“The Road to American Prosperity Cannot be Paved with a Cheap Dollar.”
That's the conclusion offered in an important book by Professors R. Glenn Hubbard, Dean of the Graduate School of Business at Columbia University and Peter Navarro, business professor at the University of California-Irvine: Seeds of Destruction: Why the Path to Economic Ruin Runs Through Washington, and How to Reclaim American Prosperity. Hubbard is a Republican, and, among his many distinguished accomplishments, served as chairman of President Bush's Council of Economic Advisers and is a trusted adviser to presidential aspirant Gov. Mitt Romney. Navarro is a Democrat and a very prominent and well respected public intellectual.
Seeds of Destruction devotes its third chapter to the explaining "Why an Easy-Money Street Is a Dead End" -- and provides an astute critique of how
"the Federal Reserve now is an almost total abandonment of the type of 'rules-based' leadership epitomized by chairmen such as Paul Volcker, who fiercely protected the Fed's independence. Critical to our GDP Growth Drivers analysis, we also show that the Fed has played a key role in exacerbating all four major structural imbalances in our economy with its often ultra-easy money policies and excessive attempts at discretionary 'fine-tuning.'"
Many conservative critiques of the economic disarray in which America finds itself limit themselves to familiar areas of tax and regulatory policy. It is rare enough to find policy makers who are willing to make monetary policy a central focus, rarer still to find those who are willing to advocate for a rules-based system and against cheapening the dollar. To find economists lucid enough to use a quote from country and western singer Toby Keith as the epigram -- "There ain't no right way to do the wrong thing." --to their indictment of "Easy-Money Street" makes this a delightful, as well as significant, contribution to the discourse.
The Gold Standard Now publicly advocates for the classical "rules of the game" that define the gold standard as the optimal monetary rule -- as demonstrated empirically. While not imputing agreement with that proposition to Dean Hubbard, we salute his role in turning the conversation toward a rules-based monetary policy and away from policy that aptly can be termed "discretionary activism."
The Fed changes the measure of money by printing new money. As Lewis E. Lehrman has said, “Money is a measure of value …a “token” which compares the value of all other goods and services in the market.” One dollar in purchasing power in 1971 before President Nixon took us off the gold standard, buys only 15 to 20 cents worth of goods and services today.
Imagine the public outcry if some other standard measures were changed by fiat. Here is a fanciful look into a future where the “Fed model” is used in another realm.
Vladimir Putin apparently passed the stress test. Official results show he won about 65% of the vote in Russia’s presidential election. And no, he did not cry when he faced supporters in Moscow. Those tears caught on camera were caused by very cold air, he says.
Rahul Gandhi appears to have flunked the stress test when his party was crushed the next day in provincial election Uttar Pradesh, the vast state in India’s northeast. Rahul, great-grandson, grandson, and son of Indian prime ministers, had put his prestige on the line but his name was not on the ballot.
In India, Anwar el-Balkimy also failed a stress test. He quit his political leadership position when it was disclosed that instead of being the victim of a vicious beating, he had gone into the hospital for a nose job. “We forced him or more pushed him, to resign from Parliament,” said a party spokesman.
It is to reassure sensitive and suspicious noses that stress tests have become so popular.
As stress tests have moved from the world of medicine to the world of economics, things have gotten complicated. American banks are fighting to limit the data the Federal Reserve releases about the stress tests that have been conducted on them in recent years. And European banks are struggling with stress tests as well.
The tests themselves are designed to build public confidence in the underlying balance sheets of the banks – the Fed having learn from the disasters of 2008 that lack of confidence can quickly lead to lack of cash held by financial institutions. The Fed has made a big deal under chairman Ben Bernanke about its own transparency.
These days, everyone is stressed – overcommitted banks, overweight boomers, overscheduled politicians. It’s understandable. Stress has been described as “the confusion created when one's mind overrides the body's basic desire to choke the living daylights out of some jerk who desperately deserves it”
The deteriorating state of monetary value is contributing to the world’s stress. A realistic administration of stress tests to major world governments would inevitably lead to the kind of dire prognosis given governments in Ireland and Greece.
Maybe it is time to move from prognosis to prescription. Rx: Gold Standard. Sign here, Dr. Bernanke.
Federal Reserve Chairman Ben Bernanke likes to talk about transparency. And it is certainly an improvement to know what the Federal Reserve Governors are thinking, doing, and expecting. Transparent actions, however, does not make them reliable. A Fed prediction of 2 percent inflation does not comfort drivers who see gasoline prices approaching $5 per gallon.
At the end of his Semiannual Monetary Policy Report to the Congress on Wednesday, Bernanke said: “I would like to say a few words about the statement of longer-run goals and policy strategy that the FOMC issued at the conclusion of its January meeting. The statement reaffirms our commitment to our statutory objectives, given to us by the Congress, of price stability and maximum employment. Its purpose is to provide additional transparency and increase the effectiveness of monetary policy. The statement does not imply a change in how the Committee conducts policy.”
Bernanke commented about the growth and inflation targets that the Fed is trying to manage: “Transparency is enhanced by providing greater specificity about our objectives. Because the inflation rate over the longer run is determined primarily by monetary policy, it is feasible and appropriate for the Committee to set a numerical goal for that key variable. The FOMC judges that an inflation rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with its statutory mandate. While maximum employment stands on an equal footing with price stability as an objective of monetary policy, the maximum level of employment in an economy is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market; it is therefore not feasible for any central bank to specify a fixed goal for the longer-run level of employment. However, the Committee can estimate the level of maximum employment and use that estimate to inform policy decisions. In our most recent projections in January, for example, FOMC participants' estimates of the longer-run, normal rate of unemployment had a central tendency of 5.2 to 6.0 percent.”
