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  • Why Experts Get the Gold Standard Wrong

    Why Experts Get the Gold Standard Wrong

    Many mainstream economists, perhaps a majority of those who have an opinion, are opposed to tying a central bank’s hands with any explicit monetary rule. A clear majority oppose the gold standard, at least according to an often-cited survey. Why is that?

    First some preliminaries. By a “gold standard” I mean a monetary system in which gold is the basic money. So many grains of gold define the unit of account (e.g. the dollar) and gold coins or bullion serve as the medium of redemption for paper currency and deposits.

    By an “automatic” or “classical” gold standard I mean one in which there is no significant central-bank interference with the functioning of the market production and arbitrage mechanisms that equilibrate the stock of monetary gold with the demand to hold monetary gold.

    The United States was part of an international classical gold standard between 1879 (the year that the dollar’s redeemability in gold finally resumed following its suspension during the Civil War) and 1914 (the First World War).

    Serving the Status-Quo

    Why isn’t the gold standard more popular with current-day economists? Milton Friedman once hypothesized that monetary economists are loath to criticize central banks because central banks are by far their largest employer. Providing some evidence for the hypothesis, I have elsewhere suggested that career incentives give monetary economists a status-quo bias. Most understandably focus their expertise on serving the current regime and disregard alternative regimes that would dispense with their services. They face negative payoffs to considering whether the current regime is the best monetary regime.

    Here I want to propose an alternative hypothesis, which complements rather than replaces the employment-incentive hypothesis. I propose that many mainstream economists today instinctively oppose the idea of the self-regulating gold standard because they have been trained as social engineers. They consider the aim of scientific economics, as of engineering, to be prediction and control of phenomena (not just explanation).

    They are experts, and an automatically self-governing gold standard does not make use of their expertise. They prefer a regime that values them. They avert their eyes from the possibility that they are trying to optimize a Ptolemaic system, and so prefer not to study its alternatives.

    The actual track record of the classical gold standard is superior in major respects to that of the modern fiat-money alternative. Compared to fiat standards, classical gold standards kept inflation lower (indeed near zero), made the price level more predictable (deepening financial markets), involved lower gold-extraction costs (when we count the gold extracted to provide coins and bullion to private hedgers under fiat standards), and provided stronger fiscal discipline.

    The classical gold standard regime in the US (1879-1914), despite a weak banking system, did no worse on cyclical stability, unemployment, or real growth.

    Unnecessary Monetary Policy Tightening

    The classical gold standard’s near-zero secular inflation rate was not an accident. It was the systemic result of the slow growth of the monetary gold stock. Hugh Rockoff (1984, p. 621) found that between 1839 and 1929 the annual gold mining output (averaged by decade) ran between 1.07 and 3.79 percent of the existing stock, with the one exception of the 1849-59 decade (6.39 percent growth under the impact of Californian and Australian discoveries).

    Furthermore, an occasion of high demand for gold (for example a large country joining the international gold standard), by raising the purchasing power of gold, would stimulate gold production and thereby bring the purchasing power back to its flat trend over the longer term.

    A recent example of a poorly grounded historical critique is provided by textbook authors Stephen Cecchetti and Kermit Schoenholtz. They imagine that the gold standard determined money growth and inflation in the US until 1933, and so they count against the gold standard the US inflation rate in excess of 20% during the First World War (specifically 1917), followed by deflation in excess of 10% a few years later (1921).

    These rates were actually produced by the policies of the Federal Reserve System, which began operations in 1914. The classical gold standard had ended during the Great War, abandoned by all the European combatants, and did not constrain the Fed in these years.

    Cecchetti and Schoenholtz are thus mistaken in condemning “the gold standard” for producing a highly volatile inflation rate. (They do find, but do not emphasize, that average inflation was much lower and real growth slightly higher under gold.) They also mistakenly blame “the gold standard” – not the Federal Reserve policies that prevailed, nor the regulatory restrictions responsible for the weak state of the US banking system – for the US banking panics of 1930, 1931, and 1933.

