The Frame of Mind of American Economic Policymakers

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Part One.

In his 1,200
page History
of Economic Analysis
, Joseph Schumpeter mentions Gesell
just twice and just en passant – in one instance when explaining
that Keynes himself acknowledged in the General
Theory of Employment, Interest and Money
that Gesell had
a much larger influence on him than Hobson. (Keynes called Gesell
a “non-Marxian socialist.”)

Keynes noted
in the General Theory that, according to Gesell’s proposal,
“currency notes (though it would clearly need to apply as well
to some forms of at least bank-money) would only retain their value
by being stamped each month, like an insurance card, with stamps
purchased at a post office. The cost of the stamps could, of course,
be fixed at any appropriate figure. According to my theory it should
be roughly equal to the excess of the money-rate of interest (apart
from the stamps) over the marginal efficiency of capital corresponding
to a rate of new investment compatible with full employment.”
And although Keynes found “the idea behind stamped money sound,”
he nevertheless conceded that there would be difficulties in the
implementation of this scheme:

But there
are many difficulties which Gesell did not face. In particular,
he was unaware that money was not unique in having a liquidity-premium
attached to it but differed only in degree from many other articles,
deriving its importance from having a greater liquidity-premium
than any other article. Thus if currency notes were to be deprived
of their liquidity-premium by the stamping system, a long series
of substitutes would step into their shoes – bank-money,
debts at call, foreign money, jewelry and the precious metals
generally, and so forth…there have been times when it was
the craving for the ownership of land, independently of its yield,
which served to keep up the rate of interest; though under Gesell’s
system this possibility would have been eliminated by land nationalisation.
(John Maynard Keyes, General Theory, London, 1936, Chapter

I briefly discussed
Gesell’s ideas because his books would make excellent bedtime
reading for Comrade Obama. I doubt, however, that the Commissar
can indulge in much reading time since he has embarked on micro-managing
the economy. Also, as Keynes himself admitted, there are enormous
problems associated with the “stamping system,” as well
as with the “hat system” explained above by Mankiw, because
savers would turn to other forms of “money” such as precious
metals, non-ferrous metals, diamonds, paintings, stamps, cigarettes
(see also below), metal coins, ecstasy pills, cocaine, prepaid cards,
etc. But back to Mankiw!

If all of this seems too outlandish, there is a more prosaic way
of obtaining negative interest rates: through inflation. Suppose
that, looking ahead, the Fed commits itself to producing significant
inflation. In this case, while nominal interest rates could remain
at zero, real interest rates – interest rates measured in
purchasing power – could become negative. If people were
confident that they could repay their zero-interest loans in devalued
dollars, they would have significant incentive to borrow and spend…

Yes, real interest
rates could be strongly negative, as was the case in the 1970s,
which generated high inflation and high nominal GDP growth rates
but a collapse in bond prices (see Figures 1 and 2). Currently,
Mr. Mugabe maintains in Zimbabwe by far the lowest interest rates
in the world in real terms. But who is lending him money? What about
capital spending and consumption in Zimbabwe? Go and look for yourself,
Professor Mankiw! But there is no need to travel that far. After
all, it is far too uncomfortable for an academic at Harvard. Closer
to home – in the US – there is sufficient evidence that
consumption as a percentage of the economy fell in the inflationary
environment of the late 1960s and 1970s when interest rates in real
terms were mostly negative.

Ben S. Bernanke, Fed chairman, is the perfect person to make this
commitment to higher inflation. [MF: I am in full agreement on
this point.] Mr. Bernanke has long been an advocate of inflation
targeting. In the past, advocates of inflation targeting have
stressed the need to keep inflation from getting out of hand.
But in the current environment, the goal could be to produce enough
inflation to ensure that the real interest rate is sufficiently

I have a far
simpler solution for creating inflation (for which I should obtain
a Nobel prize in economics) than the half-baked measures proposed
by Gesell, Mankiw, and his students, in order to create “more
demand for goods and services, which leads to greater employment
for workers to meet that demand.” The government could issue
to each US man, woman, and child free vouchers for different goods
and services, which would have a three or six months’ expiry

There are 310
million Americans. The government could issue 310 million vouchers
to be exchanged for a new car, 100 million vouchers to be exchanged
for a $500,000 home, a billion vouchers for a visit to an amusement
park, a trillion vouchers each for Prozac and attendance at a sporting
event, and so on. AIG and Citigroup would be in charge of making
a market in these vouchers, so if someone didn’t wish to buy
a car he could exchange the car voucher for cigarette vouchers or
any other voucher. But since these vouchers would have an expiry
date they would unleash a huge consumption boom, which would temporarily
lift the prices of everything and, therefore, achieve the objective
of the US economic policymakers of creating inflation and negative
real interest rates. (An even simpler solution would be to remove
all taxes for two years, or simply to send each American a cheque
for a million dollars, but the impact on spending would not be as
powerful as with my voucher system.)

