• By
  • Jon Hilsenrath




“They destroy it. That is their whole program,” says Mr. Paul in an interview, referring to the dollar. “Since 1913 up until now they’ve destroyed about 97% of the value of the dollar.” The Fed’s latest policies, he warns, could send the U.S. the way of Weimar Germany during the 1930s, marked by runaway inflation and political peril.

The fury surrounding the central bank is as old as the U.S. Before there was a Fed, there was a First Bank of the United States over which the founding fathers deeply disagreed. Alexander Hamilton, a New York banker, strongly advocated for it. Thomas Jefferson, a Virginia farmer, vehemently opposed. George Washington sided with Hamilton. James Madison sided with Jefferson. When Madison became president, he supported a second central bank, which Andrew Jackson later ended. There was no central bank until the Fed was created in 1913 — and during that stretch the booms, busts, panics, speculation and bank runs now blamed on the Fed were even more frequent.

Still, the most recent furor over the Fed’s potential for money-wrecking raises an important question: What exactly is money and how do you destroy it?

The answers aren’t obvious. In an exchange at a congressional hearing earlier in July, Mr. Paul asked Mr. Bernanke if gold was money. A puzzled and defensive-looking Mr. Bernanke said it wasn’t. “It’s a precious metal,” he retorted. Mr. Paul shot back: “Well, some people still think it’s money,” and anti-Bernanke bloggers rejoiced.

Mr. Bernanke’s message has been confusing at times on this issue. His many critics, and some TV comedians, noted with glee his March 2009 interview with CBS News’s “60 Minutes” Scott Pelley, when he said the Fed’s policies were “akin to printing money.” In a subsequent interview later he said the Fed wasn’t actually printing money.

Let’s try to clear this up.

First, the basics. Every day, workers produce goods and services. We specialize in our labor and what we produce. I produce stories for a newspaper and website. You might teach, or make cars or farm. We want things that we don’t produce ourselves. So we trade. Money is our way of making trade efficient. We use it to keep track of the value of our own labor and what we can buy in exchange for that labor. I get paid in dollars and use those dollars to buy the other things I want. Or I save it with plans of spending it later. Or I borrow it with a promise of paying it back later.

“It is a medium of exchange,” says Marvin Goodfriend, who teaches monetary economics at Carnegie Mellon’s Tepper School of Business. Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, has described money as a form of memory, an efficient way to keep track of the myriad transactions that take place in a modern economy.

The Federal Reserve’s job is to manage how much money is circulating. Hold up a dollar bill. Written right across the top, over George Washington’s head: “Federal Reserve Note.” The interest rate, which the Fed also controls, is the cost of the money, or how much you would have to pay back later to get dollars now.

Measuring how much money is out there and, importantly, what it is worth, gets a little complicated. The amount of those Federal Reserve notes circulating in the global economy as of Dec. 14 was $1.1 trillion. But that’s not all of the dollars in the financial system. That’s just the paper kind. The money that banks have access to — known as the monetary base — includes not only currency but also electronic reserves with the Fed. That is $2.6 trillion. Broader measures of money, which count bank deposits from customers or cash in money markets, total as much as $10.6 trillion.

The vast majority of money in the economy, in fact, isn’t in paper or coins. It is a bunch of zeroes and ones, electronic accounts in computer systems that tally who owes what to whom. The Fed can increase it or reduce this amount by flicking a few buttons.

This is where the critics start to get worried. Large increases in the amount of money circulating in the financial system could foretell a decline in the currency’s value or create other troubles. As Mr. Paul says, “If you double the supply of something you usually diminish its value.” He wants the supply of money to be tied to the supply of gold in bank vaults, an idea that has its drawbacks. Among them: World gold supply is driven by such countries as South Africa, Russia and Peru, not exactly great allies. Another drawback: Americans don’t have much use for gold. Annual spending on gold by Americans is about equal to annual spending on dry cleaning or going out to the movies, according to World Gold Council and Commerce Department data.

But we digress. When Mr. Bernanke said on the CBS show “60 Minutes” that the Fed wasn’t actually printing money, he meant that the amount of paper currency in circulation hasn’t been rising very fast. Since the financial crisis started, currency in circulation has grown at a 6.3% annual rate, which is relatively modest. Very broad measures of money, which include bank deposits and money market funds holdings, have grown at a 7.6% rate, having picked up recently after contracting during the crisis. Other measures of money have exploded, most notably the cash reserves that banks have on deposit with the Fed. That measure of money has increased at a 247% annual rate since the crisis started.