    Studies of the Fed’s balance sheet and activities during the 1930s have found that it had plenty of gold (Bordo, Choudhri and Schwartz, 1999; Hsieh and Romer, 2006, Timberlake 2008). The “tight” monetary policies it pursued were not forced on it by lack of more abundant gold reserves.

    Expert Opinion

    There are of course serious economic historians who have done valuable research on the performance of the classical gold standard and yet remain critics. Their main lines of criticism are two. First, they too lump the classical gold standard together with the very different interwar period and mistakenly attribute the chaos of the interwar period to the gold standard mechanisms that remained, rather than to central bank interference with those mechanisms.

    In rebuttal Richard Timberlake has pertinently asked how, if it was the mechanisms of the gold standard (and not central banks’ attempts to manage them) that destabilized the world economy during the interwar period, those same mechanisms managed to maintain stability before the First World War (when central banks intervened less or, as in the United States, did not exist)?

    Here, I suggest, a strong pre-commitment to expert guidance acts like a pair of blinders. Wearing those blinders, even if it is seen that the prewar system differed from and outperformed the interwar system, it cannot be seen that this was because the former was comparatively self-regulating and the latter was comparatively expert-guided.

    Second, it is always possible to argue in defense of expert guidance that even the classical gold standard was second-best to an ideally managed fiat money where experts call the shots. Even if central bankers operated on the wrong theory during the 1920s, during the Great Depression, and under Bretton Woods, not to mention during the Great Inflation and the Great Recession, today they operate (or can be gotten to operate) on the right theory.

    In the worldview of economics as social engineering, monetary policy-making by experts must almost by definition be better than a naturally evolved or self-regulating monetary system without top-down guidance. After all, the experts could always choose to mimic the self-regulating system in the unlikely event that it were the best of all options. (In the most recent issue of Gold Investor, Alan Greenspan claims that mimicking the gold standard actually was his policy as Fed chairman.) As experts they sincerely believe that “we can do better” by taking advantage of expert guidance. How can expert guidance do anything but help?

    3 Ways to Fail

    Expert-guided monetary policy can fail in at least three well-known ways to improve on a market-guided monetary system.

    First, experts can persist in using erroneous models (consider the decades in which the Phillips Curve reigned) or lack the timely information they would need to improve outcomes. These were the reasons Milton Friedman cited to explain why the Fed’s use of discretion has amplified rather than dampened business cycles in practice.

    Second, policy-makers can set experts to devising policies to meet goals that are not the public’s goals. This is James Buchanan’s case for placing constraints on monetary policy at the constitutional level.

    Third, where the public understands that the central bank has no pre-commitments, chronically suboptimal outcomes can result even when the central bank has full information and the most benign intentions. This problem was famously emphasized by Finn E. Kydland and Edward C. Prescott (1977).

    These lessons have not been fully absorbed. A central bank that announces its own inflation target (as the Fed has), and especially one that retains a “dual mandate” to respond to real variables like the unemployment rate or the estimated output gap, retains discretion.

    It is free to change or abandon its inflation-rate target, with or without a new announcement. Retaining discretion – the option to change policy in this way – carries a cost.

    The money-using public, uncertain about what the central bank experts will decide to do, will hedge more and invest less in capital formation than they would with a credibly committed regime. A commodity standard – especially without a central bank to undermine the redemption commitments of currency and deposit issuers – more completely removes policy uncertainty and with it overall uncertainty.

    Blaming Gold for Failed Policy

    Speculation about the pre-analytic outlook of monetary policy experts could be dismissed as mere armchair psychology if we had no textual evidence about their outlook. Consider then, a recent speech by Federal Reserve Vice Chairman Stanley Fischer.

