Beware of the creature from Jekyll Island

| Staff Columnist

In a previous article, I discussed the push to audit the Federal Reserve System. Since that time, Congress has made major progress in bringing about a transparent central bank. Now, the Federal Reserve Transparency Act of 2009 (H.R. 1207) has more than 300 co-sponsors in the House, and efforts have been made to gut the legislation and protect the central bank from any significant audit of its practices.

Currently under the United States Code, the Fed is exempt from audit regarding “(1) transactions for or with a foreign central bank, government of a foreign country or nonprivate international financing organization; (2) deliberations, decisions, or actions on monetary policy matters (3) transactions made under the direction of the Federal Open Market Committee; or (4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to clauses (1)-(3) of this subsection,” or, as I like to put it: everything they do. H.R. 1207 removed exceptions one through four and opened the Fed to audits of all their dealings.

When the bill was referred to the House Domestic Monetary Policy and Technology Subcommittee, the language was weakened by Chairman Mel Watt, D-N.C. Watt, who has received more than $200,000 from the commercial banking industry since he entered Congress, stripped the bill of all sections allowing for an audit, leaving only a hollow call for Fed transparency. It is unlikely that Watt, whose district has been gerrymandered such that he could be caught with a goat and still be re-elected, has been receiving very many calls from his constituents demanding a completely secret central banking system. Therefore, it is probable that Watt has other interests in mind when he prevents Federal Reserve transparency from becoming a reality.

The Federal Reserve is regarded by the Austrian School of Economics to be the engine of the business cycle. In a theory promoted by Austrian economists such as Freidrich von Hayek and Ludwig von Mises, the Fed causes the business cycle by setting the interest rate lower than the natural rate dictated by the market. This deludes producers into believing there are more savings in the economy than truly exist and causes them to take excessive risks to produce more than could possibly be consumed.Consequently, producers have to take major losses and retract their projects. Furthermore, the Fed’s inflationary monetary policy, agreements with foreign nations and collusion with large banks affect everyone. The Federal Reserve is a creature of Congress, and therefore, it is the right of the people to know what the Fed is up to.

There are concerns, of course, about preventing sensitive financial information from being released immediately. For this reason, the author of the bill, Congressman Ron Paul, has agreed to a time lapse between Fed action and an audit. This compromise is fair, and there is no reason why the American people cannot have full transparency in their central bank after such precautions have been added. The United States has now come the closest to Federal Reserve transparency since its mysterious inception on Jekyll Island 96 years ago. The more the Fed resists these efforts, the more reason we have to believe they have something to hide.

Philip is a sophomore in Arts & Sciences. He can be reached via e-mail at pchristofanelli@hotmail.com.

  • Jerry

    Richard Jesse Markel

    If Austrians are such idiots and unable to predict, please explain the glut of “peter schiff was right” and “ben bernanke was wrong” videos, and the some lower number (0) of “paul krugman was right” videos, on you tube please.

    And your claim that the fed saved everyone last autumn will, as austrian theory predicts, be shown in time to be 180 degrees off. Last autumn simply guaranteed a future storm of unprecedented magnitude.

  • ABW

    To Mr. Markel, I see a staunch advocate of a current system truly regulated by how many people? Not 1000, not 500, maybe 50? They may have many research personnel, but I’m referring to final decision makers, the leaders, the wise men. How few people are actually in the authoritative position of establishing monetary policy for over 300 million people in the most technologically advanced, most powerful, most successful experiment the world has ever seen?

    I suggest to you that if the Fed could perform as well as you state it can, what just happened in our economy should never have happened, never mind the ups and downs during the preceding 100 years. All I see are tremendously powerful bankers, world leaders at their chosen profession, getting handed hundreds of billions of our taxpayer dollars by the very same Fed that, for being such an effective mechanism, should have seen this coming and prevented it in the first place. Should I accept the idea from some one who seems very well read, gives me the impression they have a solid handle on global finance, that the Fed had absolutely no idea what these large banks were up to? Thankfully the Fed “saved” us but didn’t prevent the need for our being saved in the first place? Even if I grant you success on some of the smaller economic downturns of the past, how is it that this last very serious downturn came to be? This failure took years to put together, years. I’m looking for the expertise here, the command and control, the rigorous oversight, and I’m just not seeing it.

    I’m not quoting banking rules, monetary or legal theories, Congressional amendments. I don’t know what they are. I just read your comments about how great the Fed is and then look out my window and the two circumstances just don’t match!

    What happened?

    The reason for World War II can be explained on a bumper sticker… Ego’s strive for world domination.

    I’m looking for the short answer. There is one.

