How long will the current improvement in employment and output growth continue? Will the Federal Reserve’s recent policy of nudging up market interest rates impede growth and employment, or will it act as a damper on possible future price inflation without slowing down the economy or pushing it into a new recession?
The news media and policy pundits have been intensely trying to read the tea leaves to determine the economic shape of things to come. President Trump has expressed his own irritation with Federal Reserve interest rate policy, saying in late September 2018, “I am not happy about that,” and saying he is worried that the central bank’s Board of Governors “seem to like raising interest rates,” as if they suffer from a perverse set of tastes and preferences. "I'm not thrilled with [Fed Chairman Jerome Powell’s] raising of interest rates, no. I'm not thrilled."
The “Experts” Have Confidence in Central Banks
On the other hand, Tim Duy, a professor at the University of Oregon who monitors Federal Reserve policy, assured us on October 18, 2018, that we could “relax” because “The Fed Knows What It Is Doing.” Those at the helm of the American central bank are thoughtful, careful, and informed experts who continuously are busy reading the economic data to fine-tune and adapt to changing circumstances, so as to avoid both dangerous inflation and another undesirable economic downturn. Professor Duy is confident that “the Fed has the capacity and, I believe, willingness to respond to threats to the economy” through appropriate discretionary policy that will keep the overall economy on an even keel.
Confidence such as that expressed by Professor Duy has its complement in disdain for any suggestions that monetary policy should ever be removed from the direct or indirect monopoly hands of government authorities and their central banks. A recent harangue along these lines was offered by New York University Professor Nouriel Roubini, who vented his indignation and dislike for private sector cryptocurrencies and market-based blockchain devices.
On the one hand, President Trump publicly pronounces his personal likes and dislikes about where he thinks interest rates should be to keep the economy humming along. On the other hand, the professional “experts” are certain that there is no substitute for government control of the monetary system, and confident that those in charge of the central bank know what to do, when, and to what extent.
However, Roubini also has recently presented in 10 points his certain prediction that in 2020, or thereabouts, the next recession will hit and it will be a “perfect storm.” But this does not lead him to think that there would be any worthwhile alternative to the current institutional arrangement of monetary central planning through central banks.
Monetary Disasters and Central Banking
The last 100 years have witnessed some of the worst monetary disasters in history under the stewardship of central banks: severe monetary inflations during two world wars, partly hidden from public view during the conflicts because of government-imposed wage and price controls (what German economist Wilhelm Röpke called “repressed inflation”), and hyperinflations that destroyed the value and use of the medium of exchange, wiped out the savings of millions of people, and undermined the social fabric of entire countries, along with accompanying political unrest. (See my article “The Lasting Legacies of World War I: Big Government, Paper Money and Inflation.”)
In addition, central banking brought about the Great Depression in the early 1930s, which lingered on for the good part of the decade, made worse because of government interventionist policies that retarded market-based recovery. Unending government deficit spending and resulting accumulated debt was made easier and more serious through central bank money creation to feed the appetites of politicians and special interest groups hungry for the wealth of a country’s citizens. And there has been the recurrence of periodic booms and busts, with the financial and housing crisis of 2008–9 being the most recent instance of the “wise” and “expert” management of monetary affairs by the Federal Reserve System. (See my article “Ten Years on: Recession, Recovery, and the Regulatory State.”)
What lessons might be drawn from this experience, notwithstanding the views of people like Tim Duy and Nouriel Roubini? It is the fundamental disaster of placing control of the money supply in the hands of governments and their central banks.
Government Abuse of Money and the Benefits of Market-Based Money
It is worth recalling that money did not originate in the laws or decrees of kings and princes. Money, as the generally accepted medium of exchange, emerged out of the market transactions of a growing number of buyers and sellers in an expanding arena of trade. Commodities such as gold and silver were selected over generations of market participants as the monies of free choice because of their useful characteristics to better facilitate the exchange of goods in the marketplace.
For almost all of recorded history, governments have attempted to gain control of the production of money to serve their seemingly insatiable desire to extract more and more of the wealth produced by the ordinary members of society. Ancient rulers would clip and debase the gold and silver coins of their subjects. More modern rulers, whether despotically self-appointed through force or democratically elected by voting majorities, have taken advantage of the monetary printing press to churn out paper money to fund their expenditures and redistributive largess in excess of the taxes they impose on the citizenry. Today the process has become even easier through the mere click of a mouse on a computer screen, which in the blink of an eye can create tens of billions of dollars out of thin air.
Thus, monetary debasement and the price inflation that normally accompanies it have served as a method for imposing a hidden taxation on the wealth of the citizenry. As John Maynard Keynes insightfully observed in 1919 (before he became a Keynesian):
By a continuous process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. The process engages all of the hidden forces of economic law on the side of destruction, and does it in a manner that not one man in a million can diagnose.
The Benefit of a Gold Standard to Limit Government Abuse
It was the corrosive, distortive, and destructive effects from monetary manipulation by governments in the early part of the 19th century that led virtually all of the leading economists of that time to endorse the anchoring of the monetary system in a commodity such as gold to prevent governments from using their powers over the creation of paper monies to cover their budgetary extravagance. John Stuart Mill’s words from the middle of the 19th century are worth recalling:
No doctrine in political economy rests on more obvious grounds than the mischief of a paper currency not maintained at the same value with a metallic, either by convertibility, or by some principle of limitation equivalent to it… All variations in the value of the circulating medium are mischievous; they disturb existing contracts and expectations, and the liability to such changes renders every pecuniary engagement of long date entirely precarious…
Great as this evil would be if it [the supply of money] depended on [the] accident [of gold production], it is still greater when placed at the arbitrary disposal of an individual or a body of individuals; who may have any kind or degree of interest to be served by an artificial fluctuation in fortunes; and who have at any rate a strong interest in issuing as much [inconvertible paper money] as possible, each issue being itself a source of profit. Not to add, that the issuers have, and in the case of government paper, always have, a direct interest in lowering the value of the currency because it is the medium in which their own debts are computed… Such power, in whomsoever vested, is an intolerable evil.
