One of the more interesting developments during the current recession is a small but growing drumbeat of criticism of the Federal Reserve System. No longer the exclusive province of the anti-Semitic, nationalist hard right, Fed criticism has become both serious scholarly business for a number of economists and historians as well as part of the Washington political dialogue thanks to Ron Paul's presidential campaign and two follow up bills to audit the Fed.
The historical myth is that the Fed was created because laissez-faire in banking produced the periodic panics and crises of the late 19th century. In fact, banking during that period was heavily regulated, particuarly with respect to the production of currency. The National Banking System regulations made it very expensive for banks to provide additional currency when the public demanded it, especially during harvest season. Small events in the economy could quickly turn into panics and recessions if the demand for currency jumped. Limits on interstate branching also prevented the banking system from integrating and reducing its exposure to risk. The problems of that era were ones created by existing government regulation, not laissez-faire.
The Fed is better seen as a typical creature of the Progressive Era. Reformers' beliefs in the power of state-sponsored experts meshed with the self-interest of big bankers who saw a closer relationship with the federal government as a way to enhance their profits, with a central bank as an agreed-upon technocratic solution.
The unsurprising result has been more, not less, volatility in the macroeconomy than before the Fed's creation in 1913. We've had one Great Depression, several nasty recessions, decades worth of inflation, and billions wasted interpreting the latest from the Oracle of Greenspan or Bernanke. The late 19th century, even with its flaws, was a period of long-term monetary stability and had no recession that was even close to that of the 1930s.
The inflationary powers of the Fed have also enabled the federal government to run decades of deficits, which have funded American imperialism among other things. The anti-war crowd should consider more seriously the way central banks provide resources for imperialism. Increasing government control over banking has almost always been the result of the state's need for resources, particularly for wars.
With more economic historians rightly blaming the Fed for the Great Depression and many current observers rightly noting that its responsibility for the housing bubble and the current recession, it is not surprising that more people are wondering just why we need a central bank. The histories of countries with a strong degree of monetary freedom at various times demonstrate that a central bank is not necessary for a stable economy.
Pro-market arguments for the power of decentralized competition and market learning should be merging with left-wing skepticism about the desirability of the special privileges, and now bailouts, the Fed gives to already powerful private bankers. Together, both sides can make for a powerful criticism of an institution that we would be better off without.
Steven Horwitz is Charles A. Dana Professor of Economics at St. Lawrence University. His opinions do not necessarily reflect the views of Nightly Business Report. To learn more about Steven Horwitz, read his bio.
Comments
Great couple of lectures and great piece on the questionable nature of the FED. I wonder whether or not anyone really believes that government program who have effectively invested themselves in the American government can be eliminated despite it's clear lack of root capitalistic principles. I'd be curious to see your suggestion about how we potential policy makers go about making such a change...
Ok, and "missunderstand" was poor word choice (missrepresent would have been more appropriate); it was a quick post as evidenced by my butchering of "necessarily". Also interesting is this article from the Daily Beast about how imperialism used to be a liberal idea.
I understand that Jasper, which is why I think both sides need to talk to each other. The point was to try to convince leftist critics that the Fed is essentially a conservative institution and that they aren't being radical *enough* by not calling for its elimination.
Good article Steve, however I think you missunderstand the left's dislike of the Fed. They don't nesicarily dislike its power, they dislike its actions. They want to politicize it, not eliminate it.
Bull's Eye; but why you di'n't tell us this 2 years ago?
Is the fastest way to get the heavy lifting done==ask busiest man to do it? Should we now ask you to do something ahead of the curve?
Why you don't write about America the Beautiful burning up its own dwindling supply of petroleum? Could we drop all energy tariffs but heavily tax domestic oil safely into the ground for our future generation's military needs?
Why you don't write about the Beast, The Medical Insurance Industry that saps the pockets of the poor as it drives up co-payments on all things medical.
Why you don't write about the Specter of Payroll Tax who haunts the frustrated employers and our unemployed workaholics?
Whoops!
Now I feel guilty about putting another straw onto the back of overloaded camel. Why we don't provide you with better support? Why we don't pitch in to help the man who helps the land, The Man with the Plan?
Thanks, Stevedore
!
