Topic: Economics
Federal Reserve Policies Distort Pricing Chris Espinal, myself, and others have been debating the real impact of the Federal Reserve System. This article reminds us all what a free market is supposed to do, and how the Fed harms a free market.by Walt Thiessen
(Libertarian)
Tuesday, February 19, 2008
One of the things that is being lost in the discussion on this website regarding the Federal Reserve is what the role of prices and currency is supposed to be in a truly free market.
First, prices are not supposed to rise over the long term. They're not even supposed to hold steady. No, prices are supposed to fall in the long run. That's why having a truly free market is most beneficial. It makes goods and services cheaper in the long run for all concerned. We see this effect on only rare occasions anymore. Most often it occurs when a new technology is created. For instance, I think back to the 1970s when the electronic calculator was first introduced to mass markets. The early calculators cost thousands of dollars. But over time, to the amazement of many, calculators kept going down in price. Eventually, they became such commodities that today you can buy a simple calculator for $10. Similar pricing drops have occurred with computers, although to a lesser extent.
Unfortunately, in our current society calculators and computers are the economic exception, not the rule. Most goods and services go up in price. When the majority of prices go up, or even when the majority of prices hold steady, it's a sure sign that some sort of economic manipulation is going on. And sure enough, it has.
Government regulation is one form of economic manipulation. Another is taxation. But the most insidious and destructive form of economic manipulation is with currency. What makes this last form of manipulation exceptionally evil is that it is so difficult for the average person to detect it. When goverment statistics are manipulated (as in the case of the CPI during the 1990s) or even abandoned (as in the case of M3), it becomes virtually impossible for the average person to detect.
I saw a reference on another article on this website that I can't find now, but it really stuck with me. It was a claim that the aim of advocates of macroeconomic manipulation is to provide steady prices via the Federal Reserve. Espinal himself has argued that "macroeconomic goals" as he calls them are good and necessary, and I even recall him saying (again, I can't find the reference) that deflation (falling prices) is a bad thing. But is it true? I say no, none of that is true. All that macroeconomic manipulations can accomplish are the disruption of the normal, long-term process of falling prices. Prices are supposed to fall on average. That's the only way that most of the poorest among us can share in the bounty of a free market society.
Someone pointed out in a reader comment that Michigan is in a depression. Espinal dismissed it, saying that there were other long-term factors which caused that depression, implying that Fed manipulations were not one of those causes. But in fact, Detroit is a major victim of Fed induced boom-and-bust. Eventually, boom-and-bust catches up with you, even if you can't draw the exact line connecting the dots. That's what makes Fed manipulations so insidious. The paper trail is almost impossible to follow.
One of the reasons that Fed manipulations confuse conservatives like Espinal is that its influences are not uniform across the economy. In fact, they are routinely inequitable in their influences. Certain areas of the economy, certain regions of the country are always affected differently from other regions and economic areas when the Fed plays its money games in an environment that is hidden from public view. There's no way to track exactly how money created by the Fed out of thin air will precisely enter and affect the economy. The most we can ever say is that it will tend to go to those who are the "best" credit risks, which is merely another way of saying that the rich will gain access to capital for investment and their own profit, and the poor will not. As the old saw goes, the rich get richer, and the poor get poorer.
Espinal demonstrated a tendency that many conservatives have regarding the issue of gold as currency instead of paper money under the Fed. In my recent article regarding John McCain's inflationary policies, I tried to pin Espinal down on the issue in the reader comments, although he persisted in evading the issue. I posited a scenario where the government passes a forced savings law where all people are required to put aside $1,000 from their earnings for 10 years in only one of two forms: gold or Federal Reserve Notes. No other form of investment was permitted under this scenario, and no interest was permitted to be earned. The idea was to limit the discussion to a pure comparison of the relative ability of paper vs gold to hold its value. The closest that Espinal came to answering the question I posed was when he wrote, "I would put my wealth in assets to protect its value." As of this writing, I had replied that many people consider both dollars and gold to be assets, so his answer was ambiguous. However, I'll go out on a limb and guess that what he meant when he said that he would "put his wealth in assets" is that he considered gold to be the asset he would put it into under my scenario, not Federal Reserve Notes.
