Commentary
“Can we please not talk about monetary policy?”
This was the plea of a wonderful woman and wife of a good economist with whom I often had dinner. She liked me and loved her husband but dreaded where the conversation would invariably end up: discussing the pluses and minuses of monetary rules. I found the topic fascinating, and so did he, but she was not even slightly interested.
And she did have a good point. The whole topic is confusing and boring, a plaything of nerds, history buffs, and lovers of economic esoterica. We did our best to comply, but as soon as she went to the kitchen to prepare dessert or coffee, we would sneak in a bit of monetary talk until she returned.
It’s all ridiculous in retrospect. And yet, it is a hugely important topic now. We are likely getting a new system for the management of the nation’s banks and money. That will have a dramatic effect on finance, capital markets, and your household budget. So yes, it matters, even if it is boring.
Below is your one-article guide to the choices in front of us.
The Gold Standard
The United States started with a competitive monetary system with coins from the world circulating side-by-side, while local and state banks made paper currency. The word dollar comes from the Spanish word Thaler, which referred to a silver coin that many people used at the founding. Following the Civil War, the nation settled on the old-fashioned gold standard. Every dollar was convertible. States and the federal government minted the money. It was a government-imposed system, but it imposed fiscal discipline. The dollar was not inflated; just the opposite. The money rose in value (“deflation”). It was the greatest monetary system ever deployed by man.
Downside: No one has figured out a viable plan to restore such a system. I’ve read every plan, and they all falter. The consequences of an ill-considered transition would be calamitous. No one knows how much gold the government has to make this possible. Current levels of leverage in the financial system make such a system likely unsustainable. This truly seems like an age gone by, never to return.
Discretion
This is the system invented (or made famous by) J.M. Keynes, who imagined that the central bank could be useful for scientific management of macroeconomics. It would balance out aggregate supply and demand. It could stop rampant unemployment through inflation. It could substitute for fiscal stimulus when Congress did not act. It could mitigate against recession and unravel back effects when recovery arrived. You could say that this is the de facto present system, and yet no one really believes the science behind it anymore.Downside: The result of discretion has been to increase and not decrease business cycles and inflation. This is the main reason why the dollar of 1913 is worth about 3 cents today. Discretion puts too much power in the hands of the central bank. That power is unaccountable. The managers are not scientific but rather arbitrary and manipulated by politics. It was always a fool’s errand.
Free Banking
This approach is hands-off. It allows banks discretion to expand or shrink credit based on their own risk tolerance and feel for the supply and demand of money and credit. It treats banks as normal businesses, allowing them to rise up and fail according to market discipline and needs. This system has proven very effective at mitigating against large swings in business activity and incentivizes banks toward lending discipline.Downside: It has typically been the case in history that states have backstopped business failure of banks when they become too widespread or when there are regional crises in finance. Knowing this to be the likely outcome, banks have typically been subject to a moral hazard of overexpansion. The instability of the system alarms the public, and persistent failure risk drives the systems toward centralization, which is why they don’t last.
Lincoln Money
During the Civil War, the president turned away from the banking system as the creator of money and credit and put the job straight into the hands of the Treasury system. This cut out the middleman entirely, angering the bankers’ lobbies and rooting out corruption in the bond market. People look back at this experiment with romanticism and suggest that we should do this again. Many supporters of Trump today are likely to embrace such a system.Downside: This approach has been shown over hundreds, if not thousands, of years to be a prescription for inflation and even hyperinflation. The corruption is not eliminated but transferred from banks to government. Governments cannot help themselves: With the power to print, they print as much as possible, reducing the value of the currency systematically and inevitably.
MMT
MMT stands for “Modern Monetary Theory,” although it’s not clear why it has that name. It is mostly associated with the left wing of modern politics. The idea is not to worry about the debt and not to worry about liquidity and financial markets but rather to lean on the central bank to manage it all with maximum focus on funding the welfare state and a basic minimum income for everyone, courtesy of extreme credit expansion.Downside: This is essentially delusional in that it ignores all history and theory and dreams of prosperity given to us by the printing press. This is a prescription for hyperinflation and poverty.
