Paul versus Bernanke By Hossein Askari
and Noureddine Krichene | January 5, 2011
The
fascinating two-year "rumble" that has been threatening
since the November 2010 mid-term United States elections will
unfold after the new congress is seated this week. The feature
bout on the card will pit: in the right corner, Ron Paul,
the Texas Republican congressman, a graduate of Duke University
Medical School, 1988 presidential candidate and author of
the best-selling 2009 book End the Fed; and in the left corner,
Ben Bernanke, chairman of the board of governors of the US
Federal Reserve System, MIT PhD economist, former chairman
of the Council of Economic Advisors and Fed governor.
This dream prize fight should take place because the Republicans
have "mischievously" nominated Ron Paul as the
chair of an important sub-committee of the House Financial
Services Committee, namely the sub-committee on domestic
monetary policy and technology, which scrutinizes US monetary
policy.
The two combatants, Paul and Bernanke, have sharply opposite
views in ideology and policy-making.
Paul, a well-known libertarian, belongs to a school of
thought that rejects Keynesian economics, and abhors fiscal
deficits and a government that polices the world. He supports
the market mechanism, including for interest rate determination,
supports bankruptcies, and dislikes bailouts and moral hazards,
advocates the gold standard and a safe and stable dollar,
and is critical of the law that banishes the use of gold
in domestic circulation.
Bernanke's approach to economic policy is well known and
speaks for itself. As a key policy-maker under the George
W Bush and Barack Obama administrations, he was the architect
of extremely loose monetary policy that earned him the alias
"Ben the helicopter" and has provided the foundation
for recent financial developments in the United States,
resulting in financial turmoil with a severe recession,
unprecedented peacetime fiscal deficits and rising public
debt. He is a strong supporter of Keynesian economics and
quite relaxed about the dangers of inflation and inflationary
expectations. His near-zero interest rate policy has reduced
income from savings and distorted prices.
Since the nomination of Paul to chair the domestic monetary
policy sub-committee, media and academic circles have become
intrigued as to how the relationship between the congress
and the Fed will evolve. In particular, to what extent will
he be able to implement the ideas that he has advocated
since the early 1970s, calling for sound money, a return
to gold, and culminating with the elimination of the Fed?
To say that Paul faces great challenges is an understatement.
If his tenure as a head of the sub-committee ends with no
change in US monetary policy and at the Fed, then all of
his ideas could be seen as rhetoric, with his supporters
becoming discouraged at discovering the gap between his
ideas and political realities.
If, however, Paul succeeds in reforming US monetary policy
and the Fed, he would set an important historical precedent,
with his supporters gaining confidence in their ability
to make hitherto difficult changes in the US financial system.
Even before round 1, Paul has started to dampen expectations.
Although he has re-emphasized his belief that the Fed should
be abolished, he has cautioned that turning ideas into reality
takes time and effort. He has noted that his first action
on the job will be to "think things through and not
over-do things too soon." When asked if he intends
to get rid of the Fed, the congressman replied: "Not
right up front, but obviously that is the implication. Even
in my book about ending the Fed, I talk about not turning
the keys and locking the doors, I talk about a transition."
The congressman spoke about how he would go about reining
in the Fed and the reasons he believes it is vital to do
so. "I'll have plans for hearings to find out how much
information we can get. Obviously it is very popular with
the American people to audit the Fed, to know what they
are doing. They can spend trillions of dollars and we don't
know where it goes. They have a bigger budget, they spend
more money than the congress does, and yet we have no oversight.
It was never intended that a secret body like this could
create money out of thin air and spend it, take care of
some banks and big business and foreign banks while the
American people struggle."
These statements indicate that Paul has quickly become
more pragmatic and has toned down his plans for radical
reforms, possibly handing the banner of radical reform to
future generations after Americans have suffered even more
from financial turmoil and chaos.
Relegating reforms to future generations could be a disappointing
message to Paul's supporters. However, it may not be, as
it appears that Paul's priority is to audit the Fed's operations.
This would be in line with legislation he introduced, incorporated
into the Dodd-Frank Act of July 2010, enabling the Government
Accountability Office (GAO) to audit the accounts of the
Fed.
For those who are familiar with Paul's ideas, this priority
falls short of their expectations. The urgency does not
seem to lie in auditing the Fed's operation as much as to
prevent further erosion of the value of money and spreading
economic malaise. The urgency for his supporters is to stop
the hemorrhage before washing away the blood.
Although a physician by training, Paul has displayed detailed
knowledge of monetary economics and documented the adverse
effects of the Fed's policies. He has pointed out that,
contrary to its mandate to promote price stability, the
Fed has promoted price instability.
Looking at the pre-Fed era, the US consumer price index
(CPI) declined at an annual average of 0.5% and real gross
domestic product (GDP) grew at an annual 4% during 1800–1912;
this would have been labeled grave deflation by Bernanke
and would have been considered as a danger to the economy.
During the Fed era, the CPI rose at 3.5% per year and real
GDP at 3.25% per year during 1913–2009. Hence a dollar
bought almost twice as much goods in 1912 as it did in 1800;
and in 2009 it bought less than 5% of the goods it bought
in 1913.
Paul pointed out that the Fed was a joint creation of the
government and Wall Street to provide an "elastic"
monetary system, with the real and hidden purpose being
service to the interests of Wall Street.
In fact, there may not have been a more opportune time
to think about radical monetary reforms than the present,
with more Americans aware of the economic and financial
policies, the impact of Fed policies on the US economy and
in the face of a declining standard of living for the large
majority of Americans.
The standard of living has been declining; impoverishment
increasing, and the era of "opulence" as described
by the late Professor John Kenneth Galbraith only a dim
memory. A large number of Americans are still living out
the financial nightmares of 2007–2009, with millions
of foreclosures and general bankruptcies. It could be the
best time for popular support for Paul's ideas.
