Yes, I know about the famous JS Mill quotation.  But when I was younger I thought the right had a lot of intellectual momentum.  The world was moving away from statism and toward neoliberalism, and it seemed like conservatives had most of the good economic ideas.

Of course there has always been a anti-intellectual strain to populist conservatism, as when the right romanticizes the “Golden Age” of the 1950s, before all those evil liberation movements of the 60s gave rights to blacks, women, and gays.  But at least on economics I used to think of conservatives as being relatively hard-headed.  So what is one to make of this appalling column in Forbes magazine:

Amid the very reasonable handwringing about the Fed’s charitably naive attempts to stimulate the economy through “quantitative easing”, there’s an understandable drive among some Fed critics to severely reduce its mandate. Specifically, the Fed can’t create jobs as its defenders inside and outside the central bank presume, so better it would be limit its role to that of inflation watchdog.

All that is fine on its face, but in seeking to redefine the Fed’s doings, naysayers have happened upon the false notion of “price stability.” A recent editorial argued in favor of repealing the Fed’s dual mandate so that it can concentrate “on the single task of stable prices”, and then politicians such as Reps. Paul Ryan and Mike Pence have similarly called for price stability in working to redefine the activities of the world’s foremost central bank.

Sadly, handing the alleged wise men at the Fed control over prices is every bit as mistaken as allowing the central bank to manage unemployment.

Indeed, it is through prices that the market economy is organized. In that certain sense, prices rise and fall with great regularity as consumers tell producers what they want less and more of. Assuming the Fed could do what it cannot; as in fine tune economic activity on the way to stable prices, we would be much worse off if Bernanke et al were to actually succeed.

To see why, it has to be remembered that the cure for high prices is in fact high prices. Or better yet, high prices foretell low prices.

If producers create a consumer product that fulfills unmet needs on the way to high prices, the latter is the signal to other producers to enter the market for the same good on the way to lowering its cost. Gyrating prices are the necessary market signal telling businesses what we need.

Taking this further, if price stability were policy, it would still be the case that a phone call from Houston to Dallas would cost $15 for a half hour of conversation. It would similarly mean that we’d be paying thousands of dollars for flat-screen televisions, not to mention even more for computers that perform very few functions.

I’m not going to insult my readers’ intelligence by describing what’s wrong with the last paragraph.  If you don’t know, go read someone elses blog.  At first I thought this might be an innocent slip up.  Nobody’s perfect.  Editors are very busy people, they can’t spot all mistakes.  But the rest of the piece is equally bewildering:

In that case, rather than price stability, the sole goal of monetary policy should be dollar-price stability. Fed officials would credibly argue that the latter is the preserve of the U.S. Treasury, and they would have a point. Be it Treasury, or Treasury working with the Fed, the mandate should be in favor of stabilizing the dollar’s value.

Um, isn’t the entire point of price stability (which I don’t favor, BTW) stabilizing the value of the dollar?  Indeed isn’t true that, by definition, a stable value of money means a stable purchasing power?  Not to John Tamny.  He seems to define a stable value of money as a stable price of gold.  Why gold?  Why not a stable price of bricks, or toothpicks, or zinc?  He doesn’t say.  Nor does he seem to have the slightest intellectual curiosity about periods in history when the dollar price of gold was stable, like 1929-33, when we had severe deflation (which provided falling prices of electronic goods like radios!), and 25% unemployment, and so discredited capitalism that we elected exactly the sort of politician that Forbes magazine would despise.

Oddly enough, Marx once again had the answer there. Marx, much like the classical economic thinkers of his era, knew that for money values to be stable, they would have to be defined in terms of gold. Marx referred to gold as “money, par excellence.”

