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Thursday, August 17, 2006

Reynolds Rips Darda exaggeration: Part two::By Alan Reynolds

Reynolds doesn't pull any punches in dismantling Darda's article.

"All that extraneous chatter about rising velocity or whatever is just an unhelpful distraction."

I tend to think Reynolds wins this round.


Blogger Robert P. Churchill said...

It seems to me that Reynolds is saying that higher energy prices cause inflation, which I believe is absurd. Please correct me if I'm misinterpreting this. All prices go up when excess money is created, though not all at the same time. The speed at which a given price goes up depends on how high it is either up the value chain or up the time horizon (or both). The sensitivity of the reportage also is a function of how the price of energy is figured into the CPI, which itself doesn't consider substitution effects or really capture the price of housing correctly.

If there had been no excess money creation in the 70s or more recently, the cost of energy would still have risen, but not by so much, since only the fiscal and substitution effects would have occurred. It is always the case that fiscal and monetary effects are confused and conflated, and the straightening out of all that is what Supply-Side is all about.

I think his criticisms of other of Darda's minutae may have more merit (it seems particularly unenlightening to discuss "velocity," for example) but I definitely must quibble with the original point.

12:44 PM  
Blogger Dick Fox said...


Reynolds is confused concerning inflation but I do not read him as saying that higher energy prices cause inflation. He states: Those of us who do not believe that monetary policy should flucuate with energy prices simply do not agree.

But he does not understand that the POG is a reflection of the current monetary situation not necessarily a hard and fast rule indicating inflation. He points to situations where POG did not signal inflation, but he did no analysis of the fiscal conditions at the time. As we know progressive tax rates exercabted the impact of the inflation during the 1970s. Tax cuts can absorb excess money and reduce the impact of inflation. But we must be alarmed when gold is climbing because it is a clear indication of excess currency relative to demand.

But Darda seems to be grasping at clouds to define inflation. I sure don't remember him making these arguments when he was posting with us.

1:40 PM  
Blogger David Wood said...

Reynolds is saying that there just isn't that much inflation out there right now, based on the actual inflation numbers. He's not confused on gold, Dick, he just doesn't believe that there is a direct correlation between gold price and inflation. His point on energy, Bob, is that basing monetary policy on the gold price is comparable, in his opinion, of basing it on the vagaries of the energy market.

I have to say I agree with him in the current instance. The gold price is clearly out of whack right now, for whatever reason. If the Fed started using it as Darda wants, they would create a recession for sure (if they haven't already).

I don't know why gold is out of whack. Hedge funds, the new GLD ETF, whatever, I just don't believe there is that much inflation out there.

1:55 PM  
Blogger Dick Fox said...

David: The gold price is clearly out of whack right now, for whatever reason.


It seems pretty clear from the GVM that gold is what it always has been. The reason I said Reynolds does not understand gold is because he looks at gold and then he looks at the economy and if the lagging indicators do not show inflation at the same time gold is showing inflation he discounts the importance of the gold signal.

Henry often makes the point that there is monetary inflation and there is price inflation. Gold signals monetary inflation, but price inflation follows gold inflation by 6 months to a year, sometimes even longer.

And as the Austrians teach, and as Bob has pointed out, that inflation is not equal across all economic segments, it could be in housing, it could be in stocks, it could be in consumer goods, or it could be across the board, depending on the fiscal circumstances.

Gold is much like a moral code such as the Bible. Often we do not understand why certain signals are given but in the future as we look back it becomes obvious. Jude was a master of reading gold and making the right call economically. It is possible to read gold correctly, but I don't know of anyone now who is like Jude.

3:40 AM  
Blogger ed hanson said...


I will try to point out price inflation by the gold price in order to show how the dire inflation predictions are out whack. There will be some amalgamation of gold standard thinking and monetarist theory. I am defining dire price inflation as approaching that measured by the CPI of the 70's. I ask you not to hold me to strict theoretical mathematical analysis, but look at it as general overview to get handle of how dangerous the inflationary situation is.

1) To compare one era to another, it is safer and more accurate to put terms in percentages or ratios.

2) To reach double digit price inflation in the 70's, the gold price rose by a factor of 20 (35 to 700). This latest round the gold price peaked less then a factor of 2 beyond its non-deflationary level (400 to 730).

3) No matter what the Fed said in the 70's about restraining monetary growth, until Volcker, it did not by any measure, base or M's. The current Fed has been restraining monetary growth for longer than 3 years, again by actual measurement of base or M's.

