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Interesting Findings And World Unfolding Through My Eyes.

Wednesday, September 12, 2007

What, If ?

On casual glance, I think I would like Rep. Ron Paul, who is running as a libertarian candidate for the Republican nomination.

Problem is, advocating for withdrawal from NAFTA, the WTO, and the UN, his policies sing an isolationist tone. And, like a paleoconservative, Rep. Paul takes a hard-line stance on immigration, free trade, and some social issues. But the real game ending moment—why I cannot support the congressman—is his support of a gold standard. Such a belief is just absurd.

A gold standard cannot adjust the monetary base to meet liquidity demands. Yet the price of gold does vary, just not as policy might prefer. The supply of gold is a function of mining output; the demand varies vis-à-vis its non-monetary uses.

Economists universally decry deflation as an economic hamartia. Moderate inflation is preferred to even minor deflation. Deflation lowers incentives to invest, leading to a liquidity trap, and to spend, leading to a collapse in aggregate demand. Deflation forces the economy to deal with demand shocks by lowering output. Deflation is cataclysmic to debtors, as they must repay their debt in ever more expensive units of currency. Deflation, as with inflation, suffers from menu costs.

The point is, deflation is anathema to an economy, and the state should do everything in its power to prevent it. But, unable to adapt the money supply, a gold standard is a poor buttress against deflation. Indeed, the 19-th century witnessed prolonged deflationary periods. Gold bugs don't dispute this, but instead argue that the deflation was not detrimental. We don't have good economic data for that period, but economists of all persuasions argue otherwise.

Moreover, any benefit of a gold standard is more easily attainable via Milton Friedman's proposal to constantly grow the money supply as a function of an economic indicator such as GDP. Dr Friedman envisioned implementing his policy via an algorithm—replacing the The Fed with a single computer—which is simpler and less risky than tying our money's store of value to Johannesburg's mining industry. (Alas, even Dr Friedman's policy is not ideal; we need flexibility.)

Advocates for a gold standard point out that it prevents the government from inflating the money supply. But does not Friedman's algorithm prevent that, as well? Or a truly-independent central bank? Unfortunately, no. These obstacles only make government intrusion more difficult, not impossible. The government can always modify its gold standard, tweak the algorithm, or stack the central bank.

(As an aside, Rep. Paul erroneously commented in one of the first GOP debates that the U.S. government "prints money" to fund our deficit, thereby inflicting on the populace the "hidden tax" of inflation. This is untrue; unlike an African kleptocracy, we fund the deficit via borrowing. Nor is printing money how open market operations work.)

Thus, a gold standard is only as good as the government implementing it. If the government can be trusted to hold the peg immutable, then you don't need a gold standard in the first place. If the government cannot be trusted, then a gold standard is little recourse. The state is either an honest custodian of the monetary supply or it isn't.

The government can always change the peg or move off the standard, and the citizenry knows this. Thus, as with any monetary policy that fixes the exchange rate, a gold standard opens the door to speculative attacks. These attacks invariably come when the economy is at its weakest and government countermeasures such as raising interest rates could not be more ill-timed. As an historical example, The Fed was forced to maintain high interest rates amid The Great Depression, causing a monetary contraction that prolonged the depression (cf. Friedman's Monetary History of the United States) And, once the state capitulates and moves the peg, the sharp revaluations amplify economic distortions, unlike the smoother price movements of a floating currency.

Anyhow, Ron Paul, a libertarian? Nah, just anti-statist.

Today is one of reflection and remembrance. But where is the politician that helps us look forward, daring us to dream heroic dreams?

Posted by Ajay :: 9:46 AM :: 0 comments

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