An article was recently forwarded to me by a friend, who like many of us, is concerned about the state of our economy today, and increasingly alarmed by the rhetoric coming from the media, Libertarians, gold standard advocates, and countries dependent on exports to the US.
The article was written by two members of the American Principles Project, an advocacy group for Liberty out of Washington, DC.
Having read the article a few times and visited the website, I’m guessing both authors would be content to be labeled Libertarian. Conservatives and Libertarians share much of the same ideology, which is wonderful. However, when it comes to economics the two groups diverge. The article, “It’s the Money, Stupid,” written by Jeffrey Bell and Sean Filier, reveals the differences.
Libertarians have attached themselves to a failed economic school of thought, the Austrian School. They’ll be quick to quote either Ludwig Mises or Friedrich Hayek in explaining themselves. From this starting point, most of what Libertarians have been taught to believe about monetary policy and the role of the Federal Reserve System (Fed), or the international gold standard and “fiat” currencies are misguided. In this area, Libertarians are much like Conservatives; they are trying to conserve something from years gone by. The Austrian school is an economic philosophy that hasn’t kept pace with the establishment of a mature complex economy that is the United States, and for that matter, much of the rest of the world.
The article took a familiar path: the Fed is unconstitutional, poorly managed and must go. Conservatives enable the Fed out of shortsightedness and poor understanding of monetary policy. And, only paper money backed up by a piece of gold rock found below the surface of the earth is money of value.
There isn’t much you can say about the Fed to a Libertarian, or even some Republicans and Conservatives. Whether they understand monetary policy as practiced by the Fed or not, a basic tenant of Libertarian philosophy is the firm belief that the creation of the Federal Reserve System was unconstitutional. Therefore, it cannot be a success, it must be a failure, there is only fault to be found, so the Fed must be abolished. Libertarians, and likeminded Republicans and Conservatives are convinced the only things the Fed does is enrich banking executives and the well connected, create inflation which keeps Americans from still being able to still buy a piece of gum for one penny or a brand new Corvette for $5,000.00, and willfully and voluntarily finance any and all deficit spending from Washington, DC. All of which are wrong.
Actions taken by the Federal Reserve to help foster higher levels of employment while maintaining stable prices in the aftermath of America’s most severe recession since the 1930’s have moved Fed haters and gold bugs to a frenzy. Their call for an end to the Fed and a return to the good old/short-lived days of the international gold standard as a substitute for domestic monetary policy has never been louder.
Last week, the Fed announced another round of “quantitative easing” (injections of liquidity into the banking system through purchases of fixed income securities like mortgage backed securities and US treasury notes and bonds) which could total as much as $850 billion over the next six months. Through open market purchases the Fed will buy a mix of existing debt and newly issued debt ($600b), and recycle principle repayments from current holdings into these purchases ($250b). Combined with their initial round of quantitative easing, the total injection of money into the banking system could reach $2.5 trillion.
For sure an unprecedented effort by the Fed in order to maintain their mandated obligation of full employment and stable prices. Current levels of unemployment (9.6%) are still well above full employment levels of 5-6%, and current levels of inflation (below 2%) are below stable levels of 2-3 percent.
There is little doubt the Fed is taking a risk with this second round of quantitative easing. The risk is rapid, elevated and sustained inflation in the long-run. The risk of doing nothing is continued disinflation and possibly deflation, which can be more damaging to the economy in the long-run than inflation. The reward is a more rapid return to full employment levels and stable prices to induce higher levels of productivity and therefore a higher standard of living.
On this theoretical point, the pundits and complaining export dependent countries are way ahead of themselves. In theory, and in some historical experiences, concerns over long run inflation pressures due to unusually large increases in the aggregate spending or the money supply is legitimate. To date, there is no evidence that should solicit the degree of concern being expressed. Inflation has been low and stable for the better part of 25 years and has been moving towards 1 percent since the 2008 recession began. The money supply, as measured by M2 has had a stable growth rate for some time now. Since the beginning of the recession, M2 is only up 15 percent to just over $8.7 trillion.
These injections of liquidity into the banking system by the Fed are temporary, not permanent. The Fed can act to counter rapid and large increases in inflation if and when the first signs emerge.
Fed officials are aware of the risks and the trade-offs of their quantitative easing policy. Thomas Hoenig, President of the Kansas City Fed, and current member of the Federal Open Market Committee (FOMC), has been the sole vote against the Fed response to this recession we are just coming out of. He has consistently come down on the side of believing the risks of rapid and excessive inflation is greater than the risks of disinflation and deflation as an outcome to Fed actions.
Rest assured, all of the members of the FOMC are well aware of the risks that Hoenig rightly expresses concern over. The debate over this point has likely been lengthy and detailed, relying heavily on relevant historical events and large of amounts of empirical data.
