[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
THE RELATIONSHIP OF MONETARY
POLICY AND RISING PRICES
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
AND TECHNOLOGY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MARCH 17, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-20
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65-679 WASHINGTON : 2011
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HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
KENNY MARCHANT, Texas BRAD MILLER, North Carolina
THADDEUS G. McCOTTER, Michigan DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JOE DONNELLY, Indiana
BLAINE LUETKEMEYER, Missouri ANDRE CARSON, Indiana
BILL HUIZENGA, Michigan JAMES A. HIMES, Connecticut
SEAN P. DUFFY, Wisconsin GARY C. PETERS, Michigan
NAN A. S. HAYWORTH, New York JOHN C. CARNEY, Jr., Delaware
JAMES B. RENACCI, Ohio
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
Larry C. Lavender, Chief of Staff
Subcommittee on Domestic Monetary Policy and Technology
RON PAUL, Texas, Chairman
WALTER B. JONES, North Carolina, WM. LACY CLAY, Missouri, Ranking
Vice Chairman Member
FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri AL GREEN, Texas
BILL HUIZENGA, Michigan EMANUEL CLEAVER, Missouri
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
DAVID SCHWEIKERT, Arizona
C O N T E N T S
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Page
Hearing held on:
March 17, 2011............................................... 1
Appendix:
March 17, 2011............................................... 25
WITNESSES
Thursday, March 17, 2011
Grant, James, Editor, Grant's Interest Rate Observer............. 6
Lehrman, Lewis E., Senior Partner, L.E. Lehrman & Company........ 4
Salerno, Joseph T., Professor, Pace University, New York......... 7
APPENDIX
Prepared statements:
Paul, Hon. Ron............................................... 26
Grant, James................................................. 28
Lehrman, Lewis E............................................. 33
Salerno, Joseph T............................................ 48
THE RELATIONSHIP OF MONETARY
POLICY AND RISING PRICES
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Thursday, March 17, 2011
U.S. House of Representatives,
Subcommittee on Domestic Monetary
Policy and Technology,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. Ron Paul
[chairman of the subcommittee] presiding.
Members present: Representatives Paul, Jones, McHenry,
Luetkemeyer, Huizenga, and Schweikert.
Chairman Paul. This hearing will come to order.
I want to welcome our three witnesses today, and they will
be further introduced when they are ready to give their
testimony.
The ranking member, Mr. Clay, is going to be coming later,
but he has advised me that we can go ahead and start the
hearing.
So I will start with an opening statement and those who
want to give opening statements can do so, as well. I will
advise that we will have some votes, probably in about 20
minutes or so, and we might have to take a 30-minute break. But
we will deal with that when the time comes.
I consider these hearings very important. A few weeks ago,
we had hearings on the Federal Reserve's relationship to the
unemployment problem, and the Fed has been given two mandates:
one, to keep low unemployment, which they haven't done a very
good job of; and two, to maintain price stability. And the
evidence is mounting that they haven't been doing a very good
job with maintaining price stability either.
Most people refer to rising prices as inflation and that is
the conventional wisdom. But many of us concentrate on things
other than just rising prices and seeing rising prices as a
symptom of the basic problem, which means that when a money
supply has increased, the value of that currency goes down and
inevitably it will lead to rising prices, unfortunately not
uniformly, which means that some people suffer more than
others.
But the one thing that is done when prices rise is that a
lot of scapegoats are found. And this has been traditional
throughout history.
As a matter of fact, as long ago as 40 centuries, 4,000
years ago, the very first known price controls occurred in
ancient Egypt. They put on price controls because prices were
going up and they didn't want to deal with the real issue,
which was the monetary issue.
And that is a modern phenomenon too. The United States has
done this during wartime periods, during wars in the 20th
Century as well as another time in the 1970s, saying that if we
can just control prices, we will take care of the problem.
So they are always looking for something to blame for the
rising prices. Sometimes it is energy. In the 1970s, it was
energy, and boycotts caused rising prices. Even today, the
Middle East crisis is causing prices to go up and it does have
an influence, but it is not the whole cause.
Any type of crisis will contribute to rising prices.
Sometimes labor is blamed for the inflation of prices and
sometimes it is weather. Sometimes the blame is placed on the
speculators. Once prices start rising, well, if the speculators
are doing it, they are buying too much stuff and they are
hoarding and they become the scapegoats.
Also, business people, when they make profits, can be
accused of contributing to the price inflation. And sometimes,
we just blame foreigners for not managing their currencies
quite well and causing our prices to go up.
But one of the most bizarre arguments by the conventional
wisdom of those at the Federal Reserve, and other places, is
that it is excessive growth. We are having too much growth
these days and therefore we have to slow it up. And literally,
that is what they do.
If they have an inflationary period and they are concerned
about rising prices, I think if we just kill the economy, yes,
it will. Decrease demand and you will have price adjustments.
But that is a heck of a way to solve the problem, which is the
monetary problem.
But growth, in itself, doesn't cause higher prices. If you
have a healthy economy, you are more likely to lower prices
with excessive growth.
We had tremendous growth in the electronics industry--
telephones and computers and TVs. In spite of the monetary
inflation, we still saw prices drop.
So this whole idea that you have to slow up the economy in
order to keep prices down, in order to stimulate growth of the
economy, all you have to do is print money, I think people are
starting to realize that is a hoax and it is coming to an end.
The definition of inflation, by many of us, is the increase
in the supply of money. Ludwig von Mises, the great Austrian
economist, argued this case clearly. And I used to think it was
just semantics, but he argued that it was more than that. It
was deliberate, so that we in charge--the monetary people in
charge didn't want to address the subject of money and why they
are responsible, rather than these other issues.
I consider this very, very important because it is so
unfair. If governments and central banks increased money,
prices went up and wages went up and profits went up all
equally, I guess no big deal, but why do it, if that is what is
happening?
What happens, though, is some people benefit at the expense
of others. And I think it is a reasonable assumption to say,
which many have said in the free market school, that if you
destroy a currency, you will destroy the middle class. A sound
currency encourages the middle class. And I believe that the
inflation of prices, when prices go up, are most damaging to
the poor and low- to middle-income people because they suffer
the consequences much more so than those who can protect
themselves. And therefore, it is a tax on the poor and the
middle class. They tend to lose their jobs and get the higher
prices.
So to me, it is very, very important that we address the
subject.
And now, I would like to yield to the vice chairman of the
subcommittee, Walter Jones from North Carolina.
Mr. Jones. Mr. Chairman, thank you very much. And to the
panel that is here today, thank you. I think I agree with the
chairman that I don't--as a centrist in my philosophy, as it
relates to the people in my district, I really believe this is
a critical and very important hearing because the relationship
between monetary policy and rising prices brings me to my brief
statement.
I do the grocery shopping in my family. I have been married
for 46 years, and I have been doing the grocery shopping that
whole time. I found this editorial in the Wall Street Journal
that I think tells why this is an important hearing today--t
says I cannot eat my iPad--the subtitle was ``Federal Reserve
bombs in Queens.'' So let me just say that. But this is one of
the comments in the article: ``Come question time, the main
thing the crowd wanted to know was why they are paying so much
more for food and gas?''
Keep in mind, the Fed doesn't think food and gas matter in
its policy calculations because they aren't part of core
inflation. In other words, food and gas, in the eyes of the
Fed, are not part of the core inflation.
So Mr. Dudley tried to explain that other prices are
falling: ``Today, you can buy an iPad 2, that costs the same as
an iPad 1 that is twice as powerful. You have to look at the
prices of all things.''
Then from the crowd, someone quipped, ``I can't eat an
iPad.'' Another attendee asked, ``When was the last time, sir,
that you went grocery shopping?''
