The Federal Reserve has an impossible task? Of course
it does. But it's seldom mentioned. Most everyone just assumes that this
autonomous government agency "on line" since 1914 has a job to do and
should, well, simply do it. It's not that easy. The Fed does indeed have
a job which it is expected to do. In fact, given modern politics, it has
several. However, there is a profound difference between being expected
to do a job and being able to.
On the surface, to the layman, the Fed's job might
appear unequivocal: take care of the nation's money supply in such a way
as to help America. As the fiftieth anniversary edition (1967 revised
version) of The Federal Reserve System: Purposes and Functions, issued
by the system's Board of Governors, succinctly put it, "The principal
function of the Federal Reserve is to regulate the flow of bank credit
and money." (p. 4) While this seems straightforward enough, the Fed's
monetary manipulation to serve the national interest is a means to a
number of ends. In the modem U.S.A., the Fed is expected to prevent
banking crises, facilitate commerce ("at high levels of employment," as
the Board put it), cover government deficits and fight inflation. The
trouble is, manipulation toward one or more of these ends almost always
contradicts another. They don't mesh!
There is perhaps no better example of this than the
Fed's issuance of credit to cover the deficits of Congress. As monetary
experts know, unless Congress raises taxes, the Fed is virtually forced
to expand the money supply to pay for deficits. This is regarded as
essential in order to protect the credit rating of the nation. Monetary
expansion means more dollars will chase fewer goods; the dollar's value
is lowered.
While the initial surge of new money may benefit some,
often high-profiled, politically well-connected industries (most
recently, synthetic fuels, solar energy, automobiles, housing and
aerospace), the eventual effect of devalued currency on the economy
cannot rationally be regarded as a factor which facilitates commerce; it
slows commerce (and lowers employment). Inflation takes purchasing power
away from businesses as it takes it away from everyone. Persistent
inflation, such as we have had since the late 1960s, makes it more
expensive to run government, too, thereby increasing chances Congress
will deficit spend even more.
So, while attempting to help the nation meet its debts
in the short run, the Fed has in the long run actually damaged business
and private employment and increased the operating costs of government
(especially state and local governments, which cannot fall back on the
power to issue their own credit). As this happens, the Fed quite
obviously must abrogate its responsibility to fight inflation!
Conversely, if the Fed cuts the money supply, it abrogates short run
responsibilities to cover Congressional deficits and stimulate depressed
businesses (and employment) through lowered interest rates on borrowing.
After years of overlooking it, the newly more
economically aware national press is noticing this dilemma. As
Newsweek's Harry Anderson remarked just prior to the November general
elections, "Regardless of who is the next President, the pressure on the
Fed seems sure to intensify as the budget deficit swells.... Any Federal
deficit must be financed through borrowing, and unless the Fed meets the
new demand by creating more money, interest rates could be pushed to
ruinous levels as private and public borrowing compete for funds.... In
fact, the battle between the nation's fiscal and monetary authorities is
a no-win situation for the economy. If the Fed caves in and finances
immense budget deficits, the inflationary implications would be vast. If
the Fed does not, a fragile recovery -if in fact it has arrived- will be
slower than almost all the forecasts predict." (Oct. 13, 1980, p. 88)
Balling Out Banks Subsidizes Bad Investments
Another example of the failure of Fed purposes to mesh
is apparent in bank bailouts. What, in the name of preventing banking
crises, does bailing out banks accomplish long term? Whether by means of
credit subsidies, loan guarantees or perhaps forced mergers with other
stronger banks (the method makes almost no economic difference), banks
require bailing out primarily because they have made bad investments.
The policy of bailing out banks subsidizes bad investments,
True, the Fed may frown upon and chastise the makers of
bad investments, but that is not the message that sticks with the
banking community- it is not the economic message. The economic message
comes through loud and clear from the Fed's action: the rewarding of
malinvestments. A reward is exactly what it is. The more the Fed does
it, the worse it will get. It's the old incentive principle at
work-rewards encourage more of the action that is rewarded. Put another
way, subsidizing poor investments makes them appear profitable. Could
that seriously be regarded as a method of facilitating the nation's
commerce? Hardly. Commerce on a national scale gains and retains health
only through wise investments.
