Monday, December 5, 2011
Why are most economists opposed to the concept of a gold standard?
by Gary North
Higher education in the United States was transformed by Rockefeller money, beginning in 1902: the General Education Board. The GEB made grants to colleges only if they hired Ph.D-holding graduates of a handful of universities, which alone granted the Ph.D. This way, the universities could indirectly take over the rest of the colleges, which were mostly church-related. The strategy worked.
Rockefeller's academic empire included the University of Chicago, which he founded. From the turn of the 20th century, the University of Chicago's department of economics repudiated the use of gold in monetary affairs.
Milton Friedman earned his Nobel Prize for a book researched mainly by his co-author, Anna J. Schwartz: A Monetary History of the United States (1963). Born in 1915, she still works full time. In the Wikipedia entry for her, we read:
Anna Jacobson Schwartz (born November 11, 1915) is an economist at the National Bureau of Economic Research in New York City, and according to Paul Krugman "one of the world's greatest monetary scholars". She is best known for her collaboration with Milton Friedman on A Monetary History of the United States, 1867 – 1960 which laid a large portion of the blame for the Great Depression at the door of the Federal Reserve. She is a past president of the Western Economic Association (1988).
The book is known in academic circles and policy-making circles only for its thesis regarding the Federal Reserve System, 1930-33. It says that the FED had not inflated enough, 1930-33. The book is never quoted by the media on any other topic, although it is a fat book. That is the only academic thing that Friedman ever wrote that was adopted by his Keynesian peers. Why? Because he came out on their side.
The academic economics profession is united on only one topic: the superiority of central banking to the gold standard.
There has never been a college textbook in economics that called the FED a government-created cartel that exists for the sake of the largest banks. This outlook shapes the thinking of the students who get certified to teach. They are literally unable intellectually to apply the economic theory in the chapter on cartels to the Federal Reserve System, despite the fact that the theory in the cartel chapter fits seamlessly onto the facts of the FED. Support of central banking is basic to the entire curriculum in modern economics.
So, the graduates have a blind spot: central banking. This means they have another blind spot: a gold coin standard. It means that they have literally never examined the theory of a monetary standard that is based solely on the enforcement of voluntary exchange, including contracts. They are literally incapable of imagining a free market for money. The methodological tools which they apply with mathematical precision – a fake precision – to every other area of life, including marriage, they are intellectually incapable of applying to money.
For decades, the Federal Reserve's Board of Governors (government) and its 12 regional banks (privately owned) have spent tens of millions of dollars (created out of nothing) handing research jobs to academic economists. The FED has literally bought off the profession. This story was concealed for years by the FED and its bought-off defenders, but it has recently surfaced.
This strategy was first adopted by the Rockefellers. John D. Rockeffer, Jr. hired Raymond Fosdick to run the Rockefeller Foundation. After he took the running of the foundation, Fosdick continued to pay public relations pioneer Ivy Lee to help reduce criticism of the Rockefeller oil empire. Lee had been on the Rockefellers' payroll ever since 1914. One of Lee's suggestions was to pay academics a lot of money to write pro-Rockefeller books. This worked so well that Fosdick began spending millions to buy off academia. There is a book on this: Donald Fisher, Fundamental Development of the Social Sciences: Rockefeller Philanthropy and the United States Social Science Research Council. It was published by the University of Michigan Press in 1993.
THE CLASH OF THE BASHERS
With this as background, I examine a Yahoo article on ending the FED. The article appeared only because of Ron Paul's campaign to end the FED. Paul has single-handedly made this a topic of public discussion. No one else has ever achieved this.
The "End the Fed" movement appears to have a lot going for it these days. Its adherents now include both conservatives and supporters of the Occupy movement. Perhaps its most prominent proponent, Rep. Ron Paul, has garnered respectable poll numbers in the 2012 Republican presidential race and blasts the Federal Reserve at every opportunity. Plus, the succinct slogan fits well on protest signs.
Paul has been so effective that the FED hired a public relations specialist in 2009. It had never done this before. The lady was famous in Washington as the lobbyist who ran Enron's Washington office until the firm went bust in 2002. She was also an adviser to all three of Clinton's Treasury Secretaries.
Removing the institution at the helm of U.S. monetary policy since 1913 seems unrealistic, though, and opponents consider it a crazy idea, even dangerous. However, proponents keep up the call, using an array of arguments from economic theory to promoting liberty.
Academic economists call no other academically defended idea "crazy." They literally cannot imagine as sane the suggestion that the world could not run – and run better – without the government-licensed, privately owned monopoly of central banking.
Whatever view one takes, ending the Fed is a goal much more easily stated than accomplished. But if Fed bashers got their wish, here are a few snapshots of how the country might change. . . .