So, this hearing today is extremely important and I am
delighted to be part of it and I look forward to the question
period. But I want to see it end with one comment. I have my
staff email my district every time that we are going to hold a
hearing, Mr. Chairman. And when we hold a hearing, I bring to
this debate, this hearing, comments from my district.
I just want to mention one and then I will close:
``I have been retired from Ma Bell for 22 years and my
pension has only increased once. We did get a small cost of
living too, but a couple of years ago, that stopped. For people
like us, in this situation, we are getting drained. The way
things are going, my wife and I will have to hope to die before
we cannot afford to live.''
That is why this is a very important hearing, and I thank
you, Mr. Chairman, for the time you just allowed me.
Thank you, sir.
Chairman Paul. Thank you very much.
Mr. Huizenga, do you care to make a statement?
Okay. There are no other opening statements, so we will now
proceed to the testimony. I will introduce the three witnesses,
and then we will proceed.
Lewis Lehrman will be the first one to give his testimony.
Mr. Lehrman is an active proponent of the gold standard and
former member of President Ronald Reagan's Gold Commission.
After serving as president of Rite Aid in the 1970s, Mr.
Lehrman ran for governor of New York on the Republican and
Conservative party ticket. In addition to being a senior
partner in his investment firm, Mr. Lehrman continues to remain
active in a number of political and civic causes.
Next, we will hear from James Grant. Mr. Grant is a noted
investor and publisher of Grant's Interest Rate Observer. A
former columnist for Barron's, he is the author of five books
on finance and financial history. He has appeared on numerous
television programs and his writings have been featured in
numerous publications, including The Wall Street Journal, the
Financial Times, and Foreign Affairs.
And finally, we will hear from Professor Joseph Salerno,
who is a professor of economics at Pace University in New York.
He is also vice president of the Ludwig von Mises Institute in
Auburn, Alabama, and has written extensively on monetary policy
and theory, banking, and comparative economic systems. He
received his MA and Ph.D. in economics from Rutgers University.
So we will proceed, and Mr. Lehrman, you can give us your
statement.
All of your written statements will be made a part of the
record, so we ask that you give us a 5-minute summary.
Proceed.
STATEMENT OF LEWIS E. LEHRMAN, SENIOR PARTNER, L.E. LEHRMAN &
COMPANY
Mr. Lehrman. Mr. Chairman, and distinguished members of the
subcommittee, I want to thank you for the time. I want to thank
my colleagues, Mr. Grant and Mr. Salerno, who have carried on
the most distinguished research in monetary history, monetary
theory, and monetary policy.
Since the expansive Federal Reserve program of quantitative
easing began in late 2008, oil prices have almost tripled.
Gasoline prices have almost doubled. Basic world food prices,
such as corn, sugar, soybeans, and wheat have almost doubled.
The Fed credit expansion from late 2008 through March 2011
created almost 2 trillion new dollars on the Federal Reserve
balance sheet alone.
This new Fed credit triggered, as the chairman was just
suggesting, a commodity and a stock boom, because the flood of
new credit could not be fully absorbed by the U.S. economy,
then in recession.
Indeed, Chairman Bernanke recently suggested that
quantitative easing aimed to inflate U.S. equities and bonds
directly, thus, commodities, of course, indirectly.
But some of the excess dollars raced into the foreign
exchange markets, calling a fall on the dollar on foreign
exchanges.
Now with quantitative easing, the Fed seems to aim at
depreciating the dollar.
Foreign mercantilist countries such as China purchased
these depreciating dollars on the foreign exchanges, adding
them to their official reserves. Issuing an exchange, they are
pegged undervalued currencies. This new money is promptly put
to work, creating speculative bull markets and booming
economies in China. The emerging market equity and economic
boom of 2009 and 2010 was the counterpart of sluggish economic
growth in the United States during the same period.
But in the year 2011 and 2012, we will witness a Fed-fueled
economic expansion in the United States. Growth for 2011 in the
United States will, I believe, be about 3.5 percent or more,
unless there is an oil spike. Another oil spike, combined with
even greater catastrophe in Japan.
The consumer price index, the so-called CPI, will be
suppressed because unemployment keeps wage rates from rising
rapidly. The underutilization of physical and industrial
capacity keeps producer prices and finished prices from rising
as rapidly as they otherwise would. Thus, the flood of new Fed
credit has shown up first in commodity and stock price rises.
But commodity and stock inflation inevitably engenders
social effects. Two generations of inflationary, monetary, and
fiscal policies have been a primary cause of the increasing
inequality of wealth in American society.
Bankers and speculators have been and still are the first
in line, along with the Treasury, to get zero interest credit
from the Fed. The bankers were also the first to get bailed
out. Then, with the new money, they financed stocks, bonds, and
commodities, anticipating, as in the past, a Fed-created boom.
A very nimble financial class, in possession of cheap, near
zero interest credit, is able, at the same time, to enrich
themselves and to protect their wealth against inflation. But
middle-income professionals and workers on salaries and wages
and those on fixed incomes and pensions are impoverished by the
very same inflation that subsidizes bankers and speculators.
So if the problem is an unstable dollar, inflation and
deflation, boom and bust, what is the solution? I remember
Senator Robert Kennedy saying once, ``If you do not have a
solution, you do not have a problem.''
The solution is a dollar convertible to gold at a fixed
value. This is the necessary Federal Reserve discipline, to
secure the long-term value of middle-income savings and
pensions and to backstop the drive for a balanced budget.
The gold standard would terminate the world dollar standard
by prohibiting foreign official dollar reserves. Thus, the
special access of the government and the financial class to
limitless Fed and foreign official credit would end with the
gold standard.
Equally important, the gold standard puts control of the
supply of money into the hands of the American people as it
should in a constitutional republic.
If the Fed creates more dollars than the people at home and
abroad desire to hold, they can exchange excess paper for gold
at the fixed value, requiring the Fed to slow down credit
creation in order to maintain the statutory gold convertibility
of the dollar.
To accomplish this monetary reform, the United States can
lead: first, by announcing future convertibility on a date
certain of the U.S. dollar, the dollar itself to be defined
then in statute as a weight unit of gold, as the plain words of
the Constitution suggests; second, by convening a new Breton
Woods Conference to establish mutual, multilateral, gold
convertibility of the currencies of the major powers at a level
which would not, lower nominal wages; and third, to prohibit by
treaty, the use of any currency but gold, as official reserves.
The gold standard is not perfect. But it is the least
imperfect monetary system tested in the only laboratory we
human beings have available to us: the laboratory of human
history.
The dollar as good as gold is the way to restore America's
financial self-respect and to regain its role as the equitable
leader of the world.
Thank you, Mr. Chairman, and members of the subcommittee.
[The prepared statement of Mr. Lehrman can be found on page
33 of the appendix.]
Chairman Paul. Thank you.
We will go next to Mr. Grant.
STATEMENT OF JAMES GRANT, EDITOR, GRANT'S INTEREST RATE
OBSERVER
Mr. Grant. Mr. Chairman, good morning. I have the honor of
testifying--thank you.
The original Federal Reserve Act said nothing about zero
percent interest rates, quantitative easing, inflation
targeting, stock price manipulation or indeed, paper money.
The law, rather, projected an institution, ``to provide for
the establishment of the Federal Reserve Banks to furnish an
elastic currency to afford means of rediscounting commercial
paper, to establish a more effective supervision of banking in
the United States, and for other purposes.''
We should have known.
``For other purposes'' was the operative phrase. Mission
creep is endemic to bureaucracy, of course, but few government
departments have crept, indeed galloped, faster, further toward
a more unhelpful direction than our own Federal Reserve.
Central banking has elited into a kind of central planning.
