Wednesday, December 03, 2008

Does not understand Federal Reserve Banking

Brad DeLong, like all macroeconomists I've ever met, has no understanding of Federal Reserve banking, fiat money economics, or Mises. Mises was thrown under the bus a long time ago, but not getting 1) and 2) is like a physician not knowing about bacteria and viruses. Check out this reaction to Mises

Mises says:
"[T]he gold standard appears as an indispensible element of the body of constitutional guarantees that make the system of representative government function.... What the foes of the gold standard are asking for is... to intensify very considerably the already-prevailing upward trend of prices and wages.... Such a policy of radical inflationism is, of course, extremely popular.... How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's treasury department! The government, professors tell us, 'can raise all the money it needs by printing it'[1]. Taxes for revenue, announced a chairman of the Federal Reserve Bank of New York, are 'obsolete'[2]. How wonderful!... Eventually... the cleverly-concocted plans of inflation collapse. Whatever compliant government economists may have said, inflationism is not a monetary policy that can be considered as an alternative to a sound-money policy...."
DeLong responds:
this citation to Beardsley Ruml's "Taxes for Revenue Are Obsolete" is a gross and illegitimate distortion.

Ruml writes that while state and local governments must ultimately raise all the money to finance their spending through taxation, the federal government has extra freedom of action because of "the elimination, for domestic purposes, of the convertibility of the currency into gold." How should the government use this freedom of action? The first of the policy considerations it should have in mind, Beardsley Ruml says, is: "Do we want a dollar with reasonably stable purchasing power over the years?... [T]he most important single purpose ot be served by the imposition of federal taxes is the maintenance of a dollar which has stable purchasing power.... [W]ithout the use of federal taxation all other means of [price] stabilization... monetary policy... price controls... subsidies, are unavailing..." That is the opposite of what von Mises wants his readers to think Ruml's meaning is.
But both Ruml and Mises are right, DeLong is wrong. State and local governments are currency users, not currency issuers, so they must raise all their money to finance spending through taxation. The Federal Government is unique in that it is a currency issuer, and so does not need to finance spending through taxation, it can simply create the money ex nihilo. So why tax at all? Most importantly, the Federal Government must tax to create demand for the fiat currency it, and it alone, can create. There is one simple reason why my region of NorCal does not run on winterspeakBucks, and it has everything to do with the size of my standing army, and nothing to do with my ability to print out little pieces of paper with "N winterspeakBucks" written on them.

The secondary reason to tax is to reduce aggregate demand, and so keep the money supply from growing too much faster than the real quantity of goods and services in the economy (which would show up in the CPI as inflation). I cite this as a secondary reason because there are many ways to control money supply, including interest rates, deficit spending, etc. But please note, at no point does the Federal Government need to tax in order to spend. The Fed spends first, and then taxes to sterilize that increase in money supply.

So, Ruml is saying that the Fed needs to tax to create demand for fiat money, and then tax again to reduce aggregate demand and take the quantity of fiat money available in excess of that required for private saving, out of the system. Only in a fiat money system can the Fed control money supply. Compare and contrast this with third world countries who are unable to tax, and unable to have all the economic activity in their country be in their local currencies.

Mises is saying that politics, being what it is, will not control money supply wisely or well, that the incentive to create extra money and give it to favored interests is too great, and it will all end in hyperinflation which debases the currency entirely. Best to take it out of Government hands and have a fixed money supply, which in a world of rising productivity would result in an environment of mild and continuos deflation.

They are both exactly right. Taxation is central to generating fiat currency, and controlling inflation. And government has been unable to resist ultimately hyper-inflating fiat currency. The US$ has lost well over 90% of its value over three generations, which is not hyperinflation but it's certainly not a "stable source of value" either. Harvard economists are calling for 6% inflation for two years as if inflation can be turned on, and then turned off so easily. Volker raised interest rates to 20% to stop inflation in the 70s, a feat that seems impossible in the 21st century's political climate where even millionaire investment bankers cannot be allowed to become redundant, even for a few weeks.

Brad DeLong, however, Macroeconomist, writer for the NYTimes, Obama cabinet hopeful, clearly does not understand Austrian economics, which is forgivable given they were excommunicated from the Temple long before DeLong went to grad school, but sad since some of their ideas are not only brilliant, but also correct. What is not forgivable is that DeLong also does not understand Federal Reserve Banking, which is an indictment of him, and his profession.


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