End the Fed

by Ron Paul

  The poor were deceived into believing government force could get them a home even if they hadn’t saved a penny, and it didn’t work. But many thrived as the housing bubble developed. Fannie Mae and Freddie Mac executives did well and “escaped” with millions. Even after the collapse many were still able to collect taxpayer-subsidized retirement benefits. Builders made huge profits constructing houses and stashing away profits, enjoying the steady increase in prices. Sale prices frequently exceeded the anticipated price when construction started.

  Mortgage brokers, banks, insurance companies, “flippers,” landowners, and developers all enjoyed the ride, and many were able to protect themselves. The poor were not so lucky. With the collapse of the imbalances created by the dream of easy wealth, the poor, deceived into believing politicians could deliver the moon, are now unemployed and without a home. The last thing that is likely to save them is a public works program. If the government was completely wrong in allocating massively excessive capital into housing, precipitating the greatest financial bubble in human history, it is hardly capable of making the correct decision as to where capital should be directed in the next decade.

  There are many programs similar to the CRA that add fuel to the fire of waste, fraud, debt, and malinvestment. Significantly contributing to the moral hazard, that is, the bad judgment, have been the FDIC, SEC, Fannie Mae and Freddie Mac, HUD rules and regulations, court orders, the IRS, and a credit card mentality of no limits.

  GSEs (government sponsored enterprises) such as Fannie Mae and Freddie Mac sent a message to investors and lenders that the Treasury and the Fed would always be there if any problems arose. Foreign investors were definitely more inclined to invest in securitized mortgages knowing that Fannie Mae and Freddie Mac had an open line of credit to the U.S. Treasury. Interest rates were already below market due to Fed policy, but the line of credit lowered rates even more, encouraging more risk taking. Subsidized mortgage insurance produced great incentive for making subprime loans that would have otherwise been rejected. And if there was no Fed, the risk takers all would have thought much more about the consequences of their actions.

  Sarbanes-Oxley, a regulatory consequence of the Enron and Long-Term Capital Management failures that imposed massive new costs on American business, did nothing to prevent today’s crisis. Our problem today was not caused by lack of business and banking regulations. Many, including Greenspan, now argue that the major flaw in the system was the lack of adequate legislation to control “unbridled capitalism.” If only we could have monitored the “derivatives” market, the bust could have been prevented, they argue. Not so! Bureaucratic regulations cannot compensate for government programs and a Federal Reserve policy of inflationism that guarantees gross imbalances in the economy and provides a permanent safety net so that major losses are not felt by the perpetrators.

  The only regulations lacking were the ones that should have been placed on the government officials who ran roughshod over the people and the Constitution.

  The Fed, short of being abolished, should have been prohibited from creating money and credit out of thin air and exerting monopoly control of the system with authority to set interest rates. These powers, unregulated, have nothing to do with freedom and sound economic policies.

  The Treasury should be regulated much more carefully. What it can do with its power is rarely monitored or understood by the Congress. Secret use of multibillion dollars in the Exchange Stabilization Fund that’s been available since 1934 is off budget, and the Treasury can spend billions of dollars any way it pleases. It also has “legal” power to be involved in the gold market. Although there’s no admission by Treasury, I’ve always been convinced that the Exchange Stabilization Fund is involved in stock, commodity, and currency transactions by manipulating prices.

  As part of the ignored President’s Working Group on Financial Markets (Plunge Protection Team), the Treasury, along with the Fed, SEC, and CFTC, will continue to rescue the market any way possible. Unfortunately, it’s more likely that its powers will be used to bail out friends at the expense of the rest of us.

  Wall Street won’t object. It wants protection from downturns and cares little about truly free markets. Wall Street expects and welcomes behind-the-scenes assistance and the more obvious bailouts that are epidemic today. Plans were bold to control the markets for the benefit of the establishment, but evidence is abundant that the markets have shown superior strength to the elites armed with false ideologies.

  The post-meltdown bailout economy has been one of the most frightening sights I’ve seen in all my years in Washington. President Bush, anxious not to be seen as another Hoover (who in fact was a horrible interventionist, contrary to what civics-book history says), embarked on a crazy program. He found himself committed to some $700 billion in bailout money. The Fed has committed trillions of dollars. President Obama followed up with an even larger stimulus package.

  This spending will only stimulate sectors of the economy that are failing. This is like trying to rid the world of gravity by throwing things up in the air. It addresses symptoms, not causes. It robs the private sector of wealth that can be used for recovery. The debt buildup crowds out private-sector lending. It perpetuates bad views concerning home ownership. It subsidizes the past while ignoring the future.

  The deficit is nearing $2 trillion for 2009. The proposed budget promises to create nearly $10 trillion in new risk. The economist Michael Boskin estimates that all of this will lead to $163,000 in new taxes for the typical American family—that is, if it is not inflated away. 6 Even mainstream economists like Joseph Stiglitz are calling this a robbery of the American people. And the more bailouts there are, the more government gets involved in running companies like General Motors, firing and hiring CEOs. Does anyone really think that the federal government should be in the business of hiring and firing CEOs of companies?

