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How the US Created a Monster in the Federal Reserve
By Shanmuganathan Nagasundaram| Sep 14, 2013
The world needs to move away from fiat currencies, and the monopoly of central banks in creating money must end if we are to avert the next big crisis
From the perspective of the history of monetary economics, 1913 should be considered the single most important year “ever”. We are still feeling the impact of that year. In fact, the roots of what happened in 2008 and subsequently—the credit crisis, the fiscal crisis, the banking crisis, the currency crisis—can all be traced back to the creation of an entity in that year.
That was the year in which the US Federal Reserve was created. Before that, barring brief periods in between, the world had operated on the gold standard—with each currency being defined in terms of specific weights of gold or silver. For example, the US dollar was defined as 1/20th of an ounce of gold; the pound sterling was originally defined as a pound of silver and later as 1/4th of an ounce of gold, the Indian rupee was about 11 gm of silver.
So, for a bank to issue a dollar note, it needed to stock 1/20th of an ounce of gold that any customer in possession of the dollar note could redeem. By definition, these currencies operated with fixed exchange rates and maintained their purchasing power over hundreds of years, if not longer.
At this point, it is worthwhile clarifying what the gold standard really is. First, it means there is no central bank. Market participants are free to issue their own currencies and there is no state monopoly on money. One may ask: Why then should gold be the currency? The answer is: This privilege was conferred on gold not by governments, but by free market choices due to gold’s unique characteristics and consumer preferences.
Gold became money for the same reason why aluminium is used in planes, copper in wires and zinc in galvanising. Certain unique properties lend these metals to their end uses and, in the case of gold/silver, these two happen to be ideally suited to serve the function of money because of the five reasons Aristotle had observed—they are convenient, consistent, durable, divisible and have value of their own.
In a true gold standard, any market participant is free to issue any currency of his/her/its choice based on gold, copper, real estate, art or, for that matter, even thin air—without any legal tender laws granting any currency special status. Free markets then would quickly and very efficiently weed out the inefficient players.
Money then is a “good” in much the same way cars, soaps and chocolates are. The market produces them in the quantity desired by consumers. One of the prevailing misconceptions about a gold standard is that world economic growth is held hostage to mining output. This is a very fundamental misconception about money, and as Murray Rothbard explains in What Has Government Done to Our Money?, the quantity of money circulating in the system is irrelevant. Whether we have six billion or just six million ounces of gold in circulation, or $5 trillion instead of the current $50 trillion, it does not matter. The prices of goods and services move up or down to adjust to the quantity of money circulating within the system.
Another popular misconception (and possibly the one that governments would like their citizens to believe) is that the gold standard caused the great depression of the 1930s and early 1940s. Again, as Rothbard would explain in America’s Great Depression, or, as Jim Rickards would point out in his recent book, The Currency Wars, the depression was not caused by the gold standard, but at least in part because the price of gold was artificially fixed at a lower value without accounting for the inflation of the roaring twenties.
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That was the year in which the US Federal Reserve was created. Before that, barring brief periods in between, the world had operated on the gold standard—with each currency being defined in terms of specific weights of gold or silver. For example, the US dollar was defined as 1/20th of an ounce of gold; the pound sterling was originally defined as a pound of silver and later as 1/4th of an ounce of gold, the Indian rupee was about 11 gm of silver.
So, for a bank to issue a dollar note, it needed to stock 1/20th of an ounce of gold that any customer in possession of the dollar note could redeem. By definition, these currencies operated with fixed exchange rates and maintained their purchasing power over hundreds of years, if not longer.
At this point, it is worthwhile clarifying what the gold standard really is. First, it means there is no central bank. Market participants are free to issue their own currencies and there is no state monopoly on money. One may ask: Why then should gold be the currency? The answer is: This privilege was conferred on gold not by governments, but by free market choices due to gold’s unique characteristics and consumer preferences.
Gold became money for the same reason why aluminium is used in planes, copper in wires and zinc in galvanising. Certain unique properties lend these metals to their end uses and, in the case of gold/silver, these two happen to be ideally suited to serve the function of money because of the five reasons Aristotle had observed—they are convenient, consistent, durable, divisible and have value of their own.