Under a gold standard, it was gold that was the actual money. Paper currency and various forms of checking and other deposit accounts that may be used in market transactions in exchange for goods and services were money substitutes, representing a fixed quantity of the gold-money on deposit with a banking or other financial institution that was redeemable on demand.
Any net increases in the quantity of currency and checking and related deposits were, in principle, dependent upon increases in the quantity of gold that depositors with banking and financial institutions added to their individual accounts. Any withdrawal of gold from their accounts through redemption required that the quantity of currency notes and checking and related accounts in circulation be reduced by the same amount. Under a gold standard, a central bank was, in principle, relieved of all authority and power to arbitrarily “manage” the monetary order.
In reality, central banks anchored in gold standards used their authority in various ways, at various times not consistent with the rules of the game as just outlined. Nonetheless, gold standards did serve as a practical check and limit on unrestrained monetary expansion and abuse for a good part of the 19th and early 20th centuries. (See my article “The Gold Standard as Government-Managed Money.”)
The Gold Standard’s Supposed Inflexibility Was Its Strength
Many critics of the gold standard have considered these formal rules to be rigid and inflexible about how the monetary system and the quantity of money in the society is to be determined and constrained. Yet, the advocates of the gold standard long argued that this relative inflexibility was essential to discipline governments within the confines of a hard budget.
Without the escape hatch of the monetary printing press, governments must either tax the citizenry or borrow a part of the savings of the private sector to cover their expenditures. Those proposing government spending must either justify it by explaining where the tax dollars will come from and upon whom the taxes will fall, or make the case for borrowing a part of the savings of the society to cover those expenditures at market rates of interest that tell the truth about what it will cost to attract lenders to lend that sum to the government rather than to private sector borrowers, and therefore the truth about the social cost of private sector investment and future growth that will have to be forgone.
In other words, the gold standard helped to prevent government from monetizing the debt to cover all or part of its budget deficits. The government, under a gold standard, no longer could create the illusion that something can be had for nothing. (See my article “Why Government Deficits and Debt Do Matter.”)
This was why Austrian economist Ludwig von Mises felt reasonable in arguing:
Why have a monetary system based on gold? Because, as conditions are today and for the time that can be foreseen today, the gold standard alone makes the determination of money’s purchasing power independent of the ambitions and machinations of governments, of dictators, and political parties, and pressure groups. The gold standard alone is what the nineteenth-century freedom-loving leaders (who championed representative government, civil liberties, and prosperity for all) called “sound money.”
The Classical Gold Standard Worked — as Long as Guided by Liberal Ideas
Of course, the gold standard, during its heyday in the years before the First World War, succeeded in fulfilling its role in notably limiting government deficit spending and restraining the dangers from price inflation only so long as those in charge of managing the government-established central banks were guided by ideas and policy views inspired by a political philosophy of classical liberalism and limited government.
Once the political philosophy and the policy views changed during and following the First World War in far more interventionist and welfare-statist directions, central banks became engines of monetary and general economic disruption and instability. Indeed, once the control of money and credit is in the hands of government, little is really secure in terms of the reach of political control in the society. It depends almost completely on the politics and purposes of those in government and those appointed to manage the central banks.
The German free market economist Gustav Stolper, while an exile in the United States during the Second World War, wrote in his book This Age of Fable: The Political and Economic World We Live In (1942):
Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment that the state assumed control of the monetary system.… A ‘free’ capitalism with governmental responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits government intervention to go. Money control is the supreme and most comprehensive of all governmental controls short of expropriation.
Separating Money From the State, the Ultimate Policy Reform
Stolper’s insight, I would suggest, points in the direction of a reform of the monetary and banking system that does not stop with restrictions on Federal Reserve discretionary policy over money or interest rates, such as under the classical or traditional government-managed gold standard. It points in the direction of an end goal of separating the monetary and banking system from government control and oversight, and in its place putting a system of private, competitive free banking — a truly market-based money and banking system. (See my article “Free Banking and the Case Against Central Banking.”)
Only by this institutional means can a society be safe and secure from a political leader who is just not happy with central bank monetary and interest rate policy and would want to make such policy whatever he considers good and desirable by putting it into his own capricious hands.
Only by such a separation of money from the state can a society also be safe and secure from the arrogance and hubris of those “experts” — those monetary central planners — who presume to know what interest rates should be, independent of market-based supply and demand relationships between savers and investors in a competitive banking setting. (See my article “Interest Rates Need to Tell the Truth.”)
Only by such a denationalization of the monetary system can a society be free from the recurring cycle of booms and busts, the waves of inflations followed by recessions, and the socially destabilizing periods of economy-wide unemployment, which easily plays into the hands of political demagogues and power lusters offering interventionist panaceas to cure problems caused by earlier government policies. (See my eBook Monetary Central Planning and the State.)
Until then, our society will be subject to the consequences of those “experts” and political second-guessers who presume to know how money and the economy should be planned better than letting money be sorted out through the free interactions of all of us as suppliers and demanders in the marketplace.