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• Ever since the U.S. decoupled the dollar from gold in the late 1960s and early ’70s, the Federal Reserve has been able to create as much money as it sees fit. And for the last 50-plus years, our economic system has been driven by credit creation and consumption.
• Economist Richard Duncan, author of the recent book “The Money Revolution,” says this phenomenon has led to unprecedented prosperity. But the U.S. is facing the possibility of a severe recession — or worse.
• Richard shares insights on the history of global trade and the gold standard, the American reliance on credit and debt, why China has changed the way we consume goods and his ideas about what’s next.

Once upon a time, economic growth was driven by savings and investment. People would save, invest and make a profit. That profit would accumulate as capital, which was then reinvested. We called it capitalism. It was usually slow. It was often difficult. But “that’s not the way our economic system works anymore,” says economist Richard Duncan, author of the recent book “The Money Revolution” (Wiley).

“Today, our economic system is driven by credit creation and consumption, and more credit creation and more consumption.”

But is there such a thing as too much consumption? Who does our economic system work for? Is money even real? 

Take off your tinfoil hat: Our current system isn’t the result of some evil scheme. 

“This is the way our economic system evolved once it was no longer constrained by the requirement for money to be backed by gold,” Richard says. “All of classical economic theory was built around that premise.” 

However, the days of every dollar representing a fraction of bricks at Fort Knox are long gone. The shift away from the gold standard caused our economy to evolve in a completely new way — one that “resulted in unprecedented global prosperity,” he adds. 

On an episode of Top Traders Unplugged, Richard joined us to explain the historical backdrop of our current economic climate and how credit creation and consumption generate economic growth. He also talks about the influence of foreign central banks, whether the U.S. economy is a bubble waiting to pop, the role of China on the global stage, why government intervention may be the best way forward and much more. 

Read on for a recap of selected segments of our discussion. 

The ‘money revolution’ begins

Until 1968, the Fed was required by law to maintain gold backing for all of the dollars it issued. But that year, the government didn’t have enough gold to continue issuing more dollars, so Congress changed the law. In his book, Richard argues that this is when the “money revolution” began.

“The Fed was free to create as many dollars as it dared,” Richard notes, adding that its only real constraint was refraining from printing too many, which would lead to high rates of inflation.

Three years later, the U.S. stopped allowing other countries to convert their dollars into gold — and fundamentally changed the way our economic system works. With the loss of the gold standard came an imbalance between global trade partners. Richard explains it this way:

“In the 19th century, if England had a big trade deficit with France, England’s gold would literally have been put on a ship and sent to France. And since gold was money, England’s money supply would have contracted. It would have had a very severe recession, unemployment would have gone up and it would have deflation.”

Meanwhile, France would experience the opposite phenomenon: more gold, more money, expanded credit … and inflation. When the French had more money, they would buy more cheap English goods, while the English would stop buying so many expensive French goods. That’s how trade came back into balance — a sort of “automatic adjustment mechanism” under the gold standard, Richard says. “That’s the way global trade worked up until the Bretton Woods system broke down in 1971.”

Deficits and devaluation

After the demise of that system, things changed radically. 

“It took us a little while to discover this,” Richard adds. “But starting in the early 1980s, we [the U.S.] started running very large trade deficits with the rest of the world, with Japan and Germany in particular. By the middle of the 1980s, the U.S. trade deficit as a percentage of GDP had gone from effectively zero to 3.5%.”

This unprecedented shift was so alarming, he says, that a group of global policymakers met at the Plaza Hotel in New York and negotiated a solution. The Plaza Accord devalued the dollar by 50% against the Yen and the Mark, which “was enough to bring trade back into balance for a few years around 1990,” says Richard. 

But then China, as well as a handful of other countries with workforces that are paid low wages (compared to Western nations) entered the global economy. Soon, the U.S. faced even bigger trade deficits with those new trading partners. By 2006, the overall trade deficit was up to $800 billion (6% of U.S. GDP). 

Supply chain bottlenecks versus a workforce of billions 

The gold standard is just one reason for the U.S. trade deficit. Globalization is its own paradigm shift.

“When trade had to balance, that meant if the U.S. government had very large budget deficits, and if the Fed created too much money and over-stimulated the economy, then very quickly, [the] U.S. economy would run up against domestic bottlenecks,” Richard explains. 

“There would be full employment. And for industrial capacity utilization, all the car factories would be working overtime. The steel factories would be producing as much steel as they could. So we would see wages rise and the cost of manufactured goods rise, and this would lead to a wage-push inflation spiral as we saw at the beginning of the late ’60s, but mostly in the 1970s.”

But post-1971, the U.S. could circumvent these domestic supply chain bottlenecks. By the mid-2000s, instead of a workforce of 100 million people, we were part of a global economy with billions of workers, “most of whom were earning far less than Americans,” Richard adds. “In 1990, the Chinese were probably earning 5% as much as the average American.” 

