A Critical Appraisal of a Hero of Central Monetary Planning

We apologize for publishing this Report late. We have been very busy developing the business. Last week the price of gold moved up $16, and that of silver $0.39. Almost two groceries leaked out of that store of value par excellence, bitcoin. But hey, stocks are up!


We admit to having a soft spot for the politically incorrect Paul Volcker. He frequently expressed bemusement at the newfangled obsessions of his successors at the Fed (as an example, at a conference in 2006 he remarked on the increasing emphasis on “core” inflation: “A great mantra of central bankers these days is ‘inflation targeting.’ I don’t understand that nomenclature. I didn’t think central bankers were in the business of targeting inflation. I thought we were supposed to be targeting stability.” h/t Grant’s). Nevertheless, we are on board with the criticism voiced below. Volcker was indeed instrumental (along with Milton Friedman, otherwise a champion of free markets, but oddly blind to the insidious nature of a monetary central planning agency) in persuading Nixon to abandon the last remnant of the gold standard, the Bretton Woods “gold exchange standard” that permitted foreign central banks to exchange their US dollar reserves for gold at a fixed exchange rate. Not only did this decision unleash a decade of economic and currency market chaos, it ultimately paved the way for the unbridled expansion in money and credit in train since the early 1980s. In the meantime we have arrived at a juncture where central banks are “forced” to adopt ever more insane policies as they rush from trying to prevent one potential systemic collapse after another. [PT]


Former Fed Chairman Paul Volcker passed away this week, at the age of 92. The consensus among liberals and conservatives, Keynesians and Monetarists, free marketers and central planners is that Volcker beat inflation. While the various publications by and for these groups write their hagiographies, we find ourselves writing something more critical.

Ironically, for a man with a reputation for fighting inflation, Volcker helped persuade President Nixon to “temporarily” suspend the convertibility of the dollar into gold. He may be widely hailed as beating inflation, but severing the last link between the dollar and gold is widely condemned as unleashing it.

We have two things to say about the idea that a man—we are not picking on Volcker per se — beat inflation and stabilized a floating, irredeemable fiat currency. One, this is tantamount to saying he is a good central planner. A central planner is to an economy what a virus is to the body. A foreign particle that takes over and reprograms the cells with a destructive code.

We must get up to the rooftops to bellow that it is not just a matter of finding the right man to make central planning work. There is no right man, and there is no right central plan. Even if the right quantity of dollars were static (it varies moment by moment like everything else in the economy), and even if the Fed could know what that right quantity is (it cannot), the mechanism by which it would change the quantity of dollars is all wrong.

A free market is a process, not an end result such as a price or a quantity supplied. The central planner – even if he set the right price — would not create the same effect as the free market because he would not be creating the same cause. The question is never which man should be Economic Dictator (to use the fictional title from the novel Atlas Shrugged). It is the existence of the institution itself.

Two, the very theory agreed by those liberals and conservatives, Keynesians and Monetarists, free marketers, and central planners—the Quantity Theory of Money — is wrong. Changing the quantity of dollars does not change inflation the way people suppose.

As Knut Wicksell observed in the 1890’s, but has been forgotten, the price level correlates to the interest rate, not the quantity of money (or dollars). That is, higher interest rates cause and are caused by higher prices. And Volcker, to fight rising prices, raised the interest rate. It is a ratchet mechanism.

However, there is a limit because the rising cycle is characterized by corporate borrowing to increase inventory of commodities. That is, they go deeper into debt to increase their hoarding of things which have declining marginal utility.

Ultimately, the cost of borrowing exceeds the profits to be made hoarding commodities—i.e. waiting for prices to rise before selling one’s product. Then bankruptcies and liquidations begin. And the rising cycle is broken, initiating a falling cycle.

We don’t want to get too deeply into our  theory of interest and prices here. But we do want to note that whatever Volcker may have thought he was doing, and what people even today four decades later believe he did, it just does not work that way.

The Fed centrally plans the single most important price in the economic universe: the price of credit. Specifically, overnight credit. This is an awesome power (which no-one should possess). However, there is a limit to this power. The price of long-term credit is subject to market forces, and they interact with the force applied by the Fed to create a dynamic. This dynamic is characterized by a positive feedback loop. That is, the system tends to run and run in one direction for decades.

When Volcker was appointed in 1979, the trend of rising interest and rising prices had been going on since the end of WWII. Here is a graph of the Fed Funds Rate, the rate dictated by the Fed. It begins in 1954 (the earliest data the St Louis Fed provides in this series).


