Comedy of Errors

True Brits

A couple of weeks on from the Diamond Jubilee I’m still not sure why it is supposed to have made me feel particularly proud to be British. I’m generally a patriotic sort of chap but the site of hordes of cheap (to produce, not buy) Chinese made plastic flags being held aloft by crowds outside Buckingham Palace didn’t increase this a bit.

I suppose I should say early on that intellectually I am a republican. By that I mean that when I sit down and think about it the idea that our head of state is selected by genetic caprice is logically indefensible. But does Churchill’s old observation about democracy, that it was the least bad option, apply to Britain’s monarchy? I look at the United States where the head of state is routinely despised by around half the population and find the affectionate indifference of most Brits towards Elizabeth Windsor infinitely preferable. I was a fan of the Irish set up until a cross between Che Guevara and old man Steptoe took up residence at Áras an Uachtaráin.

And then there are my fellow republicans. Basing their case on envy as opposed to aspiration and making it with bitterness rather than generosity they truly are the modern version of the “hard faced Cromwellian sourpusses” Alan Partridge spoke about. About 20% of Brits call themselves republicans, a number almost unchanged over the past few decades; decades which have seen traditional structures break down utterly in many other spheres of national life. For its failure to make any appreciable headway with such favourable tailwinds the republican campaign in Britain must go down as one of the most useless in our history.

But still I find no national pride in the monarchy. What makes me proud is the things the people of this great country have done and the people who did them. I feel pride when I see Brazilians and Indians playing games invented in Britain. I feel pride when I hear a record by David Bowie, The Beatles, or The Rolling Stones on a foreign radio. I feel pride that we gave the world Adam Smith and free market economics. I feel pride when I travel on a bridge built by Isambard Kingdom Brunel. I feel pride when I think about the men who flew fighter planes over southern England in 1940. I feel pride whenever Hollywood adapts another novel by Dickens or Austen. I feel proud that so many countries have been inspired by our constitutional arrangements. I feel pride that the theory of evolution came from a Brit. I feel pride in every life saved based on the discovery of DNA by two British scientists.

And I felt pride a week after the Jubilee when I saw an Afghan theatre company perform a play by William Shakespeare. The Rah-e Sabz company was founded in 2005 by French director Corinne Jaber, coming together out of a series of workshops she had run with aspiring actors in Kabul. The actors were immediately attracted to Shakespeare and resolved to make Love’s Labour’s Lost their first production. With no translation of the play in their native language, Dari, the actors work shopped their own, and when the play was premiered in Kabul and toured Afghanistan it was a success.

The production of The Comedy of Errors which I saw before Rah-e Sabz left to tour it round India was a joy. Performed entirely in Dari, captions explaining the action were projected on to a screen. But they were barely needed such was the expressive, jubilant physicality of the performers. With sparse staging they brought alive the setting of the bazaars of Kabul, helped by some wonderful Afghan music played live. Standout performers were Shah Mamnoon Maqsudi, dragging it up brilliantly as Kukeb (the production’s Afghan name for Luce), and Farzana Soltani as a Courtesan who could have come straight out of a modern British tabloid sex scandal.

The infectious joie de vivre was all the more remarkable knowing the company’s background. Thanks to the medievally minded morons of the Taliban, Afghanistan is a dangerous place for performers. Last year Rah-e Sabz missed an attack on the compound where they were rehearsing which killed 12 people only thanks to a last minute change of schedule. One of the company’s female members came home one day to find her husband murdered as a punishment for her acting.

People from half a world and an entire culture away were united during the performance of a story by a long dead Englishman; “tickle us, do we not laugh?” as he might have said. These enormously talented and brave people had risked their lives to perform the plays of the Englishman William Shakespeare. Those Afghans made me proud to be British.

This article originally appeared at Middlebrow Magazine

Memo to Dave: No matter how much rubbish you talk, Guardianistas won’t love you

Scorned again

If you wanted lamb chops you wouldn’t go to Holland & Barrett. If you wanted a cheap shirt for work you wouldn’t look down Jermyn Street. And if you wanted a lecture on morality you wouldn’t go to a politician.

