May 2010


Once I have finished rebutting the Pragmatic Capitalist, I shall turn my attention to this missive from Mr Bernanke.

Chairman Ben S. Bernanke
At the Institute for Monetary and Economic Studies International Conference, Bank of Japan, Tokyo, Japan
May 25, 2010
Central Bank Independence, Transparency, and Accountability
The financial crisis that began nearly three years ago has caused great hardship for people in many parts of the world and represented the most profound challenge to central banks since the Great Depression. Faced with unprecedented financial stresses and sharp contractions in economic activity, many central banks, including the Federal Reserve, responded with extraordinary measures. In the United States, we lowered the federal funds rate target to a range of 0 to 1/4 percent to help mitigate the economic downturn; we expanded the scale, scope, and maturity of our lending to provide needed liquidity to financial institutions and to address dislocations in financial markets; we jointly established currency swap lines with foreign central banks (including the Bank of Japan) to ensure the global availability of dollar funding; and we purchased a large quantity of longer-term securities to help improve the functioning of financial markets and support economic recovery.1 Looking to the future, central banks around the world are working with their governments to prevent future crises by strengthening frameworks for financial regulation and supervision.

In undertaking financial reforms, it is important that we maintain and protect the aspects of central banking that proved to be strengths during the crisis and that will remain essential to the future stability and prosperity of the global economy. Chief among these aspects has been the ability of central banks to make monetary policy decisions based on what is good for the economy in the longer run, independent of short-term political considerations. Central bankers must be fully accountable to the public for their decisions, but both theory and experience strongly support the proposition that insulating monetary policy from short-term political pressures helps foster desirable macroeconomic outcomes and financial stability.

In my remarks today, I will outline the general case for central bank independence and review the evolution of the independence of the Federal Reserve and other major central banks. I will also discuss the requirements of transparency and accountability that must accompany this independence.

The Case for Central Bank Independence
A broad consensus has emerged among policymakers, academics, and other informed observers around the world that the goals of monetary policy should be established by the political authorities, but that the conduct of monetary policy in pursuit of those goals should be free from political control.2 This conclusion is a consequence of the time frames over which monetary policy has its effects. To achieve both price stability and maximum sustainable employment, monetary policymakers must attempt to guide the economy over time toward a growth rate consistent with the expansion in its underlying productive capacity. Because monetary policy works with lags that can be substantial, achieving this objective requires that monetary policymakers take a longer-term perspective when making their decisions. Policymakers in an independent central bank, with a mandate to achieve the best possible economic outcomes in the longer term, are best able to take such a perspective.

In contrast, policymakers in a central bank subject to short-term political influence may face pressures to overstimulate the economy to achieve short-term output and employment gains that exceed the economy’s underlying potential. Such gains may be popular at first, and thus helpful in an election campaign, but they are not sustainable and soon evaporate, leaving behind only inflationary pressures that worsen the economy’s longer-term prospects. Thus, political interference in monetary policy can generate undesirable boom-bust cycles that ultimately lead to both a less stable economy and higher inflation.

Undue political influence on monetary policy decisions can also impair the inflation-fighting credibility of the central bank, resulting in higher average inflation and, consequently, a less-productive economy. Central banks regularly commit to maintain low inflation in the longer term; if such a promise is viewed as credible by the public, then it will tend to be self-fulfilling, as inflation expectations will be low and households and firms will temper their demands for higher wages and prices. However, a central bank subject to short-term political influences would likely not be credible when it promised low inflation, as the public would recognize the risk that monetary policymakers could be pressured to pursue short-run expansionary policies that would be inconsistent with long-run price stability. When the central bank is not credible, the public will expect high inflation and, accordingly, demand more-rapid increases in nominal wages and in prices. Thus, lack of independence of the central bank can lead to higher inflation and inflation expectations in the longer run, with no offsetting benefits in terms of greater output or employment.3

Additionally, in some situations, a government that controls the central bank may face a strong temptation to abuse the central bank’s money-printing powers to help finance its budget deficit. Nearly two centuries ago, the economist David Ricardo argued: “It is said that Government could not be safely entrusted with the power of issuing paper money; that it would most certainly abuse it.…There would, I confess, be great danger of this, if Government–that is to say, the ministers–were themselves to be entrusted with the power of issuing paper money.”4 Abuse by the government of the power to issue money as a means of financing its spending inevitably leads to high inflation and interest rates and a volatile economy.

