Gold, the Real Bills Doctrine, and the Fed (Thomas Humphrey & Richard Timberlake)

This book focuses primarily on the 1922-1938 period, when the monetary policies in use went horribly wrong. It puts the subject in context, however, by reprising developments and commentary from the 18th & 19th Centuries (thoughts of John Law, Adam Smith, etc.) and the post-World War II era (thoughts of Lester Chandler, a Princeton economics professor, Ben Bernanke who chaired the Federal Reserve from 2/1/06 to 1/31/14, etc.).

The authors paint a detailed and informed picture of the subject, which is not only of historical interest but also sheds some useful light on the current role of the Federal Reserve. Here’s a recap:

1. The classical Gold Standard was the antithesis of having a central bank control the money supply; once set up, the system basically ran on autopilot. The GS certainly didn’t either cause or prolong the Great Depression, as it had been abandoned in practice after World War I (despite being formally preserved in the Federal Reserve System protocols). And no one will ever bring the GS back, not because it couldn’t be made to work but because central bankers want to feel that they are managing things even if they are doing a poor job of it.

2. The Real Bills Doctrine was meant to create a logical basis for the amount of money that was needed to keep the economy going without overheating. The thought was that the amount of short-term commercial paper is a reliable measure of economic activity, which could serve as a basis for determining the proper money supply. However, double-counting can occur and price levels change. And if things get out of whack, the RBD can lead to monetary policy that either fuel hyperinflation (Germany, 1923) or deflation (US, starting in 1928).

3. From 1922-28, under the aegis of Benjamin Strong, head of the Federal Reserve Bank of New York, the goal was overall price stability and it was achieved with remarkable success. Then Strong died (Oct. 1928) and the central bank reasserted itself, switching to a rigorous application of the RBD and pressuring regional banks to cut off funds that could be used for speculation. The cut in the quantity of money triggered an economic slump, thereby prompting further cuts in the money supply (and a destructive downward spiral). The anti-speculation pressure was eventually released, but the Fed never pushed to increase the money supply.

4. Excess gold reserves kept climbing, and the Banking Act of 1935 reorganized the Federal Reserve to operate as a central bank system versus a network of regional banks. The US economy remained in the doldrums (under the aegis of Treasury Secretary Henry Morgenthau) until World War II.

5. As this book amply demonstrates, dumb ideas about monetary policies are nothing new. And now, with the Federal Reserve supporting increasingly aggressive monetary ease to stimulate the economy, we may well be in for a major inflationary spiral such as Germany experienced in 1923 while mindlessly following the RBD during a period of rising prices.

6. Accepting that the GS is not likely to be restored, it would make sense to refocus Fed policy on achieving price stability and stop viewing the central bank as an economic maestro that is responsible for the full gamut of economic results.

Look Behind the Curtain (five stars),,

Richard Timberlake held a PhD degree from the University of Chicago and wrote numerous books (including this one, published in 2019) and articles on monetary policy. He passed away in May 2020 at the age of 97. We will remember Dr. Timberlake as a long-time SAFE member, who followed our blog entries, etc. with interest and offered supportive comments from time to time. See also his essay on Hot Thermometers, which demonstrated his keen understanding of the global warming debate and sense of humor as well.
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