But that’s what we got last week in the midst of ‘Carrgate’. On Wednesday, David Cameron branded the comedian’s tax arrangements “morally wrong”. Then, on Thursday, when asked what his thoughts were on the similar tax arrangements of Conservative supporting singer Gary Barlow, Cameron muttered“ I am not going to give a running commentary on different people’s tax affairs. I don’t think that would be right”

On less flip floppy but no firmer ground was Danny Alexander. On that righteous Wednesday he thundered that “people who are deliberately going out of their way to try and bend the rules to avoid tax, are the moral equivalent of the people who cheat the benefit system”

This remark didn’t go unnoticed by singer turned moralist Lily Allen, whose song Fuck You is up there with Bob Dylan’s The Lonesome Death of Hattie Carroll as one of the great political statements in popular music. “How are tax avoiders ‘the moral equivalent of benefit cheats’ ? . Surely they’re a hundred times worse ?” (sic) she tweeted before calling someone who disagreed a “fascist” – a striking display of idiocy from someone so expensively educated.

’m no fan of Jimmy Carr, although he did once give me directions on Islington’s Upper Street. I don’t find him funny and for a comedian praised for his edginess I’ve always been surprised by how old fashionedly showbiz his TV shows are. Indeed, if you wanted to list your top three Steve Guttenberg movies I’m sure Jimmy Carr would be happy to host a program about it on E4. But has he actually done anything wrong?

Let’s start with Alexander and Allen. There is, in fact, a world of difference between someone acting legally to keep hold of money they earned (tax avoidance) and someone acting illegally to get hold of money someone else earned (benefit fraud). It was precisely this argument that Allen branded “fascist” before saying that “we’re talking morals not legalities”.

This brings us to Cameron’s point. The problem with making tax a moral issue is that taxes have to be, as Adam Smith put it as long ago as 1776, “certain, not arbitrary”. And morality is an arbitrary issue because each of us has their own moral code.

Thus, I find the coalition’s reforms to housing benefit reasonable and long overdue. Polly Toynbee regards them as nothing short of an attempted “final solution for the poor”. Personally, given that our engorged government spends tens of billions of pounds it shouldn’t, I see nothing inherently moral or noble in giving it money you don’t have to. In fact, I view tax avoidance as perfectly moral in the face of a bloated and wasteful government. But that’s me, and you might disagree.

The best way to avoid these sorts of clashes is the old live and let live, maximising the arenas of life in which individual choice is sovereign. However, this is not possible in cases where the actions are of their nature collective, like paying taxes.

But if we are to respect private property, which is not only right morally (in my view) but also from a perspective of increasing all our wealth, then we have to have a tax system in which your earnings can’t be taxed away ‘just because’. At some point we need to move away from morality and towards legality. We are back with Adam Smith.

So we draw up a tax system which all of us know about in advance. You break it, you’re a tax evader. You don’t, you’re good to go. And that is where Jimmy Carr is. Telegraph blogger Dan Hodges put it as well as anyone:

“What precisely has he done that’s immoral? Has Jimmy Carr earned his money legally? Yes. Does he pay tax? Yes. Does he stand accused of tax evasion? No. Has he paid the maximum amount of tax he is legally required to? Yes…We have an obligation to pay our full amount of tax. We don’t have an obligation, legal or moral, to pay more than that. That’s why we have a mandatory tax system, not a system of voluntary charitable contributions to the state.”

So why the outpouring of blather about Carr’s taxes? Allen is just a celebrity dimwit. Alexander is playing to his restive party members. He was at it again this week, saying that“ If we could narrow the tax gap in this country by a quarter we could reduce income tax for every basic rate payer by 2p in the pound” He doesn’t seem to realise that the same effect could be achieved if he just cut spending.

And then there’s Cameron. Never one to let the low hanging fruit go ungrabbed, getting all moralistic about Jimmy Carr probably seemed a great way to try and win a few brownie points with Guardian readers. Predictably, it blew up in his face. When will he learn that he can never, ever, talk enough rubbish to make Guardianistas love him?

This article originally appeared at The Commentator

The euthanasia of the rentier: Why the assault on savers must end


Take that thrift!

With the British economy flat lining, America’s stumbling, and Europe’s in a nosedive, the clamour is growing for policymakers to ‘do something’. The Bank of England is, once again, being urged to deploy the weapon of Quantitative Easing – the spending of newly created money on long term assets.