  The U.S. debt obligations are unfathomable, approaching $12 trillion. You might say that the entire federal government is one giant toxic asset at the moment. It certainly has no business telling the private sector how to run its affairs. It is in worse financial shape than all the companies in the private sector put together.

  And yet someone is getting the money. Mostly it is powerful players in the market, institutions that are regarded as essential to national well-being, such as Goldman Sachs and AIG insurance. In fact, these companies could have been allowed to go bankrupt with no downside for the general population, just like Lehman Brothers was allowed to die. Yes, there would be pain, but at least it would be temporary. The current path is prolonging and extending the pain—while causing a slow death dressed up in fancy clothes.

  CHAPTER 10

  WHY END THE FED?

  The Federal Reserve should be abolished because it is immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty. Its destructive nature makes it a tool of tyrannical government.

  Nothing good can come from the Federal Reserve. It is the biggest taxer of them all. Diluting the value of the dollar by increasing its supply is a vicious, sinister tax on the poor and middle class.

  The Federal Reserve’s monetary policy has brought us to where we are today—in a tragic economic mess. Though the dollar survives for now, the international financial system built over the past thirty-eight years has been brought down by market forces. The fiat dollar reserve standard that evolved out of the breakdown of Bretton Woods in 1971 has come to an end. That is the significance of the economic crisis in which we find ourselves.

  Continuation of the same inflationary policies that led to this disaster cannot revive the current system or bring back the Bretton Woods system of 1944. They are finished. What it can do is destroy the dollar. Unfortunately, since the housing bubble burst, signaling the end of a monetary era, everything Congress and the Fed have done has set the stage for a dollar crisis. That’s very bad news since the rejection of the dollar will create, mainly out of fear and a lack of any other ideas
, an even greater crisis than the collapse of the international financial system.

  The evidence is abundant that the Fed is at fault and should be abolished. So far, though, all Congress has done is give it even more power as the principal central economic planner.

  Karl Marx’s Fifth Plank of the Communist Manifesto is clear: “Centralization of credit in the banks of the State, by means of a national bank with state capital and an exclusive monopoly.” This does not mean that everyone who advocates a powerful central bank is a communist. It does mean that if one is inclined toward authoritarian rule, a central bank is of the utmost benefit.

  A central bank by its very nature is the opposite of a commodity standard of money. A gold standard does not require an authority to run it. If a central bank comes into being when a gold standard is in place, the purpose is to circumvent or eliminate the restrictions the gold standard places on those who want to enlarge the government over the opposition of the people. The only government involvement needed for a gold standard to work is to enforce antifraud laws and contracts.

  Inflation and debasement of currencies have been around for a long time. Before modern-day central banks, the government, a king, or a tyrant with monopolistic powers over the monetary system could choose to debase the currency for some ulterior motive, many times to pay for war and expand an empire.

  The irony is that once the power over money is used to build the state, in time the very process of monetary debasement frequently destroys the empire with an economic crisis of its own making.

  From the time of Constantine I, for six centuries, the Byzantine Empire thrived in international trade and commerce with a gold standard. Not only did Byzantium believe in honest money, it endorsed free trade and rejected the principles of mercantilism. The gold coin, the byzant, was used all over the Mediterranean and known throughout the world.

  For 600 years, the byzant maintained its value, keeping price inflation in check while the economy thrived. In 1071, Nicephorous III Botaniates reduced the amount of gold in what was then the world’s most used coin. Fighting a war with the Turks was the excuse for the devaluation. Byzantium lost the battle against the Turks, and lost its currency. Financial chaos erupted and brought an end to the Byzantine Empire. Historians claimed the end of Byzantium resulted from “a financial tragedy.”

  Although the worldwide elites of our day are very powerful and rich and control the central banks, they, too, will face limitations, just as Byzantium did nearly a thousand years ago. The banking elite may be laying plans for even more control through globalization of trade and financial controls in a worldwide central bank managing a new fiat currency, but the laws of economics will prove cumbersome for them to overcome.

  The durability of gold as money was verified once again in December 2008. Archaeologists discovered nearly 300 gold coins dating back to a.d. 600. The coins were issued by the Byzantine emperor. The coins were every bit as valuable as they were 1400 years ago, and more.

  One must wonder what our Federal Reserve notes will be worth when discovered in some hideaway a hundred, fifty, or even a year from now. There’s no way society can build a lasting and prosperous economic system without money of real value that lasts.

  To understand exactly why the Fed must go, one must realize that a commodity used as money is needed for a society to be free. It’s as much an argument for gold as it is against a central bank.

  We need not dictate the exact commodity to be used as money in a free society, but history up until now has overwhelmingly chosen gold and silver as money.

