The American Spectator

There is no doubt with the price of gold soaring from $265 an ounce in January 2000 to $920 in August 2008, the Fed has debauched the dollar. A debauched currency corrupts everything it touches, short-circuiting price signals, aggravating the worst traits of human economic behavior — greed, gambling, dishonesty — and clouding the judgment of average people and the most astute businessmen. Although Alan Greenspan used to talk a lot about “taking away the punch bowl,” America during the first decade of the 21st century under his tenure as Fed chairman has been living on one long spring break, guzzling from a spiked currency-punch bowl.

If the currency is sound, markets work properly and are robust. They provide continuous negative feedback, which combines with an intricate system of market rewards and penalties to adjust automatically, which provides for “self-control” of human vices as a result. Properly functioning markets act as a flywheel on the economy, restraining greed by dampening profits, which in turn dampens risky and dishonest behavior and channels capital to its best and highest use. Beyond a basic amount of monitoring to ensure free information flow and to minimize fraud and corruption, markets truly are self-regulating if prices are left free to transmit information efficiently.

When a surfeit of money saturates society, however, these negative feedback mechanisms short circuit; price signals go haywire; information is distorted; capital is misallocated; people make bad judgments and engage in crazy, risky behavior based on bad information. Positive feedback replaces negative feedback, which results invariably in a financial implosion. If government tries to keep the binge going with more hair-of-the-dog liquidity, it only prolongs and exacerbates the agony. If government tries to correct the problem with price controls to fix asset prices above market-clearing levels, it further distorts economic signals and sends the economy into a tailspin.

IN THE ABSENCE of sound money, there is no other choice but to restrain people’s behavior and transmit information through stringent bureaucratic rules and regulations. Yet, regulations cannot substitute for the discipline that comes with functioning markets, and in fact the more stringent the regulations are, the more they diminish economic activity and distort business decisions. There arises a hue and cry to “deregulate” to prevent sending the economy into a decline. When deregulation of financial markets combines with debauchery of the currency, the stage is set for what we are experiencing now.

Rules, regulations, and laws are a part of the normal civilized order but to work they must be gentle, select, simple, understandable, consensual, and they don’t need excessive enforcement because they support the automatic order, not substitute for it. They are the rails on which civilization runs, not the locomotive that drives it. When the automatic order breaks down, it looks to people as if the gentle, targeted, lightly enforced regulations/laws are to blame. An uninformed consensus arises that this mess never would have happened if the regulators and policemen had been on the job, which misplaces the blame by mistaking a symptom for the root cause.

The single most important thing Congress can do now is eliminate the Fed’s discretion to debauch the currency by requiring it to conduct monetary policy subject to a simple rule that would maintain the value of the dollar, which will prevent markets from slipping the traces and running into a ditch. Congress should enact a law setting the dollar-price of gold statutorily somewhere in the range of $800 to $900 an ounce. The law also should provide that the Fed must conduct open-market operations (i.e., buy and sell federal securities in the open market) so as to maintain the dollar price of gold within a narrow statutory band about the statutory price of gold. Markets will enforce the law and automatically maintain a sound dollar if the law provides further that the U.S. Department of the Treasury must upon demand redeem dollars for gold and gold for dollars at the statutory price of gold.

Making the dollar as good as gold once again would hit the reset button on the American economy and launch it forward toward stability and prosperity.