Leaders from the investment banking firm Goldman Sachs have come to Washington like the "dollar-a-year" men during World War II. CEO Henry Paulson has agreed, after negotiating his own terms, to be the third secretary of the Treasury under the Bush administration. He is said to be a "deficit hawk," which means he can't stand the huge deficit we are currently running.
Another Goldman Sachs alumnus, Robert Rubin, who was the treasury secretary under President Bill Clinton, convinced that president to raise taxes and cut government spending so the government would reduce its requirement for borrowed money and take the pressure off rising interest rates.
Something in the water at Goldman Sachs seems to prompt these super-rich and super-smart people to lean toward fiscal conservatism. We owe a debt of gratitude to anyone who gives up a $30 million annual salary to come work for us for $200,000.
To understand the importance of Paulson's selfless contribution, it helps to understand some of the most basic fundamentals of money. The best description is found in the Peter Bernstein book, "The Power of Gold," which talks about the invention of money as we know it today: a process that took hold in the 1500s during the European trading fairs where goods were exchanged and sold.
To appreciate the complex intellectual demands that Paulson will confront, a quick look at the history of money will help us understand the challenge he faces.
First of all, there are two ways that money is created. When goods are created and then sold, like sheep being sheered and the wool sent to market, value is created from thin air, and it leads to the formation of "private money."
This growth of private money is what we root for when we see a rise in the Gross National Product. In the old days, a "bill of exchange" (an IOU that today would be a "check") would be extended in return for goods being purchased (in this scenario, the wool). That bill of exchange could then be used to buy more sheep, because someone selling sheep would accept the bill (or a new IOU) in payment.
In theory, the money supply remained the same as long as productivity remained the same. If productivity increased, the money supply should have increased in lock step with, in this case, the additional wool from more sheep.
If the money supply increased at a faster rate than productivity, inflation resulted because the currency was cheapened. It took more money to buy the same amount of wool.
How could too much money be created? Because so-called "public money" consisted of the coins and currency that could only be created by governments. While IOUs or checks can be freely traded indefinitely, there will eventually be situations in which people will actually need currency.
If a merchant had been buying wool with Italian lira but eventually needed French francs for some transaction, he could go to the central bank of France and trade one currency for the other.
Unfortunately, any number of kings at the time were tempted to solve their debt problems by just printing more of the public money they were free to create. This source of money, disconnected from productivity, led to inflation.
The modern-day version of the same technique would be a government that borrows massive amounts of money and deliberately plans to pay it back years later with dollars that will be worth less as a result of inflation.
So back to Paulson, a tough Dartmouth graduate stepping into the ring with what the departed appointee of the president's Faith-based Initiative described as "the Mayberry Machiavelians."
His challenge will be to convince the current administration that responsible financial management requires lower spending and higher tax revenues. The president will have to finally veto some spending and tax cut bills for the first time in six years.
There's too much false hope directed toward the Federal Reserve when they play only a partial role in controlling the amount of "public money" described above. Today's equivalent of yesterday's money-printing king is a government that just keeps borrowing and spending.
No amount of fine-tuning by the Fed can stop the kind of rampant inflation that can throttle an economy -- and a society. If we want to avoid the "stagflation" of the Gerald Ford era or the scene from 1930s Germany, where a wheel barrel of cash bought a loaf of bread.
Paulson may be our last hope. I hope he takes the gloves off; and if he's fired, he should refuse to leave the building.