theory of money

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Scarcely more than a year since it was signed, the Smithsonian Agreement, the “greatest monetary agreement in the history of the world” (in the words of President Nixon) lay in shambles. And so the world vibrates, with increasing intensity, between fixed and fluctuating exchange rates, with each system providing only a different set of ills. We apparently live in a world of perpetual international monetary crises.

In this distressing situation, the last few years have seen the burgeoning of a school of economists who counsel a simple solution for the world’s monetary illness. Since fixed exchange rates between currencies seem to bring only currency shortages and surpluses, black markets and exchange controls, and a chronic series of monetary crises, why not simply set all these currencies free to fluctuate with one another? This group of economists, headed by Professor Milton Friedman and the “Chicago School,” claims to be speaking blunt truths in the name of the “free market.” The simple and powerful case of the Friedmanites goes somewhat as follows:

Economic theory tells us the myriad evils that stem from any attempt at price controls of goods and services. Maximum price controls lead to artificially created shortages of the product; minimum controls lead to artificial unsold surpluses. There is a ready cure for these economic ills; they are caused not by processes deep within the free market economy, but by arbitrary government intervention into the market. Remove the controls, let market processes have full sway, and shortages and surpluses will disappear.

Similarly, the monetary crises of recent years are the product of government attempts to fix exchange rates between currencies. If the government of Ruritania fixes the “rur” at a rate higher than its free market price, then there will be a surplus of rurs looking for undervalued currencies, and a shortage of these harder currencies. The “dollar shortage” of the early postwar years was the result of the dollar being undervalued in terms of other currencies; the current surplus of dollars, as compared to West German marks or Japanese yen, is a reflection of the overvaluation of the dollar compared to these other currencies. Allow all of these currencies to fluctuate freely on the market, and the currencies will find their true levels, and the various currency shortages and surpluses will disappear. Furthermore, there will be no need to worry any longer about deficits in any country’s “balance of payments.” Under the pre-1971 system, when dollars were at least theoretically redeemable in gold, an excess of imports over exports led to a piling up of dollar claims and an increasingly threatening outflow of gold. Eliminate gold redeemability and allow the currencies to fluctuate freely, and the deficit will automatically correct itself as the dollar suppliers bid up the prices of marks and yen, thereby making American goods less expensive and German and Japanese goods more expensive in the world market.

Such is the Friedmanite case for the freely fluctuating exchange rate solution to the world monetary crisis. Any objection is met by a variant of the usual case for a free market. Thus, if critics assert that changing exchange rates introduce unwelcome uncertainty into world markets and thereby hinder international trade, particularly investment, the Friedmanites can reply that uncertainty is always a function of a free price system, and most economists support such a system. If the critics point to the evils of currency speculation, then Friedmanites can reply by demonstrating the important economic functions of speculation on the free commodity markets of the world. All this permits the Friedmanites to scoff at the timidity and conservatism of the world’s bankers, journalists, and a dwindling handful of economists. Why not try freedom? These arguments, coupled with the obvious and increasingly evident evils of such fixed exchange rate systems as Bretton Woods (1945–1971) and the Smithsonian (1971–1973), are bringing an increasing number of economists into the Friedmanite camp.

The Friedmanite program cannot be fully countered in its details; it must be considered at the level of its deepest assumptions. Namely, are currencies really fit subjects for “markets”? Can there be a truly “free market” between pounds, dollars, francs, and so on?

Let us begin by considering this problem: suppose that someone comes along and says, “The existing relationship between pounds and ounces is completely arbitrary. The government has decreed that 16 ounces are equal to 1 pound. But this is arbitrary government intervention; let us have a free market between ounces and pounds, and let us see what relationship the market will establish between ounces and pounds. Perhaps we will find that the market will decide that 1 pound equals 14 or 17 ounces.” Of course, everyone would find such a suggestion absurd. But why is it absurd? Not from arbitrary government edict, but because the pound is universally defined as consisting of 16 ounces. Standards of weight and measurement are established by common definition, and it is precisely their fixity that makes them indispensable to human life. Shifting relationships of pounds to ounces or feet to inches would make a mockery of any and all attempts to measure. But it is precisely the contention of the gold standard advocates that what we know as the names for different national currencies are not independent entities at all. They are not, in essence, different commodities like copper or wheat. They are, or they should be, simply names for different weights of gold or silver, and hence should have the same status as the fixed definition for any set, of weights and measures.

Let us bring our example a bit closer to the topic of money. Suppose that someone should come along and say, “The existing relationship between nickels and dimes is purely arbitrary. It is only the government that has decreed that two nickels equal one dime. Let us have a free market between nickels and dimes. Who knows? Maybe the market will decree that a dime is worth 7 cents or 11 cents. Let us try the market and see.” Again, we would feel that such a suggestion would be scarcely less absurd. But again, why? What precisely is wrong with the idea? Again the point is that cents, nickels, and dimes are defined units of currency. The dollar is defined as equal to 10 dimes and 100 cents, and it would be chaotic and absurd to start calling for day-to-day changes in such definitions. Again, fixity of definition, fixity of units of weight and measure, is vital to any sort of accounting or calculation.

To put it another way: the idea of a market only makes sense between different entities, between different goods and services, between, say, copper and wheat, or movie admissions. But the idea of a market makes no sense whatever between different units of the same entity: between, say, ounces of copper and pounds of copper. Units of measure must, to serve any purpose, remain as a fixed yardstick of account and reckoning.

The basic gold standard criticism of the Friedmanite position is that the Chicagoites are advocating a free market between entities that are in essence, and should be once more, different units of the same entity, that is, different weights of the commodity gold. For the implicit and vital assumption of the Friedmanites is that every national currency—pounds, dollars, marks, and the like—is and should be an independent entity, a commodity in its own right, and therefore should fluctuate freely with one another.

Let us consider: what are pounds, francs, dollars? Where do they come from? The Friedmanites take them at face value as things or entities issued at will by different central governments. The British government defines something as a “pound” and issues or controls the issue of whatever number of pounds it decides upon (or controls the supply of bank credit redeemable in these “pounds”). The United States government does the same for “dollars,” the French government the same for “francs,” and so on.

The first thing we can say, then, is that this is a very curious kind of “free market” that is being advocated here. For it is a free market in things, or entities, which are issued entirely by and are at the complete mercy of each respective government. Here is already a vital difference from other commodities and free markets championed by the Chicago school. Copper, steel, wheat, movies are all, in the Friedman scheme, issued by private firms and organizations, and subject to the supply and demand of private consumers and the free market. Only money, only these mysterious “dollars,” “marks,” and so on, are to be totally under the control and dictation of every government. What sort of “free” market is this? To be truly analogous with free markets in other commodities, the supply of money would have to be produced only by private firms and persons in the market, and be subject only to the demand and supply forces of private consumers and producers. It should be clear that the governmental fiat currencies of the Friedmanite scheme cannot possibly be subject only to private and therefore to free market forces.

Is there any way by which the respective national moneys can be subject solely to private market forces? Is such a thing at all possible? Not only is the answer yes, but it is still true that the origin of all these currencies that the Friedmanites take at face value as independent entities, was, each and every one, as units of weight of gold in a truly private and free market for money.

To understand this truth, we must go back beyond the existing fiat names for money and see how they originated. In fact, we need go back only as far as the Western world before World War I. Even today, the “dollar” is not legally defined an independent fictive name; it is still legally defined by U.S. statute as a unit of weight of gold, now approximately one-forty-second of a gold ounce. Before 1914, the dollar was defined as approximately one-twentieth of a gold ounce. That’s what a “dollar” was. Similarly the pound sterling was not an independent name; it was defined as a gold weight of slightly less than one-fourth of a gold ounce. Every other currency was also defined in terms of a weight of gold (or, in some cases, of silver). To see how the system worked, we assume the following definition for three of the numerous currencies:

1 dollar defined as one-twentieth of a gold ounce;
1 pound sterling defined as one-fourth of a gold ounce;
1 franc defined as one-hundredth of a gold ounce.

