What Vivek Ramaswamy doesn’t understand about the Dollar

Vivek Ramaswamy has called for the US Federal Reserve to stabilise the dollar in relation to the price of commodities, rather than to the consumer price index. (Source: Bloomberg)

Along with Vivek Ramaswamy’s rise in the polls should come greater scrutiny of his views on economics. In that spirit, I am here to report that — on monetary policy at least — the Republican presidential candidate does not yet have useful recommendations.

Ramaswamy has called for the US Federal Reserve to stabilise the dollar in relation to the price of commodities, rather than to the consumer price index. That formula is unlikely to bring monetary stability (or tame business cycles) in part because commodity prices themselves are notoriously unstable.

Consider the five years leading up to 1994, when consumer prices increased more than 19 percent but most commodity prices fell. Or the years from 2004 to 2008, when commodity prices rose by about three times but US price inflation rates were roughly constant, in the range of 2 percent. In other time periods, the relationship between commodity prices and consumer inflation is murky.

Many commodities are inelastic in supply in the short run. That means when demand rises, or supplies are restricted, prices for those commodities can go up a lot. This happened with the war in Ukraine, which has intermittently caused prices for wheat, oil and gas to skyrocket.

Economists may debate what a central bank should do in response to those shocks, but there is no simple and fast rule. Often the high commodity prices are a contractionary shock — and so should not be combined with disinflationary pressures, which would serve as another contractionary shock. Perhaps this reform could work if the Fed picked commodities with prices that are not so volatile. But that’s a fool’s errand.

I am reminded of economist Robert Hall’s 1982 “ANCAP” proposal to stabilise the dollar with a commodity basket. Hall argued that a bundle of ammonium nitrate, copper, aluminum and plywood (thus ANCAP) had proved stable in terms of the dollar in times past. He was right about that. But the rise of China and other nations brought an unprecedented commodity price boom. Had the US tried to stabilise the value of the dollar in terms of those commodities, the Fed would have had to apply significant deflationary pressure to stabilise the relevant commodity price index. Actual monetary policy would have been a disaster.

That leads to a more general point: Both commodities and other asset prices, such as exchange rates, may rise and fall for reasons which remain mysterious and which may not be tied to inflationary and deflationary pressures. Ramaswamy’s column for the Wall Street Journal describing his policy has a lot of single-sentence “drive by” claims about macro events that have not been confirmed on the research side.

His analysis does, however, contain two significant grains of truth. Unfortunately, neither is framed correctly.

It is reasonable to suggest that the Fed consider commodity prices as one of many market indicators when setting monetary policy. In fact, the Fed does that already. It is also reasonable to say that the Fed might usefully assign commodity prices a greater role. (I am not myself convinced, but it would be odd if all current Fed decision weights were exactly the right ones.) Yet that is hardly a radical change in procedure, and it does not equate to stabilising the prices of a commodity bundle.

The second grain of truth is that the Fed was largely asleep at the switch when inflationary pressures began to build early in the pandemic. It is important to note, however, that markets were asleep, too. Interest rates, for instance, were not forecasting the big hike in inflation rates until February 2022, when it was too late. Commodity prices were rising during this period, but by 2021 they were simply regaining their pre-pandemic levels, hardly an early warning of imminent high inflation. Overall, a greater reliance on market price indicators would not have sent sufficiently clear warnings.

What then might have been done to check high inflation? One possibility is that the Fed should have paid greater heed to the 40 percent rise in M2 money supply between March 2020 and March 2022. Another possibility would have been for President Joe Biden not to engineer a major fiscal expansion into the teeth of a strong economic recovery. Whatever other procedure or rethinking might be necessary, it is hard to see commodity prices as more than one relevant signal of many.

It is understandable that Ramaswamy would want an easy slogan — and “Stabilise the Dollar” qualifies — that calls attention to the Fed’s mistakes. The complicated truth is that many different kinds of errors fed into the US’s higher inflation rate. A complete answer will not come from merely staring harder at commodity prices.