Last week, Steve Forbes visited The Johns Hopkins Universitycampus. After lunch at the Faculty Club, Steve, Elizabeth Ames, andI retired to the library to tape an interview for a one hourdocumentary, “In Money We Trust,” that Steve is puttingtogether. The documentary is sparked by Money (McGraw Hill, 2014), a book authored by Steve andElizabeth Ames.
My big takeaway from Money is that Steve Forbes is noJames Dean. Forbes is a rebel with a cause. Free-markets and soundmoney, please. In what follows, I will briefly mention 9 of mythoughts inspired by my reading of Money and my visit withits authors last week.
Thought #1: The dedication to AlexanderHamilton signaled right away that Money was going in theright direction. We all know that Hamilton was an extraordinary financial engineer. Among otherthings, he established a federal sinking fund to finance theRevolutionary War debt. Hamilton also engineered a large debt swap,in which the debts of individual states were assumed by the newlycreated federal government. Hamilton’s ability to solve thedebt problem established America’s financial credibility andgave the new nation a much needed positive confidence shock. We arealso aware of the fact that Hamilton was a great contributor to theFederalist Papers — a superb document. Indeed, no less thanMilton Friedman once wrote in Newsweek (June 4, 1973) thatFederalist Paper 15 “contains a more cogent analysisof the European Common Market than any I have seen from the pen ofa modern writer.”
What we do not all know, particularly many of those who espousethe sanctity of private property rights, is that Hamilton was adistinguished lawyer who took on some of the most famous propertycases in U.S. legal history. After the Revolutionary War, the stateof New York enacted harsh measures against Loyalist and Britishsubjects. These included the Confiscation Act (1779), the CitationAct (1782), and the Trespass Act (1783). All involved the seizureof property and garnered wide public support. Hamilton saw the actsas an illustration of the inherent difference between democracy andlaw. Hamilton took his views to court and successfully defended, inthe face of enormous public hostility, those who had their propertytaken under the three New York state statutes.
Thought #2: Speaking of the taking of propertyand money — right here in the USA, not the USSR — letus not forget the U.S. Congress’ abrogation of the Gold Clauses in June1933; a confiscation of property that the Supreme Court upheld in1935.
Before that abrogation, private and public bond covenantsincluded gold clauses. Under this system, bond holders receivedinterest and principal payments in dollars that contained as muchgold as the dollar contained when the bonds were issued. Well,after April 1933, the U.S. government manipulated the price of goldupward until President Roosevelt redefined the dollar in gold termsunder the Gold Reserve Act of January 1934. Overnight, the dollarbecame 41% lighter. This left gold-clause bond holders out todry.
Because of the Congress’ abrogation of the gold clauses, bondholders could only receivethe nominal dollar amounts of interest and principal, as stated ontheir bonds. They could not receive enough additional dollars tomake their payments equal in value to the amount of gold originallystipulated. In short, bondholders were stuck with new“light” dollars, not the original “heavy”ones that had been specified in the original bond covenants.
Of course Bondholders sued over this theft. But, the SupremeCourt held that the abrogation of the gold clauses for privatebonds was constitutional in 1935. The Court’s decision restedon the fallacious argument that contracts that contained the goldclauses interfered with Congress’ authority to coin money andregulate its value (Article 1, Section 8 of the U.S.Constitution).
For bonds issued by the U.S. government, the situation wasdifferent because Congress did not have the authority to repudiateobligations of the U.S. government. But, because the legal briefswere defective in proving actual damages, the plaintiffs who hadheld U.S. government bonds “protected” by gold clausescould not collect damages from the U.S. government.
In anticipation of additional gold-clause cases, Congress simplypassed a law amending the jurisdiction of federal courts, barringthem from hearing any further gold-clause cases. Every time Ireflect on this Congressional maneuver, Paul McCartney’sclassic “Back in the USSR” rings in my ears. Yes, whenit comes to money, the rule of law is rather elastic (particularlyduring National Emergencies), even in the U.S.
Thought #3: It is clear that Forbes and Ameshave taken the water in Vienna, or perhaps in Baden bei Wien.Indeed, Money contains many Austrian themes:
- Forbes and Ames reject the closed economy model. Like BobMundell, who once said that the only closed economy is the world,Forbes and Ames embrace an open economy framework. This outlook isin sharp contrast to our last Fed Chairman Ben Bernanke. Bernankedid not even include the USD/EUR exchange rate (the most importantprice in the world) on his six-gauge dashboard.
- Forbes and Ames junk the idea of equilibrium and economicstability.
- Also, they embrace the central role of the entrepreneur inmarkets that are seen as a means to assemble dispersed knowledgeand information.
- As Forbes and Ames say, “Information combined with tradeand enterprise: that says everything one really needs to know abouteconomics. Money — sound, trustworthy money — is thecrucial facilitator that brings it all together.” TotallyAustrian, indeed.
Thought #4: For a more practical and lesstheoretical view, allow me to quote from Paul Volcker’spreface to Marjorie Deane and Robert Pringle’s 1995 bookThe Central Banks. Volcker’s edifying prefacecaptures both the substance and spirit of Money:
We sometimes forget that central banking, as we know it today,is, in fact, largely an invention of the past hundred years or so,even though a few central banks can trace their ancestry back tothe early nineteenth century or before. It is a sobering fact thatthe prominence of central banks in this century has coincided witha general tendency towards more inflation, not less. By and large,if the overriding objective is price stability, we did better withthe nineteenth-century gold standard and passive central banks,with currency boards, or even with “free banking.” Thetruly unique power of a central bank, after all, is the power tocreate money, and ultimately the power to create is the power todestroy.”
