Why is ‘Sound Money’ Important?
Protect Money from Government Control [Part 2 of 2]
Supply-side economics emphasizes “sound money” along with tax cuts and free trade. How is recent monetary policy reflected in the eyes of Dr. Laffer? Continuing from the last interview, Dr. Laffer spoke on the ideal monetary policy that should be adopted.
Interviewer: Hanako Cho
Cho: In the last interview, you mentioned that the Federal Reserve Board is taking on other jobs beside stabilizing the value of the currency in the long term. What are the reasons they are deviating from their original purpose?
Dr. Laffer: The reason is power. The one thing that we have to always guard upon is that government loves to control. I mean, we all do, Hanako. We all like to control our environment and our destiny, and government is no different.
The whole reason we have a legal system and a constitution is to make sure that we limit the ability of government to take control of our lives. That is why we need to limit the Federal Reserve Board.
The Fed Should be Reformed
Dr. Laffer: When I look at the Fed, I look at an organization that has way outgrown and expanded beyond its mandate. I look at the Fed as becoming an instrument of weakness, an instrument of instability and instrument of slow growth in this economy. It is a tragic shame.
The Fed has gotten into the game of creating slower growth and less output in the economy. Whenever the Fed bails out a loser and takes money away from a winner, they make sure that the economy produces less and grows slowly. That is exactly what they are doing now, in part.
Cho: Do you mean that the Fed should be reformed?
Dr. Laffer: I think the Fed should be reformed completely. I think its mandate should be limited. Their job is to stabilize prices and not pick winners and losers. It is also to make sure the banks are regulated so that they are safe. You want to know that when you put a deposit in the bank, you know that it is safe, that it is not going to go under and crash (*1).
We had period of bankruptcy in the U.S. when banks went under. That is why the banking regulation board, the FDIC, regulates banks. That regulation process is very meaningful and important. But now the Fed is going way beyond and has become an independent entity of redistribution, of interference in the marketplace. Unfortunately, it should be curtailed.
You can go back to my biography, ‘The Emergence of Arthur Laffer,’ and see all of my articles and discussions back in the ’60s, ’70s and ’80s on the role of the banking system and how to keep it that way.
Robert Mundell and I did a lot of work. I wrote this paper called ‘Reinstatement of the Dollar: a Blueprint’ on how the Fed should operate to stabilize prices.
Stable Money is Critical
Cho: Supply-side economics emphasizes sound money. Why is that?
Dr. Laffer: Sound money is money that maintains its stable value over a long period of time. The reason we need a stable numeraire, a stable value, is so that you and I and others can transact with each other using this money knowing full well that the value of that currency will maintain itself on into the future.
It allows us to be very efficient in allocating savings to investment. People who have high incomes and do not know what to do with their money have savings, and they lend those savings to investors. They can lend those savings by a loan, a dollar loan, or by buying equity and stock, and there are many ways of transferring savings from savers to investors. The efficiency of that allocation process from savers to investors is critical to the performance of an economy, economic growth and prosperity.
Therefore, one of the key elements of supply-side economics is stable value money so that the capital markets can function as efficiently as possible.
Historically, and the way I believe it should be, is that stable value was attached to some product in the marketplace. It was gold or silver. In some countries it was copper and in other countries it was salt or cattle.
That’s why I started the conversation of ‘What is money?’ in the last interview. Invariably, countries and people chose money to be a stable value product.
It wasn’t until the 20th-century U.S. when things started to change.
Gold certificates and gold coins were existent in the U.S. in 1933. During that year, Roosevelt took us off gold internally, and in August 1971, Nixon took us off gold externally. This marked the end to the 1944 Bretton Woods standard of a fixed exchange rate system (*2). Then, the Smithsonian Agreement that was implemented in December 1971 collapsed in 1973, and we finally got rid of all the value of the product. That is how we got rid of the gold standard and implemented the unhinged paper money, which is the current system we have today.
My view of this is that it is not to be trusted. The Fed is expanding way beyond its mandate, and the currency has become a major part of the problem. The Fed is not a solution. It is a problem.
