Chapter 25: Summary and Conclusion: End the Fed

What this book has established is that the central bank causes a variety of economic problems and that Austrian business cycle theory (ABCT) shines a scientific light on what otherwise is a highly complex phenomenon. I have shown that the Skyscraper Index has predicted most of the important economic crises for over a century. I have also shown that Austrian economists have predicted those crises using ABCT.

Now the question arises: what are the problems and what can be done about them? The two most obvious problems with central banking and the monetary inflation that flow from them are the boom/bust business cycle and inevitable price inflation. Embedded in the process of monetary inflation and price inflation is a degenerative process of economic inequality that is so apparent today. This effect on economic inequality and the channels through which it flows are described in further detail by Hülsmann.1

Monetary inflation depends on who gets the money and credit first and who gets it last. As fiat money is created by central banks, private banks are in a position to expand the amount of loans they make. The wealthy have established relationships with the banks, and they have the real estate and assets to provide collateral for the loans. Large, established companies and wealthy individuals are in favorable positions relative to small businesses and people with low or average incomes. The loans allow big companies and wealthy individuals to invest in capital goods during the boom phase of the business cycle. Central banks thereby create artificial inequality and poverty. This is the primary Cantillon effect of redistributing wealth.

We have rarely had a true “free market” in money and banking. The American colonies were controlled by English mercantilist policies. The antebellum era experienced the business cycles created by the First and Second Banks of the United States, which were essentially primitive central banks. Between the end of the Second Bank of the United States and the National Banking System was the era of “free banking.” This period best approximates a free market in money and banking because gold and silver coins served as money, entry into the banking business was relatively easy, and bank reserves were kept relatively high compared to demand deposits. Government spending and government intervention were historically very low. This period experienced the highest rates of economic growth in US history, but it was not perfection, as many state free-banking laws contained poisonous provisions that undermined the stability of banking.

The National Bank Acts were passed during the Civil War and “regulated” money and banking until the Federal Reserve Act was passed in 1913. The Fed and WWI effectively ended the classical gold standard and replaced it with the gold exchange standard. In 1933 all privately held monetary gold was confiscated by the federal government, and the nominal book value of gold was changed from $20.67/ounce to $35/ounce. The post-WWII Bretton Woods gold standard allowed other central banks to convert $35 into an ounce of gold, but it also freed the Fed to essentially print gold. This arrangement eventually became untenable when other central banks began converting dollars into gold. President Nixon closed the “gold window” on August 15, 1971.

Since that time the world has been on a fiat monetary system where currencies are not convertible and exchange rates between currencies are “flexible.” The power and authority of central banks has continued to expand over time. The money supplies and central bank balance sheets have continued to expand, and the value of currencies has continued to decline. For example, in mid-2008 the total assets of the Federal Reserve were less than $900 billion. By mid-2014 their total assets were over $4,400 billion. The Fed acquired these additional assets of government bonds and mortgage-backed securities by printing electronic dollars. As a reference point, measured in gold, the dollar is currently worth less than two cents of the pre-Fed dollar. The Bank of Japan, the People’s Bank of China, the European Central Banks (ECB), and other central banks around the world are pursuing similar policies in an undeclared currency war.

Murphy2 shows that the Fed’s responses to the financial crisis were overwhelming, unprecedented, and of dubious statutory authority. These responses were so egregious that Murphy labels Ben Bernanke the FDR of monetary policy. Despite the Fed’s efforts, Murphy concludes the policies have not worked. The ECB has also overstepped its statutory authority from the European Union in response to the European debt crisis, to no avail.

Have these policies worked well? There has been a constant debate since 2008 over whether the economy has recovered and is growing, or whether it is mired in a lingering recession. There are supporters of both views from across the political and economic spectrums. The real dividing line depends on the relationship the person has with the establishment. Supporters of the establishment contend that the economy survived and recovered, while opponents of the establishment generally consider the economy to be broken and regressing.

