Tuesday, September 1, 2015

You Can't "End the Fed" Unless You "End Big Government"

Count me as a critic of the Federal Reserve System. So I should be encouraged by the recent Jackson Hole Summit held by critics of the Fed at the to coincide with the Kansas City Fed's traditional August symposium at Jackson Hole, Wyoming.

Here's John Fund in National Review
A growing number of people believe the Federal Reserve has hurt rather than helped the recovery. It has pursued zero-interest-rate policies that have perversely made it impossible for many businesses to get credit to expand.
Here's Chriss W. Street in Breitbart writing about Ben Steil, speaker at the critics' "sold-out" Summit. Steil blames it all on the Bretton Woods monetary conference at the end of World War II.
Keynes fully understood that although Bretton Woods claimed to be establishing a post-war economic order where the value of money would be fixed, the agreement gave governments a capability to unfix monetary values every time there was a “crisis”.
And then there is the perennial critic of the Fed, Ron Paul, with his critique on fractional reserve banking.

OK. So why is the Federal Reserve persisting with its zero interest rate policy? Probably because it cuts about $500 billion a year out of the federal government's interest rate cost.

And why did Bretton Woods usher in an ability to "unfix monetary values?" Because modern big government is always getting in a jam, and the easiest way to get out is by devaluation of the currency.

Originally, central banking was invented by the Dutch to help them fight their war of independence against Spain. Central banks are good for managing the government's debt and helping create a market for the national debt. The Brits liked it so much that they founded the Bank of England in the 1690s and then went out to fight and win the Second Hundred Years War against the French at the end of which their national debt hit 250% of GDP.

Alexander Hamilton knew about all this, and that's why he founded the Bank of the United States.

All very nice, but you can see that the central bank is clearly intertwined with the credit needs of the government. In fact a central bank merely formalizes the fact that in a nation state the credit system is subordinated to the needs of the government. One could say that in wartime the credit system must be subordinated to the needs of the government. And once that principle is established, it's hard not to use the power in peace time.

I would say that the rise of the welfare state means that now the credit system must be subordinated to the needs of the government even in peacetime. The best way to get a handle on this is to use Ludwig von Mises' term for the modern state: the interventionist state.

The modern state intervenes in all economic relationships, favoring one party here and another party there. The result of this interventionism is that the modern state is always unbalancing the economy, always setting it up for failure. The obvious recent occasion for this was the Crash of 2008 caused by the unbalancing of the credit system in the US by the promotion of low-down-payment mortgages for people with bad credit. Came the day when these borrowers couldn't service their mortgages; then came the day that their foreclosed mortgages couldn't be liquidated. Result: the worst financial crash since the Great Depression of the 1930s.

Why is that a problem? I go to Lombard Street by Walter Bagehot. He wrote that a healthy credit system needs two things: people that can be trusted to make their payments, and loans that are adequately collateralized. If you don't have that then you'll get a crisis of confidence that might develop into a full-scale panic.

These days everyone thinks that they are qualified to intervene in the economy and disturb ordinary economic exchange relationships. Politicians, activists, and subsidy seekers all think it is the right thing to do to muck around with the credit system to advance their agenda. So long as that culture obtains we will need a central bank "to unfix monetary values every time there [is] a 'crisis'."

Unwind big government; undo crony capitalism. Then you can think about "ending the Fed."

But you'll still need some sort of "lender of last resort" to right the system after a credit crisis. And you'll still need a way of mobilizing the nation's productive capacity in the event of war.

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