And to top it all, the Fed has unilaterally added a third
mandate to the two Congress conferred on it some years ago. The
``Bank of Bernanke'' is today the self-appointed booster of
stock prices.
Now, the progenitors of the Fed, notably Senator Carter
Glass of Virginia and the economist H. Parker Willis, had no
time for Wall Street. They were rather devoted to commerce and
agriculture and to decentralization of finance.
It would sorely grieve those two to discover that in their
absence, the Fed's zero percent funds rate has simultaneously
served to starve savers and to fatten speculators.
It should likewise grieve us, the living.
There is something deeply and fundamentally wrong in
American finance.
According to Chairman Bernanke, himself, in private
testimony before the Financial Crisis Inquiry Commission in
November of 2009, 12 of this country's largest 13 national
institutions were at the risk of failure in the fall of 2008.
In our Great Recession, nominal GDP was down top to bottom
by no more than 4 percent or less.
In our Great Depression, 1929 and 1933, nominal GDP was
down by 46 percent, that is to say the economy was virtually
sawed in half, yet most banks did not fail.
The predecessor to today's Citigroup was notably solvent.
You do wonder if only one 21st Century American financial
institution could stand up to anything like the Depression of
yesteryear, well not eager to find out, the Fed insisted once,
no truck with even the statistical absence of inflation, let
alone with outright deflation.
Still less of course, with the Depression, so it boons its
balance sheet and it presses its interest rate to the floor.
That is not of course the end of the story. The dollar is
thereby materialized, the interest rate thereby suppressed,
have unscripted consequences.
They inflate prices and investment values, and because
prices and values are the traffic signals of a market economy,
the Federal Reserve unintentionally becomes the cause of
crashes and pileups on our financial streets and highways. Some
of these accidents, notably the 2007, 2009 residential real
estate debacle are the monetary equivalent of a chain reaction
on a foggy California freeway.
The trouble with our monetary Mandarins is that they
believe impossible things. They have persuaded themselves that
a central bank can pick the interest rate that will cause the
GDP to grow, payrolls to expand, and price to levitate by just
2 percent a year, no more mind you, as they measure it.
It is impossible, experience and common sense both attest,
yet they hold it to be true. Today's dollar, it is weightiness
uncollateralized by anything except the world's faith in us.
That too seemingly in history's judgment would be an
impossibility yet here it is.
Yet that faith justifiably is today fading. William F.
Buckley famously and persuasively said that he would rather be
governed by the first 400 names in the Boston phone directory
than by the faculty of Harvard.
Unaccountably, this Congress has entrusted the value of the
dollars that we own, we transact, to an independent committee
dominated by monetary scholars. In one short generation, we
have moved to the Ph.D. standard from the gold standard.
I submit, Mr. Chairman, it is past time to reconsider.
[The prepared statement of Mr. Grant can be found on page
28 of the appendix.]
Chairman Paul. I thank the gentleman, and we will go on to
Professor Salerno.
STATEMENT OF JOSEPH T. SALERNO, PROFESSOR, PACE UNIVERSITY, NEW
YORK
Mr. Salerno. Chairman Paul and distinguished members of the
subcommittee, I am very honored to be here.
The old argument has come back into vogue that modern
inflation is desirable to prevent the far greater evil of
deflation. This has been given a scientific sounding name of
``inflation targeting.''
In the past decade, this view has been promoted both by
former Federal Reserve Chairman Greenspan and current Federal
Reserve Chairman Bernanke. But this view is based on a
fundamental confusion. It confuses deflation with depression,
which are two very different phenomenon. Falling prices are,
under most circumstances, absolutely benign and the natural
outcome of a prosperous and growing economy. The fear of
falling prices is not the phobia, a deflation phobia which has
no rational basis in economic theory or history.
Let us look at the experience of the past 4 decades with
respect to the products of the consumer electronics and high
tech industries. For example, a mainframe computer sold for
$4.7 million in 1970 and probably is the size of this room,
while today, one can purchase a PC that is 20 times faster for
less than $1,000. The first hand calculator was introduced in
1971 and was priced at $240, and by 1980, similar hand
calculators were selling for $10 despite the fact that the
1970s was the most inflationary decade in U.S. history.
The first HD TV was introduced by Sony in 1990 and sold for
$36,000. When HD TV began to be sold widely in the United
States in 2003, their prices ranged between $3,000 and $5,000.
Today, consumers can purchase one of much higher quality for as
little as $500.
In the medical field, the price of Lasik eye surgery
dropped from $4,000 per eye in 1998 when it was first approved
by the FDA to as little as $300 today.
No one, not even a Keynesian economist, would claim that
the spectacular price deflation in these industries has been a
bad thing for the U.S. economy. Indeed, the falling prices
reflect the greater abundance of good which enhances the
welfare of American consumers.
Nor has price deflation in these industries diminished
profits, production or employment. In fact, the growth of these
industries has been as spectacular as the decline in the prices
of their products. But if deflation is a benign development for
both consumers and businesses in individual markets and
industries, then why should we fear a fall in the general price
level, which of course is nothing but an average of the prices
of individual goods?
The answer given by theory and history, is that a falling
price level is the natural outcome of a dynamic market economy
operating with a sound money like gold.
Under a gold standard, prices naturally tend to decline as
technological advance and investment in additional capital
goods rapidly improve labor productivity and increase the
supply of consumer goods while the money supply grows very
gradually. For instance, throughout the 19th Century and up
until World War I, a mild deflationary trend prevailed in the
United States.
As a result, an American consumer in the year 1913 needed
only $0.79 to purchase the same basket of goods that required
$1 to purchase in 1800. In other words, due to the gentle fall
in prices during the 19th Century, a dollar could purchase 27
percent more, in terms of goods, in 1913 than it could in 1800.
Contrast this with the current-day consumer who once paid
$22 for what a consumer in 1913 paid only $1 for.
The secular fallen prices under the classical gold standard
did not impede economic growth in the United States, in fact
deflation coincided with the spectacular transformation of the
United States from an agrarian economy, in 1800, to the
greatest industrial power on earth by the eve of World War I.
Ironically, while Chairman Bernanke just reaffirmed again a
few days ago that the Fed will persist in its inflationary
policy of quantitative easing to ward off the imaginary threat
of falling prices, signs of inflation abound.
I will skip over, in my testimony, the review of inflation
in the commodity markets which was given by Mr. Lehrman. But
let me just add that as a result of skyrocketing prices of
agricultural products such as corn, wheat, soybeans, and other
crops, the price of farm land in the United States has been
soaring, particularly in the Midwest, where land prices
increased at double-digit rates last year and regulators now
are fearing a bubble.
And just today it was reported that wholesale food prices
in the United States rose by 4 percent last month, the most in
46 years. That is since the stagflationary 1970s.
Not only does Chairman Bernanke seem unfazed by these
inflationary developments, but what is more astounding, he
appears to welcome the rapid increase in stock prices as
evidence that QE2 is working to right the economy. He seized on
the Russell 2000 index of small cap stocks, which has increased
25 percent in the last 6 months, stating, ``A stronger economy
helps smaller businesses.''
In other words, despite the stagnant job creation and
sluggish growth of real output, Mr. Bernanke has declared Fed
policy a success on the basis of yet another financial asset
bubble that threatens again to devastate the global economy.
This would be farcical if it were not so tragic. But what else
can be expected from a leader of an institution whose very
rationale is to manipulate interest rates and print money.
And I will just end on the following. Just today, hot off
the presses, USA Today reported substantial evidence that a new
tech bubble is starting to grow. Facebook is estimated to be
worth $75 billion on private markets and is reported to be
bidding against Google for a $10 billion purchase of Twitter.
