One In Over Five Hundred

[Note: Friday's post was published as a Guest Commentary on Prudent Bear.com - thanks to Rob Peebles, Doug Noland and the staff at PrudentBear who do a fine job over there. By the way, the links on the PrudentBear main page are one of the best collections of financial news links you'll find on the internet.]

As a country, as a world, we have become so intoxicated with easy credit, so confident in the power of central bank monetary policy, and so sure that we are deserving of the riches that now seem commonplace, that when Congressman Ron Paul stands up in the House of Representatives and talks about sound money and limited government, the vast majority of people listening must think he is crazy.

Today's post is an introduction to Dr. Ron Paul, a Republican Congressman from the 14th district of Texas. Dr. Paul favors small government, low taxes, and sound money based on commodity currency, such as what we once had with the gold standard. He never votes for legislation unless the proposed measure is expressly authorized by the Constitution and when Fed officials give testimony on Capitol Hill, he is one of the very few asking tough questions - CNBC has an annoying habit of cutting away to the in-studio brain trust when it is Congressman Paul's turn to speak.

He is unlike any other member of the House of Representatives or the Senate - he is one in over five hundred.

His latest weekly column Congress and the Federal Reserve Erode Your Dollars is another in an impressive collection of writings about how the government and the Federal Reserve are destroying our currency and acting in ways the Founding Fathers would find appalling:

Congress and the Federal Reserve, not China, are the real culprits in the erosion of your personal savings and buying power. Congress relentlessly spends more than the Treasury collects in taxes each year, which means the US government must either borrow or print money to operate- both of which cause the value of the dollar to drop.

The root of the problem is the Federal Reserve and our fiat monetary system itself. Since US dollars and other major currencies are not backed by gold, they have no inherent value ... In essence, paper currencies like the US dollar operate as articles of faith-- faith in the policies of the governments and central banks that issue them.

A true strong-dollar policy would not depend on the actions of China or any other nation. It would, however, require a constriction of the money supply and higher interest rates, both of which would cause some short-term pain for the American economy. In the long run, however, such a correction is the only alternative to the continued erosion of our dollars.

He has had some of the most interesting exchanges with Alan Greenspan over the years. One of the best is this one from several months ago:

Congressman Paul: "So my question to you is: How unique do you think this period of time is that we live in and the job that you have?"

To me, it’s not surprising that half the people think you’re too early and the other half think you’re too late on raising rates. But since fiat money has never survived for long periods of time in all of history, is it possible that the formidable task that you face today is an historic event, possibly the beginning of the end of the fiat system that replaced Bretton Woods 33 years ago?

And since there’s no evidence that fiat money works in the long run, is there any possibility that you would entertain that we may have to address the subject of overall monetary policy not only domestically but internationally in order to restore real growth?"

Chairman Greenspan: "Well, Congressman, you’re raising the more fundamental question as to the issue of being on a commodity standard or a fiat money standard. And this issue has been debated, as you know as well as I, extensively for a very significant period of time.

Once you decide that a commodity standard such as the gold standard is, for whatever reasons, not acceptable in a society and you go to a fiat currency, then - unless you have government endeavoring to determine what the supply of the currency is - it is very difficult to create what effectively the gold standard did.

I think you will find, as I’ve indicated to you before, that most effective central banks in this fiat money period tend to be successful largely because we tend to replicate what would probably have occurred under a commodity standard in general.

I’ve stated in the past that I’ve always thought that fiat currencies by their nature are inflationary. I was taken back by observing the fact that from the early 1990s forward Japan demonstrated that fact not to be a broad, universal principle."

You may have had to go back and read that last part again - the part about central banks replicating the gold standard - is that what he really said?

That's hard to believe.

This exchange and these topics were covered in a subsequent weekly column The Maestro Changes his Tune:

First, the Federal Reserve does not mimic a gold standard by any measure. The clearest example of this lies in our current account deficit, which our fiat currency encourages. Under a gold standard we would not have exchange rate distortions between the Chinese renminbi and the U.S. dollar, for example. True currency stability is impossible when fiat dollars can be produced at will and foreign lenders bankroll our deficits.

Second, inflation is a much greater problem than the federal government admits. Health care, housing, and energy are three areas where costs have risen dramatically. The producer price index is rising at the fastest rate in seven years. Bond prices are rising. To suggest that rapid expansion of the money supply and artificially low interest rates do not ultimately cause price inflation is absurd.

Third, Fed policies do indeed have adverse political ramifications. Fiat currency and big government go hand-in-hand. Without a gold standard, Congress is free to spend recklessly and fall back on monetary expansion to pay the bills. Politically, it’s easier to print new dollars than raise taxes or borrow overseas. The Fed in essence creates paper reserves that enable Congress to undertake spending measures that far exceed tax revenues. The ill effects of this process are not felt by the politicians, who can always find popular support for new spending. Average Americans suffer, however, when their dollars are “confiscated through inflation,” as Mr. Greenspan termed it.

Well, that makes a lot more sense to me than the verbal gymnastics of our Fed Chairman. How is it that people so willingly accept whatever it is that Fed officials say?

It's reminiscent of the scene from the Wizard of Oz - "pay no attention to the man behind the curtain" and Congressman Paul is the one trying to pull the curtain back ... but no one is looking and no one cares. Everyone seems to like the idea of having a wizard - they don't understand how thing works and that's fine with them - as long as the wizard understands.

But more and more, it appears that the wizard is confused - he speaks of conundrums and warns of many dangers.

As we transition from one Fed Chairman to the next, let's hope that the next wizard is as good as the current one - or more people might start tugging at that curtain.

Most people have never heard of Ron Paul and most people have never heard of sound money - but eventually they will.