“…nor am I a doctor. But here is a critique of a school of economic thought, along with an appendectomy!”
“Donny, you’re out of your element.” Fans of the cult classic film “The Big Lebowski” will recognize this line used by the neurotic Walter (John Goodman) to put the scatterbrained Donny (Steve Buscemi) in his place.
I’d like to say as much to Dana Blankenhorn, technology writer for TheStreet.com. Blankenhorn recently fired off one of the most uninformed criticisms of the gold standard to hit the blogosphere so far (I’ve seen more in-depth research on the back of breakfast cereal boxes).
In less than 700 words, Blankenhorn manages to misrepresent (or misunderstand):
- The methodology and substantive content of Austrian economics
- Ron Paul’s monetary policy prescriptions
- Basic, non-controversial tenets of monetary economics
I’ll reckon with these distortions, falsehoods, and omissions in turn:
1. Blankenhorn claims that “Austrians don’t hold with experiments or research. They know what they know through deduction. Their principles and policy prescriptions don’t change, any more than that of a Marxist may change. They just don’t accept evidence contrary to theory.” Blankenhorn is correct that the fundamental method of Austrian (or more properly, individualist-subjectivist) economics is deduction from first principles. We know a priori that people act with purpose to fulfill as many of their unlimited wishes, wants, and desires as possible. Insofar as first principles go, it is unnecessary (and impossible) to confirm such matters with experiments and research. But it is a vile misrepresentation to claim that Austrians have no use for experiments or research. A large body of applied economics by Austrian-oriented economists (again, the better term is individualist-subjectivist) consists of experiments and research (often both) into subjects such as price formation in decentralized markets, comparative institutional analysis among countries, price-theoretic research into the upper echelons of monetary theory and business cycles, etc. As for evidence contrary to theory, Austrians have been doing that all along, such as when Carl Menger reformulated value theory along marginalist lines in the face of glaring evidence that contravened erstwhile labor or cost-based theories.
Blankenhorn’s snide attacks on Austrians, Ron Paul, and the gold standard are specious right out of the gate. An honest critic could, and would, know better from just a little research. Hilariously, Blankenhorn reveals total and complete ignorance of the analytic content of Austrian economics by attempting to impugn the “steady state theories of the Austrians.” Really? Anyone with a passing understanding of Austrian economics knows that it’s the Austrians more than anyone who have gone to great lengths to critique neoclassical comparative statics models, placing much needed emphasis on concepts such as uncertainty, entrepreneurship, and the dynamism of the market economy.
2. Blankenhorn claims that Ron Paul “famously insists that money can only be backed by precious metal, preferably gold.” Blankenhorn is attempting an old rhetorical trick here of casting his opponent’s position in terms that sound about right, but are off kilter just enough to make it look looney. Nice try. If you replace the “can” in the above quoted statement with “should,” you’d be on track. But the way Blankenhorn puts it, Ron Paul does not believe that paper money can even exist (I can hear the subtext: “See, what a loon!”). Of course paper money—not defined or redeemable in gold or any commodity—can, does, and will continue to exist in the world. But does that mean it should? Here’s the gist of Ron Paul’s true stance on the issue, as I understand it: fiat money has always been the product of a government monopoly of the money supply, typically tied in to a government-privileged central bank (there’s that Austrian historical research shining through). In this setting, fiat money (i.e. un-backed paper) is extremely dangerous because it gives politicians an unchecked ability to spend money on destructive schemes like war, bailouts, and “social benefits” – all without obviously raising taxes. This sets the stage for perennial deficit spending, which ultimately wreaks economic and societal havoc in the form of a de-civilizing fiscal crisis (Greece, anyone?). It creates distortions in the structure of relative prices that are the lifeblood of economic order and progress; these distortions, in the form of artificial interest rates and price signals confused by inflation, have historically been important components of boom-bust business cycles. Finally, fiat money is morally corrupt in that it allows politicians and privileged banking elites to transfer resources to themselves and favored constituencies via the printing press.
Now, I would not expect a self-proclaimed non-economist to understand all the nuances of the Ron Paul monetary policy off hand. But 20 minutes of web-searching on the topics (via sites such as Atlas’ SoundMoneyProject.org, ahem…) would have at least clued him in that it’s about much more than just a fetish for gold. Nevertheless, Blankenhorn is either too lazy to do his homework, or willfully ignorant of the specific facts and details of the case. Either way, shame on him for perpetuating this silly nonsense about the gold standard and advocates thereof.
3. Now on to the substance of Blankenhorn’s critique of the gold standard, or “hard money,” in general. Blankenhorn notes, “I am not an economist. I cover technology, and one of the guiding principles in the field I cover is Moore’s Law.” According to Wikipedia, “Moore’s law is a rule of thumb in the history of computing hardware whereby the number of transistors that can be placed inexpensively on an integrated circuit doubles approximately every two years.” The economic result of this tremendous growth in computing power, which Blankenhorn correctly identifies, is a steady reduction in the cost of computers, and downward price pressure on computer-using devices.
