Why a little monetary economics does and doesn't matter in Travis County, Texas

Last night’s meeting of the Travis County Republican Party was delightful for lots of reasons: the Obama jokes, the weird presentation about vaccines, and the update on the impending demise of ACORN. For me, though, most invigorating was the discussion of monetary policy, not for what it accomplished, but for what it signaled. Talking publicly, I am increasingly discovering, is a good way of cajoling your friends in the silent majority into collective action.

The party, that is, was considering a resolution of support for two bills before the federal congress, collectively termed the “Federal Reserve Transparency Act”. I wasn’t thrilled with any of it (and more on that later), but at least offered a motion to strike the first paragraph:

Whereas, throughout its nearly 100-year history, the Federal Reserve System has presided over a significant decline in the value of the United States dollar. Since 1913 the dollar has lost over 95% of its purchasing power.

What was the problem? It’s simple: if you think that a 95% decline in the value of the dollar over 95 years is a problem, then you haven’t worked out the math, I explained. I had worked out the math, and told the room that the implied rate of inflation was just 3.26 percent over that near-century. Not bad performance over such a long haul, compared to other central banks, the brainlessness of Fed policy in the 1930s and 1970s excepted.

This led to howls of indignation from a few of the cryptolibertarians in the room. This resolution, after all, really wasn’t for them about accountability. It was about their general dislike of central banking and the supposed evils of fiat currency. Zero percent inflation, one of them asserted, was the only worthy goal, and the only way to achieve that was on a gold standard.

Uh, no. Not even close. It isn’t possible on a gold standard, and even if it were, it wouldn’t be good. To paraphrase Edmund Burke, that which is not possible is not desirable, so that which is neither, shouldn’t much be contemplated. If you still think so, then you missed most of your introductory macroeconomics class. So here goes the lesson, which I provided in brief last night.

Sustained Inflation is not the problem; unexpected inflation is the problem. If sustained inflation is moderate, but anticipated, then our collective rational expectation of such allows us all to plan for it. The concept of rational expectations is a big deal: one Robert Lucas of the University of Chicago got a free trip to Stockholm in 1995 for working out how it affects macroeonomics. Contracts get indexed and investors raise their expectations, demanding more cash in the future than otherwise. In the end, sustained low inflation is only a problem for someone who thinks that his mattress is a suitable investment vehicle. Most all of us are beyond that, so we all make out fine.

Deflation is a much more problematic than (expected, low) inflation. Labor costs may be sticky, so it's easier to cut real pay by simply forgoing a nominal pay increase than to tell staff that “you’re all getting a three percent pay cut—but don’t worry, it’s just a nominal cut.” Try that one at a site organized by the United Auto Workers. More generally, tolerance of deflation can be very problematic. As Milton Friedman and Anna Schwartz pointed out in their Monetary History of the United States, the recession of 1929 turned into the depression of 1931 in large part because of the Federal Reserve’s inaction. As demand dropped sharply, the board continued to pursue a tight money policy, fearing the ills of so-called “speculators,” when it should have been easing short-term credit to encourage investment in technically successful sectors. As Barry Eichengreen argued in his book Golden Fetters: The Gold Standard and the Great Depression, 1919-1939, this was largely due to slavish adherence in the US and France to the gold standard. Countries that dropped it early recovered economically much faster.

Aiming for low inflation is a widely accepted aim amongst central bankers everywhere. If you’re still wondering why Ben Bernanke is so vigilant about the possibility of deflation, you could read his book too. We call the idea the Bernanke Doctrine today, but it’s almost globally accepted amongst monetary economists that central banks have two main roles: guarding against both deflation generally, and unexpected spikes in positive inflation. While this isn't part of the law governing the federal reserve, it's now de facto practice, and opposed in Congress basically only by Ron Paul and Bernie Sanders. (Isn’t that a combination?) It is even the legally defined aim of the European Central Bank, which may say something about the Euro’s long term potential as a reserve currency. (I may just start collecting those cute little coins.)

So, what’s the alternative to fiat money? Average inflation determined by the rate of gold mining. If you still think that central bankers are somehow the problem, consider the mechanics of the ballyhooed alternative. Remember William Jennings Bryan and the silver standard talk of the 1890s? That was a big deal at the time because the global supply of gold was growing more slowly than the global economy as a whole. That is, the money supply itself (as so many countries were on a gold standard) was growing more slowly, and thus year-on-year deflation of about 2 percent in the US had set in. Farmers’ debts in the US were denominated in nominal dollars, so their real interest payments were increasing year-on-year. One can imagine why they were torqued. Then, in 1896, gold was discovered in the Transvaal, the money supply started growing again, and inflation resumed at a rate of about 2 percent per annum. So, under a gold standard, the long-run money supply is determined by the pace of gold mining in the world, and today, this substantially occurs in South Africa and Russia. [I thank Brad Delong of the University of California at Berkeley for this observation. I don’t often find things to thank him for, but this is one.] But heck, if you’re content to let monetary policy be determined in the capitals of one-party states masquerading as democracies, then go for it.

And just for a sanity check, how many currency areas have gold standards? None. That's right: zero. No one does this. If you think that it’s a good idea, you have a very high empirical and theoretical hill to climb.

All this argument aside, the motion failed, by about 24-37, after which I was the lone person in the room to vote against the entire resolution. I was asked afterwards why, and gave too explanations, either of which would be sufficient. First, if one did want an audit of the Federal Reserve Board, the so-called Government Accountability Office is not the organization to provide it. I was delighted a few years back when the name was changed from Accounting to Accountability, because accountancy really isn’t what it does. I can’t imagine that group trying to audit bank books. But if that’s not scary enough, consider the outcome of having, as one of the fed-haters in the room recommended, the currency controlled directly by the federal congress. [Eek!] That’s universally taught as a the worst possibly idea, as it subjects technical debate on the volume of money to the payola and horse-trading of politics. That sort of thing might be suitable in Zimbabwe, but certainly not in any decently governed country—and it isn’t.

Of course, there’s a bigger question as to why the county party is debating federal monetary policy. If Texas were a fully independent republic again, we’d have to deal with this. As Mark Wynne of the Dallas Federal Reserve Bank observed on the eve of European monetary union in 1999, the economy of Texas differs significantly from that of the other 53 states and territories, and as such, there is some reason to want a Texas dollar. If we had one, it sure wouldn’t be backed by gold, but we don’t have one (at least not yet).

In short, we should be spending our time crafting and publicizing policies over which Texans (and particularly central Texans) have near-term control, and avoiding talking loudly about stuff that’s outside our expertise. We can be conservatives and win elections. We just can’t do it if were cranks.