Ever since its founding in 1913, the Fed has described
itself as an "independent" agency operated by selfless public servants
striving to "fine-tune" the economy through monetary policy. In reality,
however, a nonpolitical governmental institution is as likely as a
barking cat. Yet, the myth of an "independent" Fed persists. One reason
this myth persists is that statist textbooks have helped perpetuate it
for decades.
From 1948 until about 1980 Paul Samuelson's Economics
was the best-selling introductory economics text. Generations of
students were introduced to economics by Samuelson. Although not as
popular as it once was, Samuelson's text (now co-authored with William
Nordhaus) is still widely used. According to the 1989 edition:
The Federal Reserve's goals are steady growth in
national output and low unemployment. Its sworn enemy is inflation. If
aggregate demand is excessive, so that prices are being bid up, the
Federal Reserve Board may want to slow the growth of the money supply,
thereby slowing aggregate demand and output growth. If unemployment is
high and business languishing, the Fed may consider increasing the money
supply, thereby raising aggregate demand and augmenting output growth.
In a nutshell, this is the function of central banking, which is an
essential part of macroeconomic management in all mixed economies.
For about the past fifteen years the top-selling
economics text has been Campbell McConnell's Economics, which echoes
Samuelson and Nordhaus's idealistic statism:
Because it is a public body, the decisions of the Board
of Governors are made in what it perceives to be the public interest ...
the Federal Reserve Banks are not guided by the profit motive, but
rather, they pursue those measures which the Board of Governors
recommends.... The fundamental objective of monetary policy is to assist
the economy in achieving a full employment, non-inflationary level of
total output.
These are mere wishes, not statements of facts, for
there is voluminous evidence that the Fed-like all other governmental
institutions-has always been manipulated by politicians.
The Fed as a Political Tool
When the Fed was founded, it was controlled by two
groups, the Governors' Conference, composed of the twelve regional bank
presidents, and the seven-member Federal Reserve Board in Washington. In
1935 the Fed was reorganized to concentrate nearly all power in
Washington. Franklin Roosevelt "packed" the Fed just as he later filled
the U.S. Supreme Court with political sycophants. Roosevelt appointed
Marriner Eccles, a strong supporter of deficit spending and inflationary
finance, as Fed Chairman, although Eccles had no financial background
and lacked even an undergraduate degree. In those years the Fed was
really run by Eccles's political mentor, Treasury Secretary Henry
Morgenthau, Jr., and thus ultimately Roosevelt.
Later presidents were no less willing to influence
supposedly independent Fed policy. According to the late Robert
Weintraub, the Federal Reserve fundamentally shifted its monetary policy
course in 1953, 1961, 1969, 1974, and 1977 - all years in which the
presidency changed. Fed policy almost always changes to accommodate
varying presidential preferences.1
For example, President Eisenhower wanted slower money
growth. The money supply grew by 1.73 percent during his administration
- the slowest rate in a decade. President Kennedy desired somewhat
faster money creation. From January 1961 to November 1963, the basic
money supply grew by 2.31 percent. Lyndon Johnson required rapid money
creation to finance his expansion of the welfare/warfare state.
Money-supply growth more than doubled to 5 percent. These varying rates
of monetary growth all occurred under the same Fed chairman, William
McChesney Martin, who obviously was more interested in pleasing his
political master than in implementing an independent monetary policy.
Martin's successor, Arthur Burns, was such a staunch
supporter of Richard Nixon that he lost all professional credibility by
enthusiastically endorsing Nixon's disastrous wage and price controls.
Even though his staff informed him in the fall of 1972 that the money
supply was forecast to grow by an extremely robust 10.5 percent in the
third quarter, Burns advocated ever faster growth before the election.
The growth rate in the money supply in 1972 was the fastest for any one
year since the end of World War II and helped re-elect Richard Nixon.