The battle between these two views is generally undertaken with contending sets of statistics regarding GDP, unemployment, and price inflation. Austrian economics settles the issue by looking at things such as the big increases in government spending, deficit-financed spending, and the questionable value of investments financed with artificially low interest rates since 2008. Austrians argue that the real market value of increased government spending and malinvestments is far less than the dollars expended. Thus the resulting GDP statistics are very dubious. This analysis suggests that the US economy is regressing on a long-term basis and that we are much deeper in debt as a result.

In fact, Engelhardt3 and others have argued that a central bank facilitates the process of deficit financing and the accumulation of a large national debt. A central bank can always print money to pay for the national debt, or print money to buy up the national debt, as the Fed is doing today with its various quantitative-easing policies. The US government had a debt of around $370 billion to begin the 1970s. At the end of 2007 the national debt was $9.3 trillion, and it more than doubled before the end of 2015 to a debt of $18.9 trillion and it continues to grow. In 1970 the national debt was the equivalent of 34 percent of GDP. In 2015 the national debt as a percentage of GDP was more than 100 percent. A large national debt is a negative drag on the economy and can even result in hyperinflation. Salerno4 has shown that central banks also facilitate unnecessary and expensive wars because the central bank can conceal the true costs of war from the citizens.

However, as a best-case scenario, let us make the heroic assumption that all that government spending was really valuable — that is, a dollar of additional government spending produced a dollar of consumer value — and that all those investments made between 2008 and the present will turn out great. If we take the government’s measure of the economy (i.e., GDP) and adjust for the government’s measure of price increases (i.e., the GDP deflator) and then adjust that figure by the increase in population, we find that the US economy grew at less than 4 percent over the entire period from 2008 to mid-2016. Compare that to the years during the free-banking era (1837–62) when inflation-adjusted, per capita GDP growth was 3 percent or even higher per year. That is a stark contrast.

It is not a mystery as to what has caused economic malaise in the US economy. In this, we note three important factors. First, the amount of debt that has accumulated in the US economy is enormous. The amount of debt of government, businesses, and consumers has soared over the last forty-five years, and this is no doubt linked to suppressed–interest rate policy and a depreciating currency generated by the Fed. Traditionally, the total amount of debt in the United States was about 1.5 times GDP or less. Today it is about 3.5 times GDP. In other words the debt burden is too high. Second, the personal savings rate in the United States has fallen dramatically. Prior to 1971 the average personal saving rate, as measured by the government, was over 10 percent. Since 1971 the personal saving rate has declined to as low as 2 percent during the housing bubble, although it has recovered to an average of over 5 percent since the financial crisis. The Fed’s suppressed–interest rate policy and depreciating currency are the major, but not the only causes of the low personal savings rate. Third, the regulatory burden in the US economy has increased enormously over the last half century, and the amount of and burden of regulation has only accelerated since the financial crisis in the form of Dodd-Frank financial regulation and the Affordable Care Act.

The reduction in savings and the increase in regulatory burden have caused the reduction in productivity growth. A lack of productivity growth explains the stagnation in wages and the lack of high-wage job growth. Any remaining income growth has been absorbed by the increased cost of financing debt, higher taxes to finance government debt, and mandated job benefits, such as medical insurance. All of this comes on top of the fact that family incomes have been stagnant or declining for a decade and a half. Meanwhile, billionaires thrive.

With the Fed passing one hundred years of age in 2014, there have been many retrospectives on the general value of this institution. There have been some favorable and encouraging reviews from inside the Fed, but most outsiders have taken an entirely negative stance on the very existence of the Fed and the place of central banking in a healthy and free society.

White,5 for example, questions the influence and impartiality of the Fed. The Fed spends vast resources on economic policy research, particularly on money, banking, and macroeconomics. This funding, as both carrot and stick, has no doubt produced a status quo bias in academic research on subjects that are the concern of the institution of the Fed. According to White:

The Fed employed about 495 full-time staff economists in 2002. That year it engaged more than 120 leading academic economists as consultants and visiting scholars, and conducted some 30 conferences that brought 300-plus academics to the podium alongside its own staff economists. It published more than 230 articles in its own research periodicals. Judging by the abstracts compiled by the December 2002 issue of the e-JEL, some 74 percent of the articles on monetary policy published by US-based economists in US-edited journals appear in Fed-published journals or are co-authored by Fed staff economists.6

White puts the size of the Fed’s research staff into perspective by noting that the Fed’s staff of economists in 2002 was 27 percent larger than the number of macroeconomists and experts in money and banking employed by the top fifty PhD-granting economics departments in the United States combined. The Fed has numerous research journals that publish an enormous number of articles, but the articles that are published are vetted by the staffs at both the regional Fed banks and the Board of Governors in Washington, DC. This no doubt creates a tremendous bias against criticism of the Fed itself.