Quantity Rule
Milton Friedman—and Irving Fisher before him—saw that inflation is always and everywhere a monetary problem. At the same time, they did not believe in a fixed quantity but rather one that grows with economic activity, which they assumed would expand by 2 percent to 3 percent per year. They proposed a monetary regime from the central bank with paper money that would expand the money supply strictly by the same amount. They even proposed a Constitutional amendment. The goal was a stable and flat general price level, with neither inflation nor deflation.Downside: The Fed is not that good at this trick. It can barely keep up with the quantitative effects of what they do now and faces zero incentive to mind a rule of this sort. There are always crises coming, and the Fed invariably bows toward them, obliterating any rule. In addition, even under ideal conditions, a quantity rule still distorts the yield curve by messing with capital-borrowing signals and generating business cycles.
Supply-Side
In the 1980s, there was a new interest in the gold standard, not of the 19th-century variety but like that of the Bretton Woods system following World War II. The dollar would be convertible for international trade but not domestically. The price of gold would be fixed. The supply-siders believed that we could replicate this system without the price fixing by forcing the Fed to follow the price of gold, which was and is said to be real money. The price of gold would provide the guide to policy. International exchange rates would be fixed.Downside: Gold has not been actual money for half a century but rather an industrial metal with a monetary premium. It’s not clear whether the gold price today really does reflect a genuine and accurate proxy for price pressures. In addition, this policy is reductionist and does not consider the full range of consequences of an on-again-off-again policy of quantitative shrinkage and expansion. It also lacks the discipline of an authentic gold standard. Nor does anyone believe that we can really fix exchange rates these days.
GDP Targeting
This approach is designed to replicate the monetary fluidity of the free-banking system without actually having one. It would watch the nominal gross domestic product (GDP) numbers and calibrate monetary policy based on them. If the economy is expanding at 2 percent, so should the money aggregates. This eliminates all discretion and replicates the rate at which gold is mined.Downside: This system relies on many different accurate measurements—GDP, money aggregates, and more—and strikes the critics as being too clever by half. It would put experts in charge and face all the usual pressures to depart from the rule in a crisis. It’s not clear either that such a system evades the effects of interest-rate distortion that blows up the capital sector in the event that artificially low interest rates beckon. It’s an attempt at playing the market rather than deploying a real one.
The Bitcoin Standard
This new theory posits that Bitcoin and only Bitcoin has replaced the historic role of gold. Governments should get their own stockpile and issue currency the way stablecoins do today, based on a one-per-one ratio of Bitcoin to dollars. This imagined utopia sees cryptocurrency as the basis of the entire monetary system, deprecating fiat and exalting digital hard-money technology to the center of our lives.Downside: None of these people have been able to explain why only this one cryptocurrency constitutes real money and the rest are just junk. Bitcoin is famously subject to infinite surveillance. It could expose every taxpayer to full and instant audits and become the basis of a dystopian technocratic regime. Bitcoin is a different animal today than when it was founded as a peer-to-peer currency. It could easily become the plaything of Leviathan.
Denationalization
Economist F.A. Hayek had studied monetary issues for decades when he finally gave up on the idea of creating the perfect system. As he wrote, the problem with all reform plans is that they rely on the reformers to have the best interests of the people at heart. They never do, which means that any top-down system will fail. Instead, he wanted a high wall between money and the state. Allow banks or anyone to use any currency and get monetary policy out of the hands of governments entirely.Downside: This system would seem to work in theory, and it is the one I favor, but it defies all history. Governments have always and forever will take a strong interest in money, banking, and finance. Full freedom in this sphere is highly unlikely to happen. Denationalization might be the ideal system, but it seems inconceivable that it could ever be the norm. That said, steps toward this goal seem to have the highest hopes for success.
There we have it: 10 possible roads to reform, each fraught with problems.
What is it that we are trying to achieve with monetary policy? This is the root of the dispute. Is the Fed a tool of national planning and macroeconomic management, or should it have a more humble mission? Until we can jettison the ambition to use the money as a mechanism of control, we will be on the wrong path. A better view is the classical one: Money should be sound, and it should be consistent with the idea of freedom and independence.
You see now why this is such an interesting subject. Just don’t talk about it at a dinner party, unless you want the guests to be bored out of their minds.