Thought #5: Like Volcker, and unlike most moneyand banking professionals, Forbes and Ames are straightforward andclear, but they are puzzled:
Why then is so much writing on the subject of money soneedlessly complicated, with dense, impenetrable language andequations that make sense to only a handful of academicians? Andwhy do so many people insist that bad ideas about monetary policy,like ‘inflation is needed to increase employment,’ areas settled and unassailable as scientific principles?”
To answer that question, we need go no further than research by Larry White. He found that 74% of articles onmonetary policy published in 2002 were in Fed sponsoredpublications and authored by people on the Fed’s staff orassociated with the Fed. Fortunately, Forbes and Ames leapfrog thatFed hurdle.
Thought #6: Where does this near-monopoly ofthe professional publications lead us? Well, let’s look atthe Great Recession. Even after the resulting financial crises, weare still cursed by the central bankers’ mantra of inflationtargeting and floating exchange rates. To refresh your memories,consider the following:
- Former Fed Governor Ben Bernanke sounded an alarm in November2002. He claimed that the major danger facing the U.S. economy wasdeflation. It was, of course, a false alarm. Never mind.
- To fight the phantom deflation, the Fed pushed the federalfunds rate all the way down to 1% by July 2003, when the naturalrate was 3%-4%.
- With those artificially low interest rates, the Fed became thegreat enabler for the wild yield chasing, risk taking, acceleratingcarry trade, leveraging, and relative price distortions.
- The behavior of the CPI inflation target and other importantprices in the 2003-2008 period tell the tale: the CPI, excludingfood and energy, only increased by 12.4% during that period.Indeed, that metric increased at a steady annual rate of 2.1%-right on target. Housing prices, however, went up 45% from 2003until 2006 (Q1). Stock prices went up 66% from 2003 until 2007(Q4). Commodities zoomed 92% from 2003 until 2008 (Q2).
- As Prof. Gottfried Haberler put it in 1928, “The relativeposition and change of different groups of prices are not revealed,but are hidden and submerged in a general [price] index.”But, inflation targeters ignore Haberler’s observation. Inconsequence, they (read: the Fed) fly blind. Yes, going into the2008-2009 storm, the Fed was flying blind. Recall thatBernanke’s dashboard, had no exchange-rate gauges.
- This resulted in a disaster. Indeed, the error of 2008 was toengage in a very tight monetary policy. If Bernanke had anexchange-rate gauge, he would have seen the dollar soar against theeuro by 33% from June 2008 to late October 2008. As the USD soared,oil prices plummeted, falling by about the same percentage as theUSD appreciated against the euro. And oil prices plunged from$148/bbl to $35/bbl. Annual inflation measured by the CPI was 5.6%in July 2008. By February 2009, negative annual CPI numbers werebeing registered. So much for those alleged long and variable lagsbetween changes in monetary policy and inflation.
- But, we are left today with the Deputy Governor of Sweden’s Riksbank and inflationtargeting guru Lars Svensson’s words: “My view is thatthe crisis was largely caused by factors that had very little to dowith monetary policy.” What nonsense.
- Never mind. With the central bankers’ grip on theprofessional press, we are left with inflation targeting too.Indeed, that nostrum is even more entrenched than it was before thecrisis.
Thought #7: Foreign Exchange Comment I:
Many think current account surpluses and deficits are theproduct of misaligned exchange rates. Well, truths in economicsoften boil down to accounting principles that are as immutable asthe laws of physics. Current account deficits are, for example,equal to the sum of two quantities: the excess of privateinvestment over savings and the government deficit. Exchange rateshave little to do with current account deficits.
Thought #8: Foreign Exchange Comment II:
Forget the D.C. chatter about currency manipulation. The U.S.Treasury (UST), as well as everyone else, cannot even definecurrency manipulation. That is why the UST has neverformallybranded China a currency manipulator. Fortunately, during the1997-2004 period, the RMB/USD rate was marked by fixity. And, asthe accompanying table shows, the RMB link to the USD was very goodfor inflation and growth in China. This link was also good for theglobal economy.
Thought #9: When it comes to exchange rates,more currency unification, please. The world’s two mostimportant currencies — the dollar and the euro —should, via formal agreement, trade in a zone ($1.20 - $1.40 to theeuro, for example). The European Central Bank would be obliged tomaintain this zone of stability by defending a weak dollar viadollar purchases. Likewise, the Fed would be obliged to defend aweak euro by purchasing euros. The East Asian dollar bloc, whichwas torpedoed during the 2003 Dubai Summit, should be resurrectedwith the yuan and other Asian currencies tightly linked to thegreenback. Many other countries (Brazil and Venezuela, forexample), should adopt currency boards linked to either the dollaror euro. Or, they should simply “dollarize” by adoptinga foreign currency (like the dollar, for example) as their own.
Yes. Why not dollarize? It works. Just look at Ecuador andPanama. They are dollarized, and, based on my Misery Index, they are the two least miserablecountries in Latin America. Dollarization, like currency boards,provides discipline. This discipline leads to prosperity and lessmisery.