    At a May 5, 2017 conference at the Hoover Institution, Fischer addressed the contrast between “Committee Decisions and Monetary Policy Rules.” Fischer posed the question: Why should we have “monetary policy decisions … made by a committee rather than by a rule?” His reply: “The answer is that opinions – even on monetary policy – differ among experts.”

    Consequently we “prefer committees in which decisions are made by discussion among the experts” who try to persuade one another. It is taken for granted that a consensus among experts is the best guide to monetary policy-making we can have.

    Fischer continued:

    Emphasis on a single rule as the basis for monetary policy implies that the truth has been found, despite the record over time of major shifts in monetary policy – from the gold standard, to the Bretton Woods fixed but changeable exchange rate rule, to Keynesian approaches, to monetary targeting, to the modern frameworks of inflation targeting and the dual mandate of the Fed, and more. We should not make our monetary policy decisions based on that assumption. Rather, we need our policymakers to be continually on the lookout for structural changes in the economy and for disturbances to the economy that come from hitherto unexpected sources.

    In this passage Fischer suggested that historical shifts in monetary policy fashion warn us against adopting a non-discretionary regime because they indicate that no “true” regime has been found. But how so?

    That governments during the First World War chose to abandon the gold standard (in order to print money to finance their war efforts), and that they subsequently failed to do what was necessary to return to a sustainable gold parity (devalue or deflate), does not imply that the mechanisms of the gold standard – rather than government policies that overrode them – must have failed.

    Observed changes in regimes and policies do not imply that each new policy was an improvement over its predecessor – unless we take it for granted that all changes were all wise adaptations to exogenously changing circumstances. Unless, that is, we assume that the experts guiding monetary policies have never yet failed us.

    Better, Because Science

    Fischer further suggested that a monetary regime is not to be evaluated just by the economy’s performance, but by how policy is made: a regime is per se better the more it incorporates the latest scientific findings of experts about the current structure of the economy and the latest models of how policy can best respond to disturbances.

    If we accept this as true, then we need not pay much if any attention to the gold standard’s actual performance record. But if instead we are going to judge regimes largely by their performance, then replacing the automatic gold standard by the Federal Reserve’s ever-increasing discretion cannot simply be presumed a good thing. We need to consult the evidence. And the evidence since 1914 suggests otherwise.

    Contrary to Fischer, there is no good reason to presume that expert-guided monetary regimes get progressively better over time, because there is no filter for replacing mistaken experts with better experts. We have no test of the successful exercise of expertise in monetary policy (meaning, superiority at correctly diagnosing and treating exogenous monetary disturbances, while avoiding the introduction of money-supply disturbances) apart from ex post evaluation of performance.

    The Fed’s performance does not show continuous improvement. As previously noted, it doesn’t even show improvement over the pre-Fed regime in the US.

    A fair explanation for the Fed’s poor track record is Milton Friedman’s: the information necessary for successful expert guidance of monetary policy is simply not available in a timely fashion.

    Those who recognize this point will be open to considering the merits of moving, to quote the title a highly pertinent article by Leland B. Yeager, “toward forecast-free monetary institutions.” Experts who firmly believe in expert guidance of monetary policy, of course, will not recognize the point. They will accordingly overlook the successful track record of the automatic gold standard (without central bank management) as a forecast-free monetary institution.

    Reprinted from Alt-M.


    Tim Worstall

    Tim is a Fellow at the Adam Smith Institute in London

    This article was originally published on FEE.org. Read the original article.



  • Trillions in Debt and We’re Just Scratching the Surface

    Trillions in Debt and We’re Just Scratching the Surface

    As the federal debt has gone from astounding to unbelievable to incomprehensible, a new problem has emerged: The US government is actually running out of places to borrow.

    How Many Zeros Are in a Trillion?

    The $20 trillion debt is already twice the annual revenues collected by all the world’s governments combined. Counting unfunded liabilities, which include promised Social Security, Medicare, and government pension payments that Washington will not have the money to pay, the federal government actually owes somewhere between $100 trillion and $200 trillion. The numbers are so ridiculously large that even the uncertainty in the figures exceeds the annual economic output of the entire planet.

