National Review Goes on a Crazed Attack of Ron Paul Monetary Economics

by Robert Wenzel
Economic Policy Journal

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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.

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.

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.

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.

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.

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.

Ponnuru then goes on to pull a Keynesian attack on gold:

The doctor's prescription is as mistaken as his diagnosis. The drawbacks to a gold standard are well known. If industrial demand for gold rises anywhere in the world, the real price of gold must rise – which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.

Section III of Keynes's Chapter 2 is less than a page and a half in length, and yet it is so packed with fallacies and misstatements of fact, and these fallacies and misstatements are so crucial to Keynes's whole theory, that it requires more than a page and a half of analysis. Keynes's argument in this section rests on three major confusions:

1. The word "wages" is sometimes used in the sense of wage-rates and sometimes in the sense of wage income or total payrolls.

There is no warning to the reader as to when the meaning shifts, and Keynes himself is apparently unaware of it. This confusion runs through the General Theory, and gives birth to a host of sub-confusions and sub-fallacies.

2. "Labor" is treated in a Marxian manner as a lumped total, with a lumped interest opposed to an equally lumped interest of entrepreneurs. This kind of treatment overlooks both the frequent conflict of interest between different groups of workers and the frequent identity of interest between workers and entrepreneurs in the same industry or firm.

3. Keynes is constantly confusing the real interest of workers with their illusions regarding their interests. Take this strange sentence from page 14: "Any individual or group of individuals, who consent to a reduction of money-wages relatively to others, will suffer a relative reduction in real wages, which is a sufficient justification fort hem to resist it." To see how bad this argument is, let us try to apply it to commodities. We would then have to say, for instance, that if wheat fell in price relatively to corn, the wheat farmers would be "justified" in combining to refuse to accept the lower price. If they did so, of course, they would simply leave part of their wheat unsold on the market. The result of this would be to hurt both wheat farmers and wheat consumers .In a free, fluid, workable economy relative changes in prices are taking place every day. There are as many "gainers" as "losers" by the process. If the "losers" refused to accept the situation, and kept their prices frozen (or raised them as much as "the general level" had risen), the result would merely be to freeze the economy, restrict consumption, and lower production, particularly of the goods that otherwise have fallen relatively in price. This is precisely what happens in the labor field when the members of a single union refuse to accept a "relative" reduction of realwage-rates. By refusing to accept it they do not, in fact,improve their position. They merely bring about unemployment, particularly in their own ranks, and hurt their own interests as well as those of the entrepreneurs who employ them. Keynes remained blind to the most glaring fact in real economic life – that prices and wages never (except perhaps in a totalitarian state) change uniformly or as a unit,but always "relatively."

Ponnuru then goes beyond Keynes and tells us that "Central banking is not central planning...", but then goes in Dali like fashion to discuss a central planning role for the central bank:

Considerations such as these have led some monetary economists to favor a rule that would commit the monetary authorities to stabilizing the growth of spending.

The Fed could have corrected for this excess and then gradually reduced the growth rate of nominal spending to eliminate all long-term inflation.

Instead, starting in mid-2008, it allowed nominal spending to drop at the fastest rate since the depression within a depression of 1937–38. It even discouraged the circulation of money by paying banks interest on their reserves. The consequences of these decisions have been many and horrible. Among them are booming book sales and credibility for a congressman who does not deserve them.

I humbly suggest that Ponnuru give up economics and take up abstract painting of elephants. He could likely master that in two weeks.

Reprinted with permission from Economic Policy Journal.

February 21, 2012

©2012 Economic Policy Journal

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