RSS Feed MenuRon Paul’s new book End the Fed exemplifies H.L. Mencken’s dictum: “Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong.”
Paul’s explanation for many U.S. economic and political ills — not just the recent crisis but the business cycle overall, and even welfare dependence and foreign wars — is that the Federal Reserve caused or enabled them. His solution is to abolish the Fed, with preliminary steps including (as his current legislation calls for) expanding the Government Accountability Office’s power to audit Fed transactions. He calls for a return to the gold standard, and for private currencies to compete with the federal dollar.
His explanation mixes some legitimate concerns into a stew of exaggeration, misdirection and conspiracy-mongering. His solution combines the counterproductive with the untried, and is offered with an ideologue’s certitude that no adverse consequences or difficult tradeoffs need be considered.
Paul is right to be concerned about the Fed’s capacity to expand the money supply and generate inflation. (Incidentally, he defines inflation not as a general rise in prices but as any expansion of the money supply, a neologism that produces nothing but confusion.) But his audit bill, by making the Fed more susceptible to political manipulation, will only increase such inflationary proclivities. The record is clear that central banks with some insulation from political pressure are better at curtailing inflation.
The financial crisis that blew up in 2008 evidently had many causes, with actions by government as well as by the private sector contributing in various ways. Paul sticks with a mono-causal explanation, blaming it all on the Fed (for keeping interest rates too low and enabling government bailouts; not, of course, for being lax in regulatory oversight). That provides a convenient scapegoat but a simplistic view of a complex situation. Market dynamics (e.g., banks gorging on mortgage-backed securities) and a lack of government activism (e.g., Treasury’s decision not to bail out Lehman Bros.) played a role in the crisis, and it is far from clear what would have happened if the Fed had not pumped up liquidity in response.
Financial crises occurred in America long before the Fed was created in 1913. The 19th century was rife with severe crises, most of which occurred long after the Fed’s precursors, the First and Second Banks of the United States, had been driven out of existence by the anti-financial populists of their day. Paul shrugs off this significant counterevidence to his argument, and seems to have ruled out on a priori grounds the possibility that financial crises can occur without government causing them in some way.
Similarly, he downplays the Panic of 1907, when the financial system came close to collapse and was held together, barely, by J.P. Morgan, Sr., who acted as a de facto central banker in organizing a consortium of banks and deciding where to direct funds to stem the tide of withdrawals and collapses. Paul, who repeatedly complains that the Fed serves the interests of the Wall Street elite, seems unaware that the central bank was created in significant part to avoid leaving systemic responsibility in the hands of a small number of private-sector bankers.
On page 150 of End the Fed, Paul describes the Fed itself as a “private bank,” a false description that is a staple of conspiracy literature. In reality, the Fed’s Board of Governors, which has the final word on policy, is a clear-cut government agency, with members appointed by the President of the United States, and the Fed’s regional banks — though shares in them are held by banks in their districts — are de facto government agencies (the shares cannot be bought or sold, and all profits are remitted to the Treasury).
Extolling the gold standard, Paul argues that it would bolster the dollar’s credibility while restraining government spending on social programs and “unnecessary wars.” Placing the U.S. dollar on a commodity standard (possibly linking it to a basket of commodities, rather than just gold) is not an absurd idea; it would help staunch inflation and depreciation. But any such move will have downsides as well. For one thing, a commodity standard may require high interest rates to maintain, damaging economic growth. It may also be subject to instabilities as the commodity supply fluctuates.
If the commodity standard credibly limits government spending, there may be a crisis involving the ability to pay for outstanding obligations (including wars that may not be so unnecessary). More likely, policymakers will simply dump the standard at times of crisis and war, as most of the combatant nations did with their gold standards in the Napoleonic Wars and World War I. In that case, the standard will have little credibility, which will lead to more financial turmoil. As for Paul’s further hope for a world in which private currencies compete against and possibly supplant government currencies, let’s just say we’re quite a ways off from that, and have very little historical basis for assessing its viability.
