One of the Republican candidate’s favorite whipping boys is Ben Bernanke, head of the Federal Reserve. They have been accusing him of employing monetary policies that produce inflation. But it turns out, inflation rates continue to be low:
Bernanke didn’t need to rebut his critics; the facts already have. Earlier Wednesday, the Fed reported that expectations are inflation will remain between 1.4 percent and 1.8 percent for 2012 and between 1.5 percent and 2 percent through 2014. The exceptionally low inflation rate proves false the complaints about Bernanke’s aggressive — and successful — actions to avert an economic depression after the 2008 financial crisis.
Former candidate Rick Perry has been the worst of the critics, calling Bernanke’s behavior “almost treasonous” and declaring that Bernanke would face an “ugly” greeting in Texas if he injected more monetary stimulus into the economy. “It’s a travesty that young people in America are seeing their dollars devalued,” Perry complained.
Newt Gingrich called Bernanke “the most inflationary, dangerous and power-centered chairman of the Fed in the history of the Fed.” Ron Paul accused Bernanke of “inflating twice as fast as Greenspan.” Mitt Romney joined the others in saying he wouldn’t reappoint Bernanke, who was first appointed by President George W. Bush.
On Wednesday, Bernanke allowed himself just a passing reference to such critics. “The low level of inflation is a validation,” he said. “There are some who were very concerned that our balance-sheet policies and the like would lead to high inflation. There’s certainly no sign of that yet.”
via Ben Bernanke smiles in the face of critics – The Washington Post.
Could someone explain Ron Paul’s and Newt Gingrich’s criticism of the Federal Reserve? My understanding is that Paul is against the institution on principle–what’s the principle? The need to go back to the gold standard? Is that feasible?
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I have exactly the same questions and look forward to the answers. Additional questions I have:
1. What are the advantages of our current monetary system (assuming the federal government could control its spending)?
2. What are the downsides of the gold standard?
Dr. Veith – Unfortunately, the question you ask is brought up in internet chat on a regular basis, but providing the historical, theoretical, and even moral arguments for abandoning the fiat money system we currently have is not a trivial matter. It is one better suited for a series of rather lengthy posts, examples, and ensuing discussion.
The case against the Federal Reserve system, or rather central banking in general, can be argued from a variety of points, each of which brings up other points. Probably the best I can do is point to a variety of sources that look at the problem of central banking from a critical standpoint. These are the sources for Paul’s stance. I can’t really speak to Gingrich’s viewpoints – he might be a “greenbacker” for all I know.
Anyhow, almost all of the criticism is based on books by dead white Europeans, mostly gentlemen from Austria, hence Austrian School. Before you go dismissing them since Austria is a small, out of the way country in central Europe, that isn’t the Austria these men knew and grew up in; it was the Austro-Hungarian Empire and it stretched across much of central, southern and eastern Europe. Ludwig von Mises, for example, perhaps the quintessential Austrian was born in what is now Lvov, Ukraine.
So here are a few references, most of which you can still find that lay out the basics:
von Mises, Ludwig. The Theory of Money and Credit. Everyone always says Hayek’s Road to Serfdom is the Austrian/libertarian guidebook. It isn’t. It’s generally Mises’ Money or his magnum opus Human Action. Specifically for the Fed, the grounding of the main criticisms are in Money. Mises is often derided as being “too theoretical” and out of touch with day-to-day economic reality. Not so. Before being forced to flee the Nazis, Mises worked mainly as the Chief Economist for the Austrian Chamber of Commerce.
Just prior to von Mises, was Eugen Bohm-Bawerk, who wrote a very, very good book Capital and Interest. As another aside – he was from Brno and was the Austro-Hungarian Minister of Finance just prior to WWI. His treatise provided one of the main pillars of argument against central banking, but more so against fiat banking. Bohm-Bawerk’s work introduced the concept of money (really credit) induced “malinvestment” – what we have seen manifested in the dot.com bubble, the Y2K bubble, the housing bubble, etc. All of these are not isolated events, but part of the same process – the active manipulation of interest rates by central banks.
Right about the same time as Bohm-Bawerk and the young Mises was the Swedish economist, Knut Wicksell. Wicksell also articulated how intervention in interest rates (usually through monetary policy) leads to overhangs and distortions – akin to malinvestment along with asset classes (such as real estate) being overvalued. [In short this is the rejoinder to Bernanke - he's been pumping enough money into the economy to maintain a 2% rise in overall prices when prices should be adjusting downward - we've got a lot of overvalued asset classes that are being prevented from adjusting to their market clearing prices. A good example is gas prices. Adjusted for inflation, we're paying about the same price as we did 20 or 30 or 40 years ago. But, we've expanded production of oil enormously over that same time frame, gotten far more efficient in our capital equipment, etc. we should have seen falling prices, not $3.50/gallon gasoline.]
