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Tuesday, April 13, 2010

Ron Paul on Israel

by RonPaul.com on January 12, 2009
On January 9, Ron Paul addressed Congress to voice his opposition to a House resolution expressing strong support for Israel in its invasion of Gaza, and branding Hamas as a terrorist organization. Ron Paul called for American neutrality in conflicts that have nothing to do with the United States.
Statement of Congressman Ron Paul
United States House of Representatives
Statement on H Res 34, “Recognizing Israel’s right to defend itself against attacks from Gaza, Reaffirming the United States strong support for Israel, and supporting the Israeli-Palestinian peace process”
January 9, 2008
Madame Speaker, I strongly oppose H. Res. 34, which was rushed to the floor with almost no prior notice and without consideration by the House Foreign Affairs Committee. The resolution clearly takes one side in a conflict that has nothing to do with the United States or US interests. I am concerned that the weapons currently being used by Israel against the Palestinians in Gaza are made in America and paid for by American taxpayers. What will adopting this resolution do to the perception of the United States in the Muslim and Arab world? What kind of blowback might we see from this? What moral responsibility do we have for the violence in Israel and Gaza after having provided so much military support to one side?
As an opponent of all violence, I am appalled by the practice of lobbing homemade rockets into Israel from Gaza. I am only grateful that, because of the primitive nature of these weapons, there have been so few casualties among innocent Israelis. But I am also appalled by the longstanding Israeli blockade of Gaza — a cruel act of war — and the tremendous loss of life that has resulted from the latest Israeli attack that started last month.
There are now an estimated 700 dead Palestinians, most of whom are civilians. Many innocent children are among the dead. While the shooting of rockets into Israel is inexcusable, the violent actions of some people in Gaza does not justify killing Palestinians on this scale. Such collective punishment is immoral. At the very least, the US Congress should not be loudly proclaiming its support for the Israeli government’s actions in Gaza.
Madame Speaker, this resolution will do nothing to reduce the fighting and bloodshed in the Middle East. The resolution in fact will lead the US to become further involved in this conflict, promising “vigorous support and unwavering commitment to the welfare, security, and survival of Israel as a Jewish and democratic state.” Is it really in the interest of the United States to guarantee the survival of any foreign country? I believe it would be better to focus on the security and survival of the United States, the Constitution of which my colleagues and I swore to defend just this week at the beginning of the 111th Congress. I urge my colleagues to reject this resolution.
*******
Later, Ron Paul was interviewed by Press TV about the ongoing tragedy in Gaza:
Congressman Ron Paul condemns the violence in the Gaza Strip, saying the “collective punishment” against Palestinians is immoral.

“Many innocent children are among the dead. While the shooting of rockets into Israel is inexcusable, the violent actions of some people in Gaza does not justify killing Palestinians on this scale,” said the outspoken Republican. ****
Ron Paul was also interviewed by Russia Today on the same subject. He expressed his belief that Israel’s critics and enemies will see the United States as the side to be blamed for the ongoing violence in the Gaza Strip, and called for the US to review its unconditional support of the Jewish state.
Excerpt:
Interviewer: [...]“Why do you think that so many US officials, Congress, Senate, show overwhelming support to involving the US over there?”
Ron Paul: [...] “It’s been going on for more than 50 years, because there has been a pretty strong case made for the Jewish people being treated quite badly, and emotionally there was an argument for having a place they can call their homeland, and people bought into this. But even then there was no justification for us to be using our money for doing that.
There’s one thing being friends, getting along with people and trading with people versus subsidizing them. So it’s been going on a long time, and even from the origination of the state of Israel, the American people generally have supported all of this, and it’s what they’ve read about and heard about and the way they’ve been taught, yet today there’s a growing number of Americans who are questioning it.
They don’t have anything against Jewish people, they don’t have anything against Israel per se, but there’s a lot of questioning whether or not it should be our money and our weapons, and a blank check, so to speak.
So if Israel would get into trouble, there’s not very many people in this country that don’t assume that we would come to their rescue.”
***************************************************************
  • The idea for “preventive war” is spreading
  • We should be on neither side; that conflict has been going on for a long time
  • Even though Israel invades Gaza, we – the US – will be blamed for this
  • Palestinians are confined to a “concentration camp” and are no match for Israel
  • The Middle East is a powder keg
  • We’re involved in too many wars and are going bankrupt
  • 2009 will see inflation and a rapid deterioration of the dollar
  • We’re spending too much money, borrowing too much money, and printing too much money
  • Escalation in Gaza and Afghanistan means big trouble at the world stage and at home
  • The attack on our personal liberties continues



The Federal Reserve-Then & Now (2)

The Federal Reserve: 
Then and Now 
Roger W. Garrison
Roger W. Garrison is associate professor of economics at Auburn University. 
He wishes to thank James Barth, Jeffrey Friedman, and Sven Thommesen for 
their helpful comments on an earlier version of this paper. 
The Review ofAustrian Economics Vo1.8, No. 1(1994): 3-19 
ISSN 0889-3047

