I have been watching with amusement the progress Ron Paul has been making with cosponsors on his bill (HR 1207). The cosponsors tactic was one that I used in the mid-1980s to get the gold coin bill adopted (PL 99-185), in the face of Treasury opposition. Those assholes were so anti-gold they didn’t even want a bullion coin to compete in the market with Krugerrands and Maple Leafs! Our key success in 1985 was to enlist the Black Caucus, chaired by Rep. Julian Dixon (D-CA) and his good friend Rep. Jerry Lewis (R-CA).
Questioning the Federal Reserve “Church”
I think it is true that the “audit the Fed” issue is just a publicity stunt, as Forbes points out. But it is a useful publicity stunt because it has focused a lot of attention on the Fed and its position in American society.
Until very recently, the Fed was treated as some kind of church. Its pontiffs were treated as spokesmen for the Mystery, and every member of Congress was very shy of criticizing the Fed, except for a few old populists like Henry Gonzalez who would have abolished the Fed and replaced it with the Treasury issuing fiat paper money in order to push interest rates down to zero, etc. William Jennings Bryan exercised pernicious influence back in 1913 to convert what would have been a fairly benign private clearing house that issued banknotes (just as every other National Bank also in those days did) – into a government agency that issued “obligations of the United States.” Thus the Fed was born. Rosemary’s baby.
I say Ron Paul’s bill (HR 1207) is a “useful” publicity stunt, but it could backfire if
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(1) the concerns Bernanke highlighted came true, namely that the Fed felt pressured by Congress to inflate; and
(2) some kind of “audit” is conducted and the Fed is whitewashed and the whole issue becomes covered up with a new cloak of pseudo-democratic appearances.
Certainly, if a government is going to enforce a monopoly currency, the monopoly agency should *NOT* be under popular or democratic control. It should focus strictly on maximizing profit. For a monopoly currency that means only sustaining and stabilizing the purchasing power of the monetary unit. If a central bank can do that, it will rule forever in its narrow sphere.
The business side of the Fed is already audited. The current “Tax on Federal Reserve Notes” (so called; not really accurately named), which is a line item in the Fed’s annual income statement, is a 100% tax on the Fed’s nominal monetary profits. The money goes directly to the U.S. Treasury, just as the coinage seigniorage from the Mint also goes. (Of course, the Fed gets “to skim” because it pays its operating expenses before remitting to the Treasury – but that is revealed in the audits already conducted and published.)
The three areas where the Fed is not today audited are all justified, in my view, under the system we have.
- First, transactions with foreign central banks and IMF, Bank for International Settlements, etc. are secret because the foreigners want it done that way. The Fed acts as a fiscal agent for a lot of foreign governments, particularly the smaller ones.
- Second the Federal Open Market Committee and the games it plays under the rubric, “monetary policy,” do have the power to move the stock and bond markets in powerful swings. If anyone had insider knowledge of what the FOMC were doing on any particular day, your profits from day-trading would be gigantic. A hedge fund manager’s dream come true.
- Third, the FOMC operations, buying and selling to impact the Fed Funds rate, would also be an area that should not be allowed to become something of daily, transparent knowledge. The claim that these things should be kept non-political and out of sight of speculators and day traders makes sense to me.
The Monopoly Problem
But, the real issue is WHY should the Fed be a monopoly, and WHY should the United States government even want to use an undefined F.R.A.U.D. monetary system? [Note acronym: "Federal Reserve Accounting Unit Dollar"]
The answer is because the British Neo-Classical School of economics, which developed under the Victorian era regime following Peel’s Act of 1844, had neglected and lost track of the debates among – yes, amateur for the most part – economists from 1800-1844. Lawrence H. White’s book on this history, “Free Banking in Britain,” is very informative. Even Milton Friedman changed his mind after reading about free banking.
The British Economists
The Briish economists after 1844 came to the conclusion that “scientific management” of a monetary monopoly would be superior to whatever crippled market process occurred under a “pseudo-gold-standard” (Milton Friedman’s label).