In a true gold standard, any market participant is free to issue any currency of his/her/its choice based on gold, copper, real estate, art or, for that matter, even thin air—without any legal tender laws granting any currency special status. Free markets then would quickly and very efficiently weed out the inefficient players.
Money then is a “good” in much the same way cars, soaps and chocolates are. The market produces them in the quantity desired by consumers. One of the prevailing misconceptions about a gold standard is that world economic growth is held hostage to mining output. This is a very fundamental misconception about money, and as Murray Rothbard explains in What Has Government Done to Our Money?, the quantity of money circulating in the system is irrelevant. Whether we have six billion or just six million ounces of gold in circulation, or $5 trillion instead of the current $50 trillion, it does not matter. The prices of goods and services move up or down to adjust to the quantity of money circulating within the system.
Another popular misconception (and possibly the one that governments would like their citizens to believe) is that the gold standard caused the great depression of the 1930s and early 1940s. Again, as Rothbard would explain in America’s Great Depression, or, as Jim Rickards would point out in his recent book, The Currency Wars, the depression was not caused by the gold standard, but at least in part because the price of gold was artificially fixed at a lower value without accounting for the inflation of the roaring twenties.
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The bigger reasons include regulatory interventions in the market’s natural cleansing process adopted by Herbert Hoover and Theodore Roosevelt. In any case, the US ceased to be on a gold standard after 1913.
The US Fed was formed ostensibly to implement the gold standard, but through a series of step-wise devaluations and relentless mission-creep, it deviated from its original role. The first step was the monopoly status granted to the Fed through the Federal Reserve Act in 1913; this was followed by the Bretton Woods Agreement in 1943 that banned convertibility for citizens; and finally, in 1971, Richard Nixon delinked gold from the dollar.
What the current fiat currency system unbacked by gold does is enable a transfer of purchasing power from the productive sections of society to the government as the latter can inflate additional monies at zero cost. So inflation is really a mechanism of taxation where the ill-effects (ie prices rising) can be blamed on greedy multinationals, supply bottlenecks, poor monsoons and, ironically, even growth! Growth, incidentally, happens to be one thing that diminishes the pernicious effects of inflation.
Exactly 100 years after the US Fed legislation, and after we have moved away from the gold standard, the world is now staring at a monetary precipice. Year 2008 was just a warm-up, but the main crisis lies ahead as a consequence of decades of easy money. Indeed, the intervening years have been used by various central banks to worsen the imbalances by printing trillions of new currency units. The current crisis can be resolved only by moving back into some form of a gold standard.
In the last 3,000-plus years of the history of recorded commerce, no fiat currency has survived for extended periods of time—for good reason—and it will be no different this time around. India is in a sweet spot where it has a very good stock of gold in private hands that will allow us to implement the gold standard. Instead of decrying gold as an unproductive investment, which is anything but the truth, our government could adopt policies for a sustainable monetary standard.
Even if the government doesn’t believe in this, it loses nothing by repealing laws that grant a monopoly status to the Reserve Bank and allowing gold to circulate as an additional currency. But if we do go down this path, when the crisis hits the fan, as it undoubtedly will in the next few years, we would at least have a functioning solution in place.
Shanmuganathan “Shan” Nagasundaram is the founding director of Benchmark Advisory Services, an economic consulting firm. He is also the India Economist for the World Money Analyst. He can be contacted at shanmuganathan.sundaram@gmail.c
The US Fed was formed ostensibly to implement the gold standard, but through a series of step-wise devaluations and relentless mission-creep, it deviated from its original role. The first step was the monopoly status granted to the Fed through the Federal Reserve Act in 1913; this was followed by the Bretton Woods Agreement in 1943 that banned convertibility for citizens; and finally, in 1971, Richard Nixon delinked gold from the dollar.
What the current fiat currency system unbacked by gold does is enable a transfer of purchasing power from the productive sections of society to the government as the latter can inflate additional monies at zero cost. So inflation is really a mechanism of taxation where the ill-effects (ie prices rising) can be blamed on greedy multinationals, supply bottlenecks, poor monsoons and, ironically, even growth! Growth, incidentally, happens to be one thing that diminishes the pernicious effects of inflation.
