Wednesday, November 21, 2007

An abominable proposition

An engineer proposes that control over monetary policies be given over to engineers. As a physicist, I can categorically state that that would be an economic disaster of titanic proportions. The culprit is that current hobgoblin of little, conservative minds: a fixed value of the dollar. Perhaps we physicists, being more acquanted with the theory of relativity than your average engineer, are more comfortable with relative quantities.

The first intellectual casualty of the fixed-dollar mentality is blaming the business cycle on the Federal Reserve system (author's italics):
“Capital” is measured in terms of money (dollars), is mobilized by money, but is not money. Capital represents real economic resources. The Fed cannot create capital. All it can do is create money and use that money to commandeer capital. Unfortunately, this can cause inflation.

Once inflation gets going it tends to run away, with rapidly rising prices and escalating inflationary expectations. Ultimately this must be stopped. Unfortunately, raising the fed funds rate in order to halt inflation can cause an economy to “overshoot” into recession. Then, to fight the recession, the Fed will cut its fed funds target, thus starting the next oscillation of the business cycle.
Certainly the Fed could and probably has done this in the past. Certainly other monetary policies of past United States governments have also done this in the past. Remember, the business cycle has been around throughout American history; Andrew Jackson developed the predecessor of the modern Democratic Party, in part, to fight inflationary booms and busts caused by the State banking regime of his day. In another sense, the idea that the Federal Reserve can only create money is completely false. For example, the Federal Reserve controls the amount of money that banks must keep in deposit within the Federal Reserve system. By raising this requirement, the Federal Reserve can remove money from circulation.

Setting a fixed value for the dollar in terms of gold (or anything else) also doesn't make much sense in the era of globalization. Consider the case of China before the U.S. mortage disaster. China was then exporting anything and everything that wasn't nailed down to the United States in exchange for dollars. China would then use its dollars to invest in the United States in order to earn more dollars. In effect, China was shipping mass quantities of goods to the United States for the privilege of dollarizing its economy. This should have weakened the Chinese Renminbi substationally, but it didn't because the Chinese government maintained a fixed value of the Renminbi. In effect, the Chinese government was spending huge sums of money to prop up a boutique currency to compete against the dollar for the sake of national pride.

Setting a fixed value for the dollar in terms of gold would be just another example of spending money for the sake of keeping an inherently variable number at a fixed variable. In engineering terms, it's like arguing that the space shuttle should keep a rocket engine firing at all times merely to provide a comfortably constant 1g acceleration to the astronauts inside. If the astronauts inside can work perfectly well at any net acceleration at 1g and below, then why waste the rocket fuel?

Also note that the value of a dollar, even in terms of a fixed amount of gold, can still be altered. One mechanism for doing this is rumor-mongering. "Psst. Hey buddy, rumor has it that a bar of gold from the Fed is actually 1 percent lead. Pass it on."

The worst problem with the case for the fixed value of the dollar is the contention that interest rates would be kept low:
This new system would not be concerned with the federal deficit or the U.S. trade deficit. These relate to capital, and capital is not money. Similarly, the system would not be concerned with interest rates, which represent the cost of capital, not money. (As an aside, if the dollar were as stable as the foot, interest rates would be very low.)
The idea that putting the economy on the gold standard will make everyone happily share money with each other at practically no cost is just plain stupid. After insisting that the dollar must be defined in terms of a fixed amount of capital, in effect eliminating money in preference for a capital-only economy , the author now insists that we don't have to worry about deficits or interest rates because they just involve capital and not money. Yeah, right, whatever...

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