4) The single greatest factor of the worldwide price of gold has been the creation of a third large legitimate world currency, the Euro. The Euro dwarfs the former Mark or the current Pound in size.

5) Additional factors of the world wide growth of the gold price is the reinflation of the Yen, and war scare.

6) The world currencies are now approaching eqilibrium both among the three and the world economy as a whole.

7) Fed action and this equilibrium, point to a gold price that already has reached it's peak, with only the war scare left to tend the gold price up.

The Bernanke Fed is correct, even with its less then optimal tool of the FFR, it has restrained inflation, and shortly, the expectation of inflation. Get used to currencies losing value by 0 to 2% a year, because current Fed operational theory refuses to 'risk' a 0 inflationary dollar. But on the other side, get use to the fact that the non-gold standard dollar is not going to cause the long years of deflation that occurs under the gold standard as the unit of account returns to its old value.

Dick, I could go into greater detail at greater length, but you can see where I am coming from without it.

5:24 AM  
Blogger Henry Meers said...


Isn't the 2% perpetual inflation/growth rate Milton Friedman's old goal? Turn on the money computer and send the Fed home. One way or another, the market will figure who has the lowest "inflation" rate and invest there.

Competition between currency areas will be interesting to watch. Of course, the theory says we don't need gold with perfect money management; but we have never made it there. A relatively stable rate of inflation might be a boon to the financial markets and, thereby, to the entrepreneur. This greatly favors the U.S. as place to invest, because of our institutionalized ability to fund risk.

A lack of serious inflation might be seen as deflation by those is search of "pricing power".

6:08 AM  
Blogger David Wood said...

Well put, Ed.

6:13 AM  
Blogger ed hanson said...

Henry you wrote in part:

Isn't the 2% perpetual inflation/growth rate Milton Friedman's old goal? Turn on the money computer and send the Fed home. One way or another, the market will figure who has the lowest "inflation" rate and invest there.

Absolutely not. Milton is an advocate of 0% inflation.

One of Milton's original estimates for the growth of the monetary base was 2% a year. This was his first estimate for 0% inflation.

And now Henry, the market will figure who has the greatest real growth, minus tax considerations plus safety, and invest there; this is not necesarily the least inflationary.

And here is an important thing to remember about currency competition. It is a bastardization of monetary theory and international floating currencies.

Monetary theory says the exchange rate between currencies will change depending on the monetary policy of the countries, naturally. This removes the illusion of the changing values. This theory encourages private enterprize to develop means such as a vigorous forex market to provide transparent and quick reaction of currencies relative values.

Keynesians and tariff types and other protectionist and some bankers think that by manipulating monetary policy thay can compete with other currencies, artificially. These types dislike transparent forex markets and would interfere when possible.

Henry, note, there is a real difference.

6:41 AM  
Blogger Henry Meers said...


Feel free to read my posts. In any case something near 2% is the historical growth rate of the U.S. economy over a fairly long period.

You are certainly correct that fooling with currencies does not change the way a country operates and is no substitute for sound, free-market policies. Even Jude argued against a gold currency for Switzerland for a bunch of reasons, but the stable monetary untit attracts capital, which easily offsets any temporary advantage derived from competitive devaluations. Unfortunately, too many opinion and policy makers miss this vital point even though it is right in front of their eyes in the history and practice of the U.S.

7:29 AM  
Blogger Henry Meers said...

A few minutes ago, I watched a debate between Jared Bernstein of the Economic Policy institute (he takes the Democratic Party line on Kudlow's show) and David Boaz of CATO. David was in favor of floating currencies.

Since CATO is free-market and libertarian, I had to try to figure out was David meant. Since this was in the context of China trade and the usual debate about that currency, it occurred to me that the argument is over trade-managed money if there is such a thing officially. If that is what the whole thing is about, I might be a bit more encouraged.

The idea that France might print more Francs (in the not-so-old days) to make wine exports cheaper might fit the description. In that case, the currency markets should let the Franc float down and leave other currencies alone. I'm not so sure labor-union pressure along with exporting-industry complaints don't have more to do with the Treasury's "floating dollar" policy, but it is possible they mean the dollar could get stronger in a competitive environment.

The toss-up is interesting for the Fed. Does it let the dollar rise, perhaps a strong bond market, and let the average guy buy for less; or does it do the opposite to protect domestic industries from competition? Japan appears to have been doing just that in fear of losing market share in the U.S.

