The Econ Establishment Teams Up To Denounce Judy SheltonTags The FedU.S. EconomyMonetary Theory
Ever since President Trump nominated Judy Shelton to the Federal Reserve Board, the economics establishment has been letting Americans know just how crazy she (allegedly) is. And to illustrate that the establishment is bipartisan, the condemnation of Shelton has come from both the left and the right. For example, an American Enterprise Institute fellow has an article in The Hill warning of “Trump’s bizarre Federal Reserve nomination,” while National Review’s resident monetary wonk, Ramesh Ponnuru, wrote in Bloomberg that Shelton not only has a history of pushing very bad policies, but now is apparently flip-flopping just to get the job. And on Twitter, an econ-watcher has a long thread detailing all of the self-evidently nutjob positions Shelton has advanced over the years. Why, she’s not just for the gold standard, but she’s against FDIC! And she thinks the Fed’s 2% (price) inflation target erodes your property rights. Can you imagine?!
And to show that I’m not just cherry-picking, here’s what a Google News search returned for me just now when I typed in “Judy Shelton”—and be sure to read the subheadings as well as the titles:
With this kind of opposition, it won’t surprise you to learn that Shelton has been quite forcefully condemning the whole central bank apparatus. Back in May, when she was being vetted by Trump (but before her actual nomination), Shelton gave an interview to the Financial Times in which she criticized the entire concept of the Federal Reserve:
How can a dozen, slightly less than a dozen, people meeting eight times a year, decide what the cost of capital should be versus some kind of organically, market supply determined rate? The Fed is not omniscient. They don’t know what the right rate should be. How could anyone?
She went on to condemn the Fed’s “Soviet” power over markets and likened US monetary policy to “Gosplan,” in which Soviet officials tried to centrally plan their economy.
This kind of radical talk spooks the “free market” commentators with major media perches. It’s all fine and good to quibble with the Fed’s latest rate cut, or even to suggest a new approach such as targeting nominal GDP. But to wonder aloud about why we need central planners in charge of our money and banking? That’s radical and dangerous. In the rest of the article I’ll touch on three of Shelton’s specific positions.
A Gold Standard, With Fixed Exchange Rates
Shelton has long favored some form of commodity backing of the dollar, including praise for the historical gold standard. (In his column offering qualified praise for Shelton, Joe Salerno pointed out that in her writings, Shelton has unfortunately failed to distinguish the true classical gold standard from the much more dubious Bretton Woods framework.) For example, in a 2018 proposal for the Cato Institute, Shelton argued (and here I’m drawing on the quotes contained in the Forbes.com link):
The current monetary regime permits governments to knowingly distort exchange rates under the guise of national monetary autonomy while paying lip service to avoiding trade protectionism…
It empowers central banks to channel the benefits of monetary policy decisions to some people at the expense of others, pitting wealthy investors against average savers. It facilitates cheap government borrowing. The shift toward increasing government influence over economic outcomes is anathema to the free market doctrines propounded by [Milton] Friedman.
If the United States does nothing to restore a rules-based approach to international monetary relations, our values come into question. We lose credibility by failing to challenge an international monetary anti-system that condones cheating by governments and central banks.
Now the Forbes writer who quoted the above from Shelton’s 2018 Cato piece was aghast at her heresy. After all, doesn’t Shelton realize that Fed policymakers needed flexibility to avoid a second Great Depression in 2008?
Yet this is the whole crux of the debate. Shelton and other proponents of sound money believe that it is “flexible” currency that leads to trouble. In the Austrian view (which is not identical to Shelton’s perspective which seems more supply-side), it was loose monetary policy in the 1920s that led to the inevitable crash in 1929. In contrast, those blaming the gold standard lament that policymakers’ hands were tied in the early 1930s and couldn’t inflate enough.
Likewise, the standard Austrian view is that Alan Greenspan’s loose monetary policy fueled the housing bubble in the early and mid-2000s, which then resulted in the bust of the 2008 financial crisis. Moreover, several Austrians warned of this ahead of time. Mark Thornton for example gave an eerily prescient description of what was to come, way back in 2004, and I used Austrian business cycle theory in October 2007 (which was 11 months before the crisis) to speculate that we could be in store for the worst recession since the early 1980s. (In full disclosure, I later gave erroneous warnings about imminent consumer price inflation during the Obama years, much to Paul Krugman’s delight.)
Sound Money and Free Trade
The connection that Shelton draws between free trade and monetary policy is this: Under a regime of central bank-controlled fiat money with flexible exchange rates, a government that wants to encourage exports doesn’t have to rely on the old-fashioned tools of tariffs and export subsidies. Instead, the government can simply use its central bank to devalue its currency, which will give, at least in the short run, a boost to exports by making its goods cheaper in the eyes of foreigners. (Note that this is actually a very complex topic; I explain some of the initial market reactions to a devaluation in this article.)
In contrast, Shelton is arguing that if we want truly free trade without governments leaning on the scales, then they need to have sound money with fixed exchange rates. In the Twitter thread I mentioned above, Shelton’s stance on exchange rates was supposed to be yet more evidence of how loony she was. Indeed, the tweeter linked to a 1994 article in National Review in which Milton Friedman himself quoted Shelton—way back then—championing fixed exchange rates, to which Friedman replied, “It would be hard to pack more error into so few words.”
This is something that can confuse the newcomer to free-market economics; indeed, I remember when I was confused by it, until reading an essay by Murray Rothbard when I was a young lad. (That Rothbard essay is “Back to Fixed Exchange Rates,” starting on page 306 in this fantastic collection.) Under the classical gold standard, say in the year 1910, the U.S. government would redeem $20.67 in currency for an ounce of gold (less handling fees), whereas the UK authorities would hand over an ounce of gold for 4.25 British pounds. These redemption rates by the respective governments implied an “anchor” for the dollar/sterling exchange rate of $4.86 per pound.