From Hayek, we get Prices and Production if you can find it. Actually, a very good modern take on Hayek, monetary policy and contrasting it with Keynesian banking (Bernanke-style banking) is Time and Money by Roger Garrison. A fairly dense book, but he does an excellent job of laying out the differences between the Austrians (specifically Hayek) and Keynes and how these differences play out in the actual economy. I’ve used this in truncated form in teaching undergrad econ courses, and the students really seem to follow it pretty well as he uses a very simple theoretical structure. He also has some cheesy Power Points that illustrate these concepts pretty well, also. Find them here: http://www.auburn.edu/~garriro/
This video both humorously and cogently describes the differences between Hayekian (Austrian) theory and Bernanke/Keynes: http://www.youtube.com/watch?v=d0nERTFo-Sk .
At this point I’ll trot out my usual comment in these debates, which is that Keynesian economics and Austrian economics are not the only “Capitalist” schools out there.
There are also the Ordoliberals – which are the ones with the best track record, a real proven solution. But they don’t have chat rooms, they don’t have sexy simplistic solutions that appeal to hipsters, or moguls, or simple-minded politicians.
And even reading a basic introduction will take a good hour or so out of your day. But here goes anyway:
http://www.econstor.eu/bitstream/10419/4343/1/04_11bw.pdf
Call them the Freiburg school, if you wish.
In a nutshell, the argument against the Fed is that the government can, and does, use it to remove the value from our bank accounts via inflation. Gold obviously cannot be easily manufactured (though friends of mine from Los Alamos told me you at least theoretically could do it at great expense), so it acts as a brake on inflation.
The rest of the argument is that the Fed, through its inflationary-pro-debt policies, actually creates our economic crises.
The argument against gold is effectively the same; the Keynesians argue that you WANT government to be able to inflate the currency to manipulate the economy. They just deny the effects the Austrians note.
always worth the watch:
http://www.youtube.com/watch?v=d0nERTFo-Sk
Klasie @ 3 – the closest American version of the Ordo’s are probably the Public Choice theorists like Gordon Tullock and James Buchanan. They get pretty good traffic on Austrian-flavored blogs. There are also the followers of Henry George. George was right on about 95% of what he wrote, but got a little weird with his views on land and land ownership.
With the gold standard, money in the economy had to be backed by gold, which limited the amount of money in the economy. There are those, like Keynes, who saw the lack of money in the economy as a significant problem that needed to be addressed in a down economy. He was against the gold standard and as the previous poster alluded to, believed one could manipulate the economy to keep it stable.
The gold standard is not the only option. There’s been some fierce debates in the past about including silver. Look up bimetallism. William Jennings Bryan was quite passionate in his condemnation of the gold-only standard in his Cross of Gold speech.
There are some who suggest having a Commodity Basket Standard. Here’s a recent article about that subject: http://www.forbes.com/sites/nathanlewis/2012/01/26/does-a-commodity-basket-standard-measure-up-to-gold/
Good point, Seth. Paul, et al, often get labeled as “gold bugs” or worse. Now, to be fair, Paul is for a commodity-based money system, but he doesn’t hold to any one commodity. Historically, money has settled on either a gold or silver basis; Paul is simply saying “let the market decide” what it wants to use as the commodity basis. Hayek actually thought the commodity basket might be a reasonable money. The importance is allowing for competition in both the type of commodities potentially used as money and in the form of that money.
I should say here, that this brings up the issue of fractional reserve banking – one of the other strident critiques of the modern banking system, as it allows expansive credit creation and interest rate manipulation. While some hyper-Austrians call for the abolishment of fractional reserve banking as fraudulent, others (like Garrison who I referred to in a post above) think that fractional reserve banking should be allowed, but it needs to be made riskier – not virtually risk-free as it is now. People need to understand that they may lose their money, and banks need to then be more prudent in their fractional lending standards,while competing for loanable funds by providing potential bank account holders with higher interest rates. Standard bank accounts would actually be 100% reserve banks – what you put in is what you get, but you pay an effective storage and service fee to the bank, which is the bank’s operating margin.