PART 2

TheArtificial Boom

Textbook treatments of fiscal and monetary policy recognize that 
the fiscal authority and the Federal Reserve can work together. 
The Treasury issues debt and the Federal Reserve monetizes it. 
So long as government borrowing has not been pushed to irre- 
sponsible levels, debt issue and monetization have short-run 
effects on output and incomes that reinforce one another and 
short-run effects on the interest rate that cancel one another. 
These effects of policy are derived straightforwardly from stand- 
ard analysis which focuses on aggregate supply and aggregate 
demand. But when borrowing becomes excessive, considerations 
of risk become dominant. Going beyond the circumscribed focus 
of the textbook, we can recognize that the Treasury creates risk 
and the Federal Reserve externalizes it. 
To say that the Federal Reserve keeps the default-risk pre- 
mium off Treasury bills is not to say that the risk is actually 
eliminated. The burden of bearing it is simply shifted from the 
holders of Treasury securities to others. Borrowing and investing 
in the private sector becomes more risky than it otherwise would 
be. Holders of private debt and equity shares must concern 
themselves not only with all the usual risks and uncertainties of 
the marketplace but also with the risks and uncertainties attrib- 
utable to changes in the way the federal deficit is accommodated. 
Selling Treasury bills in foreign credit markets, in domestic credit 
markets, or to the Federal Reserve can have major effects on the 
strength of export markets, on domestic interest rates, and on the 
inflation rate. The inability of market participants to anticipate 
the Treasury's borrowing strategy translates into unanticipated 
changes in the value of private securities. 
If the additional risks attributed to federal budget deficits 
and imposed upon the private sector were allocated in some 
economically efficient way, there would have been no artificial 
boom arising from the irresponsible fiscal policy of the 1980s. The 
willingness to lend and to buy equity shares in the private sector 
would have been generally reduced, as wealth holders opted for 
the artificial security provided by government debt; but the re- 
duction in private-sector activity would have been minimized so 
long as the additional risks were assumed by those most willing 
to do so. This result, though, was precluded by institutional 
factors that hid the private-sector riskiness from those who were 
(unknowingly) financing risky undertakings. Again, the Federal 
Reserve plays a strong supporting role, as does the FDIC. To- 
gether, they enabled commercial banks and their depositors to 
finance risky ventures throughout the 1980s while being shielded 
either permanently or temporarily from the risks. This shield 
from risk bearing, like the low rate of interest in the 1920s, gave 
rise to an artificial boom and subsequent bust. 
The Depository Institutions Deregulation and Monetary 
Control Act of 1980 (DIDMCA) dramatically changed the bank- 
ing industry's ability and willingness to finance risky under- 
takings. Increased competition from nonbank financial institu- 
tions drove commercial banks to alter their lending policy so as 
to accept greater risks in order to achieve higher yields. The 
Federal Reserve in its long-established capacity of lender of last 
resort diminished the banks' concerns about possible problems 
of illiquidity while the FDIC absolved the banks' depositors of 
all worries about illiquidity and even about bankruptcy. Riskier 
loans, then, were only partially reflected in higher borrowing 
costs and lower share prices. In substantial measure, specific 
private-sector risks were transformed by DIDMCA, the Federal 
Reserve, and the FDIC into (1)the generalized risk of inflation 
in the event of excessive last-resort lending by the Federal Re- 
serve and (2) the risk of a large and unbudgeted liability in the 
event of excessive last-resort closings by the FDIC. Thus, economic 
activity in the private sector was spurred on by the lure of higher 
yields, yet it was largely unattenuated by considerations of 
risk, which were effectively externalized and diffused. 
The artificially low risk premiums stemming from the risk- 
externalizing effect of potential debt monetization in the 1980s 
paralleled the artificially low interest rates created by actual 
monetary expansion in the 1920s. What was without an earlier 
parallel, however, was the impact of deposit insurance in the 
post -warperiod. Throughout the 1980s, the FDIC continued 
to protect depositors while charging the banks a premium that 
was too low in general and, more significantly, that was unrelated 
to the riskiness of bank assets. This subsidy to risk-taking may 
have been significant enough, by itself, to create an artificial 
boom. There was no difficulty in finding risks to take. Banks could 
simply lend more heavily to overextended farmers, third-world 
countries, oil prospectors, and real estate developers; or they 
could find new risks such as those created by leveraged buyouts 
and the dramatic growth of the junk-bond market. It was the 
financial sector's demand for high-risk, high-yield securities, in 
fact, that gave junk bonds and other highly leveraged securities 
their buoyancy. 
Although it is possible to think of the FDIC as having its own 
independent effect throughout the 1980s, FDIC policy was actu- 
ally an integral part of the -fiscal, monetary, and regulatory 
environment that created and externalized risks. The Treasury 
created risk; the Federal Reserve and the FDIC externalized it. 
After all, speculative lending such as for commercial real estate 
development or for highly leveraged financial re-organizations 
are risky in large part because of possible changes in such things 
as the inflation rate, interest rate, trade flows, and tax rates-the 
very things that can undergo substantial and unpredictable 
change when the federal budget is dramatically out of balance. 
The 1980s may best be understood, then, as a decade in which the 
, policy-induced externalization of risk gave rise to a substantial 
but ultimately unsustainable economic boom. 

