Questioning the Need for the Federal Reserve

At the New Republic's web site, Alvaro Vargas Llosa uses the federal raid on the Liberty Dollar as a hook to ask: do we really need a Federal Reserve? He namechecks libertarian economist greats Murray Rothbard and Milton Friedman on the way. An excerpt:

All in all, financial instability has been far greater since the creation of the Federal Reserve. What did the Great Depression teach us? Essentially that even with the best of intentions, it is impossible for the authorities to manage the supply of money in accordance with the exact needs of the economy……

The current housing market and debt market crises are in good part the children of the Federal Reserve. By cutting rates 13 times between 2001 and 2003, and then keeping them very low for years, monetary policy contributed to the housing bubble. That is not to say other factors--including financial instruments that made it difficult to see that the underlying foundation was not as solid as it seemed--did not play a part too. But, once again, the Fed has turned out to be a factor of financial instability.

In this context, Norfed's attempt to prove to the Fed that the market is ready to trust private currency backed by gold is a welcome occasion to take a second look at some of the economic institutions we take for granted.

Past Liberty Dollar raid blogging here and here.

Comments

[Jay D]

Alan Greenspan: We didn't need a central bank when we were on the Gold Standard people would buy and sell gold and the markets would do what the Fed does now. . . but by the 1930s most everybody in the world decided that the Gold Standard was strangling the economy and universally the Gold Standard was abandoned...you need somebody out there or some mechanism to determine how much money is out there because the amount of money in an economy relates to the amount of inflation...

"Most everybody" was probably looking for a get-rich-quick-scheme.

Greenspan: I was telling my colleagues the other day...I'd been dealing with these big mathematical models for forecasting the economy, and I'm looking at what's going on the last few weeks and I say, "Y'know, if I could figure out a way to determine whether or not people are more fearful, or changing to euphoric... I don't need any of this other stuff. I could forecast the economy better than any way I know. The trouble is, we can't figure that out. I've been in the forecasting business for 50 years, and I'm no better than I ever was, and nobody else is either."

If we didn't need a central bank on the gold standard, and nobody is any good at centrally controlling the economy anyway, why do it?

Stewart: So we're not a free market then - there is an invisible...a "benevolent" hand that touches us...

Greenspan: Absolutely, you are quite correct. To the extent that there is a central bank governing the amount of money in the system, that is not a Free Market, and most people call it regulation.

OK you libertarians... how can you support a system that is not free?

[Adam]

"financial instability has been far greater since the creation of the Federal Reserve."
Umm, no. The 1800s were racked by a number of financial crises that usually had to do with a sudden influx of gold into the system. The nice thing about the federal reserve is that we don't have to worry about the money supply suddenly increasing for the random reason that someone just struck the motherload. An institution controls how much money there is and can try to match the money to how much is needed by current economic conditions. Sure, it isn't perfect, but it's better than the gold standard.

[Kolohe]

financial instability has been far greater since the creation of the Federal Reserve.

William Duer Panic, 1792
Crisis of Jacksonian Finances, 1837
Western Blizzard, 1857
Post-Civil War Panic, 1865-69
Crisis of the Gilded Age, 1873
Grant's Last Panic, 1884
Grover Cleveland and the Ordeal of 1893-95
Northern Pacific Comer, 1901
The Knickerbocker Trust Panic, 1907

(q&d list from
hier veracity not determined)

The difference in America pre-federal reserve and post-federal reserve is not the frequency of business cycle busts: it's that for most of the 19th century they were only truly bad for the Eastern elites.

For the first half of American history, you could ride out an economic storm (or be apathetic to it) by being a subsistence farmer on free land (with subsidy provided by the same eastern elites in the form of indian removal services). From the closing of the frontier in 1890 to world war one, the end of free land and increased industrialization transformed the economy to make this impossible. And of course, federal income tax made it so people had to get paid in cash, vice barter or other in-kind services. So everyone begun to have a skin in the money game.