Globalization and inflation

Globalization was “extremely deflationary,” because when Americans began buying more goods from countries with ultra-low wages, and manufactured goods’ prices  plummeted while wages simultaneously decreased.

As a result, inflation fell and kept falling — from 15% or more in the early 1980s to the point when it frequently turned negative in the years leading up to the COVID pandemic. 

“This changed everything,” says Richard. 

He explains that low inflation meant that the U.S. government could run much larger budget deficits than ever before, financing those deficits at extremely low interest rates. By the financial crisis of 2008, Uncle Sam could respond with trillion-dollar budget deficits for four years in a row — made possible by creating new paper money through several rounds of quantitative easing. 

Debt and the ‘wealth effect’

When money was backed by gold, there was a fixed amount of money, so borrowing a lot would hike interest rates and crowd out the private sector. 

“But once the Fed was free to create as much money as it pleased and buy a lot of government bonds, this enabled the U.S. government to borrow much more and spend much more,” Richard notes.

Finally, the end of the gold standard caused credit growth to explode, especially after the 1970s. But “total debt and total credit are two sides of the same coin,” he argues. “One person’s debt is another person’s asset. What I’m talking about here is not just the government debt, but household sector debt, corporate financial sector debt, long corporate business debt — all the debt in the country.” 

The nation’s total debt tab first topped $1 trillion in 1964. By 2008, it was 53 times larger. Today, it's $91 trillion. 

The percentage of total credit compared to GDP went from about 130% in 1950 to 180% in 1980. Once the post-gold-standard changes kicked in, credit skyrocketed to 380% and became the main driver of economic growth. 

People borrowed money and could consume more. Businesses could invest more. Asset prices increased and “created a wealth effect,” Richard explains. 

This new global economy pulled hundreds of millions of people around the world out of poverty. China is a prime example, says Richard. 

“I first saw China in 1986,” he explains. “It was a very poor, developing country. Now things have changed entirely. It has far better infrastructure than the United States does. Shanghai looks like the Emerald City in ‘The Wizard of Oz.’ And they’re about to overtake us, economically, technologically and militarily.”

That’s a result of China’s massive trade surplus with the United States — which has transformed both of our countries.

‘Credit-ism’

In his book, Richard describes the transition from capitalism to what he calls credit-ism.

Economic growth is relatively simple when credit is expanding rapidly, Richard says. “Consumers can borrow more on their credit cards or extract equity from their homes, and they can go out and spend it. Similarly, businesses, as long as they have access to more and more credit, can invest more … create more jobs, buy more raw materials, and that makes the economy grow.” 

But eventually, credit grew faster than the economy: “It was all very positive as long as credit continued to grow very rapidly,” he adds. “In 2008, the private sector couldn’t repay all of the debt it had taken on in the housing boom years.”

When millions of Americans began defaulting on their debt, credit started to contract and the U.S. headed toward a financial crisis to rival the Great Depression. The government intervened, injecting billions into the economy and averting the worst-case scenario. After the Great Recession, multitrillion-dollar budget deficits are now the norm.

The solution? Invest in innovation and ‘turbocharge’ the GDP

How can we reach a state of equanimity? Richard’s hypothesis: Meet multitrillion-dollar deficits with a multitrillion-dollar investment program. 

Who can afford that? The U.S. government. Richard argues that it should “invest as much as possible, as fast as possible.” 

He thinks that if the government invested $10 trillion in new industries and technologies over a 10-year period, the economy would grow somewhere between 5% and 10% annually, “turbocharging” the GDP. That would mean the ratio of government debt to GDP 10 years from now would be lower than projected.

Richard notes that he has been talking about aggressive technology investment by the U.S. government for a long time. Naysayers suggest it will never happen. But “the government just did that,” he points out — with a recent $280 billion industrial policy bill meant to counter China’s technological and manufacturing dominance in the global market.

“It’s a good first step in the right direction and we need to do more of that,” Richard adds. “As we do, we will … shore up our national security, make the economy grow faster and grow out of our current debt problems. Moreover, it will ensure that credit-ism survives. It will keep credit from contracting and collapsing into a [new] Great Depression. And the kicker is, it will result in the most extraordinary technological and medical breakthroughs.”

With that kind of investment, Richard thinks U.S. innovators could transform the entire globe. They could “cure all the diseases and expand life expectancy by decades,” he argues. 

While the National Cancer Institute’s annual budget is $6 billion a year, cancer kills 600,000 Americans every year and those billions seem paltry in comparison to the $20.94 trillion GDP (still the highest in the world). Last year, the Fed created $120 billion every month. The government borrowed $2.8 trillion in the second quarter of 2020, which was equivalent to 13% of 2020 GDP for the whole year. Put simply: We have the money but not the will to act — yet.

“These are the opportunities in front of us as a result of the money revolution over the last five decades,” says Richard.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.