There's a push by some Republicans to go to a rule-based monetary policy. The question is: should a monetary system be based on market forces or a mathematical formula? Our present Federal Reserve System uses what is called "discretion" rather than preordained formulas. It wasn't always this way. This country and most of the world operated under a gold standard for many centuries. Once defined by a government, the value of money was set by the free market, not a board. An ounce of gold floated against all other goods and services. Market forces set the value of money, expressed as prices; and market forces determined the level of interest rates -- which is the price of money. Once having chosen the medium of exchange and defining it, politics and government were absent from markets.
Today, many would prefer a monetary system under the control of government. There is a movement to control and regulate, not money as such, but the Federal Reserve System. The Fed is presently a quasi-governmental institution comprised of bankers and economists from 12 different regions of the country. It is an institution indirectly controlled by government but explicitly leaves the judgement of monetary policy to the Fed. Many want that to change.
There are several rule-based schemes being advocated that would take the discretion away from the Fed and vest it in the Congress. One would like monetary policy tied to the "Taylor Rule", named for John Taylor. As described by Wikipedia:
"In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point."
This rule is one that eliminates the free market and disregards individual valuation and replaces it with a mathematical formula. Short term interest rates would be determined by the Fed as they are now, but not by judgement but instead by a rule. However, they are not determined by the market, which they were under a gold standard.
Another system favors setting the money supply at a fixed range, say 3-5% per annum. This is Milton Friedman’s “Monetarism”. It is a fiat system that places the Federal Reserve in charge of money, credit, and interest rates, but limits how much money the Fed can create. Once again the Fed is in charge of money and credit which is limited by a rule, but short-term interest rates are not free to seek their market level.
And still another rule-based monetary system is to return to a form of the Bretton Woods System which would fix the dollar to gold or a basket of commodities. All of these systems have one thing in common: they justify government control over the price and value of money versus a market system. The problem with any rule-based monetary policy, including fixing the dollar to gold, is that we are not able to maintain a fixed monetary system in a world of irresponsible and undisciplined fiscal policies. Any attempt would fail and the free market and sound money would get the blame.
Our refusal to adhere to any fiscal discipline which would balance trade and balance budgets precludes any rule-based monetary system. That's what happened to the Bretton Woods monetary system; it broke apart due to constant deficit spending and devaluations over the decades. Click here: The Death Of Bretton Woods - PaulNathan.biz
Proponents of a rule based monetary system believe that imposing a rigid monetary system will force government to live within its means. That's equivalent to the tail wagging the dog. It's illogical. A sound fiscal policy and free trade must first be established as a foundation for sound money. Many times we were forced off the gold standard in our history precisely because of runaway spending and deficits. Fiscal responsibility must be attained before any monetary reform can emerge which will only then cement fiscal discipline.
If the government immediately attempted to impose the kind of austerity required to sustain a rigid monetary system, it would likely lead to a revolution against sound monetary and prudent fiscal policies as it has in many other countries. In a recent poll, 52% of Americans think socialism is a good system. What would that figure be if we were forced into a full-fledged recession induced by a policy of extreme tight money and austerity with unemployment soaring into the teens? We would have what Greece has: a new government, but one that is anti-free market. Fiscal discipline needs to be attained, but attained gradually and rationally.
Where a rule-based monetary system may work in a fiscally prudent and robust economy, it would be counter-productive in the irresponsible economy we have today where we're running trillion dollar deficits, multi-trillion dollar unfunded liabilities, with no way to pay for them; and in an economy distorted by thousands of pages of tax laws and regulations, and an economy which is growing at the slowest pace in modern history. Debt and stagnation is what we need to be fighting, not imposing tighter money to fight inflation, which a rule-based monetary policy is designed to combat. Inflation is not our enemy today – debt, controls and regulations, and runaway government spending is.
I am for a gold standard. I wrote a book about it. http://www.paulnathan.biz/ But I stressed in that book that a gold standard is the ideal we should be working toward and that any attempt to graft one onto a fiscally irresponsible economic system would lead to disaster for those advocating freedom, free markets, and sound money. In today’s economy a gold standard or any other rule based monetary system would fail and free markets and sound monetary policies would be discredited. It could set back the achievement of those goals a hundred years.
Look at England after WWl for a case in point. During the war, the British government took over the economy. They rationed almost everything and set prices. Market prices disappeared. When the war finally ended, the government tried to return to a market economy and the gold standard they abandoned, and the economy went into a severe recession. The problem was, after years of dispensing with markets, the economy could not adjust and reinstate markets that took centuries to build. Chaos resulted.
