In this month’s issue of Forbes Steve Forbes takes Alan Greenspan’s management of the Fed to task:

Alas, There’s No Way We’ll Get the Best Way

Alan Greenspan recently declared that the Federal Reserve could raise interest rates rapidly if inflation really heated up; otherwise, rates will rise according to his assessment of the state of the economy. The time has come to ask a fundamental question: Is raising the nominal cost of money truly the best way to fight inflation?

Sadly, the Fed, Fed watchers and economic policy makers won’t even think to raise this question. Too bad. The American and global economies and the financial markets would benefit enormously if the Fed fundamentally changed its modus operandi and adopted an approach that would really give us monetary stability. Instead, we’re going to continue to chart an unsteady course that will keep uncertainties festering, which will, in turn, inhibit us from going full-speed ahead.

Thanks to Milton Friedman, most people now acknowledge that inflation is a monetary phenomenon, i.e., it results from the printing of too much money. Determining the right amount of money for the economy is the trick. The supply of money is only half the equation; the other half is demand. If animal spirits are weak because of excessive taxation or other factors, a low supply of money can still be inflationary because demand could be even weaker. Conversely, a healthy, robust economy will increase the demand for credit, and meeting that demand will not be inflationary.

The way the Fed handles money supply is to the economy what a carburetor is to an automobile: Insufficient gasoline stalls the engine, too much floods it, and the right amount makes the engine purr. At the moment, our central bank uses no reliable fuel gauge. We’re on a Greenspan standard. However the Sun King chairman sees the world is what determines the stance of the Federal Reserve. Rare is the individual who becomes a high Fed official or governor without Alan’s assent. As far as one can fathom, His Majesty still seems to think economic growth determines the rate of inflation. He hasn’t read his Friedman. In Alan’s mind the way to control inflation is to fine-tune economic activity. If the economy grows around 3% a year, all will be well. Thus, raising interest rates makes sense–the higher cost of money will slow down the economy, preventing it from going into overdrive.

But economic activity doesn’t determine inflation–price indexes, yes, but not currency debasement, i.e., inflation. The chairman and too many economists confuse price changes that are triggered by a debasement of the currency with price changes that come about from normal activities in the marketplace. Wal-Mart is always figuring out how to charge less for its products: That’s not deflation, it’s productivity. A more vigorous magazine and newspaper industry may cause paper prices to rise (assuming there’s no additional capacity coming online). But that’s not inflation; it’s the interplay between supply and demand. Price changesare good because they signal what’s dear and what’s excessive.

There’s a simpler, better way for the Fed to conduct its monetary operations. Commodity prices as a whole–gold, in particular–will tell you instantly if the central bank is doing its job right. For a variety of reasons gold is to monetary policy what the North Star is to determining location. Gold’s intrinsic value hardly changes. Its price fluctuation in dollars reflects not a change in the value of gold but a change in the real worth of the greenback. This is absolutely basic.

Understand that, and Mr. Greenspan’s job becomes infinitely simpler, and uncertainties virtually vanish. Take the 10- or 12-year average price of the yellow metal–anywhere from $330 to $340 an ounce–and use that as your benchmark. (For safety’s sake, better use $350 to $360 an ounce.) If gold goes above that range, then the Fed should pull dollars out of the economy through its open-market operations. If gold falls below that range, the Fed should pump more dollars in. Day to day, the Fed should print or extinguish dollars to keep the price of gold steady in dollar terms. If the economy is robust, it will create more dollars; if it is weak, fewer dollars will be created. The dollar should be similar to any fixed measure of value or volume–there are 12 inches in a foot, 60 minutes in an hour, 16 ounces in a pound, and so on.

Short-term interest rates? Under this model the Fed can ignore them. Let ’em float in the marketplace. The discount rate can be tied to T-bills.

There’s not a proverbial snowball’s chance in hell that such a direct, sensible course will be adopted. And though no one would want a commercial airline pilot to fly without instruments, that’s exactly how the Fed is operating. Thus, investors must always keep their seat belts fastened and hope the Fed doesn’t get into an accident–as it has so often in the past and may be doing again.

While I personally think the gold standard is archaic, given today’s technology, the idea that monitary policy should follow the economy, not lead it, is particularly wise.