In this case, the different national currencies are different in name only. In actual fact, they are simply different units of weight of the same commodity, gold. In terms of each other, then, the various currencies are immediately set in accordance with their respective gold weights, namely,

1 dollar is defined as equal to one-fifth of a pound sterling, and to 5 francs;
1 franc is defined as equal to one-fifth of a dollar, and to one twenty-fifth of a pound;
1 pound is defined as equal to 5 dollars, and to 25 francs.

We might say that the “exchange rates” between the various countries were thereby fixed. But these were not so much exchange rates as they were various units of weight of gold, fixed ineluctably as soon as the respective definitions of weight were established. To say that the governments “arbitrarily fixed” the exchange rates of the various currencies is to say also that governments “arbitrarily” define 1 pound weight as equal to 16 ounces or 1 foot as equal to 12 inches, or “arbitrarily” define the dollar as composed of 10 dimes and 100 cents. Like all weights and measures, such definitions do not have to be imposed by government. They could, at least in theory, have been set by groups of scientists or by custom and commonly accepted by the general public.

This “classical gold standard” had numerous and considerable economic and social advantages. In the first place, the supply of money in the various countries was basically determined, not by government dictates, but—like copper, wheat, and so on—by the supply and demand forces of the free and private market. Gold was and is a metal that has to be discovered, and then mined, by private firms. Its supply was determined by market forces, by the demand for gold in relation to the demand and supply of other commodities and factors; by, for example, the relative cost and productivity of factors of production in mining gold and in producing other goods and services. At its base, the money supply of the world, then, was determined by free market forces rather than by the dictates of government. While it is true that governments were able to interfere with the process by weakening the links between the currency name and the weight of gold, the base of the system was still private, and hence it was always possible to return to a purely private and free monetary system. To the extent that the various currency names were kept as strictly equivalent to weights of gold, to that extent the classical gold standard worked well and harmoniously and without severe inflation or booms and busts.

The international gold standard had other great advantages. It meant that the entire world was on a single money, that money, with all its enormous advantages, had fully replaced the chaotic world of barter, where it is impossible to engage in economic calculation or to figure out prices, profits, or losses. Only when the world was on a single money did it enjoy the full advantage of money over barter, with its attendant economic calculation and the corollary advantages of freedom of trade, investment, and movement between the various countries and regions of the civilized world. One of the main reasons for the great growth and prosperity of the United States, it is generally acknowledged, was that it consisted of a large free-trading area within the nation: we have always been free of tariffs and trading quotas between New York and Indiana, or California and Oregon. But not only that. We have also enjoyed the advantage of having one currency: one dollar area between all the regions of the country, East, West, North, and South. There have also been no currency devaluations or exchange controls between New York and Indiana.

But let us now contemplate instead what could happen were the Friedmanite scheme to be applied within the United States. After all, while a nation or country may be an important political unit, it is not really an economic unit. No nation could or should wish to be self-sufficient, cut off from the enormous advantages of international specialization and the division of labor. The Friedmanites would properly react in horror to the idea of high tariffs or quota walls between New York and New Jersey. But what of different currencies issued by every state? If, according to the Friedmanites, the ultimate in monetary desirability is for each nation to issue its own currency—for the Swiss to issue Swiss francs, the French their francs, and so on—then why not allow New York to issue its own “yorks,” New Jersey its own “jersies,” and then enjoy the benefits of a freely fluctuating “market” between these various currencies? But since we have one money, the dollar, within the United States, enjoying what the Friedmanites would call “fixed exchange rates” between each of the various states, we don’t have any monetary crisis within the country, and we don’t have to worry about the “balance of payments” between New York, New Jersey, and the other states.

Furthermore, it should be clear that what the Friedmanites take away with one hand, so to speak, they give back with the other. For while they are staunchly opposed to tariff barriers between geographical areas, their freely fluctuating fiat currencies could and undoubtedly would operate as crypto-tariff barriers between these areas. During the fiat money Greenback period in the United States after the Civil War, the Pennsylvania iron manufacturers, who had always been the leading advocates of a protective tariff to exclude more efficient and lower cost British iron, now realized that depreciating greenbacks functioned as a protective device: for a falling dollar makes imports more expensive and exports cheaper.1 In the same way, during the international fiat money periods of the 1930s (and now from March 1973 on), the export interests of each country scrambled for currency devaluations, backed up by inefficient domestic firms trying to keep out foreign competitors. And similarly, a Friedmanite world within the United States would have the disastrous effect of functioning as competing and accelerating tariff barriers between the states.

And if independent currencies between each of the fifty states is a good thing, why not go still one better? Why not independent currencies to be issued by each county, city, town, block, building, person? Friedmanite monetary theorist Leland B. Yeager, who is willing to push the reductio ad absurdum almost all the way by advocating separate moneys for each region or even locality, draws back finally at the idea of each individual or firm printing his own money. Why not? Because, Yeager concedes, “Beyond some admittedly indefinable point, the proliferation of separate currencies for ever smaller and more narrowly defined territories would begin to negate the very concept of money.”2 That it would surely do, but the point is that the breakdown of the concept of money begins to occur not at some “indefinable point” but as soon as any national fiat paper enters the scene to break up the world’s money. For if Rothbard, Yeager, and Jones each printed his own “Rothbards,” “Yeagers,” and “Joneses” and these each amng billions freely fluctuating on the market were the only currencies, it is clear that the world would be back in an enormously complex and chaotic form of barter and that all trade and investment would be reduced to a virtual standstill. There would in fact be no more money, for money means a general medium for all exchanges. As a result, there would be no money of account to perform the indispensable function of economic calculation in a money and price system. But the point is that while we can see this clearly in a world of “every man his own currency,” the same disastrous principle, the same breakdown of the money function, is at work in a world of fluctuating fiat currencies such as the Friedmanites are wishing upon us. The way to return to the advantages of a world money is the opposite of the Friedmanite path: it is to return to a commodity which the entire world can and does use as a money, which means in practice the commodity gold.

One critic of fluctuating exchange rates, while himself a proponent
of “regional currency areas,” recognizes the classical argument for one world money. Thus, Professor Mundell writes:

It will be recalled that the older economists of the nineteenth century were internationalists and generally favored a world currency. Thus John Stuart Mill wrote in Principles of Political Economy, vol. 2, p. 176:

… So much of barbarism, however, still remains in the transactions of most civilized nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbors, a peculiar currency of their own.

… Mill, like Bagehot and others, was concerned with the costs of valuation and money changing, not stabilization policy, and it is readily seen that these costs tend to increase with the number of currencies. Any given money qua numeraire, or unit of account,fulfills this function less adequately if the prices of foreign goods are expressed in terms of foreign currency and must then be translated into domestic currency prices. Similarly, money in its role of medium of exchange is less useful if there are many currencies; although the costs of currency conversion are always present, they loom exceptionally larger under inconvertibility or flexible exchange rates. Money is a convenience and this restricts the optimum number of currencies. In terms of this argument alone, the optimum currency area is the world, regardless of the number of regions of which it is composed.3

There is another reason for avoiding fiat paper currency issued by all governments and for returning instead to a commodity money produced on the private market (for example, gold). For once a money is established, whatever supply of money exists does the full amount of the “monetary work” needed in the economy. Other things being equal, an increase in the supply of steel, or copper, or TV sets is a net benefit to society: it increases the production of goods and services to the consumers. But an increase in the supply of money does no such thing. Since the usefulness of money comes from exchanging it rather than consuming it or using it up in production, an increased supply will simply lower its purchasing power; it will dilute the effectiveness of any one unit of money. An increase in the supply of dollars will merely reduce the purchasing power of each dollar, that is, will cause what is now called “inflation.” If money is a scarce market commodity, such as gold, increasing its supply is a costly process and therefore the world will not be subjected to sudden inflationary additions to its supply. But fiat paper money is virtually costless: it costs nothing for the government to turn on the printing press and to add rapidly to the money supply and hence to ruinous inflation. Give government, as the Friedmanites would do, the total and absolute power over the supply of fiat paper and of bank deposits—the supply of money—and we put into the hands of government a standing and mighty temptation to use this power and inflate money and prices.

