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Why We Still Need Rand Paul

rand paul

Rand Paul may not be impressing pollsters, but Republicans would be making a massive mistake to write him off so early. The Kentucky senator stands apart from the rest of the primary field in one crucial way: He actually understands the complicated dynamics of monetary policy. And judging from what we’re starting to see happen around the world, this will be an invaluable skill set in 2016.

Indeed, by this time next year, the world could very well be in the midst of a major financial panic.

Look at China, where the People’s Bank of China recently announced they’re dropping the renminbi’s dollar link. To make the dollar peg work, China effectively imported America’s monetary policy, constantly weakening their currency. As global demand for Chinese exports dried up over the last few years, China is trying to bolster domestic demand, which it’s doing by strengthening the renminbi.

That means unloading hundreds of billions in American debt and using those proceeds to buy back its own currency. Already in 2015 China has dumped more than $200 billion of its $1.3 trillion worth of U.S. treasuries. And if global demand for Chinese goods remains weak and the Middle Kingdom’s economy continues cratering—which pretty much everyone anticipates—expect further dumping.

Funny Money Is the Nicest Way to Put It

In Saudi Arabia, where low oil prices are weakening the Saudi riyal, the kingdom is following China’s lead and likewise dumping treasuries. Saudi Arabia owns more reserves than any other country. A senior director at Roubini Global Economics, Rachel Ziemba, reports Organization of the Petroleum Exporting Countries (OPEC) nations have sold more than $200 billion of U.S. reserves in the last year, and she expects other Gulf states to follow suit.

The world appears to be losing its appetite for financing America’s deficit spending.

China and OPEC rank first and third as the largest holders of America’s debt. In second place is Japan, which has been selling its share since 2012. Russia, Taiwan, and Norway are also selling their treasuries. Add it up, and the world appears to be losing its appetite for financing America’s deficit spending.

What does that mean for us? Either interest rates will rise—regardless of what the Fed intends. Or, the Fed itself will itself buy all of the Treasury’s debt.

Both outcomes would be painful. Already the Fed is the biggest buyer of U.S. treasuries, having bought 71 percent of America’s debt issuance in 2013 and now owning more than twice as much as China ($2.8 trillion versus $1.1 trillion). Of course, the Fed buys treasuries with money created out of thin air. Combined with other QE-related money expansion, the Fed has more than quadrupled the monetary base since the Great Recession began in 2007, from $876 billion to $4 trillion today. How much more air is the Fed going to try and squeeze into this bubble?

​The Crash Is Coming; What Matters Is the Recovery

The other outcome—higher interest rates being forced upon the United States—means maintaining current levels of government spending will become much more expensive. Obviously Obama won’t be cutting spending to make up the difference, so expect higher taxes—and a recession.

The reality is that it doesn’t matter who’s elected in 2016; the economy is set to nosedive regardless.

The reality is that it doesn’t matter who’s elected in 2016; the economy is set to nosedive regardless. The question is whether the coming recession will be allowed to expunge malinvestments from the economy, setting the stage for an actual 1980s-style recovery, or whether we’ll simply repeat the mistakes made over the last seven years and try reinflating another burst bubble.

As a senator, Paul has annually introduced legislation that would enable Congress to retake from the Fed its powers over money. This is the first step toward bringing sanity back to monetary policy. Since at least the Alan Greenspan era, America’s workers, businesses, and traders have increasingly—and dispiritingly—come to believe prosperity emanates from the minutes of the Federal Reserve Open Market Committee, as opposed to industry, innovation, capital, and free markets.

As Paul observed in a recent Wall Street Journal op-ed, the Fed responds to every crisis the same way: lowering interest rates and, in the most recent crisis, an outright expansion of the money supply. As the economy is never truly correcting, bailouts preserve bad investments and then new bad investments are piled on top, making every crash more painful than the one before. If the 2007 recession is just a prequel to the main event, the absolute worst thing to do will be to pull from the Greenspan/Bernanke/Yellen playbook and try creating a new bubble to replace the last one.

Rand Paul to the Rescue

When Ronald Reagan came to office promising to slash inflation, his chairman of the Federal Reserve, Paul Volcker, began raising interest rates, creating a recession. Concerned, Reagan asked Volker if his policies were actually working. Volker explained the higher rates were needed to strengthen the dollar and squeeze bad investments out of the economy. Despite the hit to his popularity, Reagan gave Volker his blessing to keep raising rates, and before long a recovery based on actual economic fundamentals was underway.

Paul appears to be the only Republican willing to forego popular opinion and administer the medicine the economy requires.

The next president will have the unenviable task of managing a similar crisis. And Paul appears to be the only Republican willing to forego popular opinion and administer the medicine the economy requires.

“Interest rates are a vital signal in the market; they must be allowed to do their job—that is, they must be allowed to be free,” Paul wrote in his Journal op-ed. “The sooner Fed officials withdraw their artificial monetary injections and let interest rates rise to their natural level set by free markets rather than government decree, the sooner the economy can return to genuine, sustainable growth.”

Some conservatives object to Paul over foreign policy, drug-sentencing, and other policy differences. But if America’s economy bottoms out or, worse, the dollar crashes, these kinds of debates will become academic.

What we’re seeing now around the world—the early stages of currency wars; a zero-interest rate “rescue” moving into its seventh year, an ever-shrinking labor force participation rate—indicate that monetary policy is set to be the sleeper issue of 2016.

We’re going to need Rand.