Coming to the Defense of the Gold Standard...Again

Heather Long, an excellent financial columnist at CNN Money, recently posted an article Why Ted Cruz's Gold Standard Push Is A Bad Idea that unfortunately continues a string of misinformed commentary about the purpose and efficacy of a gold standard system.

For example, see recent articles by Binyamin Applebaum in the New York Times, Greg Ip in The Wall Street Journal blog Real Time Economics, Megan McArdle at BloombergView, and Alan Pyke at the website ThinkProgress.org.

What is so frustrating about these articles is that the authors apparently did not seek input from the many prominent advocates actively promoting a return to gold-based money.

Let's take a closer look at Long's article:

"It's a plan that is getting the 'you've got to be kidding me' reaction from the business community. 'I don't think that's going to happen. I just don't believe that would be possible,' says Peter Cardillo, chief market economist at Standard Financial."

This reaction occurs simply because most people don't know, or have never learned, what the purpose of a gold standard system is, why the U.S. officially abandoned gold-based money in 1971, and cling to the easily disproved myth that the gold standard was responsible for the Great Depression. Ignorance is no excuse. There is simply to much good educational material out there. Start with a free resource from the excellent Nathan Lewis, Gold: The Monetary Polaris. Lewis also addressed the issue of the feasibility of a return to the gold standard in The U.S. Embraced A Gold Standard For 182 Years, So Why Is It 'Impossible' Today?

"Most economists now agree 90% of the reason why the U.S. got out of the Great Depression was the break with gold, says Liaquat Ahamed, author of the 'Lords of Finance'."

The fact that the academic economics community almost universally believes this point tells you a lot about the state of the profession these days. Academic economists, particularly those toiling away at elite colleges and universities, are overwhelming from the Keynesian School. Little wonder that a poll taken from such a community would be highly biased against the gold standard. Keynesians believe that government bureaucrats, namely economists with Ph.D's from elite universities, are required to "manage" the economy via the manipulation of currencies and interest rates. A gold standard system takes that power away from them. Under a gold standard system, no one would know who the Federal Reserve Chairman was, nor would anyone really care.

There are a number of excellent commentaries dispelling the notion that the gold standard contributed to the Great Depression, most recently by John Tamny, The Fed and the Great Depression: A Myth That Just Won't Die but also by Nathan Lewis, Did the Gold Standard Cause the Great Depression? and Richard Salsman, Did the Gold Standard Cause the Great Depression?, a review of Barry Eichengreen's book Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 published by the American Institute for Economic Research.

"But there's a major downside to the gold standard that caused President Franklin Roosevelt to get rid of it in 1933: It's akin to wearing an economic straitjacket".

Proposterous. The sole purpose of a gold standard system is to provide a currency with a stable value. A stable currency facilitiates investment and exchange (i.e. trade). A fiat currency system, such as the one the world lives under today, hinders investment and exchange like grains of sand in a moving gear. With a constantly fluctuating currency, investment decisions are impacted by the need to consider future changes in currency values. Will the investor receive dollars in the future worth the same as those committed today? This is a big reason why the derivatives market has grown so huge. Businesses and individuals must protect themselves from constantly fluctuating currency rates (as well as widely gyrating interest rates and commodities as a consequence of floating currencies). Capital that could be better utilized on wealth-creating investments must instead be used to hedge the risks brought on by unstable money.

Ask yourself this question: How did the U.S. become the world's economic superpower in less than 200 years while on the gold standard if such a system acted as an "economic straitjacket"?

"'I don't think the average Joe understands the economic impact. During the gold standard, there was high unemployment,' says John LaForge, co-head of real assets at Wells Fargo."

The first sentence is rather condescending; I believe that "the average Joe" indeed knows something is terribly wrong with the current monetary regime and this helps explain the call by presidential candidates Ted Cruz, Rand Paul and others for a reconsideration of using gold to back the dollar.

As for the claim of high unemployment, when exactly? During the entire period when the U.S. was on the gold standard? And precisely why would a currency with a stable value promote unemployment? It actually does the exact opposite. Since a stable currency promotes investment, it also promotes job and wage growth. It appears that Mr. LaForge threw that line out there without thinking it through.

"...The main reason is there just isn't enough gold out there to power major economies."

This is probably the second-biggest myth used to dismiss the gold standard after the Great Depression claim. The effectiveness of a gold standard system does not rely on the physical quantity of gold sitting in vaults somewhere or yet to be mined from the ground. Period. The value of the currency, not its quantity, is linked to gold. As Nathan Lewis wrote recently in Greg Ip Gets It Wrong: What a Gold Standard Really Was, And Could Be,

"From 1775 to 1900, the U.S. money supply (technically known as 'base money') increased by 163 times, from $12 million to $1,954 million. During this time, the total aboveground gold supply increased by about 3.4x due to mining production.  163 is not the same as 3.4" 

In fact, a well-functioning gold standard system would actually require very little gold to be held in reserve. If the public expects the currency value to remain stable into the future, there would be little demand to actually hold physical gold. Paper bills are a lot more convenient to carry/transact with than gold coins or bullion. 

'Beyond hamstringing the U.S. from responding to crises, the gold standard also relies on a commodity that is known for wild price swings."

It is common for gold standard critics (or those who simply are ignorant of how a gold standard system works) to claim that the price of gold is simply too volatile to serve as an effective value peg. Gold hasn't been used in monetary systems throughout human history because it is a shiny metal and looks pretty. The reason for its use is due to its unique characteristics. Essentially all of the gold ever mined is still in existence today. Annual mining production represents only a tiny amount of the total stock globally. It also has few industrial uses. The only real demand is for jewelry (and perhaps dentistry). In other words, gold displays favorable stock/flow characteristics. Therefore, changes in supply and demand have minimal impact on its value.