The Bust 

Potential debt monetization can keep Treasury bills risk free for 
the indefinite future; the reimbursement of depositors of failed 
banks can continue so long as the FDIC can be recapitalized out 
of general tax revenues. But the banking industry cannot be 
shielded from the consequences of excessive risk-taking forever. 
For almost a decade the banking industry and the speculative 
activities it supported were able to keep the economic expansion 
going. Although risk aversion normally characterizes sound 
banking, high-flying banks in the 1980s were able to indulge in 
risky lending despite the preferences of their depositors and to 
escape both market-imposed or government-imposed discipline 
until the cumulative effects of externalizing risk turned the 
undue risk-taking into a financial crisis. The Federal Reserve's 
routine functioning as lender of last resort, the FDIC's de facto 
policy of forbearance in cases of problem banks, and the implicit 
acceptance of the doctrine of "too big to fail," all help to account 
for the length of the artificial boom. But neither increased last- 
resort lending and forbearing nor more overt inflationary finance, 
such as was pursued in the 1920s, could keep the boom going 
indefinitely. As with the artificial boom in the interwar period, an 
eventual bust was inevitable. 
Like the time-consuming production processes that were 
out of line with time preferences, speculative loan portfolios 
that were out of line with risk preferences generated an artifi- 
cial boom in the 1980s that belonged to the same general class 
as that of the 1920s. However, the distinction between eco- 
nomic activities that are excessively future-oriented and eco- 
nomic activities that are excessively speculative-together with 
some institutional considerations-allows us to see systematic 
differences between the 1930s and the 1990s. 
First, the downturn at the end of the Bullish Eighties came 
in the form of a bank-led bust. A high rate of bank failures was 
experienced well before the general economic contraction. At the 
end of the Roaring Twenties, by contrast, the bank failures came 
after the economic contraction had begun. This difference in the 
timing of events is consistent with differences in the nature of 
the two expansions. Industrial borrowers in the 1920s were 
using newly created funds for excessively capital-intensive 
ventures that, in general, were not otherwise excessively 
speculative. It is true, of course, that there was heavy specula- 
tion in securities markets in the 1920s-much more so then than 
in the 1980s-but the cause-and-effect relationship in the recent 
episode was the reverse of that in the earlier one. That is, in the 
19209, monetary expansion, which allowed banks to support 
heavy industry, also fueled speculation in securities markets. 
However, because the risks of that speculation were born, in the 
first instance, by the buyers of the securities, there was no 
policy-induced externalization of risk to weaken banks even as 
the expansion continued. In the 1980s, policy-induced specula- 
tion, on the part of the banks themselves and their industrial 
borrowers, eroded bank capital, weakening the banks throughout 
the boom-so much so that the erosion of their capital base 
eventually turned boom into bust. 
Second, while the idleness of plant, equipment, labor, and 
other resources that characterized the 1930s has its counterpart 
in the semi-idleness in the 1990s, the disposition of unprofitable 
assets is different now, largely because the recent bust was 
bank-led. During the Great Depression, firms whose revenues did 
not cover operating costs simply closed their doors. Work on 
incomplete industrial projects whose present value had turned 
negative was simply discontinued. Although this form of market 
discipline was sometimes delayed by policies aimed at rekindling 
the boom, eventually resource idleness characterized those sec- 
tors of the economy that were most out of line with underlying 
economic realities, and liquidation could proceed apace. In the 
current slowdown, many failing firms are first identified as non- 
performing loans in the portfolios of failed banks. As insolvent 
banks are closed by the FDIC, the bad loans are transferred to 
the Resolution Trust Corporation (RTC), which functions as a 
caretaker until it can sell the assets. In many cases, the physi- 
cal assets, such as franchised motels or restaurants, are not 
idled. Instead, the RTC contracts with an operating company 
to run the business. The contract allows the operating company 
to earn a profit while minimizing the cost to the RTC of main- 
taining the assets. 
The existence of many such failed-but-still-operating busi- 
nesses, including firms undergoing bankruptcy proceedings but 
still operating with the newly evolved debtor-in-possession (DIP) 
financing, helps to explain why the current recession is a rela- 
tively shallow one by conventional measures. What otherwise 
would be idle capital is partially masked by RTC policy as under- 
employed capital-analogous to the underemployed labor associ- 
ated with 1930s-style make-work projects. "Zombie banks," banks 
that are allowed to continue operations after their net worth has 
turned negative, have their counterpart in RTC-owned or DIP-fi- 
nanced "zombie firms."" While the underemployed capital in zombie firms limited the 
depth of the recession, it added to the length. Recovery consists 
of re-employing resources idled by the bust. As confirmed by 
loon the role of government in adding to the severity of the Great Depression 
and,delaying recovery, see Gene Smiley, "Can Keynesianism Explain the 1930s?: 
Reply to Cowen," Critical Review 5, no. 1(Winter 1991): 81-114 and Richard K. 
Vedder and Lowell E. Gallaway, Out of Work (New York: Holmes and Meier, 1993), 
pp. 74-149. 'The term "zombie S&Lsn was coined by Edward J. Kane in the context of the 
savings-and-loan crisis, which was a precursor to the crisis in the banking industry 
and subsequent recession. See Edward J.Kane, "Dangers of Capital Forbearance: 
The Case of the FSLIC and the 'Zombie' S&Ls," Contemporary Policy Issues 5, no. 
1 (January 1987): 77-83. For a healthy perspective on RTC policy and DIP 
financing, see Stephen Delos Wilson, The Bankruptcy of America (Germantown, 
Tenn.: Ridge Mills Press, 19921, pp. 81-96 andpassim. 
experience in the early 1990s, it would have been easier to draw 
resources out of idleness than to draw them away from the RTC. 
Asset managers of the RTC, trying to avoid spoiling markets 
that dumping real assets at fire-sale price would entail, stock- 
piled them instead, creating a huge "overhang" which added 
significantly to the uncertainties in the private sector. Also, 
solvent firms and would-be upstarts, who would have to raise 
their own capital to expand or enter the market, are not eager to 
compete with bankrupt firms or with privately operated but 
RTC-owned businesses whose revenues do not have to cover the 
costs of capital. Considerations of these sorts help to explain why 
the government's recent recourse to monetary stimulation in the 
form of exceedingly low discount rates has met with such little 
success. 
Third, the unemployment currently being experienced has a 
distinctly different composition from that of the 1930s. It is 
widely reported that white-collar workers are disproportionately 
affected in the current recession as compared to earlier cyclical 
downturns. The time-preferencelrisk-preference frame of analy- 
sis makes this composition difference readily understandable. 
The boom in the 1920s involved resources allocated dispropor- 
tionately to capital-intensive projects, such as steel mills and 
manufacturing plants. The labor complement to heavy industry 
tends to be predominantly blue-collar. The boom in the 1980s 
involved resources allocated to speculative development, such as 
commercial real estate and financial services. The labor comple- 
ment to this kind of capital tends to be predominantly white-col- 
lar. In both episodes, the composition of unemployment matches 
the pattern of capital misallocation. 
Finally, macroeconomic policy after the bust reveals a critical 
difference between the current situation and that of the 1930s. 
When further monetary expansion, which sustained the boom of 
the 1920s for nearly a decade, could sustain it no longer, both the 
monetary expansion and the boom came to an end. The public's 
increased demand for currency relative to checking-account 
money, coupled with the increased reluctance on the part of 
commercial banks to lend, swamped the Federal Reserve's efforts 
to re-inflate.12 Despite the further padding of the monetary base, 
the dynamic of the bust itself was an effective check against 
continued monetary expansion. By contrast, when further deficit 
spending and risk externalization, which sustained the boom of 
''see Smiley, "Can Keynesianism Explain the 1930s?" p. 88. 
the 1980s, could sustain it no longer, the boom ended, but the 
deficit spending and risk externalization escalated. In fact, de- 
creased tax revenues and increased payments of entitlements, 
both associated with recession, led to still more government 
borrowing. The dynamic of the bust, then, provided increased 
scope for the very kind of irresponsible fiscal policy that made the 
bust inevitable.