Current reform efforts should focus on strengthening, not weakening, the Fed’s ability to constrain inflation. That could mean giving the institution clearer statutory guidance to focus on inflation (it currently is required to focus on employment as well) or mandating a specific range of inflation rates to target. In the longer run, more radical steps, including commodity standards and private currencies, may prove useful. But all that will require an interest in serious reform, not in whipping up paranoid hysteria. Nothing good will come of Ron Paul’s book and his campaign of demonizing the Fed.
Brian Macker // Sep 17, 2009 at 8:04 am
#103 brian-macker: I can’t actually believe you wrote this: “You need to learn some actual history instead of the old wives tales you sopped up as a child. There was a much more severe downturn in 1920″ [than in 1929 onwards].
Yoctobarryc: “Look it up in an history book. You know, the ACTUAL history ones. Instead of those old wives tales you sopped up as a student from the Indoctrinare’s Club.
Real GDP Contraction 1920: 4%. Real GDP Contraction 1930: 27%. Source: measuringworth.com”
I’ve decided you are intellectually dishonest fool. Why? Because you trimmed my sentence without putting in elipses and then tried to make my statement about something it wasn’t. Here’s the full sentence:
“There was a much more severe downturn in 1920 for which the government did nothing other than reducing spending, it also let the market work and let prices seek their own levels and none of these problems occurred.”
One of those problems I was claiming didn’t occur in the last part of the sentence was GDP contraction. Both production and unemployment fell much faster and deeper during the first year of 1920-21 collapse. The government did not go on a crazy spending spree and things corrected just fine. None of this crazy belief that the deflation would cause people to save forever.
Here is a video by historian Thomas Woods. Watch it and learn something, you ignoramus.
Why You’ve Never Heard of the Great Depression of 1920:
http://www.youtube.com/watch?v=czcUmnsprQI
You just don’t understand the economics involved. You’ve been taught this crazy Keynesian economics where the belief is that throwing money out of helicopters is the way to properly fix a downturn. Well it isn’t. Didn’t “work” when Greenspan did it in 2002 and it isn’t going to work now either. It’s going to generate FALSE economic signals which will compound the problems. Just like the false signals that lead to overbuilding in housing.
WillyP // Sep 17, 2009 at 11:50 am
rodcarlson:
I admit I haven’t read through all of your posts fully… I would recommend, for ease of reading, employing more paragraphs. Haha, but that’s besides the point.
I don’t claim to be a professor or even a professional (professional economist, that is), just someone who has dedicated a significant amount of time to understanding and digesting the fundamentals of human economic activity. Once the fundamentals are in place – a dedicated student can probably come to understand them in a few months – analysis becomes much clearer and the fallacious reasoning of neoclassical economics becomes readily apparent. Having said that, I’ll give credit to yoctobarryc, who is clearly willing to engage in the debate. My hope is that he’ll slowly emerge from his neoclassical shell, and see how microeconomic tenets can be applied to the “macro” case as well. the difficulty inherent in such a breakthrough in thought is that it has obvious political implications as well, and people can be awfully stubborn when it comes to politics.
While I did not major in economics, I did have to take several courses, and I now find myself at odds with several (supposedly) eminent economists/former professors. It is disconcerting to realize that an entire academic discipline is essentially in the dark, mired in seemingly endless permutations of reasoning emanating from erroneous mathematical applications. I personally do not believe that the academy can survive this downturn when their prescriptions fail utterly, though I never doubt the ability of desperate and clever people to rationalize failure and of governments to promote governmental interests.
Your mathematical examples re: fractional reserve banking are probably correct as far as they go. I admit I did not check your math. However, banks earning money off depositors is not what I’m against, per se. What I am against is the creation of credit out of thin air; what is called “checkbook money.” This undermines accounting and the effects of this reverberate across the economy. Under a gold standard, this inevitably leads to bank runs. Under the Federal Reserve system of fiat money, what it leads to is back door socialism in monetary affairs. And simply put, the monetary system is at the heart of capitalism’s ability to coordinate valuable activity. If you “thin out” the money supply, so to speak, you seize the engine. See my article here:
http://www.americantusk.com/engines-lubricant-thins-out.html
Austrian economics faces one enormous challenge to overcome: positivism. It is inconceivable to most academics that something can be true and not be “proven” empirically on-demand. Modern professors of economics are nearly schizophrenic, in that they apply classical economic theory which is deduced through verbal logic, yet at the same time repudiate themselves through empirical “tests.” It is bad thinking. Furthermore, they suffer from a fatally flawed conception of money, which infects their thought on interest. These are not trifling issues. Proper revisionism in academia on money and interest could very well end the periodic economic mayhem experienced by industrialized nations.