  • Richard Jesse Markel

    Actually your statement was generally accurate save for the bit about me lacking fundamental understanding and whatever other insults you feel like hurling.

    Here’s the problem though. We’re arguing about fractional-reserve banking, an argument which came out of talk about commodity (e.g. gold) versus US Dollar fiat. Fractional-reserve banking still has the same effect on money supply in both monetary setups. Furthermore, even under the gold standard that you seem to be promoting, there are still inflows and outflows of money and/or gold into the system, there’s still inflation and deflation, and this all happens regardless of the presence of a central bank or not. It’s really a matter of economic history to prove that this happens under any monetary standard.

    I think we’ve strayed from the point and I’m wondering what it is we’re arguing about.

    ~RJM

  • Howard Roark

    Actual paper currency is meaningless. The simple fact is that most money exists as bits in a computer and not in actual paper form. It still has buying power and its growth still causes inflation. Actual paper currency is a small percentage of the actual money supply.

    You lack a fundamental understanding of how the fractional reserve system works if you don’t see this. When borrowing increases under this system, the money supply increases. This causes inflation. When loans are defaulted on or paid back, the money supply decreases. This has no effect on the actual paper currency in circulation but has a real effect on the value of our money including its paper form.

  • Richard Jesse Markel

    Sorry Gutteck, but you’re simply wrong. You’re confusing the theoretical “money multiplier” with fractional reserve banking and lending practices. Banks cannot lend 9x what they have. They cannot lend twice what they have. In fact, they cannot even lend the entire amount that they have in deposits because they must keep a reserve requirement to cover those who wish to make withdrawals.

    Banks can lend, under what I think you were trying to say, up to 9/10 of their reserves. If a bank has $100, it can lend $90 (90%). That $90 gets put into a bank and 9/10 are lent again. That’d be another $81 and so on until the total theoretical amount of money equals approximately (Original Amount)*(1/reserve requirement %). In the 9/10s lending example, that ends with $10 circulating for every $1 originally made. Note, however, that the amount of actual paper currency stays at $100. Each bank just shaves off a bit to keep in their vault.

    If you care to restate your argument, by all means do so. However do realize that while there’s arguments to be made for and against fractional-reserve banking, the concept bears no resemblance to your above example.

    ~RJM

  • Gutteck

    Richard Jesse Markel Fractional lending is the most lucrative business around. Lets say I start a bank with $1000 in deposits. According to fractional lending practices I can lend (last time I checked 9x what I have in real money) $9,000. So I lend $9,000 when I only have $1000. Then I charge an interest on the $9,000 instead of only charging interest on $1000. So I make 9x my profit plus now I have the $9,000 the people paid back. So at the end of this I would have over $11,000 and now I can lend $99,000 and so forth until I have billions.

    Now Imagine Fractional lending to a country. Lets say I start a federal Reserve Bank of the imaginary country. Lets say I have 1 million in reserves. So therefore I can lend 9 million and charge interest on that. So I do and the country pays me back the 9 million plus interest. Now I can lend this country 81 million and so forth until they can’t even pay me back the interest alone and all they do is work for me in a very low quality of life.

    The Federal Reserve is a for profit business and I understand why you people defend it so much. It makes you very rich and powerful with very little investment.

  • Richard Jesse Markel

    In response to WSR:

    For someone who claims to understand the Federal Reserve so well, I’m surprised to see you claim it was set up “by the banks, for the banks.” That’s completely false. Allow me to correct you: The Federal Reserve was established by Congress via the Federal Reserve Act of 1913. This was in response to the Panic of 1907 and the Fed was created to provide liquidity in times of crisis. Your claim is simply wrong, sorry.

    As for your argument about interest rates and blaming the Fed for the economic catastrophe we just weathered, I’d also call you out as being wrong. Greenspan was in command of the Fed from 1987 – 2006 and, contrary to your claim, it wasn’t a big orgy of low interest rates and economic explosion. There were a few recessions in there and they had little or nothing to do with the interest rate.

    The Federal Funds Rate is a tool that is implemented by the Fed to control recessions. It does not cause them. In times of economic hardship, interest rates are usually lowered to increase the supply of funds. It’s simple monetarist theory and has been shown to be correct through decades of statistical data. Loosening the tight belt kept on the money supply allows the economy to recover quicker and lightens the downturn a bit.

    Finally I’ll come to your assertion that “Money should be backed by gold or silver and only expanded or contracted to correspond the economic growth of the country. You will then have no inflation and maintain purchasing power.”

    I think you fundamentally misunderstand the nature of inflation and deflation. Actually I don’t think, I know. Even during the periods of the strictest gold standard in the United States there was inflation and deflation. The purchasing power parity of the dollar changed a lot. I’m really not sure where you’re getting your information from, but you need to do some serious research if you care to keep arguing economics.