8:05 AM  
Blogger ed hanson said...

Henry, you gently urged me to read what you wrote. I assume that means I read something into it that you did not write. I will also assume that this derives from the following line.

"Isn't the 2% perpetual inflation/growth rate Milton Friedman's old goal?"

Henry, I read the word inflation, and I read it meaning that growth of a monetary base is the same as inflation. Thus what I wrote, and I stick to it, unless your '/' means something else.

My disagreements also is with how you say competitive devaluations are thought of. Those who think there is something to competitive devaluation use it to increase exports and decrease imports. Such devaluations are not considered as investment vehicles or capital attractions.

This does not say that devaluations can not bring investment into a country, just so called competitive devaluations will not.

An example of a devaluation that will bring investment into a country. A country fixes its currency to another. It does not follow the 'rules' of a fix, but has printed more currency then can be justified to the fix. As it becomes obvious that the country can not maintain the fix, investment in the country will fall, as the risk/reward becomes too one sided. But after devaluation, and then sometime as the economic consequences temper, then more investment becomes possible, then in the period just before devaluation. do not read into this as any recommendation for such actions on my part, i say never fix.

8:12 AM  
Blogger Dick Fox said...

Ed H,

I don't think that Ed B. and I have been saying that inflation will return to that of the 1970s.

I don't disagree with the points that you have posted. They actually support the forecast of inflation.

But I do not at all believe that the method that the FED has been using does what they claim. Inflation as indicated by gold continued through all of their claimed tightening as they raised interest rates. But almost to the moment that they paused rate increases inflation as indicated by gold began to come down. Since the pause gold has declined almost 10% and oil is falling too.

I expect that if the FED continues to pause, I doubt they will lower interest rates, that inflation will continue to fall, but if they start to once again fight "inflation" inflation will raise its head again.

8:34 AM  
Blogger Dick Fox said...

I intended to write, "fight inflation by increasing interest rates."

8:36 AM  
Blogger Henry Meers said...


Friedman may have had a target of 0% inflation, but the marketplace could have other ideas for the monetary base. The gold standard was known or its automaticity, but the economies and their money supplies were not.

While I realize countries could and had to devalue their currencies under the gold standard, they ended up the worse for it. Today, the forex markets do that every day; capital can be skittish.

8:56 AM  
Anonymous judith said...

For me, it comes down to a choice:
1) a 'man' managed floating fiat that gets out of whack with tax hikes (inflation!) or tax cuts (deflation!)
2) a gold polaris
= no inflation or deflation, no matter what the fiscal scene is doing

We have learned that BOTH inflation and deflation are signs of debasement of the monetary standard and both lead to malinvestment and reduce the overall economic wealth of folks
Now, which approach would I prefer??


....all other points in the 'debate' are noise, in my opinion.
Final note: we have also learned that gold LEADS everything else. Just because some inflation indicator isn't showing what you expect today..... just wait. It is coming, no matter what the Fed, or anyone else, does.... at this point. Pretty sad.
IF the Fed managed to sit on their hands for the next 5 years, and we get more Supply Side tax cuts.... maybe things will not get 'out of hand'.

12:11 PM  
Blogger Wayne Jett said...

David Wood said:

He's not confused on gold, Dick, he just doesn't believe that there is a direct correlation between gold price and inflation. His point on energy, Bob, is that basing monetary policy on the gold price is comparable, in his opinion, of basing it on the vagaries of the energy market.

I have to say I agree with him in the current instance. The gold price is clearly out of whack right now, for whatever reason. If the Fed started using it as Darda wants, they would create a recession for sure (if they haven't already).


I'd like to offer a few comments. The gold signal does not result from gold "doing" anything. The signal is our interpretation of what the gold price means. What it means is near nothing about gold, and near everything about purchasing power of the currency in which it is priced. If Alan Reynolds understands the gold signal differently, I respectfully suggest he is mistaken, not confused. Neither the hedge funds nor any other entities will be able to change the nature of the gold signal.

When the gold price rises, the currency value is falling on the spot market and, in and of that act, begins the process of working the currency's lower value throughout the pricing of goods and services. By the very fact of the gold price, inflation is "out there" in the dollar's lower spot value, which will appear in prices and wages as soon as the market permits accommodation.