That would be a wise thing to do, because gold holds value much better than Federal Reserve Notes do, but notice the way he phrased his answer. He said he would "put his wealth into assets." The implication is that Federal Reserve Notes are not assets, and indeed, they aren't. They are liabilities toward accumulating wealth, particularly for the poor. Espinal likes to point to the benefits for young technology workers in a Federal Reserve dominated economy, but in fact most of the poor don't work in technology. In fact, most Americans don't directly earn greater wages from technology. As one who previously worked in technology (before going into business for myself) I can point to the dangers of placing one's faith in technology-driven jobs. Eventually, competition catches up, as does age. When that happens, it's no longer possible for most people to keep up, particularly once they are no longer "young."
But getting back to the poor and working classes, let's remember that most of them do not work in technology-driven jobs with salaries that are constantly adjusted upward. For these people (and for the majority of Americans) this illusory benefit doesn't exist. They're the ones who most need a hard currency, such as a gold-based currency, because they have the least opportunity to save money. They also have the least incentive, because the long term trend in rising prices discourages them from wanting to save for the future. On an intuitive level, they know that their money will be worth less in the long run, so why not spend it now? And indeed, they are correct. It will not only be worth less, it will ultimately become worthless in the long run. Thus, there is a great disincentive for them to save it. They are trained by the Fed dominated currency to be spendthrifts.
When a gold-based currency becomes the preferred medium of exchange, this situation is reversed. Now, the poor have a reason to hang onto their money rather than spend it on whatever, because they have reason to believe their currency will retain its value. It might even increase in value. It most certainly won't decrease in value unless a bank starts fraudulently handing out paper receipts for gold they hold on reserve under a "fractional reserve" policy that the government lets them get away with.
Until one has the ability and the incentive to save, it is nearly impossible for most to raise themselves out of poverty. Thus, they end up so often on the "mercies" of state assistance. Depriving the poor of the ability and incentive to save is the opposite of what we should be advocating.
But most important, a truly free market with a hard currency where prices are permitted to fall on average is where the truly bountiful nature of a free market reveals itself. One doesn't have to be a major contributor to such an economy in order to be enriched by it. Even the poor working a small wage can be enriched by such an economy. It's a terribly sad state of affairs when such an economy is so far from our current experience that most people like Espinal have forgotten that it is the nature of a truly free market to share its bounty without macroeconomic manipulation, if they ever knew it at all.
One final note. Espinal likes to point out that store of value is not the only purpose for a currency. He likes to say that there are a lots of purposes, but he actually only names three: store of value, medium of exchange, and macroeconomic manipulation. The last one is not a requirement. Rather it is something to avoid, as this article has clearly shown. So we can easily dismiss that requirement. Advantage: gold
We've already discussed the "store of value" function, and clearly gold serves this role better than Federal Reserve Notes. Again, the advantage goes to gold on this point.
This leaves the issue of currency being a medium of exchange. The implication regarding gold that is made by critics (although it usually remains un-said) is that gold is not easily transportable, so it isn't a good medium of exchange. But this ignores the fact that you don't have to actually carry your gold with you in order to use it for trade, just as you don't have to carry your house with you in order to sell it or buy another house. Paper and electronic records of gold stores can be exchanged just as easily. A debit card can as easily access an account that stores gold as it can access an account that stores Federal Reserve notes. A computer transaction can just as easily trade in gold as in Federal Reserve Notes (aka FRNs). So really, the "medium of exchange" issue is merely a red herring. Gold is just as capable of being a medium of exchange as FRNs, and it has the added advantage that it's not as easy to defraud people using gold-based records as it is to defraud people using FRNs via a central bank whose internal workings are invisible to outside observation.
The results are in, and the answer is clear. In all three cases, advantage: gold.
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2008 Walt Thiessen, all rights reserved.
Published: Tuesday, February 19, 2008
Last modified: Tuesday, February 19, 2008
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Another interesting article Walt, thanks.