There's nothing magical about gold. Gold standard advocates would embrace alternatives if the characteristics of any such alternative were superior to gold. Alas, none have ever been identified that work as well as gold.

As for the price volatility of gold, what critics fail to understand is that it is not the value of gold that is changing in price, it is actually the currency that is fluctuating in value. A rising price of gold from a previously stable value indicates inflationary pressures that will eventually be transmitted through the economy, beginning with those goods most sensitive to currency fluctuations such as raw commodities. The opposite effect reflects deflationary pressures.

"If you look at the price of gold, the gold market certainly isn't anticipating [a return to the gold standard]," says economist Cardillo.

It's unclear to me how Cardillo was able to reach that conclusion. If anything, the price of gold falling from ~ $1,300/oz. in early 2015 to ~ $1,075/oz. today is signaling that deflationary pressures are building in the economy due to neglect of the dollar by the U.S. Treasury.

The financial press, echoing their contacts among the academic community, apparently is biased against a return to the gold standard. Recent columns have been anything but fairly balanced with opinion from both sides. Fortunately, there are many great minds out there who understand gold and the importance of gold-backed money, many of which I have cited in this article or are linked elsewhere on this blog.

Still not convinced? Please read this short, but concise column from none other than Steve Forbes, The New York Times' Leaden Analysis of Gold.

Putting the Blame for Low Interest Rates Where It Belongs

William Poole, a former president of the Federal Reserve Bank of St. Louis and now a distinguished scholar at the Cato Institute, penned a short commentary on November 24 for the Wall Street Journal where he makes a number of points worth elaborating on.

Poole correctly points out that the Fed influences the federal-funds rate, but does not control rates across the yield curve. He instead fingers the low-rate environment on non-monetary conditions, specifically the policies of the Obama Administration. As Poole mentions, "long-term rates reflect weak job creation and credit demand." 

Disincentives to business investment, from poor tax policy and onerous regulations to a unstable dollar, have been the principal reasons why the economic environment has been so subpar relative to prior recoveries. The weak economy is the better explanation of why interest rates are so low.

Capital will always migrate to where it is treated best. Little wonder then that investors have not been so enamored with the U.S. in recent years.

Since 2008, there have been numerous significant tax increases, including hikes in the top marginal personal income, capital gains and dividend tax rates, limitations or phase-outs of personal exemptions and itemized deductions for high-income taxpayers, and a new Medicare tax on investment income.

The U.S. corporate tax rate is among the highest in the developed world. While many countries in the OECD have reduced corporate tax rates in recent years, the U.S. has stood pat. The U.S. is also one of only a few countries that utilizes a territorial tax system which taxes income earned outside of the home country. This has resulted in massive amounts of cash held offshore as U.S.-based multinationals are loathe to repatriate the funds and pay the higher rate.

The uncompetitive corporate tax structure is also cited as a major reason that U.S. multinationals are choosing to relocate to foreign domiciles via corporate inversions.

Politicians in Washington D.C. continue to talk a good game about tax reform, but progress on simplifying the tax code by lowering the rate and eliminating deductions has been glacial. The corporate tax would ideally be eliminated, but that is a topic for another day.

To say that the "fourth branch of government", the regulatory state, has expanded in recent years would be an understatement. It has been hyperactive. The EPA, FDA, FCC, and a plethora of other regulatory agencies have been spitting out burdensome regulations on business at a rapid pace. Combined with the impact of major pieces of legislation, signed into law without much of the details written, such as Dodd-Frank and Obamacare, it is fairly easy to see why businesses may take a more cautious view on investment spending. Economist Bob Higgs coined it "regime uncertainty".

I am quite critical of the Fed's hubris and hope to see it dissolved in my lifetime, but I believe that many commentators, pundits, and investors give this institution far too much credit when it comes to "setting" interest rates or "managing" the economy. [Please see John Tamny's recent commentary on the Fed, "The Fed Can't Spot Nor Can It Stop 'Bubbles,' Nor Should It Try."]

Interest rates are the pricing mechanism in the capital markets, equilibrating the supply and demand for credit. Indeed, rates are being "manipulated" but put the blame where it belongs.  The poor fiscal and monetary policies of the Obama Administration with ineffective pushback by the Republican-controlled Congress are the prime culprits. Big Government is a prosperity deterrent. Low interest rates simply reflect this reality.

Gold and Liberty

My friend Richard Salsman, Ph.D, CFA, President and Chief Market Strategist at economic consultancy Intermarket Forecasting Inc., has generously provided a copy (PDF, below) of his excellent monograph Gold and Liberty published in 1995 by the American Institute for Economic Research.

This document is one of the first I read that helped me to understand and appreciate the critical importance of gold in a well-functioning monetary system.

Salsman discusses such topics as the origins of gold as money, the evolution of free banking, the purpose and mechanics of a gold standard system, government subversions of the gold standard, central banking and gold, and what the future may hold.

The monograph also contains a rich bibliography of source material.

Gold and Liberty is a fascinating and highly-educational read. Unfortunately, far too many policymakers, politicians, journalists, and academics are ignorant about gold and its historical record as the backbone of sound money. In just a few hours, this monograph would provide them with the proper respect and appreciation for gold and the futility of the current system of fiat money.