Notice the pejorative term, "Fed bashers." It is true, of course. We are indeed Fed bashers. But the term is not used with respect to academically certified critics of any other government-created cartel.
A New Monetary Standard
Many advocates of ending the Fed argue for a return to the gold standard, which President Nixon ended in 1971, due in part to growing inflation, which was itself due to the costs of the Vietnam War. In addition, Nixon was concerned that Fort Knox contained only one third of the gold needed to back the dollars in foreign hands at that time. Under this system, the dollar's value would once again be tied to the price of gold. Another option is to tie the U.S. dollar's value to a basket of commodities.
The gold-exchange standard in 1971 was a hybrid created by governments at the 1922 Genoa conference. It was their way to avoid returning to the pre-World War I gold coin standard, which put tight limits on government deficits funded by bank credit. After World War II, this system subsidized the USA's expansion of fiat money. It broke down in 1971 because the Federal Reserve had inflated ever since 1933, when the right of Americans to own gold was made illegal. The article mentions Ft. Knox, when the bulk of the country's gold is held in the vault of the Federal Reserve Bank of New York, a privately owned firm. Again, the FED's supporters refuse to discuss the facts.
End to Constant Inflation (for better or worse)
Tying the dollar's value to a commodity could very well moderate inflation. If the country moved to a strict gold standard, for example, the money supply would be bound to the supply of gold, so printing more dollars would require acquiring more bullion to back them, a big disincentive. This notion, of course, pleases proponents of controlled government spending. Though there might be short-term bouts of inflation and deflation, in the long run, prices could easily remain stable.
This is correct. For 250 years, this has been the #1 defense of the gold standard. Also, for 250 years, the inflationists have rejected it, as we see here.
There are, of course, caveats. For example, massive borrowing could spark inflation.
This is nonsense. It ought to be obvious nonsense, but gold standard bashers cannot think straight. Massive borrowing cannot "spark inflation," because borrowing cannot spark inflation without fractional reserve banking. When borrower A borrows money from lender B, no money is created. The use of an existing supply of money changes by voluntary agreement. Demand rises for the items borrower A buys. Demand falls for the items lender B would otherwise have bought. Simple. But it's not simple for gold standard bashers to grasp.
And the country would also be forced to periodically deal with the relatively unfamiliar territory of deflation.
This is nonsense, for the same reason that the previous argument is nonsense. The supply of money does not change. If prices fall, it is because production rises. You know: "More goods chasing the same amount of money." Isn't the idea of slowly falling prices the whole idea of economic growth? If scarcity is a curse – and it is – then increased output reduces scarcity. If scarcity is defined as "greater demand than supply at zero price" – and it is – then falling prices point to reduced scarcity. Yet gold standard bashers regard this as a problem of the gold coin standard.
Returning to the gold standard in particular could make these problems worse. "The gold market can have very large movements within a day," says Randall Kroszner, an economics professor at the Booth School of Business at the University of Chicago and a former governor of the Federal Reserve System. He adds that during recent times of economic uncertainty, this added volatility would likely not have been helpful.
Excuse me? The gold market today establishes the price of gold in terms of fiat money systems run by central banks. So, the price of gold as denominated in fiat money varies. Why? Mainly because the value of currencies fluctuates wildly because of investors' doubts concerning the policies of central banks and commercial banks.
The wholesale price level (a statistical construct) in the West did not change much from 1815 to 1914, the era of the international gold, coin standard. The Federal Reserve began operations in 1914. The inflation calculator of the Bureau of Economic Statistics reveals that the purchasing power of the dollar has declined by 95% since 1914.
But the gold coin standard bashers blame gold in a fiat money standard for gold's price swings.
Shock to the System
A change to the U.S. currency system could potentially be destabilizing to foreign economies. Kroszner says that, as many countries tie their currencies' values to the dollar, the potential deflationary effects of being linked to a gold standard would lead to more exchange-rate volatility.
Excuse me? Are we supposed to believe that a gold coin standard would be dangerous to America because it will call attention to the monetary instability of foreign nations' currency systems, which are run by central banks? I fail to see that this is a liability.
But advocates say the result would be more long-term stability for the global economic system. "I think it would be extremely positive, but the initial effect would be so bold as to be alarming," says Judy Shelton, a senior fellow at the Atlas Economic Research Foundation, a nonprofit organization that advocates for free markets.
Alarming! Similarly, when the employees of a house of prostitution come to the conclusion that they are living in sin, and they all walk off the job together, their patrons no doubt are alarmed. Should the ladies therefore stay on the job?
A Sad Day for Keynesians
Most Keynesian economists believe that expansionary monetary policy moves can boost economic growth.
This is surely accurate.