Given the inherent tendency of government to inflate the money supply when it has the chance, the absence of a gold standard and “fixed exchange rates” also means the loss of balance-of-payments discipline, one of the few checks that governments have faced in their eternal propensity to inflate the money supply. In such a system, the outflow of gold abroad puts the monetary authorities on increased warning that they must stop inflating so as not to keep losing gold. Abandon a world money and adopt fluctuating fiat moneys, and the balance-of-payments limitation will be gone; governments will have only the depreciating of their currencies as a limit on their inflationary actions. But since export firms and inefficient domestic firms tend actually to favor depreciating currencies, this check is apt to be a flimsy one indeed.

Thus, in his critique of the concept of fluctuating exchange rates, Professor Heilperin writes:

The real trouble with the advocates of indefinitely flexible exchange rates is that they fail to take into sufficient consideration the causes of balance-of-payments disequilibrium. Now these, unlike Pallas Athene from Zeus’ head, never spring “fully armed” from a particular economic situation. They have their causes, the most basic of which [are] internal inflations or major changes in world markets.

“Fundamental disequilibria” as they are called … can and do happen. Often however, they can be avoided: if and when an incipient inflation is brought under control; if and when adjustments to external change are effectively and early made. Now nothing encourages the early adoption of internal correctives more than an outflow of reserves under conditions of fixed parities, always provided, of course, that the country’s monetary authorities are “internationally minded” and do their best to keep external equilibrium by all internal means at their disposal.4

Heilperin adds that the desire to pursue national monetary and fiscal policies without regard to the balance of payments is “one of the widespread and yet very fallacious aspirations of certain governments … and of altogether too many learned economists, aspirations to ‘do as one pleases’ without suffering any adverse consequences.” He concludes that the result of a fluctuating exchange rate system can only be “chaos,” a chaos that “would lead inevitably … to a widespread readoption of exchange controls, the worst conceivable form of monetary organization.”5

If governments are likely to use any power to inflate fiat currency that is placed in their hands, they are indeed almost as likely to use the power to impose exchange controls. It is politically naive in the extreme to place the supply of fiat money in the hands of government and then to hope and expect it to refrain from controlling exchange rates or going on to impose more detailed exchange controls. In particular, in the totally fiat economy that the world has been plunged into since March 1973, it is highly naive to expect European countries to sit forever on their accumulation of 80-odd billions of dollars—the fruits of decades of American balance-of-payments deficits—and expect them to allow an indefinite accumulation of such continually depreciating dollars. It is also naive to anticipate their accepting a continually falling dollar and yet do nothing to stem the flood of imports of American products or to spur their own exports. Even in the few short months since March 1973 central banks have intervened with “dirty” instead of “clean” floats to the exchange rates. When the dollar plunged rapidly downward in early July, its fall was only checked by rumors of increased “swap” arrangements by which the Federal Reserve would borrow “hard” foreign currencies with which to buy dollars.

But it should be clear that such expedients can only stem the tide for a short while. Ever since the early 1950s, the monetary policies of the United States and the West have been short-run expedients, designed to buy time, to delay the inevitable monetary crisis that is rooted in the inflationary regime of paper money and the abandonment of the classical gold standard. The difference now is that there is far less time to buy, and the distance between monetary crises grows ever shorter. All during the 1950s and 1960s the Establishment economists continued to assure us that the international regime established at Bretton Woods was permanent and impregnable, and that if the harder money countries of Europe didn’t like American inflation and deficits there was nothing they could do about it. We were also assured by the same economists that the official gold price of $35 an ounce—a price which for long has absurdly undervalued gold in terms of the depreciating dollar—was graven in stone, destined to endure until the end of time. But on August 15, 1971, President Nixon, under pressure by European central banks to redeem dollars in gold, ended the Bretton Woods arrangement and the final, if tenuous, link of the dollar to redemption in gold.

We are also told, with even greater assurance (and this time by Friedmanite as well as by Keynesian economists) that when, in March 1968, the free market gold price was cut loose from official governmental purchases and sales, that gold would at last sink to its estimated nonmonetary price of approximately $10 an ounce. Both the Keynesians and the Friedmanites, equal deprecators of gold as money, had been maintaining that, despite appearances, it had been the dollar which had propped up gold in the free—gold markets of London and Zurich before 1968. And so when the “two-tier gold market” was established in March, with governments and their central banks pledging to keep gold at $35 an ounce, but having nothing further to do with outside purchases or sales of gold, these economists confidently predicted that gold would soon disappear as a monetary force to reckon with. And yet the reverse has happened. Not only did gold never sink below $35 an ounce on the free market, but the market’s perceptive valuation of gold as compared to the shrinking and depreciating dollar has now hoisted the free market gold price to something like $125 an ounce. And even the hallowed $35 an ounce figure has been devalued twice in the official American accounts, so that now the dollar—still grossly overvalued—is pegged officially at $42.22 an ounce. Thus, the market has continued to give a thumping vote of confidence to gold, and has brought gold back into the monetary picture more strongly than ever.

Not only have the detractors of gold been caught napping by the market, but so have even its staunchest champions. Thus, even the French economist Jacques Rueff, for decades the most ardent advocate of the eminently sensible policy of going back to the gold standard at a higher gold price, even he, as late as October 1971 faltered and conceded that perhaps a doubling of the gold price to $70 might be too drastic to be viable. And yet now the market itself places gold at very nearly double that seemingly high price.6

Without gold, without an international money, the world is destined to stumble into one accelerated monetary crisis after another, and to veer back and forth between the ills and evils of fluctuating in exchange rates and of fixed exchange rates without gold. Without gold as the basic money and means of payment, fixed exchange rates make even less sense than fluctuating rates. Yet a solution to the most glaring of the world’s aggravated monetary ills lies near at hand, and nearer than ever now that the free-gold market points the way. That solution would be for the nations of the world to return to a classical gold standard, with the price fixed at something like the old current free market level. With the dollar, say, at $125 an ounce, there would be far more gold to back up the dollar and all other national currencies. Exchange rates would again be fixed by the gold content of each currency. While this would scarcely solve all the monetary problems of the world—there would still be need for drastic reforms of banking and central bank inflation, for example—a giant step would have been taken toward monetary sanity. At least the world would have a money again, and the spectre of a calamitous return to barter would have ended. And that would be no small accomplishment.


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It is ironic in a way that the Federal Reserve and its “rate hikes” have played a crucial role in setting back “reflation.”  There was some renewed hope up until that last FOMC vote in mid-March.  But since then, contrary to how markets “should” approach a higher federal funds band, bonds and funding have moved opposite. Swap spreads that for the first two and a half months of this year were decompressing, suggesting an easing in “dollar” pressure, began to compress (meaning for the 10s and 30s more negative) all over again after March 15.

It’s not difficult to assess why that was the case, where eurodollar futures, for example, could rise in price and therefore signal a (much) lower interest rate paradigm in the not-too-distant future despite the outwardly “hawkish” policy stance.  I wrote earlier this week:

“The markets ‘wanted’ the Fed exit to be the one that was described three years earlier, where ‘overheating’ was a more common term slipped consciously into policymaker speeches and media presentations. But the Fed only disappointed, with Janet Yellen at her press conference forced by less fawning questioning to admit, complete with the deer-in-headlights stare only she can give, that none of the models foresaw any uptick in growth whatsoever. Worse, the FOMC statement confirmed that though the CPI was nearly 3% at that moment, it was indeed going to be just a temporary artifact of oil price base effects, and that officially inflation was not expected to return to ‘normal’ until after 2019. Major, major buzzkill.”

In other words, as we have been saying all along, the Fed is exiting not because recovery is coming but because it never will.  There is, in their official judgment, nothing left for monetary policy to accomplish.  This pathetic economic condition, which they describe in their own way, through calculations like low or possibly negative R*, is now our baseline. What was unthinkable just three years ago (in the mainstream) is reality; ten years ago, it was plain impossible.

In January 2009, I wrote, “The economy is not likely to repeat the Japanese scenario.”  Unlike Japan, I reasoned, the American economy was far more dynamic and flexible, qualities that counterintuitively were on display at that very moment.  US businesses were laying off millions of workers every month, a horrible result for them but systemically what was necessary to restore profitability and cash flow.  Japan’s economy in the 1980’s and 1990’s was a contradiction of rigidity and a tangle of sclerosis, I thought, therefore its undoing and where the US would defeat the comparison.

