Abolish the Fed

For most Americans, the Federal Reserve System is something that receives little attention. It has been in existence longer than most have been alive and with rare exceptions, the role it plays day to day is never discussed.

The Fed, as it is known, was created by Congress in 1913 after the Panic of 1907. Panics in those days would certainly be called a recession or depression in our overly sensitive current society.

The United States had been without a central bank since 1836, when Andrew Jackson closed the Second Bank of the United States. The primary purpose of establishing the Fed was to quell bank panics, and secondarily to provide an elastic currency, stable price level, and stop unemployment.

Murray Rothbard, noted economist and professor, described the Fed in the simplest terms. “The Federal Reserve System virtually controls the nation’s monetary system, yet it is accountable to no one. It has no budget; it is subject to no audit; and no Congressional Committee knows of, or can truly supervise, its operations.”

Outside of the Austrian school of economic study, there is rarely discussion of the Fed’s usefulness. Therefore, I’d like to bring everyone into the fold and discuss the reasons against maintaining a system built of failure.

The first issue with the Fed comes from the old standby, the Constitution. Article I, Section 8, granted Congress the power “to coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures.”

The people never gave congress the constitutional power to delegate this money-creating and regulating responsibility to any private group. Yet this is exactly what the Federal Reserve Act of 1913 did.

But since nobody cares about the Constitution anymore, it would be more prudent to look at the data. Specifically, what happened in the 94 years before the Fed became operational in 1914, and the 94 years since?

The United States was on the gold standard in most of the years prior to the Fed, and there was no systemic inflation over the century before the Fed. There were some periods of inflation (during the Civil War) and a sustained period of deflation in the 1890s, but wholesale prices were nearly the same in 1914 as 100 years earlier.

It should be noted there are reasonably reliable wholesale and/or producer price numbers from the late 1700’s, but the consumer price index (CPI) did not exist in the 19th century. The CPI has grown by more than 2,000 percent since 1913, meaning the typical item that cost $20 back then would now cost more than $400.

It could not be clearer that in terms of price stability, the Fed has failed miserably.

The total number of banks grew rapidly in the century before the creation of the Fed, but the number declined rapidly during the Depression of the 1930’s, both because of bank failures and mergers. The merger trend has continued in recent decades, and the total number of banks continues to fall; not necessarily a bad thing except when they are “too big to fail.”

The Fed was supposed to regulate banks to avoid large numbers of bank failures that occurred in the Panics of 1878, 1893, 1896 and 1907. However, these episodes only resulted in the closure of a few hundred banks, which turned out to be minor compared to the Great Depression where thousands of banks failed, or even the Savings & Loan crisis of the late 1980’s and early 1990’s where a total of approximately 1,600 banks failed.

The Fed stopping bank panics? Once again, disastrous failure.

There is also no evidence unemployment rates have been lower on average since the Fed’s creation. The unemployment statistics only go back to 1890. There were a few years in the early 1890’s where unemployment was in the double digits, but this episode was neither as long nor as severe as the one in the 1930’s.

The empirical data justifies the members of Congress who voted against the closely contested bill enacting the Fed.

The events of 2008 appear to have the same origins as the previous panics or recessions/depressions. What typically occurs is a monetary expansion (too much money and/or credit) where interest rates are too low, resulting in a rapid rise in the price of assets.

This leads to what Austrian economist and Nobel Prize winner F.A. Hayek called not too much investment but “mal-investment,” which, in turn, leads to a rise in consumer prices. Under a gold or commodity standard, the loss of reserves finally brings the inflation to a halt.

Under a fiat monetary system (value comes from government order), which the Fed and almost all other central banks now use, the end of the inflation only comes when the central bank finally decides to end it by restricting money and credit. This rarely happens because it is not politically desirable.

Gerald P. O’Driscoll, a former senior Fed official, recently said it best. “The central bank is like an arsonist watching a fire he set, expressing amazement at how such an event could have happened. The Fed created a moral hazard by first, implicitly, then explicitly promising to bail investors out of risky commitments.”

Before the Fed and big government, previous bank panics usually ended quickly without “bailouts” or “economic stimulus” programs. Given that the Fed, the Treasury and the Congress are obviously confused about what to do in the current situation, history indicates that perhaps the least harmful course of action is for them to do nothing.


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