On Credit Bubbles, Central Banks and the Gold Standard

Perhaps not the most interesting subject for readers but Gerald P. O'Driscoll Jr. offers some advice on salvaging the economy and on putting into place policies that would avoid the fiscal disasters we've witnessed of late. Unfortunately, it seems as though neither political Party is serious about the addressing the root causes of the problem; i.e., the leviathan entity of the Federal Reserve, the explosion of "free" credit, the abolition of a commodity standard such as gold which would confer actual value on the dollar, etc. Driscoll's advice being scholarly, sound and prudent, Obama is unlikely to take heed.

Mr. Obama needs to stop the next asset bubble from being inflated by imposing a commodity standard on the Fed. A commodity standard (such as a gold standard) imposes discipline on a central bank because it forces it to acquire commodity reserves in order to increase the money supply. Today the government can inflate asset bubbles without paying a cost for it because the currency isn't linked to the price of a commodity.

With a commodity standard in place, the government would also have price signals that would alert it to the formation of a bubble. Why? Because the price of the commodity would be continuously traded in spot and futures markets. Excessive easing by the Fed would be signaled by rising prices for the commodity. In recent years, Fed officials have claimed that they cannot know when an asset bubble is developing. With a commodity standard in place, it would be clear to anyone watching spot markets whether a bubble is forming. What's more, if Fed officials ignored price signals, outflows of commodity reserves would force them to act against the bubble.

The point is not to deflate asset bubbles, but to avoid them in the first place. Imposing a commodity standard is a practical response to the repeated failures of central banks to maintain sound money and financial stability. What would be impractical is to believe that the next time central banks will get it right on their own.

http://online.wsj.com/article/SB122688652214032407.html