Thursday, July 23, 2009

Monetary Reform

Problemo numero uno

We are talking about money. Daivd Hume the great Scottish enlightenment thinker wrote of its importance, Goethe used Hume's ideas in Faust part II, Marx (I believe, it's hard to pin down Marx) denied its role in creating value in society, John Maynard Keynes said there was the "real" economy and then there was the "money" economy, Milton Friedman even called himself a Monetarist economist.

By 1875 there were central banks in all 'western' countries except the USA, ours was formed in 1913. Today Ben Bernanke is chair of the Federal Reserve Bank, and as we know he has been instrumental in the government's costly, and some would say futile and counterproductive, efforts to overcome the financial crisis which kicked-in in late 2008. The One (President Obama) is behind creating a new super-agency to oversee (regulate through prior constraint) the financial sector. Bernanke has now said that this is unnecessary because the Fed has the knowledge base and institutional structure to handle this super-regulator role.

Which brings us to Workers take on the situation. First off, as has been said by others, there is a moral hazard of the Fed both regulating banks and being in charge of monetary policy. In other words, the central bank should do one or the other. By doing both, it creates a conflict of interest. If policy goes wrong, the Fed can always go in and coerce banks to do its will to correct for the Fed's own mistakes.

So Workers is suggesting a phased-in approach to a reform which will be long-lasting and solve the institutional problems that exist today, outlined as follows.

First, Nobel Prize winning economist James Buchanan says that a 'constitution' should be set-up to guide the central bank's policy. It should be a policy with set rules, eg, the Fed should be responsible lets say for price stability, and that is all. If its interest rate setting and quantitative easing (money printing and buying and selling of government bonds) fails to keep prices stable (we shall ignore the fallacy of there being "one price" to target at this point), then the Fed would be penalized through rules set-out in the monetary constitution.

This is an ok idea in the short-run. Assuming first, of course, that the Fed gets out of the regulatory business first. Currently the FDIC guarantees the deposits of banks, so therefore the FDIC is on the hook if banks fail. Thus, it should be the FDIC who regulates banks, not the Fed. The FDIC guarantees deposits. If a bank fails the depositor gets the guaranteed amount. This is all that the social contract requires, no bailouts are needed.

Second, as Nobel Prize winning economist Gary Becker has said, the Fed should get out of the 'too big to fail' business. This follows along with the regulatory mandate. Banks that are too big to fail are just plain too big. They should be allowed to fail as they have simply mismanaged their funds. It is counterproductive to put on life-support a financial institution which has failed. The resources should be freed-up through bancrupcy to go where they will be useful, not to where they are just kept in an institution which has failed to manage itself correctly. Capital needs to go where it can used afresh, not misused again.

Thirdly and most importantly, once the above has been done, it is time to get the Fed out of the monopoly business. A monopoly is something which by definition is not competitive. It is given an unfair advantage in society because it is freed from healthy competition. Competition is what creates innovation and progress, and, well, value, in society. People demand things in the market which give value to their lives. If something has a monopoly (in this case the Fed's monopoly over the money supply) it is society (people) writ-large who lose out while the monopolist gains unfairly at society's expense.

By the Fed having monopoly control over money they are removed from competitive pressures to keep the value of their asset. Demanders have no choice but to use the monopolist's product whether it wants to or not. This Fed central bank monopoly thusly has created a dollar which is slowly and steadily becoming worth less and less as more and more dollars are being printed to cover a larger and larger bailout and larger and larger budget deficit and therefore larger and larger debt. There is no market, competitive constraint, against devaluation of the dollar and an ever-increasing government debt.

Of course international macroeconomics ensures that the dollar will devalue over-time as other countries who manage their deficits and money supply better than the USA will see the value of their currency rise against the dollar. But this competition is just an illusion because other central banks (and remember all countries the USA trades with have central banks) too also have monopolies.

The USA was formed as the first constitutional democracy, and was envisioned to be the shining light on the hill of an enlightened political body, or if you will an enlightened form of collectivism, one which puts the people ahead of its leaders, which prioritizes the rule of law over the rule of man. With today's anti-competitive monetary policy we have lost this way, this enlightened political economy. The Fed (and now the Treasury and other politicians and government technocrats) have way too much discretionary power, way too much rule of man and not enough rule of law.

So then the final step in the needed reform to a more just, fair and sustainable political economy is to, as Nobel Prize winning economist Frederich Hayek said, "denationalize" the money. The idea is to allow competition against the dollar domestically. By allowing competition against the dollar domestically (currently illegal) the Fed and our political leaders will lose their blank check underwritten by the taxpayers (the people living in the USA and their children both born and as-of-yet born).

The way to denationalize the money is to decriminalize competition against the dollar. Right now anyone that issues currency with an intent to have that money circulate as a means of facilitating trade of one good for another (in economic jargon, as a "means of exchange") is prosecuted as a counterfitter. This is what reinforces the Fed's monopoly power and the continual (despite occassional countervaling appreciations) debasement of the dollar.

Allowing competition will not be an untoward "shock" to the economy with unforseen downside risks. It took many many years for the Fed to build up its monopoly and it will take many many years for a viable competitive domestic currency market to develop. The alternative is more of the same descretionary redistribution upward through bailouts and 'shotgun' mergers which erode shareholder and bondholder value based on unilateral, and some say totalitarian, government decisions. Most importantly mere tinkering around the edges and not adressing the monopoly problem will just bring an expected future of a continual erosion of the almost limitless good that the American entrepreneur can bring, and has brought over history, to the world.