How Little "We" Know

The failure at the dawn of the last decade to extend deregulation 
to the provision of deposit insurance and the absence of any 
market check against the Treasury's fiscal excesses provide dra- 
matic illustration of the general fallacy of the mixed economy. 
Privatized profit seeking coupled with socialized risk bearing 
undergirded both the bull market of the 1980s and the harsher 
economic realities of the 1990s. The risks assumed by lenders and 
borrowers, savers and investors, hedgers and leveragers are ren- 
dered inconsistent with the actual risk preferences of wealth 
holders in the marketplace by the FDIC subsidy to risk bearing 
and by the Fed-backed Treasury, whose power to issue risk-free 
debt imposes risks on the private sector. 
Researchers at the Federal Reserve are just two steps away 
from recognizing the problem of deficit-induced uncertainties 
as evidenced by a recent article entitled "How Little We Know 
About Deficit Policy ~ffects."'~ Macroeconomic data as illumi- 
nated by several sophisticated modeling and econometric tech- 
niques have led two economists at the Minneapolis Federal Re- 
serve Bank to conclude with confidence that "Deficit policies may 
matter, and then again they may not. Existing studies really don't 
tell us much about their effects."14 The first step from this 
disturbingly limp conclusion to a healthy understanding of the 
deficit problem is to recognize that the "We" in the title of the 
article, intended to mean "We Economists," can be extended to 
mean "We Lenders-Borrowers-Savers-Investors-Hedgers-Lever- 
agers" or simply "We Market Participants." Market participants 
do not know how deficit accommodation will affect future market 
conditions, so they have to make guesses. And if they guess 
131'reston J. Miller and William Roberds, "How Little We Know About Deficit 
Policy Effects," The Federal Reserve Bank of Minneapolis Quarterly Review 16, no. 1 
(Winter 1992): 1-12. 141bid.,p. 8'''  wrong, they may lose big. The second step is to recognize that the "We" may also refer to the holders of Treasury securities. Accord- 
ingly, the title phrase should be amended to read "How Little We 
Know or Care about Deficit Policy Effects." The potential for debt 
monetization, as manifested by the Federal Reserve in its stand- 
by capacity, has absolved the Treasury's creditors of any inclina- 
tion to care. Externalizing risk has precluded any possibility that 
the reluctance of creditors will provide an effective check against 
the excesses of the Treasury. The tripling of federal government indebtedness since the 
beginning of the 1980s' bull market stands as testimony to the 
capacity of the Treasury to issue its artificially risk-free debt. The 
banking legislation of 1980 has shown us its capacity for blinding 
the banking industry and the private sector to the black cloud of 
debt gathering above it. Together, the actions of the fiscal and 
monetary authorities have demonstrated once again how public 
institutions ostensibly devoted to stability and prosperity are, in 
the end, responsible for crises and decay. 

The Federal Reserve-Then & Now (1)

The Federal Reserve: 
Then and Now 
Roger W. Garrison
Roger W. Garrison is associate professor of economics at Auburn University. 
He wishes to thank James Barth, Jeffrey Friedman, and Sven Thommesen for 
their helpful comments on an earlier version of this paper. 
The Review ofAustrian Economics Vo1.8, No. 1(1994): 3-19 
ISSN 0889-3047

