Chris Yuhas Blog: True Economics and Politics

Federal Reserve or the Gold Standard?

Posted in Economics by Christopher Yuhas on October 19, 2009

CPI Chart

The Federal Reserve is charged with combating inflation and providing a more stable monetary and financial system by authority of the US Congress under the Federal Reserve Act of 1913. They have failed that responsibility. Due to the fact that they have an unchallenged authority to dictate monetary policy, which is setting interest rates and the money supply, they are solely to blame for the 95% devaluation of the American dollar since 1913, following the Keynesian economic ideology that promotes fiat currency, centralized banking, and heavy intervention to the economy it serves.

From the brief analysis given below, the argument for an immediate implementation of the gold standard, will be substantiated by showing that gold in free markets can regulate the inflation of currency than the Federal Reserve.

In any particular school of economics, a widely accepted truth is that inflation’s primary causes are interest rates and the money supply. When any central bank, like the Federal Reserve Corporation, wants to slow down inflation, the first order of business is that interest rates must be raised. When interest rates rise, people are less likely to borrow money. When borrowers have to pay a premium over a longer period of time it discourages riskier investments, thus the economy becomes limited in available money for investment since individuals and institutions are more likely to save.

10 Year FED Rate

If economists from many economic schools and perspectives teach that inflation of currency can be slowed by raising interest rates, it seems from the historical data chart from the Federal Reserve Corporation’s own data, that interest rates are dropping, which is encouraging more spending, usually with traditional risk assessment non existent,  thus causing more inflation.

US Currency in Circulation

The second major action a central bank has in its arsenal to combat inflation, is the direct manipulation of the money supply. A simple rule of supply and demand can easily explain why this method is effective. If you want to increase the value of anything, make it less available. For instance, a Mickey Mantle rookie card can fetch a premium in the $200,000.00 dollar range because of the rarity of the commodity. If there were to be a sudden increase of Mickey Mantle rookie cards, in the millions for example, the commodity is now diluted its luster to fetch a premium because buyers know it is not that rare. The same rule with any currency applies, such as the United States dollar. The US currency has declined over 95% since 1913, and knowing this simple rule, some currency should be removed from circulation to maintain the strength of the currency. The exact opposite is happening today. The money supply has more than doubled in the last two years, adding to even more inflation, contrary to sound rules of economics.

The Federal Reserve Corporation also sets the standards of reserve requirements that banks must hold. For every 1 dollar a US bank saves, they can lend out 10 by creating money in a keystroke. This is called fractional reserve lending. This policy has contributed heavily to the decline of the dollar as banks have feverishly been lending out money, which is only backed by a tenth of the amount. This risky policy equates to US banks being able to have person deposit money into their institution, and then create 10 dollars of money out of thin air to lend, thus diluting the value of the dollar even further. If the reserve requirements were set higher, to at least a 5:1 reserve requirement, and as only a temporary measure, this would force banks to analyze risk more effectively and not engage in the toxic subprime mortgages market, for people who should not have been able to afford the house in the first place.

A prudent individual would then look to the audits of the Federal Reserve Corporation, hoping to discover, bad investments with other central banks and corrections on their fiscal policy, however they have exemptions of being audited on the their most important actions:

(b) Under regulations of the Comptroller General, the Comptroller General shall audit an agency, but may carry out an onsite examination of an open insured bank or bank holding company only if the appropriate agency has consented in writing. Audits of the Federal Reserve Board and Federal reserve banks may not include—
(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;
(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations;
(3) transactions made under the direction of the Federal Open Market Committee; or
(4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to clauses (1)–(3) of this subsection

Given the scope of what the Government Accounting Office, is prevented by law to audit, it would be very difficult to say exactly what is going on behind closed doors. The reality is that the Federal Reserve Corporation deals in the trillions, while the United States Congress only deals in the billions, yet Congress can be fully audited, but the Federal Reserve Corporation cannot under law be scrutinized on the 4 subsections. These exemptions must be removed so that the failures can be assessed and more efficient safeguards to prevent inflation put into place.

The first recommendation is to conduct a full audit of the Federal Reserve Corporation. Only a full audit can determine why interest rates were left unusually low and the money supply was effectively doubled, when economists would agree that the opposite, being raising interest rates and reducing the money supply, would have started a correction for the inflation.

Gold Std

The next recommendation would be the full scale implementation of a 100% gold standard with all currency redeemable in a fixed weight of gold. Gold, as in the CPI index chart (above), quickly corrects the inflation of the currency. The times in US history when inflation went high, on a gold standard, is during times of war, when convertibility of currency to gold was suspended to help fund the campaign. When the wars were concluded gold became convertible, and corrected the value of the currency. This is also a check and balance for risky lending of banks, and putting a strict restraint to prevent Congress from heading to the printing press to fund their next policy. The gold standard effectively puts an end to fractional reserve lending which forces banks to back all holdings with full convertibility to gold. This in turn would force banks to use traditional risk assessment when lending money, rather than the extreme risk that is plaguing the US economy today. Again, the gold standard prevents politicians from running to the printing press, when they want to fund a program or an unpopular war, which would traditionally require people to vote for a tax increase. Politicians usually run to the printing press to fund wars, as most citizens would generally not vote to do so. The 1900’s gave rise to central banking in Europe, and naturally war followed because politicians could run to the printing press to make currency and without being backed by gold or a metallic. They continually dilute the money supply at the expense of the citizens, without a tax being voted on to fund their war. Even former Federal Reserve Chairman Alan Greenspan warned of currency abuses by politicians in the absence of the Gold Standard in his 1966 Gold and Economic Freedom:

“This is the shabby secret of the welfare statists’ tirades against Gold. Deficit spending (inflation of currency) is simply a scheme for the hidden confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism towards the Gold Standard.”

With all information considered, and a recommendation of the 100% Gold Standard, you now have a metallic that has the ability to control inflation by being convertible at all US banking institutions, which is essentially the free market itself. Therefore, there are no needs for a central bank when the 100% Gold Standard with dollars payable on demand in gold. The Gold Standard had been a self regulating and effective tool combat inflation. The Federal Reserve Corporation should be converted to a public organization and restructured under the US Treasury Department. The Federal Reserve System could then be used as a real tool to combat inflation to regulate and inspect all banking institutions across the nation ensuring they are holding sufficient gold for surrender, given the total currency in circulation.