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More Nonsense with the Phillips Curve

At the New York Times, Neil Irwin wrote an article that discusses the Federal Reserve's dependence on the long discredited Phillips Curve.

Caroline Baum also posted a related article at Economics21.

The Phillips Curve is a key tenet of Keynesian thought. It purports to show an inverse relationship between the the rate of inflation and the rate of unemployment. 

One would think the stagflation era of the late 1970s and early 1980s, when the U.S. economy experienced high levels of both inflation and unemployment, would relegate the Phillips Curve to the dustbin of history. Unfortunately Keynesians never give up that easily. According to Irwin, Fed chairwoman Janet Yellen said the Phillips Curve "is a core component of every realistic macroeconomic model."

Little wonder the U.S. economy is mired in such a pathetic "recovery" with geniuses like Yellen and her ilk burdening the economy with policy nonsense that goes by the acronyms ZIRP (zero interest-rate policy) and QE (quantitative easing).

Yellen is convinced that if the unemployment rate falls below the "natural" rate of unemployment (whatever that is), inflation is likely to accelerate. The thinking here is that low rates of unemployment will drive up wages and eventually result in higher prices for goods and services. Such a theory assumes that labor markets are inflexible and that companies can't access abundant sources of labor overseas.

The really perverse aspect of the Phillips Curve is that it assumes that too many people working and prospering is inflationary. Actually, the truth is just the opposite. With such thinking, is it any wonder that economic output is significantly below its potential?

As Ralph Benko notes at The Pulse 2016, The House of Representatives passed legislation (H.R. 3189, Fed Oversight Reform and Modernization Act of 2015) on November 19 that promises to reform the way the Fed sets monetary policy. Naturally, Janet Yellen is vehemently opposed and President Obama promises a veto if the bill makes it through the Senate and reaches his desk.

Of course, any reform that minimizes the impact of the Fed's flawed economic models, such as the Phillips Curve, is most welcome. If it prevents further Fed market manipulation in the form of ZIRP and QE, the economy can only benefit.

The Left Fires Intellectual Spitballs at the Gold Standard

ThinkProgress recently posted an article ("Ted Cruz Embraces Fringe Monetary Policy That Went Out of Style in the 1930s") by Alan Pyke lampooning Ted Cruz's advocacy of a monetary system tied to gold at the Republican debate on October 28.

Tom Woods and two guests, Austrian-school economists Joseph Salerno and Jeffrey Herbener, rip apart Pyke's ill-informed analysis in entertaining fashion in an episode of the Tom Woods Show podcast.

Not that Pyke made it very difficult to do so.

The Austrian-school view of money does differ from the supply-side view in many respects, but Woods et al. are still staunch supporters of sound money.

Although supply-side economics is most often associated with tax-cutting, the supply-side literature is rich in its advocacy of sound money, i.e., a stable currency backed by gold.

Using long discredited arguments and the usual caricatures, Pyke apparently hasn't read any of the recent literature on the successful history of gold standard systems such as two books written by expert Nathan Lewis, Gold: The Once and Future Money and Gold: The Monetary Polaris.

In addition, recent books by Steve Forbes (Money) and John Tamny (Popular Economics) discuss the critical importance of stable money in promoting production and exchange.

The political left has to realize that saying "everyone agrees the gold standard was terrible" as Pyke does is simply shoddy analysis. Just because many of today's gold standard advocates are not academics with economics Ph.D's from elite universities does not mean that they are to be simply ignored. The burden is clearly on those who believe an all-powerful central bank is necessary to "manage" the currency and the economy. The evidence is not on their side.

Gold Finally Muscles Its Way Into the GOP Policy Debate

Since the last Republican debate on October 28, there has considerable buzz in supply-side circles regarding the brief, but notable comments by U.S. Senator Ted Cruz in support of linking the U.S. dollar to gold (as well his support for "Audit the Fed" legislation) at the CNBC sponsored forum.

Ralph Benko provides commentary at The Pulse 2016 and Forbes Opinions.

Judy Shelton, co-director of the Sound Money Project for the Atlas Network, offers her thoughts at thehill.com.

The New York Sun gives credit to CNBC's Rick Santilli for asking Senator Cruz (and U.S. Senator Rand Paul) to comment on the Federal Reserve and monetary policy. The Sun correctly identifies monetary policy as the greatest issue of the election and in the final two paragraphs asks a number of critical questions that need to be answered. These are questions that the policy elite refuse to address.

Steve Forbes wrote a great piece in Forbes using the occasion of the Cruz's comments to offer a simple to understand explanation of why a gold standard is so vital to economic prosperity. If only this man could be U.S. Treasury Secretary!

It would indeed be a shame if Cruz and Paul do not carry the momentum of this issue into the next debate that is being sponsored by the Fox Business Network on November 10. The Democrat Party frontrunners Hillary Clinton and Bernie Sanders are quite comfortable with the status quo of having a handful of masterminds at the Fed manipulating interest rates and "managing" the economy.

It is a winning issue for the GOP. Let's hope for even more substantive discussion of this issue in upcoming debates and out on the campaign trail.

From ZIRP to NIRP

Richard Salsman, President and Chief Market Strategist at Intermarket Forecasting Inc., has written a pithy commentary in the Financial Post suggesting the Federal Reserve is open to a negative interest rate policy (NIRP) if it determines that economic conditions warrant such action.

