Sunday, March 25, 2012

Bernanke's Hollow Attack on Gold

Republican presidential candidate Ron Paul has consistently called for a return to the gold standard and eventual elimination of the Federal Reserve System, and his ideas are apparently gaining enough traction to prompt current Fed Chairman Ben Bernanke to publicly attack the idea.

According to The, Fed Chairman Ben Bernanke listed four reasons for rejecting a gold standard, starting with the first: “a gold standard prevents adjusting policy in response to shifting economic conditions.” In other words, it restricts the government’s ability to manipulate the economy; i.e. the economic decision-making of tens of millions of individuals.

For example, one Bernanke backer states that “at the core, you'd still want what the Fed has, which is humans, policymakers, deciding how to set interest rates." What exactly, one must ask, are lenders and borrowers in the market? A borrower sitting across the table from a lending officer is a human, as is the officer. Every time a loan agreement is signed, an interest rate is set between borrower and lender. Multiply that agreement by tens of millions, and you have a market, and consequently a market interest rate. A market interest rate encompasses millions of humans “deciding how to set interest rates.” When the fed sets rates, it is overriding the decisions of millions of people, pretending to know better than they (the market) the proper interest rate level. This is impossible, which is why we have all of the economic problems – boom-bust cycles, recessions, high unemployment, price spirals – which central bankers claim to be there to alleviate.

Restricting government economic manipulation is precisely why we need a gold standard. For proof, look no further than the recent housing boom and bust, which was fueled by the Greenspan Fed’s easy money policies of the early 2000s, followed by the Bernanke Fed’s tight-money policies of the mid 2000s. Both were instances of policy adjustments “in response to shifting economic conditions.” (There were many contributing causes to the financial crisis, all of them rooted in government intervention into the economy. But the Fed’s policies were number one among them.)

Bernanke’s second and third reasons are that “countries would be more vulnerable to developments in other countries” and the threat of “speculative attacks” against countries that don’t “sacrifice all domestic goals for the sake of maintaining the gold standard.” Translation: Market participants would move money out of a country that pursued unsound economic policies and toward more rationally stable countries, thus stymieing statist interventionists wherever they arise. To some extent that happens now, but the objective monetary value provided by an international gold standard greatly facilitates this process. "Speculators" are always blamed when economic reality intrudes on statists' schemes.

These are two more reasons for a gold standard. Under an international gold standard, markets would act as a check on irrational governments, as foreign investors (and even other governments) demanded gold in exchange for the irrational country’s currency. That country would then have to return to sound policies or watch its gold reserves plummet along with the value of its currency. (Though central bankers hate the gold standard, their government's love to stockpile gold. I wonder why.) The run on US gold reserves in the early 1970s is a case in point. As mentioned in The Street article, France, Britain, and probably others – spooked by the US government’s profligate spending - “insisted on exchanging their Treasuries for gold,” prompting President Nixon to close the gold window, shutting down the exchanges. The result was the rampant inflation of the 1970s, as any residual gold discipline was ripped from US monetary and fiscal policy. Had “strict adherence to a gold standard” been in place, America would have had to “sacrifice all domestic goals” – meaning, runaway government spending – thus saving the country, especially savers and retirees, from a lot of related economic pain and turmoil. It is this free reign over the wealth of the citizens that statists would lose under a gold standard, which is the real reason they hate gold-backed money. Gold standards, properly implemented, protect the productive private sector from government, and are indispensable to economic freedom.

The fourth reason is bizarre. “Bernanke acknowledged…

that a gold standard did promote price stability over the very long run. However, he noted that over the medium run, it sometimes caused periods of inflation and deflation. He cited the second half of the 19th century when a shortage of gold reduced U.S. money supply and fueled deflation.

The gold shortage argument is a myth that has been thoroughly debunked, and Bernanke’s example of the late 19th century proves it! The period from roughly the Civil War until the creation of the Federal Reserve in 1914 was a period of explosive economic growth, rising living standards, and extraordinary technological advance. Andrew Bernstein, author of The Capitalist Manifesto, called the era The Inventive Period for these very reasons. During this glorious near-laissez-faire capitalist period, there was no central bank, and all money was backed by gold reserves held in private banks under a system known as free banking. During this time, there were periods of greater or lesser economic growth, but no recessions or depressions; periods of actual economic contraction (Salsman, p. 47-48). Rising productivity raised the value of money, as prices gently fell, raising the general standard of living. (Falling prices do not constitute deflation. Deflation is the artificial contraction of the money supply.) Any periods of general price instability that may arise are brief and quickly abate because of gold’s relatively stable supply and rate of supply growth.

Bernanke also “warned that the gold standard often produced pro-cyclical impulses. During periods of strong growth, money supply would increase and interest rates would fall, which is exactly the opposite of modern central banking and the withdrawal of the proverbial punchbowl just as the party gets going.” “Exactly the opposite” is exactly what is needed. Bernanke’s perspective is based upon a false assumption; that strong economic growth is bad. Here is a reason why we have runaway boom-bust cycles. The fed “encourages” growth by expanding the money supply, then “combats inflation” by reducing it. But a growing money supply is a natural consequence of economic growth, because as production and trade expand, more money is needed to facilitate this activity. Under a free banking gold standard, the money supply can increase or decrease relative to the gold supply, thanks to fractional reserve banking, based on economic demand. Thus, the market, rather than a gaggle of central planning bureaucrats, determines money supply.

All of Bernanke’s objections are a smoke screen, however. There is a more covert – and morally sinister - reason for governments to abandon and/or resist a gold standard. Without a gold anchor, governments are free to engage in unrestrained inflation, which is a back-door form of taxation. Inflation is the artificial expansion of the money supply; that is, money unsupported by productive work and trade. Inflation is a tax, not on your dollars, but on your dollars’ purchasing power – i.e. its value. It is a sinister form of theft that manifests itself through rising prices somewhere in, and ultimately throughout, the economy. Again, the housing bubble is a recent example of this phenomenon. (For an in-depth discussion of the relationship between money and wealth, see my Obushonomics vs. Gilliganomics.)

By far the primary reason for governments to establish central banks and abandon gold is to create access to revenues it finds politically impossible to raise through the more honest means of direct taxation. The main purpose of a fiat currency central bank is to give inflationary powers of artificial money creation to the political class. It is a means by which politicians loot the private sector’s wealth without most people even knowing it, to finance the government’s budget. As we watch consumer prices rise in today’s economic environment, what we are actually experiencing is the draining of our wealth to pay for profligate government spending and the deficits.

A return to a gold standard would be a major step in the right direction, but only a step. For a gold standard to operate effectively as a protector of the value of money and thus of our wealth, it must be accompanied by free, laissez-faire banking; i.e., no central bank or government bank regulations other than enforcement of contracts and anti-fraud laws. Still, imposing the discipline of a new international gold standard could act as a check on government spending and manipulation of the economy in the short to intermediate term. (For an excellent education on the gold standard and free vs. central banking, see Richard M. Salsman, Gold and Liberty, reviewed here.)

The maintenance of a fiat currency regime – currency unbacked by hard assets – is a critical enabler of statist government. Bernanke admits as much, as the article notes, because “under the strict adherence to a gold standard, monetary policy tools could not be used.” This is precisely why we must advocate for a new gold standard (and an end to central banking). Bernanke’s tirade against the gold standard is the imperial political class’s counter-attack against the rising forces of gold-standard liberty, as it circles the wagons in an attempt to protect a critical tool for maintaining its power.

For more, see Bernanke Defends Fed Policy that Turned Dollar Into Four Cents

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