White also found that the Fed dominates the editorial boards of the leading academic journals specializing in money, banking, and macroeconomics. At the time of his research, one of the two main editors of the Journal of Monetary Economics and eight of the nine associate editors (82 percent) had one or more affiliations with the Fed. At the Journal of Money, Credit, and Banking, all three of the main editors and thirty-seven of the forty-three associate editors (87 percent) had Fed affiliations. Therefore not only does the Fed dominate the profession in terms of carrot-and-stick resources, but it also nearly acts as a universal gatekeeper at both the Fed and non-Fed academic journals dealing with money, banking, and macroeconomics. Not only is the Fed political in defense of its institutional power, but DiLorenzo7 has shown that the “independence” of the Fed from the political process is a complete myth.

Selgin, Lastrapes, and White8 examined the Fed’s track record and found it lacking in comparison to the National Banking system. With the exception of the Fed’s role in regulating banks, they examined its roles in controlling inflation and deflation as well as volatility of output and employment; the role of the Fed in the Great Moderation; and the frequency and distribution of recessions, banking panics, and lender-of-last-resort lending. They then evaluated the results against prior monetary experience using standard empirical techniques and published research.

They showed that prior to the Fed, the purchasing power of the dollar had long-term stability. In comparison, the Fed has produced powerful bouts of both inflation and deflation and greatly degraded the value of the dollar over the long term. There has also been a trend of increased volatility and decreased predictability of the changes in purchasing power of the dollar, making long-term plans and contracts more difficult. They found that the declining rate of inflation that occurred during the Great Moderation should be attributable to other factors than the Fed’s monetary policy. Finally, they showed that the Fed has not reduced panics or improved on its function as lender of last resort. In other words, the Fed has failed to match or exceed the results of the previous monetary regime. Historian Thomas Woods9 confirms that the problems of the pre-Fed money-and-banking system were the result of various government interventions, but that it was still better than the Fed. Klein10 and Israel11 show that the institutional features of a central bank are inherently destabilizing.

Thornton12 investigated the role of transparency in the conduct of the Fed’s monetary policy. Transparency is the notion that central banks reveal information about the concerns, intentions, and policies to the general public and particularly to specialists in markets and other central banks so as to not unintentionally shock markets with negative news. Generally, transparency by central banks has expanded over the last twenty-five years. Research on transparency has shown that increased central bank transparency has produced either positive or negligible effects on things you can measure with numbers, such as stock markets and interest rates. Instead of a statistical examination, Thornton reviewed the public statements prominent Fed officials made to groups of market specialists during 2007, the year between the housing bubble and the beginning of the financial crisis. He found that in these prominent public addresses, Fed officials consistently made misleading statements that often verged on deception. Economist Shawn Ritenour13 has confirmed that the Fed has consistently used its rhetoric to promote the incorrect view that the Fed solves economic problems, it does not create economic problems.

Given the current scenario and the above analysis, what changes have to be made in order to create an economic environment that produces a stable economy without artificial redistribution of wealth? It would seem that the economic mess might be a web of problems too large and too tangled to solve, but that is not the case.

Let us begin with what are the ultimate goals. It should be clear that given the economic and historical analysis in this book that the goal here is to reestablish genuine markets for money and banking without government regulations and privileges. Market forces alone should regulate money and banking, just like the markets for aspirin, shoes, and cell phones. The following recommendations, couched in this respect, should not be considered a matter of mere opinion.