The Fed hasn’t actually been printing dollars, but it has dramatically pumped up the electronic supply of dollars it credits to bank ledgers in programs to get the economy going. The Fed has been buying mortgage and Treasury securities from banks and electronically crediting their accounts with money they can loan or put to other uses. One problem, however, is that banks aren’t lending the money. Much of it is sitting there, as if in stagnant pools.

If they do start lending aggressively, the Fed might have a problem with too many dollars chasing too few goods, the classic definition of inflation or overheating. But it hasn’t happened yet.

How to know whether all the new electronically generated money is destroying the dollar? Some people look at exchange rates: The value of the U.S. currency compared to the value of other currencies.

By this standard, the dollar has been on a roller coaster since the 1980s. From 1985 until 1988, it lost 15% of its value when measured against a basket of other currencies. From 1988 until 2002 it more than doubled in value. From 2002 until 2008, it lost 25% of its value. Once the crisis started in 2008, it has had fits of weakness, as well as bouts of strength as a safe-haven asset. Today, it is worth about as much as just before the collapse of Lehman Brothers, which was about as much as the mid-1990s, a time of American prosperity.

Currency movements don’t always send clear signals about what is happening with your money. In the past three months, the value of the dollar, when measured against the euro, has increased by about 14%. Its strength doesn’t mean the dollar is stronger; it means Europe is very weak. Likewise, it has been weakening against the Chinese renminbi for several years. But isn’t that to be expected when a developing country like China grows at three times the rate of a developed country like the United States for decades ? Is it a reflection of Chinese strength or American weakness? And unless you’re going to China and spending your dollars there, how much does it matter to you that you can buy less Peking duck with it?

A better way to look at the value of our paper currency to you is by measuring what you can buy with it at home —what’s called its purchasing value. This is what the government’s consumer price inflation indexes are designed to do, and what the Fed tries to manage. The indexes aren’t perfect. But this is what they say:

Inflation hit 15% in 1980. During the next decade it averaged 5.6%. It fell to 3% in the 1990s and drifted below that in the early part of the 2000s. It went negative for a time during the financial crisis. During six years of the Bernanke era at the Fed, it has averaged 2.3%, which is lower than Alan Greenspan or Paul Volcker ever achieved. This takes into account big swings in food and energy prices, which the Fed is sometimes accused of ignoring.

Inflation picked up in 2011. The consumer price index was up 3.5% in October from a year earlier. But it is showing signs of moderating, with the fading of a commodities-driven surge earlier this year. Yes, some areas like food, energy, education and health keep getting more expensive. But other areas, like haircuts, movies, restaurant meals, televisions and, of course, housing, aren’t.

In short: Inflation might take off and wreck the purchasing power of a dollar. But official statistics suggest it hasn’t yet happened.

Of course, some people doubt the government’s statistics. But other private measures tell the same story. Professors at the Massachusetts Institute of Technology have been tracking the behavior of prices for goods sold by online retailers on the internet in the so-called Billion Prices Project. The professors started the index, run by a group called Price-Stats — State Street, in 2008. The index has been tracking the consumer price index closely. The University of Michigan’s surveys of consumers also show expected inflation has been stable. And yields on government bonds, which tend to surge when investors fear inflation, are near historic lows.

The much-feared collapse of the dollar, all of these indicators suggest, hasn’t happened yet. At some point, the Fed will need to drain all of those electronic dollars from the damaged banking system to prevent a big drop in the value of our money. The Fed’s critics ask legitimate questions about whether the central bank will have the will and the know-how to take the money out when needed. Fed officials retort that the time isn’t near and that they’ll be able to do it when needed.

There is another way of looking at a dollar’s value, which is disturbing. Think for a moment about the purchasing power of your own paycheck. Remember, money is our way of keeping track of the value of our labor and what it can buy. At the end of the day, this is the measure that matters to every American. It takes into account not only how much consumer prices are going up, but also how much our incomes are rising. It is indifferent to whether you travel abroad and to whether European banks are about to collapse. This measure also keeps the dollar’s value in some perspective. When measured against consistently rising consumer prices, as Mr. Paul does, a dollar looks like it is worth a tiny fraction today of what it was worth in 1913. But when we consider what we as a people can buy with a week’s worth of income today, then clearly we are better off than we were a century ago.

The most recent numbers, however, truly are troubling. Inflation-adjusted after-tax incomes per person today are lower than they were in 2006. People aren’t making enough money to keep up with even small increases in consumer prices. One critical question is how do we as a society raise real incomes?

The Fed doesn’t control this the way it controls inflation. Real, inflation-adjusted incomes are driven by worker productivity, education and the broader efficiency of the U.S. economy. This makes it a big economic challenge for the whole political system to understand and address.



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