End the Fed

by Ron Paul

  And there were many others I read that kept the spirit of the Republic alive. Some were much more interested in monetary policy, while others talked about personal liberty and foreign policy as well as economic liberty. Having read the books of John T. Flynn, Isabel Patterson, Rose Wilder Lane, Garet Garrett, Ayn Rand, Richard Weaver, Albert J. Nock, H. L. Mencken, and Frank Chodorov, I was not only influenced but convinced that a philosophy that embraced personal liberty, private property, and sound money was the only political philosophy worth championing.

  To understand the need for sound money and no central bank, one must fully understand the principles of liberty. There were also several members of Congress during this period who held their ground and voted in keeping with the Constitution: Dr. Smith of Ohio, Howard Buffett, and H. R. Gross.

  We all owe a great deal of gratitude to the men and women who did such a superb job of presenting the moral case for liberty and refuting all the monstrous lies, ignorance, and arrogance of those who spent their lives promoting authoritarianism, statism, and universal use of aggressive force.

  Although Ayn Rand never spoke kindly of libertarians and I never contemplated becoming a supporter of objectivism as a total philosophy, I did read all her novels and received her objectivist newsletter essentially the whole time it was published. She challenged many of my beliefs that I had taken for granted and forced me to understand and defend them better. However, she never convinced me of her definition and application of altruism. Equating voluntary Christian charities with Communism made no sense to me. But she also built up my excitement for championing freedom. I have in my library a copy of the original 1957 hardbound edition of her huge Atlas Shrugged. The price listed on the cover flap is $6.95. There’s no doubt she influenced a lot of people over the decades and forced them to reassess their premises, and most came away being more devoted to liberty.

  CHAPTER 4

  CENTRAL BANKS AND WAR

  Following the creation of the Fed, the government would discover other uses for an elastic money supply aside from keeping the banking system from defaulting on its obligations. It would prove useful in funding war. It is no coincidence that the century of total war coincided with the century of central banking. When governments had to fund their own wars without a paper money machine to rely upon, they economized on resources. They found diplomatic solutions to prevent war, and after they started a war they ended it as soon as possible.

  But for European governments in the late nineteenth century, the fiscal limits on war were removed. Now with central banks, governments could just print what they needed, and therefore they were more willing to pull the trigger and pick fights. The diplomats were powerless to stop governments itching to try out their newfound funding machines. Might a diplomatic solution have been found for the struggles that led to World War I had the Germans and English not had recourse to the printing press and a lender of last resort? Counterfactual history is always difficult but it is an interesting question to ask.

  As Mises wrote in 1919, “one can say without exaggeration that inflation is an indispensable means of militarism. Without it, the repercussions of war on welfare become obvious much more quickly and penetratingly; war weariness would set in much earlier.” 1

  Armed with central banks to cover liabilities, European governments began a war one year after the Fed was created. The New York Tribune wrote with horror: “The world looks on in a stunned, incredulous way while Europe is rushing forward to a stupendous catastrophe…. We have been told again and again that the financiers of the world, largely denationalized in their sympathies and interests, would never permit the great nations to impoverish themselves by a general war. A tightening of the screws of credit, it has been said, would bring most chancelleries to their senses.” 2

  It was once so, but central banking changed that forever. No more would governments be bound by the fear of bankruptcy and financial ruin. The magic of inflationary finance would provide for them no matter what.

  So, too, in an earlier time, the United States might have stayed out of the European conflict. But having the Fed, the United States entered the war in 1917, and with it came the most centralized experiment in national economic planning to date. There were price controls, new taxes, government nationalization of railroads, the War Industries Board, Liberty Loans, new bonds to float, and a massive expansion of government debt that was backed by the power of the Fed to create money to pay back the debt.

  In those days, the Fed did not have the power to create money through the discount window, but it did serve that important role of being a guarantor of the government’s debts. It was the lender of last resort, and it had plenty of capacity for creating new money out of thin air. The monetary expansion began in December 1914 and America went through the first of many false booms. Interest rates were pegged low at the very time when they should have been rising due to greater risk.

  As Friedman and Schwartz report concerning World War I: 3

  The stock of money, which had been rising at a moderate rate throughout 1914, started to rise at an increasing rate in early 1915, rose most rapidly, as prices did, from late 1915 to mid-1917, and then resumed its rapid rise before the end of 1918, rather sooner than prices did. At its peak in June 1920, the stock of money was roughly double its September 1915 level and more than double the level of November 1914, when the Federal Reserve Banks opened for business.

  Banks began to offer public credit to buy government bonds. The price level also expanded dramatically in response to monetary inflation. The false boom continued through 1918 until the war came to an end. The nation immediately went into recession, followed by another miniature boom-bust cycle from 1920 to 1921. In total, scholars have estimated that only 21 percent of the war was funded through taxation. The remainder was funded by Fed-backed borrowing (56 percent) and outright money creation (23 percent), for a total cost of $33 billion.

  So we see that the damage that the Fed wrought came rather quickly after its creation. Compared with today, its power was limited then. But the goal of creating a lender of last resort had a devastating effect on our public policy. It inspired the government to dream of ever more power, ever more programs, ever more ambitions. So long as the funding was there, there would be no restraining the state, even when people with fiscally conservative impulses entered into leadership roles.

  Never forget what the “Great War” meant for Europe. It meant the end of the old monarchies, a relatively peaceful world that was centralized in name only and decentralized in practice, and the beginning of warlike democratic states organized along technocratic lines. For the United States, it meant the entrenchment of the imperial presidency and a globalized foreign policy mission. For Germany, it created the conditions of the great inflation, which led to Hitler coming to power based on the fomenting of national resentment.

  For Russia, it meant the beginning of Communism.

  Lew Rockwell explains how: 4

  The Russian war itself was funded through money creation, which also led to massive price increases and controls and shortages during the war… the temptation that the money machine provided the regime proved too inviting. It turned a relatively benign monarchy into a war machine. A country that had long been integrated into the worldwide division of labor and was under a gold standard became a killing machine. And as horrific and catastrophic as the war dead were for Russian morale, the inflation affected every last person and inspired massive unrest that led to the triumph of Communism.

  In the United States, it fundamentally altered the balance of power in our democratic system. Votes, campaign promises, polls, public opinion, laws, restrictions on the state, all of these forces took a backseat to the goals of the government to expand. Imagine an irresponsible teenager with an unlimited line of credit. The parents, teachers, pastors, and authorities in his life are ultimately powerless to change his habits. Now imagine that teenager armed to the teeth and also immune even from the rule of law. This is what we
have with a government backed by a central bank.

  A good example of this occurred at the end of World War I. The public was sickened by the loss of freedom that they had seen, and people demanded more accountability from government and more freedom in civic and economic affairs. Government spending fell dramatically, and there were hearings in Congress to ferret out those who had profited from war. The mood was captured by Warren Harding’s 1920 campaign slogan, “A return to normalcy.” An example of a bestselling book that reflected the postwar and interwar mood is Merchants of Death: A Study of the International Armament Industry. 5

  Sadly, however, there would never be normalcy again so long as a central bank stood ready to fund a government of abnormal powers. The old rules no longer applied. The beast that promised all things to all people, made the wishes of all politicians come true, made life easy for the money creators, and promised funding for every unconstrained vision was already created. Whatever anyone demanded from the government could be granted. What’s more, the banking establishment in this country enjoyed new guarantees against failure, which created a “moral hazard” for them. Their lending activities would proceed without due consideration of risk.

  To understand the Roaring Twenties, then, it is also important to look at the role of the Fed in monetary policy. The average annual increase in the money stock ranged between 7.3 percent and 8.1 percent, for a total increase of between 55 and 61 percent. 6 It was inevitable that this false boom would lead to a bust, first in the most fashionable sector of the economy—the stock market—and spreading through the entire sector.

  President Hoover in 1930 might have done what was done in 1920: essentially the government didn’t try to bail out the system. The Fed wasn’t yet in full swing and was actually somewhat reluctant to inflate without limit. Contrary to myth, however, Hoover actually undertook a huge effort to bail out the system using the monetary tools of the time. That they were not effective in doing so was beside the point: he tried to inflate the United States out of recession (in addition to raising taxes, imposing new trade restrictions, and more such interventions).

  Franklin Roosevelt merely followed up on the Hoover antirecession plan, and went even further in destroying the nation’s money system. He closed the banks, made private gold ownership illegal, and dealt a massive blow to what was left of the gold standard. The New Deal did not end the Depression. Unemployment was as high before World War II as it was in 1932, and incomes and productivity had actually declined. But the Fed was more powerful than ever, standing ready to fund yet another war.

  Since World War II, the U.S. government has expanded its reach with a shocking voraciousness both at home and abroad. It’s been one war after another, the building of killer weapons of mass destruction, the construction of a huge welfare state that covers all classes in society. There was the Cold War, the Korean War, the Bay of Pigs, an invasion of the Dominican Republic, Vietnam, and endless involvement in the Middle East in addition to wars on Nicaragua, Salvador, Bosnia, and Haiti, as well as all the wars around the world conducted in the name of the War on Terror. And after every major crisis, whether 9/11, the dot-com disaster of 1999, or the economic meltdown of 2008, the response is more monetary expansion.

  It was once thought that the government had to choose between providing guns or butter. Now, with the Fed, it is realized that no such choice is ultimately necessary. Politicians get together and agree to logroll so that each special interest is able to get what it wants. Guns, butter, and everything else under the sun, including endless bailouts of failing businesses as well as foreign aid for the world, are all provided courtesy of the money machine. Even when the Fed is not providing direct infusions of newly created money, it stands ready to back endless creations of debt year after year, none of which would be worth anything on the free-market bond market if the Fed were not there to guarantee it all.

