Krugman and the Goldbugs

Por Nicolás Cachanosky y William J. Luther. Publicado el 23/8/19 en:


he announcement that President Trump would nominate Judy Shelton, a long-time advocate of the gold standard, for a seat on the Federal Reserve’s Board of Governors got Paul Krugman thinking: why do some economic commentators become goldbugs?

Krugman offers a rather cynical view. It is difficult “to build a successful career as a mainstream economist,” he writes.

Parroting orthodox views definitely won’t do it; you have to be technically proficient, and to have a really good career you must be seen as making important new contributions — innovative ways to think about economic issues and/or innovative ways to bring data to bear on those issues. And the truth is that not many people can pull this off: it requires a combination of deep knowledge of previous research and the ability to think differently.

So what’s an aspiring if not so smart or creative economist to do?

“Heterodoxy,” Krugman writes, “can itself be a careerist move.”

Everyone loves the idea of brave, independent thinkers whose brilliant insights are rejected by a hidebound establishment, only to be vindicated in the end. And such people do exist, in economics as in other fields.… But the sad truth is that the great majority of people who reject mainstream economics do so because they don’t understand it; and a fair number of these people don’t understand it because their salary depends on their not understanding it.

In other words, Krugman suggests most gold standard advocates are either ignorant or disingenuous — and, in some cases, both.

According to Krugman, “events of the past dozen years have only reinforced that consensus” view that “a return to the gold standard would be a bad idea.”

[T]he price of gold soared from 2007 to 2011; if gold-standard ideology had any truth to it, that would have been a harbinger of runaway inflation, and the Fed should have been raising interest rates to keep the dollar’s gold value constant. In fact, inflation never materialized, and an interest rate hike in the face of surging unemployment would have been a disaster.

Is that so?

Krugman commits two mistakes here. First, he implicitly assumes that the data-generating process for the dollar price of gold would have been the same if, over the period in question, the U.S. had been on a gold standard. Robert Lucas famously warned against such an assumption. The argument is straightforward. Individuals do the best they can given their institutional constraints. If those institutional constraints change, so too will the decisions individuals make and, hence, the data generated by those decisions.

Consider that many see gold as a hedge against inflation today. But there would be no scope for gold to serve as an inflation hedge under a gold standard. In other words, the decision to hold gold under a gold standard would be fundamentally different from the decision people face today.

The second error concerns Krugman’s characterization of the gold standard. The gold standard is not a system where the price of gold is fixed. Rather, it is a system where the dollar is defined as a particular weight of gold. Under a gold standard, the dollar price of gold cannot change because the dollar is gold.

Krugman’s mischaracterization of the gold standard as a system where the price of gold is fixed leads to a fundamental misunderstanding about how a gold standard operates. The gold standard does not require a central bank to raise or lower rates “to keep the dollar’s gold value constant,” as Krugman claims. Indeed, a central bank is wholly unnecessary.

Under a gold standard, the purchasing power of gold is determined by the ordinary forces of supply and demand. If the demand for gold coins increases, the purchasing power of gold will rise (i.e., dollar coins buy more goods and services). Miners respond to the higher purchasing power by digging up more gold and hauling it off to the mint to be coined. And, as the supply of monetary gold expands, the purchasing power gradually falls back to its long-run level. Likewise, if the demand for gold coins falls, less gold is mined and some existing coins are melted down and repurposed for nonmonetary ends. This automatic mechanism meant that the price level was much easier to forecast under the gold standard.

What about Krugman’s claim that the gold standard would have required contractionary monetary policy from 2007 to 2011, when many economists would have called for expansionary monetary policy? Wrong and wrong. It would not have called for any kind of policy — just individuals pursuing their own interests, as usual. And, since the purchasing power of gold was increasing over the period, it would have set in motion an expansion in the supply of money — not a contraction, as Krugman claims.

We won’t take issue with Krugman’s working model of the economics profession. No doubt many drift to unconventional views because they do not understand mainstream economics or find it in their interest to hold unconventional views. Advocacy of the gold standard, an unconventional view, is no exception.

Unlike Krugman, however, we do not believe the problem is limited to those holding unconventional views. Many economists have strong opinions about the gold standard. Few seem to understand how a gold standard functions and how such a system performed historically relative to modern fiat-money regimes. Krugman provides a case in point.


Nicolás Cachanosky es Doctor en Economía, (Suffolk University), Lic. en Economía, (UCA), Master en Economía y Ciencias Políticas, (ESEADE). Fué profesor de Finanzas Públicas en UCA y es Assistant Professor of Economics en Metropolitan State University of Denver.