The final few sentences are key:

"In finance there’s a standard “risk-reward trade-off.” With ZIRPs [zero interest-rate policy] and NIRPs, policymakers effectively seek to eradicate return, then wonder, in disbelief, why an economy lacks risk-taking and entrepreneurial spirit, and why banks, firms, and household alike persist in hoarding cash."

A reader from Calgary, Alberta posted a laughable comment stating that the article is ignorant of basic economic facts. Such a comment could only be written by someone so steeped in Keynesian nonsense that he believes corporate investment is weak because of "the persistent low rate of inflation (and the fear of deflation)". The reader obviously didn't grasp the passage cited above.

Quite simply, the Federal Reserve (and other central banks) cannot distort (e.g. artificially depress) one of the most important prices in the world (the benchmark overnight lending rate) and not expect serious consequences to the economy. Just because the Fed has managed to keep short-term interest rates at abnormally low levels does not mean the credit is cheap and plentiful. Price controls do no such thing. As long as central banks continue to manipulate vital market prices via a "ZIRP" or "quantitative easing (QE)", the economy will be robbed of vigor. Those with resources to lend will not offer those resources up to borrowers absent a return on that capital reflective of the risk taken. Capital will not migrate to its highest and best uses absent market-based price signals. This is pretty basic stuff and completely lost on most of the pathetic economics profession.

Note: For more information on Intermarket Forecasting Inc., please click here.

A Supply-Side Look at the Harper Defeat

Steve Forbes and John Tamny published separate commentaries recently at Forbes Opinions analyzing the electoral defeat of Canadian Prime Minister Stephen Harper to Liberal Party candidate Justin Trudeau on October 18.

Their analysis is sure to run counter to most political pundits who focus more on things such as personalities, turnout, campaign strategies, etc.

Both agree that a weak U.S. dollar was the culprit behind the poor performance of the Canadian economy in recent quarters. But Forbes believes that Trudeau is predominantly indebted to Federal Reserve chairwoman Janet Yellen for his victory. Tamny places most of the blame on the executive branch via the U.S. Treasury's responsibility as the mouthpiece for the dollar. He argues that U.S presidents get the dollar they want and with the administration of George W. Bush desiring a weak dollar, that is exactly what they got.

In an attempt to help pull the U.S. economy out of the 2000-2001 recession and to help boost American exports, the Bush Administration supported dollar weakness. Bush Treasury secretaries Paul O'Neill and John Snow were effective in talking down the dollar during their tenures.

Given the importance of the U.S. dollar to global commerce, the effects of a weak dollar reverberate worldwide. In particular, those nations that are resource-intensive such as Canada, Australia, Brazil, and Russia feel the most pain as commodities are priced and traded in U.S. dollars.

With the dollar falling in value, investors fled productive investment in favor of hard assets most resistant to the devaluation of the currency. Scare investment capital migrated to housing and other forms of real estate and to the production of commodities such as precious metals, nonferrous metals, and petroleum. The resultant boom was widely celebrated as a major boost to economic growth in the affected countries but it eventually proved illusory. The rise in prices tricked investors in thinking such commodities were in short supply when in reality supply and demand fundamentals could not explain such huge price movements. Commodities were not suddenly become scare, it was simply the dollar shrinking in value.

Canada saw a major boom in the extraction of metals and the production of crude oil, specifically from high-cost oil sands in Alberta. However, once the dollar began to strengthen from its 2011 low of roughly 1/1900th of an ounce of gold, the profitability of such resource extraction began to suffer. Investment capital started to flow away from the commodity sector and Canada's economy began a painful adjustment that continues to this day.

Unfortunately for former PM Harper, his political career fell victim to an unfortunate Mercantilist policy decision that was made some 15 years ago by his neighbor to the south.

An Analysis of Trump's Tax Plan

In a Wall Street Journal commentary on September 28, Donald Trump provided a relatively brief outline of his plan to reform the tax code. The WSJ's editorial board review of the Trump plan can be found here.

[Trump's truly awful mercantilist trade views deserve greater discussion in a future blog post.]

Trump's plan has a few attractive elements but overall still rates as underwhelming.

The best parts of Trump's plan are the four personal income tax brackets (0%, 10%, 20%, 25%) that hit the top rate for a married couple earning greater than $300,000. A low flat tax of 15% that Steve Forbes has proposed in the past or a consumption tax would be preferable simply because it doesn't punish success with progressively higher rates. Relative to the thresholds proposed by Jeb Bush, Trump's plan is superior. Bush's max rate of 28% begins at only $141,200 for a married couple.

Like Bush, Trump eliminates the death tax, the marriage penalty, and the ongoing absurdity complex alternative minimum tax (AMT).

Trump proposes eliminating deductions and loopholes but fails to get into the specifics in any meaningful way. He does say that the "middle class" will get to keep most of their deductions while those for the wealthiest Americans will be eliminated. Apparently this means the Trump plan will continue to subsidize certain behaviors by allowing deductions on mortgage interest and charitable giving to remain. Social engineering via the tax code is frustratingly difficult to eliminate.

Trump proposes lowering the corporate tax rate to 15%, which is lower than the 20% in the Bush plan. Included is a repatriation rate of 10% for cash returned to the U.S. currently held overseas which is nothing more than a gimmick. The 15% rate will certainly help raise the attractiveness of the U.S. as a destination for investment capital after cuts in recent years by other countries in the OECD  rendered the U.S. among the least competitive among the developed nations of the world.

As for the all-important capital gains tax, Trump inexplicably doesn't mention it at all in his commentary but details on his website indicate he wants it lowered to 20% for those taxpayers in the highest marginal bracket. This is still disappointing. Given the critical importance of capital investment to the creation of jobs, the optimal capital gains tax rate is zero.

