Paul versus Bernanke
By Hossein Askari and Noureddine Krichene
The fascinating two-year "rumble" that has been threatening since the November
2010 mid-term United States elections will unfold after the new congress is
seated this week. The feature bout on the card will pit: in the right corner,
Ron Paul, the Texas Republican congressman, a graduate of Duke University
Medical School, 1988 presidential candidate and author of the best-selling 2009
book End the Fed; and in the left corner, Ben Bernanke, chairman of the
board of governors of the US Federal Reserve System, MIT PhD economist, former
chairman of the Council of Economic Advisors and Fed governor.
This dream prize fight should take place because the Republicans have
"mischievously" nominated Ron Paul as the chair of an
important sub-committee of the House Financial Services Committee, namely the
sub-committee on domestic monetary policy and technology, which scrutinizes US
The two combatants, Paul and Bernanke, have sharply opposite views in ideology
Paul, a well-known libertarian, belongs to a school of thought that rejects
Keynesian economics, and abhors fiscal deficits and a government that polices
the world. He supports the market mechanism, including for interest rate
determination, supports bankruptcies, and dislikes bailouts and moral hazards,
advocates the gold standard and a safe and stable dollar, and is critical of
the law that banishes the use of gold in domestic circulation.
Bernanke's approach to economic policy is well known and speaks for itself. As
a key policy-maker under the George W Bush and Barack Obama administrations, he
was the architect of extremely loose monetary policy that earned him the alias
"Ben the helicopter" and has provided the foundation for recent financial
developments in the United States, resulting in financial turmoil with a severe
recession, unprecedented peacetime fiscal deficits and rising public debt. He
is a strong supporter of Keynesian economics and quite relaxed about the
dangers of inflation and inflationary expectations. His near-zero interest rate
policy has reduced income from savings and distorted prices.
Since the nomination of Paul to chair the domestic monetary policy
sub-committee, media and academic circles have become intrigued as to how the
relationship between the congress and the Fed will evolve? In particular, to
what extent will he be able to implement the ideas that he has advocated since
the early 1970s, calling for sound money, a return to gold, and culminating
with the elimination of the Fed?
To say that Paul faces great challenges is an understatement. If his tenure as
a head of the sub-committee ends with no change in US monetary policy and at
the Fed, then all of his ideas could be seen as rhetoric, with his supporters
becoming discouraged at discovering the gap between his ideas and political
If, however, Paul succeeds in reforming US monetary policy and the Fed, he
would set an important historical precedent, with his supporters gaining
confidence in their ability to make hitherto difficult changes in the US
Even before round 1, Paul has started to dampen expectations. Although he has
re-emphasized his belief that the Fed should be abolished, he has cautioned
that turning ideas into reality takes time and effort. He has noted that his
first action on the job will be to "think things through and not over-do things
too soon". When asked if he intends to get rid of the Fed, the congressman
replied: "Not right up front, but obviously that is the implication. Even in my
book about ending the Fed, I talk about not turning the keys and locking the
doors, I talk about a transition."
The congressman spoke about how he would go about reining in the Fed and the
reasons he believes it is vital to do so. "I'll have plans for hearings to find
out how much information we can get. Obviously it is very popular with the
American people to audit the Fed, to know what they are doing. They can spend
trillions of dollars and we don't know where it goes. They have a bigger
budget, they spend more money than the congress does, and yet we have no
oversight. It was never intended that a secret body like this could create
money out of thin air and spend it, take care of some banks and big business
and foreign banks while the American people struggle."
These statements indicate that Paul has quickly become more pragmatic and has
toned down his plans for radical reforms, possibly handing the banner of
radical reform to future generations after Americans have suffered even more
from financial turmoil and chaos.
Relegating reforms to future generations could be a disappointing message to
Paul's supporters. However, it may not be, as it appears that Paul's priority
is to audit the Fed's operations. This would be in line with legislation he
introduced, incorporated into the Dodd-Frank Act of July 2010, enabling the
Government Accountability Office (GAO) to audit the accounts of the Fed.
For those who are familiar with Paul's ideas, this priority falls short of
their expectations. The urgency does not seem to lie in auditing the Fed's
operation as much as to prevent further erosion of the value of money and
spreading economic malaise. The urgency for his supporters is to stop the
hemorrhage before washing away the blood.
Although a physician by training, Paul has displayed detailed knowledge of
monetary economics and documented the adverse effects of the Fed's policies. He
has pointed out that, contrary to its mandate to promote price stability, the
Fed has promoted price instability.
Looking at the pre-Fed era, the US consumer price index (CPI) declined at an
annual average of 0.5% and real gross domestic product (GDP) grew at an annual
4% during 1800-1912; this would have been labeled grave deflation by Bernanke
and would have been considered as a danger to the economy.
During the Fed era, the CPI rose at 3.5% per year and real GDP at 3.25% per
year during 1913-2009. Hence a dollar bought almost twice as much goods in 1912
as it did in 1800; and in 2009 it bought less than 5% of the goods it bought in
Paul pointed out that the Fed was a joint creation of the government and Wall
Street to provide an "elastic" monetary system, with the real and hidden
purpose being service to the interests of Wall Street.
In fact, there may not have been a more opportune time to think about radical
monetary reforms than the present, with more Americans aware of the economic
and financial policies, the impact of Fed policies on the US economy and in the
face of a declining standard of living for the large majority of Americans.
The standard of living has been declining; impoverishment increasing, and the
era of "opulence" as described by the late Professor John Kenneth Galbraith
only a dim memory. A large number of Americans are still living out the
financial nightmares of 2007-2009, with millions of foreclosures and general
bankruptcies. It could be the best time for popular support for Paul's ideas.
