S&P credit downgrade and Monday's stock market plunge dominating the news, it seems like every financial analyst, economics professor and business journalist able to put together a coherent sentence has appeared on some television channel during these past few days. So it should be no surprise that the former chairman of the Federal Reserve, Alan Greenspan, joined the televised economic chorus. What is surprising though is what he offered by way of commentary. Greenspan contends that the S&P downgrade of America's creditworthiness was not necessary since America would never default on its debt obligations because the country can always “print more money”.

What Greenspan said is technically true, the government can just keep the printing presses at the Mint running 24/7, and this is a great financial strategy – if you want to end up like Zimbabwe. In modern global economics, currency is not back by tangible assets like gold and silver, but rather by perceptions of its worth. A US dollar is worth a dollar because that is what people perceive its buying power to be. If you follow Greenspan's advice and just print more dollars, you're not doing anything to intrinsically increase the dollar's worth, you're just putting more of them out there. And a fundamental law of economics is that when supply increases, the value of a given commodity drops. So if the guy at the corner deli knows you suddenly have more money in your pocket because the government has magically made more currency, that one dollar pack of gum will quickly become a two dollar pack of gum. Your buying power as a consumer has not increased because you have more money in your pocket, it has actually decreased.

This was the situation faced by folks in Zimbabwe. The government of Robert Mugabe reacted to a financial crisis by printing more Zimbabwean dollars. The market reacted by immediately devaluing those dollars, which prompted a response by the government to simply print more dollars, and so on and so on until you wound up with this:

Despite all the zeros, at the height of Zimbabwe's financial crisis, that bill wouldn't even cover your bus fare across Harare. Again, it is simple economics, which is why it was so disturbing to hear the man who once had so much control over the nation's economy that he was dubbed “The Maestro” put forward such a dumb economic idea. Though on second thought, perhaps it helps to explain the mess that we currently find ourselves in...

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