What I would recommend for anyone serious about learning economics is to remove yourself from all textbooks (modern ones anyway) and look around you. Observe business, observe your own spending habits, think about how you obtain money and what happens to it after you spend it. Next, study history. Learn how societies were organized in the past – guilds, fiefdoms, aristocracies, cartels. Think about how legislation enforces certain organizational structures to emerge that impinge on individual freedom of association. Think long and hard about how law can be used to preserve special interests. I guess it should be apparent that I think law is indispensable when learning economics, so I’d also recommend reading this:
http://bastiat.org/en/the_law.html
I think it’s abundantly clear to anyone who would read this thread that Ken Silber is completely wrong in his review. It is also clear that it’s not a coincidence; as yoctobarryc’s arguments show us, it is the academic discipline that is corrupted to the core.
WillyP // Sep 17, 2009 at 12:01 pm
yocto,
I am going to stop replying directly to one-offs, because it is impossible to deal with these question if you separate them from a coherent, holistic approach to the subject. If this is going to continue (I’ll continue with it if you do, because as I see it, the more converts the better), I’m going to start responding with fuller responses that deal with the ideas as they relate to the theoretical whole of Austrian economics. This is the only way I can think to respond meaningfully.
WillyP // Sep 17, 2009 at 2:21 pm
yocto, just caught this now… (sorry I don’t always read very closely). You say “my country.” I’ve noticed your British spelling habits. Is this country Britain, or Canada? or?
WillyP // Sep 18, 2009 at 9:34 am
http://mises.org/story/3718
yoctobarryc // Sep 18, 2009 at 11:35 am
#127 brian-macker: The definition of an ellipsis is “The omission of a word or phrase necessary for a complete syntactical construction but not necessary for understanding.”
You can’t even use your own word right! You brazenly assert – no less than 3 times so far – that there was a bigger economic collapse in 1920 than in 1929 onwards. This is in complete contradiction to the historical facts, something you fail to come to terms with.
With or without government intervention, there is a substantial (6 times) difference between the two, and your comparison between the two is therefore flawed from the start. Not to mention the fact that you completely confuse cause and effect – government ‘treatment’ always happens after the crisis, not before.
#129 WillyP: I have no idea what “one-offs” you refer to. And yes, I am British. Not that should make any difference to the credibility of my ideas, mind.
1) I was reading today “The Black Swan” by Nassim Taleb, and he made a very interesting point. Both the “Post-Keynesians” like Minsky, Shiller, Akerlof etc all share very similar analysis to the Austrian School – monetary matters aside. Both schools agree on a broad business cycle, which comes about through bad business practices, and is corrected by a sharp downturn.
Where the schools differ is on their prescriptions to the business cycle: the Keynesians recommend some sort of stabilising influence, be it regulation, monetary/fiscal stimulus etc. Austrians take the complete opposite view, saying that government bureaucrats would be worse than the market, and we should let ‘nature’ take its course. It strikes me as to how much political belief and moral values underpin these two differing viewpoints.
2) Going back to previous comments, there seems to me to be a logical contradiction in your views: you strongly dislike the idea of centralised institutions, but centralised regulation seems quite pallatable to you – you endorse banning Fractional Reserve Banking, for instance.
3) You refer in your previous comment to how “the fallacious reasoning of neoclassical economics becomes readily apparent” and that “microeconomic tenets can be applied to the “macro” case as well”. You also bemoan the fact that “an entire academic discipline is essentially in the dark, mired in seemingly endless permutations of reasoning emanating from erroneous mathematical applications”.
The problem with your comments here are that you haven’t cited much evidence. If there are examples of neoclassical fallacies, please give them. Likewise, if there are erroneous mathematical applications, explain them. Otherwise I find it hard to engage with them.
