Andolfatto vs. Ron Paul

Given our discussion of him yesterday, and the increasing strength of his campaign, I think it's worth reprinting the post that David Andolfatto had up earlier this spring criticizing Ron Paul's grasp of monetary. The circumstances are worth recounting too. David Andolfatto works at the Federal Reserve as a research economist. He wrote this post criticizing the sitting chairman of the House committee that oversees the Federal Reserve, Ron Paul, and pointing out that the emperor has no clothes. I don't think I need to point out how that takes a lot of guts.

The supporters of Ron Paul, the Congressman who calls Obama authoritarian and who recently suggested that he's doing well in the polls because his opponents don't have principles, took deep offense at the fact that Andolfatto let his blood boil a little and called Ron Paul a "pinhead". Yes, the people who love the guy that throws around "authoritarian" got outraged at "pinhead". Andolfatto got so overwhelmed by the rage over the post that he took it down. Here it is:

"I can appreciate Ron Paul’s libertarian philosophy. And because this is so, it pains me all the more to say what I am about to say. The guy can be a real pinhead at times. And this is never so evident as in his persistent “attacks” against the Fed.

Now, of course, I work at the Fed, so maybe you think I’m just complaining for the sake of defending my employer. If you think that, I can understand why you do. It is because you do not know me.

There are legitimate arguments one could make against the Fed as an institution and/or about the conduct of Fed policy. And then there are the stupid arguments, for example, the one contained on pg. 25 of his book End the Fed:

"One only needs to reflect on the dramatic decline in the value of the dollar that has taken place since the Fed was established in 1913. The goods and services you could buy for $1.00 in 1913 now cost nearly $21.00. Another way to look at this is from the perspective of the purchasing power of the dollar itself. It has fallen to less than $0.05 of its 1913 value. We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy."

One might indeed say that, Mr. Congressman. But if one did, one would behaving like an opportunistic politician, which I know you are not.

Now, let us examine what is wrong or misleading in the statement above.

First, with the exception of the last sentence (which he weasels around with his “one might say”), there is nothing factually incorrect. Indeed, the data source cited by Paul is (ironically enough) the Federal Reserve Bank of St. Louis. (I’m glad he trusts us enough for some things.)

So the question is not whether he has his facts straight on this matter. The question is whether these facts matter at all.

There is this old idea in monetary theory called money neutrality. Money neutrality means that larger quantities of money ultimately manifest themselves in the form of higher nominal prices (and wages), and not on real quantities. No serious economist disputes the idea of long-run money neutrality.

Yes, what cost $1 in 1913 now costs $20. But so what? Money neutrality states that if you were earning $1 per hour in 1913, you are now earning $20 per hour (and even more, if labor productivity is higher).

So there you go, the Fed is responsible for increasing your nominal wage by a factor of 20. How do all you workers out there like them apples? Ron Paul wants to rob you of these wage increases!

Here is another example of the Congressman misleading the public (perhaps unintentionally); see his recent interview here with CNBC’s Larry Kudlow: Fed Under Fire.

At the 3:50 mark, Kudlow asks Paul: “Would oil be at $102 a barrel now if we had a sound dollar policy?” Paul’s reply is that, if Bretton Woods had not been abandoned (in 1971), oil would now be trading closer to $5 a barrel.

I ask you…how embarrassing of an answer is that? I mean, maybe oil would be trading at $5 a barrel. But what he is implicitly suggesting is that your nominal wage would not be scaled back in proportion. That is, he is suggesting that by cutting the value of paper, the Fed has somehow diminished the purchasing power of your labor over the past 100 years. Can he be serious?

The Congressman evidently suffers from money illusion. It is an affliction that can be forgiven in most people. But not one who likes to think of himself as a person learned in the finer principles of monetary theory.

And, as an aside, am I the only one who chuckles whenever he berates the Fed for creating money “out of thin air?” (I reiterate, there may be many legitimate complaints one could make against the Fed, but the “out of thin air” charge…well, let’s just say it…lacks substance).

Is it not true that the Treasury also creates its debt “out of thin air?” Do you think getting rid of the Fed (which, in conducting monetary policy, is simply swapping one form of thin air for another) will prevent Congress from issuing its own thin air? Do you really believe that a gold standard would mitigate the government’s ability to tax? (Seigniorage revenue for the U.S. is peanuts as a fraction of total taxation. Moreover, keep in mind that the inflation tax is collected off of foreigners as well.)

Let me conclude by saying that I think that America is, on the whole, well-served by having a voice like Ron Paul in Congress. I’d like to invite him to the SL Fed for lunch one day. I’d ask him to tone down his rhetoric and present his (frequently very good) arguments in a more sober manner.

But maybe this is too much to ask of a politician. Even a libertarian one."

Andolfatto had a follow up post here.