Would this do any good? It hasn’t so far. The truth is that money is not wealth, goods and services are, and a central bank simply producing more money does not make us wealthier. But if central banks can’t create more wealth by creating more money they can redistribute the wealth there is.

This has been happening in Britain for nearly four years. Between October 2008 and March 2009 the Bank of England slashed interest rates from 5 percent to the historic low of 0.5 percent. When this failed to reignite economic growth the Bank resorted to £325 billion worth of QE. Whereas the Bank usually works on the short term end of the Yield Curve when setting the base rate, with QE it set out to pull down the long term end.

The stated aim was to put money into banks to get them lending again. I’ll leave it to you to judge how far the programme has succeeded in that aim, but one predictable side effect has been to lower returns all along the curve.

And this matters. With policymakers pulling every trick to keep interest rates everywhere as low as possible, Britain’s savers are being ravaged. On one estimate they are being robbed of £18 billion per year. Simon Rose, of pressure group Save Our Savers, puts the figure savers have been stripped of at £100 billion since the start of the crisis, “a staggering amount of money” he says “given that it would pay for the Olympics ten times over.”

The Bank’s monetary shenanigans haven’t boosted growth (cheerleaders have fallen back on the old argument that they have, at least, staved off catastrophe – again, I’ll let you be the judge). They have caused a vast transfer of wealth away from Britain’s savers and towards debtors and zombie banks and this is bad economic policy for reasons of growth and stability.

An entrepreneur with an idea must spend money on premises, wages, and all kinds of other possible outlays before seeing a single penny in revenue. The only way the entrepreneur can fund this outlay is from savings, either their own or other people’s channeled through a financial institution.

An increase in saving allows this period between embarking on production and sale of the product to lengthen (or fund other production periods for other goods). The lengthening of the production period, in turn, permits more stages of production,increasing ‘roundaboutness’ as the Austrian economist Eugen von Böhm-Bawerk put it.

Take shelter, a basic human need. Without the savings to sustain us over a prolonged production period, the period between embarking on production and using the shelter must be short, perhaps as long as it takes us to find a cardboard box. But with savings we can extend the production period and introduce many more intermediate stages. We can purchase land, draw up plans, purchase materials, hire labour etc.

The story of human material progress can be characterized as the lengthening of production processes enabling ever more intermediate steps. In short, savers are the difference between a three bed terrace and a cardboard box.

This much is not controversial; almost all economists agree that saving is an indispensable ingredient of increasing wealth. But the attack on savings risks shorter term instability too.

Lowering the base rate and QE works the same way, just on different ends of the Yield Curve; assets are purchased from banks with money newly created by the Bank of England.  From the point of view of a bank there is no difference between money deposited with it by savers and money it receives from the Bank of England in return for financial assets; it can lend out and earn profits on both.

But from the point of view of the wider economy there is a huge difference between the two types of ‘savings’. When savers deposit their funds with a bank they are doing so because they wish to withdraw this money in the future to fund consumption then. The resultant fall in interest rates, which makes it possible for firms to borrow to invest in the means to supply this future consumption, represents the actual time preferences of economic agents.

The ‘fake savings’ of Bank of England deposits, however, represent no such thing. While they can be lent and borrowed to fund investment projects with longer production periods there has been no change in the time preference of economic agents. There will be no real savings to purchase the output of these enterprises in the future.

When this is revealed these unprofitable enterprises will be liquidated causing recession. It is, thus, only the deposits of savers which can provide the capital which allows for longer production processes and increasing wealth on a stable and sustainable basis.

In his ‘General Theory’ in 1936, John Maynard Keynes looked forward to “the euthanasia of the rentier” when interest rates would be driven to zero and capital would be free and abundant. This nonsense, as much as anything else he said, represents a threat to our economic growth and stability. The assault on savers must end.

This article originally appeared at The Commentator

Why the euro is working

It’s just misunderstood

The euro is a disaster. The single currency is falling apart because it does not have a central fiscal authority or a central bank capable of acting as lender of last resort standing behind it. Because of this it was doomed from the start and everybody knew it.

This line of thinking, stretching from the pages of the Telegraph to the New York Times, is so widespread that it might seem ridiculous to challenge it. Indeed, I subscribed to it myself. But lately I’ve been having second thoughts. Is it, in fact, possible that the euro is working in exactly the way it ought to be?

