Sunday, January 1, 2012

The Federal Reserve System or the Free Market?


The Federal Reserve System is the central bank of the United States. It was founded “to provide the nation with a safer, more flexible, and more stable monetary and financial system,” The Federal Reserve System: Purposes and Functions explains. How well has the Federal Reserve performed in these rolls? Do we need an alternative? If so, is there an alternative?

There were high expectations on December 23, 1913 when President Wilson signed the Federal Reserve Act. “Under the operation of this law,” the Comptroller of Currency said, “such financial and commercial crisis, or ‘panics’ as this country experienced in 1873, in 1893, and again in 1907, with the attendant misfortunes and prostrations, seem to be mathematically impossible” (Paul, End the Fed, 24). In the 1890’s, real wages had risen and prices had fallen; many were concerned that this shift of profits from capital to labor would result in economic stagnation (Livingston, 36-37). According to bankers’ analysis, cyclical problems were worsened by the lack of a central bank. “E pluribus unum has been conspicuously left out of our banking system,” Frank Vanderlip of National City Bank explained. The results were no effective countercyclical capacities, periodic violent turbulence in the money market, and, ultimately, the panic of 1907-- “one of the greatest calamities of history.” He insisted that it was senseless for the American people to continue “to look alike upon banking panics and crop failures as dispensation of an inscrutable Providence, just as we once regarded visitations of plagues and fevers” (Livingston, 177). Twenty years after the founding of the Federal Reserve, the nation was again faced with a severe financial crisis. Every bank, including the 12 reserve banks was forced to close in this Great Depression (Gregory, 146). In the 1980’s, the American people suffered the worst unemployment since the 1930’s, 10.8%. Today, our economy still struggles in the aftermath of the housing bubble burst of 2008. Families are homeless, and according to a recent article in USA Today, our “high jobless streak” which has been above 9% for 19 months, “could break ‘80s record.” The panic of 1907 pales in comparison. It is senseless for the American people to continue to take banking panics, recessions, chronic unemployment, and depressions as inevitable--unless, of course, they are under a variant of Jotham’s curse on Abimelech and the men of Shechem for killing King Abimelech’s competition (70 brothers): “Let fire (or rather fiat money) come out of the Federal Reserve and destroy the people.”

Recently, protestors have occupied Wall Street with the cry, “We are the 99%!” I do not agree with the protestors on many issues. I do believe, however, that the monetary system of the United States should not be ruled by a small group of economic planners. Paul Warburg--of Kuhn, Loeb, and Co.--had argued in favor of the Federal Reserve Act that “No automation--no tax or fixed regulation--would do. Instead, the best judgment of the best experts must indicate the policy to be pursued from time to time” (Livingstone, 197). Immanuel Kant disagrees, “Man is free if he needs to obey no person but solely the laws.” The rule of law allows people to reasonably predict what will be the outcome of their actions. Nobel Prize laureate Hayek observed that “The more the state ‘plans,’ the more difficult planning becomes for the individual.” (Hayek, 76) Entrepreneurs, whose job is to predict future consumer demands, are mislead when the Federal Reserve interferes with market signals; this leads to mal-investment that lead to recessions such as the 2008 burst of the housing bubble. The experts at the Fed have encouraged an attitude advocated by Lord Keynes--“In the long run we are all dead”--by encouraging consumption and discouraging savings by inflating the currency. The savings of the middle class and the poor have gone up in smoke--a dollar has lost 95.6% of its worth since 1913--making a mockery of the thrifty.


It’s time to end the Fed. End fractional-reserve banking which causes the business cycle (Rothbard, 17). Enforce common law and uphold contracts. History provides several examples of successful free-banking experiments. In Scotland, there were initially no legal restrictions or regulations, no reserve ratios, limits on shareholders, capital holding requirements, or legal tender laws in the age of free banking (1716-1845). Competing banks quickly redeemed each other’s notes, ensuring that excessive notes were not issued. No bank with more than 9 partners failed to pay its creditors in full, and up to 1841 all losses to the public from Scottish Bank Failures totaled 232,000 pounds. The public lost twice as much in London in 1840 alone. The Suffolk system, operating out of Boston, 1824-1858, also insured that bank notes were quickly redeemed and discouraged excessive note issue. This system worked remarkably in comparison to the “wildcat” banks of that era and avoided the carnage of the 1837 panic (Paul, The Case for Gold, 68). During the period of free banking in the United States, after Jackson had fulfilled his threat “The Bank is trying to kill me, but I will kill it,” there were two major problems: fractional reserve banking, and a prohibition against branch banking. These problems led to the formation of unsound “wildcat” banks since there were no branches where those who lived far from the banks could redeem the bank’s notes. These two problems can be avoided in a modern free-banking system with modern transportation, branch banking, and either a requirement that notes be 100% backed by gold, or the enforcement of common law (banks may not suspend specie payments; they must meet their obligations or declare bankruptcy).

In Mexico today, Hugo Salinas Price is advocating a reintroduction of the silver Libertad coin. This would be a transitional system where fiat pesos and the silver coins circulated side by side. A poll by the Mexican Congress shows 81% of the people in favor of silver money. If the Mexican people are given an inflation-proof alternative to fiat money and the experiment proves successful, we may wish to try a similar system of transition in the United States. If competing currencies are introduced, confidence will be restored in the monetary system. The Federal Reserve Note, a classic of government wizardry in turning stones into bread--or rather, paper into money--will be out-competed. The gold standard, which is utterly incompatible with the Federal Reserve since the Fed is arbitrary and the gold standard is automatic, can then be re-instated, and free market economics can be realized in full.

With Frederic Bastiat, I cry, “Away with the quacks and organizers…Away with their artificial systems! Away with the whims of governmental administrators, their socialized projects, their centralizations…their free credit, their bank monopolies, their regulations, their restrictions, their equalization by taxation, and their pious moralizations! And now that the legislators and do-gooders have so futilely inflicted so many systems upon society, may they finally end where they should have begun: May they reject all systems, and try liberty; for liberty is an acknowledgment of faith in God and his works” (Bastiat, 76). If we will return to liberty and the prosperity it brings, we must allow competition in the monetary system, end the Federal Reserve, return to the “just weights and balances” of the gold standard, and enforce the common law of justice, not inflation and bail-outs. The time of the experts’ planning is over. They have failed. The free market of the people and justice--justice alone--must reign.



Works Cited

Board of Governors of the Federal Reserve System (U.S.). The Federal Reserve System: Purposes and Functions. Washington, D.C. : Board of Governors of the Federal Reserve System, 1984. Print.
Paul, Ron. End the Fed. New York : Grand Central Pub., 2009. Print.

Livingstone, James. Origins of the Federal Reserve. Ithaca : Cornell University Press, 1986. Print.

Gregory, T. E. Gold, Unemployment and Capitalism. London: P.S. King & Son Ltd., 1933. Print.

Hayek, Friedrich A. von. The Road the Serfdom. Chicago: The University of Chicago Press, 1956, c1944. Print

Rothbard, Murray N. America’s Great Depression. Los Angeles, Nash Pub.,1972. Print.

Paul, Ron. The Case for Gold. Washington, D.C. : Cato Institute, c1982. Print.

Bastiat, Frederic. The Law. Irvington-on-Hudson, N.Y. : Foundation for Economic Education, 1998. Print