Currency Wars_ The Making of the Next Global Crisis - James Rickards [89]
Recent failures have stripped economists of their immunity from rigorous scrutiny by average citizens. What works and what does not in economics is no longer just a matter of academic debate when forty-four million Americans are on food stamps. Claims by economic theorists about multipliers, rationality, efficiency, correlation and normally distributed risk are not mere abstractions. Such claims have become threats to the well-being of the nation. Signal failures of economics have arisen in Federal Reserve policy, Keynesianism, monetarism and financial economics. Understanding these failures will allow us to comprehend why growth has stalled and currency wars loom.
The Federal Reserve
The U.S. Federal Reserve System is the most powerful central bank in history and the dominant force in the U.S. economy today. The Fed is often described as possessing a dual mandate to provide price stability and to reduce unemployment. The Fed is also expected to act as a lender of last resort in a financial panic and is required to regulate banks, especially those deemed “too big to fail.” In addition, the Fed represents the United States at multilateral central-bank meeting venues such as the G20 and the Bank for International Settlements, and conducts transactions using the Treasury’s gold hoard. The Fed has been given new mandates under the Dodd-Frank reform legislation of 2010 as well. The “dual” mandate is more like a hydra-headed monster.
From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95 percent of its value. Put differently, it takes twenty dollars today to buy what one dollar would buy in 1913. Imagine an investment manager losing 95 percent of a client’s money to get a sense of how effectively the Fed has performed its primary task.
The Fed’s track record on dollar price stability should be compared to that of the Roman Republic, whose silver denarius maintained 100 percent of its original purchasing power for over two hundred years, until it began to be debased by the Emperor Augustus in the late first century BC. The gold solidus of the Byzantine Empire had an even more impressive track record, maintaining its purchasing power essentially unchanged for over five hundred years, from the monetary reform of AD 498 until another debasement began in 1030.
Fed defenders point out that while the dollar may have lost 95 percent of its purchasing power, wages have increased by a factor of over twenty, so that increased wages offset the decreased purchasing power. The idea that prices and wages move together without harm is known as money neutrality. This theory, however, ignores the fact that while wages and prices have gone up together, the impact has not been uniform across all sectors. The process produces undeserving winners and losers. Losers are typically those Americans who are prudent savers and those living on pensions whose fixed returns are devalued by inflation. Winners are typically those using leverage as well as those with a better understanding of inflation and the resources to hedge against it with hard assets such as gold, land and fine art. The effect of creating undeserving winners and losers is to distort investment decision making, cause misallocation of capital, create asset bubbles and increase income inequality. Inefficiency and unfairness are the real costs of failing to maintain price stability.
Another mandate of the Fed is to function as a lender of last resort. In the classic formulation of nineteenth-century economic writer Walter Bagehot, this means that in a financial panic, when all bank depositors want their money at once, a central bank should lend money freely to solvent banks against good collateral at a high rate of interest to allow banks