Now so many years later, here the whole world sits in exactly the Japanese scenario.  Boy, was I wrong thinking that the Fed’s inability to affect the monetary system would be so easily set aside; or, if not so easily than overcome after enough time through good ol’ Americana.  I quite reasonably if naively assumed that faced with such incompetence on the policy level the far more dynamic American economy (which it was) would find its way out of that mess through other means. I had failed to appreciate the scale of the disaster on a longer timescale, how the eurodollar system had over the decades before entangled itself in everything here and everywhere else; and what that truly meant.

The most unambiguous and convincing evidence is how interest rates are low and have only remained that way no matter what, echoing what Milton Friedman wrote in 1963 about the 1930’s.  The issue cannot be business but money.

“The Federal Reserve repeatedly referred to its policy as one of ‘monetary ease’ and was inclined to take credit – and, even more, was given it – for the concurrent decline in interest rates, both long and short.”

He wrote again in the 1990’s warning the Japanese of the same condition, calling it the “interest rate fallacy” because though it is a clear sign of monetary tightness it is made unclear by economists who never seem able to understand money.  It’s a weird result for any central bank to be staffed with people who, at the top at least, can’t comprehend the nature of their own primary task.  It is far more so when it is a major central bank in a premier economy facing an historic liquidity situation.

It is downright criminal given the economic consequences of it, first Japan now the world.  The repeated situation strains all credibility, for the Japanese case was up to 2007 one of the most studied in all history.  How in the world could US (and European) officials end up making all the very same mistakes?

For one, US policymakers believed, in a way as I did, that they were superior to their Japanese counterparts.  In June 2003, the FOMC discussed these very scenarios and how the Bank of Japan was already at a place they increasingly believed they might have to follow.  QE had begun in March 2001 on that side of the Pacific, and was expanded after only a few months. In the US, the Federal Reserve had lowered the federal funds rate, what they believed was “stimulus”, even well more than a year after the official end of the dot-com recession.

By the start of summer in 2003, the short-term money rate was down to 1%, a level only a few years before that was thought beyond the pale of good monetary stewardship; so much so, that the gathered committee members at that meeting waxed philosophically about what they were doing, and even as Alan Greenspan contemplated what they really could do. The tone of that part of the discussion, centered on Japan and its experience at the zero lower bound that for the Fed had suddenly come into view, was “what if it’s us?”

“MR. KOHN.  Another problem in Japan was that the authorities were overly optimistic about the economy. They kept saying things were getting better, but they didn’t. To me that underlines the importance of our public discussion of where we think the economy is going and what our policy intentions are.”

That’s only true if you can be honest about it.  Japanese policy was only ever the same as American policy in that respect, for in all cases central banks believe they hold enormous power that given the will to use can only result in the preferred outcome.  Stimulus of the monetary type has been reduced to a tautology, or at best unchallenged circular logic; it works because it works. Or, as Ben Bernanke stated in his infamous “deflation” speech of November 2002:

“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

He made that statement which was received without controversy as a technical matter; philosophically, he was criticized in the Weimar Germany kind of way without thinking it all the way through. A year before, the Federal Reserve, as well as the Bank of Japan I have to assume, had already found startling contrary evidence, at least as far as quantitative easing was concerned.  QE as an operative scheme is simple and straightforward; purchase assets from private banks so as to increase the level of bank reserves, therefore satisfying Milton Friedman’s supply critique. That was the same argument that Bernanke was echoing in 2002, to raise the money supply through whatever means so as to achieve what he claimed and therefore expected.

Mark Spiegel, an economist at the Federal Reserve Bank of San Francisco, had published in November 2001 an account of some already serious deficiencies observed in the effects of QE then ongoing in Japan.  As everyone expected as a matter of basic central bank math, Japan’s M1 that had sharply decelerated in its growth rate reversed course with the introduction of BoJ’s bond buying scheme expanding so-called base money.  But, as Spiegel detected, in the real world it wasn’t so simple and easy:

“While M1 has indeed enjoyed robust positive growth since the inception of the quantitative easing strategy, there has been a matching decline in the aggregate known as ‘quasi-money,’ which includes time deposits and a number of other less liquid assets. While the central bank can increase the stock of narrow money in the economy, the banks appear to be treating the exercise much like a swap of near-zero and zero interest rate assets, and they are responding with little change in their lending activities.”

The US and global banking system after 2007 has acted in the same way, as both Japanese banks in 2001 (and after) as well as American and European banks post-crisis did more than just what Spiegel had described. This liquidity “swap” was indeed far-reaching, eventually over time eroding balance sheet factors in any number of ways.  I have tracked gross notional derivative books as a proxy for this very behavior, which suggests that in truth the conditions of bank balance sheets and therefore money in Japan as everywhere else is worse than even Spiegel spelled out fifteen and a half years ago.

We are left with one, and only one, conclusion; Ben Bernanke was right that the Federal Reserve as the duly appointed US government agency is in possession of the printing press.  However, quantitative easing no matter how much academic gloss it is given is not it. Actual monetary conditions are determined by a myriad of other outside factors (relating exclusively to bank balance sheets) that appear impervious to QE-type strategies, a verdict rendered by sixteen years of experience in Japan and another eight in the US and elsewhere.

You could have made a quantitative case against QE in the Japanese or the first American instances, where the “Q” part was simply too small.  In the last five years in particular that factor has, too, been empirically eliminated, most especially by the Bank of Japan’s QQE reaching now half a quadrillion in yen reserves with the same results (none positive).

Why the Federal Reserve merely followed in BoJ’s footsteps for all these years is almost inexplicable; almost.  Again, going back to that meeting in June 2003, policymakers here knew it wasn’t working and Alan Greenspan began to wonder about his own capabilities.

“CHAIRMAN GREENSPAN.  What is useful, as has been discussed, is to build up our general knowledge so that when we are confronted with the need to respond with a twenty-minute lead time—which may be all the time we will have—we have enough background understanding to enable us to make informed decisions. We need to know how the system tends to work to be able to make the necessary judgments without asking one of our skilled technical practitioners to go off and run three correlations between X, Y, and Z. So I think the notion of building up our knowledge generally as a basis for functioning effectively is exceptionally important.”

Or, as I put it a year ago, make sure you can actually do what you say you can do before you have to do it.  The emphasis was in 2003 clearly on the “before you have to do it part” and largely because of how the Bank of Japan was executing a theoretically sound strategy that wasn’t producing the desired or expected results. But they never did that. The FOMC as well as most of the academic literature instead focused on BoJ’s execution of QE rather than the technical factors that were clearly suggesting (really proving) from the very beginning at the very least far more complexity in money than was assumed.

And so it brings the world back to repeating the Japanese mistakes, as Governor Kohn described them so many years ago, “They kept saying things were getting better, but they didn’t.”  The Fed was never honest in its assessment of what it really could do so that by the time D-day arrived for them they were arrogantly dismissive even of direct market contradictions (especially eurodollar futures that were in early 2007 correct and have remained so despite all the QE’s).  It wouldn’t have mattered if the FOMC had their skilled practitioners run off and do X, Y, and Z correlations, because X, Y, and Z were all based on the same mistaken premises, those of Ben Bernanke’s 2002 speech. Throughout the crisis period officials kept claiming “things were getting better” (subprime is contained) only to see the whole thing nearly collapse.  Afterward it was always the same, “things were getting better” (green shoots) even though QE1 was followed by a QE2, another global liquidity crisis, a QE3, a QE4, and then another global liquidity crisis.

How can even the most robust and dynamic economy move even slightly forward under those conditions?  That is another result we have over the last ten years fully tested and established; it can’t. Whatever the unobserved direct effects of monetary tightness, such outward and visible instability is another depressive factor all its own, and a very important one.

Because of one simple variable we have followed a path that a decade ago was believed literally impossible. Indeed, everything that has happened this last period had it been described to someone in 2005 would have sounded totally insane.  And there is only one factor capable of creating that situation, the one, tragically, most experts were the least concerned about. Life does have a habit of unfolding in that way, where the one thing you don’t expect is what kills you in the end. Call it the maestro’s curse, no conundrum required.

