Critiquing the Critiques of Rand Paul and Ted Cruz
"The sole use of money is to circulate consumable goods" - Adam Smith, The Wealth of Nations, p. 370
Monetary policy is very much a part of the economic discussion among Republican presidential candidates. This is a good thing. In modern times politicians have ignored the importance of sound money to the U.S. and global economy's detriment.
Ronald Reagan was realistically the last presidential candidate to talk about monetary policy while on the stump. As Reagan put it while campaigning in 1980, "No nation in history has ever survived fiat money, money that did not have precious metal backing." Reagan was in favor of a return to a gold exchange standard.
While in office John F. Kennedy was aggressively in favor of the gold exchange standard that was revived in 1944 at Bretton Woods. As Kennedy put it, "This nation will maintain the dollar as good as gold at $35 an ounce, the foundation stone of the free world's trade and payments system." Since JFK and Reagan, dollar commentary from national politicians hasn't been as frequent. That Rand Paul and Ted Cruz are talking money is once again a good thing.
Yet last week at Bloomberg View, commentator Megan McArdle penned a post that was critical of what she terms "gold-buggery" among Sens. Paul and Cruz. As she sees it, this is the stuff of "fringe" politicians who are "sound money fanatics." In McArdle's defense, monetary policy is not something she writes about very often.
Still, she perhaps unwittingly made a good point about the focus among some sound-money advocates on the Federal Reserve. In a very small sense she was correct, but maybe not for reasons she might express.
In last week's debates Sen. Paul criticized the Fed for destroying "the value of the currency," while Cruz said "instead of adjusting monetary policy according to whims and getting it wrong over and over again and causing booms and busts, what the Fed should be doing is, number one, keeping our money tied to a stable level of gold." Those well-meaning, if slightly mis-worded comments struck McArdle as "fringe."
In truth, both senators merely misspoke. But McArdle didn't call them out on it.
What needs to be stressed is that the major devaluations of the dollar since 1913 haven't been driven by the Fed. The dollar's exchange value is a presidential prerogative through the U.S. Treasury. FDR oversaw the first dollar devaluation in 1933, and largely did so from his bed according to Amity Shlaes' masterful account of the Great Depression, The Forgotten Man. The Fed had nothing to do with the devaluation.
Fast forward to 1971, it was President Nixon's decision (backed by Treasury secretary John Connally among others) to de-link the dollar from gold; the latter an explicit devaluation of the greenback. As Allen Matusow reported in his 1998 book Nixon's Economy, Fed Chairman Arthur Burns was not only strongly against Nixon's decision to leave gold in '71, he also worked hard behind the scenes to convince Nixon to reverse course in 1973. The point here is that the Fed once again had nothing to do with what took place. As Burns put it in his diaries, "My efforts to prevent closing of the gold window - working through Connally, Volcker and Shultz - do not seem to have succeeded."
Presidents generally get the dollar they want. Nixon and Jimmy Carter wanted a weak currency and markets complied. Reagan ran on a return to a stronger dollar and markets similarly complied. Robert Rubin served Bill Clinton as Treasury secretary beginning in 1995, and it's notable during Rubin's tenure that not once did any responsible Treasury official ever jawbone the Japanese about the value of the yen. The currency quietude was a fairly strong signal that Rubin's support of a strong dollar was more than verbal. Markets complied once again.
Under George W. Bush, the dollar's decline began early on. His Treasury heads readily talked the dollar down, tariffs on steel, softwood lumber and shrimp along with jawboning of China about the yuan similarly signaled a desire for dollar weakness, and then wars have rarely correlated with currency strength. The Bush administration wanted a weak dollar, and markets complied.
Cruz and Paul are correct in their view that currency devaluation is problematic, but the Fed is not the entity to criticize. Presidents once again get the dollar they want, so their monetary focus should be on how they'll pursue a dollar-price rule once in office. It's a presidential prerogative as modern history reveals fairly plainly. Notable here is that McArdle didn't explain this historical truth. In her defense once again, she generally doesn't write about monetary policy.
That she doesn't was made apparent in her discussion of what she deems inflation. She cited a dollar "that is extremely strong against the euro," but since both the dollar and euro float, the greenback's strength or weakness vis-à-vis the euro tells little about the dollar's health or lack of same. The euro could be crushing the dollar (as the yen crushed a rather strong USD in the ‘80s and ‘90s), but that wouldn't necessarily signal a weak U.S. currency any more than a strong dollar versus the euro now would be certain evidence of dollar strength. I'm quite a bit taller than Kim Jong un, but I'm hardly a towering figure.
