The Church of the Federal Reserve is Here to Save Us

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July 28, 2022

The Church of the Federal Reserve opened its tent for quarterly services this week. Pastor Jerome Powell played the role of Elmer Gantry, a role previously filled by others in the economics profession. Like the charlatans before him, he claimed the Fed was ahead of events and in control of the economy. The message to the faithful was that everything would be fine. No reason to fear; Elmer has your back!

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The Federal Reserve is a fraud and has been from its inception. Its creation was via dubious means in 1913. That year was arguably the worst in U.S. history for freedom lovers — 1913 was during the “Progressive Era” and also saw the passage of a permanent income tax.

Oversight of the banking industry is necessary, particularly in a world of fractional-reserve banking. Banking committees and oversight functions exist inside the Federal Government. Why was this one created as some contrived hybrid? G. Edward Griffin addressed this abnormality in his The Creature from Jekyll Island.

To assess the effectiveness of the Federal Reserve, an economic review of general economic performance before and after its creation is useful. The Fed began operations in 1914. Shortly after its creation, a boom, the “Roaring 20s,” occurred. That quickly ended with the greatest stock market crash in history in 1929, which preceded the Great Depression of the 1930s:

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The stock market crashed over 90%. In the years to follow, economic upheaval ensued as the U.S. economy shrank by more than 36% from 1929 to 1933, as measured by Gross Domestic Product (GDP). Many U.S. banks failed, leading to a loss of savings for their customers, while the unemployment rate surged to over 25% as workers lost their jobs.

These outcomes suggest a failure by the Fed. Even unprecedented interventions by the Fed and the government failed to resolve this disaster. It wasn’t until the end of World War II that the economic recovery began (in the mid-late 1940s). It took 25 years for the stock market to regain its high from the 1920s.

Was this evidence of Fed failure or merely ignorance? Were they guilty of taking their “training wheels” off too soon? Economic scholars differ on the issue.

Economic growth and stock valuations strengthened in the 1950s. The rebuilding effort after the war contributed. Then, in the 1970s and early 80s, the country experienced high inflation:

In 1973, inflation tripled, from 3.9 percent to 9.6 percent. The Fed only doubled interest rates from 5.75 to a high of 11 points. Inflation continued to remain in the double-digits through all of 1974, lasting until April 1975. The Fed kept raising the fed funds rate to a peak of 13 in July 1974, and then dramatically lowered the rate, reaching 7.5 by January 1975.

The fed funds rate reached a high of 20 points in 1979 and 1980. That was to combat double-digit inflation.

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Paul Volcker, appointed as new Fed Chair, stopped the high inflation in the early 1980s. “Tall Paul’s” monetary policy was unprecedentedly aggressive and effective. He had the backing of the Reagan Administration in these efforts.

By the year 2000, more crises arrived. Two major market drawdowns occurred in this new century, only ten years apart. These were the dot-com crash and the sub-prime crisis of 2009. Both resulted in stock market declines of 50%. No other market crash, other than the Great Depression, exceeded these drops. That includes the period before the creation of the Fed!

It is reasonable to interpret these results as potentially caused by the Fed. Is there an economic rationale that can explain the increase in market (and economic) volatility? I believe there is.

The Federal Reserve is not independent, despite claims otherwise. It is an arm of the Federal Government. Board members are political appointees. Government created it and can disband it. The Fed must please the government in order to exist.

The Federal Reserve is a central planning operation. It is our equivalent to the Gosplan of the old Soviet Union. In the absence of markets, Gosplan set prices and quantity targets for every item in the Soviet economy. 

This approach was impossible. No central authority could perform these duties properly. duties Empty shelves and surpluses resulted. The country and its citizens remained poor.

The Fed is not a total Gosplan (at least not yet). Our economy works because free markets provide the pricing/ production decisions. However, the Fed still provides a central planning function. Through monetary policy and the supply of money, they affect behavior in all markets.

Their role is high-level central planning. But, like all central planning, it influences decisions to conform with government goals. It does so by misleading economic actors. The result may be short-term benefits to the economy at the cost of misleading economic actors to decide not in their best interests. 

They do this via the manipulation of interest rates and the supply of money. Changes in either produce changes in economic decisions.

If the interest rate declines or rises, that produces a shift in time preference. Lower rates make borrowing cheaper and savings less attractive. Consumers move planned future consumption forward when interest rates decline. Borrowing or reducing savings is the source of additional funds. Higher interest rates produce opposite effects.

Similarly, behavioral changes occur when the supply of money changes. If the money supply rises, some end up with higher balances than desired. Excess balances are spent or added to savings. Lower balances than desired balances create opposite reactions. The Fed is not immune from political influence. Politicians like booms because it enhances their chances of reelection. 

The most reprehensible role of the Fed is its role as “counterfeiter-in-chief.” As an “independent” agency managing the banking system, pressures to increase the money supply should not originate from government. But the Fed is not truly independent, so political demands influence their actions. Recently, when the Treasury could not fund new spending by selling treasuries to the public, the Federal Reserve bought these securities, in effect creating extra money for the government to pursue profligacy.

Now the Fed has $7 trillion on its balance sheet. It is doubtful government will ever retire these treasuries. This non-arms-length transaction was counterfeiting. It benefited the federal government at the expense of citizens.

Think of the Federal Reserve as our Gosplan without the nitty-gritty details.

Monty Pelerin blogs at EconomicNoise.com and marvels at the decline in civilization.

Image: Federal Reserve

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