By Barry Elias | Thursday, 03 Dec 2015 11:05 PM
The primary function of the Federal Reserve should be to stabilize the U.S. Dollar.
This view has been voiced recently by former Federal Reserve Chairman Paul Volcker and 2016 republican presidential candidate Senator Ted Cruz from Texas.
By stabilizing the dollar, real income for the masses will once again increase tremendously, thereby reversing a 40-year trend of income stagnation for the bottom 90 percent (the striving majority), according to Put Growth First, an organization that advocates for pro-growth monetary stability and supply side tax reform, and has provided advice to the several 2016 republican presidential candidates, including Senator Ted Cruz of Texas.
(Disclosure: I am an economic advisor to Put Growth First.)
Annual inflation-adjusted GDP growth from 1790 to 1971 averaged nearly 4 percent.
However, since 1971 – the advent of the floating paper dollar backed only by empty political promises, but no real intrinsic value – yearly growth slid to 2.8 percent, and since 2000, it fell further to 1.7 percent per annum.
Moreover, the future prospects are dismal: the Congressional Budget Office and Social Security Trustees now project real economic growth of slightly more than 2 percent.
From 1948 through 1971, the bottom 90 percent experienced a cumulative rise in real income of 85 percent according to the 2012 World Income Database.
Why was this happening?
During this time, the value of the dollar was stable and the Fed did not employ a single labor market variable on its dashboard of indicators. It was up to business to invest so productivity kept pace with wage growth.
A stable dollar permitted more stable material costs for businesses and less demand for expensive financial hedging.
This allowed capital to flow toward more productive investments that generated employment and income for the many – instead of exotic financial products that tend to rely on arbitrage and speculation that extract equity rather than enhance wealth.
The result was faster economic growth. And, despite strong income growth for the striving majority, business profits relative to GDP remained strong and steady.
The situation changed drastically in 1971 when the U.S. dollar lost its intrinsic value anchor and began floating. Since then, real income for the bottom 90 percent (the striving majority) stagnated while that for the top 10 percent grew an additional 140 percent.
Lost economic activity due to the lower growth rate since 1971 totals $104 trillion: $75 trillion since 2000 and nearly $9.2 trillion in 2013 alone. The total inflation-adjusted cost of all U.S. military wars is $7.7 trillion, according to the Congressional Research Service and Stephen Daggett, a specialist in Defense Policy and Budgets. In other words, stagnation has caused more destruction than all wars combined.
Had the 1948-1971 trend for real income of the striving majority continued, the bottom 90 percent would be earning 2½ times more than they do now. If income for the striving majority was 2½ times greater today, how many of our current problems would still be problems?
Since the dollar was no longer stable, the Fed surreptitiously began targeting wage growth as an indicator of inflation that needed to be curtailed.
This is because inflation was redefined to mean an increase in a price index rather than a decline in the value of the dollar. To keep the index from going up, they have raised interest rates every time we’ve had decent wage growth in the last 30 years. This squelched the growth along with wages and employment opportunities, causing volatile business cycles and stagnation.
This theory was promoted in the 1970’s, which suggested there was a tradeoff between unemployment and money wage inflation as depicted in the Phillips Curve.
However, empirical evidence has contradicted this model over several decades and it has become more apparent that inflation is a function of the supply and velocity of money relative to the total quantity of goods and services provided in the general economy.
Also, the Fed was given a dual mandate by Congress in the late 1970s, to minimize and stabilize unemployment in addition to inflation. Unfortunately, the Fed lacks proper tools to deal with unemployment, since it involves fiscal policy to a large degree.
In essence, the Fed was acting in a reactionary manner, since inflation and unemployment are lagging indicators, have subjective measurements and are constantly revised.
Moreover, the policy intervention has lag built into it; by the time it became operational, the underlying conditions that were being addressed may have changed. Therefore, too often we were treating the wrong problem with the wrong solution at the wrong time, causing severe business cycle volatility.
During Senate testimony, Janet Yellen (now Federal Reserve Chairwoman) said, “A key lesson of the 1970s is the critical importance of maintaining well-anchored inflation expectations so that a wage-price spiral like we saw back then does not break out again.”
There have been numerous times that Yellen has referenced strong labor market conditions as a potential source of inflation, which the Fed needs to keep in check – primarily via increased interest rates.
However, the goal of the Fed should be to maintain the stability of the dollar as a unit of measure, and not guided by fiscal parameters, such as wage levels, that the Federal Reserve Bank has little control over.
Partially backing credit and currency formation with the production of real assets, such as gold, silver and virtual currencies using market-driven pricing, would couple money supply growth with the productive use of resources, including land, labor, and capital, and lead to more productive investment of that credit. In addition, business borrowing will be predicated on well-developed ideas that have greater likelihood of being executed effectively.
As a result, the increase in money supply will be absorbed by money demand in a more timely and complete manner, thereby maintaining a stable and predictable value of the U.S. Dollar – a requisite frame of reference, since all economic activity is based on its value.
Real time, market based prices of commodities, foreign currencies and future investment opportunities (bond yields) provide better signals for altering the money supply. The market would set interest rates and determine the money supply, which would require much less monetary intervention by the Federal Reserve.
In fact, it is advantageous for wages to rise so long as they are met with commensurate gains in productivity.
This will ensure cost-effective unit production and strong purchasing power, where unit wage increases tend to be small, stable and roughly equivalent to unit commodity price increases over similar time frames.
Predicating credit creation on the production of real assets will help ensure strong productivity gains in the future, thereby creating an environment ripe for employment, economic growth, moderate and stable inflation, and strong and stable purchasing power.
Direct domestic investment has been weak over the past few decades as a result of this misguided monetary policy. This is the worst economic recovery precisely because this is the worst recovery in business investment.
A volatile dollar inhibits business investment. Business investment acts as the fuel for the train engine that drives economic growth. Consumption is the caboose that follows: it does not push the train. One only consumes what has already been produced.
Currently, Put Growth First is actively working with members of Congress, including the House Freedom Caucus led by Rep. Jim Jordan, R-Ohio, and will soon launch a Growth Task Force with input from caucus members such as Rep. David Schweikert, R – Arizona.
Put Growth First has also been involved in helping to advance House of Representatives bill 1176 in the previous 113th Congress, sponsored by Rep. Kevin Brady, R.-Texas, that would establish a Centennial Monetary Commission to examine United States monetary policy, evaluate alternative monetary regimes, and recommend a course of monetary policy going forward. It was reintroduced to the House of Representatives on June 25, 2015, as H.R. 2912: Centennial Monetary Commission Act of 2015.
Senator Cruz is right to promote a stable U.S. Dollar, which is backed by real assets that are produced with an efficient use of limited resources.
It will increase business investment, productivity, income and purchasing power over the long term for the masses.
It is important to couple this sound monetary policy with a pro-growth tax reform plan to ensure optimal results. I will elaborate on my tax proposal in the following column.
© 2015 Newsmax Finance. All rights reserved.