Looked at through the prism of today, the dollar lacks a golden anchor, and the result is a money illusion that distorts the real price of everything. Worse, with consumer prices sticky in concert with commodity prices that are most sensitive to dollar-price movements, the beneficiaries of the money illusion tend to be the hard, unproductive assets of yesterday (think housing, art, rare stamps, and oil) that are least vulnerable to currency weakness, and which in fact do best when the unit of account is devalued.

Well if Marx says money must be good as gold, who am I to argue?  Reading this column I can’t help but wonder why all this talk about currency depreciation is occurring when inflation is at the lowest point of my lifetime, indeed lower than during 1896-1914, the so-called Golden Age of the gold standard.

The answer to all of this is very basic. Price stability is a utopian concept on its best day that would hamper innovation on the way to reduced living standards.

The greater, more obvious answer is dollar price stability of the gold kind that would allow investors to rate ideas on their actual merits, as opposed to how they’ll perform amid dollar policy since 2001 that has erred in an economically crippling way in favor of weakness. Fix the dollar, and you fix the U.S. economy. Simple as that.

Isn’t that wonderful!  No need to worry about messy real world issues like macroeconomics.  No need to worry about how nominal shocks can have devastating real effects.  Gold is like a magic wand that will fix the US economy.  But there is one huge flaw with this argument; there are two types of gold standards, and neither produces anything like satisfactory macroeconomic outcomes:

1.  One type is a managed standard, such as we had in the US between 1879-33, and in a weaker form under Bretton Woods.  In that standard the nominal price of gold is fixed (just as Tamny wants) but its real value is highly unstable, as the economy would often suffer from deflation.  The most devastating example was 1929-33.  It’s true that the supply of gold rises at a fairly steady rate, but central bank real demand for gold was highly unstable, and thus the price level was unstable.  Of course you could argue that the central banks should have done a better job of stabilizing gold demand, but by that logic why not just have fiat money and then have them do a better job of stabilizing monetary policy.  Even worse, if we returned to the gold standard almost no other country would be nutty enough to follow.  In that case when people in places like China and India hoarded gold out of fear of inflation, America would suffer deflation.  And from history we know that deflation in America would lead to fears of devaluation, which would cause gold hoarding in America as well, and even more deflation.  Tamny doesn’t even think about those issues, but why should he when he considers deflation to be a good thing?

2.  Some have advocated a laissez-faire gold standard.  In this case the government simply pegs the price of gold, but doesn’t hold large stocks of gold.   This would be even worse than a managed standard, as the relative price of gold would then be determined exactly as the relative price of any other metal is determined, by “industrial demand.”   Rapid economic growth in Asia has been boosting the relative prices of other metals such as silver, copper and iron.  If gold was just an industrial commodity, then its relative price would also be quite volatile.

So either way the gold standard offers no advantages.  At best, a highly managed international gold standard might lead to rough price stability.  But if central banks were really able to manage gold that well, they’d also be able to mange fiat money.

I suppose I am wasting my time with this post.  If the right now believes that deflation doesn’t matter, that 1929-33 is like some bad dream that never really happened, then nothing I say will make any difference.

HT:  Bruce Bartlett

Paul Krugman made the following comment about a recent statement by Obama:

And here’s this, from Thomas Ferguson: Obama saying

“We didn’t actually, I think, do what Franklin Delano Roosevelt did, which was basically wait for six months until the thing had gotten so bad that it became an easier sell politically because we thought that was irresponsible. We had to act quickly.”

As Ferguson explains, this is a right-wing smear. What actually happened was that during the interregnum between the 1932 election and the1933 inauguration “” which was much longer then, because the inauguration didn’t take place until March “” Herbert Hoover tried to rope FDR into maintaining his policies, including rigid adherence to the gold standard and fiscal austerity. FDR declined to be part of this.

But Obama buys the right-wing smear.

I’m not a FDR hater; I think he was “magnificently right” to devalue the dollar (to quote Keynes.)  But FDR probably should have cooperated with Hoover–even if it meant (falsely) promising not to devalue the dollar.