Paul has been an influential member of congress and has
been member of the banking committee; yet despite his strong
views and statements and sharp criticism of the Fed in the
past few years, he was unable to initiate reforms that would
rein the Fed's expansionary monetary policies. Recently,
some House Republican members wrote to Bernanke urging him
to renounce the new quantitative easing program, which will
inject $600 billion into the economy. Their letter was simply
ignored by the Fed.
This state of affairs and the absolute power of the Fed
to impose policies regardless of strong policy disagreements
illustrate the urgency of hearings and reform. It is congress
that created the Fed in 1913; it is congress that has imposed
mandates on the Fed, including the reforms that set up the
rate-setting Federal Open Market Committee in 1933 or the
mandate of full-employment in 1946. It is congress that
could legislate reforms on the Fed.
While Paul's long-time career in congress has been rich
in ideas and prophetic of the financial crisis, it has nonetheless
been marked with very few substantive initiatives for monetary
reform.
Paul has clearly stated that he does not intend to shut
down the Fed, admitting that doing so would require far-reaching
reform. However, it is his intention that the idea has to
be nurtured over generations until new leaders are elected
with this goal in mind or until the Fed has caused such
economic and social damage that the electorate chooses leaders
with the explicit mandate of shutting down the Fed.
Hence, by stepping backward from the cherished idea in
his book, he may lead supporters and politicians to consider
his views as a form of utopia rather than a position that
can become operational in the near future. Prior to Paul,
the well-known University of Chicago and London School of
Economics professor Harry Johnson was critical of the existence
of the Fed as a policy-making body and proposed transforming
it to an agency within the US Treasury, but this idea was
never pursued.
Short of shutting down the Fed, which would require considerable
campaigning within the political establishment and proposing
the details of the monetary system that would emerge after
such a closure, there are many less revolutionary ideas
proposed by reformists during the 1930s and later, most
recently by Paul and other critics of the Fed.
Subjecting money supply to a fixed rule was emphasized
much earlier by the Currency School and translated in the
United Kingdom into Sir Robert Peel's act in 1844 that separated
the Bank of England into an issue department and a banking
department, with the issue of currency tightly determined
by the amount of gold in hand.
The advocates of the fixed-money rule, such as economists
Irving Fisher, Henry Simons, and Milton Friedman, believed
that the Fed should only control monetary aggregates according
to fixed increment rates between 2% and 4%, ensure safety
of the banking system, and renounce setting interest rates
or controlling the unemployment rate.
Besides versions of the currency school theory, reformists
during the 1930s proposed the establishment of 100% reserve
banking, which would eliminate money creation and destruction
by banks, thus making banking safe and eliminating financial
crises.
A less radical reform advocated in the past as well as
recently is to drop the Fed's mandate to achieve full employment
as this mandate may be inconsistent with the role of a central
bank as a monetary agency responsible for managing liquidity
and ensuring banking safety; this mandate may have led the
Fed into printing money, resulting in banking crises and
inflation.
Paul has considered gold as the pillar of the monetary
system that he envisions and supports. Ever since the collapse
of the gold standard in 1914, some authors have kept on
advocating a return to gold. While the metal has its supporters,
it has more adversaries among professional economists. Gold
was the common currency that unified all other currencies
in a fixed exchange arrangement under the gold standard.
The president of the World Bank has also recently proposed
a return to a gold standard. Such a move would be much more
difficult than president Richard Nixon's decision to abolish
dollar convertibility in 1971, in turn destroying the fixed
exchange arrangement adopted under the Bretton Woods system
in 1944, which had afforded gold a continuing role in the
monetary system.
However, if Paul manages to re-introduce a form of the
gold standard or abolish laws that forbid the circulation
of gold, he would have accomplished a great deal of the
reform program that he has campaigned for since the early
1970s. The menu of reforms for Paul as head of the domestic
monetary policy sub-committee is, therefore, not limited.
Paul doesn't appear to think that Bernanke is better or
worse than the previous Fed chairman, Alan Greenspan. It
is, instead, the monetary system that needs a radical overhaul.
He has predicted that under the present Fed-dominated system
the economy will deteriorate, inflation will become very
high, and that the American people will become poorer. He
holds congress responsible for fiscal management, bailouts,
re-inflation of housing prices, and authorizing Fed policies.
He has noted that foreign central banks have been buying
gold and getting out of the US dollar and that the dollar
may loose its status as a reserve currency. In such a scenario,
he does not believe that the Special Drawing Rights (or
SDRs) issued by the International Monetary Fund or any other
currency could replace the dollar – only gold could.
As a representative of the American people, he believes
that congress may have to consider substantive monetary
reforms that would restrain excessive powers of the Fed.
As it turns out, a large majority of congressmen are supportive
of the Fed, believe that printing money is the solution
to end recessions and high unemployment, and are critical
of Paul's ideas, claiming that the overwhelming majority
of Republican congressmen are not supportive of his approach
to economic and financial policy.
The 2010 November elections may have already sent a clear
message of what the electorate thinks. As Americans pay
higher prices on a daily basis for gas and food, as more
suffer the humiliation of unemployment and foreclosures
and are deprived because of economic inequities, more of
the electorate will support candidates with platforms calling
for fiscal and financial reforms.
For Paul, the US is on the verge of a currency crisis that
may undermine the very existence of the Fed: "What
I really fear is that when the Fed comes to an end it will
not be by my planning but it will end with a catastrophic
financial dollar crisis. This crisis when it comes, and
I think we're approaching it, affects everybody because
it's such an important currency. I think we're moving into
very, very dangerous times."