The True Gold Standard (Second Edition)
Key Writings: Hanke on the Gold Standard
The year 2012 has come and gone, and so have many things that were once accepted as conventional wisdom. Let’s take a tour d’horizon and examine three ideas that bear rethinking in 2013.
Rethinking the Money Supply
I begin with the nonsensical way that most central banks, including the U.S. Federal Reserve, measure the money supply. Conventional wisdom holds that the best way to measure the money supply is to define the components that make up a particular measure of money (from M0 to broad M4) and then simply add up the components to obtain a total.
For decades, the Iranian economy has been cobbled together by religious-bureaucratic regimes that have employed mandates, regulations, price controls, subsidies and a wide variety of other interventionist devices, in an attempt to achieve their goals. It's all been kept afloat – barely afloat – by oil revenues.
Shortly after Mahmoud Ahmadinejad took power as president, Iran began to draw the ire of the United States, Europe and their allies over a number of issues related to Iran's nuclear ambitions. Of late, this loose coalition of ‘allies' has ratcheted up economic sanctions against Iran.
Has the cascade of sanctions had an effect? The Iranian rial's exchange rate tells the tale. When US President Barack Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act in July 2010, the official exchange rate for the rial to the US dollar was very close to the black market rate. Since these sanctions took effect, however, the official and black market rates have increasingly diverged.
The sanctions began to bite especially hard in early September, when the slide in the value of the rial began to accelerate – punctuated by two dramatic collapses in the demand for the Iranian currency. With each collapse, there has been something akin to a ‘bank run' on the rial – with a sharp rise in the black market (read: free market) exchange rate to the greenback. Ironically, Iranians are clamoring for US dollars.
A country's money supply is made up of two distinct components. State money — the monetary liabilities of a central bank (typically referred to as base, or high-powered, money) — is one element, and is by far the smallest component of the money supply. The second and most important component of the money supply is bank money. This is the money (deposit liabilities) that is created by the banking system, broadly defined.
Changes in the money supply are a dominant force in the economy — a force that determines changes in prices and in economic activity, measured by nominal GDP. Accordingly, we must pay the most careful and anxious attention to movements in a country's total money supply, as well as to the movements in its components (state and bank money).
When it comes to forecasting economic activity, most people fail in their diagnoses because they ignore money. That said, those who do pay attention to money often come up short, because they focus exclusively on central banks and developments in state money, at the expense of the allimportant bank-money component.
A review of the accompanying money-supply chart for the U.S. tells the economic story. The money supply has been growing at a rate lower than the trend rate, resulting in a money supply "deficiency". In consequence, the U.S. has been in a growth recession — positive, but weak, economic activity, accompanied by subdued inflationary pressures.
But, most people believe that monetary policy has been ultra-loose since the collapse of Lehman Brothers in September 2008. Well, by standard accounts, it has been — the quantity of state money has almost tripled since September 2008. When looked at through the proper lens, however, the picture is quite different.
This chapter supplies, for the first time, a table that contains all 56 episodes of hyperinflation, including several which had previously gone unreported. The Hyperinflation Table is compiled in a systematic and uniform way. Most importantly, it meets the replicability test. It utilizes clean and consistent inflation metrics, indicates the start and end dates of each episode, identifies the month of peak hyperinflation, and signifies the currency that was in circulation, as well as the method used to calculate inflation rates.
Hungary is in a recession, again. According to the chattering classes, as well as many analysts and financial reporters, fiscal austerity is the cause of Hungary’s slump.
Nonsense. Hungary’s recession results from its slumping money supply.
When monetary and fiscal policies move in opposite directions, the economy will follow the direction taken by monetary (not fiscal) policy – money dominates. For doubters, just consider Japan and the United States in the 1990s. The Japanese government engaged in a massive fiscal stimulus program, while the Bank of Japan embraced a super-tight monetary policy. In consequence, Japan suffered under deflationary pressures and experienced a lost decade of economic growth.
In the U.S., the 1990s were marked by a strong boom. The Fed was accommodative and President Clinton was super-austere – the most tight-fisted president in the post-World War II era. President Clinton chopped 3.9 percentage points off federal government expenditures as a percent of GDP. No other modern U.S. President has even come close to Clinton’s record.
The money supply picture for Hungary seemed to be looking up until late 2011 (see the accompanying chart). Indeed, Hungary’s money supply had nearly returned to its trend-rate level, when it peaked in November 2011. Then, in the course of just over a month, things took a turn for the worse.
BY STEVE HANKE: