Trump’s nomination of Steve Moore and Herman Cain to Fed Board positions has shaken up the Fed establishment. Moore is advocating a CRB (commodities) Index target while Cain has written in favor of a gold standard. A gold standard or CRB Index would link the dollar to the value of a hard asset or assets. Jim Grant has labeled current Fed policy as the Ph.D. Standard. The Ph.D. Standard links the dollar to whatever occurs in the minds of our Ph.D. centric Federal Reserve. Danielle DiMartino Booth aptly describes the Fed Ph.D. cartel in her book, Fed Up, An Insider’s Take on Why the Federal Reserve is Bad for America. Rather than linking the dollar to a hard, known asset, the Ph.D. Standard links the dollar to ephemeral academic theory.
It is evident that the Ph.D. Standard is reaching its end limit. The Fed abandoned its history of traditional monetary policy in 2008 and is now making it up as it goes along. The Fed guides, reverses guidance, normalizes, ends normalization, raises the funds rate, reverses rate hikes, follows the Phillips Curve, abandons the Phillips Curve, announces secular stagnation, is surprised by higher growth, dot plots, chases a mythical natural rate of interest, and tosses out u*, r*, and π* as its guiding light—whatever that means when translated from Ph.D. gibberish.
It is well past time for new thinking at the Fed. In his instinctive way, Trump has again shaken up the status quo. An establishment backlash will no doubt occur as Moore and Cain’s nomination moves forward. Yet, it is critically important to understand the difference between a gold standard and the CRB Index.
Any commodity can be money, but only one commodity can be the unit of account—a monetary reference of constant value. Money has three roles, 1) a means of exchange, 2) a store of value and, 3) a unit of account. The unit of account is the most important. Money requires a standard of reference, the same as the scientific world requires standards of measurement. There are 19 commodities of various weightings that comprise the CRB Index: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gas, and Wheat. In limited form, most commodities have acted as money at some point in history. Over the millennia, mankind rejected all but gold and silver as universal money. Great Britain moved to a bi-metallic monetary standard based on gold and silver starting in the late 1600s. By 1900 the world rejected silver, leaving only gold as the mono-metallic monetary standard. Selecting gold as the monetary standard did not occur by whim, accident, or government decree. It occurred because gold’s properties are uniquely monetary.
Gold’s preciousness, physical properties, stock (inventory) to flow (production), and lack of a capital component—the addition of capital and technological advances do not affect gold’s production—are what distinguish gold from all other commodities and establish it as the unit of account. These unique characteristics have kept gold’s value constant for thousands of years and are the reason the world evolved in the late 1600s to a gold standard. For 300 years until its abandonment in 1971, gold standards, when properly implemented, successfully provided the stable money foundation that propelled rapid leaps in economic growth and progress.
Other than gold, and to a lesser extent silver, nobody would suggest that any of the other commodities in the CRB index meet the three requirements of money. What then is the explanation for advocating that the Fed venture forth on an entirely new monetary path and target the CRB Index?
The CRB Index represents the price level based on selected commodities. Therefore, targeting the CRB Index attempts to keep prices, represented by weightings of selected commodities, stable. A commodities target differs significantly from a gold standard. A gold standard is a reference to a monetary unit of account that history has proven is constant in value. A dollar linked to gold achieves the same value as gold’s proven stability. A dollar linked to the CRB Index fluctuates in value with changes in the value of the commodities in the index. It is axiomatic that a hard freeze in Florida, a flood in Nebraska, new oil reserves or oil production technology, a livestock disease, sugar cartels, changes in industrial production, wars, or other environmental factors will affect the price of the various commodities in the CRB Index.
When the prices of commodities change, the unit of account must change to reflect the new price level. The result is constant inflation or deflation in the unit of account to adjust to changing commodity prices. If for example, prices increase in the CRB Index for whatever reason, the value of the dollar must increase in deflationary value to maintain the same purchasing power. On a gold standard, the dollar is held constant in value with gold, and prices orbit around gold’s constant value. There is no inflation or deflation. A gold standard targets a monetary reference of unchanging value. A CRB Index targets prices that are constantly and necessarily changing in response to supply and demand dynamics that do not exist with gold.
In his book, The Golden Constant, Roy Jastram observed the relationship between gold and commodities under the gold standards of Great Britain and the U.S. Jude Wanniski corresponded with Ben Bernanke on this subject. Wanniski observed Jastram’s data relevance and conclusions and alerted Bernanke to their significance. Wanniski wrote to Bernanke:
Jastram’s book came out in 1976, as I recall, and it soon became required reading for the supply-siders. Mundell to this day talks of “the Jastram effect,” by which he means Jastram’s observation of a “retrieval phenomenon.” That is, the gold price moves first and then the general price level follows in train. It’s an awesome piece of research and I’m sure Greenspan knows about it. Jastram was a Berkeley professor who spent ten years working on it, spending considerable time in London. In rebuilding consumer and producer price indices, he realized the British monarchs kept ledgers of everything they bought back to the early 16th century… loaves of bread, bushels of wheat, lumber, iron, etc. And of course there is a daily record of the price of gold in sterling. Jastram does the same for the U.S. with his start in 1800, when government and private numbers on dollar prices become available.
Jastram summed up his work:
Gold prices do not chase after commodities; commodity prices return to the index level of gold over and over. This is one of the principal findings of my study.
Commodity prices follow gold because it is the unit of account, the monetary standard of measure. The CRB Index and its target of real prices is far better than the whim of the Ph.D. standard, but for the reasons that Jastram’s data confirmed, it will always remain inferior to a gold standard.
There are many fallacies associated with gold. It is necessary that conventional economic wisdom propagate them to justify the chaos of floating fiat currency. The fallacies are easily disproven when one objectively observes history and economic data. After all, there is a 300-year history of gold standards. One can torture and misconstrue the data and history to achieve whatever result desired, but one cannot dismiss the sustained growth rates and rapid progress that occurred under gold standards. Great Britain and the U.S. rose to global empires on the gold standard’s foundation of stable money. There is no history of any country linking their currency to a commodities index. Ever. The only reason to desire a commodity index over a gold standard is a lack of understanding of gold and a mistaken belief that mankind got it wrong and somehow missed the stability of non-monetary commodities that were right under their nose for thousands of years.
Nobody has done more in compiling and evaluating the data and history of gold and gold standards than Nathan Lewis. His website, New World Economics, and his four books on gold and Classical economics contain detailed, factual, and data-based arguments that examine every gold fallacy. Most gold fallacies are revisionist attempts to justify current economic policy. The Fed has had a 48 year run of chaotic floating fiat monetary policy. It benefits the elite and connected at the expense of the productive working class. It is time to return to a monetary policy that works.