To SKP (#8) “Standard bank accounts would actually be 100% reserve banks – what you put in is what you get, but you pay an effective storage and service fee to the bank, which is the bank’s operating margin.”
Recently, I encountered a situation which seems to fall under this premise. My mother’s bank account (of which I am the designated administrator) was accessed a “non-usage” fee; apparently, the bank was uncomfortable with simply having the funds at their disposal. If the account showed no transactions over a given period of time, this fee was accessed.
Needless to say (redundant – but relative) I immediately enacted a transaction on the account. I closed the account immediately. Am I understanding this concept correctly for I would not be inclined to give you my money and have you charge me for the privilege of holding the monies?
Pax,
Dennis
Not to start another thread, but let’s explore the idea that there has not been inflation. It is already here in some areas (groceries for instance) but it is largely hidden.
For example, the price of a box of cereal has not gone up, but the size of the box has gotten smaller. I have noticed this with many items. Thus, the unit price of the cereal has increased. Of course, the core inflation index excludes groceries.
I always like to see what David Merkel has to say on these things.
http://alephblog.com/2012/01/26/on-opaque-transparency/
Joe – but that is not a new thing at all.
How about this one: Are we poorer since Nixon went off the gold standard? Before you answer, remember that there are many other variables. The most important one is that globalisation has enabled the blue-collar, lower-middle class section of society to expand across national boundaries in ways it has not done before. The guy who used to live on the (slightly) poorer end of the street, and work with his hands in the factory, now lives across the Pacific Ocean, and works with his/her hands in the factory. IE, not wealth erosion, but a lack of wealth containment. Factor that in, and you’ll see that the fears of the gold bugs have harldy been justified. Now, that is just an idndictment of one end of the Austrian school (I think that is the Rothbard end), and not all of them.
As an example, Krugman justly indictes Mitch Daniels for a faulty understanding of economics in th latters’ answer to Obama’s SOTU address. Daniels praised Jobs, and attacked “interventionism”. But the most successfull economic policy of late, ironically, was the Auto bailout (yes, even I was apprehensive abpout that one), because it saved Industrial clusters (and thus many jobs, with the money being paid back very well), while the majority of Apples’ employees, and even more so their “spin-off” employees, sit in China, not the US. See the rest here: http://www.nytimes.com/2012/01/27/opinion/krugman-jobs-jobs-and-cars.html
Economic policy is never simplistic. Most (not all) of the Austrian supporters don’t get that.
@3 Thanks for the link.
KK – I did not say it was new. I said it was happening now – at a time that people are arguing about whether inflation is or is not happening. I am pointing out only that the purchasing power of the dollar is going down but manufacturers are trying to hide it by simply keeping the unit price the same but reducing the amount of product in the unit.
Joe,
You said “For example, the price of a box of cereal has not gone up, but the size of the box has gotten smaller. I have noticed this with many items. Thus, the unit price of the cereal has increased. Of course, the core inflation index excludes groceries.”
Exactly. Many businesses, including the one I work for try to shield their customers from the effects of inflation by gradually decreasing the portion or amount of a particular good in the package, or just offer smaller quantities at the same price.
This is a function of what is called ‘margin compression.’ Businesses realize the consumer is unwilling to pay the higher price demanded by the rising cost of labor or materials so they take a smaller profit in an effort to cushion the blow of inflation. This and the manipulation of the Consumer Price Index by stripping out of it things like food and energy that are quick to show the effects of any inflation, give an appearance of low inflation. In reality we are seeing huge inflation in the things needed in our daily lives, while simultaneously the things that have been historically safe havens for wealth (real estate, stocks etc.) are experiencing deflation and losing value. We are losing on two fronts.
Nonsense, Joe. We’re not experiencing inflation. We’ve never experienced inflation. We’ve always had a booming economy. We’ve always been at war with Eastasia.
More seriously, when costs of goods that are actually necessary for a comprehensive life–food, energy, etc.–are included in such calculations, inflation stands at something like 6 – 8%, and has for the past couple of years. That’s hardly “low” inflation, much less no inflation.
I like the idea of commodity-backed money, but the gold standard seems a bit old-fashioned. Thus, I propose a compromise that should be acceptable to both Keynesians and Austrians: the Rabbit Standard.
Like the gold standard, it’s based on a real, physical thing. At any time, you can trade in your coney-coins for real rabbits. But fear not, Keynesians! Because the physical basis for our money is constantly — and exponentially — increasing. Inflation forever!