Cho: Do you mean that we should go back to the gold standard (*3)?
Dr. Laffer: That is a possibility, but it does not have to be gold. There are lots of ways of fixing it, and it could be lots of other things. It can be a bundle of commodities (*4). There are all sorts of ways you can stabilize the value.
But you want to make sure that the value of the currency stays stable. That is what you want and now the government can do that with any forms of price rule.
If the product prices start rising, they reduce the quantity of money until they fall. If the prices start falling, they should increase the quantity of money until they rise. That is exactly what Britain did with the gold standard for two centuries, and it worked beautifully. They succeeded in keeping prices stable.
The next topic, which is getting exciting now, are there private monies coming out that will allow them to replace the Fed?
Increased Money Supply Doesn’t Create GDP Growth
Cho: In your opinion, what is the main task of monetary policy? Should the Fed be gearing policy to stabilize employment?
Dr. Laffer: I do not think that is true. I think the Fed should have a policy of stabilizing the value of the dollar no matter what happens to employment.
Employment should be the role of fiscal policy. Taxation and spending are not the role of the Fed. I think the role of the Fed should be solely to control the value of the dollar.
Cho: Going off of this topic, I would like to ask about monetarism (*5). For example, in 1953, President Eisenhower resorted to issuing currency instead of cutting taxes in an attempt to revive the U.S. economy. Japan has also tried to stimulate the economy through monetary easing, but it has not worked. What is the problem of monetarism?
Dr. Laffer: It is true in all the points you are making here.
With regard to monetarism, I explained it in my article, ‘A Formal Model of the Economy (*6),’ which is explained in great detail in “The Emergence of Arthur Laffer.”
If you go back to my article, I did a very simple thing in which I looked at the relationship between money and GDP. I used seasonally unadjusted money supply. I co-adjusted the variables with the seasonal patterns. Without getting too technical, the data say that money and GDP move together simultaneously. That implies that GDP causes money, and it is not money that causes GDP.
Monetarists such as economist Milton Friedman mistake the correlation between money and GDP as being a causation model. It is not a causation model.
Monetarism is just the opposite, and the monetarist model is totally wrong. The sooner we get rid of monetarism as we know it, the better off the world will be.
As you know, I loved Milton Friedman. He was a dear friend of mine, and I respect and admire him enormously. But that does not mean I think he was right, and I do not think he was right on this. I think it has been shown that monetarism does not work.
We have had huge increases in the money supply from 2007 to the present, and you have not seen major inflation. You and I have gone through great discussions on why we have not seen significant inflation.
The monetarist model does not work. Monetarism is dead, and I think it should be dead. Now, a stable value currency can be done overnight by the Fed. But a money supply does not cause inflation.
Now the next part of your question. ‘For example, in 1953, President Eisenhower resorted to issuing currency instead of cutting taxes in an attempt to revive the U.S. economy.’ True. In fact, he rejected cutting taxes, which is terrible.
‘In Japan, the Abe administration has also tried to stimulate the economy by monetary easing, but it has not worked. Would you elaborate the limitations of Monetarist model?’ Yes. Monetarism is dead, and by printing more money, all you do is get the private market to substitute private monies for public monies.
Afterall, money is an easy commodity to move across national borders. In recent years, in which the money markets across the world are closely interrelated, it is rare for any one country’s money supply changes to affect its domestic price level. Furthermore, the domestic money supplies of other nations or the effect of exchange-rate changes may be more important factors than U.S. money supply in affecting inflation (*7).
Economist Robert Mundell and I did a lot of work on global money and inflation, and we wrote a paper called ‘Trade Credit and the Money Market’ which was published in the Journal of Political Economy in the early ’70s. I also wrote an article on this topic titled ‘Global Money Growth and Inflation’ which was published in the Wall Street Journal in 1975.
There is also a lot of work I did with Mark Miles, one of my PhD students, showing how the banking system modifies the Fed’s actions [and creates unintended outcomes] by changing the money multiplier.
