I am writing this post as a reply to the comments I received on a previous post in which I argued that Ron Paul's 'End the Fed' plan would hurt the middle class and help those at the top of the financial sector.
But first, here's what I got wrong in my previous post: I shouldn't have implied that Ron Paul was intentionally trying to help big banks at everyone else's expense. Based on his record, that's clearly not true. It's obvious that he is concerned about the damaging effects that the current banking system has on society, and he deserves commendation for saying so. My earlier characterization of his position, therefore, was inaccurate. However, I still believe that a return to the gold standard would, however unintentionally, hurt the vast majority of Americans.
Furthermore, while I recognize that Ron Paul is the only Republican candidate who explicitly advocates the abolition of the Federal Reserve system, I maintain that the other Republican candidates' opposition to quantitative easing (Perry called it 'treasonous,' Gingrich has promised to fire Bernanke, and even Romney has expressed opposition) would, if enacted, produce a similar effect on the economy: a contraction in the money supply. And these other republicans have been receiving financial sector contributions.
So how does this help the financial sector? It's not the abolition of the Fed per se that helps the big banks- rather, it's the monetary tightening. Such tightening can be achieved either by adopting the gold standard (a la Paul) or by keeping the Fed and just ending QE/ raising interest rates (a la Perry, Gingrich, and Romney). A monetary contraction would cause an appreciation of the US dollar against other currencies, which favors the financial sector because it allows banks to purchase more assets denominated in foreign currencies. It also undermines the middle class because a more expensive dollar encourages the outsourcing of factory jobs to countries whose currencies are cheaper, and therefore production costs are lower. Admittedly, manufacturing is no longer the force in the US that it once was, but it has long served as the backbone of the American middle class, and its demise has almost certainly contributed to the yawning income gap between the rich and the rest. The adoption of the gold standard, I fear, would only accelerate this trend, and I don't think that the benefit of marginally cheaper imports fully compensates for the loss of factory jobs.
But there's another story here also: tightening monetary policy in the midst of this tepid recovery would likely force the economy back into recession, just as it did in 1937. (That was Milton Friedman's argument, by the way.) A double-dip recession would lower government tax receipts, and therefore increase the deficit, giving further ammunition to the cut-all-government-services crowd. And as a progressive, I strongly believe that further reductions to government spending on healthcare, education, poverty, etc. will only increase the gap between rich and poor.
Now, what about the argument that the Fed is just a tool of the financial sector that prints money and gives it to banks for free? First, I think that even without the Fed, Congress would offer such bailouts anyway, creating the same moral hazard. Many of the banks rescued since 2008 really were 'too big to fail' without causing serious harm to the real economy. Thus, the bailouts were a necessary evil, and there would be immense pressure on Congress to act similarly in future crises, even without the Fed. And as we've just seen in Europe, financial bailouts from national budgets can be far more damaging than bailouts from central banks. Furthermore, I think the best way to prevent banks from taking excessive risks and thus needing bailouts again is to regulate them more strictly- and the Fed can be useful here.
Second, though counterintuitive, it seems to me that the collapse of a major bank may actually hurt society at large more than it hurts the executives of that bank. Why? Because the executives of the defunct bank are not usually liable for that bank's losses. They can just walk across the street and get a job at the top of another bank, or they can retire comfortably on the huge bonuses paid during the previous boom. On the other hand, everyone else has to deal with the ensuing credit crunch and panic. Thus, while I share Rep. Paul's distaste for the excesses and privileges of the banking system, I worry that simply allowing highly leveraged banks to collapse in each crisis (by ending financial bailouts) is not the best solution. Instead, I favor stricter regulation that would reduce the likelihood of banks needing bailouts in the future.
Finally, what about the inflation potentially caused by monetary expansion? First, remember that one's purchasing power depends not only on prices but also on wages. Thus, the eroding wealth of most families in recent years can be explained not only as a product of rising prices but also as a result of nominal wages not rising fast enough (and pensions not being properly indexed to inflation)- for entirely different reasons. Second, low inflation during a recession increases the chance of the economy falling into a deflationary trap. And why are falling prices dangerous? Because when prices fall, businesses' revenue falls, forcing them to cut costs. More often than not, cost-cutting takes the form of firing employees, which increases unemployment, reduces aggregate demand, and in turn puts further downward pressure on prices, creating a vicious circle. This is exactly what's happening right now in Greece, and the gold standard could cause the same thing in America.
In conclusion, I agree that it's a good thing for democracy that Ron Paul and his supporters have forced a conversation about monetary policy. The Fed is clearly not perfect, and perhaps some reforms should be made. However, I feel that Democrats and progressives must become more willing to engage in this conversation and make the case for keeping the Fed, for using QE and stimulus to get America out of recession, and for more robust financial regulation. It's time to start making these arguments, because whatever happens in Iowa, these issues aren't going away as long as our economic troubles continue.