by Ron Paul
The economic ramifications of the Fed’s inflationary policies are endless. Due to easy credit, housing prices soared above reasonable levels. Borrowing against these increased values to increase consumption was exactly what the monetary authorities encouraged. Naturally, a bubble formed and had to eventually deflate. Now the Fed, Treasury, and Congress spend trillions of dollars trying to stimulate housing and get the price of houses higher once again. This they do even though market forces are demanding fewer houses due to overbuilding.
The central planners have become price fixers. It’s not a whole lot different than imposing wage and price controls at various times to correct rising price inflation. One attempt is to keep prices from dropping; the other is to keep prices from rising. In doing either, they are eliminating the most important mechanism needed to adjust supply and demand and rejuvenate markets. This represents a grave danger. When interventionists interfere too much with free-market pricing, we move toward a socialist system that in the twentieth century was proven to be unworkable.
The Bernie Madoff fraud case received plenty of attention, and rightly so. Adequate antifraud laws are on the books, and fraud is something every state is capable of handling. The fraud involved in the Enron scandal was prosecuted under Texas state law. Yet the consensus was that there weren’t enough SEC regulations controlling these sorts of things, even though it was active traders, not regulators, who first discovered the problem. Congress accommodated and quickly passed the Sarbanes-Oxley legislation. Just as the SEC regulations of the 1930s aggravated and helped to prolong the Depression, the bear market starting in the year 2000 has been aggravated and prolonged by Sarbanes-Oxley.
The argument following the Madoff revelation of a $50 billion Ponzi scheme prompted outcries about the deficiencies of the SEC and that we needed even more SEC regulators on the job. We have 3,500 bureaucrats in the SEC, and the argument is that we don’t have enough. Of course that’s enough, although the truth is that 20,000 SEC regulators wouldn’t suffice because they can’t police every business transaction and prevent fraud from being committed. We don’t expect a policeman in front of every house in the country to prevent our homes from being broken into.
The idea that the SEC and more Sarbanes-Oxley legislation will protect us against evildoers in the marketplace will not help us. The idea that we can depend on the SEC to protect us significantly contributes to moral hazard. More risks are taken believing the government will protect us, and our guard against evil is diminished.
Easy credit by the Fed sets the stage for excesses, both honest and dishonest. Government insurance, like the FDIC and mortgage insurance, reassures us and the banks that everything will be safe and that we’ll be protected. The current programs of endless bailouts for everyone provide plenty of incentives to take risks that most would not otherwise have taken.
The government may be able to guarantee our bank accounts up to $250,000, but what it can’t protect against is the devastation caused by collapsing financial bubbles and a depreciating currency. Deflating financial bubbles and inflating the cost of living are problems that only scoundrels at the Fed can deliver to us. All the regulations in the world on the economy won’t help. Regulations must someday be directed toward the more deserving targets, such as the Fed, Treasury, FDIC, SEC, and the Exchange Stabilization Fund.
The entire system of fiat money and fractional-reserve banking is like a super Ponzi scheme (if we can’t pay it back, let’s just create more!) and is the source of our problems. Why should we be surprised that, if our government runs a Ponzi scheme, some people feel morally justified doing the same? When did we accept this idea that governments have license to do what they want without moral restraints, and the people must live by a different standard? The answer, of course, is that government must follow the same rules that moral people are expected to.
One of the great dangers that exists once the problem breaks out from collapsing financial bubbles is the cry for protectionism. The Smoot-Hawley Tariff Act of 1930 is the well-known protective tariff that compounded and prolonged the Great Depression.
Today there’s general agreement that protective tariffs are bad, and no one runs on a platform pushing tariffs as Hoover did in 1928. That doesn’t mean there’s not agitation for protection, whether it’s for steel, cars, textiles, or agriculture, but hopefully a significant tariff is not in the works.
The issue is that problems of trade imbalances are also a consequence of Federal Reserve policy. Our trade deficits, a very serious problem, have been compounded by our privilege of issuing the reserve currency of the world. This gives us license to inflate and export dollars as if they were gold. This, plus excessive taxes, excessive regulations, and overpriced labor, causes our jobs to be exported.
We can’t solve our trade problems with tariffs. They make things worse. We can’t solve the imbalances without addressing the subject of money and the power the Federal Reserve has over the economy.
The simplest way to understand the idea of tariffs is that, in a free country, the people have the right to spend their money any way they want. If it’s to the advantage of poor people to buy tennis shoes from China, they should have the right to do so.
Tariffs are legal under the Constitution. If we had a constitutional-size government and no welfare-warfare spending, a uniform tariff to cover the cost would certainly be a better way to raise revenue than an income or value-added tax.
Tariffs that protect excessive executive salaries, excessive wages, businesses that suffer from excessive taxation and regulations, or bad business decisions only prop up inefficiencies. The problems contributing to the inefficiencies must be removed. We shouldn’t add another problem and another tax to the mess. Tariffs are taxes.
