My Recommended Federal Reserve Policy

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People ask
me, "What should the Federal Reserve’s monetary policy be?"
The answer, theoretically and practically, is simple: paralysis.

Are prices
rising? The FED should cease buying or selling assets, e.g., U.S.
Treasury debt.

Are prices
falling? The FED should stop buying or selling assets.

Are prices
stable? The FED should cease buying or selling assets.

What about
the members of the Federal Open Market Committee (FOMC), who decide
as a committee how many assets to buy or sell? Offer them early
retirement at 120% of their present salaries.

Do the same
for their respective staffs.

What if interest
rates fall in a recession? Let them fall.

What if they
rise, due to a war? Let them rise.

In short, let
participants on a free market decide what the rate of interest should

Why is the
collective, competitive judgment of profit-seeking investors who
put their own money on the line inferior to a group of salaried
bureaucrats who create money out of nothing to be put on the line?


There is a
serious possibility that, in a recession, some large banks might
not be able to stay in business.

This is true
of every line of business. Why should banks be exempt from the threat
of bankruptcy?

But, critics
may say, the government has promised to pay off depositors in insolvent
banks. How? Through its Federal Deposit Insurance Corporation (FDIC).

I respond:
Why not let Congress find the money needed, if any, to pay off depositors?
Why call on a privately owned, government-chartered central bank
to counterfeit money in order to pay off depositors? Congress made
the promise. Let Congress bear the responsibility.

That, of course,
is the whole point. Congress wants credit for a good economy. "Re-elect
us! We helped made things good!" It also wants to shift blame
for a bad economy. "Re-elect us! We’ll
get to the bottom of all this!"

Political promises
should be paid for politically. But political promises are made
by politicians who want to avoid the bills when they come due. They
rely on the Federal Reserve System’s Board of Governors to keep
the bills from ever coming due. The FED does this by creating money
and buying assets, especially U.S. Treasury debt.

The result
since 1933 has been an increase in the supply of money, which helps
political debtors to meet their monthly payment schedules.

Instead of
bankrupting the political debtors, the FED has just about bankrupted
the dollar and all those creditors who have loaned long-term money
at fixed interest rates.

The bills keep
coming due. The FED keeps paying them off with depreciated money.
"Shut up. You’ve been paid." So, creditors accept this
and seek to get higher rates of interest to compensate them for
the depreciating dollar. They can’t always get what they want.

At some point,
creditors look abroad in search of promises to pay, denominated
in stable money. But central banks are universal in our day, and
they are all inflationary. Fiat money is the standard of our era.
The world’s economy rests on promises to pay. Central banks back
up these promises with fiat money. The politically unsustainable
promises become politically sustainable inflation. Congress can
blame something else for inflation. In contrast, it would have to
blame itself for default on promises.

The central
bank cartel in one nation is always threatened by stable money in
other economies. This is why central banking is a growing cartel.
Every new nation is told by central bankers to start a domestic
central bank. All but two countries today have a central bank. The
two exceptions are Monaco, which has a casino instead, and Andorra,
which has mostly sheep. Since neither of them has an army to pay
for, they don’t need a central bank. (The old leftists Malvina Reynolds
and Pete Seeger wrote "I
Want to Go to Andorra
" in 1962. I have had that song in
my collection ever since 1963. I can still sing it. They were right.)


If the FED
were to stabilize the monetary base by refusing to buy or sell assets,
the value of the dollar in relation to other nations’ currencies
would be determined by currency speculators’ competing assessments
of the future effects of everything that might conceivably affect
the purchasing power of the dollar.

The best economic
forecasters on earth are currency speculators. The uncertainty is
enormous, the leverage is high, and the markets are relentless.
You can make or lose more money faster and with lower commissions
in the currency futures markets than any other. The market is essentially
unregulated, since the assets it trades are international. Any attempt
by governments to regulate this market has the effect of driving
the computers off shore to some island nation that doesn’t regulate

If the FED
did nothing for a year or two, world currency speculators would
conclude that the U.S. dollar had become the world’s only stable
currency. It would become the benchmark. For as long as the FED
did nothing, the dollar would be established as the world’s reserve
currency even more than it is today.

This would
force any nation whose politicians wanted its currency to replace
the dollar as the world’s reserve currency to instruct its central
bank to imitate the FED’s policy of doing nothing.

Foreign investors
would soon recognize that their capital is safe from depreciation
by purchasing dollars and investing them at whatever market rate
is available. The dollar would become as close to immune from competition
as any currency on earth. The U.S. domestic capital markets are
huge. The dollar’s role as the world’s reserve currency makes the
U.S. markets even more huge. Stable money would make the U.S. dollar
the best widely available currency unit.

What about
the trade deficit? That would depend on the comparative social rates
of future orientation. Americans’ future orientation, when lower
than foreign investors’ future orientation, is what produces the
trade deficit. With foreign investors doing even more what they
are doing today — buying assets denominated in dollars — foreigners
would buy up even more American capital and debt. But they would
do this at low rates of interest. If selling off income-producing
assets is what Americans want to do — and they seem to — then they
could buy more of what they want with stable money: more goods per
dollar because the dollar would increase in value in relation to
foreign currencies, whose central banks refuse to do nothing.


The policy
I am recommending is semi-laissez faire: "Let us alone."
The FED would let us alone as users of its currency. Congress would
let the FED alone as the taxer and borrower of the FED’s currency.

Make no mistake
about this: the currency is the FED’s. The FED has a monopoly over
it. Paper bills are by law legal tender. Congress in 1913 passed
sovereignty over money to a privately owned agency.