The money supply and the price level: a broken link?

Por Nicolás Cachanosky. Publicado el 7/4/16 en:


This past week, The Association of Private Enterprise Education (APEE) held its annual conference in Las Vegas, Nevada. As always, it was a very interesting event and I would like to take this opportunity to encourage young scholars who are serious about academic research and interested in promoting economic freedom to attend.

At the first monetary policy session that I attended, Sound Money: Are Central Banks Necessary?, it was suggested that the link between the money supply and the price level is broken. This really stood out to me. While this view wasn’t articulated by all of the presenters, it was certainly held by many of the economists in attendance.

“A new model is needed, even if we don’t know what the model should look like yet.”

Although such a statement has come from the mouths of many notable economists, there are theoretical and economic reasons why I disagree with the notion that a new model must (or should) be developed.

The theoretical reason is that the inverse of the price level (1/P) is the price of money. Therefore, to maintain that the “link is broken” is to say that the supply and demand analysis does not hold to money anymore. However, as long as money is considered an economic good, the law of supply and demand still applies. The USD is still used to buy goods and services, which means it has a value; this in turn means that supply and demand is still the link between money and its price.

One question that was posed at the session was, “What does the price level depend on if the price of money does not depend on the supply and demand of money?” This is not a trivial question. After all, money is the economy’s most important good.

One cannot maintain that money is an economic good used to buy other goods and services while maintaining that the supply and demand model is broken.

The empirical reason for this is that even though base money (BM) increased significantly with the financial crisis, the M2 monetary aggregate did not. The reason for this is that the Federal Reserve is paying banks to not lend money to the market. In other words, the Fed is moving two variables at the same time: it is increasing BM at the same time that it is reducing the money multiplier. The result is the fairly constant evolution of M2 we observe in the data. This does not mean that the model is broken, or that we need a new one, but rather that the Fed is moving different variables of the model at the same time. It is true that since 2008 M2 has increase faster than the price level. But has been the case since the mid-1990s, not since 2008.

But there is another general issue that I find troubling. Semantics implicitly exculpate the Fed from any wrong doing. While I believe that this concept was partially explored by the panel, I am now speaking more broadly. Semantics, of course, prize the Fed for any positive outcomes. The implicit message sent to the public is that the Fed can only do good. For instance, to say that today the “money supply does not depend on the Federal Reserve, but on commercial banks” or that “the Fed has no power to set interest rates” sends the hidden message that the Fed is not the cause of the poor economic performance since the crisis because the Fed does not control the relevant variables.

Of course, banks are the source of the secondary creation of money, but the Federal Reserve remains the primary source of the money supply. The Fed asked Congress for permission to pay interest on reserves, and is still doing so. To pay interest on reserves is like paying the banks to reduce the money multiplier. Surely, money creation stops at the banks, but this the result of the Fed’s policy and not a sudden change of behavior by the banks themselves. I would suggest that this policy was put in place for two reasons: First, to provide liquidity to banks while cleaning their balance sheets from “toxic assets,” and second, because the Fed is buying toxic assets, it cannot sell them back to the banks to keep base money on check. So, instead of taking reserves away from the balance of the banks, it’s paying the banks to hold them. Unless supply is vertical, if we start paying to keep reserves sitting at the Fed, then more reserves will be kept sitting at the Fed. This way the Fed avoids the high inflation that we would have seen if the expansion of base money would not have come hand-in-hand with a fall in the money multiplier.

Assume hypothetically that the Fed decides to stop paying any interest on reserves to the bank. Do you expect that all reserves would remain in the banks endlessly, or you expect that banks would start putting money back in the market? If paying interest on reserves has no effect at all, why would the Fed continue to do this?

Another hypothetical situation to consider would be the result of placing this policy (plus the demand for USD by other central banks around the world) on a demand and supply chart. What we would see is a more horizontal demand of base money than we are used to. An increase in the supply of base money would have a minimal effect on the price level. Changing a parameter of the model (or the slope of demand) is very different than saying that the model is broken and that we need a new one. Supply and demand did not disappear– they changed their slopes. We don’t need a new model as much as we need to revise how policy makers are changing the model’s parameters.

Similar deviation of attention from the Fed’s effects on the economy can be perceived when we maintain that the Fed has no power to set interest rates. If that truly were the case, it would mean that the Fed has been targeting a useless variable for years.

Again, there is a grain of truth in such a statement, but it begs contextualization.