Let’s go back to basics and look at what we want our money to do. As I wrote recently

“The textbook functions of ‘money’ are familiar to anyone with a smattering of economics; a medium of exchange, a store of value, and a unit of account. But each of these functions is entirely dependent upon money maintaining its value. If the value of the pound fluctuates it is no more useful as a unit of account or measure than a twelve inch ruler which kept changing length. Money which declines in value is a poor store of value.

Historically, when its value declines beyond a certain point people stop storing their wealth in money and trade it for commodities as quickly as possible. This acceleration in velocity of circulation exacerbates the decline in value and can trigger hyperinflation. And money which is rapidly losing value can cease to fulfil the function of medium of exchange if people refuse to accept it, legal tender laws or not.

So the value of money must be maintained for it to serve its functions and value is determined by supply and demand. Money is demanded for transactions, buying and selling. A few coin collectors aside, people do not demand money for its own sake but because they wish, at some point in the future, to exchange it for goods or services.”

So what is the greatest threat to this maintenance of purchasing power which we desire from our money? Historically it has come from currency issuers, almost always governments, who have issued excess amounts of currency to pay their bills and caused a decline in the purchasing power of everyone else’s money in the process.

In the last century this was taken to lamentable extremes. John Maynard Keynes wrote in 1931 that “A preference for a gold currency (which could not be produced at will by monetary authorities) is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now”

The following decades proved Keynes’s faith in politicians to be grossly misplaced. We’ve all heard of the Weimar inflation but over the twentieth century the dollar and the pound lost about 90 percent of their value. This didn’t happen smoothly. As D R Myddelton writes, during the Keynesian golden age “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

As a result of such monetary mismanagement many countries sought a way to get their politicians’ hands off the printing press. No one was willing to go the whole hog and reintroduce the gold standard (which had tied the issue of currency to the amount of gold the issuer held) but the German model, with the Bundesbank independent from the government, was widely copied.

The whole point, to repeat, was to remove from government the power to print excessive amounts of money to cover their own expenses and, in doing so, ruin everyone else’s money. That considered, the euro is actually performing well.

Given the dire state of several eurozone economies, this may seem a bizarre thing to say. But can Spain’s horrific unemployment really be blamed on the euro when it hasn’t been under 8 percent since 1979? Is it really the fault of the euro that the Greeks chose to pay their pastry chefs, radio announcers, hairdressers, and steam bath masseurs (among 600 other “arduous and perilous” professions) a state pension of 95 percent of their final salary when they retire at 50?

Spain’s unemployment predates the euro and won’t be solved until a labour market which makes it practically impossible to hire and fire is reformed. Greece’s politicians have to stop promising Greeks that they can spend one third of their life retired, living on money borrowed from the Germans. ‘Reforming’ the euro can’t help with either of these. Indeed, by forcing governments to address these structural issues the euro could be seen to be doing them a service.

But these steps will have to be taken against the backdrop of a debt crisis. This is where calls for the European Central Bank to act as lender of last resort or for fiscal union to match monetary union are heard. The fatal flaw of the euro, these people say, is that it cannot be produced at will by governments to pay their bills.

But then, that is, and always was, the whole point. If a given country cannot pay its bills, is the solution for it to run the printing press and devalue everyone’s money or is it for that government to stop making spending commitments it can’t keep?

Countries like Greece are faced with massive borrowings in a currency which they cannot produce at will. Those who argue that this represents a fatal cleavage between monetary and fiscal policy and that a single fiscal policy must stand behind a single currency to bridge it are arguing that the solution is to put the power to make spending commitments in the same hands as the power to print money. The lessons of history are that this does not end well.

This article originally appeared at The Commentator

The charts that could doom Obama


Know any good removal men?

In February 2009, less than a month after Barack Obama was sworn in as President, the $831 billion American Recovery and Reinvestment Act came before Congress. If the ARRA was passed, President Obama promised, unemployment would peak at 8 percent in late 2009 and would have fallen to a little over 5.5 percent by May 2012. President Obama painted a doomsday scenario if the ARRA wasn’t passed; unemployment would peak at 9 percent in 2009 and by May 2012 would still be at 6 percent.

President Obama got his Act and the graph below shows what Americans got for their $831 billion.