These concerns about the effects of political interference on monetary policy are far from being purely theoretical, having been validated by the experiences of central banks around the world and throughout history. In particular, careful empirical studies support the view that more-independent central banks tend to deliver better inflation outcomes than less-independent central banks, without compromising economic growth.5 In light of all these considerations, it is no mystery why so many observers have come to see central bank independence as a critical component of a sound macroeconomic framework, and economists have studied a variety of approaches to enhance the independence and credibility of monetary policymakers.6

To be clear, I am by no means advocating unconditional independence for central banks. First, for its policy independence to be democratically legitimate, the central bank must be accountable to the public for its actions. As I have already mentioned, the goals of policy should be set by the government, not by the central bank itself; and the central bank must regularly demonstrate that it is appropriately pursuing its mandated goals. Demonstrating its fidelity to its mandate in turn requires that the central bank be transparent about its economic outlook and policy strategy, as I will discuss further in a moment. Second, the independence afforded central banks for the making of monetary policy should not be presumed to extend without qualification to its nonmonetary functions. For example, many central banks, including the Federal Reserve, have significant responsibilities for oversight of the banking system. To be effective, bank regulators and supervisors also require an appropriate degree of independence; in particular, the public must be confident that regulators’ decisions about the soundness of specific institutions are not unduly influenced by political pressures or lobbying. But for a number of reasons, the nature and scope of the independence granted regulatory agencies is likely to be somewhat different than that afforded monetary policy. In the conduct of its regulatory and supervisory activities, the central bank should enjoy a degree of independence that is no greater and no less than that of other agencies engaged in the same activities; there should be no “spillover” from monetary policy independence to independence in other spheres of activity. In practice, the Federal Reserve engages cooperatively with other agencies of the U.S. government on a wide range of financial and supervisory issues without compromising the independence of monetary policy.

The case for independence also requires clarity about the range of central bank activities deemed to fall under the heading of monetary policy. Conventional monetary policy, which involves setting targets for short-term interest rates or the growth rates of monetary aggregates, clearly qualifies. I would also include under the heading of monetary policy the central bank’s discount-window and lender-of-last-resort activities. These activities involve the provision of short-term, fully collateralized loans to the financial system as a means of meeting temporary liquidity needs, reducing market dysfunctions, or calming financial panics. As has been demonstrated during financial panics for literally hundreds of years, the ability of central banks to independently undertake such lending allows for a more rapid and effective response in a crisis. On the other hand, as fiscal decisions are the province of the executive and the legislature, the case for independent lender-of-last-resort authority is strongest when the associated fiscal risks are minimal. Requiring that central bank lending be fully secured, as is the case in the United States, helps to limit its fiscal implications. Looking forward, the Federal Reserve supports measures that help further clarify the dividing line between monetary and fiscal responsibilities. Notably, the development of a new statutory framework for the resolution of failing, systemically important firms is not only highly desirable as a means of reducing systemic risk, but it will also be useful in establishing the appropriate roles of the Federal Reserve and other agencies in such resolutions.

The issue of the fiscal-monetary distinction may also arise in the case of the nonconventional policy known as quantitative easing, in which the central bank provides additional support for the economy and the financial system by expanding the monetary base, for example, through the purchase of long-term securities. Rarely employed outside of Japan before the crisis, central banks in a number of advanced economies have undertaken variants of quantitative easing in recent years as conventional policies have reached their limits. In the United States, the Federal Reserve has purchased both Treasury securities and securities guaranteed by government-sponsored enterprises.