I agree with your arguement that in a scenario with gold backed currency and the absence of macroeconomic manipulation, deflation would be the natural tendency of a free market. Much of this deflation would be the result of increased efficiency of the economy (ie each manufacturer can produce more goods with the same amount of labor). Service sector jobs might get more efficient as well with the help of new technoligies. There would be some jobs, however where wages were bound to decrease over time along with deflation (salesman on commission comes to mind), so they might not benefit to the same degree as other jobs although people could afford to buy more widgets, increasing the commission with their relatively increased wealth. This economic boom would not necessarily be followed by a bust as the current inflationary credit based system necessitates.
RP hit the nail on the head with his recent competing currencies bill. You could bypass the manipulative powers of the Fed in one fell swoop. I have thought that another way to "skin the cat" would be to provide transparency into the Fed Reserve System. Institute a bill that would open their books - provide data on the money supply, gold reserves, participating members, etc. That would go a long way to preventing some of the more blantant macroeconomic market manipulations that have been occuring. Thoughts?
Could someone also work on the autoformatting that seems to make my paragraphs run into each other - its pretty annoying when my comments change into one big run-on paragraph like above...
It helps if get started and go ahead and hit preview your comment. Then make any changes from that point including your paragraphs spacing. It will save correctly after that. You just have to be a little more careful about when you hit submit. Or you could always type it all up, and then just be sure to go back and put your spacing in while doing your first edit. You do have to remember that after any changes you must hit edit and preview or the changes will be lost when you submit.
I've been thinking, on examination of already existing enterprises such as e-gold and e-bullion, that since there are already businesses which store gold and allow transfer of gold between accounts, all that needs to happen is for the federal restriction on domestic transfer of gold to be removed. RP hit the nail on the head more than we think.
Overnight you'd have every major credit card company tackling each other to be the first to tie in to those systems.
I'd also like to know why nobody posits the obvious answer to gold detractors' chief gripe, its minor inflation/deflation cycle: diversification. If a store of gold was instead a store of precious metals in general - silver, platinum, palladium, rhodium, etc - wouldn't the minor inflation/deflation cycles of gold be practically eliminated by hedging it against stores of other precious metals?
Good Article. However, you continue to believe that I am trying to push past a point.
There are many roles of money... in this economy macroeconomic manipulation is one of them. Sure, it is considered a store of value, but it is not a store of value in conventional terms when the federal reserve can manipulate it's value to older currency. But you do have an option if you hope to maintain the value of your wealth: put it in assets that aren't manipulated by the federal reserve. That is what the rich do to hold their wealth instead of putting it in banks (where money can lose value).
So your scenario didn't make sense because you assume that in this economy you can't protect the value of your liquid assets: money. You can by converting it to non-liquid assets or investing in foriegn currencies that continue to improve against the US Dollar.
However, if you want your dollar to achieve store of value and not accessibility to basic transactoins then you should stick to gold, or convert liquid money to gold assets.
I will leave the debate of the purpose of a market economy to some other time. That is a debate I struggle to comprehend on a larger level. It really is a complex issue because it once again involves which monetary system we think is a better system. I just plain don't know!
"Espinal likes to point to the benefits for young technology workers in a Federal Reserve dominated economy, but in fact most of the poor don't work in technology."
I never said most of the poor work in technology. I don't remember mentioning this - could you remind me where I might have posted this comment. If I did say something like this then what I meant to say is that their lack of technological understanding (along with other facets such as education and human capital) can keep them from getting jobs beyond the blue collar sector. Because this is the case they lose jobs to trade treaties like NAFTA, where unskilled labour can be found at much lower costs.
However, this can lead to a national incentive to figure out a system that will improve education: maybe school choice or complete private enterprise. I wouldn't know which works better. Will it happen in a matter of a few weeks: Nope. However, the baby boomers are retiring which means that our economy will be dominated by those who are keeping up with creative destruction or those living in a new technological era.
Posted By: Walt Thiessen
Date: 2008-02-20 02:00:25
Chris wrote: "There are many roles of money... in this economy macroeconomic manipulation is one of them."
This isn't a requirement of the economy. It's a requirement of those who believe in manipulating the economy. The economy itself has no need of it.