The federal reserve, or some sort of central bank, seems a necessary part of a modern industrial economy and especially post industrial economy. And I would imagine any transition away would be a far worse calamity than Jackson's move to pet banks in his (constitutionally justified) move to abolish the Bank of the US.

At the very least, we are going on as many years with it as without it, and both good and bad shit has happened whether it

[Kolohe]

existed

[Kolohe]

or not.

[Shannon Love]

Jay D,

OK you libertarians... how can you support a system that is not free?

Hmmm, I think the entire point of the Reason community is that we don't have an actual free-market by one heavily contaminated by centralized coercion. If we did have an actual free-market we wouldn't have much to complain about and could outside and play with the dog.

If we didn't need a central bank on the gold standard, and nobody is any good at centrally controlling the economy anyway, why do it?

Because the general population believes in the efficiency and utility of using force to accomplish their economic goals. Most people's understanding of economics is grounded in a belief similar to that of the pre-scientific view of the natural world i.e. natural events resulted from choices of intelligent personalities. People believe that other people design the economy and chose how it performs at any given time. They simply cannot grasp the concept of a vast emergent system that operates due to rules of its own that no human designed, understands or can predict.

With such a human centric view, using the force of the state to control the economy seems as perfectly rational as our forbearers belief that they could hold other humans or spiritual beings accountable for events in the natural world.

[Jennifer]

The nice thing about the federal reserve is that we don't have to worry about the money supply suddenly increasing for the random reason that someone just struck the motherload.

No, we worry about the money supply increasing because the banks feel like creating more of it. What's the current rate these days--a bank only has to have one dollar in hand for every nine dollars it creates via debt?

[TLB]

Actually, from a Reason-style libertarian perspective, the Federal Reserve is doing the work of the angels: they're trying to take a cut of money that was earned illegally.

Of course, some non-Reason-style libertarians understand everything involved and realize that corruption can't be allowed to flourish and oppose corporatism, so perhaps they can help their Reason brethern understand this issue.

[Jay D]

Shannon Love Because the general population believes in the efficiency and utility of using force to accomplish their economic goals. Most people's understanding of economics is grounded in a belief similar to that of the pre-scientific view of the natural world i.e. natural events resulted from choices of intelligent personalities.

That may be true now, but I don't think it always was. IIRC, the general public held central banks with suspicion. Andrew Jackson, the populist opposed the National Bank. (Ironically, his face is on the $20 Federal Reserve Note.)

[Neu Mejican]

Shannon Love,

Well said, but...

They simply cannot grasp the concept of a vast emergent system that operates due to rules of its own that no human designed, understands or can predict.

Part of that emergent system, of course, are the very regulatory mechanisms that many here complain about. If you truly believe in the emergent nature of the system, why question the wisdom of the structures that it creates. All complex emergent and adaptive systems develop regulatory mechanisms and off-load complexity up or down in the hierarchies that make them up. The market is no different.

[Derrick]

Under a true, decentralized gold standard such as the Austrians want, the money supply would be very stable. That is, it would not be fixed, but would grow at a minimal rate as new gold is mined.

In other words, the Austrian argument seems to be the reverse of the central banking model. Instead of managing the money supply to keep prices stable, they would keep the money supply stable and let prices float.

Am I understanding this correctly?

[Adam]

"No, we worry about the money supply increasing because the banks feel like creating more of it. What's the current rate these days--a bank only has to have one dollar in hand for every nine dollars it creates via debt?"
Banks are strictly limited in their reserve requirements (set by the Fed and other banking supervisors). They can't just create more money through debt when they feel like it.

[fyodor]

Neu Mejican,

Part of that emergent system, of course, are the very regulatory mechanisms that many here complain about.