And please don’t say “but that would have been lying.”   Here’s the Democratic Party platform that FDR campaigned on:

The Democratic Party solemnly promises by appropriate action to put into effect the principles, policies, and reforms herein advocated, and to eradicate the policies, methods, and practices herein condemned. We advocate an immediate and drastic reduction of governmental expenditures by abolishing useless commissions and offices, consolidating departments and bureaus, and eliminating extravagance to accomplish a saving of not less than twenty-five per cent in the cost of the Federal Government. And we call upon the Democratic Party in the states to make a zealous effort to achieve a proportionate result.

We favor maintenance of the national credit by a federal budget annually balanced on the basis of accurate executive estimates within revenues, raised by a system of taxation levied on the principle of ability to pay.

We advocate a sound currency to be preserved at all hazards and an international monetary conference called on the invitation of our government to consider the rehabilitation of silver and related questions.

Politicians lie all the time.  They are expected to lie.  The British government lied in 1931, 1967, and 1992, when it said it wasn’t going to devalue, before it did devalue.  That’s expected.  Everyone knows that if you say you will devalue in the future, it forces an immediate devaluation.  And under a gold standard if there is uncertainty about whether a devaluation will occur then gold hoarding increases, which is deflationary.  This happened on four occasions during the Great Depression, and on each occasion asset prices and industrial production declined sharply.

FDR basically had three choices.  The traditional route would have been to lie and say that he would adhere to the platform, maintaining the gold standard while working toward an international agreement to give silver a monetary role.  The markets knew that other countries weren’t going to adopt silver.   Then when he took office he could have said; “Because I wasn’t able to get agreement, we have to go it alone with a currency devaluation.”

Or he could have told the truth and said he was going to devalue the dollar.  That would have forced Hoover’s hand, and a devaluation would have occurred almost immediately.  The promising upswing of July to October 1932 would have turned into an explosive boom.  The 57% increase in industrial production that occurred during the first four months of FDR’s term would have instead occurred in the last 4 months of the Hoover administration.  If FDR had gone ahead with the NIRA’s high wage policy then he would have been blamed for aborting the Hoover recovery.

Instead he was continually evasive.  Even in Hoover’s last days in office he refused to support any of Hoover’s actions to address the banking crisis.

The interregnum was a horrible period, with an enormous amount of suffering during the winter of 1932-33.  It was the low point of the Great Depression.   And although the Depression itself was Hoover’s fault, this especially bleak period was partly FDR’s fault.  I’m not one of those conspiracy buffs who thinks FDR intentionally allowed Pearl Harbor to happen.  And I doubt he fully understood the effect of his evasive answers.  But most educated observers back then knew what was going on.  They knew that uncertainty about the dollar was depressing the economy.  The press pointed to similar events during the late 1800s, when fears about the soundness of the dollar had also had a deflationary impact.  FDR had three options, and he picked the one that imposed maximum harm on the economy.  That’s no right wing smear, it’s the truth.

Update:  Commenter Russ Anderson pointed out that this post was confusing.  I should have been clearer that while the best option for the country was for FDR to state he would devalue, and force Hoover’s hand, that option was a complete non-starter, politically unacceptable.  Those things just are done.  Given that the best option wasn’t really on the table, he should have said he’d maintain the gold standard.  Nothing I said should be seen as implying that the Great Contraction was caused by anyone other than Hoover.

My research career often focused on offbeat topics that no one else seemed to be interested in.  Now it might be paying off.  One of those topics was Roosevelt’s “gold-buying program” of October-December 1933.  The only other article I’ve ever seen on this topic was published in an agricultural journal back in the 1950s.  This program was the last time (and perhaps only other time) that the US government explicitly tried to raise the price level.  Admittedly the entire April 1933-January 1934 dollar depreciation policy was aimed at reflation, but only during the gold-buying phase was the policy made explicit, and was a methodical policy followed to raise prices.