Unemployment peaked at 10 percent in October 2009 and in May 2012 was 8.2 percent. In other words, even with Obama’s $831 billion package, unemployment peaked later, peaked higher, and remains higher than in the doomsday scenario he said would befall America if the ARRA wasn’t passed. The American economy outperformed even President Obama’s own worst case scenario. The Republicans should send a copy of this chart to every household in the United States. 

To call the ARRA ‘stimulus’ is surely a mistake; it hasn’t stimulated anything. But this isn’t a one off. Despite what Keynesians say, the idea that government spending can stimulate an economy beyond the very short term is a complete myth.

The chart above shows data for EU and G20 member states from 2011 on budget deficits and economic growth. It shows a clear trend: countries with higher budget deficits are experiencing lower growth.

A snapshot might not be too useful so what about over time?

This graph uses data for the EU and G20 member states on changes in growth and budget deficits from 2010 and 2011. Again, the trend is clear: countries that reduced their budget deficits between 2010 and 2011 could expect to see higher growth.

This is not to say that the act of cutting budget deficits of itself caused higher economic growth; correlation does not equal causation. But it does show that cutting budget deficits is not the route to economic meltdown. And it does show that state ‘stimulus’ spending is not the passport to prosperity some people like to make out.

People like Paul Krugman, who was in town last week to plug his new book which takes 259 pages to convey one bone-headedly simple message: keep spending. Krugman wrote recently that “All around Europe’s periphery, from Spain to Latvia, austerity policies have produced Depression-level slumps and Depression-level unemployment.”

Nothing of the sort has happened. As we see, countries enacting ‘austerity’ policies are doing slightly better than those which, relatively, aren’t.

Krugman complains that spending cuts aren’t really about controlling runaway government spending at all; this is all simply a cloak behind which conservatives are hiding the moves towards a small state they desire. This is, to say the least, an idiosyncratic view of a British government which is going to oversee an unprecedented peacetime rise in the national debt of 60 percent during its term in office. In truth, in clinging onto the belief that government spending creates sustainable economic growth which is being discredited around the world every single day, it is Krugman who is still pushing his failed, dangerous ideology in the face of all the evidence.   

Krugman is not alone. His British Mini Me, Will Hutton, has taken to the pages of the Observer to blame austerity for the parlous state of the global economy. Hutton says that in Britain “manufacturing suffered its biggest plunge for three years, and this in an economy already suffering its longest depression since the 19th century. American jobs growth is petering out. Unemployment in Europe averages 11%”

But look at Britain with its budget deficit of 8.1 percent of GDP. Look at the US with its budget deficit of 9.7 percent of GDP. Look at Ireland, Greece, Spain and France with their budget deficits of 11.2 percent, 7.3 percent, 6.9 percent and 6 percent of GDP respectively and ask yourself in which mad universe these countries can be said to be applying ‘austerity’.

Contrary to what Krugman, Hutton, and others argue it is not ‘austerity’ which has failed, it has barely been tried. Over the last three years Britain’s budget deficits have been 10.3 percent, 10.2 percent and 8.1 percent. According to the Keynesian theory the British economy should be in fine fettle yet it’s still in the tank. It is Keynesian deficit spending that has failed. 

You would have to be a complete fool impervious to all evidence to cling like Linus with his blanket to the idea that we could get more economic growth if only the government would spend more money. President Obama is not alone in seeing his ‘stimulus’ fail to stimulate but that will be of little comfort if he is calling the removal men in November. 

This article originally appeared at The Commentator

The euro – lessons from history

Dinner money

When currencies and monetary arrangements have broken down it has always been because the currency issuer can no longer fight the lure of the seigniorage to be gained by over issue of the currency. In the twentieth century this age-old impulse was allied to new theories that held that economic downturns were caused or exacerbated by a shortage of money. It followed that they could be combated by the production of money.

Based on the obvious fallacy of mistaking nominal rises in wealth for real rises in wealth, this doctrine found ready support from spendthrift politicians who were, in turn, supported by the doctrine.

Time and again over recent history we see the desire for seigniorage allied with the cry for more money to fight a downturn pushing up against the walls of the monetary architecture designed to protect the value of the currency. Time and again we see the monetary architecture crumble.

