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Imagine a world without monetary policy

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Published : August 10th, 2019
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Category : Today's Editorial
If a domestic money consists of a commodity, a pure gold standard or cowrie bead standard, the principles of monetary policy are very simple. There aren’t any. The commodity money takes care of itself.” -- Milton Friedman (quoted by Joseph Salerno in Money, Sound and Unsound)

Though it is not light reading, Joseph Salerno's "Money, Sound and Unsound" belongs in every thinking individual's library.  More than that, the 26 essays that comprise the book should be studied as one would study any topic of supreme importance.  The complaints from readers about complex passages do not outweigh consideration of the book's countless merits.  Moreover, a passage one finds difficult to follow can usually be understood with a little extra effort.

What follows are a few selected passages from Salerno's book that I think are important, interesting, and clearly presented:

John Law (1671–1729) is a prominent character both in the history of monetary events and in the development of monetary doctrines. As the founder and head of what, in effect, was one of the first national central banks in history, the Banque Générale Privée (later, the Banque Royale) of France, Law almost singlehandedly destroyed the French monetary system in the course of four short years (1716–1720).  As a monetary theorist, Law has been called the “ancestor of the idea of a managed currency” by no less an authority on economic doctrine than Joseph Schumpeter. . . .

Law initiates his monetary theorizing with two fundamental assumptions about the nature and function of money. The first is that if money is not exactly an original creation of political authority, it ideally functions as a tool to be molded and wielded by government. Law believes that the State, as incarnated in the King, is the de facto “owner” of the money supply and that it therefore possesses the right and the power to determine the composition and quantity of money in light of the “public interest.”

***

Under the quintessential hard-money regime, therefore, the money-supply process is totally privatized. The mining, minting, certification, and warehousing of the commodity money are undertaken by private firms competing for profits in an entirely unrestricted and unregulated market.

***

Mises thus conceived inflation as a time-spanning process in which an increase in the stock of money invariably results in a sequential adjustment of prices, which necessarily alters relative prices and brings about a reallocation of productive resources and a redistribution of real income and wealth. The specific temporal sequence in which prices are adjusted, and thus the identity of those market participants experiencing gains or losses, is not deducible from economic theory. Rather, it depends concretely on the specific point at which the new money is injected into the economy and on the marginal utility schedules of those who receive and spend the new money. . . .

***

As 2003 dawned, the economy had been mired in recession and “jobless recovery” for two years, and Greenspan’s tattered reputation was threatening to disintegrate along with the New Economy he had trumpeted for so long. His convoluted and banal pronouncements were increasingly met with skepticism, if not with outright incredulity, by the media and the markets. His cherished serious image as the profound Maestro of Money was giving way to the perception of a cunning but clueless Master of Illusion who has suddenly run out of tricks. Greenspan did have one more trick up his sleeve, however, and so he played the deflation card—and he did so with all the guile at his command. . . .

***

"Like gold, [Salerno quoting Ben Bernanke] U.S. dollars have value only to the extent that they are strictly limited in supply. 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 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 then that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation." 

This passage is both true and chilling. Bernanke’s analogy is based on correct economic analysis: the Fed indeed does have the power to bring about a collapse in the value of the dollar. What is so frightening is that Fed governor Bernanke, an allegedly moderate free-market macroeconomist who was appointed by a Republican administration, dares to propose the use of such power as the remedy for a minor rise in the value of money. . . .

***

It is because politicians and their privileged banks were unable to tamper with and inflate a gold money that prices in the U. S. and in Great Britain at the close of the nineteenth century were roughly the same as they were at the beginning of the century. Within weeks of the outbreak of World War One, all belligerent nations departed from the gold standard. Needless to say, by the war’s end the paper fiat currencies of all these nations were in the throes of inflations of varying degrees of severity, with the German hyperinflation that culminated in 1923 being the worst. To put their currencies back in order and to restore the public’s confidence in them, one country after another re-instituted the gold standard during the 1920s. 