I did a long post on this in early 2009, and won’t repeat it all here.  Check out the post if you want to know more about how it was done.  Instead I’d like to discuss one very interesting aspect of the program that is relevant to what is going on right now.  (The policy involved raising the dollar price of gold to devalue the dollar.)  Here is a short passage from my Depression manuscript:

Then on November 20 and 21, the RFC price rose by a total of 20 cents and the London price of gold rose 49 cents.  On November 22 the NYT headline reported “SPRAGUE QUITS TREASURY TO ATTACK GOLD POLICY” and on page 2, “Administration, Realizing This, Vainly Tried to Persuade Him to Silence on Gold Policy”.  As with the Woodin resignation, Sprague’s resignation led to a temporary hiatus in the RFC gold price increases, this time lasting five days.

Over the next several days the controversy continued to increase in intensity.  The November 23 NYTreported “RESERVE’S ADVISORS URGE WE RETURN TO GOLD BASIS; PRESIDENT HITS AT FOES” other stories reported opposition by J.P. Warburg, and a debate between Warburg and Irving Fisher (a supporter of the plan).[1]  Another story was headlined “WARREN CALLED DICTATOR”.  The November 24 NYT headline suggested that “END OF DOLLAR UNCERTAINTY EXPECTED SOON IN CAPITAL; RFC GOLD PRICE UNCHANGED”.  Nevertheless, over the next few days the NYT headlines showed the battle raging back and forth:

“ROOSEVELT WON’T CHANGE GOVERNMENT’S GOLD POLICY, IGNORING ATTACK BY [former New York Governor Al] SMITH”  (11/25/33)

“SMITH SCORES POLICY . . . Says He Is in Favor of Sound Money and Not ‘Baloney’ Dollar . . . ASKS RETURN TO GOLD . . . Critical of Professors Who ‘Turn People Into Guinea Pigs’ in Experiments” (11/25/33)

“GOLD POLICY UPHELD AND ASSAILED HERE AT RIVAL RALLIES . . . 6,000 Cheer [Father] Coughlin as He Demands Roosevelt Be ‘Stopped From Being Stopped'” (11/28/33)

---

[1]  Fisher regarded Roosevelt’s policy as being essentially equivalent to his Compensated Dollar Plan.  Although there were important differences, the rhetoric used by Roosevelt to justify the policy was remarkably close to the rationale behind Fisher’s plan.

The Fed better fasten its seat-belt, as the previous price level raising policy was a bit controversial.  Several FDR advisers resigned in protest.

George Warren was the FDR advisor behind the plan.  Warren was to Irving Fisher roughly what I am to Milton Friedman—similar ideology but lacking the intellectual brilliance.   Here’s a more important passage:

“It is indeed difficult to find out exactly what are Wall Street’s views with regard to the monetary question.  When former Governor Smith made public his letter and stocks were going up, there seemed to be little doubt that Wall Street wanted sound money.  But yesterday, faced with the sharpest break of the month, opinion veered toward inflation again.  As one broker expressed it, it begins to appear as if Wall Street would like to see enough inflation to double the price of stocks and commodities, but little enough so that Liberty bonds can sell at a premium.” (NYT, 11/28/33, p.33.)

One explanation for this ambiguity is that investors distinguished between once and for all changes in the price level, and changes in the rate of inflation.  During the early stages of the dollar depreciation, long term interest rates held fairly steady, and the 3 month forward discount on the dollar (against the pound) remained below 1.5 percent.  The market apparently viewed the depreciation as a one-time monetary stimulus, which would not lead to persistent inflation.  Investor confidence was shaken during November, however, when persistent administration attempts to force down the dollar were associated with falling bond prices and an increase in the forward discount on the dollar.  Consistent with this interpretation, the Dow rose 4.6 percent in mid-January 1934, following the Administration’s announcement that a decision was imminent to raise, and then fix, the price of gold.  The NYT noted that:

“The satisfaction found by stock and commodity markets in the inflationary implications of the program was nearly matched by the bond market’s enthusiasm for the fact that the government had announced limitations to dollar devaluation.” (1/16/34, p. 1).