Today, though, tariffs are less likely to be imposed; competitive devaluations to gain an edge for exporters are common. Sound money and no central bank would prevent such a problem and diminish the need for protectionism.
There are many economic ramifications of a central bank like the Federal Reserve operating a totally fiat monetary system. The power to practice central economic planning is too much for the money managers to resist, and the swollen ego of a Fed chairman only encourages mischief.
The ease of financing spending by the Congress with the help of the Federal Reserve makes huge deficits a foregone conclusion. It’s cheaper in the short run to inflate than it is to borrow and much more palatable than immediate taxation to pay the bills. If a country could not borrow or inflate its currency, its government would be much smaller and the country more prosperous and safer. Needless wars would not and could not be fought.
In the long run, the seductive way to finance government’s extravagant spending ends badly. It’s never cheaper, and the real costs are significantly higher. Early on, it appears that it’s a neat trick to pay the bills this way, and politically it’s more acceptable. But the cost to everyone concerned for the economic havoc that results from the inflationary bubbles and the corrections required are far more than anyone bargained for. Instead of a free lunch, the real costs are much higher than anybody anticipated when all the misery of a depression is tabulated.
Everybody recognizes difficult economic times when the predictable recession or depression hits. The problem, though, is that with the brainwashing in economics most Americans have received, the people are unaware of the cause of the problem and the policies needed to restore the economy. Too often the people, the politicians, and the central bankers demand more of the same—more spending, more deficits, more regulations, and above all else, more inflating of the currency—none of which will be helpful. Instead, they compound the problems.
People worry what would happen in a world without the Federal Reserve. My answer is that you would enjoy all the privileges of modern economic life without the downside of business cycles, bubbles, inflation, unsustainable trade imbalances, and the explosive growth of government that the Fed has fostered. You would also disempower the secretive carte
l of powerful money managers who exercise disproportionate influence over the conduct of public policy. Without the Fed, Keynesian-style macroeconomic planning that has done so much harm would be no more. (I discuss this at greater length in the final chapter.)
Such are the benefits. But people still worry how banking might work. It would work like any other private enterprise system. Walmart might enter the market, as it wanted to but was prohibited from doing. It would be a truly competitive system that any entrepreneur would enter. But would this be “wildcat banking” of the sort that is frequently condemned from the nineteenth century? No more so than we have “wildcat restaurants” or “wildcat shoe companies.” Markets are self-regulating, responding to the wishes of consumers. It would be the same in banking.
In any case, most of the tales of nineteenth-century banking are mythical. The problems of that century’s monetary and banking system were imposed by government. There were periodic suspensions of payment, inflationary wars, crazy price-fixing rules under the bimetallism system, and other forms of debt finance. These were problems with government, not the free market. The free-market system worked rather well. In research published by the Minneapolis Fed, two scholars have looked closely at the banking system from 1830 to 1860 and found that it was remarkably stable and safe, with no wide-spread fraud. Bank failures were fewer than people believe, and importantly, there was no “contagion” effect, that is, a failure of one bank didn’t spread to other banks. 2
This is not entirely unexpected. The bad reputation of nineteenth-century American banking—which existed during what was then the most explosive increase in prosperity ever seen in any country in the history of the world—is largely the result of turn-of-the-century propaganda agitating for the creation of the Fed. We need to look at the facts. And the facts do not surprise us, once we consider that money and banking in a free market would operate like any other normal business enterprise, subject to profit and loss tests and punished or rewarded in the market based on consumer behavior.
We no more need to worry about banking in a post-Fed era than we worry about groceries, shoes, or software now. They are provided by the market and not some distant central-planning apparatus that possesses neither the knowledge nor the incentive to do it well.
To save ourselves from economic and political disaster, a dramatic change in the conventional wisdom of economic policy by our leaders is vital. Fortunately, our numbers are growing and more people than ever, especially young people, are now aware of the menace we face from the Federal Reserve and understand the importance of sound money.
CHAPTER 14
THE LIBERTARIAN CASE
So I believe that there is no more economic or constitutional justification for the existence of the Federal Reserve. When honesty prevails, there are only economic arguments against the Federal Reserve. There are no benefits except to some undeserving special interests. There is an ultimate downside to ignoring all the arguments against its existence, one that cannot be tolerated by anyone who is concerned about protecting liberty, and that is the expansive growth of government that inevitably results. There’s always a trade-off. When government grows, liberty suffers. This happens no matter what justification is given for the government programs being financed.
Those who (possibly unconsciously) seek socialism, fascism, interventionism, or corporatism always support central banking. Some sincerely seek a central bank as a tool in economic planning to make up for the perceived shortcomings of the free market. Although many who support a central bank will claim that growth of government is not their goal, the result is otherwise. It’s the nature of the beast.