Over the last year, there have been 48 tech IPOs, which is
28 percent of all deals. And the stock prices of these tech
IPOs have jumped 19 percent on their first day of public
trading.
Thank you.
[The prepared statement of Professor Salerno can be found
on page 48 of the appendix.]
Chairman Paul. Thank you. There are votes on the Floor, so
we are going to take a recess, but we will be back shortly.
[recess]
Chairman Paul. The committee will come back to order and we
will go into the question session right now. I will start off
by taking 5 minutes for that.
I do want to welcome once again, the three witnesses and I
appreciate very much you being here, and talking about a very
important subject. Not only for our business climate and our
employment, but also for all Americans who suffer the
consequences of rising prices. This hearing has been set up
mainly to sort out the relationship of monetary policy and why
prices go up.
A lot of people, as I mentioned in my earlier statement,
would like to blame everything else and try to avoid the
Federal Reserve completely. But I do want to start off with a
question about the opposite of what people call inflation, and
it was touched upon in the testimony, and that is the
deflation.
Deflation of course, for some of us, would mean that the
money supply is shrinking as it did in the 1930s but other
worry about prices going down and there is--I guess there are
some people who justifiably worry about it especially when they
are overextended and they have to pay their debts. But overall,
if we are on a sound monetary system, if we are on a commodity
standard it may well be that prices would go down.
I would like to ask Professor Salerno to distinguish
between these two, between deflating the money supply and
prices going down and who then would best benefit if prices
actually dropped?
Mr. Salerno. If we use deflation to mean falling prices, it
is the mechanism by which people are benefitted, even on a
fixed income, when we have increases in productivity, increases
in productivity result from technological progress and more
savings and investment in the economy. So workers become much
more productive, more goods are produced in a given hour, and
at the same wages their standards of living go up because their
dollars become more powerful in exchange.
If you prevent this drop in prices, then many people who
were not involved in the original increase in productivity,
people who are in other industries or people, especially on
fixed incomes, people on pensions, and insurance policies, will
benefit from the falling prices. Their real incomes go up.
Chairman Paul. Thank you. I want to ask Mr. Lehrman a
question about the long-term effects of gold. You brought up
the subject of gold and some of the advantages. There have been
studies done with gold and stability of prices over long
periods of times. Even with an imperfect gold standard, do we
not have a fairly good record of stability in prices when it
wasn't a Fiat currency?
Mr. Lehrman. We do, Mr. Chairman. If you will permit me to
wave a piece of paper at you, in my testimony, I have charted
the price of gold or the value of the dollar--was all that
heard before?
We do have the history of the general price level under the
gold standard and I have prepared in my written testimony a
chart which shows that since the end of the gold standard, that
is to say the class of gold standard in 1914 on the eve of the
First World War, the value of the dollar as measured by the
CPI, adjusted for the available statistics, before 1920, has
fallen to $0.05. The value of an ounce of gold in March, well
on March 15th, or I should say even March 17th, today, 1910,
was $20 per ounce of gold.
On March 15th or March 17, 2011, one century later, the
price of gold is approximately $1,400 per ounce. So the price
of gold is, as it were, the reciprocal of the fall in the value
of the dollar over the same period.
During the history of the American Republic from let us say
the Constitution of 1788, 1789, we can chart the price level
quite accurately. And in my testimony I submit such a chart,
with Coiny Jack of 1792, essentially Alexander Hamilton's,
Coiny Jack, the 1792, which made the dollar convertible to
precious metal, primarily under the circumstance that the
silver is first but by 1834 we were on to the gold standard.
If you take the price level under the gold standard, from
1834, and of course make the exception for the Civil War which
went on for a very long period was a convertible of suspension.
But if you take from 1834 until 1914, you will find under the
gold standard that the general price level or the CTI as we
would say today was exactly in the same position.
In other words, over the long run, near a century, there
was neither a fall in the general price level, siflation, as
Professor Salerno might describe, nor was there any general
inflation. So that is--in testing monetary theory, or even
economic theories we have only one laboratory, it is the
laboratory of human history.
And in the laboratory of human history, we find that the
gold standard, proven by the price level stability from 1834
until 1914 for example, that the gold standard provides virtual
stability in the price levels on the average level of general
prices.
Chairman Paul. I thank the gentleman and we will go on now
to Mr. Luetkemeyer for his 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman. Mr. Grant, you
made an interesting statement during your testimony that, ``The
only thing holding up our dollar was the faith in it.'' Would
you elaborate just a little on that, I have some agreement with
you on that. And that I think that our whole system right now
seems to be held together by the confidence that we will be
able to pay something back and forth versus the actual
collateralization, the actual asset backing of the actual--
there being some value there.
I think--it would appear to me that the whole system is
held together by just the confidence between you and I, that we
can do business versus the actual asset that is there.
Could you elaborate a little bit on your statement and
whether you think that is the right perception or not?
Mr. Grant. Yes, Congressman, I do. To a degree, every
monetary system is faith-based. One must have confidence in the
quality of the metal, if there is collateral behind the
currency.
Never, I think until the present day, has the world been on
a system of pure paper. The dollar is the Coca Cola of monetary
brands. It is a remarkable achievement in that it is today
treated as good money, the world over, though the cost of
production is essentially nothing.
And this is a pretty flattering expression of confidence by
the world in America and its institutions. However, faith must
be continually refreshed. It is not perpetual. I think that the
very size of this so-called quantitative easing program has
crystallized doubts as to the nature of the currency and of its
underlying value.
In the language of modern finance, the dollar is a
derivative. It used to derive its value from the collateral
behind it, mainly gold. In 1971, if you were a foreign official
institution, you presented your $35 to the Treasury and said
you would prefer to have an ounce of gold and you got it.
Over the past 40 years that has been of course, out the
window. And so the dollar is in the language of modern finance,
a kind of a nonsequitur; it is a derivative without an
underlying asset.
Sometime recently, a reader of the Financial Times wrote to
the editor and said, ``Sir, the scales have fallen from my
eyes. I think I finally understand the meaning of quantitative
easing. I think I finally get it. What I no longer understand
is the meaning of the word money.''
I think the very size and the audacity and the physics of
the project of materializing $600 billion effortlessly has
captured the imagination and the doubt of the American people,
and indeed of the world's money-holding population.
May I close with, to me, the greatest crystalizing,
clarifying line about money in American literature, and it
happens to be from a novel. It is a Laura Ingalls Wilder novel
called, ``Farmer Boy.'' And this is a story of a boy growing up
in Upstate New York, hard scrabble, dairy country, in which--
campaigned for governor, he carried all of this country, by the
way, with a huge majority.
But Alonzo, this child turns up at the county fair and he
asks his father very definitely for a nickel and his father
miraculously materializes $0.50 from his pocket and he says to
the kid, not wanting to let the moment pass without the moral
instruction, he says, ``You know what this is?'' And the boy
actually can't think of anything to say. And the father says,
``It is money, do you know what money is?'' And the boy again,
is silent. And the father says, ``Money is work.'' And for the
past 40 years, money has been a concept. It has been the
project of a Ph.D., and I think the world would like it to be
work.
Mr. Luetkemeyer. Okay, along those lines, obviously the key
too is considering it to erode the confidence in our dollar and
right now the dollar is sort of the gold standard around the
world. What happens if our dollar goes away or like some other
people are trying to look to a different currency. How does
that impact out country, in your view?
As no longer being the standard--
Mr. Grant. I think we have to answer the question. I think
we have to consider our unique privilege in creating a currency
that is treated as good money the world over and which only we
can lawfully create. This is called the Reserve Currency
Privilege and both Professor Salerno and Mr. Lehrman have
written really important stuff on this. But the nature of our
franchise, of American franchise is that we import, we pay with
our dollar bills created at essentially no marginal cost.
