Mr. President, Money's Broken. Please Fix It.

By James Soriano  /  American Thinker

“I think the Fed is making a mistake,” President Trump told the press recently.  ”They are so tight.”

He was referring to the Federal Reserve’s decision on September 26 to raise the federal funds rate to a range of 2.00% to 2.25%.  That move was the sixth uptick since President Trump took office, and the market senses that the Fed will crowbar the pinch point up again in December.  President Trump is right to be worried that all these moves will tank the economy.

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But jawboning the Fed is not enough.  The president should push for monetary reform.  It’s long overdue.

In the present monetary regime, long-term interest rates are determined by market pressures in the bond market, but the federal funds rate, the short-term interest rate controlled by the Fed, is still government property.  It’s set by the members of the Federal Open Market Committee (FOMC), who meet behind closed doors every six weeks or so and, after having pored over the latest economic data, and tested the political winds to see what’s expedient and what’s not, vote on setting the target range for short-terms rates.

An alternative approach would be to get the FOMC out of the interest rate business and let the market decide.  Here’s what a reform would look like using the so-called “gold-price mechanism,” which has been bandied about for decades.

1. The U.S. government defines the dollar in terms of an ounce of gold.  This is a political decision.  It doesn’t belong merely to economic specialists.  One way of doing this would be to calculate a long-term moving average based, say, on the monthly close for an ounce of gold.  Thus, the ten-year moving average would have 120 data points.  Of course, using different time frames would disclose a different long-term average price, but whatever time frame is used, it should be lengthy enough to capture most of the dollar-denominated contracts still in existence so as not to penalize or reward either borrower or lender.
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3. If the spot price of an ounce of gold settles on a daily basis above its long-term average price, that would be considered an “inflationary” signal.  The Fed’s response would be to drain liquidity from the system.  It should sell bonds.
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5. If the spot price of gold settles on a daily basis below its long-term average price, that would be considered a “deflationary” signal.  The Fed’s response would be to inject liquidity into the system.  It should buy bonds.

Note that this approach entails moving toward re-establishing fixed exchange rates among the world’s trading powers.  If Countries A, B, and C all define their national currencies in terms of a long-term average price of gold, then their cross-rates must be fixed against each other on the grounds that things equal to the same thing are equal to each other.

  National currencies so defined would introduce a kind of stabilized global unit of account, a public standard for measuring such things as labor costs, commodity prices, and so forth.  It is strange today that the voices raised in favor of a globalized economy, with its emphasis on outsourcing and supply-chaining, are silent this issue.

Let’s take an example of how a notional gold-price mechanism would work.  Presently, the ten-year monthly average of gold is about $1,295 an ounce.  Don’t read any farther until you guess the answer to the following question: under the parameters of the model described above, and using $1,295 as the standard for defining the dollar, should the FOMC be draining or injecting liquidity into the economy?

The answer is, the Fed should be injecting money into the system, which is the opposite of what it is now doing.  In recent weeks, the daily closing price for gold has been in the range between $1,194 and $1,229, well below its ten-year average.  Raising the federal funds rate in this situation increases the cost of capital, which decreases the demand for dollars, whereas gold is signaling that the market wants more dollars.

The market’s apparent demand for more money likely stems from the effects of the Trump administration tax cuts.  Lower tax rates, as well as a reduced burden in business regulation, tend to increase economic activity and hence increase the demand for dollars.  The Fed should accommodate this demand by supplying more liquidity.  But ratcheting up the federal funds rate has the effect of choking off marginal business activity, at the time when the nation’s tax policy is encouraging business formation.  Higher interest rates are compulsive on contraction, whereas lower tax rates are permissive on expansion.

Let’s say the Fed took its hands off the handlebars and let the market decide the level of short-term interest rates.  Would they go up or down?  Who knows?  That’s not the point.  In the current macro-economic environment, there would be no impediment hindering market-driven short-term interest rates from trending higher, if the market so determined. 

 The point is not to guess where the “just so” interest rate is located.  The key is the supply and demand for dollars, not the absolute value of any interest rate.  Even if the market determined that short-term rates should go higher, the change would be incremental, continuous, and transparent, as opposed to the Fed’s episodic and murky decision-making system now in place.

The Fed needs a new policy tool.  It should give up trying to manipulate the short end of spectrum in favor of using the price of gold as a signal for creating or extinguishing liquidity.  This new paradigm is about establishing a standard value of the dollar and keeping it there.  It would also apply to stabilizing the values of other currencies.  Once the standard of the dollar has been established, the Fed would then be called upon to act when the standard is violated and to stand aside when the system is in equilibrium.

A new monetary paradigm can come into being only if there is leadership in Washington.  Monetary reform is not a grassroots issue.  What is needed is a president who has enough self-confidence to break with the dysfunctional practices of the past and who intuitively grasps that the interests of those who would benefit the most from a stable dollar, the mass of ordinary citizens, are not necessarily served by the entrenched practices of the elites who run our country’s institutions.

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James Soriano is a retired federal government employee.

https://www.americanthinker.com/articles/2018/10/mr_president_moneys_broken_please_fix_it.html#ixzz5U83XgVWO 
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