A good friend of mine has two sons who, in their youth, were unusually mischievous. On one occasion, when my friend had just replenished his liquor supply in preparation for a cocktail party that evening, his sons decided that a liquor cabinet was a pretty good substitute for a chemistry set. They broke the seals and poured from one bottle directly into the next: scotch into rum; rum into gin; gin into scotch. And they added a little creme de menthe all around. When their father discovered the deed (not in time to save the evening guests from some innovative cocktails), he issued punishment in the form of reduced allowances and increased yard duties. The two boys accepted the punishment gracefully and promised never to do that again. 'You know," my friend told me, "I believe them. They'll never do that again. The next time, it'll be something else." 
And so it is with the Federal Reserve. Mischievous by its very nature, it rarely does the very same thing twice. Fed-watchers, always looking for a precise pattern in monetary aggregates, hoping to get an exact fix on the Federal Reserve's modus operundi, are almost sure to be disappointed. The enduring capacity of the Federal Reserve to exert a powerful influence on the course of economic events derives importantly from its adaptability. New trends in fiscal policy and modifications in the regulatory environment can change the nature and significance of Federal Reserve actions in ways that are difficult to perceive until after the fact. 
In recent years, difficulties in perceiving just how the Federal Reserve is affecting the course of the economy have translated into doubts that the Federal Reserve has a significant effect-doubts even that money has much to do with the cyclical variation of employment and output. So-called real theories of the business cycle account for each departure from trend-line growth in terms of some real shock to the economy-which typically means a change in technology or in resource availability.' In turn, the focus on macroeconomically significant real shocks, which are relatively few and far between in comparison to monetary shocks, has caused many modern macroeconomists to believe that business cycles themselves are far less troubling than was once thought. To similar effect, the increasing reliance on an analytical framework that' reduces all macroeconomic phenomena to considerations of aggregate demand and aggregate supply has led textbook writers to emphasize the temporariness of cyclical variation rather than the pervasive discoordination and painful recovery that characterize boom and Such treatments of cyclical variations and of the relationship between monetary and fiscal policy are fundamentally flawed. 
While important changes in the fiscal and institutional environment underlie the comparison between the Federal Reserve then (1920s-1930s) and the Federal Reserve now (1980s- 
1990s), the Federal Reserve's power to create money must figure importantly in the accounts of both periods. Understanding just how, though, requires an analysis that makes use of a level of aggregation much lower than that of conventional macroeconomics.  Rather than causing the economy harm, minor changes in the economy's output are understood to be a consequence of an efficient market coping with minor (macroeconomically speaking) changes in underlying realities. (In this context, the Great Depression is seen as something of an 'outliern not well accounted for by this or any other theory of the business cycle.)  

From Textbook Macroeconomics to Macroeconomic Realities

Macroeconomic policy is conventionally divided into two categories: monetary policy, which is formulated and implemented by the Federal Reserve, and fiscal policy, which is the net effect of the many spending and taxing decisions made by Congress. Macroeconomic textbooks typically introduce monetary and fiscal policies in separate chapters and then deal with the interplay between the two by constructing multi-quadrant graphs in 
which the money supply, government spending, and the level of taxation, each represented in separate quadrants, have a combined economywide effect on the rate of interest and the level of income. 
There is a certain logic to this policy decomposition. Inflating, spending, and taxing in the conventional macroeconomic frame-work have their own separate short-run effects on the interest rate and income level: expansionary monetary policy causes incomes to rise and interest rates to fall; expansionary fiscal policy (increased government spending or decreased taxation) causes both incomes and interest rates to rise. The effect of coordinated monetary and fiscal policy is simply the sum of the individual effects. Economic expansion driven by both the Federal Reserve and the federal budget, for instance, has a double-barreled effect on the level of income while leaving the rate of interest unchanged.
Yet the relevance of such textbook treatments of policy hinges on several critical assumptions. By expanding the money supply, policymakers intend to affect output and employment rather than prices and wages. Any hopes for these intended real effects-as opposed to purely nominal effects-must be based on the assumption that prices and wages are somehow stuck above their market-clearing levels at the outset of the expansion and that the new money lent at lower interest rates is used only to mobilize other- wise idle resources. If, instead, pre-expansion prices and wages are fully adjusted to their market-clearing levels, then the effects of monetary expansion are only temporary. In the long run, real incomes return to their pre-expansion levels as prices and wages adjust upward; real interest rates return to their pre-expansion levels as rising prices and wages build an inflationary premium into the structure of nominal interest rates. Similarly, expansionary fiscal policy, which increases real rates of interest, has only a temporary effect on incomes under conditions of flexible prices and wages. These assumptions and qualifications are acknowledged-though sometimes cryptically-in most modern macroeconomic textbooks. 
But these treatments employ an exceedingly high level of aggregation, whereby "income" summarily measures both the total output produced in exchange for that income and the spending power capable of buying that output. This aggregation causes the phrase "temporary effects of fiscal and monetary policy" to seem innocuous or benign, seriously understating the actual effects of policy. The conventional wisdom is that policy in the 
form of such "stimulus packages" may temporarily push the activities of producing, earning, and spending beyond levels that can be sustained. At worst, the dynamics of policy-induced 
changes in macroeconomic magnitudes give scope for political chicanery as incumbent administrations resort to fiscal and monetary stimulants just prior to election.
According to an increasingly common view, cyclical movements in income and output-whether attributable to policy actions or to real factors-are considered harmful only in that the timing of consumption is slightly less than optimal. This assessment allows for a quantitative estimate of the welfare loss due to temporal suboptimality of approximately one tenth of one percent of total consumption-which translates into about $8.50 per 
person per year. Disaggregating the economy's investment sector into policy-relevant patterns of investment, however, reveals that the temporary effects are not so benign. The scope for harm caused by monetary and fiscal stimulants can instead be seen in 
terms of unsustainable changes in the pattern of investment. Even if the spending power of income earners equals total output in aggregate terms, a systematic, policy-induced mismatch between decisions in the investment sector and the underlying preferences of consumers and wealth holders can lead to severe economic downturns and painful recoveries. 
By carefully identifying the relevant aspects of investment patterns in different cyclical episodes, we can identify both theme and variation in the story of boom and bust. We can find both similarities and differences, for instance, in comparing the experience of the 1920s and 1930s with that of the 1980s and 1990s. Further, we can show that the prolonged succession of policy-induced "temporary" effects, which has fundamentally changed the relationship between fiscal and monetary policy, has had permanent effects on the health of the economy. 