McArdle cites "core inflation" numbers like CPI "minus volatile food and energy prices" to allegedly prove a lack of inflation, but there it's well known that those numbers can be made high or low depending on what's used to calculate them. Computers have collapsed in price since 2001, so have flat-screen televisions, but gasoline and meat prices have risen quite a bit. To divine inflation or lack thereof based on prices is like saying wet sidewalks cause rain. Consumer prices are at best an effect of monetary mismanagement. Furthermore, shifting prices tend to force shifts elsewhere. If one set of prices is rising, others are falling. As John Stuart Mill explained it, "If one-half of the commodities [consumer goods] in the market rise in exchange value, the very terms imply a fall of the other half."
McArdle adds that what she deems inflation is actually good for morale simply because it means employers will be less likely to fire workers. Here she plainly misspoke, or miswrote. Jobs are a function of investment, investors are buying currency streams in the future when they invest, so the idea that currency devaluation is actually a boost to employment isn't something she likely believes. Indeed, employment springs from investment, and investors would generally like to avoid seeing future returns devalued.
McArdle's main point is that a gold standard "isn't" a good idea. She offers up many arguments, but most notably suggests that a "gold standard cannot do what a well-run fiat currency can do, which is tailor the money supply to the economy's demand for money. The supply of gold grows--or not--depending on how much of the stuff is mined." Her point there is that a commodity standard limits the supply of money.
Except that it doesn't. This too isn't McArdle's fault for promoting what is untrue. What she believes about gold correlating with "tight money" thanks to slight amounts of gold being mined each year is broadly believed. But as monetary expert Nathan Lewis has revealed with great regularity, it's spectacularly untrue. As Lewis wrote last week,
A gold standard system is not, and has never been, a system that "fixes the supply of money to the supply of gold." Absolutely not. A gold standard system is what I call a fixed-value system. The value of the currency - not the quantity - is linked to gold, for example at 23.2 troy grains of gold per dollar ($20.67/ounce). This was U.S. policy from 1834 to 1933.
From 1775 to 1900, the U.S. money supply (technically known as "base money") increased by 163 times, from $12 million to $1,954 million. During this time, the total aboveground gold supply increased by about 3.4x due to mining production.
163 is not the same as 3.4.
Gold-defined money in no way limits the supply of the measure that is money as much as it ensures as much as possible that the measure that is money will maintain its value in terms of something known for stability. As Lewis keeps pointing out, if market actors find a commodity that exhibits even greater stability than gold, he'll migrate to said commodity. But for now, gold is the best that market actors have come up with. As Mill noted about gold, it is "among the least influenced by any of the causes which produce fluctuations of value."
As for so-called "money supply," it goes to where production is. Presently it's abundant in Silicon Valley, and very scarce in Baltimore. If the dollar were to disappear tomorrow, money substitutes would quickly fill in for the dollar. McArdle's defense of floating money seems to be that a monetary authority can tailor supply to an economy's needs, but to presume the latter is the equivalent of said authority presuming to know how much and where daily production will take place. The task previously described is impossible, and if readers doubt this, imagine if the Fed were to pump billions into Baltimore banks tomorrow. If so, the money-supply surge in Baltimore banks would shrink almost instantaneously back to pre-Fed conditions to reflect the lack of production in the Charm City.
Money is solely a measure meant to facilitate the exchange of wealth produced, along with investment in wealth creation, so its stability in terms of value is of utmost importance; supply not terribly relevant so long as currency integrity as a measure of value is maintained: see the Adam Smith quote that begins the piece. Gold is merely what market actors happened upon long ago as the best way to maintain stability of the measure. Nothing else.
In that case, for McArdle to say a gold standard is a bad idea is for her to redefine money's historical purpose. If the goal isn't stability as a measure, what is it? Money certainly isn't wealth. If it were, El Salvador could be as rich as the U.S. Instead, we simply use money to exchange the actual wealth we're creating; gold arguably the best commodity against which to stabilize the currency's value. Gold doesn't limit the supply of money as much as maintenance of a fixed value between the dollar, euro, yen and gold is a way for market forces to regulate the supply of the currencies.
David Ricardo long ago asserted that "A currency, to be perfect, should be absolutely invariable in value." Far from fanaticism from the alleged "fringe," the pursuit of good money is merely the pursuit of what money has historically been: a stable measure of value. Ted Cruz and Rand Paul are right in their pursuit of sound money, while being incorrect about the Fed's role in the periodic devaluation of the dollar.
Of utmost importance is the simple truth that the dollar's exchange value is a presidential prerogative. Cruz and Paul should do as Reagan and Kennedy did in making it clear that their monetary goal would be to return the dollar to its singular purpose. This is something they can do with or without the Fed's blessing. Stable money is a tautology given the historical purpose of money, and if explained properly, well-meaning critics like McArdle will find it difficult to continue their critiques of what is quite basic and correct.