Tag Archives: Monetary Policy

The Biggest Problem the World Faces: No Stable Unit of Account

Here’s the best way to put it: Quantitative Easing (QE) is like saying that simply feeding a guy will make him exercise more. It doesn’t. It just makes him more fat (inflation). On the other hand, someone who is working out and growing muscle (ie, a metaphor for a growing economy) does need to be fed more (i.e. in economic terms this is the time to increase liquidity) or else his body won’t have the energy or building blocks to create the new muscle (i.e., analagous to derailing a growing economy by raising interest rates and choking it.) Either way, whether we have growth or recession, we can’t win. And that’s why we have continual crisis after crisis, at a time in our Civilization’s history when there should instead be a Cornucopia of Abundance for all and a Golden Age.

The sole mandate of the Federal Reserve, or any “Central Bank” should be to keep the supply and demand of liquidity (a fancy word for money) in balance. If there’s too much supply in relation to demand, then you get inflation. And this is the ONLY cause of inflation. They would have you believe that growth causes inflation, and that inflation is somehow a ‘natural’ occurence. But growth in no way causes inflation. Because growth causes an increase in production as much or even more so than it does in consumption. Growth also causes innovation with increases in productivity and efficiency. They try to make you believe that inflation is a natural occurance so that they can keep their jobs, their huge budgets, and their elevated status in society of some kind of Knights continuously “fighting inflation.”

On the other hand if demand for liquidity outstrips supply, which is the case usually during economic booms, not only does this cause ‘deflation’ but even worse it chokes off the “air supply” of much needed liquidity and kills the boom in it’s tracks. An example of this would be the late nineties economic boom caused by the Internet boom that went suddenly bust in 2000, not because of failed business plans, but because the air supply was cut off. An example of the deflation of that period was when oil hit $10 a barrel.

So, the Federal Reserves actions not only cause and unstable unit of account, they actually cause the downturns and “Financial Crises'” that seem to be a continual part of our lives, which is so ironic considering the times we live in: Technology and Science, whose knowledge and actual physical products are doubling in power and efficiency every 12-18 months, driving productivity increases throughout every area of our economy. Indeed, under such salutary conditions, it should be impossible to have any kind of economic crisis. There must be something that is throwing a monkey wrench, so to speak, in our economy, and unnaturally derailing it.

The biggest problem in the United States and the World is that adding Monetary Liquidity doesn’t stimulate economic activity. It only causes inflation. And through inflation, it actually sludges up and slows the economy even more. That’s the biggest problem that the World faces: is that we don’t have any Standard Unit of Account.

Only three things can increase economic activity: An increased appetite for risk, more work, or more efficiency, which is usually supplied through innovation.

People are only going to work more if there is a financial incentive (unless they are one of the lucky few who love their work so much, that they’d rather be doing that than what they like to do in the free time. This is why a lot of people advise that whatever it is that is your hobby, you should consider making into your career. Or the other famous phrase that’s been used so much that it’s almost lost its meaning: ‘Do what you love.’ Or Joseph Campbell’s famous phrase: “Follow your Bliss.”)

So, basically, the only way to achieve this kind of productivity, is through fiscal policy, reducing the amount of tax upon physical work. Allowing workers to keep more of what they earn.

Increasing productivity through efficiency is intimately tied to innovation, which not always, but almost always is tied to the first part of the equation, which is an increased appetite for Capital Risk. This second part can only be achieved fiscally as well. A decrease or elimination of all unnecessary regulation (ie, regulation that is not helping or protecting the public) and a lowering or completely zeroing out of the Capital Gains tax. Indeed, many Economists believe (Alan Greenspan being one, I think) that the no. 1 impediment to raising the standard of living for all is the Capital Gains tax.

This is not a tax on merely the “Wealthy.” For taxing Capital Gains directly decreases the amount and the rate of innovation in every area of society and the economy, which has a direct impact on the standard of living for all. Also, the Capital Gains tax is applied to every amount. So if a middle class or lower middle class person makes, say $1000 on a successful use of his mind and productive flow of capital into an area of growth in the form of a successful investment, he is taxed the same rate as someone who makes a million. And one could argue that the $300 confiscated from him is more of a discouragement as well as a practical harm, from a day to day living standpoint, than the $300,000 confiscated from the Wealthy person.

And what is more is that it’s the millions of thousand dollar investments that make up a much more huge majority of the nations Capital markets than the few million dollar investments. Whether they are in the form of a stock certificate on Wall Street or a small business on Main.

