What To Do With the Federal ReserveWednesday, September 11, 2013
This year marks the one hundredth anniversary of the creation of the Federal Reserve System which established the Federal Reserve Bank. There are a number of functions that the FED serves including holding deposits of commercial banks, supplying currency to banks who then supply the public, efficiently clearing checks for everyone, acting as the U.S. Treasury’s agent, regulating the banking system and, most importantly, controlling the size and growth of the money supply. It is the last function that seems to be causing problems.
Many people today want to abolish the Federal Reserve System. The primary reason is that these people fear a severe inflation problem coming very shortly. Why? Over the past four years the FED has been “monetizing” the public debt by purchasing $85 billion dollars per month of U.S. Treasury bonds that are used to pay for the huge annual deficits that the current administration has incurred. Each time the essentially unregulated Fed buys bonds, they inject reserves into the system which increases the money supply. Will this cause the rapid inflation that people are worried about?
I was fortunate to have been mentored by Milton Friedman through a corresponding relationship from 1976 to 1980. At that time I wrote a column (The [Philadelphia] Bulletin, December 18, 1980) questioning whether a tight money policy would really reduce inflation. In that column I noted that inflation was likely caused by rapidly rising wages, rapidly rising commodity prices, primarily oil and the difficulty business had responding to increases in demand with increased output. Dr. Friedman, who was kind enough to comment on my columns, told me the three main causes for inflation were 1) a too rapid increase in the money supply, 2) a too rapid increase in the money supply and 3) a too rapid increase in the money supply. So according to him, those who fear future rapid inflation today have reason to be worried.
The FED’s monetizing the debt action has caused the money supply to almost triple since the program began. Using Dr. Friedman’s theory, inflation should be a huge problem in the not too distant future. The frustration occurs because the FED is a “quazi public” agency which means essentially that there is no check on their actions. This was done intentionally to avoid any political pressure being placed on them.
How fast should the money supply grow?
The consensus view is that the rate of growth in the money supply should equal the rate of growth in nominal GDP. That means if the economy experiences a 3% inflation rate and grows at a 3% real rate, then the money supply should grow at 6%. Today real growth in GDP is in the 2% range while the money supply is growing in the 20% annual range. According to monetary economists, this could lead to inflation in the 18% range.
To stop this from happening, some people are calling for the abolishment of the FED. There are a number of views that say this will result in tighter control of the money supply. Some have even advocated a plan to issue government “notes” like currency that can be used to repay the public debt as it matures. They suggest a compensating method that raises the reserve requirements at banks to offset any increases in the money supply that this idea may cause.
Ultimately this would result in the federal government’s reduction in the selling of bonds which forces a balanced budget. While admittedly complex, the proponents believe this eliminates any inflation problem and forces the government to balance the budget. And that seems like a reasonable idea. But there may be problems.
The other functions of the Federal Reserve would have to be done by some entity, which has yet to be established. The more serious problem is determining a way to minimize the longer term, negative effects of recession. Many economists will argue that FED policy of the past four years prevented a severe recession from becoming a depression. FED chairperson Ben Bernanke is a scholar who has studied the Great Depression extensively so that he believes his policies have indeed avoided a depression. The monetary economists also believe that discretionary fiscal policy (changing of government spending and taxes) will never be effective in stimulating a recessed economy, so that the FED is indeed necessary.
The rapid increase in the money supply undertaken during the last four years may not be as inflationary as expected. The reason is that when the FED buys bonds and injects new reserves into the system, the final increase in the money supply is based on a multiplying effect caused by the fractional banking system and the ability of banks to make new loans. It is the granting of new loans that multiplies the effect of new reserves on the money supply. Because lending standards have toughened, regulations have increased and banks are somewhat reluctant to lend, the money multiplier may be smaller.
So what should we do with the Federal Reserve?
It is an answer that we should carefully consider, especially with the knowledge we have gained since 1913 when the FED was established. We must also consider the vast improvements in technology and communication that can easily supply information to the general public. It is an answer that deserves careful consideration from all those who have a view on the future of the monetary system. The more we examine the issue, the more likely people will agree that abolishing the FED does make sense.
And, by the way, Milton Friedman also advocated eliminating the Federal Reserve primarily because of its dismal failures.
A new documentary called Money for Nothing directed and produced by Jim Bruce has just been released. This film details the history of the Federal Reserve, and provides excellent information about why the FED should be abolished. Read about it here; If you want to see the movie, click here to see if it is showing in a city near you.
Michael Busler, Ph.D. is a public policy analyst and an Associate Professor at Richard Stockton College.
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Marta Mossburg’s Article on Values Is superb! Thank you. - Anonymous
Bidwell comment: I’m a big fan of Marta Mossburg as well.
Marta and I have been emailing back and forth about Mark Zuckerberg’s new white paper stating internet connectivity is a human right. John Heffern, Jr. dug this story up while doing one of the many things he does very well... staying abreast of what is happening behind the scenes.
This morning Marta sent this article from The New Yorker, to which I responded, “... While Zuckerberg is arguing that connectivity is a ‘human right,’ it might be the latest version of shipping McDonald’s to other countries…”
In light of everything from striking Syria to using our taxpayer dollars to give kids in Africa internet access, we need to guard against the age-old unhealthy state, codependency. Rest assured it will come back to haunt us the minute Africans realize that our precious Facebook makes their children unhappy.
the US dollar: the oldest surviving cancer patient. – Anonymous
Bidwell comment: One week from today is the 100th anniversary of the Federal Reserve Act passing in the House and Senate.
If you are able, I strongly encourage you to get out and see Money for Nothing, directed and produced by Jim Bruce, a friend of The Project. John Heffern, Jr. and Jim Bruce met in person in New York, we’ve watched the film here, and it is being passed around the S&A office. We believe this is a movie that every American should see. More specifically, every high school and college student in the country should be watching this movie right now.
I’ve studied the Federal Reserve pretty extensively, and this movie was not boring, nor too technical either. It captivates you for the full 100 minutes. If you can, get out and see it. You won’t be disappointed.
On another note, please remember to take a moment to remember the many men and women who lost their lives in service on this very day, September 11th, twelve years ago. These individuals will forever have a place in our hearts and minds.