The Insolvency of the Fed

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Since
August 15, 1971 the US dollar has been an irredeemable paper currency.
Every irredeemable paper currency in history has failed. Yet, the
experiment of the US dollar and the rest of the fiat paper world
continues.

During the current crisis, however, financial systems all over
the world are increasingly struggling, and the end of the experiment
seems closer. In fact, the Federal Reserve System has used up much
of its "ammunition" for monetary interventions in an attempt
to keep the experiment going, lowering its target interest rate
almost to zero. Other central banks are also quickly approaching
the "zero limit" for interest rates.

During these inflationary decades, economic structures have developed
that can only survive with falling interest rates. As the world
approaches a zero interest rate, it appears that finally there might
be a full adaptation of the structure of production to the demands
of consumers, and the experiment might come to an end.

Yet, has the Fed really "run out of ammunition"? First
of all: what is the Fed shooting at? It is trying to artificially
stimulate the economy with its monetary policy, thereby it is also
unwittingly shooting at the value of the currency. Through its monetary
policy, the Fed is trying to bail out an insolvent and illiquid
banking system to maintain an unsustainable structure of production.
As long as the currency is not totally destroyed, the Fed will never
run out of ammunition. In order to assess the ammunition left, one
should have a look at the balance sheet of the Federal Reserve –
especially at the assets the Fed can still obtain. The Fed’s balance
sheet also gives insights on the condition or quality of the dollar.

Read
the rest of the article

February
6, 2009

Philipp
Bagus [send him mail]
is an associate professor at Universidad Rey Juan Carlos, Madrid
and a visiting professor at Prague University. See his article
archives
. Markus H. Schiml [send
him mail
] is a PhD student at the University of Bayreuth, where
he founded the Ludwig von Mises Forum. He is also a leading lecturer
at the Institute of Educational Economics campus. See his article
archives
.

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