Great discussion in this thread — SKP, thanks in particular for your educational comments.
There is no question that the Fed’s policy has been a rampant expansion of money supply. Ultimately, absent a coordinate increase in production, to absorb the excess money, inflation will ultimately occur. I think SKP is right, this has manifested so far in a reported 2% inflation rate when, by rights, we should have seen significant deflation in this economy. Note that real interest rates paid on savings are sharply negative, somewhere between 0 and 1% when the inflation rate is more than 2% — that is not a healthy circumstance. Additionally, wages in the past three years have dropped, while prices have risen. We are accustomed to inflationary conditions, so we have failed to notice that inflation has continued even during a recession, when it should not have. As others have noted, the measures have been manipulated as well, by excluding the “volatile” elements, energy and food, which, in fact, account for a substantial portion of our total economy, and are relatively inelastic — we all must pay for them regardless of their price.
The danger will be what happens to inflation as recovery takes hold. The problem is that the CPI is a lagging indicator and inflationary conditions can occur very quickly. Moreover, once you get into a wage-price spiral, it’s very hard to extricate yourself, as Nixon, Ford, and Carter found out in the 70′s.
Generally speaking there are two important elements I’d like to see in our currency:
1) It’s limited in some way to a fixed stock preventing intentional debasement.
2) When created it is diffusely distributed through the economy.
My problem with the Fed is that it has the power to debase the currency (avoiding whether it has or not). It also has the power to direct currency flows in ways that benefit large financial institutions at the expense of others.
This year, it was decided by someone that the “downturn” was over.
Hence, my rent was increased… we negotiated it down to the exact sum of my raise (except that I have to pay tax on the raise). I lose.
Then, water, electric and gas need increases, all pleading that, since they haven’t raised the rate in several years (much, my water bill doubled in that interval) they need from 12 -20% more.
Not all things can be made smaller: bread prices have doubled, as many other food prices have gone up . Gasoline, we all know about.
Those of us who can’t afford to play the markets (you get better rates and lower fees on $100K) probably have a negative balance on our savings, after taxes.
On this we are supposed to “spend America into prosperity and so reduce unemployment”… oblivious to the fact that most of the jobs are still going overseas!
Tell me how that works, my economic experts!
@Klasie, #12: “Economic policy is never simplistic. Most (not all) of the Austrian supporters don’t get that.”
Austrians are the ONLY economists who seem to get this. The other schools seem to think the market is something they can intervene in without a negative outcome. But the Austrians say “Wait a sec, there are so many things happening in these different sectors, you’re very likely to produce unintended consequences.”
To quote the sequel to that awesome rap video posted above “We want plans by the many, not by the few.”
Exactly. Many businesses, including the one I work for try to shield their customers from the effects of inflation by gradually decreasing the portion or amount of a particular good in the package, or just offer smaller quantities at the same price.
I don’t see that as “shielding customers from the effects of inflation” unless they can reduce their consumption to use the same number of [shrunken] boxe cereals as they did big ones. [In the case of the "pound can" which has gone to 15, 14 or 13.5 ounces, I suppose I do. When it gets down enough, it's one meal instead of two.]
Rather, to be honest, (which “shrinkage” is not) you are shield the consumer, for a brief time from the knowledge of a price increase. Or you think you are! Housewives are not as dumb as all that.
E.g., Hershey has lost me completely as a customer but then Hershey is not bread and milk.
S’cuse the typos!
Dennis @ 9 – Sorry to get back to you so late, been a busy day or two.
As to the storage fee – remember that what we’re dealing with in the theoretical example I brought up is that the money is a commodity – gold, silver, etc and/or money certificates that are claims to the real money. You are paying essentially a simple storage fee to the bank to hold these securely, i.e. this was why banks have vaults and why they often look like fortresses – to keep the assets safe from theft. Now, you could store the money on your own property, but you would undertake the risk fully. Maybe you could get insurance, maybe not, and you’d be the one with far more sleepless nights worrying about your money. The bank assumes much of the risk, is better able to be insured, and you can rest easy knowing your money is safe for only a small annual fee.
As to your mother’s trust account. You did the right thing. That is simply a bank charging fees for holding onto you and your mother’s assets when the account is fully insured (up to $200K). One alternative you could have done is put the money in cd’s – sure it’s a lousy return that doesn’t even beat the inflation rate, but they won’t charge you a “maintenance” fee.
Actually I think Bernanke is no worse than the last guy… but no better, either!
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