Martin Mayer has never been noted as a prominent critic of the idea of central banking – or as a friend of its philosophical nemesis, free banking, which is the libertarian concept that a bank should be allowed to fail; that it should be treated the same as any other badly run business. Nevertheless, a close reading of this book raises many questions about the recent eulogizing of our central bank and its leaders. In the end, this book intimates that the Fed's policies could be a house of cards, ready to crumple at the first massive market shock and demand for liquidity.
Mayer argues that the Fed's role as the lender of last resort is becoming confused; that players in the fixed income and stock markets are wrongly looking to it as a safety net that will always save them from the destructive powers of the market. The Fed's savior role will egg banks and other financial institutions to making riskier choices because the Fed is viewed as a kind of benevolent parent, always there to protect them from disaster. But, as readers of the great classical and Austrian economists understand, markets are supposed to be destructive. In a market economy all plans can no more succeed than every team can win the World Series this year or any year. However, Mayer, pointing to the Fed's bailout actions, says market participants, including those running big hedge funds, are receiving confusing signals.
"The head of one of the largest hedge funds in the world," Mayer writes, "said to me shortly after the rescue of Long Term Capital Management that the episode had carried a clear message for him: If I get in trouble, the Fed will come and save me. I told him that if Alan Greenspan could hear him he would turn white as a sheet and resign. But he was sure he was right."
Mayer also accuses the Fed of many other sins over the last few decades. Among the Fed controversies outlined: operating in secret and deliberately trying to keep the public from understanding its policies, rigging monetary policy to help re-elect President Richard Nixon in 1972 and arrogating power from Congress by allowing banks to offer almost unlimited deposit insurance protection.
Mayer also suggests that the Fed may have been getting in over its head recently when it became the ultimate federal government financial regulator. This book contains more than its share of blundering and political shenanigans by our central bankers. Mayer notes that many banks failed in the 1980s because of the "implicit" or "explicit" protection of deposit insurance, which was inducing some banks to ease their credit restrictions and try more dicey investments than were previously in their conservative portfolios.
The Fed and its agencies, Mayer writes, also pulled an end run around Congress in the 1980s. But Mayer writes that the Fed, a creation of Congress, had become a problem child, according to one important Congressional leader.
"The idea of saying don't worry, be happy, because we are guaranteeing deposits no matter what amount – you don't have the statutory authority to do that. We never gave it to you," House Banking Committee Chairman Henry Gonzalez said as he questioned an FDIC official. But probably the biggest Fed controversy has been its quiet political role, Mayer notes.
In 1970, upon appointing his political ally Arthur Burns as chairman of the Fed, Richard Nixon, who had blamed the Fed's tight money policies for his narrow presidential election loss to John Kennedy a decade before, said, "I respect his [Burns'] independence. However, I hope that independently he will conclude that my views are the ones that should be followed."
Arthur Burns certainly followed.
An inspection of the money creation numbers for the Fed in 1971 and 1972 shows that Burns and Nixon had no disagreements when elections neared.
Mayer, in one of more clumsy sentences in this otherwise well written book, writes of this episode in monetary mischief: "The fact that the economic expansion stimulated by this rapid growth in the money supply helped Nixon win reelection was not, I think, far from Burns's mind." No one, reviewing the records of three decades ago, could dispute that.
The result of this election year monetary hijinks was, in Mayer's well-turned phrase, about to lead to "disaster time." The United States, ostensibly, had a strong economy, with strong GDP and low unemployment. However, less than a year after the election, the hangover effects of the Burns/Nixon inflation took hold. America experienced a decade of stagflation, the dollar became a currency that speculators dumped and those Americans on fixed incomes, many of whom had likely voted for Nixon and the easy money advocates on Capitol Hill, went through an economic hell. The United States, about to run double-digit inflation, appeared on the road to a modern Weimar Germany.
Mayer writes that by 1979, "prices were moving at a pace that would on the average double the cost of living every five years, and the dollar was plunging in the foreign exchange markets." Still, and here's where Mayer fails to hammer home a critical point, President Richard Nixon was easily re-elected (He carried 49 states. One wag said that, "Now the Republican party has to concentrate on rebuilding in Massachusetts," which was the only state carried by Nixon's hapless opponent, Senator George McGovern).
Mayer raises many compelling issues, but never examines what, I believe, are the most controversial issues of central banks. He never follows the logic of the recurring problems that he cites. Even if one agrees with the concept of a super state bank with exclusive control of the currency, how does one keep politics out of money creation?
Money creation is a power, given that today's fiat currencies are free from the discipline of a gold standard, which can be easily abused by politicians or just badly used by well-meaning central bankers, who misread economic data or act too slowly. This is a controversy almost as old as our republic and it has played a huge part in our history. Opposition to central banks was a prominent part of the philosophies of Thomas Jefferson and Andrew Jackson.
One need not invoke an evil pol theory of monetary history to make an effective case against the Fed. Money creation policies can, and have been, just as easily botched by central bankers who had no political motive and were, in fact, just trying to do their best (An example: The Fed severely contracted the money supply in the late 1920s and early 1930s, exacerbating the effects of the 1929 crash and turning it into a depression that didn't end until World War II; yet the raison d'etre of central banks has been that they would smooth out the business cycle and prevent depressions! Here, by almost anyone's view, the Fed grossly failed).
One rises after reading The Fed troubled by the last disturbing sentence of this book: "The tragedy for all of us would be if the Fed's and the Treasury's and the Congress's reverence for people who make a lot of money left us unprotected against some sudden revelation of the truth that become obvious only in hindsight, that a lot of them don't know what they're doing," Mayer writes.
This is surprising stuff coming from esteemed Martin Mayer, who no one would mistake for a radical. Indeed, Mayer shows his Keynesian colors late in the book, when, in seeking to belittle economist Milton Friedman, he criticizes him for his advocacy of Say's Law (supply creates demand). In Mayer's condemnation of J.B. Say, we have mark of John Maynard Keynes, whose influential General Theory is virtually a screed against Say. The General Theory also was a tribute to the wonder of inflation, a virtual primer for pols facing elections. Inflation, of course, is the main weapon of governments using central banks to manipulate economies.
Still, some of the criticism in The Fed might even have been written by a laissez-faire, free banking advocate. Maybe, just maybe, the much celebrated, Martin Mayer – the whiz kid who graduated from Harvard as a teenager and the major media darling whose op-ed pieces appear everywhere – should re-examine his philosophical premises.
Gregory Bresiger, [send him mail] a business writer and editor, lives in Kew Gardens, New York. He has written for LewRockwell.com, Mises.org and The Journal of Libertarian Studies. He is presently working on a paper on the foreign policy of Woodrow Wilson.