If the Fed were to misuse the gold signal, such as by reading it as forecasting inflation and then using that correct interpretation as justification for raising the funds rate target (as Darda argues the Fed should), it would cause recession. But not because the gold signal is in any way out of whack. The recession would be caused by use of the funds rate target, which is incapable of reducing inflation and, as administered by the Fed presently, is causing addional inflation.

8:25 PM  
Blogger David Wood said...

Good insight, Wayne. You are certainly right that my main objection is their use of the FF rate as their tool. If they used a rational tool, then the gold polaris would work much better. I'm not convinced that it wouldn't still be vulnerable to manipulation, though.

8:51 AM  
Blogger Sam Baker said...

i'm shocked you give Alan Reynolds the first round in this debate.

i recognize that many Talkshoppers do not agree with Darda's prescription for the current inflation, i.e. higher interest rates, but i also believe that most supply siders would agree that the gold signal provides the best and most reliable indicator available for liquidity conditions.

reynolds comes to the "right" conclusion about not raising rates, but he gets there for the absolute "wrong" reasons. Reynolds asserts that there is no inflation problem because core inflation has been well behaved.

since when did core inflation become a reliable forward looking gauge of inflation?

11:11 AM  
Blogger n-tres-ted said...

Yes, Sam, I have disagreed with Alan previously when he expressed the view that bond yields would prevail over the gold price signal, indicating no inflation problem. As indicated by PIMCO's Bill Gross recent statement that bonds had bottomed (yields have topped), investors may interpret signals erroneously and commit funds in ways that drive markets and prices for an interim period. But gold just "stays there" and does nothing while its varying price honestly reflects the changing purchasing power of the dollar. That changing value of the dollar does not have to pass through gold in order to influence other goods and services. The value change is already present in every dollar, which naturally gnaws at every price of every asset (bonds included).

12:12 PM  
Blogger ebreen said...

These are great comments from all. I think both Alan Reynolds and Michael Darda miss the gold signal by looking at the spot price and not the 10 year moving average. You all know my opinion on the importance of volatility in the signal. Clearly both Reynolds and Darda overlook volatility also. I prefer Alan's commentary becuase he does not compound his error on the gold signal with a bunch of other extraneous crap the way Darda does. I am a fan of simple error as compared to complex error.

1:49 PM  
Blogger ebreen said...

In addition, I want to say that I agree with Dick that the inflation that gold has been signalling need not be on the order of the late 70's. I don't think Mike Darda has a rational yardstick and I know he is recommending the wrong tool, as others here point out so well. Alan on the other hand does not know how to see the gold signal. With this pause, if it continues, the problem may not become as bad as it could be. We will see if BB has conviction as increasing CPI and PCE measures will but his faith to the test.

1:54 PM  
Blogger n-tres-ted said...


I think Mike Darda believes the funds rate target raising draws liquidity from the system. He sees the gold price as proving too much liquidity, which is true, but is wrong on the efficacy of the tool used by the Fed. I haven't spoken with him in quite a long time, but I'm reasonably certain because I previously held the same view before understanding the FFR operations better. But it's a shame for good classical economists to get off into disagreements over the details of Keynesian abstractions and actions.

5:44 PM  
Blogger David Wood said...

Sam, I'm sorry I shocked you, though if you've been reading my other posts for a while, I'm a bit surprised that this one came as a shock.

I think Wayne has the right of it that my primary objection is to the Fed's choice of tools.

But there are several other points to address.

1. I wasn't aware that Supply-Side implied a necessary adherence to the gold polaris. Certainly the two are associated here because Jude was an advocate of both. As I see it, however, supply-side policy is not much related to monetary policy. Pretty much any rational economics (this category, of course, excludes the Keynesians) advocates sound money, though individuals may differ on the best approach to that goal. Supply-siders, being rational, like sound money. That's not a defining feature of Supply-Side economics, though, as I see it. Supply-siders do have a different understanding of the mechanics of inflation, which has implications for monetary policy. But, again, that does not, IMHO, imply that there is a specific means necessary for carrying out monetary policy.

2. My economic analysis looks at everything that is going on, not just at gold. I especially look at what the monetary aggregates are doing. As such, I'm just not buying what gold is saying at the moment. Just as I didn't believe that the low gold price in the late '90s meant we were in a "deflation", as Jude seemed to think, I don't think that the current gold price means that inflation is out of control. In the late '90s, money growth was very adequate. The Fed didn't make its Phillips Curve-based mistake until late '99 through 2000, when it was too tight. True, gold was low then, but it had been low for several years, and did not go lower on the Fed's mistake. This time, they were too loose for too long, creating this inflation blip. If they had followed gold earlier, they would have been in better shape. But now they've already contained it. To continue on blindly following gold now, continuing to tighten, would be stupid and disastrous for the economy, with no benefit whatsoever.

