Keating: ‘The Scandal of Money’ by George Gilder
George Gilder. The Scandal of Money: Why Wall Street Recovers but the Economy Never Does (Regnery Publishing)
by Maryann O. Keating, Ph.D.
If negative interest rates do not make any sense to you, this book will be of interest. George Gilder, techno-utopian advocate, reminds us of times when money and interest rates stood for something other than tools to be manipulated by officials of the Federal Reserve System (the FED) in a futile attempt to control the economy. Gilder’s 1981 international bestseller “Wealth and Poverty” advanced the case for supply-side economics and capitalism, and “The Scandal of Money” could play a similar role in getting U.S. monetary policy back on track.
Gilder criticizes economists and policy makers on the left and right for what he believes is an incorrect view of the economy that fails to address the demoralization of Main Street, the debauching of Wall Street, and the doldrums of innovation in Silicon Valley (xvii). Gilder presents his conception of the time value of money in terms of information theory. He shows how money creation, interest rate targeting, and exchange rate manipulation by monopolist central banks have created a “hypertrophy” of finance destroying an essential learning curve that creates new wealth. This dysfunctional financial environment cancels out entrepreneurial job creation and threatens the economic well-being of middle-class families. Gilder proposes a restoration of “real” money either through some linkage with gold or a privately created medium of exchange, such as Bitcoin.
“The Scandal of Money” does not share in the negativity of “fashion-plate pundits” such as Thomas Piketty reconciled to a secular stagnation theory of permanent growth slowdown (91). The ignored elephant in the room is the eclipse of money as a measuring stick, a scale of value, and a signal of opportunity (9). This channel for productive innovation gave way, according to Gilder, on a single, identifiable day, Aug. 15, 1971, when President Richard Nixon permanently detached the U.S. dollar from gold.
Economists, including Paul Samuelson and Milton Friedman, urged Nixon to leave Bretton Woods’ residual gold standard. In 1988, Gilder actually traveled with Milton Friedman through China and witnessed Friedman’s chief advice to Chinese government leaders, “to get control of their money supply” (30). In this book, Gilder argues that Friedman incorrectly assumed that velocity (or the turnover rate of money) was reasonably stable and unaffected by changes in the money supply (34). “The Scandal of Money” does not address the possibility that, given professional and political will, government officials can reasonably control the money supply in spite of changes in velocity (35).
Although he documents Friedman’s concern with what monetarism has begotten, Gilder somewhat misrepresents Friedman’s view of monetary economics (32). It is incorrect to say that Friedman’s monetarist theory justifies the role of the Fed in promoting full employment or to suggest that in a fully free-market economy the central bank maintain top-down control (33). On the contrary, Friedman favored a monetary rule and adamantly opposed discretionary policy. He wrote, “An announced, and adhered to, policy of steady monetary growth would provide the business community with a firm basis for confidence in monetary stability that no discretionary policy could provide even if it happened to produce roughly steady monetary growth (“The Case for a Monetary Rule,” Newsweek, Feb. 7, 1972).
Friedman also expressed mixed feelings on the independence of the Fed versus political accountability. Unfortunately, it was only towards the end of Friedman’s career that Public Choice economists warned against the naïve assumption that officials and professionals could be convinced through reason to act in the public interest.
Gilder, in developing his thesis, describes how following the dollar’s release from its gold link, interest rates began to move up and down, in unprecedented ways. This severely damaged the critical role of interest rates in reflecting time preferences; therefore, chaotic international currency markets reflected interest rate instability. The financial sector, relishing this volatility, thrived and profits derived from “flash boy” trading triumphed over work and thrift. Income inequality broadened, as the top 10 percent of earners increased their share from 33 percent of all income in 1971 to 45 percent in 2010 (11). Central banks and government Treasuries gained by issuing new money, and the general public sought shelter for their savings and efforts in real estate appreciation as they experienced a sharp rise in the cost of food, fuel, medical care, housing, and education (12). Despite attempts by Fed Chairman Paul Volcker to maintain an informal gold price target, there was no permanent repair to the world’s exchange rate system or a restoration of a monetary restraint on government overreach (13).
Gilder presents the financial world in a helpful two dimensional diagram. International exchange rates on the horizontal axis maps out the geographical span of enterprise and time on the vertical axis is represented by interest rates that mediate between past and future. Regrettably, government bodies assisted by increasingly nationalized banking systems manipulated both currencies and interest rates. In the process, they destroyed the information needed to effectively allocate credit in a way that creates new assets to repay public and private debt.
Gilder sees “The Scandal of Money” as part of his quest to identify how monetary factors determine business and technological realities. He reasons that what matters for the economy are freedom, property rights, tax rates, and the rule of law, which enable the growth of knowledge and wealth. The money supply itself is far less important. However, by controlling money supplies, central banks and their political sponsors determine who gets money and thus who commands political and economic power (31).
According to Gilder, global profits have migrated to incestuous exchanges of liquidity by financial institutions transfixed by the oceanic movements of currency values. Government policy has trivialized banks, transforming them from a spearhead of investment to an obsequious role of borrowing money from the Fed at near-zero rates and lending to the Treasury at rates yielding a tidy risk-free profit on which to leverage more through implicit and explicit government guarantees (57).