Surely, the Fed only has limited, if any, control over real interest rates. Eventually, changes in the money supply would affect the nominal interest rate through the Fisher effect. The federal funds rate is decided by banks through inter-bank lending, not by the Fed itself. But this doesn’t mean the Fed has no power to affect interest rates in the short-run– even if it did, the short-run might be long enough to produce significant distortions. The Federal funds rate depends on the supply and demand of federal funds. The Fed does not fix the federal funds rate the same way we think of fixing prices under a price control regime. What the Fed can do, however, is change the supply/ demand of federal funds until the federal funds rate is at the desired level. To say that the Fed has no control on interest rates in the short-run is like saying that the Fed has no power to change the price of bananas in the short-run, but can “print” as many bananas as it wants until the price of bananas is at the desired level. Then, when something bad happens in the market of bananas, we don’t think of the Fed because our semantics imply that the Fed has no power to affect the price of bananas.

Such logic is simply not sound.

The monetary situation of today was not caused by a broken model or link; it was caused by discretionary central bank policies around the world– especially those orchestrated by central bankers at the Federal Reserve. If the Federal Reserve, or any other central bank, is powerful enough to do so much good, it is also powerful enough to do great harm. We do a great disservice to the cause of sound money if we promote the idea that the Fed is unable to do harm to key monetary variables.


Nicolás Cachanosky es Doctor en Economía, (Suffolk University), Lic. en Economía, (UCA), Master en Economía y Ciencias Políticas, (ESEADE). Fué profesor de Finanzas Públicas en UCA y es Assistant Professor of Economics en Metropolitan State University of Denver.

Prospects And Challenges For The U.S. Economy In 2016

Por Alejandro Chafuen: Publicado el 1/1/16 en:


Unemployment continues to fall, inflation is in check, interest rates remain near historical lows, the governments of major U.S. partners have no intention to engage in trade wars, and the price of oil and energy continues to fall. There are no major storms in the forecast for the U.S. economy.  Nevertheless, very few economists, if any, are forecasting a growth rate of more than 3% for next year. What is holding back the U.S. economy?

Three factors conspire against growth: the uncertainties about which road will the U.S. economy will take after the next presidential election; the continued high cost of the regulatory state and all its effects, from corruption to arbitrariness; and the lackluster performance of most major western economies.

Forbes_Chafuen for 2016

The stock market indices are close to their all-time high, almost at the same level as the end of last year. They have recovered nicely since their low in September. Unemployment stands now at 5%, lower than last year’s 5.8%. That means 1 million fewer people are unemployed, but this figure does not reflect the fact that 2 million more people have left the labor force since last year, so in terms of the percentage of workers in the labor force we are back to the late 1970s. In addition, almost half of the increase in the newly employed (470,000) were in the health care sector. I doubt that it is because “Obamacare” is less costly — just the opposite, it is more expensive and cumbersome. It imposes heavy costs on employers who want to hire more than 50 employees or offer more than 30 hours of work to those who are working less than part-time.

In the monetary arena, I forecasted last year that, as a way of precaution, the Federal Reserve was likely to begin introducing higher rates early in the year. My timing was wrong; the Fed waited until December. By announcing that it will increase the federal funds rate gradually, and modestly, a quarter point each time, it has already led the market to anticipate and factor that move.

In my Jan. 1, 2015, piece, I wrote that “with monetary easing in Europe and more prudence in the Fed, the U.S. dollar could likely strengthen another 10 percent against the Euro.” That is what happened on a year-to-year basis. There is still room for the dollar to strengthen another 5% against the Euro in 2016. Borrowing in Euros and investing in U.S. assets might still be a good strategy for 2016. Currency “wars,” with China trying to increase the role of the renminbi, will continue, but the impact will not be dramatic—at least not for the next couple of years.

With government debt passing $18 trillion, Obama keeps beating his record of increasing federal borrowing more than any other president in U.S. history. During his tenure, government debt increased by $8 trillion, and there is still more time to go. Yet, as interest rates will continue to be extremely low, the costs will not be felt this year.

Storms continue to cloud the future on the national security front. This is an area that should not be neglected. Both the reality and the perception of security threats have huge implications for the economy. A free economy is nothing but the free movement of goods, money, and labor. Those same freedoms can be exploited by those who want to cause harm, and those abuses can be used as excuses for those who want to promote protectionism and restrict the entry of competitors.

In 2014, we had the Russian intervention in Ukraine and the rise of the Islamic State, ISIS. In 2015, we saw new tensions with Russia in Syria, and with China in the South Seas. Apart from a successful catastrophic attack in the homeland, confrontations with Russia or China can have a much greater impact in the economy of the United States than all other security threats. Central and Eastern European countries are devising their own way to counter Russia. U.S. diplomats will work to prevent major issues with China, so I expect a stable “uneasiness” on both fronts, but no major confrontation.

