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Who should be our next money manager?

By Eddie Willers
web posted July 19, 2004

Alan GreenspanAlan Greenspan has announced that he plans to step down as Fed Chairman before the end of his term. The other day I was asked "Who do you think should replace Alan Greenspan when he steps down?" and "What should the rediscount rate be set at?"

When someone asks me, "What 'should' the price of a can of beans be?" -- or "What 'should' the correct interest rate be set at?" their question arises from and reveals certain false assumptions about the nature and role of market prices, and how they are determined. That sort of question assumes that there is such a thing as a "perfect" or eternally "correct" price for something -- that every item in commerce has some intrinsically "just" price associated with it. But in the real world of the marketplace, a price -- such as the price of a can of beans -- is merely the exchange ratio, the ratio at which a voluntary exchange takes place between two commodities or between units of money and a good or service. A price is one of the terms in an exchange arrived at by voluntary agreement between buyer and seller.

The field of economics shows us that there tends to be a "prevailing price" within a market for a particular kind of good of a certain quality, and is determined by the factors of demand and supply. Since demand and supply are dynamic factors which are ever-changing in a market economy, prices and profit margins vary according to economic conditions and technological changes.

In a free market, the price of a good tends to be set high enough to bring the quantity of the good demanded down to the level of the limited supply of it available for sale. When this market tendency is interfered with by government intervention in the form of politically fixed price levels, economic disruption ensues.

A basic study of market economics should tell us what happens when government uses its coercive powers to positively intervene in the non-coercive marketplace to affect prices. If the political authorities hold a price down below what it would be otherwise, the result tends to be shortages of the product. If, on the other hand, government intervenes to mandate an artificially high price for a product -- a price higher than what otherwise would obtain on a free market -- the result is unconsumed surpluses of that product (with shortages of resources artificially diverted from other areas of production). We have seen this over and over.

Politically imposed price controls are really people controls -- controls over human beings. When the government imposes price controls, it restricts people in what decisions they can legally take as they buy and sell in the market. It limits their freedom of choice. It introduces coercive restrictions on the peaceful behavior of people in what would otherwise be a non-coercive environment. Prices result from freedom of choice. Government intervention disrupts the role that prices play in the market. Violent force always stomps on freedom of choice. When the political authorities use the violent force of the police power at their disposal to meddle with market prices, it tends to result in either unconsumed surpluses or unnecessary shortages. If strictly enforced, price controls not only lead to shortages, but also "black markets" -- underground (illegal) markets run by sleezy criminal types -- and eventually the threat of rationing by government bureaucrats.

Interest rates are prices -- prices for borrowing money. Since money is something that is used throughout an economy, the interest rate is a very special price and plays a very important role as an economic sign post or signal for people in their role as investors.

What "should" the "correct" interest rate be set at? This question not only assumes that interest rates (prices) are (or should be) intrinsically fixed ratios, but it further implies that they ought to be set by political fiat -- that is, by government edict or by a "central bank" (such as the Federal Reserve Board in the United States) with government-granted powers and privileges.

There is no good reason why the price called "interest rate" should be an exception to free-market operations of demand and supply. Indeed, when government (or its central banking establishment) intervenes to keep interest rates artificially low, the result is credit inflation that leads to malinvestment and an artificial boom in some sectors (at the expense of other sectors) which ultimately leads to a liquidating bust (recession). Throughout the 1920s, for example, the Federal Reserve kept interest rates artificially low, creating a credit balloon which set the stage for the Great Depression of the 1930s. Contrary to what left-wing propagandists tell us, the Great Depression (and others which came before) resulted from government intervention, not laissez faire.

Any time the government or the Federal Reserve meddles with interest rates -- as they have been doing since at least 1914 -- this distorts the crucial economic signals that interest rates provide to consumers and on which investors rely to make decisions, and this in turn distorts the structure of the capital markets which depend on economically sound investments. The entire direction of production -- what and how much is produced -- is distorted by rigging interest rates through government intervention. As Milton Friedman and Anna Schwartz have demonstrated, there has been far more economic instability after the creation of the Federal Reserve (by an act of Congress in December, 1913) than what prevailed prior to its creation. Again, it must be pointed out that the Federal Reserve is not a market entity that arose spontaneously under laissez faire; it was a creation of the U.S. Government and has certain powers and privileges bestowed on it by government -- powers and privileges that no private-enterprise market business has.

Ideally, in a fully free market economic system, interest rates, like all other prices, would be set by the non-coercive interaction of demand and supply, not by political meddling. Just as there would be no government-imposed price floors or price ceilings, there would be no Federal Reserve central banking monopoly on legal counterfeiting. There would be no monetary czar -- no Arthur Burns, no Paul Volcker, no Alan Greenspan. Instead of government-imposed fiat currency, a non-inflationary market-chosen money (gold and silver coins and notes fully redeemable in gold or silver) would serve an expanding prosperity.

There are those, such as Dr. George Reisman of Pepperdine University and Republican Congressman Ron Paul of Texas, who have advanced detailed plans for a transition from our current debt-based fiat money arrangement to such a gold-based monetary system, one in which money would be independent of political control. Unfortunately, it is not yet politically feasible to realize any such reforms as too many people still believe that our modern economy needs some kind of political monetary authority to set basic interest rates or try to control the supply of money or money substitutes. There is the contention that "there is not enough gold" to serve as money for a modern, expanding economy. How much would be "enough"? These and other objections are based on certain faulty assumptions about the way a gold monetary system, or how parallel systems of money (not to be confused with the so-called "bimetalic standard"), would operate in a free-market society, and it ignores the role that price plays in helping people resolve differences between quantity demanded and available supply.

For those open-minded enough to investigate market alternatives to the current fiat monetary muddle, I recommend such works as Mark Skousen's Economics of a Pure Gold Standard, George Reisman's monumental Capitalism (Chapter 19), and the two booklets What Has Government Done to Our Money? and The Case for the 100 Percent Gold Dollar by Murray Rothbard.

So, in answer to the question I am sometimes asked, "Who do you think should replace Alan Greenspan when he steps down as Chairman of the Fed?" I say that ideally there should not be a monetary policeman or national interest-rate tinkerer at all, that there doesn't have to be a "central banking" authority at all, and that we should try free-market private enterprise for a change. (I know -- many students have been led to believe that true laissez faire has already been tried in this country in the past and that it resulted in ills requiring the intervention of government to correct; but, this is not accurate.)

I realize that many Republicans regard Alan Greenspan as the best thing since free breadsticks, but I am in no way impugning his abilities or merits, or lack thereof, when I observe that the job he has as national legal counterfeiter is virtually inherently inflationary and coercive of human rights. What has Greenspan done or what can he (or anyone else) do to promote freedom and free markets as Chairman of the Federal Reserve System?

If the person to be appointed head of the Fed would take the job only under the condition that he preside over its dismantlement and assist in an orderly transition to a sound money system, then I might venture an opinion about who might be best suited for that task. Until then, the question doesn't really interest me much. The real question is: should money be politically manipulated at all? 

(c) 2004 Eddie Willers

Other related stories: (Open in a new window)

  • Back to gold, back to prosperity by Michael R. Allen (June 1999)
    It's said that only kooks want to return to the gold standard. That's not stopping Michael R. Allen
  • Greenspan is no hero by C.W. Mayer (December 1998)
    If you have money in the market, you probably like U.S. Federal Reserve capo Alan Greenspan. C.W. Mayer does not
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