Variation on a Theme 

How strong are the parallels between the boom of the 1920s and 
the boom of the 1980s? How similar are the economic circum- 
stances of the early 1990s to those of the early 1930s? 
It may be tempting to try to account for our current 
macroeconomic plight by retelling the story of the interwar 
experience, changing only the dates and a few minor details. But 
the story doesn't fit that well. Credit conditions as judged by real 
rates of interest were relatively tight during the 1980s in com- 
parison to credit conditions during the 1920s. And although the 
overall monetary expansion was actually greater in the more 
recent episode, the patterns of monetary growth in the two 
periods differs importantly. In the 1920s, the money growth 
rate peaked near the end of the decade as the Federal Reserve 
attempted with increasing resolve to keep the boom going; in the 
1980s, the peak growth rate of M1 came at mid-decade, after 
which monetary growth fell to low single digits while the bull 
market continued. Adjusting the story by replacing the conven- 
tional money or credit aggregates with more narrow ones, such as 
the monetary base, or with broader ones, such as the Divisia index, 
does little to improve the fit. And given the intense Fed-watching in 
recent decades, it would in fact be surprising to learn that the 
Federal Reserve had nonetheless ignited and sustained an arti- 
ficial boom for several years by simply repeating its misdeeds 
of the 1920s. There is, after all, a kernel of truth in the notion 
of "rational expectations"-as recognized by Ludwig von Mises 
years before that term achieved currency in macroeconomic 
thought. 
Parallels can be found not in the strict sense of a replay but 
in the broader sense of variation on a thenie. The story requires 
a recasting of the characters and some major changes in the plot. 
The Federal Reserve no longer plays the lead; it plays instead an 
indispensable supporting role. Banking legislation and fiscal 
policy are more central to the storyline. In accounts of both 
periods,. however, we can say that unprecedented conditions al- 
lowed an artificial boom to go unchecked for a significant period 
of time. Unprecedented in the 1920s was a strong central bank 
bent on stimulating growth in a peacetime economy. Unprece- 
dented in the 1980s was a banking industry operating in a 
dramatically altered regulatory environment and a federal gov- 
ernment running deficits measured in the hundreds of billions. 
Interest rates in the recent episode play an important role not 
so much because of considerations of time discount but because 
of considerations of risk. During the 1920s, the low time discount 
signaled by artificially depressed interest rates did not accurately 
reflect people's. actual willingness to save; during the 1980s, the 
low risk premiums built into interest rates did not accurately 
reflect people's actual willingness to accept the risks of increas- 
ingly speculative investments-much less the additional risks 
attributable to the government's irresponsible fiscal policy. The 
boom of the 1980s was no less artificial, however, than the one in 
the 1920s. To see why, we shall have to shift our focus from the 
easy money provided by the Federal Reserve in the 1920s to the 
risk-free securities provided by the Treasury in the 1980s. But 
first let us highlight aspects of the 1920s that have identifiable 
counterparts in the 1980s. 
The Federal Reserve played a leading role in the dramatic 
boom of the 1920s (and the bust of the 1930s). Artificially cheap 
credit provided by the Federal Reserve underlay the economic 
expansion that lasted through mid-1929. This credit expansion, 
in- an economic environment largely devoid of Fed-watchers, 
drove a wedge between saving and investment. Guided by low 
rates .of interest, investment outstripped saving in aggregate 
terms, and-more importantly-investment projects were exces- 
sively long-term. As the boom proceeded, low interest rates lured 
capital into relatively time-consuming production processes. 
That is, the timing of the output of these production processes 
was skewed toward the future in comparison to the intertemporal 
pattern of demand for output. While the intertemporal distortion 
of output is the essence of so-called real business cycle theory, it 
is only a symptom, in the view presented here, of a pervasive 
distortion in the economy's capital structure. The economywide 
inconsistencies-attributable to Federal Reserve policy-be- 
tween investment decisions of the business community and the 
time preferences of consumers made the bust inevitable. The 
recovery, hampered by policies aimed at re-igniting the boom, 
consisted of extensive capital liquidation and a general intertem- 
poral restructuring of capital. 
Modern textbook treatments of the recent economic boom in 
comparison to the interwar boom hinge on a sharp distinction 
between monetary and fiscal policy. The earlier boom was driven 
by monetary policy; the later one by fiscal policy. It is true that 
the 1920s were characterized by (relatively) tight fiscal policy and 
loose monetary policy as each is conventionally measured, and 
that the 1980s saw a reversal in the relative strengths of the two 
policy alternatives. But the strict dichotomization between fiscal 
and monetary policy is badly overdrawn. In the 1980s, the signifi- 
cance of fiscal policy lay not in its augmentation of aggregate 
demand but in the private-sector risks and uncertainties that 
were attributable to chronic and dramatic federal budget deficits. 
This shift in focus directs attention to the Federal Reserve's 
critical supporting role throughout the decade and to the banking 
legislation at its beginning. 
While irresponsible fiscal policy created additional risks and 
uncertainties to be born by the private sector, the Federal Reserve 
in its capacity to monetize Treasury debt kept the risk premium 
off Treasury securities. Further, while extensive changes in the 
regulatory environment faced by the banking industry led banks 
to take on increasingly riskier portfolios, the Federal Reserve in 
its capacity of lender of last resort-together with policies of the 
Federal Deposit Insurance Corporation (FDIC)-kept the risk 
premium off bank securities and minimized the worries of the 
banks' depositors. Although the story of the 1980s is institution- 
ally complex, the general nature of the problems in the private 
sector is relatively simple. The regulatory and policy environ- 
ment led the business community to take on risks that were 
systematically out of line with the risk preferences of private 
wealth holders. This systematic discrepancy between risks un- 
dertaken and risk preferences, which provides the thematic 
link to the interwar episode, justifies the claim that the 1980s 
boom was artificial and that the bust was inevitable. 