However, President Ford called for slower monetary
growth as part of his "Whip Inflation Now" program, and the Fed complied
with a 4.7 percent growth rate. But when Jimmy Carter was elected, Burns
again complied with presidential wishes by stepping up the growth rate
to 8.5 percent. Carter did not reappoint Burns, but the latter's
successors were equally cooperative. The money supply increased at an
annual rate of 16.2 percent in the five months preceding the 1980
election - a post - World War II record.
In 1981 Donald Regan, Ronald Reagan's Treasury
Secretary, advocated, and got, more rapid monetary growth. A year later
the President himself met with Fed Chairman Paul Volcker to lobby for
slower growth, which was dutifully produced by the Fed. More recently,
Alan Greenspan has reportedly been most "accommodating" to President
Clinton.
Both Sides Benefit
The Fed is obviously influenced by the executive
branch. But the relationship between the Fed and administrations runs
far deeper. As Robert Weintraub observed, such contact "has been and
continues to be fostered by cross planting of high level personnel" in
both directions. Officials have also met weekly for decades. But
personal contact is not necessary for the Fed to allow itself to be used
as a political tool. The administration's policy views are generally
well known. Economist Thomas Havrilesky has even developed an index of
executive branch "signaling," based on newspaper accounts of the
administration's monetary policy preferences as reported in the Wall
Street Journal. 2 And as Weintraub concluded, "a Chairman of
the Federal Reserve Board who ignores the wishes of the President does
so at his peril."
The Fed and presidents alike benefit from this
arrangement. Economist Edward Kane has argued persuasively that the
Fed's ultimate political function is to serve as a political scapegoat
when things go wrong. Writes Kane: "Whenever monetary policies are
popular, incumbents can claim that their influence was crucial in their
adaptation. On the other hand, when monetary policies prove unpopular,
they can blame everything on a stubborn Federal Reserve and claim
further that things would have been worse if they had not pressed Fed
officials at every opportunity." 3 In return for this favor,
the Fed is allowed to amass a huge slush fund (discussed below) by
earning interest income from the government securities it purchases
through its open market operations.
A Demand for Inflation?
It is also well established that politicians use the
Fed as a tool of money creation to advance their own re-election. As
Robert J. Gordon wrote in the Journal of Law and Economics more than 20
years ago: "Accelerations in money and prices are not thrust upon
society by a capricious or self--serving government, but rather
represent the vote-maximizing response of government to the political
pressure exerted by potential beneficiaries of inflation."4
Gordon is wrong in denying that government is
inherently capricious and self-serving, but he's got a good point:
Politicians are naturally inclined to finance government handouts to
special-interest groups with the hidden tax of inflation, which hides
the true costs of government from the taxpaying public. Joining with
election--minded officials in favor of expansive monetary policies is a
"low-interest-rate lobby," led, argues Edward Kane, "by builders and
construction unions and by financial institutions that earn their living
by borrowing short to lend long."
The Fed underwrites an enormous volume of research,
some of which is very good. But, as Business Week magazine once
observed: "There is disturbing evidence that the research effort of the
bank's 500-odd Ph.D. economists is being forced into a mold whose shape
is politically determined by the staff of the Federal Reserve Chairman."
Some Fed economists admit that political expedience is the rule. Says
former Fed economist Robert Auerbach, "the practice at the Bank where I
worked was to clear research through the Board of Governors and to
'persuade' economists to delete material that the Board or the Bank
officials did not like."5
Thus, all Fed research should be taken with a grain of
salt. However, one recent study in particular deserves special
attention. In 1992 Boston Fed research director Alicia Munnel published
a report claiming to find persistent mortgage loan discrimination
against minorities in Boston. The study, used to justify racial quotas
for bank loans, was fatally flawed. The data were hopelessly jumbled.
Equally important, the report failed to control for creditworthiness -
credit ratings, job history, income, and so on. When confronted with
these facts by Peter Brimelow and Leslie Spencer of Forbes magazine,
Munnel admitted: "I do not have evidence ... no one has evidence of
lending bias."