Although quantitative easing, like conventional monetary policy, works by affecting broad financial conditions, it can have fiscal side effects: increased income, or seigniorage, for the government when longer-term securities are purchased, and possible capital gains or losses when securities are sold. Nevertheless, I think there is a good case for granting the central bank independence in making quantitative easing decisions, just as with other monetary policies. Because the effects of quantitative easing on growth and inflation are qualitatively similar to those of more conventional monetary policies, the same concerns about the potentially adverse effects of short-term political influence on these decisions apply. Indeed, the costs of undue government influence on the central bank’s quantitative easing decisions could be especially large, since such influence might be tantamount to giving the government the ability to demand the monetization of its debt, an outcome that should be avoided at all costs.

The Historical Evolution of Central Bank Independence
Support for the idea of central bank independence has evolved over time. In the United States and many other countries, the historically high and volatile inflation rates in the 1970s and early 1980s prompted a reexamination of monetary policies and central bank practices. Since that time, we have observed the confluence of two global trends: the widespread adoption of improved monetary policy practices and the virtual elimination of high inflation rates. The improved policy practices prominently include a broad strengthening of central bank independence, increased transparency on the part of monetary policy committees, and the affirmation of price stability as a mandated goal for monetary policy. Inflation targeting, in which the government sets a numerical target for inflation but assigns responsibility for achieving that target to the central bank, has become a widely used framework embodying these principles, but other similar monetary frameworks have also proved effective.

In recent years, the number of central banks with a relatively high degree of independence has steadily increased, and the experience of some major central banks testifies to the importance of that independence. The Bank of England, one of the oldest central banks in the world, was essentially an agent of the British Treasury for a substantial part of the 20th century. When the government announced on May 6, 1997, that the Bank of England would be reborn as an independent central bank, U.K. Treasury bond yields fell sharply at longer maturities, likely reflecting a substantial decline in investors’ inflation expectations and their perceptions of inflation risk. Moreover, several studies have shown that U.K. inflation expectations exhibited significantly greater stability in the years following independence.7

Prior to the creation of the European Central Bank (ECB) in June1998, independence was seen as such a crucial element that it was enshrined in the Maastricht Treaty, an international agreement that can only be changed by unanimous consent of its signatories. The independence of the ECB has helped to keep euro-area inflation expectations firmly anchored.8

The importance of central bank independence also motivated a 1997 revision to Japanese law that gave the Bank of Japan operational independence.9 This revision significantly diminished the scope for the Ministry of Finance to influence central bank decisions, thus strengthening the Bank of Japan’s autonomy in setting monetary policy.

Although the Federal Reserve was established as an independent central bank in 1913, its effective degree of independence has gradually increased over time. Initially, the Secretary of the Treasury and the Comptroller of the Currency sat on the Board; they were removed when the current structure of the Federal Open Market Committee (FOMC) was introduced with the Banking Act of 1935. The act also extended the terms of Board members from 10 years to 14 years; the long, staggered terms of Board members have also served as a brake on political influence.

During World War II, the Federal Reserve agreed to peg Treasury yields at low levels to reduce the cost of financing wartime deficits. After the war, the Fed sought to resume an independent monetary policy, fearing the inflationary consequences of continued political control, but the Treasury was still intent on containing the cost of servicing the debt. The conflict was resolved in 1951 through the negotiation of the Treasury-Federal Reserve Accord, as it came to be known. The accord reestablished the Federal Reserve’s ability to freely set interest rates, but with active consultation between the Fed and Treasury. It was only by the amendment of the Federal Reserve Act in 1977 that the Fed’s current objectives of maximum employment and stable prices were specified by the Congress.10 A clear mandate of this kind is a key pillar of central bank independence.