The chapter entitled “The High Cost of Bad Money” suggests that a drastic abuse of money and banking has been at the root of a forced transfer of wealth from Main Street to Wall Street. Deepening the global economic doldrums, bad money has sharply skewed the distribution of wealth and income, bringing to a halt fifty years of miraculous and broad-based advances in global living standards (56).
Gilder’s concern is the extent to which discretionary monetary policy has skewed not just interest rates and exchange rates, but also prices. This falsification stultifies entrepreneurs, deceives savers, and fosters tyranny (61). The Scandal of Money emphasizes the three fundamental function of money: a means of exchange, a standard of value, and a store of value. As a standard of value, money obviates the need for impossible calculations, such as those needed for barter. Although money is not an accurate gauge of the intrinsic worth of goods and services, it acts as a means of exchange in facilitating exchange, when the value of thing being traded exceeds its value as a collectible (74).
Gilder’s unique contribution in this book is his understanding of money in relation to information theory, developed by Kurt Gödel, John von Neumann, Alan Turing and Claude Shannon. Information is not order but disorder, not predictable regularity but unexpected modulation, the surprising bits. Prices, interest rates, and exchange rates, when they are permitted to function and are not arbitrarily manipulated, hum along revealing occasional unexpected information. Through this process, human creativity and economic innovation yield learning which in turn adds to our stock of knowledge. However, this process of disorder from order depends on regularities, such as monetary stability (64).
Unless a new global monetary order, similar to the one established in 1944 at the Bretton Woods Conference, is revived, it is impossible for Gilder to have a positive vision of the future. In subsequent chapters, including those entitled “Main Street Pushed Aside”, “Wall Street Sells its Soul”, and “Restoring Real Money”, the author outlines what he terms the “Hypertrophy of Finance” and offers policy solutions for curtailing present currency trading, a playpen for financial predators, exceeding the traffic in goods and services for which money is intended to enable (110). He also argues that a zero-interest-rate policy and governments’ control of rates paid on the national debt represent a futile and economically destructive war against time (142).
According to Gilder, it is essential to link world currencies to gold or another source residing outside the political system (38). A guide for his position is Nobel Laureate for Economics, Robert Mundell, whose early theoretical work established the limitations on monetary and fiscal policy in open and closed economies given fixed or floating exchange rates. Mundell support for Bretton Woods stability and for the establishment of the Euro is presented in this book as a justification for abandoning floating exchange rates.
China has led the world in growth for twenty-five years according to Gilder by following Mundell’s inspiration. China has rejected the twists and tricks concocted by other Western economists by opting out of a floating-currency regime and effectively tying its currency to the dollar (45). The Chinese realize that in keeping accounts, setting priorities, and evaluating opportunities, money must be a measuring stick rather than a magic wand (21).
A metric cannot be part of what it measures, according to Gilder, and fiat money created by government fails this test. Moving toward a modern gold standard, complemented by bitcoin or other internet digital currency standard would eliminate the profits from creating money by central banks and large traders, called seigniorage (67). Gilder hypothesizes that new breakthroughs in information theory allow for the separation of monetary security from the identification function of the network tracking the currency. Bitcoin and other digital currencies eliminate arbitrary changes imposed on money through complex mathematics and software using a time-stamped public “block-chain” of transactions (63). In other words, monetary security can be heterarchical rather than hierarchical- distributed on millions of provably safe devices beyond the network and unreachable from it (71).
An armchair reader with an interest in finance and technology will enjoy and benefit from this book. However, The Scandal of Money’s greatest value may be inspiring graduate students seeking fruitful and exciting dissertation topics. Is gold a “barbarous relic” or a useful indicator of expected inflation which is relatively benign or of predictable deflation in which prices sink as a result of real value creation (156)? Should a path to sound money rely on “Hayek” money pegged to different commodities (82) or “Shelton” bonds, five-year Treasury notes payable in gold (163)? Are decentralized bitcoin block-chain ledgers more secure than the current credit card systems using protected networks and data centers (172)? How serious is Gilder’s suggestion that ultimately the taxpayer may be the default financier for large Silicon Valley “unicorns” that are more eager to purchase start-up rivals than to complete with them (122)? Useful as well would be a discussion of the relative benefits of explaining the time value of money using Gilder’s concept of entropy versus traditional present value formulas. Each of these topics would be of far greater value than another study on targeting interest rates, a practice deplored by Milton Friedman and considered futile by John Maynard Keynes.
“The Scandal of Money” does not address the U.S. dollar’s role as an international reserve currency. However, currency reserve status has too long been used as an excuse rather than a reason for the difficulties attending the structural reforms needed to normalize monetary policy. A reader does not have to fully agree with Gilder to recognize that the U.S has abandoned the fiscal discipline required to make floating exchange rates work. In addition, the Federal Reserve System’s attempt to allocate credit through interest rate targeting has warped investment decisions and inhibited innovation.
Governments never learn; only people do. It is time for another generation to read Gilder in order to understand not the scandal but the ideal role that money plays in trade, investment, and creative economics. The author is correct in saying that reform of the world monetary regime is less a far-fetched dream than a rising imperative (70).
Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.