The U.S. has seen this at work most notably with the latest round of quantitative easing, known as QE2.
This is assumed, not proven, by Keynesian economists.
The fastest economic growth in history was 1815 to 1914, the era of the gold coin standard. Wholesale prices were flat for a century. It is interesting that Friedman and Schwartz's book shows that American economic growth was unprecedented, 1870-1914. But the academics never refer to that section of their book.
The effectiveness of quantitative easing, especially balanced with associated inflation risks, have been hotly debated in recent years. But no more Fed would simply mean no more easing programs.
He's got it!
Saving May Be More Attractive
Shelton argues that the Fed, with its near-zero interest rates and contributions toward dollar devaluation, "makes a sucker out of a saver." "You save money, you've got zero interest for saving it, and by the time you get it back out, it's worth less," she says. Without the Fed pushing interest rates low in hopes of stimulating the economy, says Shelton, saving money could be much more rewarding.
She would be correct if the FED were the cause of today's low rates. It isn't. It has not been since late 2008. The cause of today's historically low rates is the panic of commercial bankers and borrowers. They fear a return of recession. They prefer 0.01% per annum in Treasury bills to the likely effects of the central bank's attempt to avoid inflating. I do not blame them.
Ending the Business Cycle
This is how Ron Paul put it in his 2009 book, End the Fed. According to Paul and the Austrian school of economics, the booms, bubbles, and busts of business cycles are the result of meddling by central banks. But Shelton moderates this slightly, saying that the Fed has worsened the cycle's negative effects: "Instead of smoothing out that cycle, [the Fed has] tended to exacerbate it," generally providing too much credit. Ultimately, she says, this can lead to irrational exuberance. Whether or not this would be universally true, many economists do blame former Federal Reserve Chairman Alan Greenspan's policies for encouraging the housing bubble that sparked the economic crisis.
Notice that he interviews Shelton, who is among the best of the non-Austrian academic economists -- she stood alone in 1989 in forecasting the collapse of the Soviet economy one year later -- but she is not an Austrian School economist. This is typical of mainstream financial journalism. "What do the Austrians teach?" This is always asked of non-Austrian economists.
A New Regulatory System
The Fed does much more than determine the monetary base; its chief functions also include supervising and regulating banks--arguably very important functions, especially post-financial-crisis. Without the Fed in place, a new entity would have to perform these functions. In Shelton's opinion, this could be done either privately or federally.
Excuse me? Are we supposed to believe that the FED, which funded the bubbles, is the agency best equipped to regulate commercial banks? This is the agency that did not see the 2008-9 crash coming, when Austrian economists did. Are we also supposed to believe that the federal government's Civil Service-protected functionaries are reliable regulatory agents, even though they cannot be fired for not forecasting and then preventing another crisis? I ask: Which economic theory of profit and loss, cause and effect, supports that conclusion? (Hint: see the works of public choice economics.)
More Market-Based Interest Rates
The Fed has been around since 1913, so it seems difficult to envision exactly how a Fed-free monetary system would look. According to Kroszner, without a central bank, the U.S. might revert to the system in place before the creation of the Fed: one of private clearinghouses that would determine short-term liquidity, altering short-term interest rates. However, Kroszner points out, longer-term rates are already largely determined by supply and demand.
Yes, long-term rates are set by supply and demand. But the FED is now involved in "operation twist." It increases the supply of money going to long-term instruments, meaning Fannie, Freddie, and Timmy.
A Fairer Banking Industry?
"Fairness" is, of course, subjective, but Fed critics argue that two of the Federal Reserve's chief functions--selling bonds and regulating banks--are at cross purposes and make for an unfair market. "If [the Fed] goes into a community bank and says, 'We're very uncomfortable with your loans to entrepreneurs...but we won't penalize you at all if you buy U.S. Treasury bonds,' that's a huge conflict of interest. That makes me uncomfortable, that the Fed has the inside track on the financial resources of the country," says Shelton.
It makes me uncomfortable that the FED can create bubbles, pop them, and thereby wipe out the dreams of millions of Americans.
It makes me uncomfortable that academic economists cannot think straight on any aspect of money, including basic theory of supply and demand.
It makes me uncomfortable that self-proclaimed free market economists refuse to understand that a government-created cartel is bad for the public.
That is why I am a FED basher and proud of it.
It is also why I served as Ron Paul's first staff economist. Back then, nobody paid any attention to him. Today, they do.
You can keep the good old days. The future looks good for FED bashers.
Every time there is another monetary crisis or sovereign debt crisis, the FED's army of academic defenders goes into ad-hoc explanatory mode. Every time it happens -- every few weeks, these days -- I am reminded of Bobby Fisher's answer at age 15 when he was asked why he loved chess. "I love to see them squirm." Me, too.