golfnut777 -- Polyconomics: First of all, let me say that before your post I had never heard of Polyconomics, and I haven't taken the time to read other items on the Web site. The "Memo to Greenspan" is the only piece I've read. This is to admit that I don't know Polyconomics and so may be missing some important aspects of this argument.
With this preliminary in mind, what do I think about the "Memo"? It's interesting, the kind of out-of-the-box thinking that I like. It also seems to address an important structural problem in our economic system, which is that we don't really have a mechanism to inject money into the economy except through debt-creation. However, I ultimately think a program like the one the "Memo" proposes would have negative, possibly disastrous, consequences for the economy.
What I believe the "Memo" argues, if I understand correctly, is this: the Fed should target the price of gold in a manner that resembles its targeting of the Fed funds rate. The way the Fed's targeting of the funds rate works is as follows. The Fed establishes a target interest-rate level through FOMC votes, then either buys or sells government securities in order to ensure that interest rates hit the target Fed funds rate that the FOMC agreed upon. When the Fed buys these securities (which occurs when the FOMC lowers interest rates), it pumps money into the economy; conversely, when the Fed sells these securities (FOMC raises interest rates), it drains money from the economy. The "Memo" seems to be arguing that the Fed should treat gold the same way, establishing a target price for gold and then either buying or selling gold on the open market in order to peg gold at this price. Of course, as with government securities, buying gold would add money to the economy, and selling gold would withdraw money from the economy.
The important implication of this proposal, in my view, is that it would establish a mechanism that the Fed could use to control the money supply without working through the credit system. As things now stand, the Fed directly "creates" money by buying government debt and indirectly "creates" money by encouraging lower interest rates -- thus, more borrowing -- in the credit markets. On the other hand, when the Fed raises interest rates, it directly "destroys" money by selling federal debt and indirectly "destroys" money by encouraging higher interest rates -- thus, less borrowing -- in the credit markets. The power and the danger of this system is that a small lever, the establishment of target interest rates, can have massive effects that reverberate through the entire economy. What, though, if the government wants to add or drain some money without shaping the overall credit environment? Which is to ask: what if the government wants to add or drain some money without changing the overall growth profile for the economy?
It seems especially important, in economies where there is already a high level of debt, to give the government tools to add money without creating more debt. The United States -- government, corporations, and individual consumers -- is a heavily indebted nation. Do we really want to escalate this already-high level of debt any time we need to add money to the economy? There are serious dangers in this. All we have to do is look to Japan to see the risks of an undisciplined credit environment. Who, in the end, is going to step forward and save the government of the world's second-largest economy from bankruptcy? The world's largest economy? Until the 1990s, the U.S. government was following precisely the same trajectory as Japan, and U.S. corporations and individual consumers are still taking on debt at a frightening pace. Under these circumstances, it certainly seems reasonable to look for ways to inject money into the economy without relying on the old formula of money creation through debt creation.
As I said, however, I think the solution proposed in the "Memo" would create serious problems -- perhaps even catastrophic problems. The core issue is one of confidence. There is great fear of situations where governments "print money" in order to increase money supply. The example of Germany in the 1920s is the ultimate standout on this score. The German government flooded the economy with paper that was essentially worthless by the time it hit the streets. This paper became worthless because there was no confidence in it: if money can be manufactured and put into circulation just as readily as toilet paper, then what's the difference between the two? The question that's relevant to the "Memo" is this: would the money-for-gold exchange be seen as a controlled mechanism for introducing money into the economy, and therefore as a system that would maintain confidence in the value of money, or would it be viewed as a way of "printing money" and thus undermine confidence in the value of money and inspire fears of inflation? The essential assumption behind the "Memo" is that the money-for-gold exchange would be seen as controlled and therefore as a mechanism that would maintain confidence in the value of money. I'm skeptical of this, for a couple of reasons.
One, the more concrete reason, is that we see inflation as the great bogeyman of our economy -- and our economists tell us that growing supplies of money heighten the risks of inflation. I think any attempt to establish new mechanisms for money creation would yield a sense of alarm: that the Fed is more concerned with creating money than with targeting inflation, perhaps because the debt load has become so heavy that we need to print money in order to pay down our obligations. If this interpretation won out, confidence in the financial markets would crash and take the entire economy down with it.
Two, the more abstract reason, is that the "Memo" makes many assumptions about the economic function of gold that are, quite frankly, out of date. The "Memo" looks upon gold as if we were still on the gold standard: gold is intrinsically a store of monetary value, gold is the substance that backs paper currency and coinage, etc., etc. The underlying assumption is that gold intrinsically inspires confidence and therefore naturally serves as a controlled mechanism for managing the money supply. The problem is that these assumptions do not accurately describe the economic world we live in today. Gold no longer serves as an intrinsic store of monetary value; it has lost much of its justification as a reserve asset. Gold has value -- but as jewelry and as a conductive metal, not as money. This is why investors ignore gold when there's a flight to quality. It's why the price of gold is no longer useful as a gauge of inflation. (I always laugh when Larry Kudlow cites the price of gold as evidence that there's no inflation in the economy. Even if I agree with him that there's no inflation, I have to laugh at his reasoning, because the price of gold simply is not a signal on this any longer.) And it's why central banks throughout the world are dumping their gold. The de-monetization of gold would be complete if the U.S. ever decided to start unwinding its reserve of gold, although, as an aside, I'm undecided about whether I think this will happen because it would decimate the gold industries. The question is: will U.S. gold policy be determined by interests that are "long" or "short" gold? There are several influential U.S. banks shorting gold that would do very well indeed if the U.S. government started selling down its gold reserves.
The thrust of this second point is simply that gold no longer appears to command the confidence that would be required to make Fed-targeted money-for-gold exchanges a controlled process for adding money to the economy.
Here are some closing questions to ponder: what distinguishes money creation through credit creation from other possible methods of money creation -- that is, from "printing money"? In other words, why do we regard credit creation as something different from, and better than, "printing money"? Are there any conceivable mechanisms, outside the credit system, for the government to inject money into the economy without inspiring fears that the government is simply "printing money" in an uncontrolled manner? |