Chris also wrote: "So your scenario didn't make sense because you assume that in this economy you can't protect the value of your liquid assets: money. You can by converting it to non-liquid assets or investing in foriegn currencies that continue to improve against the US Dollar."
Well, yes, that's nice if you've got the wherewithall to invest in non-liquid assets. Most people don't have that wherewithall. Nor do they have the knowledge to do it correctly.
The point is that they shouldn't have to do that just to survive financially. That's the whole point to having a stable money supply, so that people don't have to do that. Fiat money can't fill that need. You shouldn't have to be a financial expert in order to mitigate the ravages of fiat currency in your own finances. Nor should you have to hire a financial expert to do it for you, which is always a dicey proposition anyway.
Chris also wrote: "I never said most of the poor work in technology."
I never claimed you did. I was making a point about the ramifications of your point for most people, including the poor.
Posted By: Christopher Espinal
Date: 2008-02-20 03:00:26
It is a requirement for society if that is what the society values. A consistent store of value in the dollar is not necessarily a requirement neither.
The people who wouldn't protect the value of their money are those who don't save...such as the poor. They consume more than they save....although it is argued that they save if they don't foresee good personal financial conditions. The people who convert their money into assets are the middle class and the poor.
Purchasing a house is one way of doing, puting money into Social Security is another way.....401K Investments.....blah blah blah....It's very accessible. Saving doesn't necessarily require individuals to put their money in accounts that have interest rates so low that they get eaten away by inflation. Money market funds....and such are so easily accessible. Another easily accessible mechanism for protection of value are high interest rate long term government bonds...which go as high as 15% per year compounded for 10 years. I'm not sure if they are tax free though.
The ramifications that you mention are short term. I'm going to be honest when saying that I just plain don't know what the short term ramifications are: I don't believe there is any professional research that shows inflation has a huge short term cost, like those that you speak of. This is still an issue of debate....not only between central bankers and austrian economists, but between Keynesains and monetarists.
In the long run, there are no real costs of inflation. The reason is because eventually all prices and wages adjust to proper nominal levels. Since GDP (Y) = National Income or National Expenditures, this identity equation tells me that eventually extra money in circulation will reach those on the income or expenditure side: producers or consumers respectively. By producers I mean those who are part of the production process: owners of production + factors of production, and by consumers I mean those who consume production: owners of firms + employees of firms. As you can see they all consume and produce!
Thus, eventually, money in circulation will find its place.
Why do economists treat hyper inflation differently: because hyper inflation distorts normal consumer patterns and confidence in the economy. Essentially, additional liquid money in the economy bears a small short term cost....this can be signaled by the fact that Americans, IN GENERAL, are doing quite well and still have confidence in our system.
If there were no confidence, the economy will be crumbling at this very moment, which according to my numbers from the Congressional Budget Office, is not happening.
Posted By: Walt Thiessen
Date: 2008-02-20 08:13:32
Chris: a number of counter-points. First, the reason the poor don't convert their money into assets is (1) because they have so little money available to save and (2) because they don't perceive that it's worthwhile to do so. There's also (3) that most don't know how to do it. This is why money being a storehouse of value absolutely 100% is a requirement.
As for your claim that macroeconomic manipuation "is a requirement for society if that is what the society values," I say Nonsense! I don't ever remember anyone I know who isn't a politician or media personality saying that they think that macroeconomic manipulation is a requirement...or even anything remotely like it. At most, they cry "do something about the economy" and macroeconomic manipulation is what the politicians deliver. Calling that "what the people want" is a distortion of reality. It's what the politicians want, and it's how they sell what they want to the people.
As for your claim that, "In the long run, there are no real costs of inflation," this is completely wrong. Inflation is all about the long run. Michigan is an excellent example of what monetary manipulation does in the long run. So is Mississippi. So are every other pocket of poverty in America. As I've said before, monetary manipulation are not the sole cause of these conditions, but pretending that monetary manipulation does not have a profoundly negative, long term effect on these regions is nothing more than burying your head in the sand.