He also seeks to treat "carried interest" generated by successful hedge fund and private equity investors as ordinary income. Carried interest income is created only when these managers are able to successfully invest capital on behalf of their investors. Like the capital gains tax, in a sane world carried interest wouldn't be taxed at all. We want Wall Street's best and brightest allocating scarce capital in pursuit of wealth-enhancing investment opportunities.

Trump does imply that the plan will be "revenue neutral" and not add to the national debt. He therefore keeps alive the tradition of candidates highlighting that their plans ensure the government will not have any less to spend going forward than it does now, as if that is some grand achievement. The true burden of government is the total amount of resources it is able to commandeer from the market-disciplined private sector. As supply-siders, we want the government to have less in the way of those resources to waste.

As I mentioned in my recent review of Bush's plan, what the the U.S. tax code needs now after a long period of subpar economic growth is anything but tinkering around the edges. It calls for nothing short of bold action. Trump's plan simply doesn't get the job done. Sure, it's better than the current Internal Revenue Code, but that's admittedly a very low bar.

Contra Krugman

Thomas E. Woods, Jr., historian and Senior Fellow of the Mises Institute and Robert Murphy, Research Assistant Professor with the Free Market Institute at Texas Tech University have finally launched Contra Krugman, a podcast intended to deconstruct the weekly New York Times column of Paul Krugman, professor of economics at Princeton University.

Krugman is widely considered the public face of Keynesianism today. His weekly New York Times column is (apparently) quite influential. However, Krugman is arrogant, petulant, casually dismissive of his critics, and often downright nasty.

Whether it's the efficacy of massive government spending as "stimulus", massive tax increases, Federal Reserve manipulation of interest rates, "quantitative easing (QE)", Obamacare, etc., Krugman is a tireless supporter of state intervention in the economy and in the lives of individual Americans.

Woods and Murphy have designed the podcast not to be merely an anti-Krugman forum per se. They intend to provide the listen with a weekly economics lesson from the perspective of the Austrian school, with which both are identified. And what better way to do that than to pick apart Krugman's  column.

I embrace much of the Austrian school's free market framework, although I generally disagree with its views on monetary policy. But we are in the same camp that believes the Federal Reserve is a menace to global economic prosperity and the best thing that could be done from a policy perspective is to "End the Fed" and allow a free market in money to take its place.

No one knows Krugman the way Murphy does. He is a true Krugman scholar. He knows things Krugman wrote in past columns better than Krugman himself. He will undoubtedly demonstrate this ability frequently in the course of this podcast series.

Having listened to The Tom Woods Show for some time, I know that it will be done in an informative and entertaining manner. What also makes me happy is this new podcast is sure to get under Krugman's skin in a major way!

You can subscribe to Contra Krugman on iTunes or Stitcher. Let the fun begin!

ZIRP is the Problem, not the Solution

Richard Salsman, President & Chief Market Strategist of economics consultancy Intermarket Forecasting Inc., has made available a recent research report "ZIRPs Make Credit (and Prosperity) Scarce, Not Plentiful" on RealClearMarkets.

Salsman explains exactly why the Fed's zero-interest-rate policy (ZIRP) has been an utter failure.

ZIRP does not provide economic "stimulus" despite its supporters protestations to the contrary. Like any other price control, ZIRP works by limiting supply, in this case the supply of precious capital needed by the entrepreneur to fund a promising business concept or the management of an existing business looking to finance a new piece of capital equipment, to cite two examples.

The economics is quite basic. Salsman provides an illustrative graph of the supply and demand for credit. If the price of a good (in this case, credit) is held below the equilibrium rate that would exist without central bank manipulation (i.e. in a free market), expect there to be a shortage of credit! This stuff is supposedly taught in introductory microeconomics classes at the college freshman level but is apparently lost on the masterminds over at the Eccles Building.

Savers quite simply will not offer up their capital if the expected return (the rate of interest) does not compensate him for the risk taken. According to Jean-Baptise Say (and quoted by Salsman on page two), "...many will prefer to keep their capital inactive, concealed and unproductive...".

If you are the government or a multinational corporation, financing hasn't been a big problem. However, if you are a small- or mid-sized business, the credit spigot is choked. Impossible to know is the number of businesses that never got off the ground for lack of capital investment during the past six years of ZIRP. They are Bastiat's "unseen".

Something so simple is complete lost on central bankers, our Federal Reserve as well as others around the world. They are so wedded to their Keynesian models that they can't even contemplate that their theories, disproved through historical experience, are just plain silly. Please see the quote from Lawrence Summers that Salsman cites beginning on page six. It says it all...and demonstrates just how worthless a Ph.D in economics obtained from Harvard University is these days.

An excellent article by John Tamny of Forbes Opinions entitled, "The Fed's 'Loose' Monetary Stance is Making Credit Tight" is also cited in Salsman's footnotes and can be found here.

Strike Two!

Another GOP debate, another missed opportunity.

Despite the three-hour CNN debate format last week, none of the Republican presidential hopefuls took a swing at Janet Yellen and the Federal Reserve.

Although the debate took place the evening before the Fed decided to maintain its zero-interest-rate policy (ZIRP), the disaster that is the Fed remained a subject apparently unworthy of discussion.

Now I realize that the CNN moderator was unlikely to steer candidates into a discussion of the Federal Reserve's manipulation of interest rates and pursuit of "unconventional" monetary policy, but that doesn't stop the candidate looking to set him- or herself apart from the competition by bringing up the topic.

