by Charles Kadlec
February 06, 2012
The Federal Reserve Open Market Committee
(FOMC) has made it official:
After its latest two day meeting, it
announced its goal to devalue the dollar by 33% over the next 20 years.
The debauch of the dollar will be even greater if the Fed exceeds its
goal of a 2 percent per year increase in the price level.
An increase in the price level of 2% in any one
year is barely noticeable.
gold standard, such an increase was
uncommon, but not unknown. The difference is that when the dollar was as
good as gold, the years of modest inflation would be followed, in time, by
declining prices. As a consequence, over longer periods of time, the price
level was unchanged. A dollar 20 years hence was still worth a dollar.
But, an increase of 2% a year over a period of 20 years will lead to a 50%
increase in the price level. It will take 150 (2032) dollars to purchase the
same basket of goods 100 (2012) dollars can buy today. What will be called
the ďdollarĒ in 2032 will be worth one-third less (100/150) than what we
call a dollar today.
The Fedís zero interest rate policy accentuates the negative consequences of
this steady erosion in the dollarís buying power by imposing a negative
return on short-term bonds and bank deposits. In effect, the Fed has
announced a course of action that will steal - there is no better word for
it - nearly 10 percent of the value of Americanís hard earned savings over
the next 4 years.
Why target an annual 2 percent decline in the dollarís value instead of
Here is the Fedís answer:
ďThe Federal Open Market Committee (FOMC)
judges that inflation at the rate of 2 percent (as measured by the
annual change in the price index for personal consumption expenditures,
or PCE) is most consistent over the longer run with the Federal
Reserveís mandate for price stability and maximum employment.
Over time, a higher inflation rate would
reduce the publicís ability to make accurate longer-term economic and
On the other hand, a lower inflation rate
would be associated with an elevated probability of falling into
deflation, which means prices and perhaps wages, on average, are
falling - a phenomenon associated with very weak economic conditions.
Having at least a small level of inflation makes it less likely that the
economy will experience harmful deflation if economic conditions weaken.
The FOMC implements monetary policy to help
maintain an inflation rate of 2 percent over the medium term.Ē
In other words, a gradual destruction of the
dollarís value is the best the FOMC can do.
First, the Fed believes that
manipulation of interest rates and the value of the dollar can
reduce unemployment rates.
The results of the past 40 years say the opposite.
The Fedís finger prints in the form of monetary manipulation are all
over the dozen financial crises and spikes in unemployment we have
experienced since abandoning the gold standard in 1971.
financial crisis of 2008, caused in no small part by the Fedís
efforts to stimulate the economy by keeping interest rates too low
for, as it turned out, way too long is but the latest example of the
Fed failing to fulfill its mandate to achieve either price stability
or full employment.
The Fedís most recent experience with
Quantitative Easing also
belies the entire notion that monetary manipulation can spur the
Between November 2010 and June 2011, the
Fed tried to spur economic growth by purchasing $600 billion in
Treasury securities, flooding the banking system with reserves and
keeping interest rates low. In response the economy, which had been
growing at a 3.4% annual rate, slowed to a 1% annual rate in the
first half of 2011.
Once, the Fed stopped supplying all of
that liquidity, economic growth in the second half of the year
accelerated to a 2.3% annual rate.
Second, the Fed does not use real time
indicators of the price level. Instead, it views inflation through
the rear view mirror of the trailing increases in the PCE. And, even
when it had evidence of rising inflation - as it did in the first
quarter of last year - it chose to temporize, betting that the spike
in inflation would prove temporary.
This spike in inflation did prove temporary, as Fed Chairman
Bernanke predicted at the time, but not for the reasons - a slack
economy - that he cited. Instead, the growing debt crisis in Europe
led to a massive shift in deposits out of the euro and into the
dollar - an event totally out of the Fedís control.
Yet, this increase in the demand for
dollars was far more important than any action taken by the Fed
because it increased the value of the dollar and produced a slowdown
in the inflation rate.
What we are left with is a trial and error
monetary system that depends on the best judgment of 19 men and women who
meet every six weeks around a big table at the Federal Reserve in
At the end of a day and a half of discussions,
11 of them vote on what to do next. The error the members of the FOMC fear
most when they vote is deflation. So, they have built in a 2% margin of
Given the crudeness of the tools the FOMC uses to set monetary policy,
allowing for such a margin of error is no doubt prudent.
For example, when
the economy slowed in the first half of last year, inflation picked up,
accelerating to a 6.1% annual rate during the second quarter. And, when the
economic growth accelerated in the second half, inflation slowed.
These results are the precise opposite of what
the Fedís playbook says are supposed to happen.
The best the Fed can do - an average debauch in the dollarís value of 2% a
year while producing recurring financial crises and a more cyclical economy
- is demonstrably inferior to the results produced by the classical gold
Hereís just one example. The largest gold discovery of modern
times set off the 1849 California gold rush and increased the supply of gold
in the world faster than the increase in the output of goods and services. The price level in the U.S. did increase by12.4
percent over the next 8 years. That translates into an average of just 1.5%
a year. The gold standard at its worst was better than the best the Fed now
promises to do with the paper dollar.
The Fedís best is hardly good enough.
The time has arrived for the American people to
demand something far better - a dollar as good as gold.