    Since 2000, the federal debt has grown at an average annual rate of 8.2%, doubling from $10 trillion to $20 trillion in the past eight years alone. Who loaned the government this money? Four groups: foreigners, Americans, the Federal Reserve, and government trust funds. But over the past decade, three of these groups have cut back significantly on their lending.

    Foreign investors have slowed the growth in their lending from over 20% per year in the early 2000s to less than 3% per year today. Excluding the Great Recession years, American investors have been cutting back on how much they lend the federal government by an average of 2% each year.

    Social Security, though, presents an even bigger problem. The federal government borrowed all the Social Security surpluses of the past 80 years. But starting this year, and continuing either forever or until Congress overhauls the program (which may be the same thing), Social Security will only generate deficits. Not only is the government no longer able to borrow from Social Security, it will have to start paying back what it owes – assuming the government plans on making good on its obligations.

    With federal borrowing growing at more than 6% per year, with foreign and American investors becoming more reluctant to lend, and with the Social Security trust fund drying up, the Fed is the only game left in town. Since 2001, the Fed has increased its lending to the federal government by over 11% each year, on average. Expect that trend to continue.

    Inflation to Make You Cry

    For decades, often in word but always in deed, politicians have told voters that government debt didn’t matter. We, and many economists, disagree. Yet even if the politicians were right, the absence of available creditors would be an insurmountable problem—were it not for the Federal Reserve. But when the Federal Reserve acts as the lender of last resort, unpleasant realities follow. Because, as everyone should be keenly aware, the Fed simply prints the money it loans.

    A Fed loan devalues every dollar already in circulation, from those in people’s savings accounts to those in their pockets. The result is inflation, which is, in essence, a tax on frugal savers to fund a spendthrift government.

    Since the end of World War II, inflation in the US has averaged less than 4% per year. When the Fed starts printing money in earnest because the government can’t obtain loans elsewhere, inflation will rise dramatically. How far is difficult to say, but we have some recent examples of countries that tried to finance runaway government spending by printing money.

    From 1975 to 1990, the Greek people suffered 15% annual inflation as their government printed money to finance stimulus spending. Following the breakup of the Soviet Union in the 1990s, Russia printed money to keep its government running. The result was five years over which inflation averaged 750%. Today, Venezuela’s government prints money to pay its bills, causing 200% inflation which the International Monetary Fund expects to skyrocket to 1,600% this year.

    For nearly a century, politicians have treated deficit spending as a magic wand. In a recession? We need jobs, so government must spend more money! In an expansion? There’s more tax revenue, so government can spend more money! Always and everywhere, politicians argued only about how much to increase spending, never whether to increase spending. A century of this has left us with a debt so large that it dwarfs the annual economic output of the planet. And now we are coming to the point at which there will be no one left from whom to borrow. When creditors finally disappear completely, all that will remain is a reckoning.

    This article first appeared in InsideSources.


    Antony Davies

    Antony Davies is an associate professor of economics at Duquesne University in Pittsburg.

    He is a member of the FEE Faculty Network.

    This article was originally published on FEE.org. Read the original article.



  • Greenspan the Undertaker and His Countless Victims

    Greenspan the Undertaker and His Countless Victims

    Emi and Glen Yamasaki were a smiling couple that waved at their neighbors in the Sun City Anthem neighborhood of Henderson. Other retirees who lived near them couldn’t believe the Yamasakis committed suicide by jumping from the top story of the Silverton Casino’s parking garage.

    What neighbors didn’t know is the couple’s golden years were not so shiny. Having bought their home at the top of the market in 2005, they were likely underwater and were facing foreclosure and other money troubles. W.C. Varones’ “Greenspan’s Body Count” counts Mr. and Mrs. Yamasaki as victims 257 and 258.

