Getting to Gold: How Good Money Can Drive Out Bad

With average annual federal deficits of more than $1.3 trillion for fiscal years 2010-12, and with Secretary of Defense Leon Panetta calling the deficit a major threat to national security, it is high time that America considers a comprehensive economic policy, uniting monetary and fiscal policies.

As Judy Shelton argues in A Guide to Sound Money, fiscal and monetary policy are intricately and dangerously intertwined. Citing former Fed Chairman Alan Greenspan in 1966, “[Greenspan] noted the ambitions of statists to promote expansionist government through unlimited credit creation and concluded: ‘Deficit spending is simply a scheme for the “hidden” confiscation of wealth’” (18).

Shelton continues:

“…now we face a government-controlled monetary regime so expansive and powerful that Americans hardly dare question its influence over financial markets or its authority to alter economic outcomes. The Federal Reserve takes the position that its policies are paramount, whether it redirects the flow of capital by manipulating interest rates, or distorts fundamental parameters of risk and return in the financial marketplace. The Federal Reserve justifies its intervention by claiming a higher economic or social objective” (19).

So, how does today’s Fed measure up?

In a recent Wall Street Journal article, economist Benn Steil highlighted the Fed’s startling inability to accurately forecast the very economic indices that its policies seek to influence.

Looking at the Fed’s performance over the twenty year period between 1986 and 2006, private forecasters more accurately predicted next year gross domestic product (GDP) and CPI along with unemployment and Personal Consumption Expenditures (PCE). The Fed, according to Steil’s article, concluded that “its historical forecast errors are large in economic terms.”

Looking ahead, Mr. Steil argues that “since history contradicts the notion that the Fed can safely pledge interest rates three years out, there is a significant likelihood that the credibility of the Fed’s new inflation target will crumble as it keeps interest rates down despite rising prices, or that its effort to persuade the market that the rates will stay near zero will end in shambles.”

Steil concludes that “the result of [Mr. Bernanke’s transparency] effort will be very different: to increase the level of distrust in markets surrounding official Fed targets and expectations.”

If the Fed is unable to make accurate forecasts about key economic indicators and federal spending remains out of control, what, then, is the solution which unites fiscal and monetary policy while promoting long-term economic growth? A return to Constitutional money, backed by precious metal.

According to Shelton, even Greenspan thought

“that the issuance of gold-backed Treasury notes [would] curb government profligacy. ‘The redemption of dollars for gold in response to excess federal government-induced credit creation would be a strong political signal,’ Greenspan explains. ‘Gold notes could be a case of reversing Gresham’s Law. Good money would drive out bad’” (18).