The takeaway from all this is that markets seem to really want higher prices, but not higher inflation.  You do that by switching from inflation targeting to level targeting, when inflation has recently run below target.  Yesterday when the Fed minutes suggested the Fed was about to do that, equity markets responded strongly all over the world.  I’d guess about $500 billion dollars in wealth was created worldwide in 24 hours by 13 words from the Fed’s minutes:

. . . targeting a path for the price level rather than the rate of inflation . . .

The markets already knew QE was likely, but now the Fed seems increasingly serious about level targeting.

In 1933, the markets were surprised when the gold buying program briefly pushed long term T-bond yields higher (Liberty bonds in the quotation.)  Under the gold standard, the expected rate of inflation was generally roughly zero.  Investors were used to a liquidity effect (easy money means low rates) but not a Fisher effect (easy money raises inflation expectations, and thus interest rates.)  Even Keynes was pretty much oblivious to the Fisher effect:

“If you are held back [i.e. reluctant to buy bonds], I cannot but suspect that this may be partly due to the thought of so many people in New York being influenced, as it seems to me, by sheer intellectual error.  The opinion seems to prevail that inflation is in its essential nature injurious to fixed income securities.  If this means an extreme inflation such as is not at all likely is more advantageous to equities than to fixed charges, that is of course true.  But people seem to me to overlook the fundamental point that attempts to bring about recovery through monetary or quasi-monetary methods operate solely or almost solely through the rate of interest and they do the trick, if they do it at all, by bringing the rate of interest down.” (J.M. Keynes, Vol. 21, pp. 319-20, March 1, 1934.)

Before we judge Keynes too harshly, recall that he lived in a time of near-zero inflation expectations, with the exception of clearly anomalous situations like the German hyperinflation.  So when FDR’s policy of reflation briefly seemed to be raising long term bond yields in November 1933, bond market participants were rather shocked.  And here’s what I find so fascinating; modern security markets are only now beginning to grapple with this distinction, which turns out to be pretty hard to wrap one’s mind around.  Here’s something from today’s news:

Neil MacKinnon, global macro strategist at VTB Capital, said the worry in the markets is that the Fed’s attempt to raise inflation may not be as manageable and as controllable as it thinks.

“The bond market is alert to the potential contradiction in Fed policy of buying U.S. Treasuries to keep bond yields down and ideas such as price-level targeting that are likely to raise bond yields,” he said.

That’s the conundrum; what counts as “success,” higher nominal bond yields or lower nominal bond yields?  Everyone seems to assume the Fed is trying to lower bond yields, but if the policy is expected to produce a robust recovery and higher inflation, how can bond yields not rise?  I can’t answer these questions, but my hunch is that it has something to do with the higher inflation/higher price level distinction.  If the Fed can convince markets that they can raise the price level without changing their 2% inflation target, it is likely that all markets will react positively.  If they are seen as raising inflation in a semi-permanent way, stocks may still rise (albeit by a smaller amount), but bonds will sell off.

This is such an unusual circumstance that I don’t have much confidence in my own opinion, nor anyone else’s.  I don’t even know of anyone else who bothered to study what happened the last time Uncle Sam tried to raise the price level.  Too busy doing those VAR studies and DSGE models.

PS:  Where did the $500 billion figure come from?  I guesstimated world stock market valuation at about $50 trillion, with a 1% bump from the Fed move.  The financial press reported that all the world’s stock markets were affected by the Fed action.  I noticed that European stocks rose about 2%, and the Fed move was cited as the primary factor.  So I think $500 billion is roughly the order of magnitude, although obviously the exact figure is unknowable.  BTW, sometimes it is possible to get semi-accurate estimates, as when a huge market reaction following immediately upon a 2:15 Fed announcement and we have relevant odds from the fed funds futures markets.  And in those cases the effect is often much bigger.  I can’t wait for November 3rd.