Remember that the people who run the Fed are just regular people, as flawed as anyone else. The only difference is that they have massive power to break civilization. Any institution that can do this is by nature tyrannical and is specifically what the Constitution was trying to prevent. Authority to create money gives credibility to legalized counterfeiting. Some supporters of this power believe that the money managers should and will be restrained in creating money for any reason other than for humanitarian purposes. This expectation of self-restraint never works out in the end.
As we have seen time and time again, central bankers have big egos and quickly adapt to the potential power they wield. Then there is also the political pressure to accommodate the deficits that politicians thrive on. Talk about moral hazard. This corrupt method of paying the bills and avoiding direct taxation only serves to institutionalize a system that breeds contempt for liberty and self-reliance, while feeding the growth of big government.
In the early years of an inflationary bubble, the benefits of central banking exceed the costs. When the bills come due, it’s hard to identify the victims. Those who do suffer from the inflation and lost jobs rarely see the connection between the Federal Reserve monetary policy and the suffering that comes as a consequence of financing big government in this evil manner.
The monetary system is used to finance welfare for rich and poor, and for fighting unpopular wars. If the people knew the real costs of the welfare-warfare state, they would rebel. But during the boom phase of the business cycle, there seem to be no real costs due to the artificial increase of value of houses and stocks. Then the bubble bursts and the truth becomes known: the prosperity was based on a fiction.
But by then, the government has taken over the economy and our lives and made foreign commitments that can’t be met. There is extravagance in both domestic and international commitments. We can no longer pay the bills for social welfare or maintain the empire overseas. How many times do we have to see this happen before we change the fundamentals?
In the process, liberty is compromised every time a new welfare program is established or a new war is entered into. When danger breaks out as a consequence of our policies, inevitably the authoritarians, already in charge, use the problems they created to tighten their grip over the people and the economy.
Terrorism is a serious problem, but if it’s not seen as blow-back from our unwise foreign interventions, then the only solution offered will be more government control of our lives. We don’t change foreign policy; we merely regulate the innocent American people by abandoning the Fourth Amendment protection of their privacy. Those who wanted bigger government anyway conveniently used the problems—such as the 9/11 terrorist attacks—to build fear in the people so they practically beg the government to protect them from harm.
It’s quite similar in economic affairs. Excessive spending and the Federal Reserve money machine bring on all kinds of economic problems in the corrective phase of the business cycle they create. The cry once again is for government, the perpetrators of the crisis, to come to the rescue with even more government, which requires more sacrifice of liberty.
The cycle is continuous. At first personal liberty is nibbled away at, but the appearance of prosperity continues. Later on, the worse the crisis, the greater is the threat of tyrannical government entirely taking over our lives and the economy.
This attitude can best be understood by what President Bush said on CNN on December 16, 2008, when he proudly announced: “I have abandoned free-market principles to save the free-market system.” Astounding and preposterous!
Unfortunately, most Americans agree with him. They agreed after 9/11 that abandoning privacy protection by the Constitution was required to keep us safe and alive. “How else,” they asked, “can you enjoy your freedom?” How could they not see the contradiction in that? The President’s statement is quite similar to the excuse for burning a village and killing civilians while being unconcerned, during the Vietnam War, about collateral damage. “Destroying the village,” they claimed, “was required to save it.”
The principle here is that we are expected to accept without question that we should welcome government action that destroys liberty to save it. It is precisely this idea that urges us to accept the destruction of the dollar in order to save it.
The whole process would be
virtually impossible without the seductiveness of a paper money system managed by a monopoly authority. Brute force at times is used by tyrants to come to power, but they quickly gain control over the monetary system to keep themselves in power.
When a society is relatively free, such as ours, it is through the use of deficits, taxes, fear, and fiat money that power is solidified. The authoritarians need the central bank for this takeover.
Those who have, on principle, correctly argued against the tax-collecting tactics of our government and the unconstitutionality of our monetary system find that their punishments can be even harsher than that of rapists and murderers. As the iron fist grows in size and the invisible hand influence on the market is diminished, we will see a transformation of America that spells the end of a grand experiment in human liberty.
All the actions of Congress, the administration, and the Federal Reserve to run the economy are designed to promote the public good, and the results are a disaster. None of the ongoing bailout programs could exist without the Federal Reserve. This process represents an iron fist. A hands-off attitude represents a more sensible approach—allowing the invisible hand of free markets to function and correct the imbalances.
It has been said that no war has been fought without inflation. If we could ever devise a monetary system where inflation was absolutely prohibited, the chance of war breaking out would be greatly reduced. If we had to immediately pay for our foreign entanglements, people would not tolerate paying the bill with higher taxation. It’s the meddling in the internal affairs of other nations that brings about the conditions that result in armed conflict. Not initially financing foreign intervention would make us much less likely to get involved in no-win, totally unnecessary wars.
