This will be my final blog post for the Power Hour, given that I’m graduating from UWG in July and will not be returning to co-host the show (heart breaking, I know, but the show will go on), but I feel that this will certainly be my most important post. This is something that I intend to cover in the Power Hour finale, something that should be at the center of economic reform discussion right now: the Federal Reserve.
This quasi-governmental entity was created under the Federal Reserve Act of 1913 with the power to coin and issue money at its own discretion. Its other initial power was to keep the rate of inflation in check, even though it was later granted an additional mandate to try to secure “full employment” in the economy through any means possible. Full employment, in a textbook economic sense, is the condition in which the unemployment rate stands at approximately 5% since unemployment can never reach 0%. Also, with the implementation of the 2010 Dodd-Frank Act (otherwise known as Wall Street Reform), the Federal Reserve was deemed the power to seize the assets of financial institutions that were deemed to contribute instability to the financial sector. Needless to say, the Federal Reserve, established as an inherently powerful mechanism in “pulling the strings” with steering the direction of our economy.
Its no question that the Federal Reserve has grown in its scope of power since its creation and is asserted as necessary for providing for economic stability, but in reality it does quite the opposite. The first issue in the flaw of the Federal Reserve and its impact on monetary policy in terms of monetary stimulus, in other words, printing money out of thin air to stimulate real market growth. The problem with this seemingly simple concept, however, is that this practice distorts and distributes market gains in wealth and growth. In his book, What Has Government Done to Our Money, Austrian economist Murray Rothbard explains this phenomenon clearly:
The new money works its way, step by step, throughout the economic system. As the new money spreads, it bids prices up—as we have seen, new money can only dilute the effectiveness of each dollar. But this dilution takes time and is therefore uneven; in the meantime, some people gain and other people lose. In short, the counterfeiters and their local retailers have found their incomes increased before any rise in the prices of the things they buy. But, on the other hand, people in remote areas of the economy, who have not yet received the new money, find their buying prices rising before their incomes. (pg. 53, Rothbard)
In other words, the richer businesspersons who are the initial beneficiaries of the stimulus gain while the poor individuals who experience the growth of the monetary supply suffer the rise in prices that come before their resulting incomes rise, IF their incomes rise. Other businesses that weren’t subjected to the stimulus lose also. Thus, creating a disparity in competitive edge that a free market economy would not produce in the absence of a central bank. Inflation resulting from the growth of the monetary supply opens ground for a disparity in wealth that is often blamed on the nature of the market economy. In other words, if you find that $50 could buy a full cart of groceries at the grocery store in 1995, but a half-cart in 2005, then you may find that it takes more of your own income to pay for something that you would have otherwise paid less for in the past. Therefore, inflation is an indirect form of taxation.
Inflation, however, is just one side effect of the policies that the Federal Reserve pursues in impacting the economy. The Federal Reserve’s impact on the market goes deeper into its manipulation of a key signal in the market: Interest Rates. Interest rates play an important role in the market in a way that it serves to notify businesses when it is plausible for them to pursue higher-order capital production to further their innovation of goods and services that benefit the demands of customers and profits of business. In other words, these higher-order capital production projects stand to bring positive outcomes for both sides of economic activity. In a free market, when interest rates are higher, it indicates to businesses that the savings (the basis of credit availability) aren’t available, indicating that individuals are consuming goods and services in the present-day without intent to save their money. While lower interest rates signal to businesses that consumers have switched their preferences to saving their money, indicating that they wish to consume goods and services in the future. From there, when interest rates are lowered, businesses take out credit from the bank to invest in higher-order production to accommodate future production needs of consumption. Oftentimes, this could lead to job creation to keep pace with production efforts.
The danger, however, comes when the Federal Reserve central bank gets in the business of manipulating interest rates. The consequences of artificial manipulation of interest rates can be seen from the 2008 Financial Crisis. As recalled, the crisis unraveled when home owners were defaulting on homes that they found that they could no longer afford, resulting in a fallout in housing prices and a ripple-effect of damage on the economy in the crisis. This is often blamed on “mass deregulation” of traditional-risk lending practices of commercial banks, but what is often not discussed is that this so-called “deregulation” was the federal government encouraging commercial banks to give out riskier loans to individuals with bad credit while tax payers were left on the hook to pay for this perverse federal incentive (see Meltdown by Tom Woods). However, the Federal Reserve played a role in encouraging construction industries to pursue higher-order capital production of housing by making ready the credit that would not have existed otherwise in a free market (of course, through lowering interest rates). Furthermore, the Federal Reserve lowered the federal funds rate, a market rate at which banks lend to each other overnight to meet their “reserve requirements” and other liquidity needs, to encourage banks to lend to individuals, regardless of credit history. Reviewing the trends of interest rate changes from 2001-2008 provided by the CRS Report illustrates the downward trend of interest rates. The federal funds rate decreasing from 4 1/2% in April, 2001 to 1% in October, 2008. While the discount rate decreased from 4% in April, 2001 to 1 1/4% in October, 2008. While the Federal Reserve altered the credit structure to create a stimulus for home ownership and production, it was inflating a bubble that was doomed to deflate. Austrian Economic minds like Jim Rogers and Peter Schiff predicted this crisis on the basis of the Austrian Business Cycle economic theory, but were laughed at by Keynesian economists for the supposedly “outlandish” claim. The economy succumbed to crisis and the Federal Reserve, instead of being scrutinized for its role in the crisis, it was given new powers to further control the economy.