 

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I wrote a comment to this Yahoo post:
“So true. Monetary “Stimulus” doesn’t stimulate anything except inflation. There’s no evidence of it ever stimulating economic activity or “growth.” The only way to create a runway for growth and jobs is to maintain a stable unit of account, which should be, in fact, the only mandate of a Central Bank. “

The Major Mistake of Both Ron Paul and Paul Krugman


 

Vis a vi Monetary Policy:

The major mistake of the “Monetarists” like Krugman is that they believe Monetary stimulation stimulates growth. It doesn’t. All that it stimulates is stagflation. I’m a Paulista, but the one thing I would disagree with him is that there is a way to know how much liquidity the economy needs: The Price of Gold. The price of Gold is the most accurate barometer of supply/demand of money, ie allowing enough liquidity for growth, but not too much for inflation.

So what is needed both to insure that there is enough liquidity for growth but not too much for inflation is neither a “Hard” Gold standard, nor the current “fiat” target interest rate policy. What is needed is a “target the price of Gold” standard. So you don’t have a dollar backed by Gold: (This could lead to a dearth of liquidity during economic growth, and an actually run on the physical gold supply which is the reason Nixon took us off the Gold standard in 1971) What you have is a Fed that targets gold, uses it as a barometer. When the price of Gold rises, that is a clear indicator that the economy has too much liquidity. When the price of Gold dips too low (like it did in the late ’90s, remember $10/barrel oil? This was also a major factor contributing to the demise of Web 1.0 because there was massive growth, but no liquidity.) that is a clear signal that there is not enough liquidity.

So what we need is not to End the Fed, but rather a new mandate: Keep the Price of Gold in a tight trading range by printing money when it dips below the range and in reverse, selling bonds to mop up excess liquidity when the price of Gold rises above the tight trading range.

There is a Time For the Fed to Create Liquidity

Maybe the only thing I disagree with Ron Paul about, is that there is a time when the Fed should create liquidity, and that time is when, like in the 90’s due to the Internet and Communications revolution, there is a period of incredible growth. A growing economy needs liquidity like a growing body needs food.

The problem is, that it’s exactly during periods of growth that the Fed turns the spicket off and starves a growing economy of the liquidity it needs. This is one of the major reasons that Web 1.0 crashed.

And then during times of recession like the past few years the Fed does the opposite. It adds liquidity, which causes inflation and “stag-flation.”

This is why we don’t need so much a “Gold Standard” in as much as we need a “De-Facto” Gold standard, meaning Gold should be used as the barometer for when liquidity should be injected and or  “mopped up.”

Using the price of Gold as a barometer, the Fed, or whoever directs monetary policy, should keep the price of Gold in a tight trading range by adding liquidity when the price of gold dips below a certain target, and mopping up liquidity when the price of gold rises above the target.

This does two virtuous things: It gives a growing economy the right amount of liquidity it needs to sustain, and it also permanently ends inflation and deflation.

Other than that I totally agree with Dr. Paul that the Fed, as it acts now, should be ended, or given the tight mandate of using a Gold barometer for monetary policy.

The Only Part of the Equation that Ron Paul is Missing

Ron Paul is correct that gold is important. It’s very important. The only part of the equation that Ron Paul is missing is the demand for money. Inflation is caused by two factors: how much money is printed and how much demand there is for money (growth increases the demand) If you had enough growth it would soak up the excess liquidity and there wouldn’t be inflation.

The reason Gold is so important to this picture is because it’s intrinsic value (for a variety of factors) is the most resistant or stable to economic or political factors. So what we need is not necessarily a “Gold Standard” but rather a de facto gold standard that uses the price of gold to indicate how much cash to print. In another words, the Fed’s policy should be to keep gold in a very tight trading range. When the price of gold goes above that range, that indicates that there is more cash in the system than the system can handle or demands (like now!) and the fed should sell bonds to soak it up. If and when the price of Gold goes below the target, that’s when they should print, because that indicates the economy is demanding more liquidity.

When the fed does the opposite, which it usually does, because it ignores the gold signal, then you get the worst of both worlds: too much liquidity and no demand for it, which equals “stagflation”

Growth is stimulated through fiscal policy (lower taxes, regulation) and inflation could be controlled through a correct monetary policy, which would be to target gold. So there is no reason at all for inflation, even during tough economic times. You can’t print your way to prosperity. You have to increase productivity and add real value.

A “De Facto” gold standard would not deprive the economy of the liquidity it needs to grow, as the the opponents of such a policy argue as a scare tactic against it. Instead, it would give the economy exactly the amount of liquidity it needs to grow without any inflation. So, in a sense we could get rid of the Fed, or at least downsize it. (No more billion dollar Fed buildings needed!) Because basically it would only take one guy and a computer to effectively execute and maintain such a monetary policy.