People ask me, “What should the Federal Reserve’s monetary policy be?” The answer, theoretically and practically, is simple: paralysis.
Are prices rising? The FED should cease buying or selling assets, e.g., U.S. Treasury debt.
Are prices falling? The FED should stop buying or selling assets.
Are prices stable? The FED should cease buying or selling assets.
What about the members of the Federal Open Market Committee (FOMC), who decide as a committee how many assets to buy or sell? Offer them early retirement at 120% of their present salaries.
Do the same for their respective staffs.
What if interest rates fall in a recession? Let them fall.
What if they rise, due to a war? Let them rise.
In short, let participants on a free market decide what the rate of interest should be.
Why is the collective, competitive judgment of profit-seeking investors who put their own money on the line inferior to a group of salaried bureaucrats who create money out of nothing to be put on the line?
There is a serious possibility that, in a recession, some large banks might not be able to stay in business.
This is true of every line of business. Why should banks be exempt from the threat of bankruptcy?
But, critics may say, the government has promised to pay off depositors in insolvent banks. How? Through its Federal Deposit Insurance Corporation (FDIC).
I respond: Why not let Congress find the money needed, if any, to pay off depositors? Why call on a privately owned, government-chartered central bank to counterfeit money in order to pay off depositors? Congress made the promise. Let Congress bear the responsibility.
That, of course, is the whole point. Congress wants credit for a good economy. “Re-elect us! We helped made things good!” It also wants to shift blame for a bad economy. “Re-elect us! We’ll get to the bottom of all this!”
Political promises should be paid for politically. But political promises are made by politicians who want to avoid the bills when they come due. They rely on the Federal Reserve System’s Board of Governors to keep the bills from ever coming due. The FED does this by creating money and buying assets, especially U.S. Treasury debt.
The result since 1933 has been an increase in the supply of money, which helps political debtors to meet their monthly payment schedules.
Instead of bankrupting the political debtors, the FED has just about bankrupted the dollar and all those creditors who have loaned long-term money at fixed interest rates.
The bills keep coming due. The FED keeps paying them off with depreciated money. “Shut up. You’ve been paid.” So, creditors accept this and seek to get higher rates of interest to compensate them for the depreciating dollar. They can’t always get what they want.
At some point, creditors look abroad in search of promises to pay, denominated in stable money. But central banks are universal in our day, and they are all inflationary. Fiat money is the standard of our era. The world’s economy rests on promises to pay. Central banks back up these promises with fiat money. The politically unsustainable promises become politically sustainable inflation. Congress can blame something else for inflation. In contrast, it would have to blame itself for default on promises.
The central bank cartel in one nation is always threatened by stable money in other economies. This is why central banking is a growing cartel. Every new nation is told by central bankers to start a domestic central bank. All but two countries today have a central bank. The two exceptions are Monaco, which has a casino instead, and Andorra, which has mostly sheep. Since neither of them has an army to pay for, they don’t need a central bank. (The old leftists Malvina Reynolds and Pete Seeger wrote “I Want to Go to Andorra” in 1962. I have had that song in my collection ever since 1963. I can still sing it. They were right.)
If the FED were to stabilize the monetary base by refusing to buy or sell assets, the value of the dollar in relation to other nations’ currencies would be determined by currency speculators’ competing assessments of the future effects of everything that might conceivably affect the purchasing power of the dollar.
The best economic forecasters on earth are currency speculators. The uncertainty is enormous, the leverage is high, and the markets are relentless. You can make or lose more money faster and with lower commissions in the currency futures markets than any other. The market is essentially unregulated, since the assets it trades are international. Any attempt by governments to regulate this market has the effect of driving the computers off shore to some island nation that doesn’t regulate it.
If the FED did nothing for a year or two, world currency speculators would conclude that the U.S. dollar had become the world’s only stable currency. It would become the benchmark. For as long as the FED did nothing, the dollar would be established as the world’s reserve currency even more than it is today.
This would force any nation whose politicians wanted its currency to replace the dollar as the world’s reserve currency to instruct its central bank to imitate the FED’s policy of doing nothing.
Foreign investors would soon recognize that their capital is safe from depreciation by purchasing dollars and investing them at whatever market rate is available. The dollar would become as close to immune from competition as any currency on earth. The U.S. domestic capital markets are huge. The dollar’s role as the world’s reserve currency makes the U.S. markets even more huge. Stable money would make the U.S. dollar the best widely available currency unit.
What about the trade deficit? That would depend on the comparative social rates of future orientation. Americans’ future orientation, when lower than foreign investors’ future orientation, is what produces the trade deficit. With foreign investors doing even more what they are doing today — buying assets denominated in dollars — foreigners would buy up even more American capital and debt. But they would do this at low rates of interest. If selling off income-producing assets is what Americans want to do — and they seem to — then they could buy more of what they want with stable money: more goods per dollar because the dollar would increase in value in relation to foreign currencies, whose central banks refuse to do nothing.
LAISSEZ FAIRE IN MONEY
The policy I am recommending is semi-laissez faire: “Let us alone.” The FED would let us alone as users of its currency. Congress would let the FED alone as the taxer and borrower of the FED’s currency.
Make no mistake about this: the currency is the FED’s. The FED has a monopoly over it. Paper bills are by law legal tender. Congress in 1913 passed sovereignty over money to a privately owned agency.
