10.01.2008 0

Price Stability, Not Deflation, Goal of Strong Dollar

  • On: 10/23/2008 16:45:11
  • In: Monetary Policy
  • “In the end, Henry Paulson’s ill-considered efforts to fix that which isn’t working have taken the form of a solution that misses the problem. Mortgage securities are for a variety of reasons under water due to a dollar that has been in decline for years. A stronger, more stable dollar would reverse the decline of the assets that weigh on our banking system, and it could be achieved free of the very expensive legislation the effectiveness of which investors seriously doubt.”—John Tamny, “A Costless Bank Rescue Proposal,” October 7th, 2008.

    Writing for Real Clear Markets, John Tamny makes a case for a stronger dollar pegged to a modern gold standard—one five-hundredth the value of an ounce of gold—as a solution not just to fight inflation, but as a critical component to stabilizing the economy.

    While a stronger dollar would work to counteract inflation—such as the commodities price spike seen this year—a stable dollar would work to counteract potential deflation—as seen with real estate and other asset prices dropping. Price stability would prevent the boom-bust cycles the economy has suffered, because it means avoiding the highs as well as the lows.

    Deflation does not come out of nowhere. Rather, it is often the end result of bubbles—which recently have been fueled by easy monetary policy over the past two decades. Simply put, what goes up must come down. That is not to say that the end result of all economic growth will be market crashes. Far from it, provided we are talking about genuine economic growth, and not bubbles.

    If all that was behind the spike in home sales throughout the 1990’s and 2000’s, for example, was genuine demand backed by honest credit, the nation would not be in the current mess it is. Instead there was government subsidization of credit that created artificial demand for homes that prompted builders and communities to flood the market with supply, and it caused prices to soar. The money had to come from somewhere, and in this case it was easy credit from the federal government. It was a classic bubble, and eventually it popped.

    A different, but related case can be made for the commodities boom of 2008. It was no coincidence that investors sought solace in commodities this year in the wake of the housing bubble having popped. The Fed began easing yet again, starting late in the summer of 2007. When easy monetary policy was coupled with soaring demand for energy in particular, the economy suffered through yet another bubble.

    Whether or not these bubbles were avoidable through sound monetary policy is the subject of this piece. We make the case that since these particular bubbles can be positively traced to monetary easing, that alternatively a stronger and stable monetary policy, combined with honest credit, would have avoided these cycles.

    Dangers still remain. Look at how universities and colleges are financed. Through federally-backed loans. University costs have soared because of this government-subsidized demand. This is a bubble waiting to pop. Once the credit dries up there, there will be yet another bailout, because the university systems will demand it as the means to preserving their livelihoods.

    It doesn’t have to be this way. With a stronger, more stable dollar, costs would not be so high. Coupled with honest credit, there wouldn’t be bubbles. There would be growth. Genuine economic growth.

    The lesson the nation has learned this year is that a nation cannot borrow its way into prosperity—any more than a drunk can drink himself sober. Price stability will mean avoiding the highs and the lows, the boom-bust cycle, and ultimately, will mean economic stability.

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