Nobel prize winning economist Milton Friedman: "There is nothing that will destroy a society more thoroughly as letting inflation run wild".
It is interesting that no politicians besides Ron Paul have addressed the hidden tax of inflation and a flawed monetary policy that boosts inflation and decreases the value of the dollar.
When the government spends more than it takes in who pays for it? The tax payers do through indirect taxation called inflation. Naturally the politicians love this because they can levy a hidden tax (inflation) while still increasing spending; meanwhile inflation looms in the background. When inflation rates increase people make more money but it is worth less, since they are now in a higher tax bracket they have to pay more taxes therefore their real income after taxes is decreased and taxes are indirectly increased. Inflation hits the lower and middle classes the hardest. Canada has a tax bracket that is indexed to inflation, not surprisingly our congress has not adopted this fair tax system.
Monetary Policy
The Fed or Central Bank was set up to control the flow of money; it has two main ways of doing this:
- Printing more money
- Lowering the interest rates (encourages people to borrow more money and save less = more money in the system)
The Fed’s two chief concerns when deciding monetary policy are:
- Avoid rapid inflation
- Avoid economic recession
How inflation works – the lag effect
When the Fed prints too much money or lowers interest rates the good effects come first...improved economy...then the bad effect of higher inflation comes usually about a year later. That's why it's so temping for the central bank and policy makers to make this poor decision.
Some negative effects of high inflation are:
- Decreased spending ability
- Devaluation of the dollar
- Less incentive to save/invest
Fixing inflation-another lag
Unfortunately the solution to inflation is not easy and requires discipline. Once inflation is upon us the only way to fix it is to print less money, but there is still a lag; the economy goes into a recession but inflation continues to rise! Only after a period of recession and increased inflation (stagflation) does deflation finally kick in. As you can imagine it is very unpopular for any Fed or politician to decrease inflation. Once again a country must live through a recession before they can enjoy the mutual benefits of low inflation and a healthy economy, there is no way to avoid this.
Gold standard
Although constitutional the gold standard doesn't make sense to me from a monetary standpoint. If more gold is found then gold devaluates = inflation. So for example if more gold was found in Africa, but the economy here was not expanding there would be inflation without growth. What we need is a realistic disciplined monetary policy that tracks our economic growth. Over the past three years the price of gold has doubled from $400 to $800 vs. the dollar, can you imagine the economic mayhem that would ensue if the dollar increased in value so dramatically in such a short period of time?
Our current situation
When 9/11 happened it threatened to throw us into a bad recession, to counteract this recession Alan Greenspan and the Fed cut interest rates allowing America to temporarily avoid recession. Along with increased government spending America experienced a period of artificial growth. Nowadays the Fed acts as though recession is permanently avoidable because it is constantly increasing the money supply so that we don't go into recession. It seems ludicrous to me that they think our economy will continually expand and never contract. Recessions are natural and unavoidable, now instead of treating the upcoming recession as the reality that it is the Fed is once again pumping more money into the system and the Federal government is doing more deficit spending. The upcoming “financial stimulus package” will infuse even more money into the system. The unintended consequence of course will be a decreased standard of living due to inflation and when the unavoidable recession does finally hit it will be worse. It is the responsibility of Americans to realize that the economy cannot always expand without contracting and to elect leaders with enough courage to impose tough monetary discipline.
Most of these ideas were lifted from Milton Friedman's groundbreaking documentary Free to Choose. I strongly recommend watching this series to anyone who wants to understand the power of the free market. You can stream it for free over the internet at ideachannel.tv. In fact you would be better off just watching Milton’s documentary than reading what I have written above.
6 comments:
Thanks for your comments Paul, it is a very interesting and important topic of discussion. I look forward to watching more of that documentary. (I have watched the first so far and it is very insightful. Milton Freedman does the commentary in a remarkably unbiased way, in the end of the documentary he invited very educated, knowledgeable people on to dicsuss the issues that he was talking about, and he knew these people would have almost opposite views from himself.
One comical thing about the documentaries, is the person who introduces them... Yes, a very young, Arnold Schwarzenegger. And to think that now he wants universal healthcare for all of California? It's amazing the change that took place, from a tax payer... to a corrupt politician. (Or maybe he's just been married to Maria Shriver for too long.)