    “A decade after the peak of his diabolical, deliberately created housing bubble, the 21st century’s most prolific serial killer is still killing,” writes Varones on his blog. “Less than a month after his most recent murder, Alan Greenspan has killed a married couple in Las Vegas.”

    The Man Who Knew

    Sebastian Mallaby describes Varones as a “vituperative blogger” in his book The Man Who Knew: The Life and Times of Alan Greenspan. However, the blog, which likely undercounts “mortgage-related suicides,” provides prescience to Ayn Rand’s nickname for Greenspan, “The Undertaker” – joining other nicknames such as “the Maestro” and “the Greatest Central Banker Ever.”

    Of Mallaby’s very readable account of his life, the Maestro himself called the book “not always positive, but accurate.” Mallaby believes his subject knew all about the bubbles the Fed was creating but didn’t act. But, of course, the market did act, harshly. It’s Mallaby’s view that Greenspan could have pricked these asset bubbles and somehow let the air out slowly, making it painless for everyone.

    So why didn’t he? The “greatest central banker in history” insisted in hindsight that bubbles were impossible to detect until it was too late.

    No doubt Murray Rothbard is somewhere laughing. Mallaby mentions Greenspan’s devotion to Ayn Rand, laissez-faire capitalism, and the gold standard often. But, as Rothbard wrote, “For Greenspan, laissez-faire is not a lodestar, a standard, and a guide by which to set one’s course; instead, it is simply a curiosity kept in the closet, totally divorced from his concrete policy conclusions.”

    The shy undertaker was not a swashbuckling Randian hero or libertarian firebrand, but a passive-aggressive political manipulator. However, those inside the Fed, like Alan Blinder, gushed as Greenspan was retiring, “Financial markets now view Chairman Greenspan’s infallibility more or less as the Chinese once viewed Chairman Mao’s” – an interesting and rather backhanded compliment from an economist who occasionally butted heads with his boss.

    In either case, history would say otherwise. Other than New York, Greenspan never saw a bailout he didn’t support or a bubble he couldn’t create. After all, it kept both Wall Street and the political class happy – both here and abroad. The man who grew up without a father and with an overbearing, doting mother wanted to gain powerful people’s’ approval. He hated confrontation.

    If Greenspan was familiar with Austrian Business Cycle Theory, and he should have been, he’d have known crashes and recessions are needed to correct the malinvestments created by central bank monetary interference. To paper over crashes and bail out losers is to destroy precious capital by keeping it in the hands of those who waste it.

    However, Greenspan was a Keynesian forecaster who, as Rothbard explains, had no interest in Austrian economics or economic theory at all. Murray, who had met Greenspan, admitted he didn’t understand how Greenspan rose to power. “He’s the least charismatic person I’ve ever seen,” Rothbard said. “He has the persuasiveness of a dead mackerel.”

    Most libertarians are familiar with Greenspan’s 1966 article “Gold and Economic Freedom,” an attack on fiat money and central banking. Years later, Congressman Ron Paul asked the Fed Chair to sign an original copy. As Greenspan signed, Paul asked him if he still believed what he wrote in that essay some 40 years before. “Greenspan – enigmatic as ever – responded that he ‘wouldn’t change a single word,’” writes Michael Kosares.

    But to read Mallaby, Greenspan was not so much an enigma as much as he was duplicitous. For instance, President Reagan was very interested in returning to a gold standard and mentioned it often. A Gold Commission was even formed. Meanwhile, Greenspan “feigned empathy with his adversaries and played skillfully for time, morphing from an ardent advocate of gold into its most devious opponent,” writes Mallaby.

    The Two Exclusions

    In the nearly 700 pages of text, two things are strangely not mentioned: the Enron Prize for Distinguished Public Service, which Greenspan accepted just a few days after Enron filed paperwork admitting to having fabricated its financial statements for five years, and his dissertation.