    As for the Austrian School of Economics, it has been discredited so many times over my economists both Neoclassical and New-Keynesian. Friedman called Austrian business cycle theory wrong as it contradicts both logic and historical statistics. It simply isn’t true. I’d recommend the following article as a brief introduction into what is considered the largest economic contradiction in Austrian theory: http://www.slate.com/id/9593

    Cheers,
    ~Richard Jesse Markel

  • WSR

    I thouroughly understand the structure if the FED, and it is a private insitution, that is a fact. It was set up by the banks, for the banks. It answers to no one, not even the presisdent. And by having the big banks as shareholders, don’t you think that is a conflict of interest? It is like the fox guarding the hen house.

    Also, every dollar that is printed and loaned to the gov’t or used for bailouts of the banks (conflict of interest, again) is not free. The principal and interest are charged to the the gov’t and the taxpayers are on the hook. That is why there is an income tax. That is why the national debt will never be retired. I do not think you understand that point.

    Also, the FED caused the economic crisis – the artificially low rates from the Greenspan years was a primary cause of the crash. Of course they had to intervene, its ‘shareholders’ were on the brink of disaster. The MARKET should set the interest rates, not a private monopolized central bank. The fed setting rates are what causes the boom and bust business cycle.

    Think Austrian economics. Money should be backed by gold or silver and only expanded or contracted to correspond the economic growth of the country. You will then have no inflation and maintain purchasing power. Interest rates should be set by the (free) market. Right now the fed is expanding the money supply many times over; the economic growth is hardly positive. It is hard to believe that they will mop up the excess liquidity.

    The FED needs to be dissolved and nationalized so the country can once again return to a sound monetary policy.

    I can’t undertand how anyone can be a Fed cheerleader. They are the cause of essentially every crash since the Great Depression.

    I suggest a good video to watch. Cheers.

    http://www.youtube.com/watch?v=iYZM58dulPE&feature

  • Richard Jesse Markel

    In response to “WSR,”

    Contrary to your belief, you do benefit from monetary policy. You’re benefitting by being able to have money to buy yourself food and medicine and water. Without the Fed, we would be in a dire situation following last fall. You can thank the Federal Reserve’s economists and bankers for preserving the wealth of the nation last year when the nation was teetering on the brink of collapse.

    As for your first point, the Federal Reserve is not a typical “private company” in the sense that it is de facto a governmental institution. The Fed, created by the government for the purpose of seeing to economic matters and monetary policy, does not have private shareholders. The Federal Reserve is structured such that it’s “owners” are banks that hold United States dollars. The largest of these are companies like JP Morgan Chase, Bank of America, etc… You cannot purchase Fed “stock” like a typical private company. Banks, by their keeping deposits with the Fed, are the sole providers of its equity. As for the liabilities of the Fed to even out the balance sheet, we’re holding those in the form of dollars.

    Also, I would encourage you to further look into the creation of money in the United States since the Federal Reserve is not the sole body of money creation. Coins are a direct liability of the Treasury. Finally, regarding your question as to why the government cannot print its own money for free, I’m not sure I understand what you’re saying. The Bureau of Engraving and Printing, a subdivision of the US Treasury, prints and sells said money to the Federal Reserve at cost. The government creates its own money and gets paid for the cost of paper, labor, and ink. I thus am not sure what you’re getting at.

    For your second point, I do not think you understand the nature of monetary policy. The Fed does not just create money at some arbitrary rate. Its money creation is aligned as best it can to economic growth. This thus creates a stable growth rate and a small, controllable level of inflation. They do so because deflation is significantly more problematic than a sustainable, low-rate inflation. That’s basic Chicago-School monetary theory and it’s validity has been demonstrated by Milton Friedman, Anna Jacobson Schwartz, and their peers. Finally, I might point out that currently, the FOMC is conducting operations to drain excess reserves out of the banking system to prevent said inflation.

    My rebuttal was anything but tough. I’d recommend you take an intermediate macroeconomic theory course.

    ~Richard Jesse Markel

  • WSR

    RJM:

    Nobody is happy with the moneraty policy, excpet the people that benefit from it, which unless your work for the fed or in gov’t, makes you sound very dumb.

    There is no reason for:

    1. A private company to print money out of thin air, backed by nothing, lend it to gov’t at interest and result in the taxpayers being on the hook for all of it. Why can’t the fed be nationalized and the gov’t print its own money for free? Would that not result in a better economy? No more income tax, which will result in more money to save and invest instead of being put into the pockets of the fed and big banks.