Statistics are a wonderful thing. Predictive statistics are a very iffy thing. And a drop in unemployment to below 6.0 would indeed be wonderful, but currently very iffy by the Fed’s own estimates. Even to produce transparency, the Fed needs a crystal ball.
Instead of a crystal ball, the Fed might contemplate a bar of gold. Not transparent, but real.
"To entrust to science … more than scientific method can achieve may have deplorable effects." -- Hayek
What if the Federal Reserve consistently gets it wrong?
Consistent wrongness is the verdict on the Fed recently confessed by the Federal Reserve itself.
As Dr. Benn Steil, director of international economics at the Council on Foreign Relations recently wrote, "Why We Can't Believe the Fed," in the Wall Street Journal:
If the Fed has a good handle on where the economy is heading over the next several years, then its pledges of extended low rates and a 2% inflation target imply little risk of its needing to change course and jar the markets. But how good is the Fed's actual track record on predicting the economy?
The Fed studied its own staff's forecasting performance over the period 1986 to 2006. It found that the average root mean squared error—or the deviation from the actual result—for the staff's next-year gross domestic product (GDP) forecasts was 1.34, compared with 1.29 by what the Fed describes as a "large group" of private forecasters. That is, the Fed's predicting performance was worse than that of market-watchers outside the Fed. For next-year CPI forecasts, the error term was 1.03 for Fed staff, and only 0.93 for private forecasters. The Fed's conclusion? In its own words, its "historical forecast errors are large in economic terms."
How about the Fed's longer-term predictions? The Fed started publishing the Board of Governors' and Reserve Banks' three-year forecasts in October 2007. At that time, the GDP growth forecasts among this group of 17 ranged from 2.2% to 2.7%. Actual 2010 GDP growth was 3%, outside the Fed's range.
The Fed forecasters told us that unemployment in 2010 would be in a range between 4.6% and 5%. In fact, it averaged about twice that, or 9.6%. The forecasters further predicted that both Personal Consumption Expenditures inflation (PCE, similar to CPI) and core PCE inflation would be in a range from 1.5% and 2%. The former came in at 1.3% and the latter at 1%, again outside the Fed's range. The Fed's scorecard on its 2007 three-year forecasts: 0 for 4.
In short, the Fed's premise that it can speak with authority about the future is flawed. During the two decades to 2006, its own experts were worse than outside ones in predicting one-year economic data. Since the start of the crisis in 2007, its three-year predictions have been worthless.
This poor track record in practice comes, of course, as no surprise to those who have been paying attention to empirical results rather than grandiose meritocratic pretense.
Hayek, in his Nobel Prize acceptance speech, famously flagged the hubris to which our elites are subject decisively and unsparingly:
"There is as much reason to be apprehensive about the long-run dangers created in a much wider field by the uncritical acceptance of assertions which have the appearance of being scientific as there is with regard to the problems I have just discussed. What I mainly wanted to bring out by the topical illustration is that certainly in my field, but I believe also generally in the sciences of man, what looks superficially like the most scientific procedure is often the most unscientific, and, beyond this, that in these fields there are definite limits to what we can expect science to achieve. This means that to entrust to science — or to deliberate control according to scientific principles — more than scientific method can achieve may have deplorable effects. The progress of the natural sciences in modern times has of course so much exceeded all expectations that any suggestion that there may be some limits to it is bound to arouse suspicion. Especially all those will resist such an insight who have hoped that our increasing power of prediction and control, generally regarded as the characteristic result of scientific advance, applied to the processes of society, would soon enable us to mould society entirely to our liking. It is indeed true that, in contrast to the exhilaration which the discoveries of the physical sciences tend to produce, the insights which we gain from the study of society more often have a dampening effect on our aspirations; and it is perhaps not surprising that the more impetuous younger members of our profession are not always prepared to accept this. Yet the confidence in the unlimited power of science is only too often based on a false belief that the scientific method consists in the application of a ready-made technique, or in imitating the form rather than the substance of scientific procedure, as if one needed only to follow some cooking recipes to solve all social problems. It sometimes almost seems as if the techniques of science were more easily learned than the thinking that shows us what the problems are and how to approach them.
"The conflict between what in its present mood the public expects science to achieve in satisfaction of popular hopes and what is really in its power is a serious matter because, even if the true scientists should all recognize the limitations of what they can do in the field of human affairs, so long as the public expects more there will always be some who will pretend, and perhaps honestly believe, that they can do more to meet popular demands than is really in their power. It is often difficult enough for the expert, and certainly in many instances impossible for the layman, to distinguish between legitimate and illegitimate claims advanced in the name of science."
With all respect due to the Fed's candor and humility in acknowledging its consistently bad predictions (and, consequently, policy measures taken upon the basis of those predictions) it is time for a more fundamental distinction to be made by policy makers "between legitimate and illegitimate claims advanced in the name of science." It is time for a restoration of a monetary policy based not upon the acknowledged flawed discernment of elite civil servants but upon convertibility of currency to a defined weight of gold.
As Lehrman Institute founder and chairman Lewis E. Lehrman recently summed it up: "The gold standard is a modern, digital, information-sharing, global operating standard. Moreover, it is a stable, networking, efficient, price transmission system in the form of a stable international monetary standard."