Tuesday, February 8, 2011

Why the Fed trumps gold

I am writing a more detailed piece on the yearning by some for a gold standard and the problems inherent in such a move. Those who favor the gold standard are typically pathologically anti-Fed. Now it is true that central bankers cannot be trusted with the money supply but why all the anti-Fed rhetoric? The main argument I hear and read is that the government will always inflate the money supply in order to spend more. That's all well and good but there is a contradiction here. While the statement is true for most countries, it is not true for the United States. In most countries, the central bank is part of the government and those in power control the power to create money. This is not true here. The Fed is an independent agency - that is independent of the Congress and the administration. Although a creature of the Congress which created it and which can change it, as it is presently constructed, the Fed is about as independent an entity as can exist. Once confirmed by the Senate its members cannot be fired - only impeached. Neither the president nor the congress can command that the Fed follow a particular path. The Fed is free to pursue the course that it thinks fulfills its mission of full employment, economic growth without inflation. If the Fed pursues another course it is not a failure of the Fed but a failure of those in the Fed. If you look at the rates of inflation of the United States and the rest of the world, it should come as no surprise that the United States has much lower price inflation. The problem today is that the last two Fed chairmen have chosen to follow paths that support the policies of the administration. Alan Greenspan supported the fiscal policies of George Bush and Ben Bernanke has complemented the spending of Barack Obama. This need not be the case. A strong Fed could set monetary policy on a stable growth path and there would be no inflationary tendency in the economy. However, it is only human nature for the Fed to bend to the wishes of those in power. Research confirms this. While some call for the abolition of the Fed and a reversion to the gold standard, those people forget that gold can be manipulated. Central banks hold only a fraction of the total gold supplies and going to a gold standard could result in inflation or deflation and leave the country more vulnerable to foreign government manipulation (more on how later). The only certainty is that those who would most profit would be speculators like George Soros. So what can be done? The problems are rather easy to fix. First, the banks should not be able to create money. The creation of money should rest solely with the monetary authorities. Therefore, 100 percent reserve requirements should be imposed so that banks cannot create money out of excess reserves. Second, the Fed should be barred from buying securities directly from the Treasury. This monetizing the debt is purely inflationary. Third, the Fed should be allowed to conduct discretionary monetary policy only in cases of national emergencies. Otherwise, the Fed should be made to adopt the "monetary rule" and grow the money supply at a rate equal to the country's long term rate of growth. As the sainted Milton Friedman once said, this would insure stable economic growth without inflation.

No comments: