Ron Paul on Greenspan's Fed

Dr. Ron Paul, an obstetrician, has sat on the House Banking Committee throughout his political career. (He was first elected to Congress in 1976.) This is not a popular committee to sit on. The committee hands out no money to constituents. It creates no projects that provide employment for the folks back home. It monitors what the banking system is doing to hand out money. Most voters don’t care.

Dr. Paul understands monetary theory. That’s because he has read Ludwig von Mises and Murray Rothbard. I doubt that any other member of the committee has — at least not since Congressman Phil Crane sat on it, even before Dr. Paul did. But Dr. Crane decided that it wasn’t worth the effort. He resigned from it 30 years ago.

So, when Alan Greenspan comes to testify, Dr. Paul grills him. No other elected politician has grilled him more systematically.

Back in 1976, I was his research assistant. Even then, when he was the newest Congressman in Congress — he had been elected in an intra-term election, because the incumbent Congressman had resigned — he was on the attack. In 1976, Arthur Burns was chairman of the FED. Burns had been chairman when Nixon closed the gold window in August, 1971. He had endorsed Nixon’s unilateral imposition that day of price and wage controls. (Ironically, Rothbard had earned his Ph.D. under Burns at Columbia. Rothbard’s view of money was very different from Burns’ view.)

Dr. Paul has watched FED chairmen come and go. He has also watched the dollar depreciate. No one in Congress has served as a louder watchdog of the decline of the dollar.

Recently, he wrote a report on the state of the financial union. It deserved a lot more attention than it received.


The expansion of the money supply has been accompanied by a rise of household debt. This is the Achilles’ heel of the financial system, Paul believes.

In testimony before the House Financial Services Committee last week, Federal Reserve Chairman Alan Greenspan painted a rosy picture of the U.S. economy. In his eyes, the Fed’s aggressive expansion of the money supply and suppression of interest rates have strengthened the financial condition of American households and industries. If this is true, however, our nation’s “prosperity” is merely a temporary illusion based on smoke and mirrors. True wealth cannot be created simply by printing money; families and businesses cannot prosper by getting deeper in debt.

In fact, Economist Frank Shostak of the Ludwig von Mises Institute throws cold water on Chairman Greenspan’s assertions in an article entitled “Running on Empty.” Mr. Shostak cites statistics showing that American families have never been deeper in debt, never saved so little, and never consumed so much more than they produce. By any objective standard, U.S. families are treading on very shaky economic ground.

Shostak has provided a series of graphs of these developments. I recommend that you click through and print out his article. Pay attention to these graphs. They make it easier to see where the economy is headed.

Dr. Paul asks some compelling questions.

Never mind, says Mr. Greenspan. Mortgage refinancing, made wildly popular by artificially low interest rates established by the Fed, will be the saving grace of American households. They can simply borrow against their homes to finance living beyond their means, a practice encouraged by Fed policies. But what happens when home prices stop going up? What happens when families reach a point where they cannot make payments on two, three, or even more mortgages? How can the Fed chairman equate mortgage credit with real economic growth?

The mortgage re-financing boom has been in full swing throughout the recession and the recovery. Analysts commonly explain the mildness of the recession by an appeal to mortgage re-financing and the growth in housing. But this has been a consumer goods boom, not an increase in productive capital resources. That boom will cease when interest rates return to normal.

Mr. Shostak also demonstrates that American businesses aren’t doing much better. As consumers exhaust their ability to borrow, they necessarily buy fewer goods and services. The ratio of business liabilities to assets is very high, price to earning ratios are still unrealistic, and investment capital remains scarce. Business may be better than it was two years ago, but the fundamentals are far less healthy than Mr. Greenspan would have us believe.

Dr. Paul then comments on a factor that the bulls ignore and the bears believe is crucial: the debt/GDP ratio. It takes more and more debt in the economy to produce a dollar’s increase in the Gross Domestic Product. At the center of this increase in debt are the Federal Reserve System and the U.S. debt. When recession hits, the first line of defense is the FED, which then creates lots of new money, just as it did in 2001.

As financial analyst Jay Taylor explains, the disturbing increase in the debt to GDP ratio illustrates that printing more money is the only solution federal policy makers know. Federal debt naturally grows faster than income — while there are no limits to how fast the printing presses can run, there are natural limits to economic growth.

He then raises the question that economists who specialize in international currencies have been raising. What happens when Asia’s central banks decide to stop increasing their money supply in order to keep the dollar from falling in value in relation to their currencies?

The end may come when foreign central banks realize the dollars they receive are worthless, or when they find other places to turn for income. When that day comes, interest rates will rise, perhaps dramatically. At that point not even Mr. Greenspan will be able to save the economy from the painful correction necessitated by his easy credit, easy money policies.


The FED has been a factor in lowering rates. A price is the product of supply and demand. The FED provides the supply. But in 2002—4, the FED has not been creating lots of new money. The increase has been under 6% — and negative since mid-2003. The FED can add to the adjusted monetary base, but this does not determine the money supply directly. The money supply has been increasing, but not at anything like the rates in Japan and China.

Then what else has forced down rates? Two things. First, businesses have been hesitant to borrow until recently. Second, lenders have been willing to lend at low rates. The fall of the stock market scared investors. They began moving into bonds and even CDs. The upward move of the stock market in 2003 did not persuade most of them to sell their bonds and mortgages in order to move back into stocks. They are still scared of equities. If they weren’t, we would see a sell-off of bonds and rising long-term interest rates. This has not happened.

The consumer has been the big borrower, not the businessman.