Now this was a “fixed” exchange rate in the sense that if the actual, market forex rate deviated too far in either direction, speculators would have the incentive to present the overvalued currency to the proper authorities to receive gold, ship it across the ocean, and deliver it to the other government and be paid in the undervalued currency. The speculators could then go back to the forex market and obtain more of the original currency than they started out with. Under the classical gold standard, this arbitraging process would cause a gold drain from any country that issued too much of its sovereign currency, relative to the other participants. Speculators would keep the actual market foreign exchange rate within a narrow band around the “fixed” exchange rate implied by the gold redemption ratios that each government had adopted. This system provided an extremely predictable foundation upon which global trade could flourish; it was as if the whole world were using gold coins as money, with the national currencies (dollar, franc, mark, pound, etc.) serving as mere details, somewhat akin to an American merchant today reckoning transactions in dimes rather than dollars.
In total contrast, when Milton Friedman is aghast at Shelton’s praise of “fixed exchange rates,” he assumes she means government price fixing of exchange rates under a regime of fiat monetary policy. In this type of scenario, a government “fixes” the foreign exchange value of its currency through coercion. And yes, if the government imposes a price floor on its own currency—inflicting punishment on any currency trader caught selling the domestic currency for less than the official floor—then all of the standard problems with price floors will emerge, including a “glut” of the domestic currency and a shortage of foreign currencies. The government will then typically supplement its price floor with other measures, such as “capital controls” and direct intervention in foreign trade.
As Rothbard explains in the essay linked above, the only thing worse than a world regime of fiat monies and floating exchange rates is a world regime of fiat monies and fixed exchange rates. But even though Milton Friedman’s “flexible exchange rates” are useful when governments issue different fiat monies (in order to prevent gluts and shortages in the foreign exchange markets), it is still much better, Rothbard argues, if all of the governments solemnly commit to redeeming their currencies for fixed rates of gold, which in turn imply fixed exchange rates among the currencies. This is the type of arrangement Judy Shelton has in mind, when she argues that fixed exchange rates are a necessary condition for truly free trade without political favoritism.
In the lengthy Twitter exposé the Shelton critic (Sam Bell) highlights her opposition to FDIC as particularly laughable. Yet the allegedly damning quotes he provides from her, seem self-evidently correct to me. An example:
Banks effectively are compensated by depositors for their expertise in selecting profitable, yet prudent investment opportunities. However, when government insurance exists, the fundamental arrangement between the furnishers of investment capital and the loan experts is grossly altered. Depositors no longer have to make judgments about the competence of bank management or the characteristics of the loan portfolios.
Except for quibbles about the distinction between checking and savings accounts, I think the above Shelton quote is quite straightforward. In any other area, students of economics understand “moral hazard” and how government guarantees can deaden the incentive for oversight. But when it comes to banking, several generations of Americans have learned since they were little kids that “laissez-faire failed us in the 1930s, and thank goodness FDR came in to make everything right.” Such a simplistic tale doesn’t explain why laissez-faire all of a sudden failed in the 1930s—after all, the U.S. had been more laissez-faire in all previous financial crises, and yet didn’t suffer the Great Depression. And as George Selgin pointed out to Sam Bell on Twitter, the Canadian banking system didn’t suffer from failures during the 1930s as the U.S. did, precisely because they had less regulation than the American banks.
Eliminating Interest on Excess Reserves
Besides highlighting her allegedly nutty policy views, the other big criticism of Judy Shelton is that she seems to have turned from ultra-hawk to ultra-dove in order to get Trump’s nomination. Specifically, Shelton excoriated the Fed’s artificially low rates during the Obama years, while recently she has been recommending that the Fed take interest rates down, possibly near zero. (Remember, this alleged flip-flop is the cornerstone of Ramesh Ponnuru’s critique.)
I don’t want to be naïve here; it is certainly possible that Shelton is adjusting her opinions to make herself palatable to Trump. However, her positions are not an outright contradiction, as most of her critics are alleging. During the Obama years, Shelton railed against the Fed pushing down interest rates through massive rounds of “quantitative easing,” i.e. the creation of money out of thin air through which the Fed bought up trillions of dollars worth of mortgage-backed securities and Treasury debt. Shelton argued, correctly in my book, that this was a grossly unfair policy that punished regular savers and bailed out incompetent bankers, as well as fueling massive deficit spending.
Fast forward to today, when the Fed is raising rates. What Shelton is complaining about is that the Fed is doing this by paying commercial banks not to make loans to their customers. Specifically, the Fed has been raising rates by increasing the interest rate that it pays on reserves parked at the Fed. (Actually, the Fed has also been letting its balance sheet shrink too since early 2018, so the situation is very complex.) Shelton explains her actual views nicely in this interview with Heather Long. She isn’t arguing for QE4, rather, she wants the Fed to stop paying commercial banks for keeping their reserves parked at the Fed. It’s possible she’s being a bit coy about whether the market-clearing interest rate should be higher or lower than it currently is, but her actual policy views are coherent as far as they go.
In this lengthy article, it was not my purpose to put Judy Shelton on a pedestal. I disagree with some of her public statements, particularly her endorsement of Trump getting tough with China on trade. But the systematic attack on her in recent weeks has been grossly unfair. Indeed, some of Shelton’s most allegedly damning policy views are actually her greatest strengths, in my book. Anybody who would liken the Federal Reserve to the Soviet central planners is an independent thinker worth considering.