Hoenig is being listened to, the other members happen to disagree with the balance of his risk assessment and believe the risks of deflation and high employment are greater at this moment. A similar event happened in 2003, when the FOMC guided by then Chairman Alan Greenspan lowered the federal funds rate to 1 percent again over concerns about the risk of deflation.
Hoenig was again a vote in opposition to the rate drop. The economy was sluggish in its recovery from the recession that had begun in early 2001 that was exacerbated by the attacks on 9/11. GDP was below potential at 2.5 percent in 2003, recovering slowly from 1.1 percent in 2001, and 1.8 percent in 2002, a three year average of 1.8 percent, well below potential. In 2001 and 2002 inflation rates were trending lower, reaching 1.6 percent in 2002. Much of the problem was in capital expenditures related to the risk tolerance of corporate America after 9/11 and the fallout from corporate scandals. From 2003 to 2008, inflation once again returned to the target range of 2-3 percent, averaging less than 3% per year over that period.
If you detest the existence of the Fed there is nothing they can do that will please you.
The Fed is making informed judgments. The staff and members of the FOMC have reams more information about the economy than anyone one of us outside of the Fed offices. There is no denying the risk of this second round of quantitative easing. An argument can be made for doing nothing and letting the stimulus provided by Obama, and the interest rate cuts and first round of quantitative easing by the Fed to work to the extent they will, and we’ll eventually emerge in recovery. It’s a timing thing. In any event, a well informed FOMC board voted 10-1 to pursue the policy.
Like it or not the Fed deserves the lion’s share of the credit for keeping the recession from being worse than it was. Still, monetary policy is the best tool available to policy makers right now. Local, state, and federal governments are tapped out.
I’m not an apologist for the Fed, though let me say this: they don’t coin money; if the Fed didn’t exist we’d create it; they’re not in-place to enrich bank executives; for the vast majority of their years in existence they have been successful in maintaining full employment and stable prices; the value of the US dollar against other currencies is not the Fed’s responsibility; independence from the political process is key to their ability to succeed; our national indebtedness is the result of the votes cast in the halls of Congress-fiscal policy not monetary policy; the cause of the bursting of the housing bubble and the resulting economic fallout lies mostly with Congress; the fed is responsible for maintaining full employment and stable prices not the price of gold or export levels of export dependent countries.
To eliminate the Fed as our central bank, and let the “market” set interest rates, money supply levels, and oversee bank supervision is to ask for economic chaos, invite the political class into decisions over the price and availability of money, or to give up a huge chunk of our national sovereignty to a foreign central bank or international governing authority.
We want to keep the Fed. It’s not a perfect institution since it’s run by human beings. For as long as we don’t politicize it or water down the intellectual integrity of the members we can always improve on what they do for the economy.
There are three choices when it comes to price stability: inflation; no inflation; deflation. Any economist will tell you a little bit of inflation (2-3%) is what is desirable for an economy, and much more welcome than zero or negative price changes.
More often than not, if you oppose the Fed, you support returning to the gold standard. Oh, the good old days, though so short lived. It makes sense you’d support the gold standard if you oppose the fed or a central bank as a concept. The gold standard, a fixed exchange rate system, would take control over monetary policy and the value of the US dollar away from US authorities. That is not a desirable outcome. What a trade-off, eliminate the Fed, but give away control of your economy. No thanks. You have to be a non-American to like that trade-off, or interested in weakening America and driving her towards global governance, the elimination of our national borders, and the usurpation of the US Constitution.
Having said that, it’s of no matter. Returning back to the international gold standard of the past can’t happen unless most of the world is ready and willing to take a giant step back in terms of economic development and standard of living. You see, there is one big problem: there isn’t enough gold. There isn’t enough gold to back up the economic activity of the US economy, let alone the whole world. Gold reserves total just over $5 trillion. The money supply in the US as measured by M2 (cash, coin, checking ,savings, etc) is over $8 trillion. You’d have to discover a lot more gold quickly, or sharply reduce our current standards of living.
The time has come when we put to rest the idea of having faith in the value of a rock dug up from the earth as being more valid then to have faith in the value of a piece of paper issued and backed up by a governing authority.
Gold is meaningful only for jewelry, to make things sparkle, and some advanced technology goods. So what the price of gold is at $1400 an ounce. That is pure speculation. Riding the trend. The supply and demand price for gold is probably somewhere down around $500. The rest is pure speculation. Some of it with the belief gold will soon be a means of exchange. Good luck with that. In the meantime enjoy your capital gains.
Those who hate the Fed love the gold standard because it would neuter the Fed. The cost, giving up control of our economy to a foreign governing body. Foreign nations, globalists, internationalists, America haters like the gold standard because it ties down America and helps accelerate the transfer of wealth from the US to the rest of the world, reduces our dominant economic role, and moves a giant step closer towards global governance. Oh, and by the way, the gold standard has proved long ago to be unsustainable, it’s inefficient, and not at all simple or transparent. The frequency and severity of the boom & bust cycle was more severe in the decades preceding the establishment of the Federal Reserve and the end of the gold standard in the 1930’s. Forget the gold standard.