The 2008 Financial Crisis is not the first time that we have seen the Federal Reserve tangle itself in crisis in an effort to stimulate growth. The Great Depression would be brought on by these loose money policies as well. History often blames the Depression frivolous, mass mal-investment made by businesses and investors that led to the Stock Market Crash. Familiar? Monetary activity of the Federal Reserve was very high during the mid and late 1920′s, with the money supply increasing by over 60% and interest rates falling, as pointed out in Murray Rothbard’s America’s Great Depression case study. You would think that we would learn from history by now.
But how were economic crises handled without central banking involvement? Refer back to the Depression of 1921. Unemployment was rising and the marketplace was hurting badly. In spite of this depression-like phenomena, the President at the time decided that the federal government and Federal Reserve would be inactive and allow the market to recover on its own without the monetary stimulus. The result? The economy recovered in less than a year and did well until the Federal Reserve got involved to stimulate investment and activity and led the way for economic crash. Before the Fed, Depressions lasted for only brief time periods and the markets showed to recover on their own means when given breathing room to liquidate bad investments, pay off debts, an saved for better investments. The opposite of the Keynesian remedy of fiscal stimulus perpetuated by central banks. It took cutting government spending by 70% along with taxes and Federal Reserve activity for the economy to truly thrive again, not WWII.
There is so much more on the Fed that can be covered and why it has done more harm to the market economy than help. I just decided to touch on some main points of it to hopefully get the reader to think more on this structure of money printing and false credit creation. I feel that the true solution for monetary reform incorporates the following reforms:
- Repeal the Dual Mandate on the Federal Reserve. That is, restrict the focus of the Fed to curtailing inflation instead of trying to maintain full employment, which is impossible and something the Fed has consistently failed to do. Repealing the mandate, along with its power to seize monetary assets from financial institutions established by Dodd-Frank would help to narrow its commitments and rein in its power.
- Delegate authority to the Government Accountability Office to audit the activities of the Federal Reserve to their fullest extent, as established in former Congressman Ron Paul’s Audit the Fed bill. Doing this would create needed transparency and would pressure the Fed to be more accountable to the American people as opposed to select interests.
- Abolish all legal tender laws currently established that give the Federal Reserve monopoly protections by the Federal Government to print money and force it to be the only usable currency in our economy. Abolish capital gains taxation on gold and silver commodities to encourage equal currency competition fairness. The fiat dollar will still be authorized by the Fed, but it will no longer have monopoly power to force the market to use that one currency alone. Given the history of money in market exchange and transaction, it is shown that the consumers and producers in the market choose gold and silver as their currencies of choice because of their viable use as currency and other commodity functions. Nobel Prize Economist Friederich Hayek endorsed a similar idea in his essay, Denationalisation of Money.
With these 3 reform ideas implemented, the Federal Reserve’s power would be reined it and would be eventually obsolete for our growing marketplace and be phased out in a reasonable time while championing policy transparency. We need to take on the Federal Reserve for its role in the anatomy of our economic crises and exacerbation of the Boom-Bust cycles. Grant it, economic problems will never go away. Free market capitalism is not perfect, but we cannot turn to the government every time something goes wrong. The best thing we can do is leave the market to its own devices and only then can we see true recovery, and it starts with reining in the Federal Reserve. The ignored elephant in the room.
If this continues to go ignored, then we can expect to experience another economic crisis by the end of this year that involves the collapse of our currency. I warned about this on the Power Hour and on “The Conversation” during my interview and I stand by it. Furthermore, the Federal Reserve has served as the Great Enabler of our government’s deficit spending with the flexibility of our fiat dollar to buy off government debt. Either way, if we ignore the Federal Reserve, it won’t stop it from bringing abysmal deconstruction of the economy.
I would recommend these lists of reading to learn more about monetary economics and the Austrian Business Cycle Theory. Some are in e-book form for easier access:
- What Has Government Done to Our Money? -by Murray Rothbard
- Economics in One Lesson -by Henry Hazlitt
- Meltdown -by Thomas Woods Jr.
- How An Economy Grows and Why It Crashes -by Peter Schiff
- What Is Money? -by Frederic Bastiat
- The Theory of Money and Credit -by Ludwig von Mises
- Denationalisation of Money: The Argument Refined -by Friederich Hayek
- Austrian Business Cycle Theory Explained -by Thomas Woods Jr.
- End the Fed -by Ron Paul
Nathan Fuller, Conservatarian Co-Host of the Power Hour