We aren’t yet dead, though we are now living in John Maynard Keynes’ long run.  Apologies to Dr. Keynes, it does matter, quite a bit actually.  Chaos, whether social or political, is the inevitable product of extended economic dysfunction.  People will put up with a lot, a large recession and even a sluggish recovery, but no people (the Japanese have committed to demographic suicide) will be able to withstand the social consequences of unceasing bleakness and no legitimate answers for it.  Such a condition offends all modern sense of human progress.

It is a testament to how far down we have gone, that in 2017 pleading with the Fed to just say it one more time, “things are getting better”, because that is all that is left standing between the comforting fiction and the cold reality of Japanification.  It could only have been a bitter blow, for the Fed in truth was up until now good for only that one thing, meaning optimism; carefully worded, of course, but in the end constant positivity about recovery even if always off just over the horizon. For many, that fiction was more meaningful than being led unwilling to the truth about a world without growth.

Thus, all hope is not extinguished, merely transposed to right where it belonged all this time.  Central bankers have said “listen to us because that is the only way for recovery”; only now to say instead, “listen to us because there is no recovery” as if nobody is allowed to notice the change.  We need only stop listening to economists altogether because they were wrong then and utterly so now.  The problem isn’t economics but economists, the former having been removed from the latter generations ago.

That is the great unappreciated truth about Japanification. It was never about zombie banks and asset bubbles, at least so far as separate issues from economists who know nothing, prove they know nothing, and then refuse to learn when all results show it. Nobody ever bothers to challenge a central banker about money because who would ever do such a thing?  It is such a thin façade, though, as once you move past it to do so is incredibly easy.  One need read only a single FOMC transcript from 2008 (and now 2011) to establish this.

As “reflation” hopes fade just as they did three years ago, how the world proceeds is a choice.  It is a collective one, but one that must be made nonetheless. We can allow nothing to ever change as the Japanese have.  The political situation in Japan has been upended several times over the past quarter-century, but what is the one thing that has remained constant no matter which side sits in power?  The Bank of Japan.  Republican or Democrat, what is the one thing that hasn’t changed in America?  Monetary policy that was and remains strangely devoid of any money.

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The theoretical foundation for the book comes from Ludwig von Mises, the great Austrian economist, who pointed out that credit is a claim on resources. Tamny reasons that if credit is a claim on resources, then new credit cannot be created unless new resources are created. This renders the idea of ‘excess credit’ an oxymoron. And if there cannot be more credit than output than there cannot be an excess of credit over output.

Tamny makes the argument that new credit can only be created if there are new resources that are also created. This argument is incorrect.

Credit is a claim on resources and when credit increases and there is no increase in resources, the price paid for those resources also rises. Therefore there is no necessity for an expansion in resources, for there to be an expansion in credit. This is why a credit expansion leads to inflation.

Credit, when newly created, is not distributed evenly. Certain institutions and people receive that credit first and the new credit gradually disperses throughout the economy over time.


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The theoretical foundation for the book comes from Ludwig von Mises, the great Austrian economist, who pointed out that credit is a claim on resources. Tamny reasons that if credit is a claim on resources, then new credit cannot be created unless new resources are created. This renders the idea of ‘excess credit’ an oxymoron. And if there cannot be more credit than output than there cannot be an excess of credit over output.

This line of reasoning causes Tamny to call in to doubt the Austrian Theory of the Business Cycle, at least the popularly understood versions of it. After all, if there can’t be excess credit at all, then there certainly can’t be excess-credit-driven over-production. Yes, some parts of the economy can grow too much, due to credit mis-allocation, but the economy in general cannot be made to grow above capacity due to allege ‘excess credit’. Thus, the Fed doesn’t cause economy-wide bubbles, only sectional distortions. Central bank interventions such as interest rate setting, on balance, actually decrease the expansion of the economy – perhaps even during the ‘bubble’ period.

On the way to this conclusion, Tamny takes aim at the idea that under a fractional reserve banking system, new money is created in the banking system according to a ‘money multiplier’. In doing this, he stays faithful to supply-side thinking, but veers greatly from almost every other camp, including the mainstream.

I welcome Tamny, a former editor of mine at Forbes and a good friend, into this debate. If the ideas he’s attacking can withstand the attack, then they’ll be stronger for having been challenged. If not, then good riddance to them. The theoretical foundations of the money multiplier are in need of a shaking up. So is monetarism. The Fed quadrupled monetary base in response to the Great Recession, and many commentators called for imminent spikes of high, perhaps even hyper, inflation.

Since early 2010 I, myself, have been a short-term inflation dove (but long-term inflation hawk) because I had  concluded that financial over-regulation and the European debt crisis would cause money to be hoarded both domestically and abroad, and that inflation would tarry until those issues had resolved themselves.  This put me at odds with many of the most highly visible Austrians and monetarists, many of who have been veritable Chickens Little clucking about imminent hyper-inflation. This has given ammunition to left-of-center critics such as Paul Krugman.

Tamny’s answer as to why exploding led balance sheets have not led to exploding price inflation is that the Fed cannot create money and therefore quadrupling its balance sheet does not cause inflation.

I think the Austrian answer would be that the Fed cannot create money by itself, but that it needs banks and their money multiplier to do so. For Rothbard and his acolytes, this process is akin to counterfeiting and should be illegal because it is a form of fraud. To tolerate fractional reserve banking is to invite exploding inflation. The milder form of this view comes from monetarists who favor higher capital requirements for banks to reign in the money multiplier.

But what about the natural brakes on the multiplier? Banks don’t just lend ad infinitum: There are many nations in the world which do not place any reserve requirements on their banks. What prevents them from infinite money multiplication? Answer: Incentives. If bankers over-lend, they will end up lending to those who are unlikely to repay. Banks end up eating the loss…or at least suffering the humiliation of bail-out and Federal takeover.

One of the key issues goes back to a debate about what this stuff called M2, quasi-money which results from the money multiplier actually is. For supply-siders, these deposits are called credit. For Austrians, they are called money. But although this argument has a semantic aspect, there are more than semantics at issue: there’s a methodological difference.

Austrians tends to focus on theory: definitions of words, deductive processes of reasoning. Tamny comes at this as a financial journalist first and a theoretician second. He sees a world in which the Fed has exploded its balance sheet without seeming to have made much difference. He sees a world in which most business lending is done outside of the world of banks and their fractional reserve powers of multiplication. He sees a world in which credit seems quite difficult to get, even though the Fed has embarked on ‘easy money’ policies. And if reality doesn’t square with the traditional theories, even of allies, then so much the worse for the theories.

When I asked Tamny in a recent interview where debasement does come from (if not from the Fed) he acknowledged that he really doesn’t have a firm answer, and called for the thinkers of the various schools to get together and hash that question out. I think that would be a good idea. What I’ve always loved about supply-side thinking is its willingness to look at the world as it is and learn economics from the economy instead of from economists. On the other hand, what I’ve always loved about Austrian economics is that it sees economics as the science of human action, which potentially makes it highly adaptable. If economics is big enough to include all the ways people try to get what they want, then its theoretical limits are as unconstrained as the variety of human wants and means. This makes Austrian theory expandable enough to include anything which we economists can observe.

Tamny has revived moribund monetary theory debates between supply siders and Austrians of yore by once again taking up the supply side arguments against money multipliers. By doing so he has done all the camps a service by shaking things up enough to create an opportunity for all of us to improve our thinking.

I sat down across a Skype line with Tamny recently to talk about Who Needs the Fed?, what supply-siders can learn from the working class revolt which swept Trump into office, and a few other topics. You can listen to the interview here.

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“Money, as money, satisfies no want; it’s worth to any one, consists in its being a convenient shape in which to receive his incomings of all sorts.” – John Stuart Mill, Principles of Political Economy

Daily Telegraph columnist Jeremy Warner has concluded that the euro has “destroyed” Europe. It’s when journalists write about currencies that one wishes Adam Smith, David Ricardo and John Stuart Mill (to name three) were still around to relieve them of their confusion.
Currencies don’t “destroy” a country or continent simply because currencies quite simply are. They’re a measure. Nothing else. As Mill long ago put it, they materialized thanks to “the want of a common measure for values of different sorts.” I’ve got bread, but I want the vintner’s wine. The problem is that the vintner has no interest in my bread, though he lusts for the butcher’s meat. Money is the “common language” that allows those three producers of different goods to trade with one another despite wants that are the opposite of coincident. We produce so that we can get money, but in truth, we produce so that we can get all that we don’t have.

