Battle4Liberty

I recently attended a conference devoted to analyzing the Federal Reserve’s record since its inception in 1913. Presenters included well known economists on various sides of the issue, former Fed officials, and even a former bank CEO. I returned home more knowledgeable about the Fed, but also with a clear understanding of a deeper problem.

Initially, the Federal Reserve was designed to promote maximum employment, price stability, and moderate interest rates. The Fed was also charged with taking action to ensure that any major financial disruptions don’t infect other parts of the economy. When comparing the pre-Fed and post-Fed years—and even removing the interwar period—the scorecard doesn’t look good. Since the creation of the Fed, booms and busts have become more pronounced, inflation has intensified, and research has demonstrated that monetary policy has little to do with the long term unemployment rate anyway. It’s easy to conclude that the Fed is not serving us well and we should look at other alternatives. To be fair, however, it’s not that simple.

The Fed was established when a gold standard was in place, and that standard—not necessarily Fed intervention—was presumed to be an adequate check on inflation. Currency can’t be created “out of thin air” when every dollar must be backed with something tangible like gold. With today’s fiat currency, expanding the money supply by printing more dollars or manipulating banking requirements can be done much more easily.

In the end, the government must play some role in currency transactions; it’s unavoidable. Without a gold standard, the Fed—or whatever replaces it—can expand the money supply at will. Returning to the gold standard will be a difficult political feat, but without such a change, abolishing the Fed would be akin to overthrowing Mubarak in Egypt. The real question is not what you dismantle, but what replaces it. Put another way, just imagine what the economy would look like if monetary policy was run by Congress instead of the Fed.

Some have proposed fixed monetary rules for managing the Fed. The late Milton Friedman once proposed expanding the money supply by a fixed low, nominal rate every year. Ostensibly this would keep the Fed from doing too much damage, but politicians can always change rules and permit exceptions in the face of wars, recessions and other national “emergencies.” Hence, such a rule is only as good as those we elect to enforce it.

Friedman also proposed (at one time) that the debt be automatically monetized each year. In other words, a trillion dollar deficit this year would be financed by printing another trillion dollars right away to pay it off. Monetizing the debt would be inflationary, but Friedman’s intention was actually sound. He wanted Congress to face the economic effects of its runaway spending whenever it passes a budget. Friedman believed such a requirement would result in a great anti-spending fervor from the public because the link between deficit spending and inflation would be immediate and clear. He might have been correct.

Despite Congressional and Fed efforts to the contrary, markets correct themselves much more efficiently when governments (and quasi-governmental entities) stay on the sideline. Abolish the Fed or not, Keynesians and others on the left will always claim to know better than the market. Their cries for redistribution and other schemes to “correct” capitalism’s failings will never cease, as elections will inevitably hang in the balance. Wendell Phillips echoed the sentiments of our founding fathers when he warned us that “eternal vigilance is the price of liberty.” He couldn’t have been more correct.