Fed up - replacing the current US monetary system with one that limits inflation

National Review, Oct 10, 1994 by Lawrence A. Kudlow

Good as Gold

To restore sound money and permanent price stability, a new system must be designed which places the private international gold market at the center. That gold is still the best inflation indicator, I have no doubt. If the Fed had heeded the message of the world gold market, then the U.S. and the rest of the world would not have been forced to suffer the consequences of repeated stop-and-go policies. The gold price signal worked in the Sixties and Seventies to warn of impending inflation, and it worked in the Eighties and Nineties to signal disinflation. It even picked up the mild reflation of the late Eighties, just as it is now signaling another reflation.

Private citizens today are permitted to own and contract for gold. Indeed, they are free to exchange dollars for gold, commodities, foreign currencies, and foreign financial instruments as they wish. In that important sense we are already on a new gold standard. And for those who remain uncomfortable with gold as the single instrument of policy, there is no reason why the Fed should not also monitor price movements in the international auction markets for bonds, commodities, and currencies. All send off early warning signals of inflation.

The trouble is, the Federal Reserve - and the Treasury - are not heeding the markets' message. The authorities are still focused on economic variables such as unemployment, capacity utilization, retail sales, and real GDP, as if too much employment, or production, or growth will create inflation. But prosperity does not cause inflation; bad money does. If money is sound, then people will hold it. If they hold it, then bond yields will fall, gold will be soft and commodities uneventful, and the dollar will rise. Call it the World Information Standard, or the New International Gold Standard, or the Bond Market Vigilantes. Whatever the label, markets, not government, should regulate the money supply.

What is to be done? We must take money out of the politicians' hands. To achieve this, I propose a series of new monetary reforms.

First, the Humphrey-Hawkins Act must be amended to eliminate the directive of low unemployment and to make price stability the Fed's sole objective. Printing more money will not reduce unemployment. Real purchasing power comes not from money creation but rather from profits, production, entrepreneurship, and risk taking. These are a function of low taxes, deregulation, free trade, and restrained federal spending, all of which permit proper incentives and returns for the private economy. The Fed's rule should be preservation of steady dollar purchasing power and stable prices. Government cannot and should not try to control the economy.

Second, price stability should be defined in terms of a specific inflation target; I propose a 0 to 3 per cent range for the rate of change of the CPI. Inflation targets have been successfully implemented in Britain, Canada, and New Zealand; Germany and France are on the verge of such targets. It is time for the Fed to surrender. A cost-of-living target is something the public understands.