Reaction to Fed moves and the price of gold has raised concerns about the US dollar. The media, pundits, export dependent countries talk about the US dollar losing reserve currency status and collapsing. Reserve currency status is nothing particular to be proud of. It’s got some benefits, but it also has costs for US citizens. Don’t worry about reserve status. We have it because of the size and wealth of our economy and the reach of our military when compared to all other nations. Collapse? Have you heard anyone define it. When it comes to the US dollar, all is relative. Don’t worry about collapse either. Could we get fast and out-sized moves in currency rates? Yes. It’s just as likely to take the form of buying dollars as a safe haven status, than selling US dollars to buy the Chinese Yuan or the Euro to escape the US. Let the market decide the value of the US dollar based on fundamentals.
When it comes to the value of the US dollar against other currencies, responsibility lies with the US Treasury. Apart from verbal communication, the US Treasury has a record of very rarely intervening in the foreign exchange market to change the value of the US dollar. This in contrast to China whose financial authorities must intervene in the foreign exchange and money markets daily to maintain their fixed exchange rate with the US dollar. While the Fed has no direct responsibility for the level of the US dollar when it comes to the conduct of monetary policy, there is little doubt it is a consideration in their deliberations about the level of the federal funds rate and quantitative easing measures.
Since the level and direction of interest rates are one of the key determinants for the value of foreign exchange rates, with the US federal funds rate dropping for some time and reaching historic lows of 0 – .250 percent, and the 10 year Treasury bond rate dropping for some time with an interest rate today below 3 percent, it’s no wonder the US dollar has weakened over the past few years. It is completely appropriate and necessary.
Ordinarily the US dollar’s value changes related to economic fundamentals; interest rates, growth rates, consumer confidence, inflation rates, trade deficits, budget deficits, etc. Over the past four years fundamentals have taken a back seat to first, the carry trade, then risk aversion trade, and back to the carry trade.
The carry trade is about interest rates. Finding the countries with the lowest ones to fund investments in the countries with the highest ones. Borrowing money in the currency of countries with low rates, and lending or investing money in the currency of countries with high rates. It’s related to the increased globalization of finance and the ease with which speculative assets move around the world to find the highest return. It’s also related to emergence and now dominant role of algorithmic trading (Black box trading where speed is the advantage. Detailed software programs created to replicate human trading actions but execute at speeds that are much higher).
The US dollar, with our interest rates at historic lows has become a funding currency. This helps explain a good portion of the US dollar weakness over the past few years. However, the US dollar is benefiting from the occasional re-emergence of the risk aversion trade. Which means, when uncertainty spikes more money flows into the safest asset class on the planet, US Treasury bonds; which helps explain the historic low levels of the interest rates on the US 10 year and 30 year bond. In order for foreign nationals to buy US Treasury bonds they have to buy US dollars first.
Given our massive trade imbalance, our massive budget deficit and national debt, and an administration seemingly dedicated to weaken America’s role in the world, we rightly deserve a weaker dollar. Forgetting the political component for a moment, the transmission mechanism for correcting our trade deficit goes through the foreign exchange rate. As a result of poor trade policy and low household savings rates the price we pay for incurring such a huge deficit is a weaker dollar. The weaker dollar initially leads to higher prices for imports from overseas, lower prices for American goods sold overseas, a short term worsening of the trade deficit as the value of imports rise, which leads to a decrease in the volume of imports and a increase in the volume of exports, which leads to a correction in the trade imbalance.
When it comes to the value of the US dollar, we get what we deserve. It would be nice to have a stronger dollar, but we can’t afford it right now. No US government official is deliberately driving down the value of the dollar directly, the market is.
The real problem with the US dollar story is China. Our voluntarily negotiated trade deal with China in the late 1990’s, and China’s fixed exchange rate are at the root of global imbalances right now. Until China let’s their currency float and we renegotiate our trade deal with China, the US will remain on the losing end in a variety of ways. Why do you think China is so upset with the actions by the Fed? They don’t want to lose their number one export market or see their ability to sell to the US weakened in any way. They’re dependent on us to keep their economy growing. That’s their fault. The same applies to Germany, and all other countries who complain about what the Fed is doing yet rely on US imbalances for their own success.
The US economy is slowly improving. We have fiscal and structural challenges ahead that must be dealt with sooner rather than later. Make no mistake, as long as we keep getting up to go to work each day, keep our expectations in check, avoid self fulfilling prophecy, we’ll continue on our long path of greater productivity and standards of living while maintaining our desirable dominant role around the globe politically, economically, and militarily.
If your only source of information on these topics is Glen Beck or Rush, I urge you please seek out other sources as well. Those two are scaring the heck out of Americans, and unnecessarily so.
