Stable Dollar Is Needed to Fix Economy

There are so many destructive big-government policies these days that sometimes it’s hard for free-market reformers to know what to fix first. The tax code, healthcare, drastically out-of-control spending?

Reforms of all these policies would no doubt help economic growth, but their effects would pale in comparison to enacting a policy to maintain a stable dollar, according to Rich Lowrie, co-founder of Put Growth First, market strategist and former economic adviser to presidential candidate Herman Cain.

At a panel discussion at the National Press Club in Washington, D.C., on June 1, hosted by Restore America’s Mission, Lowrie said the need for a stable dollar is necessary for sustained growth, much like hooking the chain to the gears on a bike. A dollar should be a stable and consistent unit of measure, just like a foot, pound, or hour.

When the value of the dollar is stable, businesses can make long-term plans regarding things like capital investments, hiring, or pricing. Just as it would be incredibly hard to build a house without a constant unit of measurement, it is hard to build a business, save for retirement or engage in other economic transactions without a stable monetary unit.

Not only does an unstable dollar make it hard to engage in economic calculations, but easy money policies can fuel asset bubbles, causing irreparable harm to investors and savers. The recent housing bubble was an example of this, noted Peter Ferrara of the Heartland Institute, another one of the panelists.

This in turn also contributes to growing financial inequality. Before 1971, income growth of the bottom 90 percent grew in step with income growth of the top 10 percent. But shortly after 1971, income growth of the top 10 percent completely diverged, continuing its upward growth while the income growth for the bottom 90 percent stagnated.

Put another way, for 23 years income for the bottom 90 percent grew over 85 percent, but for the next 41 years it remained flat. This intuitively makes sense as the Federal Reserve’s policies inflate financial assets, which is what makes up the majority of wealthy people’s income while the other portion of the population face rising costs of living.

The reason we have an unstable dollar today is due to abandoning the gold standard and a shift in policy by the Federal Reserve. Before 1971, the dollar was still implicitly linked to gold. This resulted in a stable dollar when compared to gold or other commodities. After the gold standard was completely abandoned, the dollar’s value wildly fluctuated and overall it has precipitously declined, losing over 80 percent of its value since the Nixon shock as measured by official consumer price data.

Today the Federal Reserve continues to keep its easy money policies in place in an effort to create 2 percent price inflation, which it believes will “stimulate” the economy. This is exactly the opposite of a stable dollar policy as 2 percent annual inflation will result in a loss of one-third of the dollar’s purchasing power over 20 years.

The other error in the Fed’s current policy, according to Lowrie, is worrying too much about wage growth and treating it as dangerous inflation. A graph of real income growth for the bottom 90 percent of the population between 1982 through 2012 shows that wages grew each time broad-based tax cuts were implemented, from the Reagan tax cuts in the early '80s to the capital gains tax cuts in the late '90s to the Bush tax cuts in 2003.

But the Fed, incorrectly viewing wage growth as inflation that needed to be cooled, began hiking rates reversing those wage gains. Wage growth should be a sign of prosperity as it indicates higher productivity, not seen as inflation.

The unfortunate outcome of these examples is that the free-market reforms were undermined by the Federal Reserve actions. This allowed the left to spin the resulting decline in real incomes as the negative consequences of free-market policies, when in fact they were due almost entirely to the Federal Reserve’s flawed actions of raising rates.

Rather than trying to stimulate or manage the economy through monetary policy, the Federal Reserve should seek to preserve the dollar’s value and integrity as a unit of measure. Ryan Young of our organization, the Competitive Enterprise Institute, has previously written on this topic as well, noting that instead of constant tinkering and manipulations, the Federal Reserve should focus on a policy of stability, honesty and predictability. This in turn will enable more investment, better investment decisions and more innovation.

There are a number of measures that could be discussed to achieve this, such as linking the dollar either implicitly or explicitly to a basket of real commodities, which is what Mr. Lowrie suggested. If the Federal Reserve were forced to manage the dollar’s value to real assets, it would not be able to devalue the dollar and market participants would begin to smooth out the volatility in anticipation of the Federal Reserve’s actions.

Linking the value of the dollar to a commodity or basket of commodities would also naturally shackle the size of the government. For example, before Nixon abandoned the gold standard, the United States was facing rising costs abroad with the Vietnam War as well as at home with the continuation of the Great Society programs.

Many countries began to worry about the financial condition and debt of the U.S. government, prompting them to convert their dollar reserves into gold. Faced with rapidly dwindling gold reserves, Nixon was forced to either scale back the size of the U.S. government to restore confidence or suspend the convertibility of dollars for gold, essentially defaulting and devaluing the dollar.

Once a stable dollar is restored, entrepreneurs and investors can focus on finding ways to produce new or better goods and services at cheaper prices. This is the only sustainable way economic growth and prosperity can be achieved, not through playing with monetary policy, Lowrie concluded.

This post was co-authored by Chris Kuiper, research associate at the Competitive Enterprise Institute.

John Berlau is a senior fellow at the Competitive Enterprise Institute. He is the author of the book “Eco-Freaks.” Read more reports from John Berlau — Click Here Now.