Monetary expansion is also, for Paul, a key enabler of what he takes to be our imperialist foreign policy: The creation of money out of thin air allows the government to finance wars, as well as the welfare state. Central banking is a form of central planning, on his theory, and as such “incompatible” with freedom. Paul allows that “not every supporter of the Fed is somehow a participant in a conspiracy to control the world.” The rest of them, judging from comments repeatedly made in the book, have fallen for the delusion that expanding the money supply is a “magic means to generate prosperity.” Paul finds it baffling that anyone could hold this absurd view, but attributes it to Chairman Bernanke, among others.
Almost all of the criticisms Paul makes of central banking, when stated in the axiomatic form he prefers, are false. To put it more charitably, he assumes that the negative features that monetary expansion can have in some circumstances are its necessary properties. Consider, for example, a world in which the Federal Reserve conducts monetary policy so that the price level rises steadily at 2 percent a year. Savers, knowing this, will demand a higher interest rate to compensate them for the lost value of their money. If the Fed generates more inflation than they expected, as it did in the 1970s, then savers will suffer and borrowers benefit. If it undershoots expectations, as it has over the last few years, the reverse will happen. The anti-saver redistribution Paul decries is thus not a consequence of monetary expansion per se, but a consequence of an unpredictedly large expansion. For the same reason, monetary expansion does not necessarily lead to less saving. There is no reason to believe that the real burden of home loans would be any larger in a world with 2 percent inflation than in one with 1 percent inflation.
Nor is the wage earner necessarily defrauded. Continuing with our scenario of a steady 2 percent increase in the price level, the prices he pays after ten years are higher but, on average, so are his wages. There is no reason to expect a larger money supply over the long run to affect relative prices — to change the ratio of the cost of a week’s supply of vegetables to a week’s wages, for example. That’s why central banking isn’t central planning: It never attempts to fix the relative prices or quantities of all the goods an economy produces, and it cannot cause the total amount of goods an economy produces to hit any particular target.
Paul is right that more money does not magically produce more goods in circulation over the long run. (So right, that nobody believes otherwise.) It’s because he’s right that we ought not to regard all of the prosperity of the last few decades as an illusion. Productivity growth was real and we don’t have to roll it all back and start over with a better monetary regime.
Paul’s contention that the Fed has continuously abetted the expansion of the state — its wars, its welfare, its attacks on civil liberties — is also false. The federal government uses its monopoly over the currency to finance very little of its spending. It gets almost all of its money through taxing and borrowing, and the borrowed funds come from people who are well aware of the need to charge a premium to cover the risks of inflation.
The doctor’s prescription is as mistaken as his diagnosis. The drawbacks to a gold standard are well known. If industrial demand for gold rises anywhere in the world, the real price of gold must rise — which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.