These dollars we ship effectively to Wal-Mart suppliers in
Asia, the dollars wind up, because the suppliers don't need it,
on the balance sheet of the central banks of our Asian
creditors. The Asian creditors turn right around and buy
Treasury securities.
So it is as if the dollar has never left the 50 States. So
that is what we have and if the world were to lose this
astounding confidence in the institution of the Federal Reserve
we would lose that franchise, this privilege of seignorage,
this reserve, this--what was the last term they--exorbitant
privilege.
Mr. Luetkemeyer. Exorbitant privilege.
Mr. Grant. And we would quickly find that we, like Paraguay
and other nations not uniquely blessed with a reserve currency
would have to suffer a lower standard of living.
Mr. Luetkemeyer. Okay. Thank you very much. Thank you, Mr.
Chairman.
Chairman Paul. Congressman, I wonder if I may just add a
couple of numbers to the question?
Mr. Lehrman. May I interrupt?
Chairman Paul. Yes, you may, but I wanted to advise the
members if they would like, there will be a second round of
questioning, also.
Yes, go ahead Mr. Lehrman.
Mr. Lehrman. Mr. Grant's comment is so compelling, and I
think the numbers themselves are illuminating. The official
reserves of foreign central banks held in custody at the
Federal Reserve System itself, published in the balance sheet
of the Federal Reserve every Thursday evening at 4:00, those
official reserves now amount to $3.5 trillion invested in U.S.
Government securities, primarily in U.S. Treasuries, the
residual in Federal agency securities.
That just gives you a quantitative estimate of the
mechanism that Mr. Grant just described. The best way also, if
I might say, to think about this is that this is the credit
provided to our government, to the Treasury in deficit by the
purchases by foreign central banks who are mostly mercantilists
wanting to maintain undervalued currencies. This is the credit
provided to our U.S. Government.
Until we end the official reserve currency system and, I
might add, the unlimited discretion of the Federal Reserve to
buy $600 billion worth of U.S. Government securities in a mere
8-month period, until we end that, all efforts to control the
deficit will be unavailing.
All of the great conscientious efforts of so many of the
Congressmen, especially freshman Congressmen, Republicans and I
believe some Democrats too, all of them will be unavailing. We
have gone through 40 to 50 years of every President declaring
that he was going to reduce spending and the deficit, even
President Reagan, a great President, wound up with deficits
running somewhere between 3 percent and 7 percent output.
The reason is that the U.S. Government grows through the
deficit spending which is authorized and then it is financed in
combination by the Federal Reserve System and the official
reserves which are accumulated and reinvested in U.S. Treasury
by foreign governments making limitless credit available. When
limitless credit is available event to an individual, over a
very long period of time, we can be assured that they will make
use of it.
Chairman Paul. Thank you.
Now, to Mr. Schweikert, from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman. That limitless
credit as an individual would be an interesting concept.
Can I go--something I have ultimately wanted to ask and if
our two--the two trading partners that actually buy most of our
debt which is China and Japan, what happens--what sort of
cascading effect, at all if there is, let us say Japan right
now; bless them with their disasters and things they are
facing, begins to have fairly substantial steps up in
inflation. All we were seeing, regionally, rather aggressive
inflation in areas of China, what potentially does that do in
our inflation indexes?
And could we actually start from the right and go left?
Mr. Salerno. I think the big danger is that if Japan needs
extra imports and so on as their economy slows down in reaction
to this disaster, and they begin to offload reserves of
American currency which are actually government securities,
there could be a cascading effect as it puts downward pressure
on the U.S. dollar. And if China does the same thing, then we
are at the situation where there--the only thing that the U.S.
Government can do to finance this deficit is to borrow from the
American people.
Mr. Schweikert. But that is also our bond prices
functioning, start having to move up to be able to sell the
product. That was actually going to be the second half of my
question.
But even just--let us say there was just a national
inflation step-up within Japan and China. What do you see from
just that in the price of the products being imported and
exported?
Mr. Salerno. To the extent that China keeps its exchange
rates with us, their prices would actually become higher in
relation to us and we would actually have an increase in our
exports and a decrease of imports from China. So for
mercantilists, that would sort of be a good thing.
So given the system of exchange rates that we have today,
there would not be a huge impact on the U.S. price level of
those developments. Although, the problems in Japan if their
economy slows down, that would put an upward tick on world
prices and there would be some effects on consumer prices here
in the United States.
Mr. Grant. Agreed.
Mr. Schweikert. No, no I appreciate brevity.
Mr. Lehrman. Agreed, Congressman.
Mr. Schweikert. Okay, now going back in the other
direction. What if we actually start to see the nation of
China, which is the second biggest buyer of our debt, now they
have to start to begin to finance their own reconstruction so
they no longer are participating as much in the U.S. debt
market so now we have lost one of our customers. So we start to
tick up our own bond rates.
What do we face?
Mr. Lehrman. Do we go from right to left? There are at
least two alternatives. One would be that despite Japan not
absorbing U.S. dollars in exchange for exports and then adding
them to their official reserves, that other emerging countries
who have absorbed enormous amounts of dollars in their banking
systems and then into their official reserves, which have risen
even more dramatically than Japan, in the last 10 years, that
they too would absorb whatever Japan no longer absorbs.
I might add that Japan had been out of the market for
absorbing U.S. dollars and then investing them in U.S.
Government securities in custody of the Fed for a good long
while until recently, as the yen strengthened and they of
course wanted to lower its value in order to maintain their
valued export industries.
The other possibility is that there was no other emerging
country or major country willing to absorb the residual of the
securities and were the United States balance of payments to
remain the same, all fairly large assumptions, the dollar would
then fall on the foreign exchanges until there was intervention
by countries who did not want the dollar to become increasingly
competitive in the export markets or until the Federal Reserve
reduced the volume of credit they were issuing talk in the
market especially the subsidizing of banks and the U.S.
Treasury and deficit.
For a concrete example of that, that is exactly what Paul
Volcker did in 1981, 1982. He imposed the most Draconian credit
contraction in American history since the Great Depression, or
least comparatively with all other recessions. He put the Fed's
fund rate up to 20 percent the prime rate hit 21 percent.
Unemployment in New York State that Jimmy referred to, in
1982, which was my year on the campaign, the unemployment rate
in New York hit 11.2 percent. The unemployment nationally, in
1982, under the Volcker credit contraction policy hit almost 11
percent nationally, higher than at any time during the so-
called Great Recession.
So that these two options, namely a great fall in the
dollar with no residual buyer of excess foreign dollars in the
foreign exchange markets, combined with Federal Reserve
contractions, presents us with two unattractive alternatives.
Mr. Schweikert. Mr. Chairman, without objection, can I have
another 60 seconds?
Mr. Grant. Briefly, the more birthday candles I blow out,
the less certain I am about cause and effect with bond prices
and interest rates. Paradox seems to govern many of these
markets. For example, the difficulties, the tragedy in Japan
has forced the yen not downward but upward as the Japanese
repatriate assets from abroad to finance the holes in their
income statements and balance sheets. To attempt to suppress
the rise in the yen the Japanese buy more dollars. They help to
finance our deficit even in the midst of their travail and our
interest rates have been going down since 1981. For 30 years,
bond prices ostensibly have been rising and interest rates
falling.
I think probably that no matter what happens with respect
to the dollar, no matter what happens with regard to these
hearings or with the congressional approach to monetary policy,
the chances are that the next 30 years would see more likely
interest rates rising and falling. Interest rates have tended
to rise and fall in generation length intervals since the late
19th Century.
Mr. Salerno. Foreign confidence in the dollar is
precarious. So that if there is a drop in the dollar as the
foreign demand for the dollar falls, I think what you are going
to see is a cascading effect. There is already talk among China
and Brazil and the president of the IMF of moving towards this
sort of a gold-based reserve currency or a currency that has
basket weight entities.
