Wednesday, April 22, 2009

The Case Against the Fed

by Murray N. Rothbard

However scary and threatening, government agencies, even the dread Internal Revenue Service, are all subject to being checked by Congress.

One entity, however, which people who know their economics believe is the scariest since it has iron-clad control of the nation's monetary system, is accountable to nobody, not even Congress. It is the Federal Reserve (1).

The establishment assures the public that the Fed needs to be in such a position. Anything as important as that needs to be “independent of politics.” Don't fall for it! What that really means is the Fed can do anything it darn pleases with the money supply (2). The banks the Fed controls like it that way. There is something fishy here. Since when do those who are being regulated want unbridled power in the hands of their regulators (3)? The Fed wants this power “to fight inflation.” Hah! And, since when do bankers want inflation checked (4)?

The fact is, there is inflation. Only one institution can bring it about (legally, that is, but illegal counterfeiters are few and far between) and that is the Federal Reserve as it creates more money out of thin air. The Fed stays away from “inflation” to about the extent that I stay away from pasta, and that is darn little.

So, the Federal Reserve is not a solution but is a big problem. To understand this, Dr. Rothbard says (5) we need to understand the history of money. I have discussed this in other essays in reviews of Rothbard's other works, so it is not really necessary to go into much detail here. Suffice it to say that any commodity that is used in the market and is marketable enough can be used as a medium of exchange, or money. This commodity can either be used as a consumer good in its own right or as something to exchange for other goods. Gold and silver are both time-honored moneys (6). This did not come about by government edict. It came about over time in a free marketplace. Having such a medium of exchange greatly facilitates and accelerates prosperity. It also allows business firms to calculate profits and losses more accurately than is possible under barter.

Dr. Rothbard reiterates, and I will too, briefly, that, even though money is a “good thing,” an increase in the supply of money in the economy will not be helpful (7). This is because this increase cannot augment the amount of available goods and services in the market. There is no “optimal” supply of money. Now we are beginning to see through the Fed's and the establishment's propaganda.

That counterfeiting is wrong should be obvious to anyone. But what is not so obvious is that the manufacture of un-backed-up money by the Federal Reserve is really not different (8). The temptation to counterfeit is in the fact that the counterfeiters get to spend the “money” they manufacture before the increase in the money supply they are causing has had a chance to raise the price level. This enriches the counterfeiters at the expense of the rest of us. Those who get this new money first, the counterfeiters themselves, are the “first receivers” of the money. They get to spend it right away. Those businesses they patronize and their employees receive it next, and the businesses they patronize receive it next after that, and so on and so on. By the time you and I get it, the new demand caused by it has already long since pushed up prices, so actually the “first receivers” of the money have benefited at our expense (9). As I said before, this amounts to a transfer payment from you to the well-connected.

Inflation, therefore, does not happen evenly.

Next time you pour cream into your coffee, observe something. When you pour the cream in (slowly near the edge of the cup will illustrate this better), the coffee nearest the cream source gets the cream first. The coffee on the other side of your cup stays black a while longer.

Think of the coffee as the marketplace, the cream pitcher as the Federal Reserve and the cream as money. When the Fed manufactures money backed up by nothing and adds it to the economy, they add it through the banks. The first receivers are the well-connected establishment people, for the most part, although there might be an occasional dissident first receiver. Their place in the “coffee” is near the source of the “cream.” People like most of us are closer to the other side where the “coffee” remains “black,” meaning it lacks the new money. By the time we get it, supply and demand have already raised the price level.

This is why wealth gravitates toward establishment interests. And, as far as the Federal Reserve's manufacture of money is concerned, is this really any different from counterfeiting?

Is it? Just because it has the blessing of the government? Unless you think of government as some sort of god, you have to agree with Dr. Rothbard and me on this!

This is the root cause of our economic problems in late 2008. Obviously greed in places other than government is a factor, but the main blame is on the Fed and the federal government (10). But people will fall for any propaganda the establishment dishes out because almost all public school graduates and most private school graduates are illiterate when it comes to monetary economics.

And, you can bet your last nearly-worthless dollar that, while government officials are acting as though they are scrambling for solutions and throwing you a few crumbs, they are laughing all the way to their cronies at the bank! They are aware that inflation is more than just a general rise in prices due to an increase in the money supply. They are aware that it is an uneven distortion of the economy through transfers of wealth (11). They know this; how could they not?

Dr. Rothbard then discusses loan banks in a free market. These banks borrow from you when you set up a certificate of deposit for interest, and then they lend that money at higher interest (12). There is nothing crooked or inflationary about this.

Next, he turns to the subject of warehousing and warehouse receipts, which is something we have seen in other works.

The point driven home (13) is this. Right now, in November, 2008, the government is anxious to “get the economy going again” by a couple of ways that Dr. Rothbard believed (and so do I) are totally pernicious. One is they want to encourage borrowing. So they enact this $700 billion “bailout,” giving huge amounts of money to banks and other such entities. Where did this money come from? Thin air! It rolled off the printing press. This is a blatant case of first receivers being the bankers. So is the money being loaned? From what I hear, no. Well, thank goodness! It is the low interest rates and liberal lending practices that got us into this mess in the first place! Do you seriously think the same practices will get us out? The banks seem to know better, so they are being cautious.