Thinking about so-called “money supply,” it’s logically abundant where there’s lots of production, and scarce where there’s very little economic activity. Money is the proverbial “ticket” that can be exchanged for everything else, so it makes sense that tickets are in copious supply wherever the rich and economically productive are, and then it similarly makes sense that there’s always a “shortage” of tickets wherever the unproductive hang their hats. Applied to Warner’s London, Chelsea, South Kensington and Belgravia rarely have a “Pound supply” problem, but Brixton, Hackney and Peckham nearly always do.

What needs to be stressed here is that “money supply” is merely an effect of productive economic activity, not a driver of it. To see why, Warner need only consider a theoretical attempt by the Bank of England to stimulate lending in Dagenham, a relatively poor (by London standards at least…) part of city. The central bank would buy bonds from banks there, suddenly banks in Dagenham would have lots of Pounds to lend, but they would exit the downtrodden area between breakfast and lunch. Banks don’t long stay in business by making loans to people and business who lack the means to pay them back. In that case, a Pound supply “increase” in Dagenham in the morning would be in Mayfair by the afternoon.

The Dagenham example is a reminder that when central banks naively seek to stimulate economic growth, they do no such thing. Money always and everywhere goes to where it’s treated well. Central banks can’t alter this reality despite the wishes of a discredited economics profession. Attempts to boost money supply in economically weak areas will always fail, while at the same time well-to-areas don’t need central bank “ease” to begin with. Savers are lined up trying to direct their wealth toward those with the means to pay monies borrowed back. The economically productive quite simply don’t need the very central banks that similarly can’t help those who aren’t productive.

That’s what’s so comical about Warner’s assertion that what little European growth there is exists thanks to “the drip feed of central bank money printing.” Really? How? Economic growth springs from talent being matched with capital on the way to production. If we then accept Warner’s gross oversimplification of ECB policy as “money printing,” why on earth would the latter drive economic growth?

Implicit in “money printing” is a devaluation of the euro that would logically slow investment. Investors buy future currency income streams when they invest, which tells us that printing (usually an explicit attempt by monetary authorities to devalue a currency) would be an investment deterrent. Warner might reply that the printing would stimulate buying, but the latter isn’t growth. If buying or consumption were the same as growth, policy for the Pound, dollar and euro would be heavily accented toward constant devaluation to reduce any incentive to save. We would all be very poor since wealth always and everywhere results from saving. Devaluation mocks the saver while rewarding the prodigal at which point growth capital is scarce. Somehow Warner thinks devaluation powers growth.

Of course, all this speaks to the obvious problem with Warner’s rather confused argument. A currency on its own could never “destroy” anything, and certainly not a continent. At the same time, bad currency policy can weaken a country or a continent. When money floats in value it’s less reliable as a measure meant to foster trade and investment. To blame a currency itself for a country or continent’s problems is the equivalent of a short person blaming a foot ruler for his diminutive stature. Money’s not the problem, but floating money whereby the measure deprives an economy of a common language can surely cause problems. Warner doesn’t touch on this.

Instead, he blames the euro for creating a situation in which “economies were growing apart, not together.” Warner believes the lack of harmonic growth indicts the euro since the European states that utilize the currency have not been growing “richer together.” Yet that was never the purpose of the euro, at least not to the mildly sentient.

England has a common currency in the Pound, but has this equalized growth in England? No, and it’s obvious why it hasn’t. Money is once again an effect of economic growth, not a driver of it. It’s only a measure. Pounds are once again plentiful in England where economic activity is frenzied, and scarce where it isn’t. Implicit in Warner’s argument is that money is wealth. No. Money, per Adam Smith has one purpose only: to help circulate “consumable goods.” Wealth is what we create. Money is what we use to facilitate the exchange of the wealth we create. Nothing more.

Applied to the U.S., we have a common dollar across 50 different states with very different tax and fiscal policies. But has the dollar lifted West Virginia, Mississippi and Louisiana up to the economic level of California, Texas and New York? Obviously not. Money is not magic. Neither is currency union. All a currency can do – and this is a good thing – is facilitate trade and investment among producers, consumers, savers and entrepreneurs.

Warner’s belief that the euro has “destroyed” Europe simply speaks to his confusion about what money is. It’s the equivalent of a basketball coach fingering foot-rulers that unceasingly measure 12 inches as the reason his team of 5’7″ players consistently lose. But the foot ruler is merely a measure confirming reality. So is money. Where production is abundant, so is money, where production is light, money is once again scarce.

If the euro has a weakness, it has to do with the fact that it floats. This deprives it of its sole purpose as a measure. Worse, all global currencies still maintain at least a vague peg to the dollar. Since 2001 the dollar has weakened substantially, and while the euro is up on the dollar since ’01, the latter masks the bigger truth that both currencies have lost a lot of value since in the 21st century. The much higher price of gold measured in both currencies since 2001 represents the clearest evidence of broad currency weakness. This has predictably reduced investment in both the U.S. and Europe with predictably sluggish consequences.

So yes, Europe has a problem, but it’s not the euro itself. The problem is euro policy, along with all manner of government barriers to growth in Europe more broadly. For Warner to blame the euro itself for Europe’s woes is the equivalent of a portly person yelling at the scale.

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CASH is one of mankind’s greatest inventions; a vast improvement, one would imagine, on carting around sheep or bales of hay. Despite the proliferation of other forms of payment, cash retains qualities that alternative methods cannot match, including anonymity, instant clearing, universal acceptance and a relatively tech-free mechanism. It can be used even if the power grid goes down or the banks are all hacked. Yet a growing number of economists are now calling for cash to be phased out. Why?

In “The Curse of Cash”, published on August 16th, Kenneth Rogoff makes the case for gradually getting rid of most paper currency. It certainly has benefits, he admits, but these are outweighed by the costs associated with its murky side. Take anonymity. The same virtue that provides the ability to pay for a self-indulgent treat or a naughty service without its appearing on bank records or credit-card statements also allows criminals to fund their activities and tax-dodgers to avoid levies. The record $1.4 trillion circulating outside of banks in dollars alone, mostly in high-denomination bills, might suggest that every four-person American family has $13,600 in $100 bills stashed in a jam jar. That is unlikely. According to Mr Rogoff, the bulk of the rich world’s currency supply is used to facilitate tax evasion and illegal activities such as human trafficking and financing terrorism. A cashless world would also make monetary policy more effective, argue some, including Mr Rogoff, because savers would no longer be able to stuff cash under mattresses in case of negative rates. And as shopkeepers and businesses in relatively cash-light countries such as Sweden are discovering, there are other real benefits to preferring electronic payments over cash, including security, lower costs, hygiene and convenience, for both business and customer.

Moving away from cash would not be without complications. Some objections can be easily dismissed, such as a claim expressed by a fifth of a sample of Germans, who said in a recent survey that they like the feel of carrying cash. But other problems are harder to pooh-pooh. The most intractable are the loss of anonymity and the risk that parts of society will be left out of the financial system, in a world where smartphones and plastic become the only ways to pay. The anonymity problem can in part be solved by retaining smaller notes and coins; enough for punters to keep buying porn, weed and birthday presents, but not so much as to buy property. The point about financial exclusion is trickier. In a near-cashless world vulnerable groups, such as the poor, the elderly and migrants, could become further marginalised, and those who are especially cash-dependent for income, such as churches, charities and the homeless, could expect to see a drop in their incomes. But changes can be made gradually and intelligently, for example by paying benefits on prepaid debit cards and supplying charities with contactless card machines. The switch could in fact increase financial inclusion, by ensuring that the unbanked become banked.

The debate elicits strong reactions; Bild, a German newspaper, recently organised a reader protest against a €5,000 ($5,633) limit on cash transactions. And German academics have argued that banning cash won’t magically end crime and black-market dealings: electronic fraud, cyber-crime and anonymous payments online are easy enough for those with skill and determination. Yet as countries in the rich world grow increasingly detached from cash, with some shops and cafes flat-out refusing to accept the stuff, economists can already see early evidence of the benefits of going cashless—as well as the relatively painless nature of the transition.