As I discussed in a previous post, this is an issue just begging to be addressed.

As a professional investor who is essentially required to pay attention to most utterances of voting members of the Federal Reserve's Open Market Committee (unfortunately), I am beginning to sense that even more people are finally catching on that the Fed has absolutely no idea what it is doing.  The Fed brass and countless bevy of nameless, faceless Ph.Ds who wallow away in obscurity producing academic studies in Washington, D.C. and the various Fed branches around the country simply will not acknowledge that their models of how the economy functions are utterly worthless.

This is a good sign. As I have stated before, the general public senses something is very wrong with the Fed's conduct of monetary policy. Now if only one of the candidates will be bold enough to take it on.

Of course, I am not the only one writing about the missed opportunity of GOP presidential candidates to highlight destructive Fed policy. Larry Kudlow does so here.

In an excellent "Fact and Comment" essay on Forbes.com, Steve Forbes discusses why the economy will continue to suffer under current Fed policy here.

Is Capitalism Moral?

Over at Cafe Hayek, Don Boudreaux links to a Prager University video narrated by the excellent Walter Williams, professor of economics at George Mason University.

In just over 5 minutes, Williams explains in a devastatingly simple manner why the free market system is the morally superior form of economic organization.

"In a free market, the ambition and the voluntary effort of citizens, not the government, drives the economy."  -Walter Williams

Access the link here.

Jeb Bush Announces Tax Simplification Plan

Jeb Bush announced his tax overhaul plan in an op-ed in the Wall Street Journal on September 9.

My perspective is that any simplification of the byzantine, anti-growth U.S. tax code, short of throwing it away altogether, is a good thing.

But make no mistake, as much as I support any effort to cut taxes, its benefit to the economy still pales in comparison to the prosperity that would be unleashed if the U.S. dollar was relinked to gold. Bush makes no reference to the dollar or monetary policy in his piece. Cue the sigh.

Bush wants to reduce the number of marginal tax rates from seven to three. Disappointing to say the least! Can't we have something bolder? One flat rate perhaps? Progressivity punishes success. How about making the case that the tax code should not contain any disincentives to achievement?

A cut in the corporate tax rate to 20% from 35% is also much too modest. How about just eliminating it altogether? That also does away with the gimmicky one-time tax repatriation benefit he proposes. Let's make the U.S. a magnet for capital investment from around the world. With that investment comes all the benefits we crave such as higher levels of employment, greater productivity, and rising wages.

That said, if the tax must stay then a transition to a territorial system that Bush proposes at least ensures corporate income is taxed in the country that is actually earned. This is a major improvement over current law. The U.S. is the only major developed nation that taxes income without regard to where it is actually earned.

I champion Bush's elimination of certain itemized deductions, including the state and local taxes deduction and the business interest deduction. The deduction for state and local taxes simply subsidizes profligate governments, such as California, New Jersey, and New York. The deduction of business interest distorts business financing decisions by favoring the issuance of debt over equity.

Unfortunately, he preserves the charitable contribution deduction and the worst one of all, the mortgage interest deduction. Americans are incredibly generous people and don't require a taxpayer subsidy to support worthy charities, places of worship, or those in need. The deduction of mortgage interest is bad policy simply because it subsidizes homeownership. The last thing we need is to have even more precious capital sunk into non-productive assets such as housing. It also is unfair to those taxpayers who decide that renting is a better option.

My favorite part of Bush's plan is the elimination of the estate tax. It is a compliance nightmare, raises very little revenue for the government, and is patently unfair.

Bush wants to expand the Earned Income Tax Credit (EITC), a sop to the political left, and is just another form of income redistribution. Persons who do not pay income taxes should not be receiving cash payments from those that do.

Finally, there is no mention of cutting or eliminating the capital gains tax, easily the most destructive tax of all. Capital investment is a vital ingredient to the creation of jobs. The tax code should treat the gains from risk-taking activity as lightly as possible.

In summary, Bush's tax plan has some admirable elements but is unfortunately too timid. It lacks the boldness that would help begin to set his candidacy apart from his main rivals.

Dan Mitchell provides his thoughts in a blog post at the Cato Institute here.
The WSJ's editorial page staff gives the Bush plan a thumbs up here.

BloombergView's McArdle Repeats Typical Keynesian Falsehood

Megan McArdle recently wrote a column over at BloombergView, "Printing Money Goes Haywire in Venezuela" that contained a dangerous falsehood that seems to be accepted as common wisdom by too many economists these days. Dangerous in that it leads policymakers to do stupid things such as manipulate interest rates or currency values.

McArdle writes:

"The core thing to understand about inflation as a policy tool is that in general, steady-state inflation doesn't do you any good; what you need is accelerating inflation. A little bit of inflation is actually OK -- it allows the economy to naturally cushion economic shocks that would otherwise lead to unemployment."

Like some kind of creature in a bad horror movie the long discredited Phillips Curve, which McArdle implicitly references in the quote, simply won't die. To review, the Phillips Curve purports to show an inverse relationship between the rate of inflation and the rate of unemployment. In order to lower the unemployment rate, central bankers need to allow inflation to rise. And vice-versa. To bring down inflation you need to have more people thrown out of work.

The Keynesians believe in something called "NAIRU" or the "non-accelerating inflation rate of unemployment". When the actual unemployment rate falls below this nonexistent measure, Keynesians worry about the economy "overheating". To their way of thinking, inflation is a function of too much economic growth which eventually leads to labor and capacity shortages.

