Saturday, March 19, 2011

Ron Paul's Subcommittee Hears Gold Testimony

Three gold experts, highly critical of the Federal Reserve, testified at a hearing of the House Subcommittee on Domestic Monetary Policy, chaired by Congressman Ron Paul, on March 17, 2011. Paul is a long-time critic of the Fed and author of the 2009 best-selling book End the Fed.

The three were: Lewis Lehrman, an investment banker, who served on Ronald Reagan's Presidential Gold Commission in 1981, and is head of the Lehrman Institute, a public policy foundation; James Grant, long-time editor of Grant's Interest Rate Observer and the author of five books on finance and financial history; and Joseph Salerno, an economics professor at Pace University in New York.

Here are excerpts from Mr. Lehrman's testimony:  "The Fed credit expansion, from late 2008 through March 2011--creating almost two trillion new dollars on the Fed balance sheet--triggered the commodity and stock boom, because the new credits could not at first be fully absorbed by the U.S. economy in recession.  Indeed, Chairman Bernanke recently wrote that Quantitative Easing aimed to inflate [italics added] U.S. equities and bonds directly, thus commodities indirectly.  But some of the excess dollars sought foreign markets, causing a fall in the dollar on foreign exchanges.  With Quantitative Easing the Fed seems to aim at depreciating the dollar.  In foreign countries, such as China, financial authorities frantically purchase the depreciating dollars, adding to their official reserves, issuing in exchange their undervalued currencies.  The new money is promptly put to work creating speculative bull markets and booming economies....

"The Consumer Price Index (CPI) will be suppressed because unemployment keeps wage rates from rising rapidly; the underutilization of industrial capacity keeps finished prices from rising rapidly.  Inflation has shown up first in commodity and stock prices....Bankers and speculators have been, and still are, the first in line, along with the Treasury, to get the zero interest credit of the Fed.  They were also the first to get bailed out.  Then, with new money, the banks financed stocks, bonds, and commodities, anticipating, as in the past, a Fed-created boom....But middle income professionals and workers, on salaries and wages, and those on fixed income and pensions, are impoverished by the very same inflation that subsidizes speculators and bankers.  Those on fixed incomes earn little, or negative returns on their savings.  Thus, they save less.  New investment then depends increasingly on bank debt, leverage, and speculation.  Unequal access to Fed credit was everywhere apparent during the government bailout of favored brokers and bankers in 2008 and 2009, while millions of not so nimble citizens were forced to the wall, and then into bankruptcy.  This ugly chapter is only the most recent chapter in the book of sixty years of financial disorder."

Mr. Lehrman pointed out that various changes in the way the CPI is calculated make it an unreliable inflation indicator.  He noted that if the CPI were calculated the way it was in 1980, it would show inflation now at 8 percent.

James Grant began by noting that the 1913 Federal Reserve Act says nothing about zero percent interest, quantitative easing, inflation targeting, stock price manipulation or even paper money. Grant showed the banking system is worse off because of the Fed's expansion of its role over the decades: he said Ben Bernanke testified that 12 of the 13 largest financial institutions were at risk of failure in 2008 although the GDP during the current recession has fallen no more than 4 percent, yet in the Great Depression the GDP fell 46% and most banks did not fail.

Grant said that Bernanke's zero-interest rate policy inflated price and investment values. And because “prices and investment values are the traffic signals of a market economy,” the Fed created “the unintended consequences of crashes and pile-ups on our financial streets and highways.” He also said Bernanke was the “self-appointed booster of stock prices.”

Grant explained the process by which purchasing goods from China is paid for by printing more dollars, which the Chinese central bank loans back to the U.S. by purchasing U.S. Treasury securities. It is as though the dollars never left the U.S. This maneuver is possible because of the U.S. dollar's status as the world's reserve currency. That status is a holdover from the days when the dollar was convertible into gold, but in today's parlance the dollar is now a “derivative.” The world's monetary system is now based on a derivative that has no asset value. Grant noted that if the dollar loses its status as the world's reserve currency, the result will be a lowering of the standard of living in the U.S. He also noted that the Fed should use terms that the public will understand. For example, instead of “quantitative easing,” it should say “printing money.”

Here are excerpts from Prof. Salerno's testimony: “Since it began operations in 1914 the Federal Reserve System ('the Fed') has presided over a relentless decline in the value of the U.S. dollar. Prices increased in 83 of the 97 years of the Fed’s existence....As a result the cumulative loss of the dollar’s buying power during the Fed’s existence has been staggering. For example, today a consumer pays $22.13 to purchase a basket of goods comparable to a basket that a consumer in 1913 would have paid $1.00 for. This means that since 1913 the dollar has lost 95 percent of its purchasing power and that today’s dollar is worth roughly a nickel in terms of the pre-Fed dollar of 1913...[EC: the 95 percent loss of purchasing power is based on the government's CPI since 1920, with adjustment for commodity prices before 1920; but there are other measurements that show greater inflation. See my series Monetary Mess, the Dollar, Gold—and You, Part II link]

"[I]n orchestrating this inflationary process, the Fed has repeatedly driven the interest rate below its natural market level, misleading investors and entrepreneurs and causing disastrous asset market bubbles, unsustainable business investments, and the creation of jobs that are not consistent with consumer preferences.  It is the arbitrary manipulation of the interest rate by the Fed that has caused the financial meltdowns and recessions that the U.S. economy has suffered over the last four decades.

"As technology advances and saving increases in a progressing economy, entrepreneurs and business firms are given the means and the incentive to invest in new methods of production, which in turn enable them to lower their cost and expand their profit margins.  In a given market, the natural result is an increase in the supply of the good and more intense competition among its suppliers.  Assuming no change in the money supply and continuing technological innovation, this competitive process will drive the production costs and the price of the good ever downward.  Consumers will benefit from the falling price because their real wages will continually increase as each dollar of income commands an increasing quantity of the good in exchange....

"Under a gold standard, prices naturally tend to decline as ongoing technological advances and investment in additional capital rapidly improve labor productivity and increase the supplies of consumer goods while the money supply grows very gradually.  For instance, throughout the nineteenth century and up until World War I, the heyday of the classical gold standard, a mild deflationary trend prevailed in the U.S.  As a result, an American consumer in the year 1913 needed only $0.79 to purchase the same basket of goods that required $1.00 to purchase in 1800.  In other words, due to the gentle fall in prices during the nineteenth century, a dollar could purchase 27 percent more in terms of goods in 1914 than it could in 1800....

"Ironically, while Chairman Bernanke just affirmed 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....The U.N. index of grain export prices has risen by 70 percent in the past year and stands at its highest level in 21 years.  Gasoline prices have surged 49 percent in the last six months.  According to IMF statistics, commodity prices are up by 33 percent in the past year; metal prices by 40 percent; energy prices by 30 percent; crude oil prices by 31 percent; and commodity industrial inputs by 40 percent....Mr. Bernanke has declared Fed policy quantitative easing a success on the basis of yet another financial asset bubble that threatens again to devastate the global economy.  This would be farcical were it not so tragic.  But what else can be expected from the leader of an institution whose very rationale is to manipulate interest rates and print money."

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