The Failure of the Fed

This is your last chance. After this, there is no turning back. You take the blue pill - the story ends, you wake up in your bed and believe whatever you want to believe. You take the red pill - you stay in Wonderland and I show you how deep the rabbit-hole goes.
– The Matrix, 1999

What if I were Morpheus, and you had just taken the red pill? Where would I start? How deep does the rabbit hole go, anyway?

Perhaps I should start with the Federal Reserve. Its brief, we are told, is monetary policy. Since money underlies all things economic, monetary policy underlies everything economic. My supply of red pills is from the Jackson Hole Summit, held in late August. Videos of the proceedings are being posted.

In the 19^th century, Britain was the world's economic and military powerhouse. For over a hundred years, Britain thrived on a gold standard and balanced budgets. It powered the world, to the point that Brazilians used sterling to buy shares in Brazilian companies traded on the London Stock Exchange. World prices were broadly stable. Railroads, canals and other long term projects issued – and paid – 30 and 50 year bonds. Try that today!

In the 20^th Century all that fell apart. What happened?

In 1913 the federal government – whose motto appears to be "If it works, fix it until it's broken" – gave us the Federal Reserve, a central bank. Never mind that we had done very well, thank you, without one, for more than 400 years.

Even on its own terms the Fed is a failure.

• We were told that the Fed would "tame the business cycle". All we've done is re-name the worst part of the cycle. First we called them panics, then depressions. Now we call them recessions. But the Fed hasn't ended them. Indeed, since World War II, recessions have lasted longer than than they did under the classic gold standard. Oops.
• We were told that it would preserve the purchasing power of money. The dollar is worth less than three percent of its value in 1913. Oops.

Not only has the Fed not tamed the business cycle, it has made it worse. In the 19^th century, under the gold standard, panics were allowed to run their course, to liquidate the bad investments caused by the previous bubble. The policy of the Fed today is to interrupt that necessary but painful process and prevent the liquidation. The result is bailouts, crony capitalism, and continued mal-investments.

The monetary fad du jour is "quantitative easing", or massive creation of money. This is nothing but inflation of the money supply. It will show up in the economy as price increases. In other words, quantitative easing is simply preparation for the next inflationary boom. What will it be this time? Dot com companies with not so much as a business plan? Stocks with stratospheric price/earnings ratios? Or maybe student loans that burden graduates with useless degrees and massive debt?

As money is created, it ripples through the economy driving up prices as it goes. The people who get newly created money first benefit most because they can use it to buy things at the old, lower prices. Since Wyoming has few stock jobbers or bond salesmen, we don't get this temporary benefit of fiat money. Worst off of all are the poor and those on fixed incomes, who see prices rise before they see any of the new money.

With quantitative easing comes interests rates at or near zero. This means small savers don't get paid. It also means companies borrow money. But why spend that money on production? With recessions that go on for decades – think Japan's "lost decade", now entering its third decade – why invest? Instead companies buy back their shares. This drives up the price of the remaining shares. So we see higher stock markets but no increase in jobs, pay, sales or productivity. And the rich get richer and the poor get poorer, thanks to Fed policy.

Low interest rates create the moral hazard of allowing debtors – such as Detroit and Illinois – to postpone the reckoning by taking on yet more debt. But when that day of reckoning comes, it will be that much worse and that much more destructive.

What's the alternative? Hint: the Peoples Bank of China and the Reserve Bank of India are buying that "barbarous relic", gold. Hint: counties are looking for alternatives to the dollar for trading essential commodities like oil and coal.

The euro is a fiat currency, same as the dollar. Trading oil in the euro instead of the dollar won't solve anything. The yuan, more of the same. Neither one is an alternative.

It is past time to end the Fed. It is past time to stop sacrificing the lives of millions of productive people on the altar of outworn, outmoded catastrophic intellectual conceits. There is a way out. But it will take courage, something rare in Cheyenne and conspicuously absent from Washington. I'll show how shortly.