But at that point, I think then it could be a vicious
circle in which it feeds on itself, the dollar drops, if the
Fed doesn't contract the money supply what you will get is an
explosion upward of import prices, no more cheap shopping at
Wal-Mart. And it is so precarious, but a few years ago there is
evidence that--now that drug dealers are beginning to offload
their $100 bills, 80 percent of the $100 bills that are printed
in the United States are not in the United States, they are
financing drug deals they are hedging against inflation.
And they are beginning to stop using them and they are
replacing them with EUR 500 notes. So that is just sort of the
first step.
Mr. Schweikert. Mr. Chairman, forgive me, but should I be
worried about that?
Chairman Paul. I think we all should be, and we should have
been a long time ago.
Mr. Schweikert. Something about when the drug dealers have
attended their monetary economic classes I--we are in trouble.
But please, I interrupted.
Mr. Salerno. No, that is what I was going to say.
Mr. Schweikert. Thank you, Mr. Chairman.
Chairman Paul. I would like to talk a little bit about the
measurement of price inflation. The government depends on this
CPI, there is an old CPI and a new CPI. John Williams has spent
some time as a free market person, trying to keep us honest
about what the CPI is really doing. And of course
traditionally, when the government makes reports, they talk
about core CPI and they drop off those unessential things like
food and energy and it seems like the markets very frequently
accept whatever they say.
``Oh, inflation is only 2 percent; prices are only going up
at the rate of 2 percent.'' Of course, eventually, I think the
numbers catch up, even with the government. In the 1970s, he
did admit that prices were going up at a 15 percent rate.
But my question is, talk a little bit about the difference
about the CPI, how good is it, how accurate is it? Is it--does
John Williams have a good point there, saying that the
revamping of it--what do you all look at if you want to know
how prices are going up? I know we all look at the CPI and the
PBI and it seems to have the immediate effect, but where do you
put your most importance, what price measurement do you use?
All three of you, could you give me your comment?
Mr. Salerno. Varese's once said that the housewife who just
checks a few prices in the supermarket and keeps track of them
is much more scientific than the arbitrary price indexes that
are used by economists and statisticians. But I tend to look at
something called median CPI which is calculated by the
Cleveland Fed. It is not perfect and it shares some of the same
problems as the CPI itself. But also I like to look at the raw
prices of goods and what has happened over time, to them.
I do want to mention that these adjustments are just
ridiculous. We have a substitution bias adjustment which, if
the price of prime beef goes up, they don't include that
increase; they reduce that and they say, ``Well, people can eat
chicken at a lower price.'' So the full increase is not
reflected.
They have hedonic adjustments, if a car gets two-side
airbags, ``The increase in the price of the car has to be
reduced by the fact that it is a higher quality now.'' And new
technology adjustments, the iPad as someone talked about, when
that comes into play, that is a deflating force. Despite the
fact that other prices are going up at a certain rate, that
rate is reduced for that reason.
Chairman Paul. Are there any other comments?
Mr. Lehrman. I think it may be Mr. Williams' research, Mr.
Chairman, I am not sure, I cannot quote the author for certain,
but in his research on the CPI, he used the methodology that
was in force in 1980. And if one were to use the methodology in
force in 1980 without the hedonic adjustments, without the
substitution effects and so much of the changes which have
occurred, that the price level is increasing at approximately 8
percent by that methodology as opposed to the methodology
presently adopted by the Bureau of Labor.
And for purposes in our investment business, we pay no
attention whatsoever to these fictitious Ph.D.-created
mechanisms otherwise known as the CPI. Even the PPI leaves much
to be desired up until--for the longest period of time, up
until the Second World War, which was a period, certainly
before the Great Depression, of the greatest economic growth
the world had ever experienced, it was the Industrial
Revolution. It was the Wholesale Price Index, which was used to
measure the level of prices.
The CPI and the PPI themselves aren't innovations. So
looking at commodity prices, looking at equity prices which
themselves are articles of wealth in the market and are
excluded from the CPI, means to anybody who is involved in
business, corporate capital allocations, or if you will, in
long-term investing, one has to ignore the publication on a
monthly basis of the CPI and PPI and look at the actual prices
in the market which serve as indicators of the cost of
production of producing another article of wealth to the
market.
Chairman Paul. Would it not be true that if they would use
the CPI, wouldn't some groups of people suffer more by rising
prices, and other groups be more protected? Everybody is not
going to be penalized the same way, even if we did look at
those numbers. The average person might spend their money
differently. If your income is $25,000 a year, the inflation
rate might be much more painful than if you were making a
couple of hundred thousand a year.
Mr. Grant. Or depending on your age, it--a younger person
spends a great deal of his or her money on consumer
electronics, that personal CPI is plummeting. He or she is in
clover. It seems to me, and Professor Salerno will know whereas
I am surmising, but it seems to me that the ancients posited
that inflation is not too much money chasing too few goods,
inflation is too much money, that which the money chases is
variable. In one cycle, it might chase skirts at retail, and in
another cycle, it might chase the Russell 2000 Stock Index.
And I think the complacency of our masters, the Fed, with
respect to inflation, has to do with their overlooking this
most basic concept about inflation.
Mr. Lehrman. Conversely, if I may, with the--with respect
to the younger generation and the amount of money they spend on
technology, with ever falling prices, you have the entire world
of emerging markets, not to mention middle-income families and
poorer families in the United States driven from subsistence
level to starvation by basic food prices. The milk price has
doubled in the past year and a half. Food prices, we know, have
risen, depending upon the supermarket, anywhere from 15 percent
to 20 percent in basic foods.
So, I believe that the political turmoil for example in
North Africa, indeed all around the world, and some of the
protests, the intensive protests about issues which in the
past, in the United States have been received without quite the
kind of ferocious protests, I think are related to the
frustration that middle-income and poorer families all around
the world are feeling.
As the political class is indifferent to what the effect of
the commodity price is, the basic food and food prices have
done to those on subsistence or near subsistence level, as they
feel ever more the threat of starvation.
Chairman Paul. Mr. Schweikert.
Mr. Schweikert. Mr. Chairman, actually--is it pronounced
``Lehrman?''
Mr. Lehrman. Yes, sir.
Mr. Schweikert. Actually, heading in that same direction,
just--and I know this is a bit of a lark, and there are other
components that go into that food price. While our farm
policies in this country subsidize certain commodities crops--
or make them more expensive around the world. I once sat down
with some agricultural economists who basically said U.S.
agricultural policy kills people in Sub-Saharan Africa. So when
you talk about the food prices, particularly what we see around
the world, and some of the protests breaking out, what is a
combination of just purely organic inflation and also
government policy.
Mr. Lehrman. Government subsidies in the agricultural
sector, as you suggest Congressman, are themselves very
controversial. In the end, if I can make it brief, it is a
question of, compared to what?
The common agricultural policy of the European Union
causes, for example, corn prices and wheat prices and they too
are great producers and exporters, to be about twice or more
the level of basic agricultural prices in the United States
because the United States farmer is the most efficient producer
of all basic food goods and high-protein goods such as meat
products, in the world.
So, that the elimination of subsidies in the United States,
it is true, might make the production, the total output of farm
goods sometimes--in some areas in which we export 50 percent of
our own output to the world at very cheap prices relative to
the rest of the world, those subsidies might reduce the prices,
but it is also true I think that the profitability of the
industry would change and the supply therefore would contract
in the U.S. market in general and thus make less of our output
in the farm sector available for export to countries: (A) which
do not product sufficient food to feed their population; or (B)
have to buy much more expensive goods subsidized at much higher
rates of subsidy from the European Union.