This policy recommendation is not pure laissez faire. Pure laissez faire in money would be based on legally enforceable debt contracts. Banks would not be allowed to promise two check-writers — the depositor and the borrower — the right to withdraw their deposits at the same time. In other words, there would be no fractional reserve banking.
Then it’s “Come one, come all!” Anyone could set up a bank. Anyone could issue a warehouse receipt for gold or silver or copper. The free market would allow money users to assess the reliability of every bank’s IOUs. The banks would compete.
Congress would get out of the money business entirely. It would merely identify the private currency or currencies that it is willing to accept for the payment of taxes. No more legal tender laws. No more government mint. No more monopoly central bank. Congress would do what the FED ought to do: nothing.
This suggestion is opposed by academic economists, commercial bankers, politicians, historians, and all other inflationists, who are, like the demons of old, legion. This would place the fate of every currency solely in the hands of the judges, who would enforce contracts, and currency speculators, a group which ultimately includes everyone who uses money. Such a view of money places sovereignty over money into the same hands as sovereignty over chewing gum: owners.
This view of money rests on a presupposition, best stated by Jesus in the parable of the employer. "Is it not lawful for me to do what I will with mine own? Is thine eye evil, because I am good?" (Matthew 20:15)
When it comes to money, the evil eye is universal. Men do not trust the principle of exclusive private ownership. They may say they do, but they really don’t. The most flagrant masters of this evil eye are free market economists — Austrian School economists excepted — who praise the free market to the skies until they get to the chapter on money and banking. Then the free market needs the guiding hand of — you guessed it — academically certified economists.
Three decades ago, I knew a newly certified Austrian School economist. He showed considerable promise academically. But then he got an offer from the FED to become a staff economist. He disappeared into the bowels of the FED, never to reappear. He ceased writing. He maintained, when the deal was first offered to him, that he would write on the side. He never did. Somehow, his enthusiasm for the ideal of the free market ceased to motivate him enough to sit down and write. That monthly check from the world’s supreme monopoly undercut his ideology, which had been opposed to government-licensed monopoly. “Let us alone” was replaced by “fully vested pension.”
A free market in money and the enforcement of contracts in banking are ideas so utterly foreign to the modern world that they are simply not discussed in polite circles.
The best way to discover the heart, mind, and soul of a society is to discover those issues that are so widely taken for granted that they are not discussed in public. I don’t mean hate crimes. I don’t mean political correctness. Here, there have to be negative sanctions to keep them from being discussed. I mean ideas that are so off the mental radar of a society that they are essentially inconceivable.
A free market in money and banking is such an idea.
THE FUTILITY OF REFORM
People for four decades have asked me, “How can we reform the FED?” I always tell them: “Let it alone.” Laissez faire works both ways.
The FED is immune to reform because central banking is a universal phenomenon. Ever since the creation of the Bank of England in 1694, academics and opinion leaders have supported the idea. It has spread ever since, but especially in the 20th century. You cannot reform an institution that rests on a universally accepted idea — so universally accepted that to think otherwise is to join the lunatic fringe.
There have been Congressmen over the years who have exposed the FED. Some have thought there was hope. Others have used the FED as a whipping boy. Of all institutional boys to be whipped, the FED is at the top of my list. But we should recognize the difference between analysis and implementation.
To undermine the public’s confidence in the FED is impossible, except for one factor: the FED. Central banking is inherently immoral. It is inherently inflationary. It is inherently de-stabilizing. Why? Because it is inherently statist. It rests on coercion. It rests on the idea that a committee of tenured, salaried, government-protected people possesses greater insight into supply and demand than speculators who put their own money, or their clients’ money, on the line, moment by moment. It rests on the idea that government-enforced central planning is more efficient, more compassionate, and more profitable for a society than market planning by owners of capital.
Central planning is irrational. Ludwig von Mises proved this in 1920. In 1991, the collapse of the Soviet Union finally verified what he had argued theoretically.
Central banking is irrational. Ludwig von Mises showed why in 1912 in his book, The Theory of Money and Credit. As yet, we have not seen a collapse comparable to the fall of the Soviet Union, although the Great Depression was a good first-stage early warning indicator. So is the decline of the dollar by 95% since 1914. But, ultimately, either central banking will be replaced by market institutions in a slow and steady way, or else there will be a replacement after a worldwide collapse. I hope for the former, but the latter is possible.
If the latter happens, I will want to be in Andorra.
For people who have read about the Federal Reserve System’s monopolistic power over the economy, it is frustrating to imagine that the voters can do nothing. Trust me: the voters can do nothing. Most voters have not heard of the FED, do not understand central banking, and do not have allies in Congress, other than Ron Paul.
Yet the FED is doomed, as is central banking in general. Government power cannot make the irrational rational. It cannot make coercion productive. It cannot make committees wise.
You might as well use the system to profit from it. You can’t change it.
If you want a good 42-minute introduction to the Federal Reserve System, watch the video produced by the Mises Institute.
If you want a simple introduction to the issue of central banking, read Murray Rothbard’s book, What Has Government Done to Our Money? It’s free.
For the most detailed book on fractional reserve banking — law, practices, results — read DeSoto’s 800-page book, Money, Bank Credit, and Economic Cycles. It’s free.
Published on May 30, 2007. It's here.