Tuesday, October 15, 2013

Monetary policy? Child’s play

The promise made a century ago that the U.S. central bank would eliminate economic crises is not raised very often.  To raise it would question the need for government’s most untouchable monopoly.  So it is not raised.  The Fed is the heart of the economy, we often hear.  It is the government’s ATM machine.  It bails out the big players when the roof caves.  It’s ridiculous to think the government could “do something” about crises without massive amounts of money at its disposal.  

Today, the Fed is stronger than ever as a result of the financial crisis of 2007-2008, the biggest since its other major failures, the artificial boom of the late 1920s and its role in the Great Depression, and the stagflation of the 1970s.  The Fed’s twin mandates of keeping inflation and unemployment low has been only half-successful.  According to one line of thought, the Bernanke Fed’s policy of buying close to $1 trillion a year in government debt may be too moderate to ease the pain of unemployment.  Fed chairman nominee Janet Yellen said in a speech earlier this year that the 7.3% unemployment rate is really 14.4% when you include part-timers who would prefer full-time positions and discouraged workers who have given up looking for jobs.  Since she’s expressed concern for workers excluded from the official (lower) unemployment rate, most analysts believe she will keep monetary policy “easy” for the foreseeable future if she’s confirmed.

The blessings of easy money

The Fed’s distinguishing characteristic is its grant-of-privilege to buy assets with money it doesn’t have.  No other person or institution can legally do this in the United States.  At the very least you might think this would raise eyebrows, but it doesn’t except in fringe quarters.  It is simply part of modern monetary gospel, never to be examined too closely.  Another part of that gospel is fractional reserve banking, wherein commercial banks normally loan money they don’t have. 

This monetary structure, blessed by all schools of economic analysis except the Austrian school, underlies the global economy. 

There’s a theory somewhere that says it is literally impossible to buy something with money you don’t have.  The Fed and other central banks have an answer to that theory: It creates the money in the act of purchasing something, what we might call a monetary deus ex machina.  If this isn’t clear, imagine a child playing make-believe who simply invents something on the spot to make her fantasy work.  When politically-appointed adults who are certified in economics conjure money on the spot it makes the economy work.  And it does.  If you don’t believe it check the profits of the biggest banks.  The only problem, seemingly, is the annoying unemployment rate.  In the fantasy world of political whim, where economic law is ignored, why not take the next step and let each person print dollars?  Unemployment would become an obsolete term.  Crimes against property would vanish.

Of course this wouldn’t fly because the big guys make the rules, and one of their rules is Thou Shalt Not Print Our Money.  Unauthorized currency creation in today’s fiat money world is counterfeiting, and governments go after counterfeiters with a vengeance.  It’s simply a turf issue, as Gary North wrote.  Governments regard counterfeiting as a high crime because it competes with its own counterfeiting activities.

Recall that the original purpose of money was to facilitate barter.  Money was the most marketable commodity, as Ludwig von Mises wrote over a century ago [pp. 32,33].  People bought it with goods they owned and sold it for other goods they wanted.  Money enables trade for people who are both producers and consumers, and allows them to specialize in their preferred occupations.

Government gradually muscled in on the money business, and eventually the paper dollars that had served as claims to deposited gold coins became money itself, by decree.  Also by decree the paper dollars were no longer claims to deposited gold coins or anything else.  Fiat paper money makes wealth transfers to the government invisible to most people.

Since the price of producing fiat paper money is negligible compared to the price of mining and minting gold, it performed the magic of filling the government’s coffers without legislating an unpopular tax increase.  It thus became the preferred method of financing wars and buying votes.  When money is cheap to produce it also attracts unauthorized producers, from government’s enemies as well as its citizens.

The U.S. Secret Service, in fact, was authorized by Lincoln on the day of his assassination, April 14, 1865, and commissioned on July 5th of that year “with the mission of suppressing [the] counterfeiting” of U.S. currency.  Following the passage of the Legal Tender Act of 1862, which “mandated that paper money be issued and accepted in lieu of gold and silver coins,” unauthorized counterfeiting became a serious problem for the government.   By 1865 between one-third to one-half of all U.S. currency in circulation (“greenbacks”) had been produced by someone other than the Union government. 

Let the market define money and control its supply

When gold coins circulated as money private citizens, as miners or owners of gold ore, largely determined the growth in the money stock.  Market forces determined monetary inflation.  When Lincoln forced greenbacks on the economy, only the government could legally control the money supply.  Political considerations determined monetary inflation.*  For political money to work, all other producers of money had to be eliminated.  

The one problem of fiat money from the government’s perspective is having it accepted as money, but this is solved through government’s defining tool, coercion, along with its vast propaganda apparatus.  Hence, the modifier “fiat” in “fiat money.”

The distinction made between government issues of money and private issues is of political importance only.  It’s a matter of cui bono - who benefits. Assuming the private issue is indistinguishable from the public issue in normal, day-to-day transactions, it will circulate as if it were in fact issued by the public authority.  Economically, the source of the issue is irrelevant.  The privately-issued currency will increase the money supply and redistribute wealth in the same way as the government-issued money.

When a fiat money producer, whether government or private, takes his newly printed money into the market to buy something, he is not offering sellers an economic good in exchange, as he would do in barter.  Both the government and private counterfeiter are consuming economic goods without producing economic goods first.   People who take the goods of others at gunpoint are thieves.  People who print fiat money and use it to buy things are no less criminal.

But notice this difference: In the first case, we have no trouble identifying the victims as the ones who are robbed.  In the fiat - counterfeiting case, the victims are emphatically not the ones who surrender their goods in exchange for money.  In the short run at least, they are beneficiaries.  Because the whole of society is forced to accept the notes, the first recipients of the new money can spend it at current prices.  Only much later are prices affected negatively. 

In practice there is a further distinction.  Private counterfeiters do not as a rule announce their counterfeiting activities to the public.  Their goal is to counterfeit without getting caught.  They are likely to spend the new money in such a way that it disperses through the economy undetected.  Government too can’t announce its counterfeiting to the public.  But rather than try to keep it a secret, government calls it monetary policy, and many highly-educated and brilliant people with financial connections to the Fed devote their lives to rationalizing it. 


Milton Friedman once wrote that monetary policy under a commodity standard was simple - there is none. [p. 251] The commodity money takes care of itself.  It also to a large extent takes care of politics. 

*One could argue that it was necessary to print money to pay for a war to free the slaves but this raises many objections, such as how other countries ended slavery without war.  Nor did Lincoln invade the South for that purpose.  It’s also hard to imagine hundreds of thousands of northerners and southerners fighting to the death to free people for whom they had little respect.