What Kind Of Dollar Do They Want?

Benjamin Cole ends his most recent blog post saying "To get to higher interest rates and inflation, we may have to endure years and years of prosperity. And even that may not work. I think we should try anyway." This is a terrific bit of writing, and will inflame those whom he calls the "righty-tighties".

I did, however, take slight issue with his first two comments, namely (a) that tight money is sacred to the right, and (b) that the right always finds monetary policy too loose. That is (deliberately, I'm sure) exaggerated, and thus unfair to the right. The likes of David Beckworth and Ramesh Ponnuru have published numerous times in the National Review in favour of easier monetary policy, as has Jim Pethokoukis at the AEI. Still, Benjamin's jibe raises a valid question: What kind of dollar does that faction of the right want?

"Sound money" is often advocated by Internet Austrians, but is a sufficiently imprecise concept as to be unhelpful. In theory, there should be plenty of middle ground between those who desire "sound money" and flexible inflation targeters. However, some common objections to FIT are (1) the Fed's dual mandate is wrong, and should focus solely on inflation; (2) "sound money" demands no inflation (and hence no loss of purchasing power), not the unforgivable 2% inflation that most central banks target, (3) the Fed uses incorrect (and possibly doctored) inflation statistics to hide its inflationary bias, revealed by ShadowStats and other sources, and (4) the only way to ensure sound money is to rid the world of fiat currency.

While I won't go through the counter-arguments to these (incorrect, in my opinion) points, it's worth noting that this is an age-old debate. This 1896 paper from Fred M. Taylor, for example, evaluates the merits of an "elastic currency" - language that made it into the Federal Reserve Act of 1913 - defined loosely as "a currency the amount of which varies in accord with the needs of industry." While the terminology is archaic, it is the precursor to the Fed's dual mandate. Taylor seems to conflate the concepts of money and credit in the paper, but he properly distinguishes between ordinary and emergency elasticity, writing "By the former, I mean that elasticity which adapts the amount of the currency to the varying needs of trade within the limits of a single ordinary year. By "emergency elasticity", on the other hand, I mean the capacity of the currency to adjust itself to those fluctuations in the need for money which characterize a panic." The concept of "emergency elasticity" is one that "sound money" types seem to ignore. Taylor notes that at the time of writing, victory belonged to "the advocates of a safe rather an an elastic currency." While the supporters of elasticity are mainstream today, "sound money" proponents seem to yearn for a return to "safety". The costs of this safety, however, surely deserve attention.

Equally worth of criticism is the "Strong Dollar" demanded by other righty-tighties. Many "Strong Dollar" types seem to be business people who pride themselves on their practical leanings and material success, and decry the Fed's intervention in the free clearing of a market (unless dollar strength limits their ability to export - there sometimes seem to be fewer true libertarians in business than there are atheists in foxholes!). Alas, these practical types do not seem to realize that they would scoff heartily at fellow producers who decided that their sole goal in business should be a "strong price". Yes, business people seek the strongest price possible, but within the limits of competition. What they truly aim for is the strongest price that customers will bear, and which results in the highest total profit (broadly speaking). To seek a strong price ignoring customers' willingness to pay would be madness. Furthermore, when demand is high for their goods, these producers often increase supply, but criticise the Fed for pursuing a similar course of action (as the Fed should rightly do, when furnishing emergency elasticity, for exampe).

No doubt we'll be hearing more from the righty-tighties as the pressure mounts on the FOMC to raise rates. It's even possible that at some point they'll be right. But the rest of us should remind them they've been consistently wrong for the past 7 years. While "sound money" and "strong dollar" policies sound inoffensive at first blush, the faulty thinking underlying them cannot be allowed to infect central banks, who may face pressure from politicians looking to score points. We've seen how that's played out in Europe, and to allow such thinking to fester anywhere else is an invitation for trouble.