Ramesh Ponnuru, senior editor of National Review, is out with a vicious hit piece on the monetary views of Ron Paul (Apparently after studying Austrian economics for two weeks.) The attack can only be described as ignorant and absurd. Salvadore Dali would be proud. Perhaps it should not come as a surprise that Ponnuru assigned this task to himself. He has a graduate degree in history from Princeton University, which seems to specialize in monetary quackery. The economics faculty includes (or has included) such economic cranks as Paul Krugman (who most recently missed the call on the turning economy that was right in front of him) and Ben Bernanke, who as Fed chairman crashed the economy (see here, here, here, here, here, here and here) and is setting the economy up for one of the greatest price inflations in the history of the United States.
So what problems does Ponnuru find with Ron Paul monetary economics? Let us review.
Ponnuru writes:
In End the Fed, his 2009 book, Paul writes that a rotten monetary system underlies "the most vexing problems of politics." In his view, any expansion of the money supply counts as inflation, whether or not prices rise.
He ignores to mention this is the classic definition of inflation. (Webster's New World Dictionary 1957) defines inflation as follows: 2. an increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and a rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined).
Ponnuru then goes on to correctly identify other features of Ron Paul monetary economics:
Paul follows the Austrian school of economics, which holds that the expansion of the money supply (or, in some variants, the overexpansion of it) is the reason we suffer through business cycles. Loose money artificially lowers interest rates and misleads businesses about the demand for capital goods, causing them to invest in the wrong lines of production. Eventually the "false" or "illusory" prosperity of the boom gives way to a bust in which these malinvestments have to be painfully liquidated. Efforts to mitigate the pain merely prolong the necessary process. In End the Fed, Paul treats the entire period from 1982 through 2009 as "one giant financial bubble" blown up by the central bank. (At one point he dates its beginning to 1971.) Absent his preferred reforms, "we should be prepared for hyperinflation and a great deal of poverty with a depression and possibly street violence as well."
Monetary expansion is also, for Paul, a key enabler of what he takes to be our imperialist foreign policy: The creation of money out of thin air allows the government to finance wars, as well as the welfare state. Central banking is a form of central planning, on his theory, and as such "incompatible" with freedom. Paul allows that "not every supporter of the Fed is somehow a participant in a conspiracy to control the world." The rest of them, judging from comments repeatedly made in the book, have fallen for the delusion that expanding the money supply is a "magic means to generate prosperity." Paul finds it baffling that anyone could hold this absurd view, but attributes it to Chairman Bernanke, among others.
So what does Ponnuru think of Dr. Paul's economics? He writes:
Almost all of the criticisms Paul makes of central banking, when stated in the axiomatic form he prefers, are false. To put it more charitably, he assumes that the negative features that monetary expansion can have in some circumstances are its necessary properties.
Ponnuru begins his attack:
Consider, for example, a world in which the Federal Reserve conducts monetary policy so that the price level rises steadily at 2 percent a year. Savers, knowing this, will demand a higher interest rate to compensate them for the lost value of their money. If the Fed generates more inflation than they expected, as it did in the 1970s, then savers will suffer and borrowers benefit. If it undershoots expectations, as it has over the last few years, the reverse will happen. The anti-saver redistribution Paul decries is thus not a consequence of monetary expansion per se, but a consequence of an unpredictably large expansion. For the same reason, monetary expansion does not necessarily lead to less saving.
This indicates that Ponnuru has read perhaps one book on Austrian economics, but has no deep understanding. It brings to mind a Boston Bruins head coach who tells the story of taking under his wing for two weeks a cub reporter who was assigned to cover the Bruins and knew nothing about hockey. After two weeks, the reporter was writing columns criticizing the head coach's line changes.
The problem with a steady price level (if somehow that could actually be achieved over a long period of central bank manipulation) is that such a price level is the result of three components: Money supply, the demand to hold cash and productivity. Thus, if the Ponnuru desire to achieve a steady 2% price level is to be achieved during a period of high productivity, it would require huge amounts of money printing and result in massive capital-consumption structure distortions.
Ponnuru would have understood this if he had read Murray Rothbard's America's Great Depression. In AGD, Rothbard points out that prices were stable for the most part but actually falling in certain sectors through most of the 1920's, despite the fact that the Fed was printing money aggressively, because of high productivity.
One shudders to think how much more money the Fed would have had to print to achieve Ponnuru's goal of 2% annual price level increase.
Rothbard teaches that every dollar printed by the Fed, despite the price level, distorts the economy. Does Ponnuru need empirical evidence that this can occur? I direct him to the Great Depression itself.
Thus, by focusing on a fixed annual price level, Ponnuru fails to understand the key Austrian insight that ANY money printing, regardless of the price level results in distortions of the capital-consumption structure.
Here's Rothbard in AGD:
One of the reasons that most economists of the 1920s did not recognize the existence of an inflationary problem was the widespread adoption of a stable price level as the goal and criterion for monetary policy. The extent to which the Federal Reserve authorities were guided by a desire to keep the price level stable has been a matter of considerable controversy. Far less controversial is the fact that more and more economists came to consider a stable price level as the major goal of monetary policy. The fact that general prices were more or less stable during the 1920s told most economists that there was no inflationary threat, and therefore the events of the Great Depression caught them completely unaware.
Actually, bank-credit expansion creates its mischievous effects by distorting price relations and by raising and altering prices compared to what they would have been without the expansion. Statistically, therefore, we can only identify the increase in money supply, a simple fact. We cannot prove inflation by pointing to price increases. We can only approximate explanations of complex price movements by engaging in a comprehensive economic history of an era – a task which is beyond the scope of this study. Suffice it to say here that the stability of wholesale prices in the 1920s was the result of monetary inflation offset by increased productivity, which lowered costs of production and increased the supply of goods.
But this "offset" was only statistical. It did not eliminate the boom-bust cycle; it only obscured it.
In other words, after studying Austrian economics for all of two weeks, Ponnuru has no f'ing clue as to what he is talking about. Austrians understand problems are caused by money printing, even when the price level is stable, something Ponnuru doesn't even discuss.
Ponnuru goes on:
Paul's contention that the Fed has continuously abetted the expansion of the state – its wars, its welfare, its attacks on civil liberties – is also false. The federal government uses its monopoly over the currency to finance very little of its spending.
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