Taxpayer-Funded Lobbying
The Fed also uses its privileged position - and
especially its multi-billion dollar slush fund generated by interest
income on open market purchases-to lobby. Its preferred method is to
pressure member banks, which it regulates, to lobby for it. It also
recruits a small army of academic researchers, who benefit from Fed
research grants, visiting appointments, and invitations to conferences
at exotic locations, to testify on its behalf at Congressional hearings.
For instance, in the late 1970s Representative Henry
Reuss introduced a bill authorizing the General Accounting Office to
audit the Federal Reserve system. It was defeated because, as Reuss
later explained, "with the Federal Reserve Board in Washington serving
as the command center, a well-orchestrated lobbying campaign was
mounted, using the members of the boards of directors [of the regional
banks] as the point men." In a speech to the American Bankers
Association after the GAO bill was defeated, the Richmond Fed's
chairman, Robert W. Lawson, congratulated the assembled commercial
bankers for their success: "The bankers in our district and elsewhere
did a tremendous job in helping to defeat the General Accounting Office
bill. It shows what can be done when the bankers of the country get
together." 6 Academics conducted themselves in an equally
disgraceful way, warning of potential abuses and assuring Congress that
the Fed could be trusted to behave responsibly.
For decades, believers in the "public interest" theory
of Fed behavior blamed the Fed's failures to ensure price stability on
the agency's incomplete knowledge and difficulty "fine-tuning" the
economy. But research suggests that the Fed's abysmal record in
controlling inflation reflects not mere incompetence, but the way in
which the Fed is organized.
Until the Fed's creation, there was no overall upward
trend in the price level. Inflation occurred during wars, but prices
then gradually declined to their former levels. Since the establishment
of the Fed, however, there has been a continuous upward surge in prices.
Public choice scholars believe that an important reason why the Fed has
caused so much inflation is that it benefits from inflation. Since the
entire operation has been funded since 1933 from revenue acquired
through interest payments on government security holdings, the Fed has
an incentive to purchase securities (thereby expanding the money supply)
more than it has an incentive to sell them. Purchasing government
securities is a source of income to the Fed, whose income is "earned" by
the interest paid on the securities. Selling securities, on the other
hand, causes a loss of income.
The Fed is constrained to return "excess revenues" to
the Treasury, but enjoys great discretion over its budget and managed to
spend over $2 billion on itself in 1996. Fed officials live quite well
on their revenues. As a recent General Accounting Office report
revealed: "The Fed has 25,000 employees, runs its own air force of 47
Lear-jets and small cargo planes, and has fleets of vehicles, including
personal cars for 59 Fed bank managers.... A full-time curator oversees
its collection of paintings and sculpture." 7 The Fed held
$451 billion in accumulated assets as of 1996, when it was engaged in
building for itself several expensive new office buildings. The number
of Fed employees earning more than $125,000 per year more than doubled
(from 35 to 72) from 1993 to 1996; even the head janitor (known as the
"support services director") is paid $163,800 in annual salary plus
benefits. Money is lavishly spent on professional memberships,
entertainment, and travel.
Economist Mark Toma has studied the Fed's spending
habits and believes that the Fed does in fact conduct monetary policy
with an eye toward how its managers and employees can themselves profit
from it. That means instituting a bias toward bond purchases and money
creation.8 Similarly, William Shughart and Robert Tollison
contend that the Fed behaves exactly like many other government
bureaucracies, padding "its operating expenditures by increasing the
number of employees on its payroll." 9
That is, the Fed uses staff expansion to reduce the
amount it must return to the Treasury. Thus, "when engaging in
expansionary policies," write Shughart and Tollison, "the Fed can both
increase the supply of money and increase the size of its bureaucracy
because the two goals are served by open market purchases of
securities." Contractionary policies, on the other hand, force the Fed
to lower its profits and staff. Because of this unique financing
mechanism, argue Shughart and Tollison, "the Fed has been more
successful in enlarging its employee staff over time than the federal
government as a whole." This employment effect, moreover, "may partially
explain why the Fed has apparently been more willing to engage in
expansionary than in contractionary monetary policies."