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Harry Dexter White was one of the chief architects of the Bretton Woods system, indeed the person most responsible for the conference itself. All throughout World War II, it was White working at Treasury directly under Secretary Morgenthau who set up all the predicate conditions for the dollar achieving global currency status. He argued that American servicemen should use the dollar and only the dollar as they spread across the globe, overvaluing each local currency so that local populations might find nothing but tradition to block acceptance of the US dollar upon its arrival. For the Axis countries, there was to be only a dollar until such time as they had been politically transformed likely long after the war was over.

White had completed a draft plan for the postwar monetary world in March 1942. It was revised and “polished” before being presented to Secretary Morgenthau on May 8 of that year. In his letter to the Secretary, he gave equal treatment to the specifics of his intended arrangements but was careful to note that none of it would do any good if it were to languish within politics. In other words, what he wanted done would have to be subordinated for a time to how it could get done. To White, the only way forward was an international monetary conference.
To even get that far, however, Treasury had domestic American politics to overcome. There was some debate as to protocol: should Morgenthau go directly to President Roosevelt with the idea, or approach Secretary of State Cordell Hull first. Having sat in that office for almost a decade by then, Secretary Hull was not accustomed to being circumvented. When asked his thoughts on how to proceed, White apparently said, “hit them both at the same time”, meaning to inform FDR and Secretary Hull simultaneously.

Morgenthau ultimately decided to deliver his policy draft to the President first, to which FDR responded (as Morgenthau predicted) in seeking Hull’s input. From the President’s perspective, this could not be only a Treasury idea as it would have to have significant development and ownership among State, the Federal Reserve, and even the Board of Economic Warfare.

According to the book, The Battle of Bretton Woods by Benn Steil, the first meeting to address the postwar monetary paradigm was held on May 25, 1942, and it did not go well from the start. State’s representatives at the meeting Leo Pasvolsky and Herbert Feis argued matters of protocol and turf, forcing Morgenthau to the position that rivalry was the chief danger. He responded by holding another meeting only with more friendly faces (to Treasury’s side). Among them was a White House economist, indeed the first ever White House economist, Lauchlin Currie.

Morgenthau’s invitation to Currie was particularly blunt, asking him directly, “want to get in a fight?” The Treasury Secretary told the economist that he was convinced the State Department was already against the conference because, “we’ve got an idea and State hasn’t, and they don’t want anybody else to have any ideas.”

Lauchlin Currie had ended up at the White House via Harvard and a series of policy papers and a book all published in the first half of the 1930’s. His ideas were set widely against prevailing opinion, even at such a “conservative” institution as Harvard was in those days. In a January 1932 memo, Currie, along with co-authors Paul Theodore Ellsworth (who was best known for pioneering what would become the IS-LM framework of understanding Keynes’ General Theory concepts) and, who else, Harry Dexter White, advocated “vigorous” open market operations at the Federal Reserve to expand the level of bank reserves. Even that was deemed by the authors likely insufficient to get the US out of the depression, so in addition Currie, White, and Ellsworth advocated aggressive fiscal action to go with it.

Beginning in 1933, Currie wrote several articles and in several publications that further clarified his expansionary positions, including the great monetary distinction between money and credit. He wrote in 1934, “The merit of the proposal here set forth lies, in the writer’s view, in the fact that it divorces the supply of money from the loaning of money.” From that he accused the modern (as separate from the classical) version of economics at that time for confusing money and credit via what he called “an historical accident.”

In his 1933 article Money, Gold, and Incomes in the United States, Currie, a devoted follower of quantity theory, computed the first velocity variable not of transactions or money, but rather from national income. He argued that monetary control should be literal, and that only credit is left to banking. That led to his 1934 book The Supply and Control of Money in the United States where Currie theorized an ideal, as he saw it, monetary regime for the American system. Because the government was, in his view, responsible for the depression due to “almost complete passivity and quiescence” that somehow led him to believe the monetary answer lay in total government control. It wasn’t the government so much he objected to, rather the impeded and constrained government.

Shared in conjunction with Harry White, both of them at the time working at the US Treasury, Currie demanded that only government should control the quantity of all money and close money substitutes including demand deposits. He envisioned a government agency or several agencies that would all across the land buy and sell government securities in order to “precisely” expand and contract the level of deposits. Currie believed this was nothing like nationalizing the banking system because, again, money and credit were and are separate; only the functioning money supply within banking would be nationalized leaving banking otherwise undisturbed.

He correctly envisioned that most objections to his ideal system would be political, a fact that was realized in the New Deal era more than anyone might have imagined. But it also opened tremendous opportunity for those who saw the chaos as an opportunity not to be wasted. Currie would get his chance in 1934 after catching the attention of Marriner Eccles. When Eccles ascended to the Chair of the Federal Reserve Board, he brought Currie with him as his private secretary. That position at exactly that time in history allowed him to essentially draft the Banking Act of 1935 that set out the modern Federal Reserve System; which is why you can see Ben Bernanke/Janet Yellen in the positions he advocated seven decades before they did.

In a speech given by then-Chairman Bernanke to the Fourth ECB Central Banking Conference in November 2006, the Fed Chair noted the durability of a good part of Currie’s emphasis in modern monetary policy:

“In any case, the Federal Reserve began to pay more attention to money in the latter part of the 1930s. Central to these efforts was the Harvard economist Lauchlin Currie, whose 1934 treatise, The Supply and Control of Money in the United States, was among the first to provide a practical empirical definition of money. His definition, which included currency and demand deposits, corresponded closely to what we now call M1. Currie argued that collection of monetary data was necessary for the Federal Reserve to control the money supply, which in turn would facilitate the stabilization of the price level and of the economy more generally.”

With Currie’s contributions, as Bernanke credited, the Federal Reserve began in 1939 its first serious project on quantifying money and monetary statistics. By 1943, around the time White and Currie were reuniting to plan out what would become Bretton Woods (actually what would become the political battle over the plan deciding how the conference for the planning for Bretton Woods would go), the Federal Reserve published its first catalog on money and banking statistics.

Though measurement was a primary issue in the “ideal” monetary policy, there was just as much emphasis on politics. Currie often asked some variation of the question, “what good is precision if there is no legal authority or political will to use it?”

A good part of the Banking Act was devoted to politics by necessity. The Federal Reserve is solely an institution of Congress; it is not in the Constitution. By definition, the Fed is political. One of the causes he identified of the Great Depression was that, “America possesses one of the poorest, if not the poorest, monetary system of any great country.” It did not act as a “maladjustment-compensating factor” but rather a “maladjustment-intensifying factor” because of its contradictions. Currie identified, correctly, the hybrid system of, “the compromise of private creation of money with government control.” In his view, this vital and basic power must not be shared; therefore he had it destined to the enlightened few of “independent” government rather than the “imprecision” of the marketplace.

Up until that time, the Federal Reserve Act had given the Federal Reserve the mission to “accommodate the monetary and credit needs of commerce, agriculture, and industry.” Rather than a powerful institution of control and prestige, the central bank was a backwater instrument of the 19th century mechanics. Currie, along with Eccles, felt it necessary to deliver a broader mandate that would be specific enough to leave out political influence. Eccles wanted the Fed’s mandate changed to, “promote business stability and moderate fluctuations in production, employment, and prices.” In other words, he, like Currie, wanted the Fed out of the business of running nothing more than the seasonal flow of money from NYC to the interior and back again and into the business of running the whole economy (and doing so from only DC rather than in 12 districts).

Ironically, Currie and Eccles believed that this new mandate would, “resist political pressure for the use of its [the Fed’s] authority for purposes inconsistent with the maintenance of stability.” Currie expressly explained that such a mandate would actually strengthen the Fed since every Board action would be evaluated and judged by this objective; any attempt to interject partisanship into the monetary and economic affairs of the Fed would lead to impeachment of any Board member attempting it.

The new mandate did not, however, make it into the 1935 Act because of the strong objections from Senator Glass (despite, ironically, the heavy backing from Congressman Steagall). Senator Glass charged the mandate, “did violence to Jefferson democracy, since the effect of the change would be to give the central government too much power.” Senator Glass was right but also wrong, however, as Currie and Eccles were correct in that “too much power” would not be vested in the “central government” but in the independent body of the Federal Reserve Board – just as they wanted it. Glass was right only about what would be given not where it would be given.

