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Price Stability Is An Economically Dangerous Fad

The commentary below is for the benefit of our readers from opinion makers and writers not associated with Euro Pacific. We do not guarantee the accuracy and completeness of third-party authored content. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific, or its CEO, Peter Schiff.
By: 
John Tamny
December 6, 2010

Amid the handwringing about the Fed’s charitably naïve attempts to stimulate the economy through “quantitative easing,” there’s an understandable drive among some Fed critics to severely reduce its mandate. Specifically, their proposition is this: the Fed can’t create jobs as its defenders inside and outside the central bank presume, so better it would be limit its role to that of inflation watchdog.

All that is fine on its face, but in seeking to redefine the Fed’s doings, naysayers have latched onto the false notion of “price stability.” A recent editorial argued in favor of repealing the Fed’s dual mandate so that it can concentrate “on the single task of stable prices.” Politicians, such as Reps. Paul Ryan and Mike Pence, have similarly called for price stability in working to redefine the activities of the world’s foremost central bank.

Sadly, handing the alleged wise men at the Fed control over prices is every bit as mistaken as allowing the central bank to manage unemployment.

Indeed, it is through prices that the market economy is organized. In that certain sense, prices rise and fall with great regularity as consumers tell producers what they want less and more of. Assuming the Fed could do what it cannot — fine tune economic activity on the way to stable prices — we would be much worse off if Bernanke et al were to actually succeed.

To see why, it has to be remembered that the cure for high prices is in fact high prices. Or better yet, high prices foretell low prices.

If producers create a consumer product that fulfills unmet needs on the way to high prices, the latter is the signal to other producers to enter the market for the same good on the way to lowering its cost. Gyrating prices are the necessary market signal telling businesses what we need.

Taking this further, if price stability were policy, it would still be the case that a phone call from Houston to Dallas would cost $15 for a half hour of conversation. It would similarly mean that we’d be paying thousands of dollars for flat-screen televisions, and even more for computers that perform very few functions.

What Chairman Bernanke doesn’t understand, as evidenced by his scary presumption that falling prices are an economy killer, is that prices naturally fall all the time. A world of stable prices would not only be one of greatly reduced living standards, but also one marked by very little innovation.

As Karl Marx of all people long ago observed, a demand once satisfied engenders new demands that producers will logically attempt to fulfill. Falling prices not only enhance our standard of living, but they also expand the range of goods we can access alongside the expansion of our ability to save. The latter ensures that entrepreneurs will have access to greater amounts of capital that will enable them to remove even more unease from our lives.

Importantly, none of this is deflationary. Once again, if the price of one product falls, we can then concentrate our demand elsewhere for what was formerly out of reach, thus driving up the cost of those goods. Inflation and deflation are solely monetary concepts of dollar strength/weakness, and if the value of the unit of account is stable, there can be no inflation or deflation.

In that case, rather than price stability, the sole goal of monetary policy should be dollar-price stability. Fed officials would credibly argue that the latter is the preserve of the U.S. Treasury, and they would have a point. Be it Treasury, or Treasury working with the Fed, the mandate should be in favor of stabilizing the dollar’s value.

Oddly enough, Marx once again had the answer there. Marx, much like the classical economic thinkers of his era, knew that for money values to be stable, they would have to be defined in terms of gold. Marx referred to gold as “money, par excellence.”

Looked at through the prism of today, the dollar lacks a golden anchor, and the result is a money illusion that distorts the real price of everything. Worse, with consumer prices sticky in concert with commodity prices that are most sensitive to dollar-price movements, the beneficiaries of the money illusion tend to be the hard, unproductive assets of yesterday (think housing, art, rare stamps, and oil) that are least vulnerable to currency weakness, and which in fact do best when the unit of account is devalued.

Considered from an investment standpoint, commodities such as oil and gold continue to rise in nominal terms while the dollar falls, but sticky consumer prices remain relatively stable. The signal to investors is to redirect limited capital away from the entrepreneurs creating business and consumer innovations whose earnings will be eviscerated by the dollar’s weakness, and into commoditized assets such as oil that realistically only have value thanks to past innovations of the mind.

Simply put, the economy suffers not so much a lack of price stability (it’s once again the last thing an economy would need), but a lack of dollar-price stability that is driving always scarce capital into defensive assets least likely to be devalued in real terms by monetary mischief in Washington. As is always the case, there are no innovative companies and jobs without investment, but the dollar’s weakness and instability understandably has investors unwilling to commit capital for dollar-denominated returns that will likely be cheaper down the road.

The answer to all of this is very basic. Price stability is a utopian concept, and a misguided on at that. If achieved, it would hamper innovation on the way to reduced living standards.

The obvious goal should be dollar-price stability, as gold can provide, that would allow investors to rate ideas on their actual merits, as opposed to how they’ll perform amid a volatile and weakening dollar environment. Fix the dollar, and you fix the US economy. Simple as that.

John Tamny is editor of RealClearMarkets, a senior economic adviser to H.C. Wainwright Economics, and a senior economic adviser to Toreador Research and Trading.

Article originally published on December 5th, 2010 at forbes.com. John Tamny, Forbes, H.C.Wainwright and Toreador Research and Trading are not affiliated with Euro Pacific Capital, Inc. Euro Pacific Capital does not guarantee the accuracy and completeness of third-party authored content.