Deficit-Induced Uncertainties 

It is not difficult to demonstrate that chronic and dramatic 
federal budget deficits create uncertainties in the private sec- 
tor.' A numerical example can serve to illustrate. Suppose the 
government's anticipated rate of spending over the next several 
years is a trillion dollars per year and that it anticipates collect- 
ing $800 billion per year in tax revenues. The difference, the 
anticipated annual deficit, of $200 billion represents yet-to-be- 
funded government spending. The business community understands that the government 
will appropriate a trillion dollars worth of resources each year. 
Tax codes stipulate the particular targets of eighty percent of 
the government's appropriation activities. Production plans 
can be made in the light of these codified taxing procedures. But 
there can be no plans that effectively take into account the other 
twenty percent, the anticipated deficit. In effect, the government is 
putting the private sector: "We are planning on appropriating 
another $200 billion worth of resources, but we are not saying 
just how, just when, and just whose." 
The government may continue issuing new Treasury bills 
while holding the line on the money supply. This would mean 
continued strains on credit markets, real rates of interest higher 
than they otherwise would be, and continued trade deficits as the 
Treasury sells those bills both at home and abroad. Alternatively, 
the government may rely more heavily on money creation. The 
Federal Reserve may begin buying Treasury bills at an acceler- 
ated rate. This process of debt monetization would take the 
pressure off credit markets and strengthen export markets. It 
would reduce the real rate of interest (temporarily) but would build 
an inflation premium into the entire structure of interest rates. As 
still another alternative, the government may institute new taxes 
of some kind or raise tax rates in some yet-to-be-specified way. In 
the meantime, a $200-billion cloud of "intent to appropriate in 
some unspecified way" looms large over the private sector. 
There is no effective hedge against uncertainty of this kind. 
There are no probabilistic answers to the question ofjust how the 
government will appropriate the additional resources. Should 
long-term capital be shifted out of export industries because of 
the currently high foreign-trade deficit and correspondingly weak 
export markets? Or should it be kept in place by anticipations of--or 
hopes for-a change in fiscal strategy? Should long-term financial 
commitments be based on the current credit conditions or on the 
contingency of some unknown likelihood that the Treasury will 
borrow more heavily in domestic as opposed to foreign credit mar- 
kets? Should land, durable assets, and even inventories be bought 
or sold at prices that reflect current inflation rate? Or should 
such transactions reflect accelerating inflation based upon some 
guess about the extent and timing of debt monetization? 
Although the government's borrowing at irresponsibly high 
levels adds to the riskiness of private-sector activities, none of these 
risks are born by the holders of Treasury securities. This discrep- 
ancy between risk created and risk assumed can be directly attrib- 
uted to the Federal Reserve in its capacity to monetize Treasury 
debt. Overextended borrowers in the private sector must pay a 
substantial default-risk premium in order to continue borrow- 
ing. Even overextended municipalities pay a default-risk pre- 
mium as their bonds are downgraded by bond-rating agencies. 
The power to tax alone is not enough to protect municipal bond- 
holders against default. But the interest rate paid by the federal 
treasury contains no default-risk premium at all. The. Federal 
Reserve stands ready to monetize the Treasury's debt in circum- 
stances that otherwise would require an outright default. It is true, 
of course, that actual monetization imposes costs in the form of 
price distortions and a general price inflation, but these costs are 
imposed on the economy in general-not just the holders of Treas- 
ury securities. Since a "monetization risk," unlike a default risk, is 
born by holders and non-holders alike, there is no monetization- 
risk premium-separate from the economywide inflation pre- 
mium-built into the nominal yield on Treasury securities. The very 
potential for debt monetization is what breaks the link between 
fiscal irresponsibility and some corresponding risk premium. 
The Federal Reserve, then, plays a critical supporting role in 
the pursuance of fiscal policy. Relieving the holders of Treasury 
securities of any risk burden increases the attractiveness of those 
securities and thus eliminates what would otherwise be a binding 
market constraint on further Treasury issues. The increasing 
significance of potential debt monetization suggests that the 
magnitude of the Federal Reserve's influence is not to be detected 
in actual movements of monetary aggregates. The mere fact that 
the Federal Reserve stands ready to monetize debt gives the 
Treasury a much longer leash than it would otherwise have. 