The classical gold standard

At the start of the twentieth century much of the planet and its major economic powers were on the gold standard which had evolved from the 1870s following Britain’s lead. This was based on the twin pillars of (1) convertibility between paper and gold and (2) the free export and import of gold.

With a currency convertible into gold at a fixed parity price any monetary expansion would see the value of the currency relative to gold decline which would be reflected in the market price. Thus, if there was a parity price of 1oz gold = £5 and a monetary expansion raised the market price to 1oz = £7, it would make sense to take a £5 note to the bank, swap it for an ounce of gold and sell it on the market for £7.

The same process worked in reverse against monetary contractions. A fall in the market price to 1oz = £3 would make it profitable to buy an ounce of gold, take it to the bank and swap it for £5.

In both cases the convertibility of currency into gold and vice versa would act against the monetary expansion or contraction. In the case of an expansion gold would flow out of banks forcing a contraction in the currency if banks wished to maintain their reserve ratios. Likewise a contraction would see gold flow into banks which, again, in an effort to maintain their reserve ratios, would expand their issue of currency.

The gold standard era was one of incredible monetary stability; the young John Maynard Keynes could have discussed the cost of living with Samuel Pepys without adjusting for inflation. The minimisation of inflation risk and ease of convertibility saw a massive growth in trade and long term cross border capital flows. The gold standard was a key component of the period known as the ‘First era of globalisation’.

The judgement of economic historians Kenwood and Lougheed on the gold standard was

One cannot help being impressed by the relatively smooth functioning of the nineteenth-century gold standard, more especially when we contemplate the difficulties experienced in the international monetary sphere during the present century. Despite the relatively rudimentary state of economic knowledge concerning internal and external balance and the relative ineffectiveness of government fiscal policy as a weapon for maintaining such a balance, the external adjustment mechanism of the gold standard worked with a higher degree of efficiency than that of any subsequent international monetary system

The gold exchange standard and devaluation

The First World War shattered this system. Countries printed money to fund their war efforts and convertibility and exportability were suspended. The result was a massive rise in prices.

After the war all countries wished to return to the gold standard but were faced with a problem; with an increased amount of money circulating relative to a country’s gold stock (a problem compounded in Europe by flows of gold to the United States during the war) the parity prices of gold were far below the market prices. As seen earlier, this would lead to massive outflows of gold once convertibility was re-established.

There were three paths out of this situation. The first was to shrink the amount of currency relative to gold. This option, revaluation, was that taken by Britain in 1925 when it went back onto the gold standard at the pre-war parity.

The second was that largely taken by France between 1926 and 1928. This was to accept the wartime inflation and set the new parity price at the market price.

There was also a third option. The gold stock could not be expanded beyond the rate of new discoveries. Indeed, the monetary stability which was a central part of the gold standard’s appeal rested on the fixed or slow growth of the gold stock which acted to halt or slow growth in the currency it backed. So many countries sought to do the next best thing and expand gold substitutes to alleviate a perceived shortage of gold. This gave rise to the gold exchange standard which was put forward at the League of Nations conference in Genoa in 1922.

Under this system countries would be allowed to add to their gold reserves the assets of countries whose currency was convertible into gold and issue domestic currency based on this expanded stock. In practice the convertible currencies which ‘gold short’ countries sought as reserves were sterling and dollars.

The drawbacks were obvious. The same unit of gold could now have competing claims against it. The French took repeated advantage of this to withdraw gold from Britain.

Also it depended on the Bank of England and Federal Reserve maintaining the value of sterling and the dollar. There was much doubt that Britain could maintain the high value of sterling given the dire state of its economy and the dollar was weakened when, in 1927, the Federal Reserve lowered interest rates in order to help ease pressure on a beleaguered sterling.

This gold exchange standard was also known as a ‘managed’ gold standard which, as Richard Timberlake pointed out, is an oxymoron. “The operational gold standard ended forever at the time the United States became a belligerent in World War I”, Timberlake writes.

After 1917, the movements of gold into and out of the United States no longer even approximately determined the economy’s stock of common money.

