Much has been made about how the massive bailouts of Wall Street firms have come at the expense of US taxpayers. And after having posted record profits during the peak of the real estate boom, it is easy to understand Main Street’s anger at picking up the multi-trillion dollar tab – especially as Wall Street’s bonus machine is spinning once again.
But Wall Street also receives a much more insidious benefit which is almost never discussed, much less protested. From our vantage point, this subsidy – greatly expanded by the federal government nearly 40 years ago – ensures that Wall Street is provided with a virtually unlimited supply of the raw material it requires to operate and grow its business.
Perversely, most of the cost of this material is not borne by Wall Street itself; rather, it is borne by every individual and business in the country. Worse, the cost is not billed to the parties that pay it; rather, it is stealthily embedded into every transaction that takes place in US dollars, without notice or approval.
The word ‘liquidity’ sounds innocuous enough. In fact, it sounds downright beneficial. The media often speaks approvingly when the Fed “provides liquidity” to ensure the smooth functioning of the financial markets. Liquidity evokes an image of life-giving water, and to Wall Street, it has performed precisely that function. Thanks in large part to liquidity, the financial services industry has mushroomed since the 1970s. During this period, Wall Street has used liquidity to create ever more complex financial products, such as options, swaps, derivatives, and other vehicles, racking up huge profits – and paying obscene bonuses – along the way.
However, after giving life to Wall Street, liquidity seeps through the economy like acid, corroding US living standards and industrial competitiveness. Because what Wall Street calls ‘liquidity,’ Main Street calls ‘inflation.’
It was not always this way. Article 1, Section 8 of the US Constitution limits the authority to coin money to Congress alone. In fact, the founding fathers were so concerned about the improper issuance of currency that they addressed the matter again in Article 1, Section 10. Currency debasement (and resulting inflation) had been practiced for centuries, and they wanted to ensure that this did not happen in the newly independent United States of America.
Built on a foundation of sound money, the United States became one of the greatest industrial powers in the world in the 19th century. During that time, the interests of Main Street and Wall Street were closely aligned. Main Street went to Wall Street to finance new investment, and paid back its financiers out of profits from successful ventures. Under the reigning gold standard, a dollar was worth a fixed amount of gold – so borrowers and creditors knew exactly what to expect down the road.
But with the passage of the Federal Reserve Act in 1913, the United States Congress delegated its authority to issue currency to a new central bank called the Federal Reserve. The Fed could print new dollars at will, making liquidity available to Wall Street at the expense of Main Street.
Still, between 1914 and 1971, the Fed’s ability to provide Wall Street with liquidity was restricted by the gold-backing of dollars. During that period, every dollar that the Fed created could hypothetically be redeemed for a fixed amount of gold (after 1933, only foreign governments were allowed to redeem, not private citizens). As a result, the Fed could provide only so much liquidity before dollar-holders would start redeeming their notes for gold.
But with President Nixon’s announcement of August 15th, 1971 that US dollars would no longer be redeemable in gold, that check was removed. Disconnecting the US dollar from gold was effectively disconnecting Wall Street from Main Street. The Federal Reserve was now free to print as many dollars as it wanted. Wall Street now had a virtually unlimited capacity to grow its business; and, tragically, Main Street would pay the bill. Because once it passes through the hands of Wall Street, ‘liquidity’ becomes ‘inflation.’
Inflation is the phenomenon of too much money chasing too few goods. When Nixon took America off the gold standard, the supply of money was greatly expanded by the Federal Reserve, averaging 11.5% growth annually in the decade after the President’s decision. Meanwhile, the industrial businesses that made up the US economy couldn’t increase their production nearly fast enough to keep up. As a result, Main Street experienced ‘inflation’ – that is, rising consumer prices – and workers and businesses began to lose ground to Wall Street.
Real average weekly earnings for workers in the United States peaked in 1973, and have never recovered (by some measures, real average weekly earnings are down 70%). Some sociologists have even theorized that a wide variety of social ills, such as rising rates of obesity, divorce, and crime, can be traced in part to the devastating effects of inflation.
Squeezed by rising costs, most industrial businesses have moved production offshore (taking high-paying jobs with them). Some industrial firms, such as General Electric, effectively transformed themselves into financial services firms in order to survive. Still other firms, such as General Motors and Chrysler, struggled valiantly before succumbing to bankruptcy.
The credit market collapse of 2008 was the beginning of the end of this unsustainable state of affairs. Eventually, I believe that Main Street will go bankrupt, leaving Wall Street with no subsidies and no customers. The only way to avoid the collapse of both Wall Street and Main Street then is to ‘reconnect’ them with a new gold standard.
Returning to the gold standard may involve a painful recession, as excesses are wrung out of the US economy. It could be a long and difficult process. But only by restricting Wall Street’s liquidity – Main Street’s inflation – can we begin to restore the foundation that made the United States the greatest industrial power in the world.
Hemant Kathuria is Branch Manager of Euro Pacific Capital’s Los Angeles office and an experienced investment consultant. Hemant shares Peter Schiff’s outlook on the global economy and the decline of the U.S. dollar. He completed a dual major in Economics and Political Science at UC Berkeley in 1989.