Yet, of course, the whole appeal of “scientific management” of an economic system ought to have passed away with the fall of the Soviet Union.
The observation that fewer business cycle downturns occurred after 1913 than before the Fed ignores a lot of economic history. First, it ignores the stupid regulations imposed by the National Bank Act of 1863 that forced banks to operated as undercapitalized agencies, because they were forced to buy government bonds in order to issue currency (but not demand deposits). This crippled the banking system and led to many more runs on banks and contractions than would have occurred without such rules.
Comparing the Canadian experience with the U.S. experience shows how much more stable the Canadian system was, with a more pure system of free banking. Canada didn’t create the Bank of Canada until the late 1930s, and by that time it was the mania of every government on earth to have its own central bank – and there was no longer any international gold payments system.
Second, although there was no Federal Reserve prior to 1913, there was the Bank of England, which acted like a global central bank for all the “gold standard” countries. And the Bank of England was very incompetent in running monetary policy, which is one reason the British Neo-Classical School economists were so critical of the classical pseudo-gold-standard. As the Bank of England induced expansion and contractions in the London financial markets, those markets affected all the rest of the world, New York in particular because of America’s close links with the British Empire. See Walter Bagehot, “Lombard Street” (1873) on “the unnatural system of centralization” and the mismanagement of the Bank of England. Bagehot was the editor of The Economist magazine.
Moreover after 1935, monetary policy was deliberately conducted with a bias never to allow a contraction and to promote a mild and gradual inflation. If you look at a graph of monetary expansion since WW2, many of what would have been contractions before 1913 are just flat spots on a rising chart. This is why Milton Friedman emphasized that it is the 2nd derivative (change in the rate of change) in monetary expansion that affects the growth of nominal GDP after a 6-18 month lag.
So, the bottom line is that I much prefer Ron Paul’s bill (HR 2779) to relax legal tender laws. If I could go all the way to utopia, I would urge a law having Congress make appropriations, budgets, and to assess taxes using the gram of gold as the government’s official unit of account, with a floating rate of exchange between the [thereafter] non-legal-tender F.R.A.U.D. units, which would continue to circulate and probably continue to dominate the financial markets. The U.S. national debt could still be payable in “dollars” but at a floating exchange rate with gold grams.
This might be the way to conform with the 14th Amendment, Section 4, and to pay off the national debt (in “dollars,” but not in gold grams).
Optimal Currency Areas
Indeed, in the literature of “optimal currency areas” it is not clear the whole United States should be a single currency area, much less all of Europe under the Euro. Labor markets in particular could operate more efficiently if wages were paid in local currencies. Michigan right now could experience a currency devaluation and that would help with unemployment.
Financial markets would probably operate more efficiently if prices were quoted in a global currency independent of national governments (e.g., gold grams).
And with floating exchange rates among them all.
This is great. I have felt that this was the situation for a while but I didn’t have the little bits of info to tie it all together. Great writing!
Thanks for your thought-provoking writing Joe. I agree with you that the Fed is audited sufficiently.
In response to your closing paragraphs, would I be correct to conclude that the Registered Warrants or IOUs issued by the State of California http://www.sco.ca.gov/5935.html to pay its bills is an example of a local currency? If so, how does it create prosperity to create a currency market for these IOUs? Does the average recipient of IOUs have the skill to determine whether to hold them until redemption or sell them at a discount? Wouldn’t this just increase the prosperity-dampening gap between rich and poor, with the cash flush taking advantage of the cash desperate?
By prosperity-dampening gap, I mean how can our economy with its safety net of government services (e.g. unemployment insurance, Medicaid, food stamps) bear the burden of more poor? Or did you not factor this into your equations?
Also, isn’t it sufficient that the dollar’s value is determined in a global currency market? Would the benefits of additional competition from local currencies outweigh the losses incurred by those who can’t calculate the true price of goods given the multiple currencies in which they could be purchased?