Ron Paul- NEW currency policy


Sound Money

853 Responses
Henry Ford once said, “It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
Are you confused by all the talk about monetary policyfiat money and inflation? You’re not alone. Bankers and politicians have worked hand in hand for many decades to obscure their activities from the public. They hide behind elaborate structures designed to inflate the money supply while creating the false impression that they are looking out for our best interests.
Inflation is a very simple concept to understand: More money = less value. It may seem contradictory but it’s very straightforward.
For illustration purposes, join me on a brief journey of the imagination. One beautiful morning, you wake up and realize that you own twice as much cash as you had just last night. Magic money elves entered your home and bank account and simply doubled your entire cash assets. You’re now twice as wealthy (or half as poor as the case may be).
But you soon realize that the same thing happened to everyone else in the country. Themoney supply (total amount of money) has doubled! It’s just a one-time event and your regular income remains the same… you just got lucky this one time. It’s okay to dream, so stay with me.
What happens next? If you’re like most people, you probably start spending. You buy things you always wanted to buy but couldn’t afford. You pay back some debts. You buy stocks. In other words, you put the new money into circulation. So do most other people in the country.
Demand for many products increases because a lot more people can afford them now. Consumers are buying so much stuff that some shortages occur. To protect themselves against these shortages, shops and businesses decide to increase their prices. They know that once prices go up, fewer people will be competing to buy the same products, and the situation will be back to normal.
As a side effect of these higher prices, shop owners start earning higher profits than usual. They have more money in their bank accounts, which allows them to increase their spending. They will invest in new stock or expand their business. They might pay out dividends to their investors and bonuses to their employees, allowing these people to buy more products as well. This additional demand puts even more pressure on other shops to increase their prices.
A few months later, prices of almost everything have gone up. Suppliers and manufacturers are faced with the same threat of too much sudden demand from their clients so they too decide to start charging more.
You went on a one-time buying spree and look what happened! Your income stayed the same, but after a few weeks you can suddenly no longer afford the products you used to buy all the time because all prices in the economy have gone up.
Naturally, you demand a higher salary from your employer. If you’re self-employed or in business, you have to charge your customers more money just so that you can maintain your standard of living. Everyone else is in the same situation. Higher prices keep spreading throughout the entire economy, and it’s getting more and more difficult to make a living.
Can you see how this lucky one-time incident which at first seemed so exciting was extremely harmful not just for you but for the entire country? You briefly had a good time but now you’re worse off than before. In our story there are now twice as many dollars in circulation, but your income remains the same and each dollar you earn is worth only about half as much as it used to be. You’re really hoping for those money elves to come back.
As a matter of fact, some people, companies and banks have managed to develop an inside connection to the “money elves”, allowing them to receive new money into their bank accounts whenever they want to. The money is officially a loan (credit), but they know they never have to pay it back… they just “roll it over”, i.e. take up even more debt. With all that easy money in their accounts, and after hearing on TV that stocks only go up and that real estate prices will continue to rise forever, they tend to get a bit lightheaded and start making bad investment decisions. They know that if anything happens to their investments they will be bailed out by the government, so they do not hesitate to take huge risks with their new found “wealth”.
Let’s stop dreaming and look at the reality of things. What if I told you that these “money elves” do exist and that they spring into action not just once in a lifetime, but every couple of weeks? And that they repeatedly give money to their closest friends, but not to you? That prices are going up because the total amount of money in circulation increases, but that you’re missing out on all the fun?
Well, that’s inflation at work. Who benefits from inflation? Only those who are at the top of the pyramid and receive all that new money directly from the source. As you might have guessed by now, the source is the Federal Reserve, and its recipients include the government which “borrows” a lot of new money each year, without any intention of ever paying it back. Another beneficiary these days are failed banks that are being “bailed out” for the good of the “economy”, or defense contractors that receive money to build up our military so we can have a constant presence all over the world and fight never-ending and unnecessary wars. There was even a huge number of small-time beneficiaries who received consumer loans and sub-prime mortgages they would never be able to pay back.
What, then, is fiat money? It’s exactly what we just talked about: money that can be inflated or increased at the push of a button at the say-so of a powerful person or organization. Nowadays most dollars are just blimps on a computer screen and it’s extremely easy for the Federal Reserve to create money out of thin air whenever they want to.
If our money were backed by gold and silver, people couldn’t just sit in some fancy building and push a button to create new money. They would have to engage in honest trade with another party that already has some gold in their possession. Alternatively, they would have to risk their lives and assets to find a suitable spot to build a goldmine, then get dirty and sweaty and actually dig up the gold. Not something I can imagine our “money elves” at the Fed getting down to whenever they feel like playing God with the economy.
As you can see, inflation and fiat money are very seductive and beneficial to those at the top, and very dangerous to everyone else and the nation as a whole. That’s exactly what Henry Ford was talking about. He knew that every country that relies too much on fiat money is ruined sooner rather than later.
There is only one possible solution to the inflation problem: Stop creating money out of thin air. But we’re already in such a mess that the only way to have a real impact on the money supply is to increase interest rates so that people pay back their loans and borrow less money from the banks, which decreases the amount of money in circulation. However, higher interest rates might very well crash the economy. So the Fed’s current “solution” to overcoming inflation is… creating even more of it.
Fiat money is a dangerous addiction. Even if the Fed found a way to stop inflation, as long as the current system persists the temptation will always be there to resume pushing the easy money button. That’s why we need to get back on the gold standard and eliminate the Federal Reserve altogether.
But that won’t happen “before tomorrow morning”, as Henry Ford said, or even this year. Ron Paul believes that the first step towards monetary freedom is to allow open competition in currencies. Once gold and silver are allowed as legal tender and can be sold without sales tax, everyone can use them to store their wealth and to pay for the things they want to buy. The Federal Reserve will finally have a very compelling motivation to stay honest and maintain the value of the dollar because if they don’t, they will simply lose all their customers.
Ron Paul has been an advocate of the gold standard and open competition in currencies for many years. He is the Federal Reserve’s most outspoken opponent in Congress and has frequently questioned Alan Greenspan and Ben Bernanke about the Fed’s actions.
Join the Ron Paul Revolution and help us put the Fed where it belongs: into the history books and out of our financial lives.

More Information

Thomas Jefferson and Andrew Jackson understood “The Monster”. But to most Americans today, the Federal Reserve is just a name on the dollar bill. They have no idea of what the central bank does to the economy, or to their own economic lives; of how and why it was founded and operates; or of the sound money and banking that could end the statism, inflation, and business cycles that the Fed generates.