In addition to terrorist violence in the Middle East, the acts of violence of Boko Haram in Nigeria and neighboring countries, Cameroon, Niger, and Chad, continue to be a grave threat to that region. The role of the United States is that of helping the local governments contain and defeat them. Given the little economic relevance of those countries for the U.S. economy, their threat does not enter into the economic debate. More problematic were the Paris attacks, the numerous terrorist events in Turkey, and the recent San Bernardino attack. Libertarian economists might point out that, statistically, they are not very significant, but the attacks have huge cultural and social impacts and can marginalize efforts to promote more restraint in U.S. foreign interventions. With little willingness to send large amounts of U.S. troops abroad, and with defense spending at manageable levels, the growth or decline of the U.S. economy will not depend on this sector.

The forecasts on the price of oil continue to underestimate supply and overestimate its price. Except for some of the oil-producing states, this will be a boon for the economy. If you own oil stocks, enjoy the high dividends but do not expect much growth. The positive impact of cheap oil and gas will be mitigated, however, by an intrusive regulatory state, and by the uncertainties created by the political battles over health care and immigration that will continue during 2016. Do not expect much change during these next 12 months. The recent budget deal can serve as an indicator that the Republicans will avoid major battles in Congress. The national debate will continue, but in the presidential campaigns, as usual, real action will be reserved for the future.

World trade has stalled at 2008 levels, and it has even gone down this last year. Free or freer trade is a great engine for healthy economic growth, and despite some protectionist voices, I do not expect trade wars — but neither do I anticipate much advance. Last year, I stated that “President Obama’s search for a positive legacy in the international arena might still lead him to turn his back on his more ideological base and push to approve TPP and TTIP.” After the approval last October of the Trans-Pacific-Partnership (TPP), the next challenge is the Transatlantic Trade and Investment Partnership (TTIP) with Europe. I believe that even in this polarized pre-electoral political environment, it will be easier to achieve consensus in the United States than in Europe for its passage. But, because of opposition across the Atlantic, it is doubtful that the agreement will be signed before the end of Obama’s term.

The 2016 U.S. economy can’t expect much push from its neighbors. Mexico and Canada, which together represent 30% of total U.S. trade and one third of U.S. exports, will continue to grow at modest rates. Mexico’s GDP will likely increase by 3.6%, one percentage point more than this past year. Canada, on the other hand, will likely grow at a more modest rate, just above 2%. Europe, another major trade partner, survived the Greek and other radical populist crises, but, on average, will grow less than the United States; I anticipate the same with Japan.

Respect for the rule of law in the United States has been declining, and, unfortunately, respect for private property continues to go down in the world. In the Fraser Institute index, the U.S. score in this front went slightly down (from 7.02 to 6.97), but it is way down from the year 2000, when it stood at 9.23. The United States is now 29th in the world. In the Heritage Foundation index, respect for property rights in the United States went down from 4th place in 2009 to 20th today, same as last year. In the rule of law index of the World Justice Project, (which ranks 102 countries), the United States is again in 19th place. Of the top 10 economies, four countries—Germany, the United Kingdom, Japan, and France—have better rule of law scores than the United States. Nevertheless, given the size and opportunities in its economy, the United States will remain as an attractive destination for foreign investment in 2016.


Alejandro A. Chafuén es Dr. En Economía por el International College de California. Licenciado en Economía, (UCA), es miembro del comité de consejeros para The Center for Vision & Values, fideicomisario del Grove City College, y presidente de la Atlas Economic Research Foundation. Se ha desempeñado como fideicomisario del Fraser Institute desde 1991. Fue profesor de ESEADE.

Why free-banking?

Por Nicolás Cachanosky. Publicado el 29/6/15 en:


The need for and convenience of a central bank are usually taken for granted. To say that a central bank is a good institution and, therefore, needed, is not enough. Unfortunately, the assumption that central banks are necessary seems to weigh more heavily than the facts that suggest otherwise.

Good and bad are relative terms. With respect to what then is a central bank good? Some might say to the absence of a central bank- or more specifically, to the presence of a free banking regime.

Historical records, however, show that free banking outperforms central banks in most, if not all, of the cases.

A free banking regime is such where the market for money and banking is free of specific regulation (save, of course, illegal activities such as the violation of third party property rights.) Let me be clear. The absence of a central bank is not equivalent to free banking. The absence of regulation is equivalent to free banking. This is why to think of the pre-Fed era in the United States as a case of free banking shows a superficial understanding of what an unregulated –free– market is.