The main point in what Ron Paul wants to do is to find out who is getting the money. If you or I all of a sudden got 10 million in our bank account, we could be acquiring a lot of assets. This, at at time when everyone else is being laid off, having to accept part time work, foreclosing on homes, having a stock market worth a lot less than it was, etc. We want to know if just a few key people are getting the money & if that is a trend. We want to know if a few people are being given a lot of unearned money at times when everyone else is desperate, thereby enabling those few to take advantage of us when we are at our weakest.
We also want to know if the fed has been orchestrating the business cycle – as opposed to trying to temper it. If there is a connection between the fed and who gets the money and the fed’s influence on the business cycle, we want to know about it. Making the business gives great power, as during expansion, everyone is going into debt; during recession many people are unable to pay their debt and are losing real assets to the lenders.
The Fed is not audited sufficiently. Just like Enron and WorldCom were audited, they left out certain key information from their reports. In that case the IRS can audit them; in the Fed’s case, no one can audit them… yet.
Sorry if you thought that men in power can do no harm, are not self-interested, and are only looking out for the public. But seeing as how you like economics, you should take a hint from Adam Smith: “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest”.
Self-interest, opacity, and control over the money supply is a recipe for disaster and corruption. It’s to be expected. It’s human nature, sad to say. Don’t kid yourselves otherwise, you are just doing yourself a disservice.
Well-said, and something that the populists need to hear.
I’d say that this “F.R.A.U.D.” thing doesn’t do you any favors, but maybe with the populists, it does.
Little bit of confusing. Financial market requires an efficient person to give guidance while dealing with price index.Like Foreclosures contain lot of procedures to be clearly known. This requires an efficient person to give guidance while dealing with foreclosures.
Reply to David Weston’s comment, above August 9.
(1) Yes, the California warrants are “bills of credit” (to use a classical term of finance), and they are serving as a local currency to the extent that banks and merchants are accepting them as payments. This is what Von Mises identifies as “circulating credit.” He was distinguishing between “money” and “credit.”
But both are forms of liquidity – spending power; trade lubrication in a decentralized, division-of-labor society. Credit cards work even better. I do not know how well the California warrants are circulating there, but it is *NOT* inflationary in these circumstances to add lubrication and circulation for trade.
(2) No, there is not an impact on rich-vs-poor. Who is made poorer? Who is made richer? To the extent that trade is lubricated – closing the gap after the collapse of credit in 2008 – the California warrants help people mange their suddenly more difficult financial contracts and obligations.
If the welfare state has over-promised, particurlay in medical benefits, then it will simply have to cut them back or raise taxes. Money and credit are not sustainable solutions.
(3) Global vs. local determination of currency values: There are different markets, for example the local labor market and the international stock and bond markets. For such an international market, a global currency – outside a government – is best, unless of course some “central bank” to manage it could not be trusted. For a local labor market, more suitable might be a local currency.
The primary benefit of any monetary system is the ability of businessmen to quote relative prices in a common denominator, but the benefit of a “floating exchange rate” monetary system between international or interregional trade areas is to provide a “cushion effect.”
Consider that some prices in some markets are auction prices, like the prices on stock exchanges and commodity exchanges. Other prices are contract prices, like the wages of workers. The latter do not change, as worldwide market conditions change. So, it would be best if relative prices in the labor market were quoted in local currencies. If the local region were falling on hard times, the local currency would depreciate. Wages would remain unchanged. Standard of living for the unfortunate, lower-productivity workers would decline due to the higher prices for imports from other regions.
An efficient market requires flexible prices. Contract prices are an impediment, but floating exchange rates among local currencies, with an international non-political currency at the top, for the financial markets, would take care of many price inefficiencies.
Just thought i would comment and say neat design, did you code it yourself? Looks fantastic.
My site is a WordPress site. I do most of my HTML coding, but only in the text formatting, not in the whole site.