For example, the 1 MHz Apple II debuted for $1,298 in 1977 (about $5,000 in today’s dollars). Modern iPads run at 1000 times processor speed, are a fraction of the size, and can be had for $500 or less. I’d label this phenomenon as “awesome technological innovation leading to amazing economic growth.” I imagine Blankenhorn would agree, but the label he chooses to apply is “deflation.” If we define “deflation” as strictly a decrease in prices of goods, so be it (note that monetary economists would typically address the supply and demand for money as well in definitions of both deflation and inflation). According to Blankenhorn, this is bad: “As we’ve seen in the last several years, deflation is much worse for an economy than inflation. Wages have a tendency to lead prices down. People lose their jobs as companies can’t make money at new prices.”
Blankenhorn is attempting to articulate the classic Keynesian argument about a slowdown of total spending in the economy possibly contributing to lower growth or even recession (for a full explanation, see here). I’ll give Blankenhorn a pass on the elementary error of claiming that wages fall before prices. Good Keynesians (heck, good economists) know that it’s wages that are sticky; deflation makes commodities and consumer goods prices fall faster and more steeply than wages, raising the relative price of labor and potentially causing unemployment. Doubtless this is the scenario Blankenhorn has in mind when he laments the technology-induced “deflation” associated with Moore’s Law; and therefore, if deflation causes recession, a stiff dose of inflation would be just the thing for economic recovery. But as a correct interpretation of the Ron Paul/ gold-standard view would admit, “hard money” is notoriously anti-inflationary. Thus the gold standard, by preventing the needed monetary medicine to offset the destructive deflation, is standing in the way of recovery, and all who support it are stone-age lunatics.
Inflation and deflation both can certainly be bad. But the blanket claim that “deflation is worse than inflation” is totally unfounded—it would be akin to a physician claiming that “anorexia is always worse than obesity.” As always in economics, context matters! This is why it’s important to interpret the precise cause of the deflation (or inflation).
“Good deflation,” as in the case of Moore’s Law, is caused by economic growth. In short, new goods are being cranked out each year at a faster pace than new money, hence prices must fall. These very conditions characterized the US economy during the late 19th century; prices fell steadily as America embraced the industrial revolution and became the world’s most productive economy. History thus shows that deflation per se is nothing to be feared. Blankenhorn likely has something else in mind, namely:
“Bad deflation,” which is associated with a reduction in the supply of money relative to money demand. This is what happened to the US in the early 1930s; 4 years of successive financial panics, and a mountain of banking regulations, tanked nearly 10,000 banks and reduced the US money supply by about 1/3. Recall from your principles of Macroeconomics course that banks generated most of the nation’s money supply; so when banks went under, much of the checking-account money they issued went “poof!” as well.
This is problematic for many reasons, one of which being that at least some of those banks had made bad investments and thus wasted capital. Moreover, the fact that commodities and consumer goods prices fell faster and more steeply than contractually fixed prices like wages and interest rates meant that much labor became un-employ-ably expensive, and that real debt burdens increased for businesses and consumers. This latter phenomenon is what people often have in mind when talking about problems of deflation. In the worst case scenario, known as “debt deflation,” progressively lower price levels imply progressively higher debt burdens which imply progressively higher default/bankruptcy rates, less total spending in the economy, progressively lower prices, etc. Hayek referred to this as a “secondary deflation.” Yes, that Hayek—the Nobel Prize winning Austrian economist! He was cognizant of the problems of deflation, and well-rounded Austrians continue to share this deflation sensitivity; hence the importance of the distinction between productivity-based, or “good deflation,” vs. debt-deflation/secondary deflation (Again, context is the key: is it bad that water is flowing into your house? Depends. Is your roof leaking, or are you drawing a bath?). Credit and debt deflation was the big problem in the early 1930s, which later led economists like Milton Friedman to excoriate the Fed for not doing its job of propping up the banks (i.e. the money supply) in order to prevent such a deflationary disaster.
If you don’t like Ron Paul’s views on money, fine. But before mouthing off about it in front of the entire internet, you should get a clue as to the actual content of his views. If you want to debate whether the gold standard is better or worse than paper money, I’m game. But again, please be prepared to discuss matters in terms of actual economic theory, and understand the actual methodology, positions, and traditions of a school of thought instead of merely attempting a cheap smear. Then, we can have a grown-up discussion involving things like research, evidence, and (proper) monetary theory. We can discuss whether gold standards or fiat money regimes have had better historical track records with respect to both inflation and deflation. We can discuss whether the monetary debacle of the early 1930s was an inherent failing of the gold standard, or due to central bank mismanagement. And maybe we can get down to the real issue of our time: whether politically managed and bureaucratically regulated monetary and financial regimes will outperform competitive market institutions in terms of economic growth and stability.
Tyler Watts is an assistant professor of economics at Ball State University.