The Fed Is Flying Blind
I'll start with a confession. After about 10 years of reading Austrian economics, attending events at the Mises Institute, studying carefully through Human Action and completing my coursework for a Masters in Political Economy, I still find central banking a bit mysterious. Ask me about price controls, monopoly theory, value theory, international trade or just about any other economic topic and I should be able to give you an impromptu lecture that would be fairly satisfactory. But bring up M1, M2, velocity of money and so forth and you'll see that "deer caught in the headlight" look start to come over me.
In my defense, part of the reason that the subject is so confusing is because central bankers do not want the essence of what they do to be clear to the masses. As J. M. Keynes (of all people!) wrote in 1919: "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."
I was at a lecture recently by Roger Garrison, author of Time and Money, in which he discussed the parallels between the boom of the 1920s and the boom of the 1990s and started getting into this M1, M2 stuff, (he even mentioned an M13!?). During the question and answer period, I suggested my simple summary of this whole central banking thing. So, just in case there's anyone else out there who gets confused on this topic like me, here's my short and sweet breakdown of everything most of us need to know about central banking:
1) Socialist Money
What we have with these Federal Reserve Notes (or any of the other central bank managed fiat moneys throughout the world), is non-private, centrally managed, socialist money. In this system the interest rate and the money supply are not determined by the free interplay of suppliers and demanders of money and loans, they are "planned" and "targeted" by a government agency.
2) Socialist (Mis)Calculation Applies
Because we're dealing with a socialized aspect of the economy, Mises' socialist calculation argument applies, (see his original 1920 article on this here). As Mises writes, "Where there is no free market, there is no pricing mechanism; without a pricing mechanism, there is no economic calculation." If the government abolished private ownership in the means of producing steel, the state steel production agency would have no prices to guide it as to how much steel to make, or what quality of steel to make. It would be subject to fads, like a belief that making massive amounts of cheap steel would result in a wonderful "new economy" of industrialization. Since a central bank has a government enforced monopoly on the issuing of money within that government's borders, the central bank does not face the profit and loss discipline (or guidance) of the market. Therefore...
3) The Fed Is Flying Blind
This means that the central bank is not receiving the crucial signals that a truly private company has to guide its behaviour. Did the Fed print too much money last year? Too little? Should the Fed even be "in business"? Who knows? The monopoly means that crucial market feedback is turned off for the Fed. What should the rate of interest be? Without a free market in money and loans no one knows. Not me, not Milton Friedman and not Alan Greenspan.
4) What We Do Know
No one can really know precisely what the Fed should be doing (besides going away), but something can be said about what it shouldn't be doing. If the Fed starts printing so much money that we have to use a wheelbarrow to bring enough money to buy a loaf of bread then the Fed has definitely screwed up. But don't think this means we know that much. We can probably all agree that the Federal Government should not manage the huge tracts of land that it "owns" in the United States by setting off nuclear bombs on them. But that doesn't mean we really know precisely how it should be managed... How much of the land should be for parks, how much for industrial development, how much for residential housing. Without real prices from a real market, the government simply can't manage any of the things it socializes in a sensible way.
Turning the Lights Back On
For some reason it's considered a great critique these days to say, "All you do is criticize... What should be done?" I'll go for it and lay out my admittedly overly simplistic plan. Socialist money makes as much sense as socialist food or socialist education. The solution is to abolish the socialist system and allow freedom. In the case of money that means abolishing the central bank and getting the government out of the money business. Then what money we use, how much there is of it and the interest rate can all be determined like everything else, through voluntary exchanges and cooperation.
Even many so-called free market advocates think that we should have socialist money when they don't think socialism works in any other area. I'll admit it. I'm still confused on why that would be.
April 14, 2003Stephen W. Carson [send him mail] is a working software engineer and a graduate student in the Department of Political Economy at Washington University in St. Louis.
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