Regarding your claim that, "Thus, eventually, money in circulation will find its place." Yes, of course. The question is what the consequences of that will be, and they are universally negative for everyone except those who get first crack at the new money. After it has worked its way in, even those who had first crack experience the harm, but since they had the initial "go" at it, they benefit the most (or are harmed the least, depending on how you look at it).
Posted By: Christopher Espinal
Date: 2008-02-20 18:50:27
Politicians are voted in by the people - by votes - democratic solution which signals the direction of a society. In our case, like most prosperous nations, we are moving to the left. Most Republicans nowadays don't even mind the big government stuff going on! You might as why? Because they too believe they can benefit from these institutions. However, we have the money to institute them....or at least the resources. Our 9 trillion dollars of debt will continue to rise, but if we have a responsible government, actually like we do today, that will remain a small percentage of GDP.
There are no costs of inflation in the long run: it's known as the classical dichotomy, where nominal variables don't have an effect on real variables and vice versa. This applies to money. All prices and wages will eventually adjust to inflation, including your wages. In the short run, we should be worried about inflation going out of control like in Zimbabwe or the pre-Hitler days in Germany.
No, Michigan is not an example of what inflation does. If you knew what created Michigan - it was the huge car manufacturing and steele companies moving elsewhere...of course taking the jobs with it. That is what kept Michigan in hell....along with Gary, IN. Inflation has nothing to do with it. I bet you don't have evidence to back your claim.
I know nothing of Mississippi to verify.
Every other pocket of poverty is caused by inflation? Yeah right. Are you saying that most people of color are in poverty because of inflation? The same for poor whites in the Appalachian Mtns? No, It's because there's no capital in poor communities, or there is dead capital. They have no financial foundation from which to accumulate income generating assets, or capital generating assets.
Again, you have no evidence, or there is no evidence that the people who lose out on inflation are those who are at the bottom of the trickle-down-economics scale. You need evidence Walt to back those claims! The ones I provide, such as lack of capital/ loads of dead capital, and manufacturers making moves overseas, are all backed by information and history.
This society has become one that requires manipulation of the economy. People believe it works so they will vote on those standards. Although I believe the Fed has done quite well in manipulation because we have a group of very responsible economists in place (including Bernanke), a gold standard may be a better system, but we value larger government.
I still don't believe any economist in the nation has PROVENthat one monetary system is better than the other.
I will continue reading about price theory/ monetary economics from different schools of thought.
Today I was talking with my professor on the Gold Standard, he even said that Gold is not necessarily a bad thing. Mind you, he is a neoclassical monetarist who abides by the economic laws of Friedman. It was really an interesting conversation. He also admitted that competitive currencies have worked, and have done so for all the time before the Fed took control.
Posted By: Christopher Espinal
Date: 2008-02-21 12:34:47
"This society has become one that requires manipulation of the economy. People believe it works so they will vote on those standards. Although I believe the Fed has done quite well in manipulation because we have a group of very responsible economists in place (including Bernanke), a gold standard may be a better system, but we value larger government."
I would like to clarify on this statement: What I was trying to say is that this country had a shift in values. Essentially Keynes had a thing for controlling the economy in short run because in the long run "we are all dead." Obviously, his ideas were quite at odds with the classical economists - Alfred Marshal, Adam Smith, John Stuart Mill, David Ricardo, etc. Essentially, the US gave monetary manipulation a shot....and we started out on the luggish side (over inflating during the 20's - our first central bank induced bubble) and the Great Depression (which economists argue was due to horrible macroeconomic policy.) The Great Depression issue varies amongst economists of different schools thought. However, the consecutive generations improved.
This society is still standing and doing quite well. I don't think anyone is entirely sure which system, fiat or gold, will prevail as a better system.
It comes down to values - an activist Fed provides tools for government to control macroeconomic fluctions. Essentially they try to curb the effects of free markets on the poor and middle class. This brings us into a whole different topic still debated, quite emotionally might I add, about whether or not government can socially engineer situations to provide positive externalities for society. Quite frankly, I don't even know how to answer this question fully!
Thanks for the article.
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2008 Walt Thiessen, all rights reserved.