"I
think the Fed is making a mistake," President
Trump told the press recently. "They are so
tight."
He was
referring to the Federal Reserve's decision on September 26 to raise the
federal funds rate to a range of 2.00% to 2.25%. That move was the
sixth uptick since President Trump took office, and the market senses that the
Fed will crowbar the pinch point up again in December. President
Trump is right to be worried that all these moves will tank the economy.
But
jawboning the Fed is not enough. The president should push for
monetary reform. It's long overdue.
In the
present monetary regime, long-term interest rates are determined by market
pressures in the bond market, but the federal funds rate, the short-term
interest rate controlled by the Fed, is still government
property. It's set by the members of the Federal Open Market
Committee (FOMC), who meet behind closed doors every six weeks or so and, after
having pored over the latest economic data, and tested the political winds to
see what's expedient and what's not, vote on setting the target range for
short-terms rates.
An
alternative approach would be to get the FOMC out of the interest rate business
and let the market decide. Here's what a reform would look like
using the so-called "gold-price mechanism," which has been bandied
about for decades.
- The U.S. government defines the dollar in terms of an
ounce of gold. This is a political decision. It
doesn't belong merely to economic specialists. One way of doing
this would be to calculate a long-term moving average based, say, on the
monthly close for an ounce of gold. Thus, the ten-year moving
average would have 120 data points. Of course, using different
time frames would disclose a different long-term average price, but
whatever time frame is used, it should be lengthy enough to capture most
of the dollar-denominated contracts still in existence so as not to
penalize or reward either borrower or lender.
- If the spot price of an ounce of gold settles on a
daily basis above its long-term average price, that would be considered an
"inflationary" signal. The Fed's response would be to
drain liquidity from the system. It should sell bonds.
- If the spot price of gold settles on a daily basis
below its long-term average price, that would be considered a
"deflationary" signal. The Fed's response would be to
inject liquidity into the system. It should buy bonds.
Note
that this approach entails moving toward re-establishing fixed exchange rates
among the world's trading powers. If Countries A, B, and C all
define their national currencies in terms of a long-term average price of gold,
then their cross-rates must be fixed against each other on the grounds that
things equal to the same thing are equal to each other. National
currencies so defined would introduce a kind of stabilized global unit of
account, a public standard for measuring such things as labor costs, commodity
prices, and so forth. It is strange today that the voices raised in
favor of a globalized economy, with its emphasis on outsourcing and
supply-chaining, are silent this issue.
Let's
take an example of how a notional gold-price mechanism would
work. Presently, the ten-year monthly average of gold is about
$1,295 an ounce. Don't read any farther until you guess the answer
to the following question: under the parameters of the model described above,
and using $1,295 as the standard for defining the dollar, should the FOMC be
draining or injecting liquidity into the economy?
The
answer is, the Fed should be injecting money into the system, which is the
opposite of what it is now doing. In recent weeks, the daily closing
price for gold has been in the range between $1,194 and $1,229, well below its
ten-year average. Raising the federal funds rate in this situation
increases the cost of capital, which decreases the demand for dollars, whereas
gold is signaling that the market wants more dollars.
The
market's apparent demand for more money likely stems from the effects of the
Trump administration tax cuts. Lower tax rates, as well as a reduced
burden in business regulation, tend to increase economic activity and hence
increase the demand for dollars. The Fed should accommodate this
demand by supplying more liquidity. But ratcheting up the federal
funds rate has the effect of choking off marginal business activity, at the
time when the nation's tax policy is encouraging business
formation. Higher interest rates are compulsive on contraction,
whereas lower tax rates are permissive on expansion.
Let's
say the Fed took its hands off the handlebars and let the market decide the
level of short-term interest rates. Would they go up or
down? Who knows? That's not the point. In the
current macro-economic environment, there would be no impediment hindering
market-driven short-term interest rates from trending higher, if the market so
determined. The point is not to guess where the "just so"
interest rate is located. The key is the supply and demand for
dollars, not the absolute value of any interest rate. Even if the
market determined that short-term rates should go higher, the change would be
incremental, continuous, and transparent, as opposed to the Fed's episodic and
murky decision-making system now in place.
The
Fed needs a new policy tool. It should give up trying to manipulate
the short end of spectrum in favor of using the price of gold as a signal for
creating or extinguishing liquidity. This new paradigm is about
establishing a standard value of the dollar and keeping it there. It
would also apply to stabilizing the values of other currencies. Once
the standard of the dollar has been established, the Fed would then be called
upon to act when the standard is violated and to stand aside when the system is
in equilibrium.
A new
monetary paradigm can come into being only if there is leadership in
Washington. Monetary reform is not a grassroots
issue. What is needed is a president who has enough self-confidence
to break with the dysfunctional practices of the past and who intuitively
grasps that the interests of those who would benefit the most from a stable
dollar, the mass of ordinary citizens, are not necessarily served by the
entrenched practices of the elites who run our country's institutions.
James
Soriano is a retired federal government employee.
