News reports indicate Republicans have finalized their policy platform for November’s elections. The two main economic planks - keeping tax rates low and cutting spending - provide strong legs for the party’s economic message.
However, the GOP policy stool is missing a vital third leg: sound money.
While eyes tend to glaze over at the mention of monetary issues, most Americans intuitively appreciate the subject. They understand that when the dollars in their pockets lose value, the value of their work and savings declines too, impacting their decisions to work and invest. As Steve Forbes recently summarized, “A weak dollar means a weak recovery.”
What do we mean by sound money? A currency is sound if it maintains its value compared to real things, especially raw materials that come from the earth, i.e., commodities. Historically, the most stable commodity has been gold, which is why it has been humanity’s most reliable barometer of currency value.
Today, currencies float, meaning they fluctuate in value. In other words, they are unstable, inflating when they are oversupplied relative to market demand, deflating when they are undersupplied.
Why should we care about sound money? Unstable money leads to investment bubbles, causes important commodities such as oil to rise or fall rapidly, distorts international trade and capital flows, and damages creditors or debtors. In short, unstable money causes the market system to weaken and eventually break down. When people lose faith in the most basic financial unit - their money - it creates a domino effect across the economy.
Currencies fluctuate because of central bank incompetence or the mistaken belief by government leaders that an economic advantage may be had by manipulating the currency’s value. Monetarists, for example, suggest that consumption may be stimulated and employment increased by elevating the money supply. Many Keynesians think trade deficits can be reduced by lowering the currency’s foreign-exchange value, thereby making exports cheaper and imports more expensive.
The U.S. has been through two historical eras in which it attempted to increase exports with a weaker dollar: 1971-1980 and 2001-present. Not coincidentally, these eras featured commodity and real estate booms, weak stock markets and flat or declining wages. Both eras featured sharp currency reversals, from weak to strong, resulting in crashes and recessions.
In April at the Heritage Foundation, RobertMundell, the Nobel laureate and creator of the supply-side economic model, explained that dollar instability was a primary cause of the subprime and financial crises. He suggested that the dollar’s significant fall against gold and other currencies from 2001 to 2008 overstimulated the real estate boom, leading to the bubble and bust as capital flowed from the productive economy into hard assets.
The Federal Reserve, Mr. Mundell argued, caused the subsequent financial crisis when it tightened the money supply in the summer of 2008, leading the dollar to rise sharply in the middle of the subprime crisis. The dollar shot up against the euro, gold fell, oil plummeted, and consumer prices cratered. A nasty but manageable downturn became a systemic crisis.
Such dollar volatility - rising (as in the late 1990s), then falling (2001-08), then rising again (2008), then falling again (2009-10) -distorts capital flows and has created tremendous uncertainty. Supply-siders think the world is in turmoil today because of U.S. monetary authorities’ failure to keep the dollar stable over the past decade.
To be sure, the era of near-complete dollar stability was ended in the early 1970s when President Nixon severed the dollar’s link to gold. But a key element of President Reagan’s successful economic reforms was recommitting to sound money after the 1970s weak dollar fiasco. While the dollar/gold price was never fully stabilized, Reagan ushered in almost two decades of relatively low dollar volatility, which underpinned 1980s and ‘90s prosperity.
Until the GOP retakes the executive branch, it will not be in a position to set monetary policy. Nevertheless, a Republican Congress could repeal the Federal Reserve’s schizophrenic mandate to target price stability and employment, in favor of the former. It could hold hearings on the unstable dollar’s impact on business and trade. And it could pressure the Obama administration to negotiate exchange-rate treaties with China and Europe to prevent destructive future fluctuations among these key currencies. In short, it could pave the intellectual way for a 2012 Republican presidential candidate fully dedicated to restoring sound money as the foundation of American prosperity.
For constituents concerned about high prices for oil and food, for exporters afraid to make long-term commitments to trade abroad and for investors sidelined into hedges rather than the productive economy, Republicans should add a sound money component as the third leg of their policy stool.
Sean Rushton worked in the Small Business Administration during the George W. Bush presidency.