8:20 AM  
Blogger Wayne Jett said...


Integrity in value of the currency unit is the central principle of classical (supply side) economic theory. Failure to honor that principle undercuts the foundation of other classical principles of economic growth, including fiscal analysis that shows higher tax levies reduce production and tax revenues.

Supply side analysis got so much attention during the Reagan years of cuts in marginal tax rates that many identify supply side as meaning nothing but tax cuts. To my knowledge, Jude never fell into that misconception because he understood from the beginning that monetary policy had everything to do with the success of economic policy. He got into economics due to the dollar being cut from gold, and Mundell soon became his primary mentor. Beyond doubt, Jude understood the central premise of his success was his understanding of monetary theory based upon the gold signal, not tax theory.

Keynesian (demand side) theory does not place the same primacy on integrity in the currency unit as does supply side theory. Other considerations allowed to take primacy are unemployment levels and/or interest rates. These concerns are more directly identified as political short-term objectives, and Keynesian operatives accommodate them by constructing theories that sacrifice currency integrity on grounds that a defined political objective must take precedence.

By doing so, demand siders have brought us to the point that defective monetary policy overrides supply side tax policy. With the resulting economic failure, political leadership may revert to demand side tax policy. Thus, to assure its future opportunity for success, supply side cannot stop with tax/fiscal policy. Supply side must prevail in guiding monetary policy if it is to survive at all.

10:07 AM  
Blogger David Wood said...

Wayne, I like your posts.

We may be talking past eachother a bit here. I really don't disagree with anything you've said.

I'm not trying to say that monetary policy is not important. Coming from an Austrian background, I am fully aware of the importance of a sound currency. And I guess that's my point. That area is not what makes supply-siders supply-siders.

You and I share the importance we place on the value of a sound currency, and the destructiveness of currency manipulation as an attempt at manipulation of the economy. The only point where we differ is on the infallability of the gold price as a short term guide to monetary policy. I can fully get behind Ed's 10 year average as an indicator. But that's not a basis for weekly or monthly management of the money supply. And though his volatility approach is interesting, it too, IMHO, it also is lagged from the monetary aggregates. And using any lagged indicator as a guide will introduce unnecessary cyclicality.

10:43 AM  
Blogger ed hanson said...

David you wrote;

I'm not trying to say that monetary policy is not important. Coming from an Austrian background, I am fully aware of the importance of a sound currency. And I guess that's my point. That area is not what makes supply-siders supply-siders.

That is so well said.

12:34 PM  
Blogger Wayne Jett said...


If infallibility means absolutely perfect, then the gold price signal for currency management is not. But IMO the gold price is both practical and the nearest-to-perfect means to sound current management we have.

If the gold price moves sharply up or down, it warrants central bank operations to maintain the stability of currency value. By acting promptly, the central bank removes the accumulation of anxiety/pressure that tends to move the currency value to further extremes. Also, by acting promptly and assuring the currency value stays steady at all times, the central bank causes speculative forces to move away from currencies and to other market factors.

This mechanism works perfectly well and could be proven in its soundness by simply moving to a gold price target to be achieved through open market desk operations with T-bills/bonds, which the FOMC already does (except with no theoretically sound design). And, since this mechanism will work to provide stable currency while no other successful approach has ever been found, I respectfully suggest a quest to find a different "holy grail" of monetary stability is doomed to failure. Better to spend the intellect and energy towards putting the most excellent design into effect.

1:44 PM  
Blogger David Wood said...


Well, now we're starting to differ a bit more.

When I say stable currency, the main thing I am looking for is a low relatively stable rate of growth of the money supply.

I most definitely do not think that the goal is a stable value. Perhaps that is where we are differing.

For example, if money supply is growing at a moderate rate, but the economy is exploding, as in the late 90s, the gold prices go down. But this is not due to lack of money, it is due to the expanding money demand. Following a gold polaris and injecting more money is not a correct action, it is inflationary. And vice versa if the price rise is caused by falling money demand, not excessive supply. That's the mistake they made in the depression with the real bills policy, trying to cut the supply to match the lowered demand.

