10.01.2008 0

The Dollar: Why Judge Poe is Right and Ron Paul is Wrong

  • On: 10/22/2008 14:30:46
  • In: Monetary Policy
  • ALG Editor’s Note: As ALG News reported to you yesterday, Congressman Ted Poe (R-TX) has a new legislative proposal to value the U.S. dollar as one five-hundredth of an ounce of gold, which he apparently based on an article by Louis Woodhill. In the following featured commentary, Mr. Woodhill responds:

    The Dollar: Why Judge Poe is Right and Ron Paul is Wrong

    By Louis R. Woodhill

    Our unstable dollar is the biggest single problem facing the U.S. economy. Congressman Ron Paul (R, TX-14) has been speaking and writing about the dollar issue since at least 1981. However, on July 31, Congressman “Judge” Ted Poe (TX-02) did something that Ron Paul has not done in all of these years. He introduced a bill, H.R. 6690, that would actually solve the problem. It is illuminating to compare Judge Poe’s approach with the reforms advocated by Ron Paul.

    Ron Paul advocates replacing our current “fiat” (paper) currency with gold coins and eliminating our existing “fractional reserve” banking system. A few simple calculations expose the impracticality of this idea.

    The U.S. government currently owns about 215 million ounces of gold. At the current market price of gold ($752/oz), this is worth about $162 billion. If we emptied Fort Knox and converted all of our gold reserves to the gold coins that Ron Paul advocates, this would provide enough gold “dollars” to replace just under 19% of the paper dollars currently in circulation (i.e., the monetary base). If we took Ron Paul’s proposal one step farther and went to 100% reserve banking, we would suddenly have less than one eighth as many “dollars” as we have now.

    Of course, we wouldn’t have to use today’s market price of gold. At a higher gold price, the same amount of gold would allow us to make more “dollars” of gold coins. However, to replace all of our dollars of paper currency with our available gold would require a gold price of $4050/oz. The gold price would have to be pegged at $6500/oz to replace all of the “dollars” of M1, which is what we would have to do in order to implement 100% reserve banking.

    Given that Ron Paul (correctly) points to today’s $752/oz gold price as evidence of inflation, it is a strange idea that raising the price to $6500/oz would solve the problem.

    In many of Ron Paul’s writings, he advocates going to a gold coin standard and simply letting prices fall to make up the difference. Since Paul believes that it was a mistake to depart from the original $20.67/oz conversion price in 1933, let’s look at what would happen if we went back to that.

    After we replaced M1 with gold coins at $20.67/oz, the general price level would fall. Ron Paul points out that because all wages and prices would fall by the same percentage, this would not matter. However, take the case of a family with a $150,000 mortgage that watched its income fall from $100,000/year to $317/year. It’s not clear that this family would believe that they were better off, even though they would now be receiving their pay in gold coins.

    These calculations show that Ron Paul’s gold coin standard fails for the same reason that the classic gold standard failed-there isn’t enough gold in the world to prevent it from being wildly deflationary. Because all America has known for almost 70 years is inflation, many people have forgotten that deflation is much, much worse. The Great Depression was caused by deflation. People want stable money, but they aren’t willing to starve to get it.

    Fortunately, it is possible to stabilize the dollar and create an economic boom at the same time. Judge Poe’s bill, H.R. 6690, would do this. It would require the Federal Reserve to use its Open Market operations to bring the COMEX price of gold down to $500/oz and keep it there. H.R. 6690 would also give the economy a powerful supply-side stimulus in the form of “first year expensing” of all capital investment.

    H.R. 6690 defines the value of the dollar in terms of the market value of gold, but does not use gold as money. In this way, Judge Poe’s bill would not create a new and potentially unlimited source of demand for a scarce commodity. This is the key difference between H.R. 6690 and both Ron Paul’s approach and the classic gold standard.

    Ron Paul believes that governments should not have the power to create money. However, the U.S. Constitution gives the Federal government exactly that power. Article I, Section 8 of the Constitution provides that: “The Congress shall have Power…To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures…”

    Ron Paul argues that paper currency amounts to “bills of credit” and that the Constitution prohibits the Federal government from issuing these, and from making them “legal tender”. However, the only place in the Constitution where these issues are mentioned is Article I, Section 10, which merely denies these powers to the States. Ron Paul believes that the Framers should have denied these powers to Congress as well, but they did not.

    As it happens, it is a very good thing that Congress has the power to issue paper money. It would be impossible to “regulate” the dollar to a stable value if it were not possible to adjust the supply of dollars to meet market demand. The lack of this ability is the flaw in both Ron Paul’s proposed gold coin standard and the classic gold standard.

    The flaw in our current monetary regime is that Congress has abdicated its responsibility under the Constitution to “…regulate the Value…” of the dollar. H.R. 6690 corrects this problem by defining the value of the dollar as being equal to the market value of 1/500th of an ounce of gold. It also ensures that the Federal Reserve will supply the market with all of the paper dollars it wants at this price.

    It is likely that the market demand for the stable “H.R. 6690 dollar” would be huge. The financial markets yearn for a single, stable, world currency, and the now-regulated dollar would quickly become this. Fortunately, H.R. 6690 places no limit on the number of dollars that the Fed can create. It merely requires that each dollar always be worth as much as 1/500th of an ounce of gold. The Fed would likely find itself in the position of having to buy up billions of dollars worth of Treasury bonds to meet the increased market demand for the U.S. monetary base, but this is something it can easily do.

    In directing the Fed to maintain the real value of the dollar, H.R. 6690 will force the Fed to stop trying to control interest rates. This will be a good thing. Interest rates are the price of capital, which represents the right to control real resources for a period of time. Interest rates should be set by the market. That is to say, interest rates should be set by the interaction of savers, who supply real resources and investors, who put those resources to productive use.

    The Fed cannot create real resources. All it can do is to print money and use that money to commandeer real resources. This process causes inflation, and it is therefore a good thing that H.R. 6690 will prevent the Fed from doing this.

    Judge Poe’s bill, H.R. 6690, takes the Constitution at face value and uses the powers granted to Congress to solve the biggest single problem facing the U.S. economy. Unlike Ron Paul’s gold coin standard idea, H.R. 6690 would actually work.

    Louis R. Woodhill, an engineer and software entrepreneur, is on the Leadership Council of the Club for Growth. He can be reached at smia1948@hotmail.com.

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