Thanks for all the kind comments folks. I hope that the arguments I raised will indeed be helpful for those of you "on the ground" making the case against the Fed. Two quick responses to specific comments:
@Tom G.: If you were persuaded by 500 words, I'd be disappointed! I'm glad you found the argument at least a reasonable one. There's a decent literature in economics on alternatives to central banking. If you're really interested in the topic, there's plenty more to be said.
@Pavel: I actually think the inability of the NBS to provide currency when the public demanded it was a BIG problem. It was what caused the various panics of the period. But I also agree that *credit* shouldn't be given just because people demand it. The key is to distinguish between *currency* as one form in which people choose to hold their monetary wealth (another being deposits at the bank) and *credit* which is the creation of loans by banks.
The problem in the NBS is that people who *already had money in the bank* could not easily convert those deposits to paper money (currency) which is what most folks would accept at the marketplace. Meeting the public's demand to convert deposits into currency would have created no additional credit whatsoever. It should be, in a good banking system, no different than getting change for a dollar is today. The problem under the NBS was that regulations made that conversion unnecessarily costly, leading to currency shortages and financial panics.
Very good article. Clear, competent and relatively concise, especially comparing to the most of others on this quite complex subject. It's interesting the author does not take the position about it's being "very expensive for banks to provide additional currency when the public demanded it, especially during harvest season" (the quote). Whether artificially providing easier access to credit would be better or worse is a key question. Some people obviously believe if the public demands something, it should be given "it".
I think the access to credit should be tough and competitive -- then only the best, most solid projects (farms in this case) would be funded. The entrepreneurs risking higher share of their own funds as comparing to the borrowed funds must have advantage -- then we would see more of responsible investing and proportionally less of bubble-bursting.
Thank you Dr. Horwitz for this excellent article. It takes courage to speak truth against an entrenched system even if that truth becomes apparent when presented to an open mind. In answer to some other commenters: There is hope and there is time. Speaking truth to power as well as to anyone else is the key. Dr. Horwitz has given us great talking points in this article. Kudos!
Dear Mr. Steven Horwitz:
Thank you for this well written article concerning the 3rd Central Bank of the United States. It is refreshing to see a bit of Austrian economic perspective to counterbalance the Keynesian philosophy which permeates the mainstream ad nauseam.
Bravo.
excellent points....
now, how do we do that? i see no hope for THAT "change."
First legitimate explanation of this idea I've seen. Don't think you can change my mind though.
Bravo! Investigative reporting at its best!
Professor Horwitz, this article should definitely resonate with the intelligent layman, whose probably concerned with how our central government has vastly increased its control of different sectors (i.e., banking and auto industry) of our economy; all in the name of protecting us from the evils of the supposedly "unregulated market".
Never mind the role the Federal Reserve played in distorting the interest rates; and as a result, diverted precious resources to unsustainable investments (the collapse of residential and commercial real estate market being the most prominent).
It would be comical, if not for the serious possibility, that the current Administration (i.e., President Obama) might actually pull-off one of the greatest expansions of governmental control (e.g., the Socialized Health Care and Cap and Trade proposals), since the "New Deal" under President Roosevelt.
Great insights, and a terrific overall pitch to Middle America why the Federal Reserve Bank is not their friend. Can't really say much more, just a great post.
Congrats on this gig, Steve, and let's hope you
succeed in bringing Austrian ideas into the
overall debate.
Thank you for the insightful and honest article. It stands out in the sea of Keynesian economists that forget that all a central bank ultimately does is destroy a currency. Also, thank you SO much for your statement in the first paragraph that Fed critics aren't just a bunch of anti-semites looking for a punching bag. Fed critics are still largely painted as such in the media. Keep up the good work sir.
Fabulous article.The Fed. is THE means that the statists use to control our decisions in life.
Thanks for a great article. The nineteenth century saw essentially no domestic US inflation and an enviable stability in the size of the roles of the federal government. During the twentieth century the Fed brought endless rounds of inflation which, combined with the so-called progressive income tax, funded an ever-growing federal government with its resultant limits on our fundamental freedoms. Ending the Fed strikes a blow for liberty, and auditing the Fed is a start. Please support Ron Paul's initiatives.
Fantastic article, one of the best that I have read in a long time! Thank you!
Great article. The gradual, but rapidly increasing, destruction of our currency is now probably the greatest threat to our security -- the security of our families. Many on both the left and right are beginning to understand this and realize this isn't a partisan issue. Hopefully, it isn't too late.