Why Do They Love the Fed?

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Yesterday I lost my patience with political "progressives," whose confidence in the state is no less pronounced than that of the neoconservatives who had all manner of grandiose plans for what our rulers could accomplish in Iraq. I wrote that piece because of something I read over the weekend: a progressive blog posted some nice comments about Congressman Ron Paul, Republican candidate for president. So far, so good, of course. Some progressives noted that Paul had been more antiwar than any Democrat and that his record on civil liberties was second to none.

But naturally some progressives were hostile: so what if he’s better on the crucial issue of our time, they essentially said. He’s anti-government! One even said the neocons were much better than Paul, since at least they wouldn’t try to scale government back. (It was limited government, you know, that caused the Katrina fiasco.) That kind of candor is refreshing: when presented with a small-government, local-control libertarian who will resolutely keep the country out of war, some progressives actually prefer perpetual war. Is there anything more we need to know about them?

One, though, took Paul to task for favoring the gold standard. Now we can’t have that, of course, since it would be unthinkable to call for something that isn’t even on the radar screen of the New York Times, the Washington Post, or Chris Matthews. And in any case, doesn’t Ron Paul know that our betters can do a much better job running our money for us? Doesn’t Paul know the Federal Reserve is a wonderful institution designed by the government to prevent economic downturns?

So there you have it: when push comes to shove, this vaunted progressive, for all his claims to independent thought, merely repeats a stream of platitudes that may as well have come from a Federal Reserve press release.

Now if this alleged progressive could, for seven seconds, turn off the voice in his head that forces him to give all existing government institutions the benefit of the doubt — and yes, an institution created by act of Congress, whose board is appointed by the president, and which does the government’s bidding, is a government institution — he might actually be able to ask some useful questions. What exactly is self-evidently "progressive" about the Federal Reserve? Why is it obviously a step forward when we make it far easier for the federal government to wage war and prey upon the public?

In the progressive la-la land, the Federal Reserve was founded when the American people demanded reform of the banking industry, and their elected representatives, eager to contribute to the public good, complied with their wishes. The resulting Federal Reserve smooths out the business cycle and keeps our economy strong.

Anyone interested in living on this planet, on the other hand, might be interested to know a fact that almost sounds too spooky and conspiratorial to be true: bankers in fact drafted the Federal Reserve Act themselves, in a private meeting in Jekyll Island, Georgia, in 1910. And — can you believe it? — it was not designed to benefit the public at bankers’ expense; oddly enough, bankers drew up legislation that benefited themselves.

Now this is not how bills are drawn up according to your tenth-grade social-studies class, which gives you the government line: bills are drawn up by the people’s public-spirited representatives in order to benefit and protect them. That’s a nice way to think about it if you’re in the business of keeping the racket going, but not especially useful if you actually want to know how the world works.

It’s sadly amusing to observe progressives functioning as shills for well-connected banks and businesses, but that’s precisely what they’re doing by mindlessly supporting the Fed and assuming all its critics to be cranks and fools. The Federal Reserve System makes it possible for the banks to profit from all manner of financial shenanigans that they could never get away with under a gold standard — for more on this, see my reading suggestions below — and it stands ready to serve as a lender of last resort in case the banks’ reckless behavior gets them in trouble. How many other industries benefit from such overt grants of special privilege?

The Fed doesn’t just benefit the well connected; it also harms those who aren’t so well connected. We know inflation hurts people on fixed incomes (since their incomes stay the same while the prices for the goods they buy go up), but what people usually overlook are the distribution effects of inflation. More money in the economy normally means higher prices. But when the government spends billions of dollars created out of thin air (yes, the Fed can do this) on the defense industry, for example, defense firms get the money at the very beginning of this process, before prices have commensurately risen. In effect the economy doesn’t yet know how much the money supply has increased, and prices have not yet adjusted accordingly. By the time the new money makes its way through the whole economy, prices will have risen throughout most if not all sectors. But while this process is taking place, the privileged firms that are lucky enough to get the new money early benefit from being able to make their purchases at the previously existing price level — thereby silently looting those from whom they buy. By the time the new money finally makes its way to the average Joe, prices have already been rising for quite a while, and he’s been paying those prices all this time on his existing income.

What exactly is so "progressive" about that? Why do progressives not condemn this expropriation of the poorest that goes on day after day? Surely their commitment to government management of all sectors of society, money included, cannot be so strong that they have lost the ability to ask fundamental questions.

Here is another way to think about it. Money in your possession amounts to compensation for some good or service you have provided in the past. When you buy a dozen apples, you do so with the proceeds from a good or service that you yourself provided in the past. So you are able to buy the apples because in the past you gave someone else something he needed.

Now imagine a situation in which business firms or banks connected to the government receive a new round of paper money courtesy of Fed credit expansion. That money comes out of thin air, not from the sale of some previous good or service. Thus when these favored firms spend this money, they are in effect taking goods out of the economy without providing anything themselves. Here we see very clearly how they benefit at the expense of the rest of society: they take from the stock of goods without giving anything in return. The money they pay for their goods didn’t originate in a good or service that they themselves had previously provided; it came from nowhere. The analogous case under a system of barter would be one in which I come and take your apples, period.

This is "progressive" why, exactly?

The Federal Reserve can prevent massive contractions of the money supply, our critic tells us, and that’s how it can avoid things like the Great Depression (an event it mysteriously failed to prevent, I might add). Whether the Fed should have engaged in expansions of the money supply in the first place, whether these expansions themselves might not deform the economy, or whether we’re really expected to believe that the power to print up green paper tickets out of thin air can make society wealthier and the economy more stable — well, none of these questions are asked. They’re not listed on that Federal Reserve press release, after all.

The dollar has lost over 95 percent of its value since the Fed was created. Now had the value of our money declined by 95 percent under the gold standard, the progressive would cite that as evidence against gold. When the government is responsible for debasing the currency to that extent, on the other hand, the matter is passed over in silence. This is example number 5,271 of Westley’s Law, which I’ve sometimes rendered this way: the public sector is always held to lower standards than the private sector.

(Some people think they know all about the American economy under the gold/silver standard, incidentally, but the country’s commodity standard does not deserve the blame for the problems that careless scholars foolishly ascribe to it. If you’d like to know the real history of money in America, there are four books I heartily recommend, the first two being short introductions for laymen and the latter two more detailed and scholarly studies. They are What Has Government Done to Our Money?, The Case Against the Fed, The Panic of 1819: Reactions and Policies, and A History of Money and Banking in the United States: The Colonial Era to World War II, all by Murray N. Rothbard. You can download What Has Government Done to Our Money? for free on mp3 here. You’ll never have to suffer fools in silence again.)

Now it’s bad enough that the federal government loots rich and poor alike. Much worse is when its victims, too bamboozled by state propaganda to know any better, cheer on the looting, and solemnly warn their fellow citizens about how frightening and perilous life would be without it.

These are the same people who wouldn’t dream of taking a Pentagon press release at face value, and who attribute the basest motives to the architects of American foreign policy. But apply the same standard of criticism and skepticism to the motivations behind, say, the Federal Reserve? What are you, some kind of extremist?

Thomas E. Woods, Jr. [view his website; send him mail] is senior fellow in American history at the Ludwig von Mises Institute. His books include How the Catholic Church Built Western Civilization (get a free chapter here), The Church and the Market: A Catholic Defense of the Free Economy (first-place winner in the 2006 Templeton Enterprise Awards), and the New York Times bestseller The Politically Incorrect Guide to American History.

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