The contention that Federal Reserve policymakers were “managing” the gold standard is an oxymoron — a contradiction in terms. A “gold standard” that is being “managed” is not a gold standard. It is a standard of whoever is doing the managing. Whether gold was managed or not, the Federal Reserve Act gave the Fed Board complete statutory power to abrogate all the reserve requirement restrictions on gold that the Act specified for Federal Reserve Banks (Board of Governors 1961). If the Board had used these clearly stated powers anytime after 1929, the Fed Banks could have stopped the Contraction in its tracks, even if doing so exhausted their gold reserves entirely.

This was exacerbated in the United States by the Federal Reserve adopting the ‘real bills doctrine’ which held that credit could be created which would not be inflationary as long as it was lent against productive ‘real’ bills.

Many economists, notably Ludwig von Mises and Friedrich von Hayek, have seen the genesis of the Depression of the 1930s in the monetary architecture of the 1920s. While this remains the most debated topic in economic history there is no doubt that the Wall Street crash and its aftermath spelled the end of the gold exchange standard. When Britain was finally forced to give up its attempt to hold up sterling and devalue in 1931 other countries became worried that its devaluation, by making British exports cheaper, would give it a competitive advantage. A round of ‘beggar thy neighbour’ devaluations began. Thirty two countries had gone off gold by the end of 1932 and the practice continued through the 1930s.

Bretton Woods and its breakdown

Towards the end of World War Two economists and policymakers gathered at Bretton Woods in New Hampshire to design a framework for the post war economy. Looking back it was recognised that the competitive devaluations of the 1930s had been a driver of the shrinkage of international trade and, via its contribution to economic instability, to deadly political extremism.

Thus, the construction of a stable monetary framework was of the most utmost importance. The solution arrived at was to fix the dollar at a parity of 1oz = $35 and to fix the value of other currencies to the dollar. Under this Bretton Woods system currencies would be pegged to gold via the dollar.

For countries such as Britain this presented a problem. Any attempt to use expansionary fiscal or monetary policy to stimulate the economy as the then dominant Keynesian paradigm prescribed would eventually cause a balance of payments crisis and put downward pressure on the currency, jeopardising the dollar value of sterling. This led to so called ‘stop go’ policies in Britain where successive governments would seek to expand the economy, run into balance of payments troubles, and be forced to deflate. In extreme circumstances sterling would have to be devalued as it was in 1949 from £1 = $4.03 to £1 = $2.80 and 1967 from £1 = $2.80 to £1 = $2.40.

A similar problem eventually faced the United States. With the dollar having replaced sterling as the global reserve currency, the United States was able to issue large amounts of debt. Initially the Federal Reserve and Treasury behaved reasonably responsibly but in the mid-1960s President Lyndon Johnson decided to spend heavily on both the war in Vietnam and his Great Society welfare program. His successor, Richard Nixon, continued these policies.

As dollars poured out of the United States, investors began to lose confidence in the ability of the Federal Reserve to meet gold dollar claims. The dollar parity came under increasing pressure during the late 1960s as holders of dollar assets, notably France, sought to swap them for gold at the parity price of 1oz = $35 before what looked like an increasingly inevitable devaluation. Unwilling to consider the deflationary measures required to stabilise the dollar with an election due the following year, President Nixon closed the gold window on August 15th 1971. The Bretton Woods system was dead and so was the link between paper and gold.

Fiat money and floating exchange rates

There were attempts to restore some semblance of monetary order. In December 1971 the G10 struck the Smithsonian Agreement which sought to fix the dollar at 1oz = $38 but this broke down within a few months under the inflationary tendencies of the Federal Reserve. European countries tried to establish the ‘snake’, a band within which currencies could fluctuate. Sterling soon crashed out of even this under its own inflationary tendencies.

The cutting of any link to gold ushered in the era of fiat currency and floating exchange rates which lasts to the present day. Fiat currency gets its name because its value is given by governmental fiat, or command. The currency is not backed by anything of value but by a politicians promise.

The effect of this was quickly seen. In 1931 Keynes had written that “A preference for a gold currency is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now” But, as D R Myddelton writes, “The pound’s purchasing power halved between 1945 and 1965; it halved again between 1965 and 1975; and it halved again between 1975 and 1980. Thus the historical ‘half-life’ of the pound was twenty years in 1965, ten years in 1975 and a mere five years in 1980”

In 1976 the pound fell below $2 for the first time ever. Pepys and Keynes would now have been talking at cross purposes.