Unfortunately, the new gold standard of the 1920s was fundamentally different from the classical gold standard. For one thing, under this latter version, gold coin was not used in daily transactions. In Great Britain, for example, the Bank of England would only redeem pounds in large and expensive bars of gold bullion. But gold bullion was mainly useful for financing international trade transactions. . . .

While the U.S. dollar was technically redeemable in honest-to-goodness gold coin, banks no longer held reserves in gold coin but in Federal Reserve notes. All gold reserves were centralized, by law, in the hands of the Fed and banks were encouraged to use Fed notes to cash checks and pay for checking and savings deposit withdrawals. This meant that very little gold coin circulated among the public in the 1920s, and residents of all nations came increasingly to view the paper IOUs of their central banks as the ultimate embodiment of the dollar, franc, pound, etc.

***

Salerno also includes articles originally posted in The Freeman in which he explains the Fed's role in bringing on and prolonging the Depression of the 1930s.  Salerno was responding to The Freeman articles of monetarist Richard Timberlake, who took the position that the Fed was at fault for failing to inflate sufficiently after the Crash.

 As Salerno concludes, "... once the data have been properly arranged and interpreted, it becomes clear that the Fed does not deserve praise for the bank credit deflation of 1930–1933. This honor goes to private dollar-holders, domestic and foreign, who attempted to reclaim their rightful property from a central bank-manipulated and inflationary financial system masquerading as a gold standard that had repeatedly betrayed their trust."

In wrapping up his monetary analysis of the Great Depression, Salerno writes:

Our conclusion, then, is that the Fed’s monetary policy, except for very brief periods in 1929 and 1936–1937 when it turned mildly disinflationist, was consistently and unremittingly inflationist in the 1920s and 1930s. This inflationism was the cause of the Great Depression and one of the reasons why it was so protracted.

***

As for the nearly universal agreement among economists and commentators that deflation and depression have a strong empirical connection, Salerno discusses in detail a 2004 study "by two economists with impeccable mainstream credentials and affiliations" that upends that view: “Deflation and Depression: Is There an Empirical Link,” American Economic Review Papers and Proceedings, authored by Andrew Atkeson and Patrick J. Kehoe.

Writes Salerno:

Finally, the study is potentially devastating to the now widely accepted Friedman-Schwartz explanation of the Great Depression. In a recent symposium celebrating the fortieth anniversary of their famous work, A Monetary History of the United States, Milton Friedman correctly noted, “The most controversial of [our major themes]—our attribution to the Federal Reserve of a major share of the responsibility for the 1929–1933 contraction—has become almost conventional wisdom.”  Friedman and Schwartz ascribed culpability to the Fed for what they called the “Great Contraction” because it allegedly pursued deflationary policies in the early 1930s.  

Unfortunately, for Friedman and Schwartz the causal connection they posited between the deflation and depression of the early 1930s was purely empirical, based not on sound praxeological reasoning, but on statistical correlations using the data of a single country for the years 1857–1960. 

With the validity of their correlations now called into serious question by a study using well over 100 years of data from seventeen different countries, we may yet see the deflation-depression link follow another supposedly ironclad empirical relation, the Phillips Curve, into well-deserved oblivion. 

***


If you're new to monetary economics, try reading an introductory volume on the topic first.  Though there are several good ones to choose from, my own personal favorite is Gary North's "What is Money?" available on Kindle.


George Ford Smith is the author of eight books, including The Flight of the Barbarous RelicEyes of Fire: Thomas Paine and the American Revolution, and The Fall of Tyranny, the Rise of Liberty.  He is also a filmmaker whose latest work is a five-minute documentary about the Christmas Truce of 1914, A Christmas to Remember.

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George F. Smith is the author of The Flight of the Barbarous Relic, a novel about a renegade Fed chairman and the editor of Barbarous Relic.com.
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