Exactly 100 years after the US Fed legislation, and after we have moved away from the gold standard, the world is now staring at a monetary precipice. Year 2008 was just a warm-up, but the main crisis lies ahead as a consequence of decades of easy money. Indeed, the intervening years have been used by various central banks to worsen the imbalances by printing trillions of new currency units. The current crisis can be resolved only by moving back into some form of a gold standard.
In the last 3,000-plus years of the history of recorded commerce, no fiat currency has survived for extended periods of time—for good reason—and it will be no different this time around. India is in a sweet spot where it has a very good stock of gold in private hands that will allow us to implement the gold standard. Instead of decrying gold as an unproductive investment, which is anything but the truth, our government could adopt policies for a sustainable monetary standard.
Even if the government doesn’t believe in this, it loses nothing by repealing laws that grant a monopoly status to the Reserve Bank and allowing gold to circulate as an additional currency. But if we do go down this path, when the crisis hits the fan, as it undoubtedly will in the next few years, we would at least have a functioning solution in place.
Shanmuganathan “Shan” Nagasundaram is the founding director of Benchmark Advisory Services, an economic consulting firm. He is also the India Economist for the World Money Analyst. He can be contacted at shanmuganathan.sundaram@gmail.c
Published on Mises Institute (https://mises.org)
Saving India from the Keynesians
English
Mises.org Publish Date:
March 22, 2012 - 12:00 AM
In the murder mystery The Da Vinci Code [2], Silas the albino is in search of the keystone and, on confession by the four sénéchauxabout the location, he visits the Saint Sulpice church in Paris to retrieve the same. However, upon digging at the specified spot, all that he finds is a stone with the inscription "Job 38:11." A nun explains the symbolism: "Hitherto shalt thou come, but no further," indicating that Silas has reached the end of the road in his attempts to find the keystone.
Much like Silas, members of the Indian economic think tank are lost in terms of what needs to be done.1 While in The Da Vinci Code, the elaborate ruse was an explicit design by the four sénéchaux to safeguard the keystone, in the Indian scenario, the problem lies between the ears of the think-tank team and was put in place decades ago by John Maynard Keynes. Operating perhaps with the most altruistic of intentions, Keynesian economic thinking has been and will continue to be the stumbling block in our progress forward. Unless this team can unlearn the Keynesian "witchcraft" to understand capitalism (i.e., the free market as understood by Austrian economics), progress is going to be halting, if there is any at all.
At this point, readers could rightfully ask the question "How then did the same team engineer the reforms of 1990–2010?" The answer is fairly straightforward: all that we have managed is a transition from a nearly communist economy (defined as state ownership of production) to a nearly fascist economy (in which ownership of production is private, but the state plans and controls the means of production.)2 The above transition was intellectually consistent with the Keynesian beliefs of the reform team and hence was not difficult to implement. Even this limited movement in the direction of "free markets" has given the Indian economy tremendous rewards in terms of growth and poverty reduction.
Despite the obvious benefits of liberalization, India still continues to centrally plan the economy and indulge in various socialistic schemes. While political compulsions of democratic politics could be part of the problem, the real stumbling block lies in retrograde economic thinking. Given below are a few issues where the flawed ideology is affecting the progress.
I have taken three examples to explain how government interference inhibits economic activity and encourages inefficiencies. The beneficiaries of the current economic system are corporates who can thrive under the corrupt system and the citizens who are recipients of the subsidies. This comes at the expense of a depreciating currency and bearing the brunt of these policies is the large Indian middle class.
While there would be impediments to implementation as cited above, the bigger stumbling block lies in the realization by the economic team as to why the above is the right thing to do. For a team that has paraded the NREGA as its flagship achievement, indulges in price controls as a way to manage inflation, has praised ministers for presenting socialistic budgets (for example, the railway budget, where passenger fares have not been revised for the last eight years and due to the burgeoning deficit, there has been a nominal increase in 2012), the intellectual blind spot is the real hurdle. With the repeated hyperbole in the mainstream media of Indian Prime Minister Dr. Manmohan Singh being a "brilliant economist," and given that he has surrounded himself with advisers who are essentially welfare/Keynesian economists, salvation truly lies only within.