The other way they claim to be restarting the economy is “economic stimulus packages.” Tax “rebates” went out to less well-to-do taxpayers last spring, and I wrote in last year's essay that I hoped people would be smart enough to use this to pay down their debts and to squirrel away what was left for a rainy day. This is exactly what people did. This isn't rocket science! If you are in debt and realize you have nothing at all saved for retirement, and this check comes in, what would you do? Buy a big-screen TV? Not if you have a measurable I.Q. But the Bush administration, which created this money out of thin air, wanted you to do just that.

In Man, Economy and State, Dr. Rothbard explained why saving and investing creates more employment and wealth over the long run than spending does. This is why bailouts and “stimulus” packages will not work in the end.

Now, President-elect Obama (as I write this in November, 2008) wants another “economic stimulus package” and will probably call for another bailout too.

Back to the bankers, they want to keep the public in the dark, or at least in blind faith, about their solvency. They are not solvent, thanks to fractional reserve banking. This means the banks only hold a fraction of the reserves needed to cover all the demand deposits. Now, what if all, or even some, of the depositors wanted to draw out all their money at the same time? This thought strikes fear into the bankers because banks cannot honor their promise to very many people (14). The bank would go belly-up, unless it got a supply of cash from the Federal Reserve's printing press. That would really be inflationary.

If there are monetary problems (and there are right now in November, 2008) and banks begin to worry about runs on banks (which they do), what they are likely to do is curtail loans (which they are) (15). Obviously, this is the smart thing to do. Just as you and I cannot spend ourselves rich, banks that are in trouble due to loan defaults are likely to hold on to their money. Prospective borrowers are thinking twice also.

The Bush administration, and the coming Obama administration want more lending and more credit and the Fed is pumping new money into the banks. I have said this before and will be the first to admit that I seem like a broken record. But this is critical. This is exactly the wrong thing to do, and in the long run it will not solve the problems that government's poor monetary policy has created. I will belabor this no more right now. I think you get the point, or at least you will if you read the book.

Dr. Rothbard gives a brief history of central banking. We learn that this creates a cartel among a country's banks. They all do together what, in a free market, no one bank would dare do and that is to not have sufficient funds in case all the depositors wanted their money at the same time (a bank run), or if there were anything like a gold standard, not have enough gold deposits either in the bank or at the central bank.

One bank trying that in a free market would quickly go out of business as has been explained. But all of them together, under the central bank, would only have a problem with banks in other countries (16). The central bank has no control over banks in other countries. This is why the establishment would like to see a world central bank.

Once the brief history of central banking in general is discussed, Rothbard gives us a brief history of banking in the United States. It was interesting to note that it was the Republican Party during Lincoln's time that called for a central bank and inflationary policies, where it was the Democrats (the party of Jefferson) who were calling for sound money. Actually that should be no surprise after reading my The Three Worst American Enemies of Freedom on this blog and the references listed (17).

And, of course, nobody should be surprised that it was the big industrialists who were also the top Republicans who were the most avid supporters of central banking (18). The Panic of 1873, which was caused by war and inflation, was what brought about at least a temporary victory for gold (19). I guess it is too much to hope that the economic crisis of today would re-kindle a gold standard, as today's people are so terribly uninformed of such matters and government is so much stronger. Unfortunately, by the turn of the century, the Democrats fell and became even worse than the Republicans.

As the strong belief in freedom decreased, the power of the anti-hard-money establishment increased (20). In Dr. Rothbard's narrative on how central banking with its attendant inflation and gravitation of wealth toward establishment interests, it is plain that the establishment snookered the general public into acceptance of central banking. It did it through academia and newspapers such as the Wall Street Journal (21), which should surprise nobody since in modern times the “educational” system and the “news” media have replaced the church as the means of keeping the people in line.

The actual bill to authorize the central bank was hammered out at a posh resort on Jekyll Island, Georgia, in 1910. The participants were a who’s-who of the new establishment which still has to this day a stranglehold over each and every honest, hard-working person on the planet, and which is responsible for the poverty, illness, and death of billions of people worldwide. These people, and those who took over for them after they died and went to where nobody wants to go, have destroyed our freedom and prosperity, and somehow have managed to fool enough people enough of the time to continue the destruction.

Dr. Rothbard (22) describes a step-by-step process of how the money supply is inflated, at least how it was done when the book was written. I doubt there has been much change, unless it is for the worse.

So, what to do? Obviously the Fed has to be abolished. While this is not going to happen any time soon, Dr. Rothbard ends the book with ways it could be done.

(1) Rothbard, Murray N., The Case Against the Fed, Ludwig von Mises Institute, Auburn, 2007 edition, P.3.

(2) Ibid. P. 4 - 5.

(3) Ibid. P. 7.

(4) Ibid. P. 9.

(5) Ibid. P. 12.

(6) Ibid. P. 16 - 17.

(7) Ibid. P. 19.

(8) Ibid. P. 20 - 22.

(9) Ibid. P. 24.

(10) Ibid. P. 24 - 25.

(11) Ibid. P. 25 - 26.

(12) Ibid. P. 29 - 33.

(13) Ibid. P. 39 - 40 in particular.

(14) Ibid. P. 46.

(15) Ibid. P. 54 - 55.

(16) Ibid. P. 64.


(18) The Case Against the Fed P. 78.

(19) Ibid. P. 78.

(20) Ibid. P. 91.

(21) Ibid. P. 112 - 113.

(22) The Case Against the Fed starting P. 137.


Anonymous said...

Very good review! I wish there were more of you that think this way.

Alice Lillie said...

Thank you!

Yeah...don't I wish...