Today, a present day example is the difficulty China is having establishing a convertible international currency. After decades of monetary mandates rather than markets it is a real task for China to establish the value of their money. They are forced to piggy-back on the dollar’s value by tying the Yuan to the dollar. No true market value has yet been established for their currency. They are still in the process of evolving after decades of reforms.
Markets are information dispensers. Prices reflect values -- the values of millions of individuals that buy and sell products and services in a society. Eliminate that, and it takes years to rebuild the communication that markets provide. England only partially succeeded in rebuilding markets. Many government agencies established during WWl still exist today, preventing a truly free market from ever existing in those sectors.
The same is true in America. We have government agencies established decades ago that serve little if any purpose and cost a fortune which fail daily to do what markets can do quicker and more efficiently. Yet, we refuse to eliminate them because we fear that what will replace them will bring chaos. And that assumption is probably correct in the short term. A transition is needed.
Take Obamacare. By the time it's repealed or changed, there will be no health care markets; no market information from a consumer that has been left out of the process. And there would be no price system that accurately reflects supply and demand. To repeal Obamacare without a plan to deal with the inevitable confusion that would follow will probably lead to the call for a one-payer system called socialized medicine. The likelihood of that system being voted into law would be higher than it is today if chaos follows a free market approach without a workable transitional plan.
That's why those for freedom and free markets can't expect to simply do away with government agencies, controls, and regulations that have been in place for years if not decades, and assume a free market will automatically solve all problems. There will be no market to solve those problems. A country will need the time to "build" a market. Time will be needed to establish real production, real demand, and a system of free market prices. You can't legislate that into existence. Markets must evolve naturally.
This is why a rule-based monetary system is impossible to legislate into existence, which is what free market and hard money advocates are for. The goal is correct, but the method to achieve it is not. This holds true of all government-controlled sectors of an economy in transition to a market-controlled sector.
The method of transition may vary, but the principle is to establish a free market in medicine, in money, in banking, in education, in energy, etc., that would run side by side with the controlled sector. Let the two compete. The result will be that market oriented sectors will be chosen over government controlled sectors. Look at what's happening in the mail delivery sector where private enterprise is competing against the post office. It's no contest but it has taken time to evolve. A transition need's to occur, but one that will be a gradual and natural transition. Market economies are always more efficient than government controlled economies. The most controlled markets of the past, such as the Soviet Union and China are testimony to the efficacy of free market economies as those command economies failed and have turned instead to the efficiency of markets.
Statists hate and fear choice in economics. Individual values and free markets when expressed shines a spotlight on the inefficiency of government run sectors. This is why they oppose, for example, the idea of vouchers as a transition from government controlled sectors like education, to a market system. Vouchers are a way to transcend government bureaucracy. A voucher based policy will reduce the confusion of transition because they will evolve over time. The same can apply to moving from Obamacare to a free market approach to healthcare and to many other sectors in the future. Competition is the key.
Those on the Right are making a big mistake advocating taking over the Federal Reserve. Instead, we should reduce the Fed's mandates, rather than increasing the control of it politically. The Fed's role in today's world should be as bank of last resort and charged with price stability -- and that's all for now. They should not be a regulator, or a policeman of the financial system, or in charge of setting the federal funds rate.
Mandates charging the Fed with the power to control interest rates, growth and unemployment are counter-productive and should be rescinded. They should be the province of the market economy, not government. That would give us time to get our fiscal house in order before tackling real monetary reform while keeping the Fed in place in a reduced capacity, yet not causing confusion, disruptions, or panic in the process.
Click here: Are The Fiat And Gold Standards Converging? - PaulNathan.biz
And the same is true talking about eliminating all government agencies, controls, and regulations without establishing a market first to deal with things like healthcare, education, energy, and the like. To defeat Statism, we need to allow new markets to develop to compete within all of those sectors and allow people to choose which one they prefer.
At the same time we need to eliminate all laws that would prevent them from doing so by eliminating all tax subsidies, corporate welfare, and loopholes from the tax system. And we need to reduce controls and regulations that strangle free enterprise.
Competition and a level playing field is what's required for markets to thrive.
For a further discussion of this issues see:
Click here: The Agenda - PaulNathan.biz
Click here: Freedom: Morality vs. Force - PaulNathan.biz