Mr. Schweikert. Mr. Lehrman, I know we are not doing
agriculture, but isn't there also, the flip side of that
domestic agriculture in these foreign countries is also
suppressed because we import a cheaper product than they can
actually produce it domestically?
Mr. Lehrman. If I understand the question, are they able to
import U.S.--
Mr. Schweikert. No, no, yes, often our commodity hits the
country often at a price that is sometimes below what they
would domestically produce. And so therefore all--
Mr. Lehrman. That is correct and that is because we produce
it so cheaply in this country relative to the rest of the
world.
Mr. Schweikert. And therefore, if we hit any price bumps or
those things there they have no domestic agricultural safety
net?
Mr. Lehrman. They do not, in some countries, most countries
have a--most countries that are well advised have a food
sufficiency strategy, the Chinese being a particular and a good
example of this. Whereby believing that they always have to be
prepared for a war, that--and this used to be the United
States' policy, that food sufficiency in time of war, total
war, was absolutely indispensable since only a blue water navy
could fully protect the sea lanes in order to import food in
the event it was blockaded by the enemy.
Mr. Schweikert. Mr. Chairman, may I ask unanimous consent
for another minute or 2 minutes?
Chairman Paul. Granted, yes.
Mr. Schweikert. Now, back to what I was actually really
hoping to ask. Okay, if I was a market observer and I have a
fixation of watching bonds and bond futures, but I think one of
those over there said as his birthdays move along he sometimes
isn't sure what those numbers really mean. If you were me and
you are trying to watch the financial markets, where do I go to
see a tell of both my future on interest rates and a tell of my
future in inflation? Let us start from the far side and come
back.
Mr. Salerno. I think the tell on inflation is the long-term
bond markets which will crystalize inflationary expectations in
the longer-term bonds. And I think contrary to what Chairman
Bernanke and the Fed believed when they engaged, when they
undertook QE2, long-term bond rates did not fall they went up.
And that because of the expectations that were stimulated, of
an inflation in the future.
Mr. Grant. With respect, I think that there is no long-term
tell on anything, especially inflation, especially interest
rates. Two examples from history, one in 1946, April, the long-
dated U.S. trades at an astonishingly low 2.2 percent, 2.2
percent. At that time, the CPI was running in double-digits
when General Marshall delivered his famous Marshall address at
Harvard the next year, the CPI was even higher, close to 20
percent, bond yields rather lower, but Marshall was looking
backwards. He was looking at the Depression and not forward to
the prospects of a full generation of inflation and rising
interest rates, observation number one.
Observation number two is, in the spring of 1984, bond
yields are quoted at 14 percent, 14 percent and the CPI is at 4
percent, the market was looking backward to the experience of
the tumultuous and wholly profitless period, 35 years of a bear
market in bonds, rising interest rates, 1946 to 1981.
So the bond market to me is like an--it is like a badly
trained waiter, looking at his shoes, looking left, not meeting
your eye. He is--the bond market is an arbitrage market, that
is it is priced, principally, I submit, off of the cost of
financing a portfolio of bonds and not with regard to a
possible scenario for the future.
The stock market is meant to look forward, the bond market
I think is rather present minded.
Mr. Lehrman. Observation three, agreed on all the
propositions that Mr. Grant just put forward. The one
exception, I believe, on forecasting, would be that when an
economy is fully employed, all resources--labor, capital,
savings--are fully mobilized, the banking system is fully
committed to full output and we are the authorities then
because prices were advancing to establish wage and price
controls then I think as the--as you the observer or the bond
investor or speculator, you could bet on a rising level of
interest rates and thus a falling bond market in the future.
And the example I would cite would be the infamous example
of President Nixon deploying the Federal Reserve to pump up the
money supply in 1971 on the verge of the 1972 elections.
Having--on August 15, 1971, declared the dollar no longer
convertible to gold. And in 1972 with the effects of the vast
inflation which were developing as a result of the Fed policy,
imposing wage and price control.
We know what happens after that.
Mr. Schweikert. Mr. Chairman, can I ask that there be no
more cursing like that. Those are dirty words.
Chairman Paul. Which words?
Mr. Schweikert. Wage and price controls.
Chairman Paul. Oh.
Mr. Schweikert. Mr. Chairman, would you allow me just
because there is one. In the whole sort of discussion of tells
and inflation and my fear of a classic sort of cascading event,
it is sort of the miniature version of a black swan; we float
much of our U.S. debt, very short term. Our WAM is, I think,
actually somewhat dangerously short. If we start to hit some
ticks on the short end of the curve, what--does that create a
ratcheting affect both on interest rates and therefore
inflation or should I just stop worrying about it?
Mr. Grant. No, you should really worry.
Mr. Lehrman. You should worry substantially. The average
maturity of the U.S. Treasury debt is approximately 4 years
which is very short for a country which is approaching a level
of direct debt equal to total national output. We are at the
level of interest rates now subsidized by the Federal Reserve,
despite their marginal rise, as Professor Salerno suggested, we
are at the level of interest rates to rise close to market
rates which are typical of full employment.
The level of debt service payments would rise by an order
of magnitude, consume that part of the Federal budget, the
total Federal budget which today is almost unthinkable and
could be only as little as 4 or 5 years away.
And all of the talk about cutting $100 billion of spending
would be consumed by the fact that the level of interest rates
had risen from several hundred billion to as much as $700
billion, $800 billion. So the political leaders of our country,
the Congress, need to worry very much about a rise in the level
of interest rates from their present subsidized level to market
interest rates associated with a more fully employed economy.
Mr. Grant. Think about how this might just look in
retrospect. We are sitting here in 2011, we have a Federal
Reserve that is suppressing money market interest rates, it is
funds rate notoriously is zero. We are running $1.5 trillion a
year, public deficit we are running deficit on current account
of 3 percent to 4 percent, 5 percent, depending on the fiscal
quarter, of GDP. We are enjoying generation low market interest
rates and the measured rate of inflation as they measure it is
comfortable.
That is the moment--and one can imagine looking back on
this moment saying, couldn't we see that this was Nirvana that
nothing better was going to be coming down the pike. In fact,
as Mr. Lehrman has suggested, market interest rates were going
to revert to something like normal. So if the long-dated
Treasury bond goes from 3.25 percent to 6 percent, and if money
market interest rates go from zero to 3 percent, or 4 percent
that presupposes an immense increase, as has been suggested, in
the cost of financing these debts, these are the good old days
with respect to interest cost.
Mr. Schweikert. Anything else to be shared?
Mr. Salerno. I agree with both Mr. Grant and Mr. Lehrman.
Mr. Schweikert. All right. Thank you for your tolerance,
Mr. Chairman.
Chairman Paul. You are welcome. Thank you.
I have a couple more additional questions that I want to
touch on before we adjourn. The opposition, those people who
believe in a monetary system quite different than you describe,
the people who believe in Fiat money and the creation of money
out of thin air, do they deliberately have a purpose for
dealing with the debt? We know that the debt won't be paid, do
they actually believe that it is a proper policy to liquidate
the debt by just reducing the debt by devaluing the money
because real debt goes down?
If you have a $14 trillion debt and you can get inflation
going again, because I sense when I talk to individuals at the
Federal Reserve that they would sort of like inflation to come
back.
Do they ever actually in their writings describe that this
is one way you can handle the debt? And likewise, is there ever
an argument by those who believe in that system that this is
one way you can lower real wages without lowering nominal
wages? If there is a correction it is necessary, wages, maybe
they should go down.
But nobody can quite accept the idea of, we are going to
lower your wages, but we will lower the real wage by inflating
the currency. Do we have evidence that they actually use that
as a policy? Would anybody care to answer that?