Over the years, a consensus developed among U.S. political leaders that the Federal Reserve’s independence in making monetary policy is critical to the nation’s prosperity and economic stability. In 1978, the Congress formally recognized this principle by approving a provision that exempts monetary policy, discount window operations, and the Fed’s interactions with other central banks from Government Accountability Office policy reviews. In 1979, President Carter appointed Paul Volcker chairman of the Federal Reserve with the expectation that Volcker would strengthen the central bank’s inflation-fighting credibility, even though those steps would likely involve short-term economic and political costs. Subsequently, President Reagan’s support for Volcker’s politically unpopular disinflationary policies and for the principle of Federal Reserve independence proved crucial to the ultimate victory over inflation, a victory that set the stage for sustained growth.11 Presidents and other U.S. political leaders have since then regularly testified to the benefits of an independent Federal Reserve. For instance, President Clinton said in 2000, “[O]ne of the hallmarks of our economic strategy has been a respect for the independence and the integrity of the Federal Reserve.”12 President Bush noted in 2005, “It’s this independence of the Fed that gives people not only here in America[,] but the world, confidence.”13 And President Obama said in August 2009, “We will continue to maintain a strong and independent Federal Reserve.”14

Transparency and Accountability
Central bank independence is essential, but, as I have noted, it cannot be unconditional. Democratic principles demand that, as an agent of the government, a central bank must be accountable in the pursuit of its mandated goals, responsive to the public and its elected representatives, and transparent in its policies. Transparency regarding monetary policy in particular not only helps make central banks more accountable, it also increases the effectiveness of policy. Clarity about the aims of future policy and about how the central bank likely would react under various economic circumstances reduces uncertainty and–by helping households and firms anticipate central bank actions–amplifies the effect of monetary policy on longer-term interest rates. The greater clarity and reduced uncertainty, in turn, increase the ability of policymakers to influence economic growth and inflation.15

Over the years, the Federal Reserve–like many central banks around the world–has taken significant steps to improve its transparency and accountability. Policymakers give frequent speeches and testimonies before the Congress on the economic situation and on the prospects for policy, and the Federal Reserve submits an extensive report to the Congress twice each year on the economy and monetary policy.16 The FOMC, the Fed’s monetary policymaking arm, releases a statement after each of its meetings that explains the Committee’s policy decision and reports the vote on that decision. The FOMC also publishes the minutes of each meeting just three weeks after the meeting occurs and provides, with a lag, full meeting transcripts. In addition, the FOMC has begun providing the public a quarterly summary of Committee participants’ forecasts of key economic variables and, more recently, their assessments of the longer-run values to which these variables would be expected to converge over time.17 The information released by the FOMC provides substantial grist for the activities of legions of “Fed watchers” who analyze all aspects of monetary policy in great detail.

Apart from traditional monetary policy, the Federal Reserve’s response to the financial crisis has involved a range of new policy measures, about which the Fed has provided extensive information. For example, the Board has regularly published detailed information about the Federal Reserve’s balance sheet and the special liquidity facilities that were introduced. We created a section on our website devoted to these issues and initiated a regular monthly report as well.18 And we are committed to exploring new ways to enhance the Federal Reserve’s transparency without compromising our mandated monetary policy and financial stability objectives.19

Conclusion
As a result of the crisis, countries around the world are implementing significant financial and regulatory reforms. Such reforms that reduce the chance of a future crisis and that mitigate the effects of any crisis that does occur are worthy of our full support. As we move along the path of reform, however, it is crucial that we maintain the ability of central banks to make monetary policy independently of short-term political influence. In exchange for this independence, central banks must meet their responsibilities for transparency and accountability. At the Federal Reserve, we will continue to work to facilitate public understanding of both our monetary policy decisions and our actions to ensure the soundness of the financial system.

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“Government statistics are about the last place one should look to find inflation, as they are designed to not show much. Over the last 35 years the government has changed the way it calculates inflation several times.”

Now, I don’t entirely disagree here. No one should rely solely on the government for all of their facts but in defense of the government, they do confront these exact questions on the BLS website. And second, there are plenty of sources for unbiased inflation data. The first and foremost is the market itself. US bond yields continue to tick lower despite these supposedly increasing signs of inflation. Any investor who has been positioned for inflation (even the uber bearish ones) have been terribly wrong.

The Pragmatic Capitalist suggests that the Treasury market as being a source of unbiased information regarding inflation data. Is he joking, or just plain ignorant?

