via: campaignforliberty
Massive amounts of suffering is occurring in the world today due to a financial collapse of historic proportions. Governments and peoples cannot go forward without truly understanding the underlying causes of this catastrophe. The current economic crisis around the world has finally brought to the forefront long-dormant questions about economic policy; among these is the Federal Reserve Bank. The Federal Reserve Bank should be abolished because the economy is too complex to be directed by a small group. It cannot be effectively held accountable by voters, and its policies tend to cause financial instability.
The population in the United States consists of 300 million people as of the last census, all working to affect the economy as a whole with each decision they make. Gross domestic product sits close to $14 trillion. This trillion-dollar economy has connections with 191 other distinct economies throughout the world. The size and scope of the connections within the US economy as well as the connections it has with economies outside of it are tremendous and unprecedented in scale. The Federal Reserve Bank attempts to direct this massive economy largely through the Federal Open Market Committee (FOMC) (2009). The FOMC consists of ten members and five alternate members (2009). Based on size alone, no group of ten people could ever hope to exercise control over the direction of such an enormous economy. Even if this small number of people could collect every possible data point necessary to predict the effects of their actions, they would still fail based on one key aspect of economics: The US economy is driven by the complex choices of 300 million Americans and thousands of corporations, and as psychologists know, complex behaviors are often difficult to predict, especially over long periods of time.
However, some would argue that the Federal Reserve can act as a stabilizer on the economy. The Federal Reserve itself says in The Federal Reserve System: Purposes and Functions, that “it was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system” (Board). The argument for the Federal Reserve states further that the many crises — or “panics” as they were known then — faced by the American economy throughout the nineteenth century could have been avoided if a centrally planned economic system had been in place. However, supporting the idea that the Federal Reserve is capable of providing a stable economic system becomes increasingly difficult if one examines the economy from a historical perspective. Only sixteen short years after the creation of the Federal Reserve, the United States suffered the worst economic catastrophe in history — something the Federal Reserve failed to prevent. The Great Depression dwarfed the previously-referred-to panics, or recessions, that occurred during the nineteenth century, during which time the Federal Reserve was not in existence. Another bout of economic instability infected the US during the 1970s and 1980s, which saw an incredible rise in inflation as a series of increasingly worse recessions occurred. The Great Inflation, as it was known, provides yet another example of the failure of the Federal Reserve to direct this increasingly complex economy.
In addition, the Constitutionality of the Federal Reserve as well as its supervision and accountability remain in question. Under no article nor section in the Constitution is there a mention of the right of the Congress to establish a central bank; however, in 1913 the Federal Reserve System was created by an act of Congress. The Federal Reserve Bank is run by a board of seven “governors” appointed for fourteen-year non-renewable terms by the President and confirmed by the senate. This permanent, ad-hoc “fourth” branch of government has the power to influence the value of the dollar as well as the economy in general, yet is relatively immune to the will of the people. With fourteen-year terms, the governors are more or less free to do as they please with little, if any, chance for the American people to hold them responsible for their actions. The board can be thought of as analogous to a hypothetical group of fourteen-year cabinet members who, as a whole, would wield as much or more power than the President.
However, proponents of the Federal Reserve System state that it is necessary for the Federal Reserve to remain heavily insulated against Washington politics. In Economics By Design, an introductory textbook to the field of political economics, Robert A. Collinge states that
“The fear that originally motivated Congress to insulate the Fed from politics is that political pressures could influence the Fed to pursue an expansionary monetary policy at the wrong moment — a policy that would ultimately lead to excessive inflation. . . if the Fed were subject to political pressure, decision making could favor a short-term popularity at the possible expense of long-term economic goals” (338).
As the politics in Washington appear to spiral out of control at an ever increasing rate, insulating those in charge of the economy from such politics has a clear value.
Be that as it may, the Federal Reserve is far too insulated from political pressures and accountability. Save for the Senatorial confirmation votes, the people have no ability to influence monetary policy and the direction of the economy whatsoever. So immune to public pressures is the Federal Reserve that the Comptroller General, under Subsection B of section 714 of title 31 of the United States Code, cannot even audit the Federal Reserve to discover, amongst other things, “transactions for or with a foreign central bank, government of a foreign country. . . deliberations, decisions, and actions on monetary policy. . .” (US Code). For it to be illegal to discover the inner workings of the institution that directs the economy represents a significant deviation from a government that is supposed to be “by the people and for the people.”
In regards to the Federal Reserve, accountability becomes increasingly important as one examines its potentially destabilizing policies and actions. Robert P. Murphy, who holds a doctorate in Economics from the prestigious New York University, describes how the policies of the Federal Reserve are sometimes based on faulty economic theories (Murphy). In the 1960s, economists discovered a relationship between unemployment and inflation, which they dubbed “the Phillips curve.” This curve showed that, as inflation increased, unemployment decreased. Unfortunately, in the 1970s and 80s, the Phillips curve was shown to be a fallacy due to what economists refer to as “stagflation”, in which the US economy went through a period of high inflation coupled with high unemployment. According to Murphy, the Federal Reserve is buying into this discredited theory today by “showering the economy with new money” (Murphy para. 8). In following this theory, the Federal Reserve may create more economic instability.