  Gold was naturally selected by people to use in exchange and trade for more than 6,000 years. In 4000 B.C., Egyptians had bars of gold stamped with Pharaoh’s name and used them as money. The first real coinage was introduced by the Lydians in approximately 750 B.C.

  Certain characteristics made gold a natural choice as money. It didn’t become money merely because some government decided to use it as such. A recognizable substance that was easily portable and that had inherent value was called for. Some say money should serve as a store of value, easily divided, scarce, and desirable. Its most important function is to act as a means of exchange to facilitate trade. Most people recognize that prices of all goods fluctuate and the free market adjusts these changes quite efficiently. Some mistakenly think the value of gold is rigid and leads to “stable” prices of goods and services. Since gold supplies are limited compared to government’s ability to print paper money, it indeed does give us much more stable prices. But the value of gold or silver or Federal Reserve notes is affected by their supply and relationship to other commodities. That is why the system of bimetallism, that is, fixing the ratio of gold to silver, was not a satisfactory system in our early history.

  Money developed in early history to facilitate trade and avoid the cumbersome transactions required by barter. Today’s complex world trade could not exist without money; bartering works only in primitive economies. Sometimes, though, modern economies become primitive and barter returns, such as occurs after wars and in financial crises. If we’re not careful, it could happen again to us.

  The importance of money is obvious, and though gold may not be rigid in value, it becomes practical because of its scarcity and efficiency in trade.

  The monetary unit of account is used as half of every economic transaction, the other half of course being goods and/ or services. One could argue that understanding the nature of money is crucial since every transaction depends on the current perception of its value and the anticipated value of the money in the future. Dealing with economic problems is an overwhelming task for a society that is forced to use an indefinable paper currency that may quickly suffer loss of value at the whims of the monetary authorities who have monopoly powers over its supply.

  In a modern economy, no matter how sophisticated it may seem or how long in operation, the more an unpredictable fiat currency serves as the reserve currency rather than a nongovernment entity like gold, the more fragile will be the system. Because the authorities can get away with the fraud for decades, the imbalances will continue to grow and will eventually bring the system to a halt. The more definable the unit of account is, the more smoothly and longer the economy will operate. Paper money, politicians, and central banks always fail the test of time.

  When the Federal Reserve was established, its purpose, according to the Federal Reserve Act of 1913, was to “furnish an elastic currency to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States and for other purposes.” This was pretty broad in scope; look at what it has brought us after ninety-five years: no stability whatsoever and numerous crises of historic proportions.

  An elastic currency! I’ve always been fascinated with this term. I think of it more as a method to allow the government and banking authorities to be elastic with their powers to inflate the currencies for whatever goal they seek. They paint it as the Federal Reserve serving as a lender of last resort in order to protect the workers and depositors, but that is not the prime purpose of having an elastic currency.

  In an interesting and good sort of way, gold is elastic. It might be said that it is flexible, efficient in dealing with all the factors that affect prices of goods and services and the value of money. It adapts to market forces. Its supply, unregulated, is always adequate. It serves to adjust for settling current account imbalances so much better and smoother than fiat currency does.

  Bernanke and Greenspan always conceded to me that the imbalances in the current account and the foreign deficits we’ve run up are a serious problem but would never concede that this reflected the shortcomings of the fiat dollar reserve standard. They would never concede that these problems would not have developed with the gold standard.

  But gold adapts monetarily and can be “stretched” to serve as money when prices drop as a consequence of high productivity. The purchasing power of gold goes up and is stretched to accommodate more transactions. T
here’s too much concern about an inadequate amount of gold. This is a worry that need not be. Paper may be “elastic” in the sense of inflating and bailing out bad debts, but it also acts like a boomerang as the “stretching” money supply snaps back with both inflationary and deflationary consequences.

  Putting money in the right perspective is crucial. Money does not equal wealth; gold alone is not wealth. Some believe that an increase in paper money will provide wealth, yet all it does is dilute the value of the existing money in circulation. Just automatically doubling the amount of gold in circulation may be a lot more fun compared to doubling the amount of paper currency, but it doesn’t substitute for productivity and improve commerce and trade. If productivity doesn’t go up, even doubling the gold supply will merely push prices up in the gold currency.

  Greenspan and I sparred over a definition of savings at one of our hearings. I considered it a bad sign that we were no longer saving and that all we were doing was borrowing and consuming (and that too often the borrowing was possible only because of an increase in home equity as a consequence of inflation). He argued that because the value of most people’s homes was going up, this valuation represented “savings.” I strongly disagreed and claimed he was confusing debt with true savings. He thought it was perfectly fine for the increased value of peoples’ homes to be borrowed against with the funds used for consumer purposes.

  If the value of one’s home comes from savings and not from artificially inflated prices, there would be no housing bubble. If one puts down 20 to 30 percent on the purchase of a home, the value of the house may fluctuate with the economy for various reasons, but these changes couldn’t create a housing bubble that is destined to explode.