The short-end, or the Bills market is the very definition of a controlled and manipulated market. This is where the FOMC conducts Open Market Operations to execute monetary policy. Thus the interest rate or yield is an entirely artificial one, fixed by the Federal Reserve.

What about the blatent manipulation of Quantitative Easing that Mr Bernanke imposed upon the markets earlier this year to the tune of $1.2 trillion dollars?

No, the Treasury Market is not an area that I would be looking for independant and unbiased verification of inflation, possibly the last.

Mr. Einhorn then takes the credit rating agencies to task. This is the point where the article really begins to gain some traction. These companies have proven themselves mostly useless over the last few years. Unfortunately, he takes issue with the AAA rating of the United States. Luckily for us, Moody’s recently affirmed our Aaa rating – whew! We really dodged a bullet there. Of course, Moody’s doesn’t exactly understand the monetary system either as they view our “foreign debt” (of which there is none) as a potentially crippling fiscal hurdle. The very fact that this ignorant institution can even impact the trust in the national currency should be viewed as a national security issue.

Well there is the non-existant Government debt, broken down to allocations, which in total now exceeds $12 trillion dollars.

Of course not listed are liabilities for Social Security, Medicare, Medicaid, which truly are the elephant in the room, totaling some $70 trillion in future liabilities.

Essentially the US is bankrupt. Of course Moody’s et al would not be so gauche as to actually downgrade the US to Junk status, that simply would not be cricket old chap.

Mr. Einhorn continues his essay by stating that easy money has not solved the crisis. Of course it hasn’t. In a balance sheet recession monetary policy becomes useless. I’ve been beating on this dead horse since well before Bernanke initiated his insane “trickle down” monetary approach. Mr. Einhorn said:

Simply because to allow, or encourage a deflation, which is necessary, the government might well collapse. Those who have power, do not relinquish power freely nor easily.

“Modern Keynesianism works great until it doesn’t.”

I am not sure why the world is so black and white to most. I refer to myself as an “opportunistic Austro-Keynesian”. I never pigeon-hole myself.

Unusual combination, as the two are polar opposites. It would be difficult to reconcile the two.

Not in my investment strategies (which is why they are multi), not in my politics, and certainly not in my economics. Each economic environment is its own unique situation. Economists and portfolio strategists should view each economic scenario like an ER doctor –

Poor analogy. Allopathic medicine has it’s successes based on the universality of anaotomy, physiology and pathology. Without this universality, medicine could not be empirically based.

Economics is actually the same. It has unviversal principals that allow for predictive premises.

never expect that the exact same surgery will work on every patient. But for some reason certain economists prefer to claim that all government intervention is bad and others prefer to claim that all government intervention is good. The truth lies somewhere inbetween.

However the same surgery will be performed on the same diagnosis. Unfortunately the truism that government intervention leads to poor outcomes has been proven time-after-time.

In terms of government spending (or blanket Keynesianism as most doubters prefer to call it) it’s largely an accounting identity. Private sector deficit is public sector surplus. If government never spends private sector funds are slowly drained. Just imagine a one time 100% asset tax. What would happen to the economy? It would die of course. Contrary to popular opinion, government must spend before it can tax. Not vice versa. Therefore, a certain level of government spending is necessary.

Government spending falls into broadly two categories: transfer, and resource using. Resource using transfers resources that could have been utilised by the private sector to satisfy demand, based upon the price system, to government directing where the resources will be allocated in an arbitrary manner.

Transfer expenditures are pure subsidies.

As to the assertion that the government must spend before it can tax; I find this unusual in that it contravenes common sense. I’m pursuing the point only in that it’s such an odd statement to make.

If I have no job, and no source of income, it is obvious that I cannot continue to pay cash for goods/services once any savings I may have are exhausted. Any credit will be advanced on an assessment of my income or ability to pay principal + interest.

Why would government be considered any different?

The recent CBO findings show that government spending was the primary reason why the economy didn’t sink into a black hole over the last year. We also know from borrowing data and bank conditions that monetary policy has failed entirely.

I note that this data is referred to, but not presented. Second, when you refer to the economy, what data points are you actually referring to?