With my voucher
system, the current interventionist government could even target
the bailout of some specific industries that are currently ailing.
For instance, it could issue 310 million vouchers, each of which
could be exchanged for the purchase of a new car; whereas it would
not issue vouchers for goods where demand remains strong –
namely, for guns, cocaine, ecstasy, prostitutes, and porno magazines.
And if some protectionist flavour was desired – since this
would really stimulate domestic capital spending and employment
– the government could issue a disproportionately larger quantity
of vouchers for the purchase of domestic goods than for foreign

And who would
pay for the vouchers that businesses would receive from consumers?
Nobody! The Treasury Department could issue bills, notes, and bonds
to pay businesses for the tendered vouchers, and have the Fed buy
them all. But would nobody really pay for my voucher system? The
objective of my voucher system would be fulfilled, which is to create
inflation, but at the cost of a tumbling US dollar and collapsing
bond prices, as was the case in the 1970s (see Figures 3 and 4).

I may add that
a collapsing dollar might lead to a “little too much inflation”–even
for the Bernankes and Mankiws of this world! The astute reader will
naturally ask what will happen when the economic stimulus arising
from the vouchers ends, since they are issued with an expiry date.
The answer is very simple: the same thing as occurred after 2007
when the stimulus from easy monetary policies and strong debt growth
(inflation) ended: demand collapsed.

But that should
be of no great concern to the Mankiws of this world. The government
could then issue new vouchers with a higher face value and in higher
quantities. So, whereas my initial voucher program would have issued
310 million car vouchers with a face value of $40,000 each, the
government could now issue 400 million car vouchers with a face
value of $100,000 each. Now, some of my readers may think that I
have lost my mind, but macroeconomically there is very little difference
between my voucher program, which guarantees to stimulate demand
and bring about inflation immediately, and the way the Treasury
has recently expanded the fiscal deficit and the Fed has increased
its balance sheet (see Figure 5). My vouchers stimulus runs out
when the vouchers expire, and the Treasury’s and the Fed’s
stimuli run out when these esteemed institutions stop increasing
them! But my point is that if a government is determined to create
inflation and negative real interest rates, there is really nothing
standing in the way of its doing so.

both voucher and money stimuli lead to enormous economic and financial
volatility. In this respect, I urge my readers to read R.A. Radford’s
“The Economic Organisation of a P.O.W Camp,” in Paul A.
Samuelson, John R. Coleman, and Felicity Skidmore (eds), Readings
in Economics
(McGraw-Hill, 1952). (For those people who
have little time to read, this is a superb book about economics
and contains brief contributions by economists such as Malthus,
Marshall, Boehm-Bawerk, Taylor, Hayek, Tobin, Friedman, Samuelson,
Schumpeter, Ricardo, Bastiat, Rostow, Kuznets, Burns, Eckstein,
Keynes, and Kindleberger, and many more.)

Radford describes
how in a prisoner’s camp during the Second World War cigarettes
became the principal “currency” and how prices compared
to cigarettes fluctuated widely. The Red Cross would make weekly
deliveries of cigarettes to the P.O.W. camp and prices would subsequently
fluctuate largely as a function of the quantity of cigarettes delivered.
When plenty of cigarettes were delivered the prices of other goods
would increase; conversely, when the supply of cigarettes was scarce,
prices would deflate. Radford concluded that “the economic
organisation described was both elaborate and smooth-working in
the summer of 1944. Then came the August cuts [in the delivery of
cigarettes by the Red Cross – ed. note] and deflation. Prices
fell, rallied with deliveries of cigarette parcels in September
and December, and fell again. In January 1945, supplies of Red Cross
cigarettes ran out and prices slumped still further: in February
the supplies of food parcels [to a lesser extent, food also was
used as medium of exchange – ed. note] were exhausted and the
depression became a blizzard. Food, itself scarce, was almost given
away in order to meet the non-monetary demand for cigarettes.”

Radford never
won a Nobel prize for his observations about the economics of a
P.O.W. camp, but they taught me far more about relative and absolute
price movements than did economists at Ivy League schools. When
supplies of cigarettes (money) increased relative to food items,
prices for food rose more than for cigarettes; and when supplies
of cigarettes fell, food prices fell more than prices of cigarettes.
In other words, the successful P.O.W. camp hedge fund traders had
to constantly adjust their investment position between cigarettes
(money) and food (assets), depending on their relative supplies.
This is the investment environment I expect for the foreseeable

13, 2009

Marc Faber [send him
] lives in Chiangmai, Thailand and is the author of Tomorrow’s

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