The literature on free banking is vast. Let me just give a brief description and comment on a couple of illustrative historical cases. First, under free banking, each bank is free to issue their own convertible banknotes. Convertible to what? To whatever functions as base money in the economy. Historically, this has been gold, but this does not need to be the case. It could be, like Selgin describes in his Theory of Free Banking, that the Federal Reserve shuts down the FOMC and that the USD becomes the base money to which private convertible banknotes are convertible. Whether or not the USD will eventually be replaced by gold, silver, or any other asset is up to the market process to sort out.

Second, because all banknotes are convertible to the same base money, there is no multiplicity of units of account. Under this regime, there should be no fear of confusion about the multiplicity of prices. If today you travel to Hong Kong, Ireland, or Scotland, you’ll see a strong presence of private money in circulation, but you won’t see multiplicity of units of account. It could be said that the US banking system is not the most developed and flexible of the developed world. On the contrary, the heavy regulation imposed on this market suggests that lot of improvement is possible and needed.

Third, the stability of the system comes from banks competing with each other for deposits and therefore for base money. Surely, mathematical models showing how banking without central banks are instable can be developed. With the right assumptions, it is possible to shows anything in a mathematical model. Free banking shows a remarkably good performance, despite the claims that many academic models try to make.

Let me now comment on two examples that show that bank failures are not the same as bank runs. This would likely be the case under a fiat currency regime managed by central banks, but free banking works under a different regime and therefore with different incentives. The outcome is a different performance.

Consider first free banking in Scotland (1716 – 1844). In 1772 the “Ayr” bank collapsed, bringing other smaller banks down with it. As spectacular as the Ayr Bank failure might have been, the Scottish free banking system did not suffer a bank run. What happened? The Ayr Bank was doing what any efficient bank would not do: aggressively increasing the issue of their convertible banknotes. With the increase in circulation of convertible banknotes, the Ayr Bank started to lose reserves until it went bankrupt. What about the other small banks? These smaller banks were also doing what an efficient bank should not do. These small banks invested their reserves in the Ayr Bank. Why was there no bank run? Succinctly, because the reserves that the Ayr Bank was losing were being transferred to other more efficiently managed banks. This is the market outcome of over-expanding credit- no central authority is needed for this to take place. The result is an increase in the market share of efficient banks at the expense of inefficient banks. Isn’t that the outcome we want for any market- for efficient firms to displace inefficient firms?

The second case I want to mention is the economic crisis in Australia in 1890 under a free banking regime. Australia was under free banking between 1830 and 1959. The first thing to keep in mind is that the 1890 crisis in Australia was the result of Bank of England credit expansion being channeled to Australia. The result was a bubble in land prices (sound familiar?.) When this process of credit expansion is reverted (in part to the Baring Crisis that was born from Argentina’s default) some banks experience solvency problems, other did not. Those banks that saw the bubble and adjusted their portfolios where ready to buy the portfolio of the failing banks that did not see the crisis coming (again, sound familiar?)

Namely, the crisis was ready to be reverted. But the U.K. government thought it knew better and made things worse (I can keep asking if it sounds familiar, but at this point the parallelism is quite obvious.) The government committed two important mistakes. First, it forced a bank holiday on banks that were in good standing and wanted to keep their doors open to their customers. The result? The market could not sort out which banks were solvent and which were not. Second, it allowed failed banks to re-open their doors free of their previous liabilities, but this generosity was not extended to efficient banks. The result was a bank run against efficient banks towards inefficient banks. It should be patent that this was not a free banking failure, but just another case of regulation failure in one of the more complex and delicate markets.

If one looks at historical facts, rather than just let be guided by pre-conceived ideas, the need and superiority of central banking next to alternative monetary regimes is thrown into serious doubt. Surely, free banking is long gone and gold, which was used as base money under these cases, is not money anymore.

Why then look at free banking? I can mention at least two reasons: (1) To do away with the almost ideological position that a central bank is needed. This position, or assumption, needs to be questioned rather than taken as fact if we want to come up with innovative alternatives to our monetary regime. (2) Even if the old free banking system based on gold standard is not feasible, it certainly helps us to come up with reform that can improve the status-quo.


Nicolás Cachanosky es Doctor en Economía, (Suffolk University), Lic. en Economía, (UCA), Master en Economía y Ciencias Políticas, (ESEADE). Fué profesor de Finanzas Públicas en UCA y es Assistant Professor of Economics en Metropolitan State University of Denver.