Paul has been an influential member of congress and has been member of the
banking committee; yet despite his strong views and statements and sharp
criticism of the Fed in the past few years, he was unable to initiate reforms
that would rein the Fed's expansionary monetary policies. Recently, some House
Republican members wrote to Bernanke urging him to renounce the new
quantitative easing program, which will inject $600 billion into the economy.
Their letter was simply ignored by the Fed.
This state of affairs and the absolute power of the Fed to impose policies
regardless of strong policy disagreements illustrate the urgency of hearings
and reform. It is congress that created the Fed in 1913; it is congress that
has imposed mandates on the Fed, including the reforms that set up the
rate-setting Federal Open Market Committee in 1933 or the mandate of
full-employment in 1946. It is congress that could legislate reforms on the
While Paul's long-time career in congress has been rich in ideas and prophetic
of the financial crisis, it has nonetheless been marked with very few
substantive initiatives for monetary reform.
Paul has clearly stated that he does not intend to shut down the Fed, admitting
that doing so would require far-reaching reform. However, it is his intention
that the idea has to be nurtured over generations until new leaders are elected
with this goal in mind or until the Fed has caused such economic and social
damage that the electorate chooses leaders with the explicit mandate of
shutting down the Fed.
Hence, by stepping backward from the cherished idea in his book, he may lead
supporters and politicians to consider his views as a form of utopia rather
than a position that can become operational in the near future. Prior to Paul,
the well known University of Chicago and London School of Economics professor
Harry Johnson was critical of the existence of the Fed as a policy-making body
and proposed transforming it to an agency within the US Treasury, but this idea
was never pursued.
Short of shutting down the Fed, which would require considerable campaigning
within the political establishment and proposing the details of the monetary
system that would emerge after such a closure, there are many less
revolutionary ideas proposed by reformists during the 1930s and later, most
recently by Paul and other critics of the Fed.
Subjecting money supply to a fixed rule was emphasized much earlier by the
Currency School and translated in the United Kingdom into Sir Robert Peel's act
in 1844 that separated the Bank of England into an issue department and a
banking department, with the issue of currency tightly determined by the amount
of gold in hand.
The advocates of the fixed-money rule, such as economists Irving Fisher, Henry
Simons, and Milton Friedman, believed that the Fed should only control monetary
aggregates according to fixed increment rates between 2% and 4%, ensure safety
of the banking system, and renounce setting interest rates or controlling the
Besides versions of the currency school theory, reformists during the 1930s
proposed the establishment of 100% reserve banking, which would eliminate money
creation and destruction by banks, thus making banking safe and eliminating
A less radical reform advocated in the past as well as recently is to drop the
Fed's mandate to achieve full employment as this mandate may be inconsistent
with the role of a central bank as a monetary agency responsible for managing
liquidity and ensuring banking safety; this mandate may have led the Fed into
printing money, resulting in banking crises and inflation.
Paul has considered gold as the pillar of the monetary system that he envisions
and supports. Ever since the collapse of the gold standard in 1914, some
authors have kept on advocating a return to gold. While the metal has its
supporters, it has more adversaries among professional economists. Gold was the
common currency that unified all other currencies in a fixed exchange
arrangement under the gold standard. The president of the World Bank has also
recently proposed a return to a gold standard. Such a move would be much more
difficult than president Richard Nixon's decision to abolish dollar
convertibility in 1971, in turn destroying the fixed exchange arrangement
adopted under the Bretton Woods system in 1944, which had afforded gold a
continuing role in the monetary system.
However, if Paul manages to re-introduce a form of the gold standard or abolish
laws that forbid the circulation of gold, he would have accomplished a great
deal of the reform program that he has campaigned for since the early 1970s.The
menu of reforms for Paul as head of the domestic monetary policy sub-committee
is, therefore, not limited.
Paul doesn't appear to think that Bernanke is better or worse than the previous
Fed chairman, Alan Greenspan. It is, instead, the monetary system that needs a
radical overhaul. He has predicted that under the present Fed-dominated system
the economy will deteriorate, inflation will become very high, and that the
American people will become poorer. He holds congress responsible for fiscal
management, bailouts, re-inflation of housing prices, and authorizing Fed
He has noted that foreign central banks have been buying gold and getting out
of the US dollar and that the dollar may loose its status as a reserve
currency. In such a scenario, he does not believe that the Special Drawing
Rights (or SDRs) issued by the International Monetary Fund or any other
currency could replace the dollar - only gold could. As a representative of the
American people, he believes that congress may have to consider substantive
monetary reforms that would restrain excessive powers of the Fed.
As it turns out, a large majority of congressmen are supportive of the Fed,
believe that printing money is the solution to end recessions and high
unemployment, and are critical of Paul's ideas, claiming that the overwhelming
majority of Republican congressmen are not supportive of his approach to
economic and financial policy.
The 2010 November elections may have already sent a clear message of what the
electorate thinks. As Americans pay higher prices on a daily basis for gas and
food, as more suffer the humiliation of unemployment and foreclosures and are
deprived because of economic inequities, more of the electorate will support
candidates with platforms calling for fiscal and financial reforms.
For Paul, the US is on the verge of a currency crisis that may undermine the
very existence of the Fed: "What I really fear is that when the Fed comes to an
end it will not be by my planning but it will end with a catastrophic financial
dollar crisis. This crisis when it comes, and I think we're approaching it,
affects everybody because it's such an important currency. I think we're moving
into very, very dangerous times."
Let the rumble begin!
Hossein Askari is Professor of International Business and International
Affairs at the George Washington University. Noureddine Krichene is an
economist with a PhD from UCLA.