In other words, the best thing the central bank can do is maintain stability in the quantity of money, not try and manipulate the value. The function that money serves is as a stable point against which all other prices are measured. It is the market's job to sort out all the relative prices. The central bank creates inefficiency in the pricing mechanism if it intervenes to change supply in response to perceived changes in demand for money.

7:44 PM  
Blogger Wayne Jett said...


I don't know whether this is best carried over to the other new board, but it seems to me the issues are sufficiently important to continue to a point of resolving as many differences as possible.

I'm glad you made your view explicit regarding your objective being to keep the growth rate of the money supply stable. I had not recognized that view. May I ask why? Of what importance is it to one individual, say a farmer, how much total currency there is in the world? Or how fast the total number of dollars is growing?

The considerations that are uppermost in the mind of this farmer is: what is the value of the dollar I'm being offered for my produce, and will that value change before I exchange the dollar for something else I want? He cares nothing about those aggregate numbers or growth rates. All he cares about is preservation of value of the produce of his labor and capital, so that value is not eroded by his use of the currency available in commerce.

If you don't care about the value of the currency unit, then what is the point of bothering with managing the total currency and its rate of growth? The Volcker Fed tried to manage the growth rate of the money quantities back in 79-82 specifically for the purpose of achieving stability in the value of the dollar, and even then it was a complete disaster. When you try to manage money quantities without even the defined purpose of a stable dollar value, I can only imagine the results would be worse yet.

8:46 PM  
Blogger ed hanson said...


Not only has David clarity, he is right.

And Wayne, I am sorry, but that is not the way a farmer thinks, they are much more sophisticated than that.

And finally, about Volcker, 1979-1982, if you remember, I led a long discussion on his actions at Talkshop. Volcker actions from 1979 to 1981 was in every way an economic miracle. Every time I showed this, the response was the deflationary recession of from his actions of 1981 and 1982. These two times need to be looked at separately, and by using supply-side analysis. That is fiscal supply-side analysis and how that interacts with monetary policy.

6:13 AM  
Blogger David Wood said...


I agree that this is an important area. I also appreciate your excellent posts, as they have made me think and figure out how we are looking at things differently, which clarifies my own thinking. So thanks.

If you go back to Mises, somewhere, unfortunately, I forget in which book, he states that all of the services that money can provide are provided by a fixed amount of money, and adding to the supply only detracts from that service. The reasoning here is that the primary, and most valuable, service that money provides is that of a stable point against which everything else can be measured. When that stable point changes, every other price has to adjust, which enters inefficiency into the pricing mechanism.

Now, the above is modified by the fact that although the above is the most valuable service that money provides, it also is used in transactions. So there is a divisibility issue, and the whole issue of sticky wages and prices, and the difficulties inherent in all kinds of economic activities in an environment of declining prices. Thus, the rationale for a steadily growing money supply. But the relative stability of the supply is still valuable. I.e. given a rising supply, the service that money provides can be maximized by having the rate of increase both steady and broadly known. Anything else enters more mistakes into the pricing mechanism.

Now the difficulty in all this is that it is very difficult to measure or even define money any more. With a fractional reserve banking system, the Fed really does not have direct control over the supply of money, only over the supply of reserves and the banking rules. So that opens a whole other can of worms, but before we get into that, I think I will pause and see if the above makes any sense to you.

8:14 AM  
Blogger Wayne Jett said...

David and Ed,

Thanks for your comments. The 79-82 experiences of Volcker as reflected in minutes of the Fed show complete frustration with the difficulties in measuring money quantities in a useful way, and futility in efforts to quell inflation by measures taken to regulate growth in those quantities. Then there was the "surprise" regarding volatility of an inflating dollar. There are some indications Volcker never really had confidence it could be done, and he went to the monetarism approach as cover for his core view that much higher interest rate targets were necessary than he could get away with politically if he were adopting them as policy. In any event, monetarism was buried by the Fed in 82. I think Jude was right on in his conclusion that the objective of steady growth in money quantities makes no more sense than pressing the accelerator of a car the same, no matter whether the road ahead is straight, curved, rising, falling or a corner.

Nevertheless, my question to you remains, what is your objective in managing money quantities if it is not to maintain stable value of the currency unit?

12:21 PM  
Blogger ed hanson said...


That is quite a challenge to read the minutes from 1979 to 1982, but for those who like, go to:

but I warn you, these are transcips, not minutes.