This policy
recommendation is not pure laissez faire. Pure laissez faire in
money would be based on legally enforceable debt contracts. Banks
would not be allowed to promise two check-writers — the depositor
and the borrower — the right to withdraw their deposits at the same
time. In other words, there would be no fractional reserve banking.

Then it’s "Come
one, come all!" Anyone could set up a bank. Anyone could issue
a warehouse receipt for gold or silver or copper. The free market
would allow money users to assess the reliability of every bank’s
IOUs. The banks would compete.

Congress would
get out of the money business entirely. It would merely identify
the private currency or currencies that it is willing to accept
for the payment of taxes. No more legal tender laws. No more government
mint. No more monopoly central bank. Congress would do what the
FED ought to do: nothing.

This suggestion
is opposed by academic economists, commercial bankers, politicians,
historians, and all other inflationists, whose are, like the demons
of old, legion. This would place the fate of every currency solely
in the hands of the judges, who would enforce contracts, and currency
speculators, a group which ultimately includes everyone who uses
money. Such a view of money places sovereignty over money into the
same hands as sovereignty over chewing gum: owners.

This view of
money rests on a presupposition, best stated by Jesus in the parable
of the employer.

Is it not
lawful for me to do what I will with mine own? Is thine eye evil,
because I am good? (Matthew 20:15)

When it comes
to money, the evil eye is universal. Men do not trust the principle
of exclusive private ownership. They may say they do, but they really
don’t. The most flagrant masters of this evil eye are free market
economists — Austrian School economists excepted — who praise the
free market to the skies until they get to the chapter on money
and banking. Then the free market needs the guiding hand of — you
guessed it — academically certified economists.

Three decades
ago, I knew a newly certified Austrian School economist. He showed
considerable promise academically. But then he got an offer from
the FED to become a staff economist. He disappeared into the bowels
of the FED, never to reappear. He ceased writing. He maintained,
when the deal was first offered to him, that he would write on the
side. He never did. Somehow, his enthusiasm for the ideal of the
free market ceased to motivate him enough to sit down and write.
That monthly check from the world’s supreme monopoly undercut his
ideology, which had been opposed to government-licensed monopoly.
"Let us alone" was replaced by "fully vested pension."

A free market
in money and the enforcement of contracts in banking are ideas so
utterly foreign to the modern world that they are simply not discussed
in polite circles.

The best way
to discover the heart, mind, and soul of a society is to discover
those issues that are so widely taken for granted that they are
not discussed in public. I don’t mean hate crimes. I don’t mean
political correctness. Here, there have to be negative sanctions
to keep them from being discussed. I mean ideas that are so off
the mental radar of a society that they are essentially inconceivable.

A free market
in money and banking is such an idea.


People for
four decades have asked me, "How can we reform the FED?"
I always tell them: "Let it alone." Laissez faire works
both ways.

The FED is
immune to reform because central banking is a universal phenomenon.
Ever since the creation of the Bank of England in 1694, academics
and opinion leaders have supported the idea. It has spread ever
since, but especially in the 20th century. You cannot
reform an institution that rests on a universally accepted idea
— so universally accepted that to think otherwise is to join the
lunatic fringe.

There have
been Congressmen over the years who have exposed the FED. Some have
thought there was hope. Others have used the FED as a whipping boy.
Of all institutional boys to be whipped, the FED is at the top of
my list. But we should recognize the difference between analysis
and implementation.

To undermine
the public’s confidence in the FED is impossible, except for one
factor: the FED. Central banking is inherently immoral. It is inherently
inflationary. It is inherently de-stabilizing. Why? Because it is
inherently statist. It rests on coercion. It rests on the idea that
a committee of tenured, salaried, government-protected people possesses
greater insight into supply and demand than speculators who put
their own money, or their clients’ money, on the line, moment by
moment. It rests on the idea that government-enforced central planning
is more efficient, more compassionate, and more profitable for a
society than market planning by owners of capital.

Central planning
is irrational. Ludwig von Mises proved this in 1920. In 1991, the
collapse of the Soviet Union finally verified what he had argued

Central banking
is irrational. Ludwig von Mises showed why in 1912 in his book,
Theory of Money and Credit
. As yet, we have not seen a collapse
comparable to the fall of the Soviet Union, although the Great Depression
was a good first-stage early warning indicator. So is the decline
of the dollar by 95% since 1914. But, ultimately, either central
banking will be replaced by market institutions in a slow and steady
way, or else there will be a replacement after a worldwide collapse.
I hope for the former, but the latter is possible.

If the latter
happens, I will want to be in Andorra.


For people
who have read about the Federal Reserve System’s monopolistic power
over the economy, it is frustrating to imagine that the voters can
do nothing. Trust me: the voters can do nothing. Most voters have
not heard of the FED, do not understand central banking, and do
not have allies in Congress, other than Ron Paul.

Yet the FED
is doomed, as is central banking in general. Government power cannot
make the irrational rational. It cannot make coercion productive.
It cannot make committees wise.

You might as
well use the system to profit from it. You can’t change it.

If you want
a good 42-minute introduction to the Federal Reserve System, watch
video produced by the Mises Institute

If you want
a simple introduction to the issue of central banking, read Murray
Rothbard’s book, What
Has Government Done to Our Money?
It’s free.

the most detailed book on fractional reserve banking — law, practices,
results — read DeSoto’s 800-page book, Money,
Bank Credit, and Economic Cycles
. It’s free.

30, 2007

North [send him mail] is the
author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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