End the Fed?

End the Fed?
Stephen Williamson
Fri, 11 Mar 2011 17:52:00 GMT

Ron Paul was on Fox News this past week (see this, particularly the exchange starting at about 3:40), and seems interested in "intellectual arguments," so I thought I would do my best to help him out. I just read Paul’s book End the Fed on the airplane (a quick read), and in previous post on Ron Paul I learned a lot from commenters about Paul’s intellectual roots.
In case you didn’t know, Ron Paul is a US Congressman who currently heads the House Financial Services Committee’s subcommittee on monetary policy. I assume that this gives him some power to mobilize forces to implement his ideas. Paul is of course a vocal critic of the Fed. If there was good science backing up Ron Paul’s ideas, and if the ideas were tight and well-reasoned, that would be great. Unfortunately, End the Fed which I take to be the best Paul can do in marshaling his thoughts, is for the most part bad science, consisting of flimsy arguments and some utter nonsense.

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3. The Fed is impractical. Paul seems to think that the Fed is the wrong tool for getting the job done. What’s the job that we want done? Apparently we want price stability, so let’s take that as given. What is Paul’s alternative to the Fed? He wants to go back to the good old days of the gold standard. So what’s wrong with that? I discussed some of the issues here. Basically, if price stability is the goal, any commodity standard is incapable of delivering it. Here is what Paul appears to have in mind, though he is pretty vague about the whole arrangement. One of Paul’s Austrian-economics heroes is Murray Rothbard, who wrote this. Rothbard thought the gold standard was a good idea, and also had a problem with fractional reserve banking. Basically, what Rothbard his in mind is some combination of the gold standard and Friedman’s 100% reserve requirement on any transactions medium. Any liability used in transactions must be backed 100% by gold. Now, the key problem with this arrangement, aside from the usual difficulties with the fluctuating relative price of gold, is that there is not provision for "currency elasticity," a term written into the Federal Reserve Act of 1913. Currency elasticity is a concept you can teach to students in homework problems. Roughly, the demand for money will fluctuate due to fluctuations in various exogenous factors (time of day, day of the week, month of the year, productivity, transactions technologies, etc.). If the money supply does not accommodate these shocks, prices will fluctuate as well, and we will not have price stability. If all media of exchange are backed one-for-one with gold, then you get some elasticity due to the fact that gold can be diverted from other uses (and dug out of the ground) to use as backing for transactions media. But this necessarily implies that the relative price of gold is fluctuating and, by implication, there is no price stability. Further, restricting private financial intermediation with a 100% reserve requirement, while un-Libertarian and inconsistent with what Paul seems to stand for, is also economically inefficient – it works like a tax on financial intermediation. Theft, as it were.

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