Macroeconomic illiteracy

In his February 24th article, “A critique of the Federal Reserve System,” Eric Yao provides some seriously disturbing, frankly catastrophic, prescriptions for central banking in the United States. In his critique, Yao channels century-old Austrian economic theories that are unfortunately still espoused by a conservative minority. While it is hardly a point of contention that the Fed’s policies have been far from perfect in the past century, proposing to get rid of the central bank altogether or to eliminate its power to conduct monetary policy implies a severe case of macroeconomic illiteracy.

I will, however, save my remedy for this until later. First, let’s address the colossal impracticality of the gold standard alternative Yao proposes (I am forced to assume gold here because Yao simply fails to make his actual choice clear and he seems to like Ron Paul). In essence, a gold standard calls for a strict tethering of the value of a country’s currency to the amount of gold it has in reserve. As of September 2013, the US held about 8,133.5 metric tons of gold and the current market price of gold is roughly 1,350 dollars per troy ounce. The current Money Supply M0, the most liquid measure of the amount of dollars in circulation, is about 3.7 trillion dollars. With these conditions, if we were to successfully attach the value of the dollar to gold, one of three things (or perhaps a combination) must happen: we would have to allow the price of gold to rise to about 10 times its current level, find a way to increase the amount of gold we hold in reserve beyond the amount we know to exist on earth, or allow unprecedented deflation and shrink in the money supply.

I’ll address each of these points separately. If the dollar value were connected to gold price, the gold market’s inherent volatility would have the potential to cause serious and uncontrollable economic instability. Small changes in the market price for gold would cause equivalent changes in the dollar value and ultimately the price level of all goods across the country. I can only imagine that allowing the price of reserve gold to increase tenfold in an attempt to attach it to the current money supply will exacerbate this problem.

Now for the second scenario — increasing our gold holdings beyond the amount that actually exists in the world. As I am unaware of any major advances in alchemy since the early 18th century, we’ll probably have to write this one off as a no-go.

Lastly, we’ll look at the effects of massive deflation and shrinking money supply. Here are a few immediate consequences: unbearable increases in real debt burdens, an astronomical jump in unemployment rates all over the world, and sure destabilization of an already wobbly international economy. Chaos, as I understand it, is poor economic policy.

Now that it is clear that the standard-backed solution is not a viable one, we can tackle one of Yao’s few important criticisms: “Some citizens have never even heard of the Federal Reserve, let alone explored its history and influence.” Why don’t we fix that here?

Yao claims that the Fed has “[exacerbated] political and socioeconomic policy by creating boom and bust cycles” through its monetary policy. Let’s turn to the monetary policies the Fed used during the Great Recession of 2009 and see if they were indeed as harmful as Yao indicates. Luckily for us, renowned economists Alan Blinder and Mark Zandi have already taken on the complex task of isolating the effects of the Fed’s monetary policies in response to the Great Recession. Data from their acclaimed 2010 paper, “How the Great Recession Ended,” shows that financial policies, which include quantitative easing and money supply changes, were single-handedly responsible for a 2.65% increase in real GDP, a 4.46% increase in payroll employment and a 2.70% decrease in the unemployment rate. This, I’d say, is decidedly unharmful.

Analyzing even this small portion of the Fed’s history provides an overwhelming argument for the preservation of its monetary power. Yao fails to realize that a fiat-monetary system, like the one we have in place, has the ability to manage inflation and an even greater potential to respond to serious economic crises and market failures. More importantly, eliminating monetary policy altogether will only intensify the “boom and bust” cycles that rightfully worry him.

Mark Koba, Senior Editor at CNBC, provides possibly the most convincing support for the Fed’s existence: “Out of 100 years of Fed control, the country has had 22 recessional years, including one depression. The 100 years before the Fed saw 44 recessions and six depressions.” The problems with the central banking system are real and pressing. Putting Janet Yellen, possibly the most qualified Chair in Fed history, out of a job and transferring control of the world’s most important currency to a shiny metal, however, is not the solution.

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