End the Fed: An Illegal and Destructive Enterprise

During Thursday night’s debate between Presidents Biden and Trump many questions related to the state of the economy and economic policy were broached. Conspicuously absent from the debate, however, were any questions or even a mention of the largest economic elephant in the room: the Federal Reserve System.

Economic headlines are a swirl of contradictory reports of low unemployment, sluggish economic output, distressed banks, income inequality, and rumors of income inequality. Yet hardly any member of the press corps or candidate for elected office desires to seriously consider the Federal Reserve’s role in bringing our society to its present economic condition. When they do, a plethora of politicians and supporting intellectuals increasingly embrace the Federal Reserve System as indispensable to our nation’s economic health. (READ MORE: Is the Federal Reserve Overstepping Its Mission?)

The reality is that pro-Fed propaganda started at the very beginning of its creation. A mere year after its founding, the Report of the Comptroller of the Currency said that with the advent of the Fed, financial panics such as what happened in 1907 would “seem to be mathematically impossible.” Claims that financial crises could be avoided by the Fed’s provision of an elastic currency transitioned over the past 110 years to claims that the Fed would provide stable prices, full employment, and ultimately complete macroeconomic and financial stability.

In light of this rhetoric, how should we evaluate the real consequences of Fed action? To put it bluntly, far from being the necessary first cause of economic prosperity, the Fed is neither necessary nor helpful. In fact, it is a criminally destructive enterprise.

The Federal Reserve is the monopolist of all monopolists. It has the sole privilege of issuing bank notes accepted as legal tender in the United States. Defenders of the necessity of the  Fed forget that money, as an economic good, can be produced competitively just us well as soft drinks, celery, shoes, gasoline, or smart phones. Just as we do not need a central shoe producer to ensure the optimal quantity and quality of shoes, we also do not need a central bank maintaining some supposed optimal money supply ensuring stable prices or magnitude of spending.

In the first place, it should be recognized that there is no single “price level” to be stabilized. Prices can never truly be averaged into one number that scientifically measures the level of all prices. To average something, the items must be in the same units. If we cannot add up different goods such as hats, a pound of sugar, a smartphone, a pair of shoes, and a tank of gasoline, we cannot get a true average.

Using a weighted average such as is done by the Consumer Price Index does not solve the problem because any basket of goods relevant for one household will be different than that for another household. Additionally, the goods represented in the denominator of the chosen basket are still different units of different goods. Because there is no solitary price level, it cannot be stabilized.

Even if a scientific price level existed for the entire economy, we do not need a central bank to provide any optimal quantity of money to increase, decrease, or keep it the same. In a free society, the optimal quantity of money would be provided by private money producers guided by the same profit and loss calculations constraining the producers of every other economic good.

If people demanded to hold more money, they would satisfy their demand by spending less and selling more consumer and producer goods, thereby lowering overall prices and increasing the purchasing power of money. The increased value of money will, on the one hand, increase the real value of cash balances and, on the other, make money production more profitable, encouraging money producers to increase their supply to satisfy the demand. The Federal Reserve is not necessary to facilitate this process.

We do not need a Fed managed price inflation target, we merely need sound money — money free from government manipulation.

Not only is the Fed not necessary to manage the monetary system, but it has also miserably failed the charge it has been given by the Congress. To measure an institution’s effectiveness, we might examine whether it has fulfilled its stated purpose. The amended Federal Reserve Act that is part of the Federal Code, the current law of the land, says that the Fed is mandated to “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

How well has the Fed maintained price stability during its almost 110-year tenure? Not well at all. The dollar has lost over 97 percent of its purchasing power since the Fed’s creation. The increase in prices has been especially steep since leaving the last gasp of the international gold standard in 1971, when the only thing controlling money creation became the character and wisdom of the members of the Federal Open Market Committee.

It was one thing for the Fed to keep prices relatively stable when it knew that profligacy meant a significant gold drain. Indeed, even that threat proved too weak by August 1971, which prompted Nixon to abandon our obligations by suspending specie payments, cutting the dollar free from gold. Since then, relying only on its own wisdom and character, the Fed has overseen a 675 percent increase in consumer prices.