This seems like a tall task, but the process can begin on day one. The first thing to do is to disband the Federal Open Market Committee (FOMC) and allow the interest rate in the federal-funds market — the federal funds rate, which banks charge other banks for short-term loans — to be determined by market forces. The FOMC consists of the seven members of the Board of Governors in Washington, DC (political appointees), the president of the New York Federal Reserve Bank, and four rotating Federal Reserve District Bank presidents from the remaining twelve Federal Reserve District Banks. Their job is superfluous at best. This central-planning committee is the source of all the problems described in this book. It should be disbanded and its interest-rate–setting authority abolished.

The entire Federal Reserve System should be shutdown. Its legitimate functions, like check clearing, should be privatized. Gold on its balance sheet should be used to redeem Federal Reserve Notes for “gold dollars” equal to some established weight of gold. The Fed’s holdings of US government bonds should be cancelled and other assets should be turned over to the US Treasury. Howden and Salerno14 offer a similar plan, and Salerno15 finds that most of the other types of plans to return to a “gold standard” do not work and that a “gold plated standard” does not stabilize the dollar or the economy.

All taxes on capital gains on gold and silver should be eliminated along with taxes on anything else that might emerge as a new type of money — for example, Bitcoin and copper. Legal tender laws should also be repealed so that people are not forced to use any particular type of money. Currently it is possible to deposit dollars into gold banks and make payments using a variety of media, such as checks or debit cards, but you have to pay capital gains taxes if a payment generates a capital gain.

Federal insurance of demand deposits should be eliminated. This would be replaced with banks complying with laws regarding other deposit-taking institutions, such as grain warehouses. They would be forced to use their own capital or money raised by selling bonds to make loans. By charging fees on the use of demand deposits (i.e., checking accounts) and offering interest on bonds, banks would reduce the amount of demand deposits and increase their long-term bonds. This would help solve the perennial problem of banking — borrowing short term, but lending long term. Banks would effectively be 100 percent reserve institutions. Banks would probably receive a great deal of deposits and bond purchases from the now largely irrelevant investment demand for gold, as hoarders of gold would have no reason to hold gold and more reason to invest in gold bonds in order to earn interest, instead of hoarding gold. The personal saving rate would no doubt increase. See Askari (George Washington University) and Krichene (International Monetary Fund)16 for a full explanation of the nature and history of 100 percent–reserve gold standard reform and the impressive list of noteworthy economists who support it.

None of this would be easy or free of disturbance. The highly leveraged economy would likely face a painful deleveraging process, concentrated in industries that benefitted most from the fiat-money central bank regime. There would probably be a massive wave of bankruptcies, foreclosures, defaults, and other legal and entrepreneurial solutions. The national debt would be in precarious shape and would have to be openly repudiated rather than the current process of default by inflation. The national debt could be put under the control of a legal custodian who would make payments from sales of government assets. If Obamacare, Medicaid, Medicare, and Social Security were significantly reformed and replaced with market institutions, the federal government appears to have enough assets to pay off the national debt and to meet its obligations. The federal government would probably not be able to draw additional credit, but forcing future generations to pay for past mistakes is an abhorrent practice. Massive budget cuts would have to be passed in order to balance the budget and to reestablish a market economy free of government intervention. The more government intervention that can be removed, the better the process of economic adjustment and the faster the economy will adjust and grow.

This process would involve deflation or falling prices. Mainstream economists have an unwarranted phobia of deflation. They think that deflation causes economic crises from which an economy cannot ever escape. Austrians have shown that deflation is actually the corrective process by which asset prices and wages fall relative to consumer goods, thus creating profit opportunities for entrepreneurs to reorganize and employ such resources.

With the United States moving to a 100 percent reserve gold standard, the value of the gold dollar would be fixed as a weight of gold. The exchange value would increase relative to other world currencies, and Americans would be made richer by the fact that their incomes and savings would buy more. It would be increasingly difficult to import goods into the United States. This would put pressure on other countries to follow the United States’ lead in adopting the gold standard and other monetary reforms. With the United States also cutting back on military and regulatory spending and selling vast amounts of resources to the private sector, the standard of living would quickly recover and the economy would experience high rates of economic growth.

Most people would not want to take the risks imagined by these recommendations. Politicians know this and exploit it. They and mainstream economists have plenty of horror stories to scare everyone else. However, Salerno17 has shown that the standard criticisms of the gold standard are baseless.