However, for whatever reason these economists ignore the stagflation era of the late 1970s/early 1980s when the U.S. economy had both high unemployment AND high inflation, something the Phillips Curve says cannot occur because of the aforementioned inverse relationship.

The bottom line is that faster economic growth (and wage growth for that matter) is never a reason for inflation to accelerate. In a market economy, price signals work their magic to help alleviate any shortage of labor or capacity.

If a local factory in the U.S. is facing a shortage of skilled workers, higher wages serve as a lure for labor to migrate into that market. Also, a company can access labor from around the world if there is a shortage of workers with particular skills. Price signals are powerful and work extremely well when government doesn't interfere with them by creating artificial barriers to the movement of labor and capital across borders (both nationally and internationally).

The Fed also doesn't even recognize true inflation, which is not an increase in some statistical measure of inflation such as the consumer price index (CPI) or GDP price deflator.  Those are crude concepts at best and almost meaningless at worst.

True inflation is a decline in the value of the dollar from a previously stable level. The best measure of that value is gold (or alternatively a broad basket of commodities). Gold is far and away the preferred measure because is not consumed the way wheat, crude oil, or pork bellies are. Every ounce of gold ever mined is essentially still in existence today. When we see the price of gold moving in value, in reality it is not the gold price that is moving as much is it the value of the currencies in which it’s priced that is changing. Therefore, when gold's price in any currency rises substantially, that signals the unit of account is weakening and inflation is on the rise.

A "little bit of inflation", such as a 2% target (something the Fed defines as "price stability"), is very destructive to savings and capital formation. Inflation at 2% represents a halving of purchasing power within a generation. That can hardly be considered stable.

Any unit of measurement, such as the minute, foot, or pound, must be stable if it is to be useful. What good is the foot as a measure of distance if is allowed to "float" in value? One day it represents 12 inches, the next day 8 inches, and perhaps 15 inches next week. You might still be able to construct a building with a floating "foot" but you'll build fewer of them and the quality of the ones you do manage to build will be suspect.

The same concept applies to money. Quality money is that which is defined relative to something stable such as gold. A gold-defined dollar provides the market with a stable unit of measure, free from harmful fluctuations that we define as inflation or deflation. Therefore it is most conducive to capital formation and long-term investment.

Since job creation requires capital investment, a return to the gold standard system is the surest path out of the economic rut that plagues the economy.

It can be done and fortunately Nathan Lewis shows the way here and here.

John Tamny on The Tom Woods Show

You will find me posting links to The Tom Woods Show on a regular basis simply because Tom has such excellent guests, interesting topics, and is a great interviewer.

Tom is proponent of the Austrian school and not a supply-sider per se. Of course, the two schools of thought share much in common. The main difference being in how the role of money in the economy is viewed. A topic for another day.

This show goes back to last April when John Tamny of Forbes Opinions and RealClearMarkets discussed his recently released book, Popular Economics.  It is a book I can't recommend highly enough. John deftly handles a number of economic controversies using examples from the worlds of business, entertainment, and sports. And there is nary an equation in the text. It's a quick read but after completing the book I can honestly say you will know more about economics than Janet Yellen, Paul Krugman, Joseph Stiglitz, or Ben Bernanke!

You can order the book through Amazon at the link I have provided on the right hand side of the page under "Book Recommendations".

John Tamny on The Tom Woods Show

Where is the Sound Money Candidate?

With 17 candidates presently vying to be the Republican Party's presidential nominee in 2016, I find it amazing that no one has taken up the issue of sound money and the urgent need to reform the Federal Reserve System.

It's out there just waiting to be seized upon and the candidate that does so effectively will clearly set himself apart from the pack.

Sure, discussing monetary policy may not exactly fire up a crowd looking for the usual red meat such as building a wall on the southern border or getting tough with the government of Iran. But I believe the public instinctively knows something is terribly wrong with our present monetary system.

The Federal Reserve has pursued all manner of "unconventional" policy in the form of acronyms such as ZIRP and QE. ZIRP, or "zero interest rate policy" has essentially suppressed short-term interest rates at abnormally low levels, crushing the very savers whose capital is needed to fund promising entrepreneurial ideas that advance our economic well-being. QE, or "quantitative easing" represents the purchase of Treasury and mortgage-backed securities in the Fed's lame attempt to "stimulate" the economy via currency depreciation.

Politicians that even mention the need to reignite economic growth from its present moribund level, such as Jeb Bush or Mike Huckabee, never connect the issue of weak growth with our unstable dollar.

Monetary policy seems to be an issue that candidates consider to difficult to grasp or address in a way that resonates with voters. However, Ron Paul really didn't have that problem during his political career. He made monetary policy a key component of his legislative agenda. Paul was a student of the topic and a passionate advocate for reestablishing a gold standard. He effectively questioned the existence of the Federal Reserve itself. He showed the way. It can be done.

Tax cuts, relief from onerous regulations, and dismantling restrictions on international trade are certainly key supply-side components of improving economic prosperity but pale in effectiveness compared to monetary reform that results in a stable dollar (preferably linked to gold).

There are a number of legislative efforts underway to both audit the Federal Reserve System, aka Federal Reserve Transparency Act of 2015 (S. 264) and to establish a commission to investigate the effectiveness of the Federal Reserve's monetary policy over its first 100 years of existence, aka Centennial Monetary Commission Act of 2015 (H.R. 2912).

