Stop Intervening in the Economy

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the House Financial Services Committee, Humphrey Hawkins Hearing,
February 25, 2008

Mr. Chairman,

We find ourselves
mired in the deepest economic crisis to afflict this country since
the Great Depression. Yet, despite the failure of all the interventionist
efforts to date to do anything to improve the economy, each week
seems to bring new proposals for yet more bailouts, more funding
facilities, and more of the same discredited Keynesian ideas. There
are still relatively few policymakers who understand the roots of
the current crisis in the Federal Reserve’s monetary policy. No
one in government is willing to take the blame; instead we transfer
it onto others. We blame the crisis on greedy bankers and mortgage
lenders, on the Chinese for being too thrifty and providing us with
capital, or on consumers who aren’t spending as much as the government
thinks they should.

One aspect
that needs to come to the fore once again is that of moral hazard.
When the government acts as a backstop to insure losses that come
about from making poor decisions, such poor decision-making is rewarded,
and thereby further encouraged in the future. Such backstopping
took place through the implicit government guarantee of Fannie Mae
and Freddie Mac, it takes place through FDIC deposit insurance that
encourages deposits in the fundamentally unsound fractional-reserve
banking system, and it has reached its zenith in the TARP program
and its related bailouts.

When banking
giants are reimbursed for their losses through redistribution of
taxpayer money, what lesson do we expect them to learn? Can anyone
in Washington say with a straight face that these banks will shape
up their business practices when they are almost guaranteed billions
of dollars in taxpayer funds? Even if this does provide a temporary
lifeline, it only delays the inevitable collapse of a banking system
built on an unsustainable model. Fractional-reserve banking is completely
dependent on faith in the banks’ abilities to repay depositors,
and when that ability is thrown into doubt, the house of cards comes
crashing down. The Federal Reserve may be able to manage public
confidence, but confidence only goes so far. When banks are required
to hold a maximum of ten percent of their deposits on reserve, the
system is fundamentally insolvent. Such a system cannot be propped
up or bailed out, except at the cost of massive creation of money
and credit, which would result in a hyperinflation that would completely
destroy our economy.

Bernanke and others in positions of authority seem to gloss over
these systemic instabilities and assume an excessively rosy outlook
on the economy. I believe we are at another major economic crossroad,
where the global financial system will have to be fundamentally
rethought. The post—Bretton Woods dollar-standard system has
proven remarkably resilient, lasting longer than the gold-exchange
system which preceded it, but the current economic crisis has illustrated
the unsustainability of the current dollar-based system. To think
that the economy will begin to recover by the end of this year is
absurd. The dollar’s supposed strength exists only because of the
weakness of other currencies. The Fed’s increase of the monetary
base and establishment of "temporary" funding facilities
has set the stage for hyperinflation, and it remains to be seen
what results.

If banks begin
to lend their increased reserves, we will see the first steps towards
hyperinflation. Now that the Fed has increased the monetary base,
it finds itself under pressure to withdraw these funds at some point.
The question, however, is when? If it withdraws too soon, banks’
balance sheets collapse, if too late, massive inflation will ensue.
As in previous crises, the Fed’s inflationary actions leave it compelled
to take action that will severely harm the economy through either
deflation or hyperinflation. Had the Fed not begun interfering 18
months ago, we might have already seen a recovery in the economy
by now. Bad debts would have been liquidated, inefficient firms
sold off and their resources put to better use elsewhere. As it
is, I believe any temporary uptick in economic indicators nowadays
will likely be misinterpreted as economic recovery rather than the
result of Federal Reserve credit creation. Until we learn the lesson
that government intervention cannot heal the economy, and can only
do harm, we will never stabilize the economy or get on the road
to true recovery.

the Ron Paul File

27, 2009

Dr. Ron
Paul is a Republican member of Congress from Texas.

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