  The Fed is what has made this crisis-response model possible, for without the money machine standing by to provide all the funding that the powerful people need, none of this would be possible. The American people would have to be taxed, and I doubt that they would stand for too many tax increases along these lines. Disguise this tax increase in the form of monetary expansion and you can provide government funding and spread the costs throughout society.

  The Fed is not alone among the failed central banks of the world. The interwar period also created catastrophic hyperinflations in Germany, Austria, Russia, Poland, and Hungary. 7 The promises of the glorious world created by central banking were in tatters. But by then, governments were hooked on the loose-credit drug and would not restore sound money.

  The longer we delay a conversion to sound money and away from central banking, the worse our crises will grow and the more government will expand at the expense of our liberties.

  CHAPTER 5

  THE GOLD COMMISSION

  There is no denying that the subject of gold is central to the issue of restoring sound money. That’s because gold emerged from within the structure of the market economy as the most important guarantor of the quality of money. It was not chosen by governments but by the market. The reason is easy to understand. Gold has all the qualities that we associate most with good money: divisibility, portability, high value per unit of weight, durability, and uniform quality.

  Whenever I talk of a gold standard, there are always people ready to accuse me of having some obsession or fixation. Fetish is a word thrown around. In fact, I’m only observing reality: the idea of sound money in most of human history has been bound up with gold money. Can there be sound money without a gold standard? In principle, yes. And I’d be very happy for a system that would permit markets to once again choose the most suitable money, whatever that turns out to be. I’m not for government imposing any particular standard: no central bank, no legal tender, no privilege for any commodity chosen as a backing for the currency.

  And yet the reality is that the dollar is money, even if the quality of the dollar is very poor. I’ve always believed that government has a responsibility to restore what it has destroyed. In the late 1970s, many people began to agree. I coauthored with Jesse Helms the legislation that passed in the closing days of the Carter administration to form the Gold Commission. The commission was not organized until after President Reagan took office. Of its seventeen members, Lewis Lehrman and Arthur Costamagna were the only others who were sympathetic to gold. The rest were antigold politicians, Fed members, and Treasury officials.

  Secretary of the Treasury Donald Regan was the chairman of the committee and presided over our first meeting on July 16, 1981. Interestingly enough, that first meeting was off the record, without the media, and no minutes were taken. The plan to keep all meetings secret and without minutes was revealed to the public with the help of columnist Bob Novak and others, and there was a bit of a public uproar. Due to public pressure, a vote of the committee membership showed overwhelming support for open hearings.

  Henry Reuss, chairman of the House Banking Committee, attended one meeting and left in a rage. He couldn’t stand one minute of serious consideration of the importance of gold. Before ownership of gold was made legal once again in the United States, which occurred in 1975, Reuss predicted that if it were to occur, gold would drop to $5 an ounce and the “gold bugs” should be happy with the government propping the price up at $35 an ounce. He, of course, had it wrong; it was the artificially low price of gold that was propping up the value of the dollar—at least temporarily.

  By the time of our first hearing, gold had topped $800 an ounce. Reuss was not in a good frame of mind. He had been given a pro-gold newsletter by an attendee that prompted his outburst. As he left, he crumpled up the newsletter, tossed it, and let out a tirade attacking the commission’s purpose. Let it be recorded that though there was little sympathy on the committee for gold, Reuss won the award for being the most hostile to the thought that gold could replace the “wisdom” of the Federal Reserve Board and “wise” chairmen of the
Banking Committee.

  At the time, no one seriously believed we were on the verge of restoring some relationship of the dollar to gold, yet there was deep concern regarding the dollar, inflation, and the very weak economy. The worries were great, but compared to the fear felt today, there’s no comparison, and for good reason.

  In 1981 we had only been operating with the fiat dollar reserve standard for ten years. Today, we’ve had the imbalances build up for thirty-eight years. In some ways the painful adjustments of the 1970s were helpful for the short term. The need for dollar devaluation was recognized. Fluctuating exchange rates, as disruptive as they were, provided a “market” mechanism that was better tolerated than the pretense of artificially fixed exchange rates. In other words, a token market mechanism was helpful to prop up a very fragile system.

  I recall vividly an event following one particular meeting of the Gold Commission at the Treasury Building. The Houston Republican delegation made plans to attend a Republican function in Houston, along with President Reagan. We were to meet Reagan at Andrews Air Force Base and fly on Air Force One to Houston. Due to the commission’s hearing at the Treasury Building, which is across the street from the White House, my staff arranged for me to walk across the street and fly with President Reagan on Marine One to Andrews. That way I wouldn’t miss any part of the hearings and could still travel to Houston for the Republican meeting.