Last summer, we explained how the Federal Reserve’s management of the US economy had returned to the confusing policy of the late 1970’s and early 1980’s when good economic news was bad for commodity prices and bad economic news was bullish for commodity prices.
How can that happen?
Paper currency is no longer tied to something of value such as gold, silver, or in the old days, salt. People with paper currency used to be able to go to a bank and redeem the paper for something of physical value. Americans could exchange a dollar for a fixed number of grams of gold at any bank until 1933. Franklin Roosevelt’s New Deal ended that, but Americans were promised the value of the dollar was still tied to gold.
In the early 1900’s, some countries did away with their currency being tied to standard value. The only value of the paper currency was the “good faith” in the government that issued it. Pretty quickly, it became obvious the amount of paper currency in circulation needed to be managed carefully or an economy could be wrecked, such as what happened to Germany after WWI. Germans were heating their homes in 1921 with Deutschmarks because they had less cost per unit of heat than coal or even wood.
After the debacle in Germany, John Keynes (1883–1946), a British economist, was the first to try to develop the principles of how to manage a country’s floating value of its currency without wrecking its economy. He concluded any expanding economy will have some level of inflation and the key is to balance a growing economy with a reasonable level of inflation and that is accomplished by the government spending newly printed money, lower interest rates, smaller bank reserves to increase the money supply (easy money policy). As the money supply increases, the economy expands. Yep, it is true. People spend easy money for just about everything and businesses flourish.