Now we can look at what the Fed wants its policy to do and what it's actually doing. Well, again using common sense and not econo-babble, what happens when you make more of something (in this case money...)? Its value drops! Supply and demand! So the Fed is actually achieving the reduction of the value of all dollar monetary assets in the United States and abroad (hear this Arab/OPEC countries!). It is, in effect, creating a process by which everyone wants to get rid of dollars. And how do you get rid of dollars? You buy things with them. And this, supposedly, is improving the economy. Unrestrained spending not backed at all by production or any commodity money value.
Again let's visit Mr.Smith. Mr.Smith has $500 in his bank account which he was planning to save for hard times. However, he realizes that the Federal Reserve is increasing the money supply and his money is going to drop in value. He can observe this without knowing anything about the Fed or its actions. All he needs to do is look at the fact prices are visibly rising in the stores (as they have been for the past 100 years). Now Mr.Smith is inclined to spend his money as fast as possible instead of saving it! After all his $500 might buy him and TV today and tomorrow it might not be enough for a radio... who knows? All is uncertain when Mr.Bernanke is at the helm! We are all Mr.Smiths. We all spend as quickly as possible. Fed policy discourages savings. And that drives market interest rates way up. So the Fed has to lower its own interest rates to near zero levels in order to allow for any investment to occur. And this vicious cycle continues... on and on and on. As I wrote earlier this month - the Fed are serial-bubble-blowers. This term, coined by Peter Schiff, has definitely become one of my personal favourites.
"The value of a currency depends on the volume of production standing behind it. Falling production weakens, rising production strengthens it. Money is only a matter of paper production. The real task is to increase production to the extent that money is increased." By no means are these words by German Führer Adolf Hitler about money ideally true. However, he seems to understand much more about the economics of money than Mr.Bernanke or Mr.Krugman. Fiat money is indeed just a matter of paper production. We need more viable production to back it. If not, the gold standard is the only option. In the long run the Commodity Standard is the only viable option!).
Economists have noted various problems and benefits associated with a commodity standard. A potential problem arises when the price of the anchor good (or goods) regularly fluctuates. Since the prices of all other goods in the economy are determined by the price of the anchor good(s), they adjust to price fluctuations of the anchor good. Take for example an economy operating under a commodity standard where gasoline is the anchor good. Gas station signs show that the price of gasoline fluctuates on a daily basis. In such a scenario, the prices of every other good are adjusted on a daily basis. Facing daily changes in prices would be a nuisance for consumers, whose natural desire is to see stable prices. A way to avoid this problem is to select an anchor good whose price does not fluctuate, or to choose a basket of goods whose price remains stable over long periods of time.
ReplyDeleteIt is questionable whether an economy under a commodity standard would indeed have less inflation than under a fiat currency system. The reason for this is that the commodity content of the dollar can be redefined by the government at any time. That is, the government would have the power to create inflation simply by raising the dollar price of the commodity base(s). Such an act would have the same effect as increasing the amount of dollars in the monetary base.
The fed's actions have hurt developing nations far more than America's. Most of the $600 billion the Fed pumps into the U.S. economy is going to find its way into the financial markets of emerging market countries, strengthening their currencies with devastating consequences for exports from developing countries. That is why China is taking steps to combat the natural appreciation of their currency in the face of QE2, because even the Chinese Premier Wen Jiabao states that they are still primarily and export economy because they "want to keep as many Chinese employed as possible, regardless of economic monetary policy." Interestingly enough, the new 2011-2015 five year plan of China states that they are driven to turn the economy from export based to consumer based within the fifth generation of Chinese leadership. In other words, China is still reliant on the US regardless of debt levels to keep unemployment low in their "developing" country.
ReplyDeletehttp://blogs.wsj.com/chinarealtime/2010/11/18/premier-to-be-expounds-the-five-year-plan/?KEYWORDS=china+2011+2015
Also, every major economist is expecting food and fuel prices to rise, but no one except for a handful of the vocal minority, not even the WSJ, is expecting the CPI to exceed 4% to 5% annual past 2018. Everyone is predicting 9% unemployment until 2015, which will probably mean an unfortunate level of minimal stagnation. Gdp growth will be about 1-3% over the next decade, well below maximal efficient output. The economy will not be able to handle the new work force efficiently. But college graduates have an unemployment rate of less than 4.5%, which is great for us considering we're from a relatively well respected institution at least in local Northeastern terms.
I think I will need to write a post defending the commodity standard from a economic perspective soon! It still seems that people don't understand that what is morally right is more important than what is economical or pragmatic. Fiat money is neither.
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