We have seen consumers take on more debt as rates have fallen. This is what bothers Shostak. Consumers are not paying attention to their overall burden of debt. They are looking only at their monthly payments. This is determined mainly by interest rates. As the price of borrowed money — interest — has fallen, more of it has been demanded by consumers. The monthly debt burden seems low because of lower interest rates.

The businessman looks at the level of debt that his business can safely sustain. He knows that rates can rise. He knows that if his business’s revenues don’t keep pace with the rise in rates, he can get caught in a cash-flow squeeze. He therefore prefers long-term debt to short-term debt, i.e., bonds rather than bank loans. Big businesses have been doing this. Small businesses don’t have the credit rating to do this — no access to the bond market. But they have stayed away from bank credit, with loan renewals every five years, and maybe as often as three. This indicates that they fear rising rates. They don’t want to get trapped when banks call the loans.

Consumers don’t care about these negative factors. They think today’s rates are permanent. For a 30-year mortgage, they are correct. The rate is fixed. But taxes aren’t fixed, and fire insurance premiums aren’t, either. Operating expenses generally aren’t. But American consumers are optimists. They look at the interest rate today, borrow, and buy. They risk getting trapped.

The only thing that will keep rates from rising is price deflation. The economy has yet to produce price deflation, but it’s getting close this year. Prices are rising, but just barely. Under such circumstances, buyers will not be able to pay off their debts with depreciating dollars. The housing boom will therefore come under downward pressure. The rate of increase in housing prices will slow or even reverse, especially for middle-class and upper-class housing.

As debt rises, the threat of rising rates and price inflation becomes greater than debtors had expected. On the other hand, if rates stay low, this can be only because the price level is close to stable or even falling. That would thwart the dreams of “buy now, pay off with cheap money.” In either case, the level of debt is too high. Debtors’ optimism is greater than the economy warrants.


There is productive debt, of course. Higher education is usually productive, although paying $50,000 to $150,000 for a college degree when you can get one for $8,000 doesn’t seem sensible. At least 99.9% of college attendees overpay. I have written a report on this. Click in this link, and then click SEND.

Buying the tools of your trade (preferably used but in good condition), subscribing to magazines and newsletters in the field, attending hands-on seminars, and spending time in the library (which few people do) all require money, either out of pocket or in forfeited income. Yet this is the road to wealth. If you invest as little as an hour a day for one year in reading about some field, you can become an expert, or close to it. If you have to go into debt, do it.

Start a small business. Sign a lease or a bank note, but only after you have invested at least 300 hours in researching the field. The debt enables you to gain a high pay-off from the time that you invested in gaining entry to a field. The debt leverages your information. But get that information early, as cheaply as you can. And if you can start a business without debt, I recommend it. But remember: a lease is a debt.


There are people who say, “Never go into debt.” These people have one thing in common: they don’t have enough investment capital to live on. If they should lose their jobs, they would be in trouble. They operate on the assumption that they won’t get sick or get fired. Most people make this assumption.

Now, if it’s a question of living on your salary without debt or with debt, the former is preferable. It reduces your risk. But without capital, you will remain dependent on the debt decisions of your employer. You have not escaped debt in your life. You have merely transferred to your employer the responsibility of deciding how much debt to bear. If he guesses wrong, you could lose your job.

How many salaried people are aware of the financial condition of their companies? Very few. They trust their employers. They assume that their employers have looked at the company’s debt/income and debt/capital ratio, and that their employers have made wise decisions. Even employees who work for companies that must submit reports to the Securities & Exchange Commission rarely read these reports, even though they are posted on-line (EDGAR). They don’t know how to interpret them. They don’t invest time and a little money to find out how to interpret them.

It never ceases to amaze me that people who are meticulous about their own financial condition are uninformed about the financial condition of their employers. They are dependent on other people’s decisions, yet they prefer to remain uninformed about the solvency of the organizations that supply them with their jobs, their pensions, and their future.

Debt can be productive. It can also be a liability. My recommendation is that you know the debt condition of your employer. You should also know something about the market your employer competes in and the strength of his competitors. If you do this, you will be in a position to jump ship early, if required. You will also become a more valuable employee. You will be much more likely to move up in the corporate hierarchy.


The debt condition of the United States is an important factor in the success of the economy and therefore of your employer. Yet most voters pay no attention to government debt. They assume that Congress knows what it is doing. This is not a safe assumption.

Because of the extreme division of labor today, we can’t second-guess everyone on whom we are dependent. But we can and should spend time and money in finding out more about the debt level of those on whom we depend directly.

The debt structure is like a row of dominoes. If a key one topples, it could topple the system. We assume that there are safety switches and fuses in the system that will keep this from happening. There are, but the question is: Will they work? Usually, they do. But when most people rely on these fuses to protect them in all situations, they are playing with statistical fire. No system is protected from all eventualities.

Dr. Paul is correct: the debt structure is the interconnected domino that offers the greatest risk for the economy. Congress spends more than it takes in. It issues IOUs on a massive scale every month. The Federal Reserve supposedly is the lender of last resort, the switch that will keep everything running smoothly. But today, the Bank of Japan and the Bank of China have more to do with the international value of the dollar than the FED does. Foreigners have become major players in our markets. Above all, salaried central bankers in Asian countries hold the hammer.

How much do you trust their judgment? The less you trust them, the more time you should spend on establishing alternative sources of income that will not run dry when interest rates rise, the value of the dollar falls, and unemployment increases. You do not want to spend your golden years saying, “Welcome to Wal-Mart.” It’s better to shop there than work there.

February 28, 2004

Gary North [send him mail] is the author of Mises on Money. Visit For a free subscription to Gary North’s newsletter on gold, click here.

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