Fed Law-Breaking

The main reason for increasingly higher prices is that the Fed has made its peace with breaking the law. How so? Well, despite its legal mandate to promote stable prices, the Federal Reserve explicitly targets a 2 percent rate of annual price increase. Now, the Merriam-Webster dictionary defines stable as “not changing or fluctuating.” Stable prices mean prices that are increasing at a rate of 0 percent a year. However, the Fed explicitly targets an annual rate of price increase of 2 percent. Price stability has mutated from a policy of 0 percent price increases to an average of 2 percent over time.

The Fed, in other words, desires to make the dollar worth less every second of its existence. It is guilty of explicitly and boldly breaking the law, seemingly without political or legal consequences.

Now if this legal transgression was merely a matter of technical red-tape, then one might concede no harm, no foul. Alas, make no mistake, people are being significantly harmed and, therefore, the Fed commits foul after foul. It privileges the politically and financially connected rich while keeping the rest of us relatively poor. In fact, Fed-induced inflation explains much of the income inequality exercising many in society.

At best, inflationary monetary policy provides no general social benefit. Increasing the money supply does not generally increase wealth for everyone because it does not increase the quantity of producer or consumer goods. It merely increases the amount of money being spent on the same quantity of goods, so overall prices increase, and the purchasing power of the dollar falls. People may have more dollars, but they must pay higher prices. There is, therefore, no general benefit from monetary inflation.

The consequences of inflation, however, are much worse than zero. While monetary inflation never provides a general social benefit, it does provide private benefits for those who get the new money first. When the Fed inflates the money supply, it does not increase everyone’s cash balances simultaneously in the same proportion. Rather it injects reserves into commercial and investment banks, and they then lend new money to borrowers. Those people who receive the new money first — financial institutions and the government — get to spend it first before prices change. They benefit while those people who receive it later are harmed.

Especially grievous is the lot of those on fixed incomes. They do not see a dime of the new money, but must pay higher prices, nonetheless. As such, monetary inflation redistributes wealth, leaving some richer while many others are made poorer. The Fed cannot plead ignorance to these distributional consequences. They were explained as early as the middle of the 18th century by Richard Cantillon as well as the 20th century economist Ludwig von Mises. (READ MORE: The Fed Has More Than a ‘Credibility’ Problem)

Inflation’s harvest of income inequality has been helped along by the shift toward compensating CEOs in stock options. In an unhampered market CEOs will tend to receive compensation commensurate with what they contribute to the value of the firm. If a CEO gains more than his contribution to the firm, the firm will be less profitable.

However, much of the new money the Fed creates is quickly poured into the stock market and then asset-backed securities. Therefore, those CEOs compensated with stock options benefit from being closer to the new money. Their compensation packages greatly enhance in value from monetary inflation, resulting in a shift in income distribution. The Fed is more responsible than anyone else for skewing income in favor of crony CEOs.

Additionally, the new money is created via artificial credit expansion — loans not funded by voluntary savings — which creates business cycles. Inflationary credit expansion artificially lowers interest rates, spawning capital malinvestment.  Many unwise investments (say, in residential and commercial real estate and financial derivatives) are made to look profitable because of the accessibility of cheap credit, so business activity expands, manifesting itself in an inflationary boom.

Bad investments, however, are not made economically sound merely because there is more money in existence. They eventually must be liquidated. The boom resolves itself in a bust whose twin offspring are capital consumption and unemployment. Monetary inflation is no way to sustainably generate economic prosperity.

That is why the Fed also fails in its legal mandate to maintain full employment. It turns out that the post-World War II unemployment rate has been wildly erratic. The track record is one of repeated economic cycles which manifest significant unemployment. The clear conclusion is that the Fed is a failure. Sound monetary theory and business cycle theory teaches that the Federal Reserve has failed because it causes massive price inflation, an extreme shrinkage of the purchasing power of the dollar, and the business cycle. In short, the actions of the Fed are both illegal and destructive.

Any other monopolistic business enterprise guilty of breaking Federal law and sowing destruction hither and yon would immediately be shut down. What is good for the private goose should be good for the politically privileged gander. No institution is above economic law. Neither should it be above civil law. If members of Congress truly care about the welfare of the citizenry, not to mention their oath of office, they should end the Fed.

Shawn Ritenour, Ph.D., is professor of economics at Grove City College. His books include The Mises Reader Unabridged, Foundations of Economics: A Christian View, and The Economics of Prosperity.

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