It does appear that Arnold has done a 180, you have to also keep in mind that in order for him to stay in power and do any good at all he has to "reach across the aisle". I still think he's better than most of the liberal alternatives. He is definitly a shrewd politician. Dicusion #9 from free to choose is the one that talks about inflation.
One more thing, I think that it is a mistake to have a Centeral Banking system that is not held responsible by the elected representatives of the people. It opens things up for coruption. Who knows if the Fed is doing things for their own self interest or the self interest of the people they are supposed to represent but don't elect them. Even if they are just who is to stay that they will stay that way if they aren't held accountable?
Milton Friedman was my hero, one of the last true free-market economists in the tradition of Adam Smith. He was responsible for Chile (or Peru?) privatizing their failing social security system; largely saving it from disaster. He has been mostly a lone voice championing economic freedom.
The FED was created in 1913 by an act of Congress. Congress basically gave away their Constitutional power to coin or print money. Constitutional powers cannot be delegated except by amendment. Now a commitee of seven executive bankers have control of the money supply and are largely unaccountable to either Congress or the people. Since its inception, the U.S. has experienced the worst recession in its history. The the Great Recession of the 1930s was largely due to a mismanagement of the money supply by the FED. The inflation cycle has been worstened by the debt-based economy controlled by the FED.
Before the creation of the FED, the money supply was based on the gold standard and was largely controlled by the free market on a local level. As the demand for money or credit arose, new banks would spring-up chartered on a state or local level (like Joseph Smith's Safety Society). There were occasional ups and downs in the market but this is natural in any system; the important thing is that the system is responsive to correct itself and this is best done on a local level. In summary, Congress set the gold standard and the local banks controlled the money supply. The system worked well with some normal ups and downs that were short-lived. We could learn a lot from the original system.
I think that it is viable to go back to this system. We are used to thinking that the value of gold is changing, but it is really the dollar! It costs about 20 oz of gold to buy a car today; the same that it costed back in 1920! We could also use silver which is abundant in the U.S. The main advantage of a gold or silver system is that it curbs the abuse of printing fiat money.
Cicero, (who are you by the way). I too am a big Milton Freidman fan, I have searched and searched and I could not find anywhere where he supported going back to the gold standard. True, gold is the only form of currency that maintains it's value over a long period of time, but it can and has fluctuated wildly in the short term verse any and all currencies. The fluctuation over the past 3 years for example from $400 to $850 is more from an increase in the value of gold than a decrease in the value of the dollar. These fluctuations represent short term economic instability; this realization is probably why Milton Freidman did not support a return to the gold standard. I think that you are oversimplifying the issue when you say that a car costs the same amount of gold today as it did 50 years ago.
To whom it may concern... cicero is Joseph and Sparrow is Paul.
I have yet to finish Milton Freedman's series, and perhaps that will help, but my dilemma on economic policy, is that I feel like I just simply don't know enough about it. That's not true with all economic policy. On some political policy we can clearly see a link between government actions and effects that those decisions have on our country. For example, it seems clear enough that a truly free market, free of too much government intervention makes for a healthy and more efficient economy. It is also easy to see that excessive government spending is harmful, as it will have to be paid back by future generations, devalue the dollar, and causes inflation. As far as the logistics of the economy, though, how are we to know, in such a complicated system, whether a gold or silver standard would be even workable, let alone know if it would solve anything. Take the Great Depression, for example, does any one really know why it happened? I've heard and studied a variety of different explanations, most of them contradicting other explanations, or simply admitting that we don't really know for sure. (In all reality, there was probably an enormous amount of contributing factors). Maybe someone can enlighten me on this matter... Along those same lines, I am curious as to why the fed is so horrible. Why was it created in the fist place, and what would change if that power was restored to an official government branch? I'm not sure if I totally buy the argument that it needs to change because the constitution gives congress the power to coin money. I believe that the founders added that to the constitution because they new it was important for the United States to have a common currency to allow trade in between the states. I'm not so sure they had an objection to the government delegating the power of setting interest rates and such like they did with the fed. Does it really work so badly? Is there impending doom in sight?
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