Nor can the Fed bailout obligation be regarded as a
sound banking practice or even a method of preventing banking crises.
Admittedly, in the short run it may well appear sound, especially to
those banks "pulled out of the fire," to the investors of the banks and
to a Fed determined to polish its image as a financial savior. (One must
always remember that the Fed is subject to the bureaucratic survival
principle: act to serve those who perpetuate your existence, or die.)
But one could quite cogently argue that repeatedly making malinvestment
remunerative must ultimately lead to banking crises-perhaps on a
massive, unmanageable scale.
As banks, including some of the nation's giants,
continue operating in this insulated atmosphere of guaranteed bailouts,
they become progressively involved in larger and larger unwise, often
downright speculative loans. Loans to third world countries -whose
political instability makes their solvency highly questionable - are
frequently in this category. (See the Wall Street Journal's article last
summer on American financial involvement in Zaire if you'd like to read
an excellent tale of dubious investment.)
As the unwise investments accumulate, the danger
increases that a bailout, or series of them, will be required that is so
large the American government will not be able to generate the funds.
Not only will we see losses to millions of American investors in banks,
we could also see a severe monetary crisis. If the Fed hyper-inflates in
order to "save" the banks and the savings of American citizens and
businesses, respect for the dollar will nosedive along with its value.
It's crucial to constantly bear in mind that the dollar is the reserve
currency of most of the free world. Therefore, a rapid dollar
depreciation could precipitate a world depression.
Consider the depth of the economic contradictions
involved in the Fed's various tasks. Manipulating the money supply must
serve the masters of Combatting Banking Crises, Covering Government
Deficits, Inflation Fighting and Facilitating Commerce. But different
manipulations are required to accomplish these ends- depending on the
range of one's vision. This means the monetary caretaker function of the
Fed is necessarily eroded. Being a caretaker requires that one should
ensure no harm comes to that for which one cares. If the Fed's service
to multiple masters creates a currency of wild fluctuations, a currency
neither business nor consumers can count on, it cannot fulfill what an
AP business writer aptly termed the Fed's obligation as the "appointive
guardian of the nation's money supply." (Oct. 7, 1980, AP Wire)
In addition, one must take note of what I call "the
confusion factor" existent at the Fed. The guardian of the nation's
money supply must know clearly what it is to guard; a doubting guardian,
a confused guardian, cannot function efficiently and cannot be counted
on in times of crisis when his efficiency is critical, With the
conflicting functions the Fed is expected to pursue these days,
frequently at the expense of the health of the nation's currency, its
purpose as a money supply guardian cannot be clear to the agency.
After all, Fed members are human and therefore subject
to human pressures and frustrations. Human beings subjected to
contradictory orders and aims exhibit lowered efficiency and confusion.
While this state of turmoil over objectives makes the Fed's job tougher,
it is not what makes it impossible. Rather, the turmoil occurs because
the Fed's job is impossible. Nevertheless, the doubts and confusion over
purpose do act as a feedback loop, amplifying the difficulties.
Catering to Expediency
There are people in respectable economic circles who
argue that the basic purpose of the Fed is not to act t1purely" as a
money supply caretaker, or, for that matter, as a caretaker of any
single function. They argue, and have argued for over sixty years, that
the Fed must also act as a servant of "political necessity," as a
caterer to the political "facts of life" in a modem democracy. But what
is increasingly apparent even to the man in the street is that the
primary fact of life in modern politics is the equivalency of "political
necessity" and rampant expediency.
Catering to expediency makes the Fed a neurotic,
nervous servant of favor and fancy-no matter how much it likes to regard
itself as above all that. If the Fed is not above it all, why bother
having a Fed? Surely, elected politicians, bickering and empire
building, could successfully provide a proper Congressional psychology
of neurosis in which to manipulate the money supply in a most honorable
tribute to frenzied expediency!
Of course, it was precisely such a madhouse political
free-for-all Congress intended to avoid when it passed the Federal
Reserve Act of 1913 (augmented, eventually, by the Banking Act of 1935).