Floating exchange rates marked the first public policy triumph for Milton Friedman who as long ago as 1950 had written ‘The Case for Flexible Exchange Rates’. Friedman had argued that “A flexible exchange rate need not be an unstable exchange rate” but in an era before Public Choice economics he had reckoned without the tendency of governments and central banks, absent the restraining hand of gold, to print money to finance their spending. World inflation which was 5.9% in 1971 rose to 9.6% in 1973 and over 15% in 1974.

The experience of the era of floating exchange rates has been of one currency crisis after another punctuated by various attempts at stabilisation. The attempts can involve ad hoc international cooperation such as the Plaza Accord of 1985 which sought to depreciate the dollar. This was followed by the Louvre Accord of 1987 which sought to stop the dollar depreciating any further.

They may take more organised forms. The Exchange Rate Mechanism was an attempt to peg European currencies to the relatively reliable Deutsche Mark. Britain joined in 1990 at what many thought was too high a value (shades of 1925) and when the Bundesbank raised interest rates to tackle inflation in Germany sterling crashed out of the ERM in 1992 but not before spending £3.3 billion and deepening a recession with interest rates raised to 12% in its vain effort to remain in.

Where now?

This brief look back over the monetary arrangements of the last hundred years shows that currency issuers, almost always governments, have repeatedly pushed the search for seigniorage to the maximum possible within the given monetary framework and have then demolished this framework to allow for a more ‘elastic’ currency.

Since the demise of the ERM the new vogue in monetary policy has been the independent central bank following some monetary rule, such as the Bank of England and its inflation target. Inspired by the old Bundesbank this is an attempt to take the power of money creation away from the politicians who, despite Keynes’ high hopes, have proved themselves dismally untrustworthy with it. Instead that power now lies with central bankers.

But it is not clear that handing the power of money creation from one part of government to another has been much of an improvement. For one thing we cannot say that our central bankers are truly independent. The Chairman of the Federal Reserve is nominated by the President. And when the Bank of England wavered over slashing interest rates in the wake of the credit crunch, the British government noisily questioned its continued independence and the interest rate cuts came.

Furthermore, money creation can reach dangerous levels if the central bank’s chosen monetary rule is faulty. The Federal Reserve has the awkward dual mandate of promoting employment and keeping prices stable. The Bank of England and the European Central Bank both have a mandate for price stability, but this is problematic. As Murray Rothbard and George Selgin have noted, in an economy with rising productivity, prices should be falling. Also, what ‘price level’ is there to stabilise? The economy contains countless different prices which are changing all the time; the ‘price level’ is just some arbitrarily selected bundle of these.

An extreme example, as noted by Jesús Huerta de Soto, is the euro. Here a number of governments agreed to pool their powers of money creation and invest it in the European Central Bank. The euro is now widely seen to be collapsing. So it may be, but is this, as is generally assumed, a failure of the architecture of the euro itself?

Let us remember that the purpose of erecting a monetary structure where the power to create money is removed from government is to stop the government running the printing presses to cover its spending and, in so doing, destroy the currency.

The problem facing eurozone states like Greece and Spain is presented as being that they are running up debts in a currency they cannot print at will to repay these debts. But is the problem here that these countries cannot print the money they need to pay their debts or that they are running up these debts in the first place? The solution is often offered that either these countries need to leave the euro and adopt a currency which they can expand sufficiently to pay their debts or that the ECB needs to expand the euro sufficiently for these countries to be able to pay their debts. But there is another solution, commonly called ‘austerity’, which says that these countries should just not run up these debts. As de Soto argues, the euro’s woes are really failures of fiscal policy rather than monetary policy.

It is thus possible to argue that the euro is working. By halting the expansion of currency to pay off debts and protecting its value and, by extension, preventing members from running up evermore debt, the euro is doing exactly what it was designed to do.

There is a growing clamour inside Europe and outside that ‘austerity’ alone is not the answer to the euro’s problems and that monetary policy has a role to play. The ECB itself seems to be keen to take on this role. But it is simply the age-old idea, based on the confusion between the real and the nominal, that we will get richer if we just produce more money. Germany is holding the line on the euro but history shows that far sounder currency arrangements have collapsed under the insatiable desire for a more elastic currency.


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This article originally appeared at The Cobden Centre