The truth is the alternative of not reforming the system is much, much worse. As the dollar status as a reserve currency for other central banks worsens, the likelihood that some other government embarks on such a reform process increases. The government is too big, the national debt is too large, savings are too low, the money supply has been expanded too much, and the extent of artificial inequality threatens the fabric of cooperative society. These problems will only get worse over time and will end in hyperinflation, where that fabric is finally set ablaze on a bonfire of worthless paper money and government bonds.

The events in Washington, DC, today in 2018, represent a stalemate between President Trump and the establishment. This stalemate sustains the status quo at a time when there is radical rumbling on both left and right. Despite marginal reforms in taxation and regulation and despite the Fed’s announced reversal of policy, nothing remotely has changed to address the calamity that lies ahead, and that I’ve discussed throughout this book.

• 1Jörg Guido Hülsmann, “Fiat Money and the Distribution of Incomes and Wealth,” in The Fed at One Hundred: A Critical Review on the Federal Reserve System, edited by David Howden and Joseph T. Salerno, (New York: Springer, 2014), pp. 127–38.
• 2Robert Murphy, “Ben Bernanke, the FDR of Central Bankers,” in The Fed at One Hundred, edited by Howden and Salerno, pp. 31–42.
• 3Lucas Engelhardt, “Unholy Matrimony: Monetary Expansion and Deficit Spending,” in The Fed at One Hundred, edited by Howden and Salerno, pp. 139–48.
• 4Joseph T. Salerno, “War and the Money Machine: Concealing the Costs of War beneath the Veil of Inflation,” Journal des Economistes et des Etudes Humaines 6 (March 1995): 153–73. Reprinted in Joseph T. Salerno, Money Sound and Unsound (Auburn, AL: Mises Institute, 2010).
• 5Lawrence H. White, “The Federal Reserve System’s Influence on Research in Monetary Economics,” Econ Journal Watch 2, no. 2 (August 2005): 325–54.
• 6Ibid., p. 235.
• 7Thomas DiLorenzo, “A Fraudulent Legend,” in The Fed at One Hundred edited by Howden and Salerno, pp. 65–74.
• 8George Selgin, William D. Lastrapes, and Lawrence H. White, “Has the Fed Been a Failure?” Journal of Macroeconomics 34, no. 3 (September 2012): 569–96.
• 9Thomas E. Woods, “Does U.S. History Vindicate Central Banking?” in The Fed at One Hundred, edited by Howden and Salerno, pp. 23–30.
• 10Peter G. Klein, “Information, Incentives, and Organization: The Microfoundations of Central Banking,” in The Fed at One Hundred, edited by Howden and Salerno, pp. 149–62.
• 11Israel, Karl-Friedrich. “The Costs and Benefits of Central Banking,” PhD dissertation, Department of Law, Economics, and Business Administration, University of Angers, France, 2017.
• 12Mark Thornton, “Transparency or Deception: What the Fed Was Saying in 2007,” Quarterly Journal of Austrian Economics 19, no. 1 (Spring 2016): 65–84.
• 13Shawn Ritenour, “The Federal Reserve: Reality Trumps Rhetoric,” in The Fed at One Hundred, edited by Howden and Salerno, pp. 55–64.
• 14David Howden, and Joseph T. Salerno, “A Stocktaking and Plan for a Fed-less Future,” in The Fed at One Hundred, edited by Howden and Salerno, pp. 163–69.
• 15Joseph T. Salerno, “Will Gold Plating the Fed Provide a Sound Dollar?” in The Fed at One Hundred, edited by Howden and Salerno, pp. 75–90.
• 16Hossein Askari, and Noureddine Krichene, “100 Percent Reserve Banking and the Path to a Single-Country Gold Standard,” Quarterly Journal of Austrian Economics 19, no. 1 (Spring 2016): 29–64.
• 17Joseph T. Salerno, “The 100 Percent Gold Standard: A Proposal for Monetary Reform,” in Salerno, Money Sound and Unsound (Auburn, AL: Mises Institute, 2014), pp. 333–63.