Much like Silas, members of the Indian economic think tank are lost in terms of what needs to be done.1 While in The Da Vinci Code, the elaborate ruse was an explicit design by the four sénéchaux to safeguard the keystone, in the Indian scenario, the problem lies between the ears of the think-tank team and was put in place decades ago by John Maynard Keynes. Operating perhaps with the most altruistic of intentions, Keynesian economic thinking has been and will continue to be the stumbling block in our progress forward. Unless this team can unlearn the Keynesian "witchcraft" to understand capitalism (i.e., the free market as understood by Austrian economics), progress is going to be halting, if there is any at all.
At this point, readers could rightfully ask the question "How then did the same team engineer the reforms of 1990–2010?" The answer is fairly straightforward: all that we have managed is a transition from a nearly communist economy (defined as state ownership of production) to a nearly fascist economy (in which ownership of production is private, but the state plans and controls the means of production.)2 The above transition was intellectually consistent with the Keynesian beliefs of the reform team and hence was not difficult to implement. Even this limited movement in the direction of "free markets" has given the Indian economy tremendous rewards in terms of growth and poverty reduction.
I have taken three examples to explain how government interference inhibits economic activity and encourages inefficiencies. The beneficiaries of the current economic system are corporates who can thrive under the corrupt system and the citizens who are recipients of the subsidies. This comes at the expense of a depreciating currency and bearing the brunt of these policies is the large Indian middle class.
Saving the Country from Keynesians
Given the challenges ahead in terms of disruptions in the global economy, the right thing for the government to do would be to free up capital by reducing their expenditure (leading to lower taxes and inflation) and dramatically decrease the involvement in economic activities/decision making by allowing competitive forces to decide market outcomes. Of course, there would be vested interests protesting these changes by the corporates that are benefiting today from government policies and by the citizens who enjoy the Keynesian dole outs.While there would be impediments to implementation as cited above, the bigger stumbling block lies in the realization by the economic team as to why the above is the right thing to do. For a team that has paraded the NREGA as its flagship achievement, indulges in price controls as a way to manage inflation, has praised ministers for presenting socialistic budgets (for example, the railway budget, where passenger fares have not been revised for the last eight years and due to the burgeoning deficit, there has been a nominal increase in 2012), the intellectual blind spot is the real hurdle. With the repeated hyperbole in the mainstream media of Indian Prime Minister Dr. Manmohan Singh being a "brilliant economist," and given that he has surrounded himself with advisers who are essentially welfare/Keynesian economists, salvation truly lies only within.
- 1.The think tank is not a formal body, but refers to the group of people who decide on major policy issues. It consists of Dr.Manmohan Singh (the Indian prime minister and an economist), Montek Singh Ahluwalia (deputy chairman of the planning commission and ex-World Bank), Dr. Kaushik Basu (chief economic adviser to the prime minister and former professor of finance from Cornell), and Dr. Rangarajan (former RBI [3] governor of India).
- 2.On our scale of economic schools, fascism would come in between Marxism and Keynesian economics.
Media:
Topics:
Global Economy [4]
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Source URL: https://mises.org/library/saving-india-keynesians
Links
[1] https://mises.org/profile/shanmuganathan-shan-nagasundaram
[2] http://www.amazon.com/gp/product/0307474275?ie=UTF8&tag=misesinsti-20&linkCode=xm2&camp=1789&creativeASIN=0307474275
[3] http://www.rbi.org.in/home.aspx
[4] https://mises.org/topics/global-economy
[5] https://mises.org/austrian-school/other-schools-thought
[1] https://mises.org/profile/shanmuganathan-shan-nagasundaram
[2] http://www.amazon.com/gp/product/0307474275?ie=UTF8&tag=misesinsti-20&linkCode=xm2&camp=1789&creativeASIN=0307474275
[3] http://www.rbi.org.in/home.aspx
[4] https://mises.org/topics/global-economy
[5] https://mises.org/austrian-school/other-schools-thought
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