With the stock market one never knows for sure, but this AP story is at least hinting that tight money in 2008 explains the severity of the recession:

NEW YORK (AP) — Stocks are set to extend their gains Wednesday as expectations continue to grow that the Federal Reserve will take steps to stimulate the economy at its meeting next month.

.   .   .

But weak jobs figures could also be enough to get the Federal Reserve to resume buying Treasurys in an effort to try and stimulate borrowing and spending. Japan’s announcement Tuesday that it cut a key interest rate to near zero percent and will buy some of its government bonds is adding to expectations the U.S. Fed will take similar actions to buy bonds.

The U.S. central bank long ago set interest rates at near zero percent, so it’s likely to buy Treasurys in an effort to further drive interest rates lower. The move would also make investing in stocks and riskier assets more enticing because yields on bonds would continue to drop.

[Note: The story was later altered, so the link has changed.]

If mere expectations of a Fed move that is likely to be cautious and timid are causing a significant rally on Wall Street in recent weeks, then that tells me that monetary policy is still very important at zero rates.  It also tells me that if policy had been much more expansionary in late 2008, the stock market would have done far better, for two reasons:

1.  The drop in AD would have been milder if NGDP growth expectations 2 years out were much higher.

2. The financial crisis would have been milder.

One almost never observes severe recessions without stock crashes, so if policy had been expansionary enough to give the stock market hope that the recession would be mild, then I think stocks would have done much better, and the recession most probably would have been much milder.  It would have been a “recalculation recession” of the sort we had during December 2007 to July 2008.

Perhaps an analogy from the Great Depression would help.  During the long contraction of 1929-33 a number of progressive monetary theorists like Hawtrey, Cassel, and Fisher said the root cause of the Great Depression was the increasing value of gold.  That was not a widely held view (otherwise the Great Depression never would have happened.)  Between March and July 1933, FDR provided a decisive test of that theory, by sharply reducing the value of the dollar in terms of gold.  Stocks, commodities and industrial production took off like a rocket, despite a banking system flat on its back, with many banks shut down.  I saw this upsurge as providing retrospective confirmation of the explanation of the Great Contraction provided by the progressive monetary theorists.

The likely monetary easing this time will be far, far milder, and the stock rally is also much less impressive.  So it’s not proof, just a tantalizing piece of evidence that we quasi-monetarists might have been right all along.

PS.  Because of a heavy workload at school and a huge volume of comments, I will fall way behind for a few days.  As usual I hope to eventually get to all my comments.  Thanks for your support.

Consider this:

The present depression is not an act of God for the purification of men’s souls. It is not a business cycle. It is not due to extravagant living. It is not due to unsound business practices. It is not due to too great efficiency. It is not due to lack of confidence, but is the cause of lack of confidence. It is due to high demand for gold following a period of low demand for gold. It teaches the devastating effects of deflation, but teaches no other lesson that is good for society. (Warren and Paerson, 1933, p. 125)

I think that’s the first time I ever used both italics and bold font in the same passage.  I would have preferred to have used a megaphone—in an FOMC meeting, but my computer doesn’t have that option.  Here is Gustav Cassel:

 “the way in which the Gold Delegation presents the causes of the breakdown of the gold standard seems to me entirely unacceptable. What we have to explain is essentially a monetary phenomenon, and the explanation must therefore essentially be of a monetary character. An enumeration of a series of economic disturbances and maladjustments which existed before 1929 is no explanation of the breakdown of the gold standard. In fact, in spite of existing economic difficulties, the world enjoyed up to 1929 remarkable progress. What has to be cleared up is why the progress was suddenly interrupted.” (1932, League of Nations, Memorandum of Dissent.)

HT:  Douglas Irwin