Employee of St. Louis Fed Takes on Ron Paul

LvMIC:

Earlier today I came upon an article written last spring by David Andolfatto, teacher of economics at Simon Frasier University and currently employed at the Research Division of the St. Louis Federal Reserve, that is heavily critical of U.S. Congressman and Presidential candidate Ron Paul’s view on monetary policy.  As anyone who follows politics knows, Paul is ardent follower of the Austrian school of economic thought and is currently bringing its teachings to wide audience thanks to his campaign for president.  Andlfatto’s article is an attempt to discredit Paul and “end the Fed” advocates by praising the institution that cuts him a check.  While I certainly can’t blame him for defending his employer, his reasoning is elementary at best (ht Daniel Kuehn):

There are legitimate arguments one could make against the Fed as an institution and/or about the conduct of Fed policy. And then there are the stupid arguments, for example, the one contained on pg. 25 of his book End the Fed:

One only needs to reflect on the dramatic decline in the value of the dollar that has taken place since the Fed was established in 1913. The goods and services you could buy for $1.00 in 1913 now cost nearly $21.00. Another way to look at this is from the perspective of the purchasing power of the dollar itself. It has fallen to less than $0.05 of its 1913 value. We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.

One might indeed say that, Mr. Congressman. But if one did, one would behaving like an opportunistic politician, which I know you are not.

Now, let us examine what is wrong or misleading in the statement above.
Yes, what cost $1 in 1913 now costs $20. But so what? Money neutrality states that if you were earning $1 per hour in 1913, you are now earning $20 per hour (and even more, if labor productivity is higher).

So there you go, the Fed is responsible for increasing your nominal wage by a factor of 20. How do all you workers out there like them apples? Ron Paul wants to rob you of these wage increases!

Now Andolfatto is correct insofar as once all is said and done, wages adjust to new price settings as new money becomes completely integrated into the economy.  Yet Andolfatto doesn’t mention this very key understanding of inflation that Henry Hazlitt succinctly identified nearly half a century ago:

“no actual inflation happens by a simultaneous or proportional increase in everybody’s money supply or money income.”

New money hits the economy in stages, enriching those who received the newly created funds first.  The way Andolfatto paints the picture, it would seem like wages and prices adjust simultaneously when the Fed turns the printing press on.  Nothing could be further from the truth however.  The Fed isn’t responsible for increasing wages, it’s responsible for increasing the size of the money supply.  Wages in nominal terms adjust to reflect this new norm after prices have been bid up.  Increasing nominal wages is only a byproduct of inflation.  If anyone is being misleading, it’s Andolfatto, not Dr. Paul.

Here is another example of the Congressman misleading the public (perhaps unintentionally); see his recent interview here with CNBC’s Larry Kudlow: Fed Under Fire.
At the 3:50 mark, Kudlow asks Paul: “Would oil be at $102 a barrel now if we had a sound dollar policy?” Paul’s reply is that, if Bretton Woods had not been abandoned (in 1971), oil would now be trading closer to $5 a barrel.

I ask you…how embarrassing of an answer is that? I mean, maybe oil would be trading at $5 a barrel. But what he is implicitly suggesting is that your nominal wage would not be scaled back in proportion. That is, he is suggesting that by cutting the value of paper, the Fed has somehow diminished the purchasing power of your labor over the past 100 years. Can he be serious?

So Paul didn’t come out and say nominal wages would be less had Bretton Woods not been abandoned.  Andolfatto neglected to say that time plays an important role in monetary policy.  Somehow he comes to the conclusion that the Fed devalues labor through printing dollars.  I have never heard Paul make such a illogical statement.  Paul only speaks to currency devaluation.

And, as an aside, am I the only one who chuckles whenever he berates the Fed for creating money “out of thin air?” (I reiterate, there may be many legitimate complaints one could make against the Fed, but the “out of thin air” charge…well, let’s just say it…lacks substance).

So whenever the Fed conducts open market operations, where exactly does the newly created money come from besides the keying in of numerical balances?  How is “out of thin air” not a apt charge?  Andolfatto does not say.

Is it not true that the Treasury also creates its debt “out of thin air?” Do you think getting rid of the Fed (which, in conducting monetary policy, is simply swapping one form of thin air for another) will prevent Congress from issuing its own thin air?

Paul never levies a charge that the U.S. Treasury doesn’t create debt out of thin air. Andolfatto is correct that when bonds are sold in a fiat economy, they are created out of the same “thin air.”  And of course getting rid of the Fed wouldn’t prevent the Treasury from issuing bonds.  The Treasury can only sell bonds if there are buyers.

Do you really believe that a gold standard would mitigate the government’s ability to tax?

Again, Paul makes no such claim.  What he does say is that a true gold standard would put more of a limit on government spending.

Though dated, Andolfatto’s piece is incredibly lacking as far as a substantial rebuttal to Paul’s (and most Austrian’s) criticism of the Fed.  He fails to address the fact that inflation doesn’t effect the economy ceteris paribus.  There is no mention of the elite primary dealers that receive new money first before prices and wages fully adjust.  Most central bank apologists ignore this as it would be clear endorsement of the kind of crony capitalism that would have Mussolini cheering in his grave.

Now Andolfatto had a follow up post to his article that is a much more thoughtful argument.  He makes many of the same arguments as before but provides some data to back him up.  He cites “low and stable” inflation over the past 30 years without addressing the concern many free market oriented economists have made over the calculation of the CPI.  He also claims that the Fed will one day unwind its balance sheet despite the amount of junk it has accumulated that may or may not be repurchased.  In short, Andolfatto attempts to show that nominal wage increases have adjusted to inflation, thus keeping things relatively equal and not resulting stolen wealth opportunities.  But if this were the case with inflation, what would be the point of monetary policy?  If wages and prices adjust automatically, there is no real justification of increasing the monetary base.  But as we know, the point of monetary policy is to enrich some at the expense of others to “boost” spending.

All in all, Andolfatto falls into the same trap that central bankers do when justifying their job.  They attempt to demonstrate the neutrality of monetary manipulation when the manipulation can never be neutral in regards to who benefits and who doesn’t.