Now Ron Paul wants to debase the currency?

 

Oh dear sweet Jehovah.

First Republicans, after spending years warning about the danger of a debt default, decide to not only recommend a U.S. sovereign default, but actively push for one in Congress.

Now, after Republicans spent years warning us about the (then nonexistent) possibility of hyperinflation, Ron Paul comes out and suggests a policy that would be a huge step toward hyperinflation.

Specifically, Ron Paul wants to have the Fed destroy its holdings of U.S. Treasury bonds. This would be retroactive seigniorage; it would mean that the money that the Fed printed in the past to buy those Treasury bonds was actually printed to pay off the U.S.'s sovereign debt.

As any Econ 101 student knows, large-scale sustained seigniorage is what causes hyperinflation. Now, the Fed doing a one-off round of retroactive seigniorage would not be enough by itself to push us into Weimar Republic territory - in particular, because the money has already been printed. But it would also send a signal that the Fed is no longer an independent central bank, and that Congress feels free to strong-arm the Fed into paying off U.S. sovereign debt with printed money at any time in the future. That would be a signal that much more seignorage is on the way, which would push us into hyperinflation. (Tyler Cowen sees this possibility, but rather euphemistically labels the future seigniorage "QEIII".)

So what the heck is Ron Paul thinking? Paul is a well-known supporter of the gold standard, which policy-wise is the exact opposite of hyperinflation. Is he simply betting that we'd decide to go back on the gold standard after we got tired of pushing around wheelbarrows full of billion-dollar bills? Or does he just know absolutely nothing about economics?

More generally, what is with the Republicans trying to push us into the very doomsday scenarios that they've always warned us about? Hyperinflation and sovereign default are basically THE worst self-inflicted disasters that we have ever seen befall a modern rich economy. And the only reason that there is any worry, whatsoever, that either of these things might happen to the U.S. is that the Republican Party seems to be flirting with the idea of intentionally causing them. The GOP seems to no longer be the "party of business", but a mad-dog populist gang that is running around chucking sticks of dynamite in all directions.


Update: Greg Mankiw agrees that Paul's idea is crazy, but is actually less worried than I am about the signal of future seigniorage that would be sent by revoking the Fed's independence in order to pay off our debt. Dean Baker actually likes the idea, and thinks we could deal with any inflationary effects by raising reserve requirements. So he's really cavalier about revoking central bank independence.

Update 2: A bunch of people (including Greg Mankiw and Andy Harless) are saying "But the Ron Paul plan just transfers money from one part of the government to another, and hence would be harmless." I tried to explain above why I don't think that's the case, but let me try again. Yes, having the Fed destroy a bunch of government bonds would be harmless if we only did it once, and if people believed we were only going to do it once. If we did it again and again as a regular policy, we would have to get the Fed to keep printing more and more money so that we could destroy U.S. Treasuries again and again. That would cause hyperinflation. But suppose we only do it just this once. Could we convince people that it was only a one-time thing? I doubt it. First of all, doing the Ron Paul plan even once requires revoking the independence of the Fed, which tells people that Congress is now willing to use the Fed to implement fiscal policy. That by itself is a huge policy change. Second of all, if the Ron Paul plan achieved results that pleased lawmakers (i.e. reducing headline federal debt), that would tend to make the lawmakers want to do it again. And again. So there is every reason to think that the Ron Paul plan would lead to popular expectations of large-scale seigniorage...and hence to hyperinflation. In any case, it's an absolutely enormous risk. To take that risk, for the sole purpose of reducing headline debt (while leaving net debt unchanged), is, as Greg Mankiw says, crazy.