On the other hand, some would argue that it is not the Federal Reserve that causes instability but the free market. For example, the prevailing wisdom about the current crisis says that deregulation, greed, and the free market created this catastrophe. Maria Bartiromo cites Senator Byron Dorgan of North Dakota who states about the current economic crisis that, “I happen to think [banking deregulation] was a significant cause of what we’re now experiencing. . . What about American consumers? They also helped cause this train wreck by taking on mortgages they couldn’t afford.” (Bartiromo). The view that the free market is solely to blame can be rebutted by examining economics from the Austrian perspective. Thomas Woods, author of Meltdown, a New York Times Bestseller, recently spoke at the Campaign for Liberty event in St. Louis, Missouri. In his speech, Woods discusses F.A. Hayek’s Austrian Theory of the Trade Cycle, for which Hayek won the Nobel Prize in economics in 1974 (Woods). Woods states that interest rates are the single most important measurement in an economy (Woods). In his theory, Woods says, Hayek tells of two ways in which interest rates can be lowered: through the “natural” way of increased savings and through the “unnatural” way of a central bank artificially forcing them down by flooding the market with credit (Woods). In the case of the United States, the forced lowering would be caused by the Federal Reserve reducing the target interest rates through what is called the “federal funds rate.”
The consequences of the natural way of increased savings, says Woods, is that consumers are indicating they are planning on spending more in the future by saving now (Woods). By saving, consumers also give producers and investors the opportunity to find funds, and hence resources, with which they can create new forms of economic capital; in effect, they are getting ready to “produce more in the future” to complement the consumer’s indication that they will consume more in the future (Woods).
The result of the unnatural way of central bank forced lowering through an entity such as the Federal Reserve is that producers are misled into thinking that consumers will spend more in the future (Woods). Investors have large amounts of credit with which to invest, and do so because of lowered interest rates (Woods). Unfortunately, due to a lack of savings, consumers have not actually released the real resources into the economy necessary to complete building projects and allow for the maturation of investments, nor have they indicated a desire to consume more in the future; there is only the illusion that this has occurred (Woods). Because of the lack of true resources, investors discover that goods are actually more expensive than they were led to believe by interest rates, and as a result, prices for goods go up due to increased scarcity (Woods). Because of the increased prices and lack of true resource availability, builders find that their projects cannot be completed, and as Woods puts it, “. . . the thing has to become a bust” (Woods).
The previously stated description of Hayek’s theory applies perfectly to the current crisis. Throughout the 1990s and 2000s, interest rates were artificially lowered by the Federal Reserve. This allowed excess credit creation and higher prices which ultimately led to the Dot Com bubble and the more recent Housing and Commodities bubble. The Austrian Theory of the Trade Cycle directly implicates the Federal Reserve System in the problems faced by the economy today.
Though the Federal Reserve System is a morally laudable idea, in practice it has proven to be ineffective at best and financially poisonous at worst. The economy is far to large for a small group of people to ever hope to direct. The Federal Reserve, a defacto fourth branch of government due to its massive amount of power, remains mostly unaccountable to the will of the people. In addition, the Federal Reserve has been shown to likely be the underlying problem behind the large systemic failures in the U.S. economy by the advent of Austrian Economic Theory. At the very least, Congress should amend subsection B of section 714, title 31 of the US Code and permit an extensive audit by the Comptroller General of the Federal Reserve. This entity has gone far too long without any supervision or accountability and it is time the American people woke up to the disasters that this entity has wrought.
Works Cited
Board of Governors of the Federal Reserve System. The Federal Reserve System: Purposes and Functions. The Federal Reserve System, 2005.
2009. Board of Governors of the Federal Reserve. Washington D.C. 15 Apr. 2009.
Book TV on CSPAN. Woods, Thomas. Campaign for Liberty Regional Conference. Millenium Hotel, St. Louis, Missouri. CSPAN2. 13 Apr. 2009.
Collinge, Robert A., and Ronald M. Ayers. Economics By Design: Survey and Issues. Upper Saddle River: Pearson Prentice Hall, 2004.
Maria Bartiromo. “BYRON DORGAN ON WHY THE FINANCIAL CRISIS NEEDS INVESTIGATING.” Business Week 23 Mar. 2009: 15-16. ABI/INFORM Global. ProQuest. John Peace Library, University of Texas at San Antonio. 16 Apr. 2009.
Murphy, Robert P. “Threat of Hyper-Depression.” Campaign for Liberty. 04 Apr. 2009.
United States. Office of the Law Revision Counsel of the U.S. House of Representatives. United States Code. Jan. 2006. Apr. 15 2009.
