Saturday, April 19, 2008

Paul Phenomenon

Paul Phenomenon
Ron Paul corners Fed chief Bernanke over rates: fuss-budget

Representative Ron Paul has cornered Federal Reserve chairman Ben Bernanke at a congressional hearing this month, on whether rate manipulation got the US economy in trouble - again.


A central bank's power lies in its ability to manipulate rates (usually lower them) by printing money when the market forces demand a higher rate.
This ability is very useful for governments in times of war and to finance programs to buy votes, but it is also the key problem with central banking that results in bubbles, high inflation and also personal financial ruin of ordinary people.

In a market driven economy, a central bank is an anachronism that can change the interest rates by bureaucratic decisions (monetary policy committee) rather than actual market forces that drive the demand and supply for credit.

In the US the Fed was established in 1913 amid stiff opposition, through a bill that was secretly promoted by the big banking families of the US.


But central banks were relatively benign under the gold standard, when their ability to print money was restricted by a link to gold, though a boom accommodated by the Fed during the 1920's later caused the great depression.

The link with gold was broken during the World Wars and re-established under the Bretton Woods agreement where the US dollar was linked to gold and other currencies were linked to the dollar.

Ultimately the US government defaulted on its obligations under the Bretton Woods agreement in 1973 when heavy money printing (and the Vietnam War) made it impossible to preserve the link with gold.

The US finally went to a fully fiat (paper) currency in 1973 after firing a global commodity bubble and oil shock.

For more than one and a half centuries before that gold was priced at 35 US dollars an ounce and there was no long-term 'inflation'.

But since 1973 the US currency has been debauched to 1,000 dollars an ounce and the world is now in the grip of another massive 1973-style bubble which is bringing real misery to millions of poor people around the world in the form of higher food prices.

Meanwhile, the US is now printing more money to save its banking system (rate cuts) and chase an elusive concept called 'growth'.

n Asian dollar linked countries like Sri Lanka which do not have an independently floating currency to counter US inflation and is burdened with a weak domestic monetary system that creates it own inflation, people are suffering with high rice prices amidst the highest inflation it its history.


At a congressional hearing this month Fed chairman Bernanke was forced to make an admission by Ron Paul (see transcriptions below) to the shocking extent to which central banking rate decisions are a little more than guesswork.

Paul, who is associated with the Ludwig von Misses Institute is one of the few politicians of the world who has an in-depth understanding of 'monetary policy', with the possible exception of senior ministers in Singapore who actually run that country's monetary authority.

He makes the point that central banks create 'growth' by keeping rates artificially low and giving rise to business cycles or bubbles which then burst spectacularly (like the sub-prime bubble).


Representative Paul (interrupting): Does excessive credit and low interest rates cause mal-investment? Artificially low interest rates, which aren't market driven?

Chairman Bernanke: Well, the question is you know is the judgment where the interest rates ought to be. We have a mandate of course for maximum employment and price stability. We are trying to balance these obligations.

We could make mistakes and put the interest rates to the wrong place and that would have negative impacts. I agree. So we are doing the best we can to find the right place to put the interest rates. One that is consistent with the neutral rate. Or the rate that establishes the full employment in the economy.

Representative Paul (smiling): And some day we may try the market to determine the interest rates. Thank you.