The fact that Fed Chair Janet Yellen and numerous other Fed officials vehemently oppose both pieces of legislation speaks volumes about how nervous the Fed bureaucracy is over congressional scrutiny of its conduct of monetary policy and banking regulation.

Both efforts should be enthusiastically embraced by all GOP presidential wannabes. Rand Paul re-introduced the Audit the Fed bill in early 2015 as S. 264 but has curiously gone silent on the issue during his presidential campaign. Senators Ted Cruz and Marco Rubio are co-sponsors but unfortunately have said little about it.

The unstable dollar creates economic chaos in numerous ways, such as stultifying long-term capital investment and impeding the efficiency of global trade flows to name just a few.

It is crucial that the next President make monetary policy a key priority if the U.S. (and global) economy is to break free of the pathetically meager levels of growth experienced in recent years.

Who will pick up the ball and run?

A Note on Savings and Consumption

Steve Patterson, a non-economist, refutes the Keynesian "paradox of thrift" as a fallacy in a concise article and video posted at the Foundation for Economic Education (link).

The heart of Keynesianism is that the consumer drives economic activity via consumption and that an economy suffers when individuals "save too much". However, this is just not so. One simply cannot consume before producing something to exchange first or obtaining the ability to consume from another (such as a family member, bank, or other financial intermediary). If you doubt me, quit your job and see how long you can live on your own after you have burned through your savings. Good luck with that.

The act of savings can never detract from demand. Savings gets channeled to others with capital needs such as an entrepreneur funding a start-up enterprise, a business looking to expand a manufacturing facility, a local school district constructing a new building, or a young couple buying their first home.

Savings never sits idle. Banks and other financial intermediaries have every incentive to put that capital to work to earn the institution a spread between the rate it can loan the funds at minus what it must pay to obtain them. This is why a popular explanation among many economists that a "glut of savings" is the reason global interest rates have been at abnormally low levels is so absurd.

"To accumulate capital, we must reward the saver and encourage him to save. The man who accepts the responsibility of denying himself the pleasure of current consumption in order to save and accumulate capital is the real hero and patriot who is conferring vast blessings upon his fellows."  Howard Kershner, Dividing the Wealth (Devin-Adair), p. 32.

Welcome to The Supply-Side Revivalist!

My primary reason for writing this blog is to provide an ongoing forum to discuss and promote supply-side economics.

I plan to post original commentary, critique the work of others, provide book reviews, post links to interesting articles/videos, and respond to reader replies.

My intention is to post commentary on a regular basis. However, as my family and career come first there may be some lengthy periods between posts.

Like 99.9% of students who studied some economics in college, I learned the subject from a “demand-side” perspective (predominantly Keynesianism with a bit of Monetarism as well).  The demand-side stresses the primacy of the consumer. I left college believing that the market economy is inherently unstable and that wise minds (e.g., politicians, bureaucrats, and policymakers) are required to “manage” the economy and remedy market “failures”.

In college, I received absolutely no exposure to the Classical school that was essentially rebranded as supply-side economics sometime in the mid- to late-1970s. Interestingly, this omission occurred despite the prominent role supply-side economics had played in policymaking during the Reagan Administration in the years before I started college in 1986.

I also never received any introduction to the free-market Austrian school. As incredible as it seems, I didn’t know the names Hayek and Von Mises until many years later.

Apparently the free market was déclassé and remains so to this day in much of academe [notable exceptions include George Mason University, Grove City College, and Hillsdale College].

I was well into my career as an investment management professional when I began to question the usefulness and efficacy of demand-side economics as a tool to help make better investment decisions.  The problem became apparent. Demand-side theories simply don’t explain what happens in the real world.

Fortunately, the supply-side framework does have explanatory power and can be used to help forecast markets.  

During my self-education beginning in the early- to mid 2000’s, I was greatly influenced by many classical political economists and philosophers of the 17th and 18th centuries such as John Baptiste-Say, Frederic Bastiat, Adam Smith, David Ricardo, and John Stuart Mill.

I learned supply-side economics from key pioneers who are unfortunately no longer with us including Jude Wanniski, Robert Bartley, Jack Kemp, and Warren Brookes. Wanniski’s Supply-Side University, still available on-line at Polyconomics.com, remains a treasure-trove of knowledge for the aspiring learner. I still visit the site on a regular basis.

Late Austrian influences include Ludwig von Mises, Friedrich Hayek, Leonard Read, and Henry Hazlitt. Incredible sources of information in the Austrian tradition include the Ludwig Von Mises Institute and the Foundation for Economic Freedom.

Key contemporary influences include the following: John Tamny, Richard Salsman, Nathan Lewis, Steven Forbes, George Gilder, Arthur Laffer, Louis Woodhill, Brian Domitrovic, Ken Landon, Seth Lipsky, Robert Mundell, Reuven Brenner, Ralph Benko, Charles Kadlec, Lewis Lehrman, Larry Kudlow, Judy Shelton, Marc Miles, Vlad Signorelli, Paul Hoffmeister, Dan Mitchell, Walter Williams, Thomas Sowell, Thomas Woods, and Ron Paul.

I will single out John Tamny, who is editor at Forbes Opinions and RealClearMarkets, as the most important source of my understanding and appreciation of supply-side economics. John is easily one of the smartest persons I have had the pleasure of meeting. No one can explain the importance of sound money better than John. I am truly indebted to him for the knowledge he has imparted to me through his columns and public appearances.

It is my sincere hope that you enjoy the content and become a regular visitor!