Unemployment?

Bank failures?

Producer Prices [inflation measure]

Interest on cash savings

Structure of Production

Federal Debt held by Foreigners

Or were you looking at some other aspects of the economy?

Of course, I have argued that the government spending has been very poorly targeted and resulted in more malinvestment and ineffective output than should have been the case, but that shouldn’t surprise anyone when you allow the bank lobbyists to control legislation.

The two are essentially one and the same, and have been since the 1890’s when the Morgan and Rockerfeller empires took over the US government to create a cartel by which to control the money supply, and thus enrich themselves via bank created inflation, legislated by the US government.

Spending is not the answer, but we must understand that spending at the government level also isn’t the enemy. Regardless, these blanket statements that government spending is always bad is flat out wrong.

Yes it is. The government apart from being inherently corrupt and dishonest, cannot respond in the same manner as the free market due to profit and loss having no impact on their decision process. Government intervention is always bad and wrong.

Like most inflationistas Mr. Einhorn justifies his inaccurate macroeconomic outlook by claiming that it is a big government conspiracy to conceal the facts. He says the inflationistas haven’t been wrong (even though the markets vehemently disagree), but that the government is just lying to us all:

Do the markets disagree? Really? On what basis?

“As far as the Fed is concerned, we will not monetize the debt. We will maintain price stability.”

Now, this is generally the point in the conversation where the inflationistas begin talking about the “effective default” of the USA via dollar devaluation.

The problem is, each time the crisis flares up the price action in markets makes it abundantly clear that there is no inflation, but rather continuing deflationary fears.

Einhorn’s comments regarding inflation are no different than the other inflationistas who continue to scream “fire” in a crowded theater despite no signs of fire. Of course, there has been no inflation because there is none. The inflationistas have made the same error that Mr. Bernanke made when he supposedly “saved the world” in 2008. Mr. Bernanke assumed that banks were reserve constrained while Mr. Einhorn assumes that adding to reserves is inherently inflationary.

But as we see very low levels of borrowing (due to the private sector’s lack of debt demand – caused by the continuing balance sheet recession and de-leveraging) we see zero signs of inflation.

In a world recession, where all banking systems are inherently at risk of bankruptcy and collapse, there has been a run to the US dollar, this is true. That a run to the dollar improves the dollar’s purchasing power of the US dollar relative to other currencies is also true. However when you compare purchasing power of the US dollar against commodities, a different picture emerges.

The CPI:

M2 Money:

So we can so a consistent and determined inflation from the governments own statistics. We can also see that Bernanke has created an inflation within the monetary supply via reserves, to save the banks that had severely overleveraged their Balance Sheets and were all insolvent.

Let’s take a quick look at government expenditures and revenues to see how the deficit is being created.

Expenditures:

Receipts:

This deficit needs to be funded either through debt, in which case the purchaser of the US Treasury debt becomes a creditor of the US and requires interest payments, which incidentally are consuming an increasing share of government tax receipts, or, print more money.

So unfortunately, The Pragmatic Capitalist’s criticisms of Mr Einhorn do not stand up to the data provided by the governments own statisticians.

Had some feedback in the comments section that requires a longer answer:

MarkS Says:

May 29, 2010 at 11:15 am e
I’m familiar with TPCs position. He would say that you don’t understand the monetary system because you are thinking in terms of the gold standard. The bond market funds nothing in a country where the government has monopoly supply of currency issuance. The bond market funds nothing.

I would explore TPCs comments further. The dude knows his stuff and has contacts in the Fed and banking system that most don’t. I think he’s dead right and he’s been scary accurate in his market calls and macro outlook. I think you’re barking up the wrong tree here duc. Thanks for the good work though!

Ok first off, let me address the monetary system. The monetary system of the US is based on a fiat currency system. This means that the issue of fiat currency has no backing of goods/services produced. It is backed by faith alone.

The Bond market, is the market for debt. The Treasury market is simply the market for government debt. The government requires “money” with which to purchase goods/services that exceeds their [government] tax revenues. The government has three options: [a] increase taxes [revenues] or reduce expenditures, [b] borrow money, [c] print more money.