4) The problem I have with Austrian Economics – although well reasoned and often written eloquently – is that I have not seen any logical or empirical proof of its theories. Now, if someone has a statistical study showing, on average, countries without central banks did better than those without them, I would be intrigued. If someone produced a study showing that, when the country was on the gold standard, macroeconomic perfomance was in general better, I would sit up and pay attention. But just hearing the same arguments over and over again (although again well argued and eloquently spoken) is not conducive to advancing the Austrian cause.
You seem to bemoan the use of mathematics in economic study. I would say that excessive use of maths is a bad thing, and is no replacement for a clear precise use of worded summary. But maths can bring some useful properties to rigorous academic study:
a) It allows quantification. You could say “gold standards improve economic performance” or “reduce inflation” or “cut the money supply” but the challenge here is saying by how much these effects would happen.
b) Maths allows you to integrate different theories together with ease. You can literally bolt together the model of gold standards on the money supply with a standard economic model of the economy.
c) It forces you to distil your ideas down into a simple formula – devoid of rhetoric or wordy rambling.
5) The POW economy article you found was a fascinating insight into what Hayek’s idea of “spontaneous order”. Amazing to think that from some simple food parcels, and people with lots of time on their hands, a whole microcosm of an economy could spring from nowhere.
I think it backs up the importance of a stable currency though – when in August 1944, the supply of cigarettes collapsed, I think the author was clear that a re-emergence of the cigarettes would have been universally beneficial. What was regulating the money supply equivalent? The whims of food parcels. If the food parcels (or even the Germans) had been giving out cigarettes at a more constant rate, the camp economy would have benefited.
WillyP // Sep 18, 2009 at 1:34 pm
By one-offs I mean very specific objections to what I’ve written. I don’t have a problem responding because I’m incapable, but because it make seeing the forest in the trees very difficult. So, excuse a one-off response or two here, but in general I’m going to stick to theory and the “big picture.” First, a quote.
“It is important to recognize that the additions to, or subtractions from, a cash balance are all voluntary acts on the part of the individuals concerned. In each period, some individuals
decide to add to their cash balances, and others decide to reduce them, and each makes that decision which he believes will benefit him most. For centuries, however, fallacious popular
usage has asserted that one whose income is greater than expenditures (exports greater than imports) has a “favorable balance of trade,” while one whose expenditures have been greater than
income for a period (imports greater than exports) has suffered an “unfavorable balance of trade.” Such a view implies that the active, important part of the balance of payments is the “trade”
part, the exports and imports, and that the changes in the individual’s cash balance are simply passive “balancing factors,” serving to keep the total payments always in balance. In other
words, it assumes that the individual spends as much as he wants to on goods and services and that the addition or subtraction from his cash balance appears as an afterthought. On the contrary,
changes in cash balance are actively decided upon by each individual in the course of his market actions. Thus, Brown decided to increase his cash balance by two ounces and sold his
labor services to obtain the money, forgoing purchases of consumers’ goods to the extent of two ounces. Conversely, in the later example, when he spent three ounces more than he earned
in the month, he decided that his cash balance had been excessive and that he would rather spend some of it on consumers’ goods and services. There is therefore never a need for anyone to
worry about anyone else’s balance of payments. A person’s “unfavorable” balance of trade will continue so long as the individual wishes to reduce his cash balance (and others are willing to purchase
his money for goods). His maximum limit is, of course, the point when his cash balance is reduced to zero. Most likely, however, he will stop reducing his cash balance long before this point.”
-Murray N. Rothbard, Man, Economy, and State
I quote this because it is critical to understand. Central banking activities and fractional reserve banking both undermine accounting. They create fake units of account. I don’t think you realize how absolutely crucial honest bookkeeping is to society, but you must have some idea after citing Enron and Worldcom. The automatic, self-correcting system of lending and saving that is fostered by double-entry accounting is undermined in a deadly way by counterfeiting. Economics is the overarching science behind two sub disciplines, accounting and finance. You would agree that both of these practical areas that utilize monetary units of account are extremely important to economic growth and coordination. Yet at the same time you’d undermine their methods by clipping the coins, so to speak – i.e., debasing the currency through the Fed and fractional reserve banking.
