One of the core principles of our campaign is Sound Money. I find it very unfortunate that today so many Americans are bewildered by our monetary system and unaware of the dangers of central banking. It does not have to be this way. Money and what it is, is no more complicated that any other commodity in an economic system and pretty much follows the same rules of supply and demand.
Most people understand that in an economy a fixed supply of a commodity such as wheat for example, will command a certain price based on the demand. If the supply of wheat and the demand for wheat remains fixed, then in general the price also will remain fixed. If the farmers have a good year and supply goes up, prices will naturally go down as sellers try to under cut their competitors to distribute their product. The same process occurs in reverse. If farmers have a bad year and supply goes down, prices naturally will rise. One added feature to this system is that as prices climb consumers begin to buy less and less of the commodity thus reducing demand and slowing the rate of price increase.
If on the other hand farmers hold back their product in order to get a better price in the future, this has the effect of lowering supply and thus driving prices up. If more farmers produce more wheat thus increasing supply and effectively lowering prices, it is likely that some of the less efficient farmers will then need to go out of business. This not only makes the farming business more efficient as a whole, it also has the effect of lowering overall prices for wheat, because the production of wheat is now being accomplished in a much more efficient manner.
This is just a very simple explanation of the free market setting the fair value of wheat in a free market economy. Money is no different; it is just a commodity like wheat. Its price is set by supply and demand, and is reflected in its cost which is the interest rate. In a productive society, where people are working and earning money that they do not immediately need, they will save it. As that money accumulates in the banks, the banks will lower the cost to borrow that money in order to get it out of the door, so to speak. This is a signal to the producers in an economy to borrow money and expand productive capacity. When less money is being saved or actually being withdrawn, because of a downturn in an economy, the cost associated with borrowing money increases and thus sends a signal to the producers to slow or stop borrowing. The time to begin increasing production is when there is pent up demand for this production in the form of accelerating saving rates. This will occur at the beginning stages of an economic upturn. This is the economic model described by Ludwig Von Mises and the Austrian School of Economics.
Notice that all of this occurs without anyone’s approval. The market sets up the forces that determine when expansion and contraction should occur, not a central planning authority. In our system with a central bank, we appoint a group of men who determine what the cost of money should be by manipulating the interest rates and other not so obvious methods. This does not work any better with money than it would if our system were dependent on a group of men determining the price of wheat.
The basic principle of sound money says that if you earn a dollar today you should still be able to purchase a dollar's worth of goods tomorrow. Money is just a temporary storage of wealth and a means to transfer wealth between people and institutions. The one thing that money should always be is stable and trustworthy. If due to manipulations the people begin to lose faith in the soundness of the money, then the money itself begins to be a driver in the marketplace and the decisions the people make. This should never be allowed to happen, but in fact this happens all the time now, with the Federal Reserve.
After the attacks of 911 the Federal Reserve lowered interest rates to near zero. Unfortunately, this was not the time to do this. Our economy had just come off of a Fed fueled boom in the late 90’s and needed to contract to shake out the non productive producers. Instead of becoming more efficient, our economy was becoming less efficient. The unwarranted new money, created by the Fed, found its way like it always does into mal-investment in the form of the housing boom. There was no genuine call for this increase in production, but because the economy interpreted the low interest rates as a genuine signal to increase production it did.
These asset booms and busts, recessions and depressions will continue as long as we continue to believe in the myth that 12 men sitting a room are best qualified to absorb the trillions of data points in an economy, and from that information determine what the exact cost that money should be. We would do better by going to the Oracle of Delphi, or perhaps reading the entrails of sacrificial lambs.
Stay tuned for the next installment when we discuss the Gold Standard.