George Bush has nominated Ben Bernanke, Chairman of the President's Council of Economic Advisors, as Alan Greenspans successor to head the Federal Reserve Board of Governors. This is undoubtedly Bushs most important appointment. If confirmed, Bernankes policies will have a major impact, not just on our own economy, but on the economy of the rest of the world as well. Even mere words from the chairman of the Fed, such as irrational exuberance, have the ability to talk markets down or up. Considerable news coverage is being devoted to comparisons between Greenspan and Bernanke because of the jobs power. However, we should also take this opportunity to ask more fundamental questions about our monetary institutions.
Most comparisons focus on whether Bernanke will follow inflation targets or take a more discretionary approach to monetary policy as Greenspan did. Although these questions are interesting, the more important question is whether an economy that depends so much on the choices of one man can remain stable in the long run.
For nearly thirty-five years we have been in a new monetary era. Since President Nixon closed the gold window, none of the worlds major trading currencies has had a commodity backing. The current world monetary system is without historical precedent. The value you attach to a dollar bill, or any other currency, is created by your expectation of how much others will provide you in exchange for it. Expectations can be quite fickle, which is why there is so much concern over the ability of a Fed chairman to instill confidence.
Although many take the existing monetary regime for granted, other arrangements that dont rely on something as shaky as expectations have served us well in the past and may again in the future. From the time this country was founded until the Federal Reserve was created in 1913, the U.S. operated under the gold standard without a central bank. The gold standard served us well. Despite wars and gold discoveries the overall price level of goods was approximately the same in 1900 as it had been in 1800.
The same cannot be said since the creation of the Fed. The price level today is nearly twenty times higher than it was when the Fed was created in 1913. Some of the increase occurred while we still had some ties to gold and much occurred after all links with gold were severed. In fact, even under Greenspans widely acclaimed tenure the price level has increased 71 percent.
The international classical gold standard was not discarded because it failed. It was largely self-regulating and never depended on a lone chairman to keep it stable. It was abandoned because it placed limits on governments ability to spend and inflate. World War I financing caused most major countries to leave the gold standard. After the war it was never fully readopted.
Before becoming involved in politics Alan Greenspan himself recognized the importance of a gold standard. In the 1960s he wrote, Gold and economic freedom are inseparable, the gold standard is an instrument of laissez-faire and each implies and requires the other.
Despite the gold standards success its unlikely to be reintroduced by the U.S. government very soon. However, other monetary arrangements are still possible. As technology evolves, private forms of money may crowd out the importance of government money. Peter Thiel, co-founder of PayPal, said that in 2000 his company thought, were going to replace every government currency in the world. Although PayPal is an alternative payment system its not an actual alternative money since it is denominated in national currencies. If other companies, which denominate accounts in commodities such as gold, like E-gold, increase to PayPals size, technology may yet provide alternatives to government money.
Nobel Laureate F.A. Hayek argued in his 1976 monograph, The Denationalization of Money, that private firms should be allowed to compete with government money and that the competition would provide a more stable and sound currency. With globalization, technological change, and firms like PayPal and E-gold we may eventually get there. In the meantime, as the Fed changes personalities, it is important to keep in mind that our modern monetary system, based entirely on expectations, has existed for only a brief time and its stability should be monitored cautiously.
Benjamin Powell is a Senior Fellow at The Independent Institute, Director of the Free Market Institute at Texas Tech University, and former President of the Association of Private Enterprise Education. Dr. Powell received his Ph.D. in economics from George Mason University. He has been assistant professor of economics at San Jose State University, a fellow with the Mercatus Center's Global Prosperity Initiative, and a visiting research fellow with the American Institute for Economic Research. Benjamin is also the editor of Housing America: Building out of Crisis.
Full Biography and Recent Publications
See the Independent Institute book, Money and the Nation State.