Mises often quoted Goethe:
“Double-entry bookkeeping is one of the most beautiful discoveries of the human spirit… It came from the same spirit which produced the systems of Galileo and Newton and the subject matter of modern physics and chemistry. By the same means, it organizes perceptions into a system, and one can characterize it as the first Cosmos constructed purely on the basis of mechanistic thought… Without too much difficulty, we can recognize in double-entry bookkeeping the idea of gravitation, or the circulation of the blood and of the conservation of matter.”
I know you aren’t one for old authors, but does this give you any pause? Especially when taken in conjunction with the quote above from Keynes? Further, when considered in context of historical examples of the effects of rampant inflation? You should ask a professor what he thinks of the process of undermining accounting.
“Going back to previous comments, there seems to me to be a logical contradiction in your views: you strongly dislike the idea of centralised institutions, but centralised regulation seems quite pallatable to you – you endorse banning Fractional Reserve Banking, for instance.”
To be fair, I may have advocated banning this practice. However, it is more accurate to say that I believe that people would abandon the practice if there was a repeal of legal tender laws. Then very few people would choose to put their money in an unscrupulous bank. We now run into problems of methodology and what Hayek called the “Pretense of Knowledge.”
Your objection to the Austrian school is understandable in the context of poor theoretical reasoning; a problem that afflicts the academy at large in economics’ departments. Austrian economists are not opposed to mathematics in the least. It’s just that they recognize that it is not the proper way to advance the science. Instead, we use verbal descriptions of human action and consequence to arrive at certain truths. The method used to advance the science past the individual and to broader society is called methodological individualism. We don’t claim to make predictions with great specificity. Instead, we look to describe the laws of nature, and through that make broad predictions. Again, if you require proof that your school’s approach has failed, just look around. It isn’t Austrians sitting around and running the Fed, the IMF, and the ECB.
For example: if the Fed cuts rates dramatically, a bubble will form and then pop. We know that it is impossible to consume a loaf that is not yet in existence, so how does the seeming magic of the boom materialize? It comes at the expense of future savings and investment in capital! Let’s say as a businessman I reinvest $500/week into my business for future production/expansion. If this $500 is worth substantially less a year after a rate drop from the Fed and I don’t know, I go on continuing to reinvest $500, when it’s now only worth $400. This extra $100 is invested somewhere else at below market rates. In a few years, the errors are exposed and two things occur: 1) The unprofitable businesses started on the presumption of low interest rates must be liquidated 2) I have under saved, and am under capitalized, so I must save more going forward. So, a dramatic reduction in interest rates amounts to a giant loan for the country. It fuels uneconomic and unprofitable ventures, and distorts the capital structure of an economy. It is worth emphasizing: once the boom has been initiated, there is no avoiding the bust. It is absolutely 100% inevitable, no question about it.
“If someone produced a study showing that, when the country was on the gold standard, macroeconomic perfomance was in general better, I would sit up and pay attention.”
Bluntly, this is sloppy thinking. How can a social science produce a controlled experiment? It cannot. We advance social sciences by improving on theory. However, if you insist on historical examples, the Great Depression offers an example of how disastrous widespread government intervention into an economy can be. We’re talking a decade of poverty for a modern, industrialized nation because some paper money disappeared – followed by the importation of fascism by FDR as a solution to America’s economic woes. How’d that work out? And, to top it off, the Fed caused the damn thing to begin with! Please don’t tell me that America was on a gold standard. Yes, it was technically, but it was also recently slapped with a central bank that began manipulating its interest rates.
The Neoclassical school, it seems to me, views the economy like a car with a dead battery. It just needs a jump-start, a jolt from without, to kick back into gear. To me this sounds like a rather simplistic notion unless we’re talking cars. Nonetheless, humans are the dead batteries. “Hey, those silly underlings stopped spending money because somehow they were all duped into buying overpriced houses ha ha! No matter, flood the economy with money and they’ll spend more. This in turn will spur production, and create more demand. And then we’ll have ‘fixed’ it! Oh, those miserly, stupid peasants who live under our jurisdiction. How blessed they are to have us to tell them noble lies and save them from their shortsighted selves!” For me, that about sums up the neoclassical economic attitude.
I’ll keep repeating it: you do not understand money. It too is subject to marginal utility. Read the Bastiat piece.