Finance, Banking & Monetary Policy

September 10, 2019 11:19AM

Inside America’s Worst Financial Crisis: Gold, the Real Bills Doctrine, and the Fed

The Cato Institute's newest book, Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922–1938 is out now — and it's already getting rave reviews for challenging conventional wisdom on the Great Depression.

InGold, the Real Bills Doctrine, and the Fed,preeminent monetary historians Thomas M. Humphrey and Richard H. Timberlake deliver a compelling critique of the U.S. central bank’s once-central theory on monetary policy: the Real Bills Doctrine. Theirs is the first full-length treatise on the doctrine and its formative role in the Great Depression and other monetary disorders of the early 20thcentury.

Even today, the gold standard remains one of the most popular scapegoats for "the Great Contraction" — the unprecedented collapse of the U.S. money supply, which began after the 1929 stock market crash and led to the Great Depression. Skeptical of this hypothesis,Gold, the Real Bills Doctrine, and the Fedtraces the Contraction and the Depression — along with similar monetary crises like the German hyperinflation — to their true source: the Real Bills Doctrine. By drawing a false dichotomy between “productive activity” and “speculative activity,” Humphrey and Timberlake argue, the Doctrine wrongfully impugned speculation as the source of asset price bubbles and financial panic. Such flawed premises made the Fed unduly reluctant to make full use of the United States' ample gold reserves.

Gold, the Real Bills Doctrine, and the Fedrefutes these erroneous beliefs and vindicates the true gold standard. It also provides a stirring defense for what was once the United States’ decentralized network of competing monetary regimes.

Among the book’s many compelling contributions are:

  • Its thesis that a centrally-managed “gold standard” is a contradiction in terms: a true gold standard requires no discretionary management whatsoever.
  • Its discussion of the difference between a money stock based on real production — which can be price-stabilizing — and a money stock based only on the nominal dollar value of real production, which can never stabilize prices. Humphrey and Timberlake illustrate this distinction by comparing the New York Federal Reserve Bank’s monetary regime, which stabilized prices by adhering to the “quantity theory” of money, with the dysfunctional Real Bills-driven monetary regime that the Washington Fed Board imposed, and struggled under, at the same time.
  • The authors’ revolutionary new economic model,which presents the Real Bills Doctrine as a “metastatic equilibrium concept”: one whose ability to support a stable economy is exogenous to the Doctrine itself. On its own, the authors’ formal model shows, the Real Bills Doctrine can neither stabilize nor destabilize the economy. It can only reflect the preexisting level of political or economic stability within the price level and money supply.
  • A chapter on the history of the quantity theory of money, explaining its relative success compared to the Real Bills Doctrine.
  • The authors’ full-fledged refutation of the Real Bills Doctrine’s erroneous beliefs about production and speculation: Humphrey and Timberlake show that all productive activity is driven by expectations of future outcomes, and is therefore partly speculative. Likewise, all speculative activity is capable of producing real value, and can therefore be productive.

Former president and CEO of the Federal Reserve Bank of Richmond Jeffrey Lacker writes that the book "persuasively document[s] the baneful effects of a well-intentioned but hopelessly flawed economic idea — the Real Bills Doctrine." And long before the book's publication, 1976 Nobel Prize recipient Milton Friedman praised Humphrey and Timberlake's scholarship on the Real Bills Doctrine, writing:

It certainly was not adherence to any kind of gold standard that caused the [Great Depression]. If anything, it was the lack of adherence that did. Had either we or France adhered to the gold standard, the money supply in the United States, France, and other countries on the gold standard would have increased substantially… . [Tom Humphrey and Dick Timberlake’s] emphasis of the Real Bills Doctrine complements in an important way Anna [Schwartz] and my analysis of why Fed policy was so "inept." We stressed and discussed at great length the shift of power in the System. We did not emphasize, as in hindsight … we should have, the widespread belief in the Real Bills Doctrine on the part of those to whom the power shifted.”

Finally, Phil Gramm, economist and former chairman of the Senate Banking Committee, calls this

the most important book written on the Great Depression since Friedman and Schwartz published theirMonetary History of the United States. In originality and significance, I know of no other book that comes close in … explaining why U.S. monetary policy during the Depression allowed a financial panic, not significantly different from the Panic of 1907, to cripple the banking system, destroy a third of the money supply, and cause the most traumatic economic downturn in our history. . . .I strongly recommend this book to anyone who seeks to understand the economic history of America.

Gold, the Real Bills Doctrine, and the Fed is the only book in the economic literature devoted to the Real Bills Doctrine, its logic, history, strengths, weaknesses, and role in policy debates. It is also the first and only book to suggest that the Real Bills Doctrine was a key causal factor of the Great Depression and other monetary disorders of the 20thcentury. Anyone interested in understanding the causes of Great Depression, the role that prevailing economic theories played in it, and its implications for monetary policy and alternative currencies today, should regard Gold, the Real Bills Doctrine, and the Fed: Sources of Monetary Disorder, 1922­–1938 as an absolutely essential work. You can order it here today!

