Thursday, August 21, 2008

It's 1969 All Over Again

Brian Wesbury, Chief Economist of First Trust Advisors says that inflation is a big problem and that today we’re about where we were back in 1969.

Back in those days of flower children, the Beatles studio years, the first man on the moon, and the Vietnam War at the close of the 60s, inflation was just starting to rear its ugly head. The inflation tide didn’t crest until a decade later, after a recession (73-75) and years of “eroding living standards.”

Even after Fed Chairman Paul Volcker’s tight money policies began to tame the inflation dragon, there were two more “damaging recessions” in 80 and in 81-82. Most people under 50 today have little understanding of just how severe of a blow inflation was to the US economy and to the American psyche.

Wesbury asserts that our nation is in a state of denial about the seriousness of our current situation. He takes on each argument put forth by various deniers and shows how the problem they claim isn’t a problem is actually worse than we realize.

The culprit for rising inflation — including most of the recent rise in the cost of fuel — is the Fed’s loose money policy that began back in the 1990s. Wesbury writes, “We hear over and over that the Fed cannot tighten because the housing market and the economy are vulnerable. This was the same argument made in the pre-Volcker 1970s, when the U.S. bounced from one economic crisis to the next.”

Once Volcker raised interest rates to painful levels, there was indeed a lot of pain. But it was relatively short lived, and it produced an economy in the 80s and 90s that was far healthier than the economy of the 60s and 70s — or the economy of this decade, for that matter.

Imagine what the 70s might have been like had the money supply been tightened in 1969. Yes, there would have been some problems in 70-71, but those problems would have been minor compared to the cost that had to be paid when the rates were finally raised in 79-82. The result would have been a longer term, more sound economy much sooner.

Wesbury doesn’t sound hopeful, however. He says that we are following the same pattern of denial and counterproductive arguments that was followed in the 60s and 70s. If we continue along this path, we will see real decline in general standards of living over the next decade until the pain becomes so severe that we acquiesce and do a repeat of Volcker’s policies. Wouldn’t it make more sense to get that out of the way right now without having to endure a decade of inflation?

I fault Wesbury for not taking on the core problem: centralized banking. While we have developed a mythology around the notion of the Fed providing needed economic stability, objective consideration of the history of our centralized government banking system reveals an endless series of corruption, bad behavior, and poor results.

We should privatize money. Many people will think this idea is nutty, but bear in mind that this criticism comes ostensibly from people that think they can’t live without the biggest monopoly on the face of the earth; the Federal Reserve. When you think about it, you will realize that money existed long before any government entity controlled it. There is no rule that says that government control of money is necessary or even desirable. Governments are involved in the money supply because it is a plentiful source of wealth and power.

Private money holders should be allowed to issue their own currencies denominated as they wish. Of course they should be subject to rules and laws that require them to actually have assets to back up their currencies. But competition would take care of much of this. A bank that issues too much currency would see its value drop with respect to currencies from competing institutions.

Wouldn’t such a system create a financial wild-wild-West, where different merchants accept only certain currencies? Wouldn’t I have to carry around 14 credit cards denominated in different currencies? That’s inside-the-box thinking. Necessity is the mother of invention, and I am confident that the market would soon provide a satisfactory solution that would simplify life for consumers. This kind of thing is already working in many border communities throughout the world. Moreover, ubiquitous computers (and even cell phone applications) allow for quick exchanges to different currencies.

Markets tend to produce order rather than chaos. The banking runs from the days where private banks did produce their own currencies were actually less severe than the problems the Fed has caused throughout its existence. Many of the “principles” that the Fed has operated under over the years have ultimately proven to be false or misunderstood, causing them to be discarded one by one. Today the Fed has no clue what principles it is following. How is a roomful of “smart” and powerful financial people that don’t have a clue what they are doing with our national money supply other than by gut instinct better than allowing the market to work things out?

If the Fed continues on its 1970s back-to-the-future tour, I wonder if competing currencies might not spring up on their own. They’re illegal, of course. The government hates competition. But clever business people have already found some ways to exploit loopholes in the laws. Some competing currencies already exist.

While it’s scary — thanks to indoctrination — for many people to think about it, life without the Fed would likely be much better than life with the Fed, much in the same way that life is better without the mob’s protection racket.

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