Friday, November 30, 2012

Fed Economist Disses the Gold Standard (and what would happen to him under a gold standard)


Here we go again. St Louis Fed economist David Andolfatto explains to a reader of the St. Louis Fed web site the problems he sees with the gold standard. My comments are in italics.

Q. Why doesn't the U.S. return to the gold standard so that the Fed can't "create money out of thin air"?

A.The phrase "create money out of thin air" refers to the Fed's ability to create money at virtually zero resource cost. It is frequently asserted that such an ability necessarily leads to "too much" price inflation.

The problem is not only price inflation, though that is serious, but the distortions in the capital structure of the economy caused by the Fed money printing. This is what causes the boom-bust cycle, even if there isn't price inflation. Money goes first to the banksters and they spend it on their projects.The rest of us get it, most of the time, only after prices have gone up.

Under a gold standard, the temptation to overinflate is allegedly absent, that is, gold cannot be "created out of thin air." It would follow that a return to a gold standard would be the only way to guarantee price-level stability.

The goal of "price-stability" is not something that should be aimed at, as implied by the above. Under a true gold standard, where dollars would be convertible into gold at a fixed rate and the Fed didn't print money beyond the gold it had on hand, the economy would be in even better shape than a world of price-stability. Prices of goods would be dropping across the board as productivity increased. It would be heaven for consumers. Because the Fed prints so much money now, prices now fall only on products in sectors where productivity gains are very high, e.g. cellphones, personal computers, large scale televisions. With a gold standard economy this would  happen across the economy.

Unfortunately, a gold standard is not a guarantee of price stability. It is simply a promise made "out of thin air" to keep the supply of money anchored to the supply of gold. To consider how tenuous such a promise can be, consider the following example. On April 5, 1933, President Franklin D. Roosevelt ordered all gold coins and certificates of denominations in excess of $100 turned in for other money by May 1 at a set price of $20.67 per ounce. Two months later, a joint resolution of Congress abrogated the gold clauses in many public and private obligations that required the debtor to repay the creditor in gold dollars of the same weight and fineness as those borrowed. In 1934, the government price of gold was increased to $35 per ounce, effectively increasing the dollar value of gold on the Federal Reserve's balance sheet by almost 70 percent. This action allowed the Federal Reserve to increase the money supply by a corresponding amount and, subsequently, led to significant price inflation.

This historical example demonstrates that the gold standard is no guarantee of price stability.

This is a one helluva an argument. As far as I can tell, the argument boils down to this: "If you go off the gold standard, the gold standard won't work." True and if you stop drinking prune juice, prune juice will no longer help you with your bowel movements.

 Moreover, the fact that price inflation in the U.S. has remained low and stable over the past 30 years demonstrates that the gold standard is not necessary for price stability.

Here are prices over the last 30 years, as measured by the CPI:


Oh yeah, that looks low and stable to me, especially if you take out the first 140% increase in prices over the period. If you break the data down even further, the annual rate of change is anywhere between 6.0% and below zero for the period,with 15 significant changes in direction. Some stability.

 Price stability evidently depends less on whether money is "created out of thin air" and more on the credibility of the monetary authority to manage the economy's money supply in a responsible manner.

In one sense this is true. The problem is that no monetary authority has ever managed money supply in a responsible fashion. It's print, print print---and cart the newly printed money over to the banksters. Recent dramatic results of out of control Fed printing include: The printing before the stock market crash of 1929 that led to the Great Depression and the  recent financial crisis caused by Alan Greenspan driving interest rates down. Since the start of the Fed, there have been 18 recessions. These downturns  have resulted in stock market crashes, tens of  millions of unemployed and untold business bankruptcies. It's hard to understand how this is credible management.Under a true gold standard, the Federal Reserve would not be able to print money at the beck and call of the banksters. If the banksters called the Fed,when the country was truly on the gold standard, the janitor/nightwatchman, that is the only one in the building most of the time, would answer the phone and tell the banksters, "There's no one here to print any money. We might get a small gold shipment in six months but then we would have to give the new dollars in exchange for the gold received to the miners who brought in the gold. But again this is a very limited amount, you know how hard it is to get gold out of the ground." And that's one way the price inflation and money printing distortions of the capital structure of  the economy would end. No need for Fed economists answering questions about paper money by spreading anti-gold propaganda.

Bottom line: Under a gold standard, David Andolfatto would be fired and the country would be much better of because of it.