[Cross-posted from]

September 4, 2019 9:20AM

Why the Fed Needs a Monetary Rule to Protect Its Independence

As the 2020 presidential election season heats up, Federal Reserve Chairman Jerome Powell is being pushed from all sides. President Trump has castigated him for overly tight monetary policy and has implied that Powell is a “bigger enemy” than Xi Jinping.  Meanwhile, William Dudley, who recently headed the Federal Reserve Bank of New York, the most important reserve bank in the system, boldly called for Powell to enter the political fray against Trump and use a tighter monetary policy to help defeat him in 2020.

We’ve seen this pattern before—only this time, it’s more extreme. President Trump, like many executives before him, wants the Fed to sacrifice its independence in favor of more accommodative monetary policies, while Dudley, on the other hand, is willing to sacrifice the Fed’s independence in the short run.

The real problem is that, in our purely discretionary fiat money system, there is no rule to provide long-run guidance to monetary policymakers. This allows Congress to delegate too much power to the Fed and expect too much from it in return.  In conducting monetary policy, the Fed needs to be accountable to political institutions, yet independent of political pressures to finance budget deficits or use the printing press to satisfy special interests (whether those interests take the form of a border wall or a “Green New Deal”).

Only a rule—about how to track economic stability and how and when to respond to changes in that stability—can provide that independence.[1]

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August 29, 2019 12:00PM

Puerto Rico Financial Oversight Board Was Unconstitutionally Appointed

By 2016, Puerto Rico’s government was in dire financial straits. To avoid bankruptcy, Congress enacted the Puerto Rico Oversight, Management, and Economic Stability Act (“PROMESA”), creating a board responsible for restructuring the island territory’s substantial public debts. But there are serious questions regarding the constitutionality of this Financial Oversight and Management Board for Puerto Rico (the “Board”).

Under PROMESA, the president chooses six of the seven members of the Board from “secret lists submitted to [him] by the House and Senate leaders.” But in view of the Board members’ selection process and responsibilities, the U.S. Court of Appeals for the First Circuit held that they are “principal federal officers” who must be nominated by the president and confirmed by the Senate, rather than “inferior officers” whose appointment does not go through the same constitutional rigmarole.

Under the Constitution’s Appointments Clause, the president “shall nominate” principal federal officers, “and by and with the Advice and Consent of the Senate, shall appoint” them. But that is not what happened here. PROMESA’s appointment scheme raises serious separation-of-powers concerns because it positions the legislative branch to assume a role the Constitution exclusively reserves to the executive.

The First Circuit did not see it this way. Although it deemed the Board members “principal federal officers,” it applied an archaic doctrine to uphold their appointments. Under the “de facto officer” doctrine, acts performed by an officer that has assumed official duties without having been properly appointed to an office are valid even though it is later discovered that the officer’s appointment is legally deficient.

But this ancient doctrine is inapplicable to this case. Here, it is not the appointment of individual Board members against a valid appointment process that is in question. By all accounts, the appointment of each Board member did not violate any of PROMESA’s express prescriptions. Instead, it is PROMESA’s appointment process itself that is constitutionally suspect. In such case, the “de facto officer” doctrine has no real bearing, because no officer can be validly appointed in the first place.

Supreme Court precedent confirms, again and again, that the Board members are indeed “principal federal officers” who must be nominated by the president, and only then Senate-confirmed for appointment. That’s because they (1) occupy a “continuing” position established by federal law, and (2) “exercise significant authority pursuant to the laws of the United States.” While (1) is obvious, perhaps (2) is less so. And so it bears emphasizing that the Board, under PROMESA, has ultimate authority over the fiscal future of a U.S. territory of more than three million inhabitants. If that authority is not “significant,” we don’t know what is.

Cato has thus filed an amicus brief supporting several of Puerto Rico’s creditors before the Supreme Court, in their argument to overturn the decisions of the Board and invalidate its statutory authority. If PROMESA is allowed to stand, and the Board’s decisions are upheld, this will signal to the executive and legislative branches—both complicit in this perilous scheme—that anything goes, that they are free to strike at the heart of our constitutional structure without any pushback from the one branch left to preserve the ever-fragile separation of powers.

The Supreme Court will hear argument in Financial Oversight & Management Board for Puerto Rico v. Aurelius Investment, LLC on October 15.

August 29, 2019 10:06AM

On Targeting the Price of Gold

Thanks to President's Trump's picks for prospective Fed Board nominees, the subject of gold price targeting (or a gold "price rule") is getting attention once again.

The idea, which got a lot of attention back in the 1980s, after Arthur Laffer  and other supply-siders, including Alan Reynolds, first began promoting it, is that the Fed could mimic a gold standard, keeping inflation in check and otherwise making the dollar "sound," by employing open-market operations to stabilize the price of gold. The topic has come up again because three of Trump's prospective nominees have at one time or another suggested that the U.S. should revive the gold standard, and two of them, Herman Cain and Stephen Moore, are full-fledged supply-siders. Although Cain and Moore are no longer in the running, Judy Shelton, the third gold standard fan, is still in the race (along with Chris Waller of the St. Louis Fed), and she also has strong supply-side leanings.