Generally increasing taxes is hugely unpopular, and would result in their being removed from office. Printing money is surreptiously undertaken via creating demand deposits, which happens all the time, and money is also borrowed via the Treasury Bond market.

Creating demand deposits is inflation at it’s most basic level, and is executed via the banking system, pyramided upon the Central Bank, the Federal Reserve system.

With regard to loans taken by government via the Bond market, this is debt, with interest contracted at the floated rate, fixed for the term of maturity. This debt must be serviced. The purchasers of this debt are the creditors of the US government, viz. China, Japan, etc.

Thus the Bond market funds the deficit between tax revenue and government expenditure that the government incurs. This deficit can only be paid by either borrowing, or debasing, assuming tax hikes need to be avoided or cannot be coerced from the population.

With regard to TPC on this issue, he is categorically incorrect. As to the appeal to higher authority to support your argument, viz. TPC’s connections to Treasury et al, this is a logical fallacy, and adds nothing to your argument.

jog on
duc

“The current upset in the European sovereign debt market is a prequel to what might happen here.”

No, it absolutely is not. The irony here is so thick I am nearly choking on it. What Greece has essentially gotten themselves into a single currency system akin to the gold standard. There is no flexibility within such a currency system. There is no floating exchange between economies.

There have been a couple of variations in the Gold Standard. The pure Gold Standard was when gold coins were in useage. When sovereign countries made trade payments in gold bullion.

Then we have the watered down Gold Standard, where one country prints fiat money, dollars, that are exchangeable into gold. Every other country then pegs their currency to the dollar, this was the Bretton Woods system.

Now the Euro for Greece most certainly floats against the US Dollar, the Chinese Yuan, the Russian Rouble, etc. It does not float against the Spanish Euro, nor the German Euro, nor the French Euro.

So while Mr. Einhorn talks up his positions in gold he is actually justifying his actual portfolio composition without realizing that the piece of metal he is so heavily invested in is effectively the cause of the Greek crisis! This is exactly the kind of crises the world used to confront under the gold standard when there was no currency float.

So let me understand this, the Greek crisis is due to there being no way to float Euro against Euro? It has nothing to do with Greece spending more than they earn, and wanting to borrow the difference. They cannot legally print the difference, because they are part of the Euro, and do not have access to the printing press, so they are forced to borrow to make up the difference in their deficits.

As I’ve previously explained, trade deficit nations (such as Greece) are at an inherent disadvantage in such a system because there is no room to devalue or utilize fiscal/monetary policy to alleviate pressures. Because they are not the issuer of their own currency they are forced to beggar thy neighbor and turn to the bond markets to “finance” their spending.

Fiscal policy and Monetary policy are two very different approaches. Monetary policy is a method by which a Central Bank increases or decreases credit in the Banking system, which increases or decreases credit in the economy.

Fiscal policy however is different. Fiscal policy controls Government income and expenditures. When a recession/depression intervenes in the business cycle, Keynesian theory mandates that Government runs deficits to increase spending [someone elses income] within the economy. This deficit is financed through debt in Greece’s case, or debt and/or printing in the case of the US.

The great irony here is that the Greek crisis is not a condemnation of the US dollar or the British Pound (though the Brits clearly think so) or any fiat money system. If anything, it is a condemnation of the gold standard.

Really. How so?

Mr. Einhorn continues his rant while evoking the ageless fear mongering visualization of “money printing” and “debt monetization”. Both terms are not truly applicable to a monetary system in which the sovereign nation has a monopoly supply of currency in a floating exchange rate system.

Absolute nonsense. First, no country has a momopoly on the fiat money system. Second, even if they did, said country could only exist while other countries were willing to accept the fiat money in exchange for goods and services. Once the monopolist overplayed his hand and debased the money, such acceptance would cease.

But believers in the gold standard like to invoke these images because they give the appearance that the government is simply creating money out of thin air and being totally reckless.

Yes we do. Because that is exactly the truth of the matter.

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