    Greenspan’s mentor was Arthur Burns, who happened to chair Murray Rothbard’s dissertation at Columbia. The fruit of Rothbard’s work was the seminal Panic of 1819. Meanwhile, “Alan,” Princeton economist Burton Malkiel gushed, “is one of the smartest people I’ve ever known in my life,” but didn’t manage to file his dissertation until 1977 at New York University, where boyhood friend Bob Kavesh urged him to finish his Ph.D.

     

    Jim McTague, a reporter for Barron’s, secured a copy in 2008. As excited as McTague was to get his hands on it, there wasn’t much to it. It was merely a collection of articles totaling 180 pages. “Two chapters that had been published as articles in the American Statistical Association’s annual proceedings contain several pages of algebraic equations that, frankly, made our head ache,” wrote McTague.

    Paul Wachtel, an NYU economics professor who was on Greenspan’s dissertation committee, defends Greenspan’s work, claiming, “the chapter written by Greenspan in 1959 on investment risk and stock prices anticipated by 10 years the Q ratio developed in 1969 by the late James Tobin,” who would become a Nobel laureate.

    Mallaby sprinkles his narrative with anecdotes that make The Man Who Knew very fun to read for those of us who lived through the roller coaster Greenspan economy and appreciate political skullduggery á la House of Cards. Although, with the way the author describes Alan and wife (finally) Andrea Mitchell, you’d think they were as glamorous as Brad and Angelina.

    And who knew there was a “Manley Put” supporting stock market prices before there was the famous “Greenspan Put”? Perhaps ironically, the Manuel (“Manley”) H. Johnson Center For Political Economy at Troy University has one of the most free-market oriented economics programs in the country.

    I had the occasion to meet Manley before a Troy football game and we traded stories about Rothbard. Johnson was a 38-year old vice chair at the Fed when Greenspan took over. He is described by Mallaby to have “shocking youthfulness” and “the courtly charm of a Southerner.” I can verify that he still does.

    The idea that the Federal Reserve is somehow independent of the executive branch is quashed by the author. Greenspan, like his mentor Burns, was eager to do the President’s bidding. George W. Bush’s first meeting as President was with the Fed Chair. Greenspan made a trip to Arkansas to meet with President-elect Clinton.

    The Man Who Bailed

    Ultimately, Greenspan’s gift was timing. Janet Yellen, then the president of the San Francisco Fed, is quoted by Mallaby as saying on Greenspan’s last day in January 2006 that “it’s fitting for Chairman Greenspan to leave office with the economy in such solid shape.”

    As it turned out, he left just in time: the bubble was a year away from popping and Ben Bernanke would step in to engineer the bailout of all bailouts, prolonging the fallout to this day. Meanwhile, Greenspan earned $250,000 by speaking to a “handful of Lehman’s hedge-fund clients,” just a week after leaving his Fed post. (Lehman would file for bankruptcy a year and a half later.) Then work began on his memoir, aptly entitled The Age of Turbulence, for which Greenspan was paid $8 million.

     

    The man who knew is actually the man who bailed out: countries, companies, and finally himself. Ayn Rand always had her doubts about Greenspan, and would frequently ask her associates, “Do you think Alan might basically be a social climber?”

    To this day, Greenspan is still in high demand as a keynote speaker. He is represented by the Washington Speakers Bureau which claims it is “Connecting You to the World’s Greatest Minds.” He is addressing the Private Equity International CFOs and COOs Forum this month.

    Meanwhile, facing a retirement drowning in debt, Emi and Glen Yamasaki were 63 when they took their lives. The Maestro, Undertaker, or Greatest Central Banker Ever will reach the ripe old age of 91 in March, long outliving the victims of the bubble economy he created, and sadly reaping riches from his status and mythology.


    Douglas French

    Douglas French is an Associated Scholar at the Johnson Center at Troy University and adjunct professor at Georgia Military College. He is the author of three books: Early Speculative Bubbles and Increases in the Supply of Money, Walk Away, and The Failure of Common Knowledge.

    This article was originally published on FEE.org. Read the original article.