These facts prompted Representative Jennifer Wexton (D-Va.) to ask Jerome  Powell, following his July 10th testimony, whether the U.S. should "go back to the gold standard." In response Powell, whether because he had a Laffer-style gold price-rule in mind or for some other reason, interpreted the question as one asking whether the Fed should "stabilize the dollar price of gold." That, he said, wouldn't be a good idea:

There have been plenty of times in fairly recent history where the price of gold has sent signals that would be quite negative for either [maximum employment or stable prices]. …If you assigned us [to] stabilize the dollar price of gold, monetary policy could do that, but the other things would fluctuate, and we wouldn’t care. We wouldn’t care if unemployment went up or down. That wouldn’t be our job anymore.

Powell's statement raises three questions. One is whether it's proper to equate reviving the gold standard with having the Fed target the price of gold, as Powell did. The second is whether Judy Shelton has herself endorsed a gold price rule. The third is whether such a rule would be as disastrous as Powell claims.

This post is devoted to answering, or trying to answer, these questions.

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August 22, 2019 11:55AM

Really, It’s True: Creditors, Predators Not Same Thing

Between the print version of Rebecca Traister's August 5 New York magazine profile of Elizabeth Warren, and the version now online, there can be spotted an amusing correction. Print version:

Clip of 8/4/19 NY mag "predators"

Online version

Clip, NY mag 8/4/19 online, "creditors"

Let's hope editors in the nation's leading financial center continue to keep in mind that lending money to someone doesn't necessarily make you a predator. 

August 19, 2019 9:53AM

How to Flip a Yield Curve

If the recent yield curve panic proves anything, it proves that, in financial markets, what may start out as a mere statistical correlation, and possibly a spurious one, can become a genuine causal relationship. In particular, if enough people subscribe to a post-hoc fallacy, it may not stay a fallacy for long.

A Self-Fulfilling Prophecy

It was, therefore, just a matter of time before the discovery that inverted yield curves often anticipate recessions resulted in the world's first yield-curve induced panic. And the distance between panic to recession is no great stretch. Knowing that the curve has turned turtle, and anticipating tumbling stock markets and shrinking incomes, the public rushes to trade stocks for more liquid assets, while banks tighten lending standards. Lo and behold, stocks do tumble, and incomes do shrink. A slowdown then threatens. Should the monetary and fiscal authorities fail to avert it, the slowdown can become a contraction. If the contraction lasts, it becomes a recession. And all this because the yield curve went concave. Post hoc ergo propter hoc. Really.

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August 14, 2019 9:20AM

Progressives’ Financial Inclusion Agenda Is Likely to Backfire

In a recent op-ed for CNN, Rep. Rashida Tlaib (D-MI) suggests a plan for improving the financial inclusion of minority households. She believes that reversing the Trump administration’s recent regulatory initiatives on credit discrimination and mortgage reporting legislation would improve matters.

While Rep. Tlaib is right to point out the disproportionate numbers of blacks among those lacking access to financial services, their financial exclusion goes back, not years or months, but decades. Moreover, her recommendations would mainly double down on existing regulations that seem to perpetuate rather than mitigate financial exclusion.

Rep. Tlaib begins with the striking finding that, ostensibly, the black homeownership rate in the second quarter of 2019 was lower than at any time since 1970. At 40.6 percent, it came in six percentage points below the Hispanic homeownership rate and almost a third below that of whites. Tlaib worries that, because black Americans are so much less likely than other racial groups to own their home, they will have a harder time achieving economic stability.

While homeownership is indeed a popular form of wealth accumulation, the share of Americans who own their homes is hardly a straightforward measure of financial security. For example, the homeownership rate among all households hit an all-time high of 69.1 percent at the start of 2005, a time of exceptionally high home prices and extremely loose credit standards. The financial crisis that followed, with foreclosures hitting up to 10 million families, belied the assumption that the new homeowners had achieved financial security.

Black Americans’ low homeownership rate is the product of many causes, notably decades of institutional discrimination that made it difficult or impossible for blacks to gain access to the same job opportunities and schooling as whites. Discrimination caused black households to have persistently lower incomes and greater professional and personal instability, frustrating their attempts to earn and save. Explicit government policies also limited black Americans’ access to credit by designating predominantly black neighborhoods as “hazardous” to prospective lenders. Because banks since the 1930s have sold most of their mortgages to government and government-sponsored entities, an official recommendation against lending in certain areas had the power of a veto.

Rep. Tlaib is right to focus attention on the troubling legacy of redlining, but blaming a recent and marginal reduction in regulation for blacks’ low homeownership rate is highly suspect. For one thing, the most recent quarterly rate of 40.6 percent is only slightly below the 41 to 43 percent range recorded for most quarters since the beginning of 2012. The estimate’s margin of error, at 0.9 percent, is also high. Thus, the record low reported for the last quarter could be a statistical fluke or a short-lived dip. Giving one quarterly result great significance is probably unwise at this stage.

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