In fact, I have come to the conclusion that the Fed does not control the money supply. But if they wanted to, they could control the value of money in terms of a product or a bundle of products. That is what the Fed should do—stabilize the value of the currency in terms of a product.
Any attempt to stimulate the economy by printing money, as Eisenhower did in the ’50s or as Abe did recently, fail. They do not stimulate the economy. They do just the reverse. By not cutting taxes and by stimulating with money, they cause the economy to grow slower and to produce less, to create more poverty and less prosperity.
Eisenhower did it and it failed. Abe did and it failed. Not only did it not work, but it worked in the opposite direction.
It is very sad. Whenever the government borrows four trillion dollars and lends four trillion dollars at the same interest rates, there are no effects on inflation or anything.
The only thing they have done by borrowing and lending, if they give that money to non-producers and take that money from producers, is not to create inflation. It creates poverty, despair and slow growth. This is exactly what I was talking about with transfer payments in our last interview. It is devastating for the economy.
Cho: Why was the Reagan administration able to continue tolerating a strong dollar?
Dr. Laffer: Because a strong dollar is a good dollar. People do not want a weak dollar. Do you want to go to your bank and see that inflation has taken away all the value of your deposits?
Cho: No.
Dr. Laffer: No one does. What were the strongest economies in the post-World War II period? Germany and Japan. Which were the two countries that overwhelmed poverty and created prosperity? German and Japan. What were the two countries that had sound money, tax cuts and limited spending back in the day? Germany and Japan.
What are the two countries that have denounced their past and now are doing all the policies wrong? Germany and Japan. What Germany and Japan need to do is go back to what they did in the post-World War II period.
Japan created such prosperity. You created jobs, output, employment. You made people hopeful and then suddenly it stopped. It was so sad, and I feel so sorry.
I used to be the biggest fan of Japan when visited in the ’70s with Secretary of State George Shultz and Presidential Aide John Ehrlichman on Air Force Two. I thought Japan was the most wonderful country in the world. I came over all the time to Japan to give lectures, and I loved it. My students were Japanese students, and the professors there were great. All of that is gone.
In 1989, I think Japan’s market cap of its stock market was the size of the U.S. Japan in 1989 was called the ‘Japanese Challenge.’ Everyone was saying, ‘We’ve got to do what Japan does. We need to follow our leader. They are so wonderful.’ No one says that anymore. The question now is, ‘Is that a country? I’ve heard of Japan. Where is Japan?’ It used to be that everyone knew what Japan was when it was powerful and strong—had good economics and loved its citizens.
We need to get back to a very, very wonderful Japan and a very, very wonderful United States, and we can move in this world as partners.
We need to return to the five pillars of prosperity: a low-rate, broad-based flat tax, spending restraint, sound money, minimal regulations and free trade.
The important thing is the old phrase, ‘primum non nocere,’ which means ‘first, do no harm.’
The Latin phrase is ‘vis medicatrix naturae,’ the healing power of nature. I can remember Ronald [Reagan] saying it very clearly. He said, ‘Don’t just stand there. Undo something. Don’t do something. Get the hell out of the way and let the economy solve itself.’
People know what is best for them. Yes, we need government, but an ideal-sized government. It should not go beyond the powers of creating prosperity. Do what Reagan did. Don’t do what Biden does. Please let Japan be Japan.
Cho: What is your view of cryptocurrency?
Dr. Laffer: You are saying that because governments do not understand economics, they make mistakes on their policies. They spend way too much; they print way too much money, and they issue way too much debt. That causes weakness in the capital markets and in the money markets, which leads to an opening for cryptocurrencies. That is what I’m reading your comments to say, and you are exactly correct.
I think cryptocurrencies are wonderful. Anything that takes the power of creating money away from the government is very good. Maybe cryptocurrencies are the new gold. They may well be. But fiscal stimulus is not spending money. Fiscal stimulus is cutting tax rates and reducing spending. Fiscal stimulus is cutting regulations, not increasing regulations. Fiscal stimulus is not giving unemployed people more money. It is taking money away from unemployed people who do not need it to get them to work. That is my story and I’m going to stick to it.