Regulation as a Political Tool
The Fed also uses its vast regulatory powers for
political purposes, rather than to promote the "public interest." The
Fed's authority is vast, but is most abused through enforcement of the
Community Reinvestment Act of 1977. Under the CRA, the Fed must assess a
bank's record of "meeting community needs" before allowing a bank to
merge or open a new branch or even an automatic teller machine. An
entire industry of nonprofit political activists routinely files
protests with the Fed, which must be evaluated before the bank can win
Fed approval. The activists typically threaten to stall mergers or
branch expansions unless banks give them - not the poor in their
communities - money, a practice that many bankers consider pure
blackmail.
For example, the Chicago-based National Training and
Information Center threatened to delay a merger by a Chicago bank unless
it received $30,000 to renovate its office. The bank agreed, and also
gave $500,000 to other leftist organizations. In Boston, left-wing
activist Bruce Marks, the head of the Union Neighborhood Assistance
Corporation, filed complaint after complaint with the Fed over Fleet
Financial Group's community lending record until Fleet agreed to give
$140 million to his organization and to make $8 billion in loans to
individuals and businesses favored by Mr. Marks. "We are urban
terrorists," Marks explained to the Wall Street Journal.10
The CRA is frequently used as a means of racial
extortion. For example, the Fed, under the direction of former Governor
Lawrence Lindsey, found "statistical disparities" in lending, i.e., the
percentage of loans granted by the Shawmut Services Corporation to
blacks and Hispanics did not match the groups' proportion in the
population. Yet no individuals complained of discrimination and the Fed
did not claim to have found any "victims." In fact, between 1990 and
1992, when the discrimination allegedly occurred, Shawntut's mortgage
loans to blacks and Hispanics more than doubled, and the mortgage
rejection rate fell by 45 percent and 26 percent, respectively. However,
the Fed employed 150 people to go out and find people who claimed to
have been "discriminated against" by Shawmut and to offer them $15,000
each, effectively robbing the company of $1 million.
Conclusions
Any government monopoly will be corrupt and
inefficient, but the Fed may be the worst government monopoly of all.
Not only does it operate for its own advantage in the name of promoting
the public interest, and offer gov- ernment officials political cover
for their sell- interested policies, the Fed also allows no escape. One
can at least refuse to do business with, say, the government school
monopoly by home-schooling or by sending one's children to private
schools. But one cannot avoid the effects of the Fed's monetary
monopoly. It is time to de-politicize and denationalize our money.
At the time of the original publication, Dr. DiLorenzo
was a professor of economics at Loyola College in Maryland.
1. Robert Weintraub, -Congressional Supervision of
Monetary Policy," Journal of Monetary Economics, April 1978, pp 341-362
2. Thomas Havrilesky, -M-t-y Policy Signaling from the
Administration to the Federal Reserve,"Journal of Money, Credit and
Banking, vol. 20, no. 1, February 1988.
3. Edward J. Kane, -Politics and Fed Policy-making,
"Journal of Monetary Economics, vol. 6, 1980, p- 206.
4. Robert J. Gordon, "The Demand for and Supply of
Inflation," Journal of Law and Economics, vol. 18, 1975, p. 808.
5. Robert D. Auerbach, "Politics and the Federal
Reserve, Contemporary Policy Issues, Fall 1985, p- 52.
6. Ibid, p- 53.
7. John R- Wilke, "Feds Huge Empire, Set Up Years Ago,
is Costly and inefficient," Wall Street Journal, Sept. 12,1996, p. 1.
8. Mark Toma, "The Inflationary Bias of the Federal
Reserve System, -Journal of Monetary Economics, vol. 10, 198Z pp.
163-190.
9. William Shughart and Robed Tollison, "Preliminary
Evidence on the Use of Inputs by the Federal Reserve System" American
Economic Review, June 1983, pp. 291-304.
10. Susan Alexander Ryan and John Wilke, "Banking on
Publicity, Mr Marks Got Fleet to Lend Billions," Wall Street Journal,
Feb. 11, 1994, p- A-5.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
April 1997, Vol. 47, No. 4.
Yourname@libertyhaven.com