Mr. Salerno. In academic writings, increasingly they are
talking about adjusting wages through the device of inflation.
As far as the debt is concerned, it is hard to know people's
motives but the standard argument is that we owe much of it to
ourselves and increasingly more to the rest of the world but
that we would still, as a reserve currency, we can pay the rest
of the world off by simply printing money to pay those debts.
They don't go on and say that in fact what we are really
doing is repudiating the debt over time.
Chairman Paul. I have trouble, politically, as others
would, to describe our position about what to do when a bubble
forms. Those of us who believe in sound money don't create the
bubbles; they come from the excessive amount of credit that is
created.
But when the crisis hits and the bubble bursts, we can do a
lot of things like we have done in the last 2 years--we just
turn off the printing presses and the spending and hope that is
going to take care of it. Others would argue that we just do
nothing like we did in 1921. How do we handle this politically,
because right now it is virtually impossible to talk to--people
are saying, let us just not do anything. Any suggestions on how
you present this to people who want to and feel compelled to do
something?
Mr. Grant. I have a modest suggestion speaking as a non-
politician. I would suggest, as an interim step before the
promulgation of a new gold standard, let us say as an interim
step to that, I would suggest to the Congress, respectively,
that the Congress admonishes the Federal Reserve to speak in
plain language, in plain English. For example, ``quantitative
easing'' should be called money printing. ``Quantitative
easing'' should not be allowed in the official discourse.
Similarly, the chairman used the phrase ``portfolio balance
channel'' to convey the Fed's intentions to manipulate stock
prices higher. In place of ``portfolio balanced channel,'' I
would suggest the Congress admonish the Fed to use the term
``thimble rigging,'' an ancient Wall Street term, or a little
more clinically, ``manipulation.'' So if we talk about money
printing and manipulation, the public will understand what is
afoot. These three-dollar words signify nothing, and I think
that Congress should outlaw them.
Mr. Lehrman. I wish not to assail the motives of any man.
But I would say, directly, in answer to your question, Dr.
Paul, that it is not, I think, correct to blame or to assign
motives to those who are manipulating the monetary system. We
live in America, in a world of institutions that were created
over time and created a set of facts and circumstances in which
men and women find themselves operating.
The academics believe that the Federal Reserve System
should be a form of the GOSS plan; it should be sort of general
manager of the national economy if not the world economy. But
they have been trained to think that way. In the economics
department of almost every graduate school, this is the way
they are trained to think. They are either neo-Keynesians or
they are members of, if you will permit me to say it, the
discredit moniterus school.
So that it is sufficient to say that the system is flawed,
it is imperfect that the Federal Reserve manipulates interest
rates as well as the money supply. That foreign officials, the
governments are financing the Treasury, creating inflation,
without attributing base motives to the individuals who are
operating in a set of institutions which were bequeathed to
them sort of by chance or by historical developments rather
than by any satanic design.
Mr. Salerno. From an academic perspective, Keynesian
economics and even the moniterus have no place for bubbles in
their theories. They deal with the effect of the money supply
on current production and employment, and so on. So that when
Chairman Greenspan made a statement that--in the early part of
the last decade, there is no bubble, you wouldn't know if there
was one and if there was one we wouldn't do anything about it
because it would cause recession.
Most macroeconomists agreed with him. Now, that is starting
to change and they are starting to cast around for some sort of
an explanation of bubbles. But what they have seized on now is
irrationalities in the markets which certainly from the off
stream perspective, it is not true. What we look at is the
manipulation of the interest rate by the Fed, there is a ready
explanation for the creation of bubbles.
Chairman Paul. I had a Federal Reserve Board Chairman
testify before the committee that the gold standard had some
merits but it was unnecessary because central bankers have now
learned how to manage a Fiat currency in a manner in which it
would mimic the gold standard. Would anybody care to comment
about where the flaw is in that thinking?
Mr. Lehrman. I am anxious to comment on that, Dr. Paul.
Under--and I must say Mr. Greenspan made the same insipid
remark. Mr. Greenspan and Mr. Bernanke will have to then
explain why it was that two of the greatest booms in American
history, and two of the greatest panics and busts in American
financial history, occurred under their 25-year watch.
We have the just unparalleled boom in the U.S. equity
market focused on the Internet stocks of the late 1990s and a
collapse under Mr. Greenspan's tutelage of not only the stock
market but a fall in the economy and a rise in unemployment.
This is not what Mr. Greenspan, I think, believes would be the
characteristics of an economy regulated with a stable price
level, under the gold standard.
And equally, Mr. Bernanke himself, who was the Vice
Chairman of the Fed under Mr. Greenspan, would have to explain
the near catastrophic boom generated by the Federal Reserve in
the real estate market in the United States among other
markets. The great panic and the bust which have then led to
Mr. Grant's quantitative easing one, two and--
Mr. Grant. Money printing.
Mr. Lehrman. --money printing, one, two, one and two. So
that this is just an--it is incredible that a responsible
academic economist from Princeton or one preceding him, from
NYU, could have the temerity to suggest.
All of their 25 years presiding over the U.S. monetary
system is a witness to the contrary.
Mr. Grant. I would say something a little bit different,
and I would echo Mr. Lehrman's earlier observation that gold
standard is the least imperfect system, but it is not people-
proof. Long before the Federal Reserve was conceived, let alone
enacted, we saw plenty of booms and busts. We got rich we got
poor, there was a terrific boom in Great Plains farm land in
the 1880s, Moody's hadn't even been invented.
For a really fouled-up economy, you don't need anything
except people; that goes without saying. But what the gold
standard did was to introduce an element of reciprocal movement
in money from one country to the next, in one country that
participated in the gold standard to the next.
So I think the telltale feature of our present day
landscape that shows you how far we have come from the gold
standard is the existence of the 3 trillion and counting dollar
bills on the balance sheets of our mercantilist counterparts,
counterparties, in Asia.
That never happened, it couldn't have happened in the gold
standard because creditors and debtors exchanged cash to clear
trades.
The failure of AIG is so instructive in this respect. AIG,
this immense insurance company with this ever so brilliant
financial products group, didn't do one thing. It didn't mark
its positions to market. Finally came the day of judgment and
it argued with Goldman Sachs about what these things were
worth, AIG said 100 cents on the dollar, Goldman Sachs said not
close, Goldman Sachs won that debate and AIG failed.
As with AIG and Goldman Sachs, so it is today with the
United States and its Asian trading partners. We never clear
our trades. Our dollars go there, and they come right back
here. We run 25 consecutive years of debts on a current account
and there will be for us, as there was for AIG, a moment in
truth in which we must settle.
Mr. Salerno. I just want to add that the statement that you
quoted by the Fed Chairman shows a complete innocence of any
familiarity with the history of monopolies. The Federal Reserve
has a legal monopoly of printing money. In history, every
monopolist that has been granted a legal monopoly has used it.
Now, they could use it for motives they believe are
altruistic. You can use it to cure unemployment or think you
can use it for that. Or to keep interest rates low. But the
point is, even if Mother Teresa was reincarnated and was given
this monopoly, she would use it to print money to feed poor
people, but the effects would be exactly the same: bubbles;
manipulated interest rates; and inflation.
Mr. Lehrman. I want to demur. I think Mother Teresa would
be a sound money lady.
Chairman Paul. I want to thank our very excellent panel for
participating in this very important hearing.
I have a couple of announcements before we adjourn. Without
objection, all members' opening statements will be made a part
of the record. The Chair notes that some members may have
additional questions for these witnesses which they may wish to
submit in writing. Without objection, the hearing record will
remain open for 30 days for members to submit written questions
to these witnesses and to place their responses in the record.
This hearing is adjourned.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
A P P E N D I X
March 17, 2011
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