None of Currie, White, nor Eccles were thinking about any of this in terms of power, specifically, but rather precision. They believed total government control over the money supply would lead to stability of credit and banking in the marketplace. That would further deliver stability in prices and overall economy. And to do it, they would in parallel design the new “science” of monetarism and quantity theory.

As anyone with any basic, common sense engineering knows, any system so deliberate with such raw inflexibility is destined to operate successfully only within the narrowest of tolerances. Deviate just that much and there is no incorporated ability to adapt. The whole arrangement would follow upon only one factor; that by politics and by economic “science”, the economy would only be stable if economists were right in both economics and now “their” money. It was a possibility none of them ever contemplated, enshrined in the basis for the Banking Act of 1935, further augmented in the Treasury-Fed pact of 1951, that shifted the Fed permanently toward economic management. As Eccles wrote in 1937,

“The economics of the system as a whole differ profoundly from the economics of the individual; that what is economically wise behavior on part of a single individual may on occasion be suicidal if engaged in by all individuals collectively; that the income of the nation is but the counterpart of the expenditures of the nation. If we all restrict our expenditures, this means restricting our incomes, which in turn is followed by further restrictions in expenditures.”

The Fed would be thus ever forward devoted to socialism (small “s”). Further, the Fed would also be not merely Platonic in its aims for the perfect economic republic, stripped by legal right of politics so that it could be empowered into perfect science and precision, it would be god-like in its execution and delivery; it would have to be. The one thing missing from all of this is anyone, other than Senator Glass, asking, “what if we are wrong?”

The system they envisioned did not permit such flexibility, a fact that Bretton Woods was forced to confront from its earliest days. Convention assigns 1971 as the end of it, but in reality the US defaulted on its gold obligations eleven years before in the creation of the London Gold Pool. The origins of the eurodollar itself around 1955 was due almost entirely to the cracks in the global reserve system that neither Currie nor White ever foresaw. Theirs was a static system of perfect knowledge somehow supposed to be applicable through all time despite the constant change and innovation all around everywhere.

Furthermore, these enlightened few never seem to grasp that inflexible systems only become more inflexible as they are challenged; and they are always challenged. It seems a blindspot always attached to centralized socialism that human nature can be perfectly expressed as if these great scientists will respond in purely scientific fashion and correctly to each trial; it is more than the pretense of knowledge, it is the pretense that socialists actually seek only knowledge rather than power.

Indeed, as Ben Bernanke himself noted in that same 2006 speech, though Currie and White were long gone (both accused of being Communists, though it isn’t clear whether either ever was) M1 was too well before Nixon slammed the gold window shut:

“However, during the 1960s and 1970s, as researchers and policymakers struggled to understand the sharp increase in inflation, the view that nominal aggregates (including credit as well as monetary aggregates) are closely linked to spending growth and inflation gained ground. In 1966, the Federal Open Market Committee (FOMC) began to add a proviso to its policy directives that bank credit growth should not deviate significantly from projections; a similar proviso about money growth was added in 1970. In 1974, the FOMC began to specify “ranges of tolerance” for the growth of M1 and for the broader M2 monetary aggregate over the period that extended to the next meeting of the Committee.”

So much for precision. Congress responded in 1977 by amending the Federal Reserve Act to direct the Federal Reserve to “maintain long run growth of monetary and credit aggregates…so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” Though it echoes Currie’s Depression-era recommendations as far as the socialism of the Fed, it defiles the manner in which he suggested it be done. Credit and money were now lumped together in, as Bernanke and modern economists call them, “aggregates”; thus stripping modern monetarism from its necessary nuance, the only matter that actually explained both the rise and fall of the economy before and after the Great Crash. Currie in the 1930’s foresaw a permanent institution dedicated to precise handling; the Fed by the 1960’s and the 1970’s rather didn’t care anymore about such exactitude, operating more so on a standard of “good enough.”

That was once again the standard by which these economists in the 1930’s were initially seeking to overcome. Currie has observed that one of the most pernicious feedbacks of the Great Depression collapse was in the quest for liquidity itself. Writing, “One of the most disastrous developments in the whole depression was the scramble for liquidity on the part of thousands of individual banks and by their very scramble effectively precluding the possibility of liquidity”, he correctly observed the modern notion of liquidity; it isn’t contained in the monetary “aggregates” of money stock but in the action of individual financial actors to either supply it or deny it. Liquidity is an action that lies beyond any of the M’s.

This process does not just apply in the simple monetary factors of the Depression era; in fact, this was again observed in 2007 and 2008 in many other places that the inflexible, independent Fed never bothered to look. From credit default swaps to repo collateral, liquidity was impaired in such a way that no matter what mainstream or “extraordinary” policy the Federal Reserve undertook it made no difference whatsoever. The Fed failed on every count because it was institutionally incapable of success in any world except one that remains static for all history; “good enough” wasn’t even close.

Princeton economist Stephen Goldfeld deemed the monetary mystery of the Great Inflation the case of the “missing money.” As noted above, the Congressional power under the 1977 amendment to the Federal Reserve Act amounted to nothing because the adoption of targeting “aggregates” was not in any way an actual constraint, mostly because the economy is not obliged by monetary policy targets in the way that monetary theory believed. That statutory regime change was not imposed upon the monetary scientists at the Fed; far from it, the political influence was originated by them to tie more into their control. They never bothered to ask, “what if we are wrong?”

The stagflation of that period left no mistake about that question. In a way, that shows just how much better the 1970’s were than the 2010’s (actually the whole of the 21st century). It is often said and written that though we might experience stagnation now, it is at least absent the huge consumer price increases of the “missing money” age. This is false; the declaration simply assumes that the stagnation portion is equal between now and then, leaving the lack of “inflation” now the deciding factor. The stagnation we currently experience is far more nefarious and challenging, leaving the economy far worse off not just in outlook but more so in how to get out of it.

In the 1970’s, there was no argument as to what was wrong; that much was clear. Debate centered on how to stop inflation, not whether there was inflation in the first place. In the 2010’s, economists won’t even admit there is a problem, and spend all their time and effort trying to convince everyone that there isn’t. By every economic measure, the economy now is far, far worse than even the worst of the Great Inflation in the late 1970’s. From GDP to individual economic accounts, including the labor statistics, there is every reason to want to go back to the 1970’s than stay here. From cyclical peak to cyclical peak, 1973 to 1980, the BLS’ index of total hours worked increased by 12.1%, or 1.93% annualized. From 2007 to the latest update for Q1 2016, total hours worked barely increased at all, up just 1.31% total, or 0.15% annualized.

There may have been inflation at that time to erode wages and wreak downstream economic havoc, but at least the economy was producing at its most basic level. In this economy, the lack of basic production is taken for success by economists that are so inflexible that they force themselves to see the world entirely upside down. Monetary independence was never a virtue, it was the removal of all accountability as is the common theme of all socialism. When a small group of people are handed the unshakable ability to determine what is “good for you” it isn’t long before they determine everything they do is “good for you” even if they have to alter the standards for judgment. They couldn’t do it in the 1970’s, but now they can because the depth of disorder is more opaque and complex, reflective of the evolution of money itself.

Lauchlin Currie and Harry Dexter White saw the inherent flaw in a hybrid monetary system, part government control, part marketplace genesis, and determined to resolve it by imposing total government. What they actually did was foist a narrowed gaze upon the government agencies that believed in the socialist principle. All monetary policy from that time until now has been spent on “proving” its preconceptions about what it could do rather than asking the only relevant question, “what if we are wrong?”

Only once in recent history did the Fed actually confront such doubt, in June 2003, but only for the briefest of moments. As Bernanke’s speech just three years later showed, such doubt never lingered; his major theme was to suggest that monetary policy had learned from all its mistakes and the constant change. That obviously wasn’t true, proved beyond all doubt just nine months later, and still isn’t to this day; all the FOMC learned was that no matter how much it fails time and again, and how much words are warped beyond all actual meaning (recovery, money, stimulus), political independence is all that ever mattered or ever will. Not for the economy, of course, but the socialist principle that people can’t ever be trusted with it even if the central bank regularly removes a decade or two of healthy progress. And it didn’t even prevent another crash.

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