The Audacity of Pessimism

Academics throw econobabble at Jim Grant's bow-tie...

JIM GRANT, the bow-tied voice of old-fashioned economic wisdom, likes to call today's monetary arrangements the "PhD Standard", writes Nathan Lewis of New World Economics in this article first published at Forbes.

That's compared, of course, to the gold standard that the United States embraced for a stretch of nearly two hundred years, until 1971.

This is a joke, a punchline – and yet, like many of Grant's wisecracks, there is more to it than may first appear.

The gold standard is pretty simple. You just keep the currency's value linked to gold, such as the $35 per ounce. gold parity that prevailed before 1971. Gold serves as the best practical approximation of a standard of "Stable Value", a universal constant of commerce much as the kilogram or meter serve as unchanging standards of weight and length. Interest rates are left entirely to market forces.

There are really only two possible criticisms of the gold standard: one, that gold's variance from the ideal of Stable Money is large enough to cause probleMs.There is, I would argue, little to no evidence of this over centuries of history.

The other is: that, like any fixed-value system including the fifty-plus countries using the Euro as a "standard of value", it does not allow discretionary funny-money manipulation of the economy. You can't use monetary distortion to attempt to ameliorate nonmonetary problems.

Once you choose gold, you sort of put your faith in it. It has worked in the past. Will it work in the future? We hope so. No reason why not. If it doesn't, then we can try something else. But, that day has not yet come.

Grant's other option is the "PhD Standard". If you aren't using gold, then you are putting your faith in the opinions of people bearing PhDs.

These opinions can be based on a dizzying array of conceptions and goals. Phillips Curves, Taylor Rules, mechanistic "rules-based" systems, CPI or NGDP targets, monetarist targets using a wide variety of indicators, interest-rate targets, ad-hoc reactions to all sorts of economic statistics, ever-shifting goals drifting from "stable value" to "macroeconomic stability" to "full employment", a growing catalog of novel concoctions including "negative interest rates", QE, interest on reserves, reverse-repos, coordination of Treasury deposits at the Fed, "Operation Twist", long-term interest rate targeting, changes in foreign exchange rates, adjustments in reserve requirements, the ebb and flux of academic fashion, the endless scrum of one notion over another, picked up or dropped, combined together or excluded, for any of a thousand reasons or no reason at all.

Some people get very involved in this process. They are sure that, with the benefit of their brilliant insight, we will somehow have a better result than we have had from the brilliant insights of past generations of PhD-wielding money manipulators. But, for most of us, we are left with little more than faith that this process will somehow produce a good result. This is the "PhD Standard". Our money is based – instead of gold – on this endlessly raging tempest of econobabble.

At first, in the early 1970s, there was a lot of confidence and consensus among economists about how things should be done. They were going to teach us all how to funny-money our way to glory. Unfortunately, it was a total failure: when Nixon gave them the car keys in 1971, the result was a stagflationary car crash. The general trend over the following forty years has been an increasing fracturing of consensus until, today, it seems that even central bankers themselves are completely confused and demoralized.

Am I being a little too harsh? Let's see what Mervyn King, former governor of the Bank of England, had to say in his recent book The End of Alchemy: Money, Banking and the Future of the Global Economy (2016):

"Only a recognition of the severity of the disequilibrium into which so many of the biggest economies of the world have fallen, and of the nature of the alchemy of our system of money and banking, will provide the courage to undertake bold reforms – the audacity of pessimism."

Three cheers for the PhD Standard! Okay, one cheer. Actually, no cheers. Actually, his "audacity of pessimism" is to say that: this isn't going to get any better, until we fix it – until we, as King suggests, End the Alchemy.

We aren't going to get there by replacing one guy's alchemy with some other guy's alchemy.

King is not the only one. Former Federal Reserve Chairman Paul Volcker called for a "new Bretton Woods," and his successor Alan Greenspan sings the praises of the pre-1914 Classical Gold Standard. Not an Alchemy advocate among them.

Over the past century, we have had a lot of experience with the "PhD Standard". It has been the only game in town since 1971; and there were many examples before that time too. Unlike the gold standard, this has never worked very well. Sometimes, it has been an outright disaster. We place our faith not in the idea that what worked brilliantly in the past will work in the future, but the idea that what has never worked well in the past can somehow be reformed.

In 1927, when the "PhD Standard" was more of a daydream among certain fringey economists rather than something that anyone actually did, George Bernard Shaw warned us:

"The most important thing about money is to maintain its stability...You have to choose between trusting the natural stability of gold and the honesty and intelligence of members of government. With due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold."

With ninety years of hindsight, can we now say that Shaw was wrong? I don't think so. I think he was the opposite of wrong.