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Ron Paul's Tilting at Gold Windmills

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Rep. Ron Paul is the new chairman of the House Financial Services Committee's subcommittee on monetary policy. One of the issues the Texas Republican has championed over the years is a return to the gold standard to support our nation's currency. He cites the Austrian scholars Friedrich Hayek and Ludwig von Mises as his intellectual support for some of his positions. He might also have included Don Quixote.

There are few topics where so much intellectual capital has been spent on an issue of so little practical value as the prospects for either a partial or total return to the gold standard. For that reason, the issue tends to be discussed and debated among a handful of loyal advocates or opponents. But perhaps it is time for bankers to pay closer attention.

One reason is that the renewed focus on the gold standard is coupled with pockets of genuine unhappiness regarding the role and management of the Federal Reserve in monetary policy, in financial institution supervision, and as a lender of last resort. In other words, the debate could open the way for congressional involvement in monetary policy — a direction that has been carefully avoided by most Republicans and Democrats since the establishment of the Fed as our central bank. Another reason is that when a subcommittee chairman is a determined advocate of a major policy change on an issue that few people care to examine carefully, it is possible for the policy to become law without the consequences being fully understood.

Discussion of this issue tends to revolve around several points. High on the list is both the constitutionality and efficacy of the government's issuing "fiat" money — money without intrinsic value created by governmental statute declaring it "legal tender." The question of constitutionality is the easiest to dismiss. The movement away from full redemption of currency into gold began during World War I and continued through the Nixon administration's dramatic 1971 decision to end the direct convertibility of dollars into gold. This decision resulted in currencies around the globe uncoupling from the U.S. dollar. The constitutionality of this progression has never been seriously challenged.

As to the efficacy of currency that is not commodity-based, there can be only two reasons for this concern. The first is that governments cannot be trusted to issue currency without external restraint. As the argument goes, the temptation to print money to satisfy the short-term priorities of lawmakers is so overwhelming that a commodity-based currency is a necessary constraint. Indeed history is full of examples of governments cranking the printing press — including U.S. history. But recent history is also testimony to the growing understanding among central bankers that the ravaging effect of galloping inflation can be averted with appropriate management of the money supply. Indeed, among the major economic powers, inflationary pressures in the last decade have been managed more successfully than at any time in recorded history, which is a tribute to the broad understanding of Milton Friedman's dictum that inflation is "always a monetary policy event."

The second reason, related to the first, is that without an external commodity of recognized value to support a currency, its value could readily evaporate. This argument flies in the face of reality — the currencies of the world's major economies are now fiat currencies. It is true that we do see significant changes in currency values relative to each other. But these changes in valuation reflect all the complex interrelationships of the economies of the world.

Currency values adjust for imbalances of labor and capital among nations, and they also reflect the confidence, or lack of same, in the manner in which the economy is being managed. In spite of legitimate concerns about our nation's financial stewardship, the U.S. dollar continues to be the currency of choice during times of global economic crisis.

To me the most compelling argument for dismissing the idea of a partial or full return to the gold standard is to imagine the transitional issues and the resulting strains in attempting to adjust our money supply to the stock of gold in our vaults. It is even more difficult to understand how we as a country could address financial crises such as the crisis in 1987 or the most recent crisis if our ability to generate liquidity was limited by the inventory of gold in our vaults. If there is one element of global monetary policy on which all sides seem to agree, it is the call for China to increase the flexibility of its currency valuation. Imagine the impact on our credibility if we returned to an inflexible policy like the gold standard.

From a banker's perspective, it is important to remember that currency essentially is our inventory.

But its value is not the intrinsic value of the underlying instrument, but the role of currency as a medium of exchange. Many of us who have traveled abroad have had the experience of merchants in that country requesting payment in U.S. currency rather than in the currency of that country. The first time I hear a U.S. merchant asking for an alternative to our currency, I will join the debate for an alternative.

Mark W. Olson has served as a Federal Reserve Board governor, chairman of the PCAOB and chairman of the American Bankers Association. He currently serves as co-chairman of Treliant Risk Advisors LLC and can be reached at molson@treliant.com.

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