The Fed and the Golden Fleece
By William Anderson
Published 04/22/09
When I teach my economics classes about money, I pass around a $10 gold coin that is a replica of those that were in circulation around 1913, the year Congress created the Federal Reserve System. The coin is made from one-half of an ounce of gold, dating from the time when the dollar was based upon a standard of $20 an ounce.
If I were to value that coin today, according to current gold prices, it would sell for more than $400, which means that according to this way of measuring the value of money, the dollar is worth about 1/40 of what it was when the Fed came into being. Now, this is not necessarily the best or most accurate measure of the decline of the dollar, but it is good enough for the purposes of this article.
Whether or not the dollar has declined to 1/40 or 1/50 or even 1/30 of its value of what it was before the Fed was created really does not matter, or at least a precise numerical measurement is not particularly vital for our understanding. What we do need to understand, however, is that the dollar is a mere shell of that currency that existed about a century ago, and that the predations of the Federal Reserve System are the main reason why this has happened.
A popular chant at Ron Paul rallies was "End the Fed," but if we are going to call for the closing of the nation's "central bank," we first must understand the role of this agency in the financing of government activities. Furthermore, we have to understand what it is that the Fed has done in order to justify our condemnation and our demands that it be eliminated from our body politic.
First, we have to remember that governments do not need a central bank in order to engage in the act of inflation. Abraham Lincoln financed most of his war against the Confederacy by circulating "Greenbacks," which actually were demand notes issued by the U.S. Department of the Treasury. These notes circulated as legal tender, but by 1879 ultimately were redeemed in gold, albeit indirectly.
Second, even commodity money can create inflation. When William Jennings Bryan ran on the Democratic ticket for president in 1896, his platform was based upon inflating the money supply with silver coins. In our day of fiat money, the idea of a silver-based inflation seems fantastic, but in 1896, the dollar was so valuable that it actually was possible to engage in a silver-based inflation. The problem was that there were large U.S. silver deposits and powerful U.S. senators from the newly-created western states were able to push through laws that obligated the Treasury to purchase large amounts of silver and strike new coins, many of which never were put into circulation.
Thus, it is not central banking per se that actually is inflationary. However, the reasoning behind the creation of the Fed is one that sooner or later was going to run into a collision course with sound money, no matter how soothing the original language of the Federal Reserve Act might have been with regard to sound money.
According to its creators, the purpose of creating the Fed was to have an entity that could act as a "bankers' bank." Because fractional-reserve banks were vulnerable to periodic run which often could explode into panics, the influential bankers of the United States wanted a system that would backstop them in case the public lost confidence in monetary institutions. Under the original doctrine of the Fed, the central bank would lend money to banks to hold them through these runs, which supposedly would stymie any deterioration into a panic or full-blown crisis.
However, it was not long before Federal Reserve officials were doing a lot more than just backing up the banks. During the 1920s, the Fed, and especially its New York branch, aggressively expanded the amount of money in circulation by purchasing U.S. Government bonds in so-called open market operations and increasing bank reserves and, thus, the monetary base.
This aggressive Fed-inspired monetary expansion led to two major financial bubbles, the Florida land boom and later the infamous stock market bubble, which collapsed in October, 1929. Contrary to popular belief, it was not the stock market crash which led to the Great Depression, but rather the response of the federal government to the crash.
The Fed's role in all of this is misunderstood. The popular story is that the Fed was not aggressive enough in trying to stop the thousands of bank runs that occurred from 1930 to 1933. However, the truth is much more sinister. Because of what economist Robert Higgs has called " regime uncertainty," the banking system could not be propped up as long as government was massively intervening into the economy, creating uncertain conditions and trying to support economic entities that no longer could stand up on their own.
Yet, the Fed tried all through the 1930s to keep the Hoover and Roosevelt "New Deal" alive by inflating the currency. Because the Hoover-FDR programs generally were aimed at contracting overall industrial output, the government sought to counteract these contractionary policies by inflation. The idea was that although the economy would produce fewer goods, inflation would drive people to spend money quickly, which supposedly would "stimulate" more production.
This is a policy akin to trying to walk simultaneously uphill and downhill and, nor surprisingly, the economy was moribund all through the 1930s and really did not recover until after the end of World War II, when more sane economic policies were put into place. However, the political success of the New Deal led to even more government spending, and by 1971, it was obvious that the U.S. Dollar no longer was as good as gold.
However, to place things in perspective, the world price of gold in 1971, when President Richard Nixon cut all dollar ties with gold, was about $100 an ounce, while dollars were scheduled to trade at $35 an ounce. Thus, under those pricing agreements, the value of the dollar had slid by a third, and if one compares that situation to the 1913 price of gold, the dollar was worth about a fifth of what it had been when Congress created the Fed.
Would be that the dollar was worth only a fifth of what it was a century ago! One-fifth still is better than 1/40, and the future prospects of the dollar are grim. For one, the USA is the most profligate debtor nation in world history, and given the rogues gallery of nations that has preceded this country, that, indeed, is an infamous "honor." There is no way that the dollar can withstand the pressure that the current deficit spending is creating. The USA cannot "stimulate" the economy by spending wildly, nor can it afford its world-wide military ventures.
Simply put, the USA is broke, but the very presence of the Fed creates the illusion that all that is needed is for the central bank to purchase more U.S. debt, and then monetize those debts into oblivion. This country's monetary future is grim, and there is no other way to say it.
It is true that a central bank is not necessary for a government to engage in reckless and ruinous spending. However, because the Fed is able to create the illusion of wealth and prosperity by creating even more dollars, it is an important ally to the government's profligacy. For all the worshipful attention that the various governors of the Fed receive from the media and the U.S. Congress, the alleged "economic conservatism" of the Fed officers is a sham; government irresponsibility has no greater ally than the nation's central bankers.
Getting rid of the Fed would not automatically mean that this country could begin to find its way back to fiscal sanity. However, this country never will return to sane policies and sound money unless the Federal Reserve System is abolished. Lest one ever question this last statement, remember that before the Fed was established, gold coins circulated freely as real money, not collectors' items.
http://www.campaignforliberty.com/article.php?view=59
--~--~---------~--~----~------------~-------~--~----~
Thanks for being part of "PoliticalForum" at Google Groups.
For options & help see http://groups.google.com/group/PoliticalForum
* Visit our other community at http://www.PoliticalForum.com/
* It's active and moderated. Register and vote in our polls.
* Read the latest breaking news, and more.
-~----------~----~----~----~------~----~------~--~---