It intended to avoid that kind of mess and what was then seen as the
"frenzied" actions of the free market. Congress has not succeeded. It
could be no other way. The nature of the task it set for the Fed decades
ago and the additional duties demanded of the Fed in more modern times
are permeated with contradictions. What seems generally unrealized in
modem economic forums is that the creation of the Fed involved not just
problems but a fundamental flaw common to all economic tyrannies.
A Legally Empowered Tyranny
The Fed is an economic tyranny -a democratically
created, legally empowered tyranny over the nation's money supply.
Whether an economic tyranny takes the broader forms of socialism,
fascism and communism or this narrower form of federal monetarism, it
holds an error in common: it seeks to subjugate private, individual or
business decision making to state authority. In fact, private monetary
decision making was precisely the economic "frenzy" -i.e., free human
action - so unacceptable to the politicians and fellow supporters of
federal monetary centralization.
Politicians have long understood that maintaining and
expanding state power is incompatible with freedom. The Fed has been
used for just such maintenance and expansion -perhaps more than any
other government institution created by man. Given that this nation's
money supply is crucial to the U.S. economy and to the world economy,
that it underlies and affects all transactions of the free world (and
much of the unfree world), the creation and perpetuation of the Federal
Reserve System is the most gripping, insidious economic tyranny yet
accepted. The domains and edicts of such agencies as the Federal Trade
Commission, departments of Energy, Education, or Health and Human
Services and most other agencies of this government are small potatoes
indeed when compared to the realm and power of the Fed.
Yet, most of today's established market economists
tacitly support this tyranny. Even the most influential of them, Milton
Friedman, in his current bestseller, Free to Choose, while documenting a
damning case against government economic intervention in general and the
Fed's specific malfeasance in the 1930s depression, nevertheless insists
that the Fed could have "used wisely the powers that had been granted to
it (in order to) perform the task for which its founders had established
it." (p. 85) Unfortunately, it is instances of this sort of wishful
thinking, which divert attention from a proper, contextual focus on the
subject.
The issue is not that a government agency could have
made a right decision in any particular instance, but rather that the
propensity of government agencies is to make wrong economic decisions.
Friedman and his admirers (and even more so the statist economists)
forget that the Fed's task is to perform as monetary dictator. The
evidence is overwhelming that no government has succeeded for long in
productively dictating the actions of any segment of the economy;
monetary policy is no exception. Governments have succeeded -notoriously
so- in destructively dictating economic actions; monetary policy is no
exception.
Abolish the Fed and Privatize Monetary Functions
The case record of the Fed -most notably, its
recession- causing sharp monetary contractions after World War 1; its
inflation in 1927 which created the dangerous speculative market boom;
its effort to counter that boom with a panicky, severe contraction which
led to the Great Depression; its hand in causing the severe 1937
recession; and its everwidening post-World War II swings between
over-inflation and recession-spawning contractions which have finally
merged into "stagflation," plunging the business morale and hopes of
American citizens for their future to new lows -is enough by itself to
warrant a case for abolishing the Fed. But the fact that the Fed is by
its nature bound to serve impossible ends must surely add philosophical
ammunition to the case.
There is in the long run only one answer to the problem
of managing the monetary economy: It should be privatized, with
privately coined and printed currency, privately controlled credit
systems and private insurance of monetary deposits. Because of the scope
of such a revision we would also be forced to consider more seriously
privatizing many other government services. For without its own monetary
machinery, the government will find the financing of redistributive and
vote-buying schemes considerably more difficult.
Privatized monetary functions do act as a natural check
on the power of government. But the alternative to privatizing the U.S.
monetary system, tinkering and fiddling with the derelict government
system we have, means keeping a form of tyranny intact. There is only
one way to prevent the damages to human liberty which a tyranny inflicts
-take away the tyranny. The Fed is such a tyranny. There is no place for
it in the future of a free America.
At the time of the original publication, Mr. Ross was
an Oregon broadcast commentator and news editor especially concerned
with new developments in human freedom.
Reprinted with permission from The
Freeman a publication of the Foundation for Economic Education, Inc.,
February 1981, Vol. 31, No. 2.
Yourname@libertyhaven.com