    2. Having the money not backed by a physical asset such as gold or silver, which would result in the dollar keeping its purchasing power. Constantly increasing the supply of money, greater than the growth of the economy causes inflation, erodes savings and destroys purchasing power. Explain how this is a good thing. And even though we may be in a temporary depressionary period, unless all of the excess liquidity is taken back by the fed, the inflation will be brutal.

    Rebuttal? Its going to be tough.

  • Richard Jesse Markel

    In response to “Gutteck”

    I would say that my language was probably not the most accurate when I said that “Congress is inherently dumb…” Perhaps it would have been more apt to say that Congress is inherently limited in its capabilities. In saying so, I mean that monetary policy is really not something they all are experts at. Specialization makes for efficiency. Congress is not comprised of hundreds of economics PhDs. We need a Federal Reserve to guide monetary policy and help moderate economic growth. That’s their job and it is one that Congress is incapable of doing. Congress is given the right “To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;” (Article I, Section VIII). If Congress chooses to delegate that power to an independent authority much more capable than themselves, that’s their right. Congress cannot possibly carry out every single stated power that they have. They have to pass it off to subcommittees or separate organizations.

    As for your “argument” I am not entire sure I understand what you’re saying. You call me dumb for “backing up a monetary system based on paper and illusions that benefit no one.”

    That’s patently untrue. Allowing our currency to not be fixed to a standard gives it more stability. I’d urge you also to read Friedman’s “A Monetary History of the United States: 1867-1960.” You’d see that being fixed to a gold standard would increase the volatility of the economy as gold flows would artificially yank us between unnecessary recession and uncontrolled growth. Saying that the current monetary system benefits nobody is simply untrue. It’s more stable, plain and simple.

    Finally, if you’re so concerned with the current state of the monetary system, why don’t you just go out and buy gold? Put yourself on a gold standard. If the dollar plummets, you’d be protected. Conversely, if the purchasing power parity of the dollar rises, you’d lose value. You can invest in gold quite easily. Don’t force everyone to jump on the boat of a risky investment just because you like the idea of it. Go do it yourself – nothing’s stopping you. As for the rest of us, I think we’re happy with our monetary policy the way it is.

    ~Richard Jesse Markel

  • Gutteck

    Richard Jesse Markel all those words you typed summarize to you saying that congress and therefore the American people are too dumb to manage the country’s finances. How come we are not dumb when it comes to producing trillions of dollars per year? Why are we only dumb when it comes to spending it and regulating it? I believe you are the dumb one for backing up a monetary system based on paper and illusions that benefit no one.

  • Richard Jesse Markel

    See Phil, here’s the problem. You base your argument on the Austrian School of Economics and claim that they regard the Fed as causal in economic downturn. However you fail to state that while the Austrian School is a nice theory, it has been pretty much lambasted for its lack of cyclical predictability. Anybody could write an article and frame it as factual when it’s based off some Mickey-Mouse pseudo-theory.

    You further fail to mention, or perhaps even realize, that the Federal Reserve is responsible for maintaining steady economic growth and for tempering the business cycle overall. A not-so-quick read through Milton Friedman’s “A Monetary History of the United States: 1867-1960″ would show you that the Fed, once it got its act together, has been the force responsible for both cutting off economic growth peaks and for preventing the economy from totally bottoming out. You can thank the Fed for salvaging the economy from what would have been the ashes of an unprecedented recession last fall.

    Auditing the Federal Reserve is not a goal we should be striving toward. Congress is inherently dumb on all sides right or left. If we open the Federal Reserve to congressional transparency, we’re inviting every single Congressman to throw in their uninformed 2-cents on how the Fed ought to run and who it should do business with. The Fed was created to be an independent authority on monetary policy. Opening it to the petty politicking of our elected officials would seriously undermine its ability to maintain its economic considerations.

    P.S. Since we’re in a period of deflation, I find it laughable that you criticize “inflationary” policy. Furthermore, even when the Fed was comprised of a bunch of squabbling idiots at its inception and throughout most of the 20s, wholesale prices fell at an average rate of .9% / year (Friedman 243). That’s deflationary monetary policy, not inflationary. Additionally the Fed has been responsible for the cutting of inflation from the record 13.5% during the inept Carter years and through into Reagan’s first year all the way down to ~3.5% in 1983. The Fed Chairman at the time, Paul Volcker, sent the economy into a short recession for the sake of protecting its long-term viability. Thus your arguments about inflationary policy are really just wrong. I’d recommend you read Friedman’s book since it’s really a seminal work on monetary policy and economic history before you go spouting off with some half-baked theories and blatantly wrong “facts.”

    ~Richard Jesse Markel