Federal funds rate since 1954. Let’s just say that this is not exactly what we imagined “stability” would look like. [PT]


The rate is a consistently rising trend, with one exception. The Fed pulls it back, once it has triggered a recession. Each time the pullback ends on a higher low (the opposite of the trend today, with lower highs before each recession). We assume most readers know that consumer prices were rising relentlessly during this period.

By the time Volcker got into power, this trend had been running for so long that it would have been inconceivable for it to reverse. Much less to reverse on its own. To make it stop, the Fed would have to do something.

Like the doctors who let the blood of their patients, based on the current medical science thinking of their day, the Volcker Fed pushed up the interest rate further. The time of managing the interest rate was over (you can see how well their management worked in the chart above). Based on the current monetary science thinking, now the Fed would manage the general price level. Or at least the quantity of dollars which is held by said monetary science thinking to be causal of the general price level.

Invalid theories can persist a long time. Sometimes, shortly after bloodletting, the patient would recover. His body finally eradicated the influenza virus or staphylococcus bacteria. People — especially the doctor and the patient — thought that the bloodletting worked.

Have you ever noticed that on many elevators, whether you press the Door Close button, or whether you don’t press it, the doors close in about three to five seconds? Did you know that experiments show that when rats are addicted to cocaine, they will keep pressing a bar to get another dose of drug even after researchers have removed the drug?

Volcker immediately began pushing rates up. He relented when a nasty recession occurred. We assume that some doctors would cease bloodletting, if the patient became pale. In any event, he resumed and raised rates again.

In this case, we can’t really say that that the corpus economicus got better. This part is not analogous to the body defeating an infection. A closer analogy would be that the giant Wrecking-Ball-of-the-Economy had wreaked its damage on the north side of the street and began to swing to the south side. When it begins destruction on this side, nothing repairs the damage on the other side.

The north side, of course, is rising interest and prices. The problems of that era were well-known then, and are still well-known now.

The south side is falling interest and prices (or soft prices, if ever-increasing mandated useless ingredients prevent them from falling). Manufacturers struggle to make enough margin to service their debts, much less cover their cost of capital.

People now speak of the “post-industrial” economy and a “post-manufacturing” world. Of course, this doesn’t mean that we don’t make things any more. Would you please excuse us as we finish typing this on a computer connected to the Internet, leave our office and trust the motion-sensor light to turn off, take the elevator down, get in a car, and drive to a restaurant that cooks meat in a kitchen with sophisticated equipment?

All of those things have to be made. What people mean by this phrase “post-industrial” is that industry is not where the value is. They are right, sadly, that the value is in finance and especially where capital gains may be made. Industry struggles to earn scant profit margins… quick, somebody lower the interest rate!

The problems of Keynes’ falling interest rate world are not well understood. Keynes smirked that not one in a million is able to diagnose the problem. It was true then, and it is still true now. We hope that our Report helps more people grasp the enormity (and simplicity, in a sense) of the problem.


Fundamental Developments

Let’s look at the only true picture of the supply and demand fundamentals of gold and silver. But, first, here is the chart of the prices of gold and silver.


Gold and silver priced in USD


Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio dropped this week.


Gold-silver ratio, bid and offer


Here is the gold graph showing gold basis, co-basis and the price of the dollar in terms of gold price.


Gold basis, co-basis and the USD priced in milligrams of gold


There was little change in the scarcity of gold (i.e., the co-basis) this week, though the price was up a few bucks. The Monetary Metals Gold Fundamental Price, was up $3 this week, to $1, 470.

Now let’s look at silver.


Silver basis, co-basis and the USD priced in grams of silver


The silver price rose by a greater percentage, and we see a little decrease in its scarcity.

The Monetary Metals Silver Fundamental Price rose a bit, to $16.92.

© 2019 Monetary Metals

Charts by St. Louis Fed, Monetary Metals

Chart and image captions by PT


Dr. Keith Weiner is the president of the Gold Standard Institute USA, and CEO of Monetary Metals. Keith is a leading authority in the areas of gold, money, and credit and has made important contributions to the development of trading techniques founded upon the analysis of bid-ask spreads. Keith is a sought after speaker and regularly writes on economics. He is an Objectivist, and has his PhD from the New Austrian School of Economics. He lives with his wife near Phoenix, Arizona.




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