Wayne, I feel now that I have become a total nerd. I read the transcripts of the Oct. 5, 1979 and the Oct. 6, 1979; the fabled secret meeting; and I loved it. It had drama, humor, and above all, an concrete example of a new chairman taking complete control of a committee.

Wayne, there is a book in this, do you want to write one with me? A fascinating topic of inside the meetings of the Open Market Committee of the Federal Reserve surely would find 50 or 60 readers.

Wayne, do you have any specific meeting to point to which describes the uncertainty of action by Volcker?

4:02 PM  
Blogger David Wood said...

Wayne wrote: "...what is your objective in managing money quantities if it is not to maintain stable value of the currency unit?"

My objective is to make the pricing mechanism in the market as efficient as possible, and to introduce as few monetary distortions as possible.

As a further note, I'm not really even sure what the phrase, "value of the currency unit" means. In an economy with money and N goods, each good has a price, and money has N prices. So what is the price of money? That makes any attempt to define "the value of the currency unit" into a somewhat arbitrary exercise, such as the various price indices. And that brings us full circle on this thread, since the arbitrary you are advocating is gold. And whereas I agree that gold makes the best money, I'm not sure that it can perform the valuation service you think it can in a fiat currency environment where it is officially just another commodity.

And regarding gold, the reason it is good money is that its supply is strictly limited, and, usually, expands at a low, relatively steady rate. Which is exactly the prescription I'm advocating for the fiat currency.

If you were running a gold standard, would you attempt the type of value manipulation you are advocating with the fiat currency (if it were possible) to expand or contract the money supply in accordance with money demand? And if you could do it, would it enhance or detract from the efficiency of the pricing mechanism in the market? It seems to me that such manipulation would be pro-cyclical, exactly opposite of the natural mechanism of the true gold standard.

7:42 AM  
Blogger David Wood said...

By the way, Wayne, I'm very willing to concede that there are difficulties in executing the strategy I'm advocating, but I don't think that addresses the question of whether it is the best objective to shoot for.

In all of this, we are ignoring the real problem with the Fed, which is that it has the dual objective of managing the currency and managing the economy. These are directly contradictory objectives and the second is really not possible. With money, they really can't manage the economy, they can only manipulate in the short term, which inevitably introduces distortions and volatility. If we eliminated this second irrational objective from the Fed, then probably pretty much any mechanism for managing the currency would work fairly well, including the stupid one we're using now.

8:02 AM  
Blogger ed hanson said...

David you wrote in part:

In all of this, we are ignoring the real problem with the Fed, which is that it has the dual objective of managing the currency and managing the economy. These are directly contradictory objectives and the second is really not possible. With money, they really can't manage the economy, they can only manipulate in the short term, which inevitably introduces distortions and volatility.

You are absolutely correct that is unfortunate that the Fed seems to consider the economy in each of it's decisions. The only times I see such as valuable are the few times of extreme economic disruption. 1987 and 9/11 come to mind. While it can be argued that 1987 was a creation of the Fed, I believe the blame should be put on the Treasury.

While nothing in a gold standard prohibits the Fed from such emergency injection of liquidity, the likelyhood that it would just flow into the price of gold is real possibility.

8:45 AM  
Blogger Wayne Jett said...

David Wood said...

Wayne wrote: "...what is your objective in managing money quantities if it is not to maintain stable value of the currency unit?"

My objective is to make the pricing mechanism in the market as efficient as possible, and to introduce as few monetary distortions as possible.

Your objective requires keeping the monetary unit's value stable. Every change in the unit's value causes great friction and distortion in commercial relations. That is my point in saying the mechanism for achieving quality currency must aim specifically at the objective. The best measure of a dollar's value would be in relaton to an ounce of gold.

5:45 PM  
Blogger Wayne Jett said...

Ed Hanson said:

Wayne, do you have any specific meeting to point to which describes the uncertainty of action by Volcker?


I missed your post somehow until this afternoon. I think the more efficient way is to review the St. Louis Fed's Review of Mar/Apr 2005, pages 187-231. Three authors trace the minutes pretty well. Don't miss the first couple of paragraphs of page 226. After reviewing the article again, it seems pretty clear that Volcker believed he did not have support on the board to raise interest rates as high as they would have to go (in his belief) to beat inflation. So he decided to get more running room for the FOMC by changing to the monetary targets in an effort to achieve the same strategy; i.e., high interest rates as a means to defeat inflation.

4:02 PM  

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