Neu Mejican,

No, Neu Mejican, "emergent system," as it's being used here, does not include decisions made by a centralized authority and enforced coercively on its constituents. Now if you want to redefine "emergent system" to include anything humans do, then sure, then emergent systems would include regulation, as well as Communism and Naziism. We did it all, we didn't have any help from deities (well, depending on your POV on that) or aliens (heh, maybe STILL depending on your POV!), etc. But if we're to use that definition of "emergent systems," it's meaningless, or at least useless, anyway. No, I'd say Shannon meant it to mean what evolves from human behavior without interference from a central authority. (That libertarians support government to protect personal and property rights is a separate issue from that of centralized economic decision making.)

[Shannon Love]

A modern private currency will not arise by reverting to an old technology such as gold but by using a new technology, the internet.

Money evolved in the first place to solve an informational problem in barter networks. When the number of trade goods is small, individuals can track the optimum amount of good A that should be traded for any other good B-Z. However, when the number of goods soars the bater network collapses from information overload. Money solves this problem by providing a universal trade good i.e. a single good that anyone, anywhere will trade for any other good. Now, producers and consumers need only know one trade amount, the amount of the universal trade good needed to exchange for any other one good.

With modern computers and the internet, however, we can handle the information problem of the barter value of millions of goods without having to resort to a proxy trade good. Modern commodity and currency markets are the cutting edge of this evolution.

In the future, I think our computers will communicate to us the "price" of any item in terms of the amount of time we as individuals would have to work in order to barter for any particular amount of any good.

[fyodor]

As much as I like saying Neu Mejican's, the repetition of it above can be blamed on rephrasing and forgetting to edit.

But I also post anew to relate the thought that taken broadly enough, "emergent systems" could include God and aliens, too!

Please note that I am satirizing such a broad understanding of the term, not endorsing it.

[Shannon Love]

Neu Mejican,

Part of that emergent system, of course, are the very regulatory mechanisms that many here complain about.

Yes, but irrelevant to my main point. Most people still seem to believe in what we might call "economic creationism" the belief that a natural event results from conscious design and intent.

In a nutshell, people choose to use regulation or other means of violent coercion because they believe that they can use threats of violence to control the people who control the economy. Humans seem to have an innate tendency to see personality behind any phenomenon that changes or evolves.

Just because people repeatedly resort to violence to try to control a natural system doesn't mean that doing so represents the optimal strategy. Remember, the thing the free-market is free of is violence. People make economic decision based on their individual assessment of the optimal tradeoffs and not because they fear they will be killed by another human.

Such a system process far, far more information than an violence based system could ever hope to. Our goal is to educate people to the point where they no longer see the need to resort to violence to get those things they need or want.

People no longer kill each other because it does not rain or the cows died. We need to reach that same level of awareness in economics.

[John]

"Essentially that even with the best of intentions, it is impossible for the authorities to manage the supply of money in accordance with the exact needs of the economy......"

No. What Friedman proved and won his nobel prize for was that it was the authorities unwillingness to manage the money supply that caused the Great Depression. The Fed did nothing to increase the money supply, in part because it was limited because of the gold standard, and also failed in its lender of last resort role. When midwestern banks began to fail, the federal reserve did not step in and make loans and keep the banks from failing and keep confidence in the system. The Fed also raised the reserve requirements for banks, thus reducing the money supply, three times during the 1930s and greatly contributed to the recession of 1937 and 1938.

[Caleb Rackliffe]

Well, there is always free banking 🙂

It's a little more realistic than Friedman's "just freeze the high-powered money idea", even though it eventually does this.

Free banking is becoming more and more attractive, especially as pocket money becomes a smaller and smaller portion of the total money supply aggregates.

http://www.cato.org/pub_display.php?pub_id=926&full=1

[R C Dean]

Free banking is becoming more and more attractive, especially as pocket money becomes a smaller and smaller portion of the total money supply aggregates.

I wonder if this isn't the true destination of Shannon's thought that:

With modern computers and the internet, however, we can handle the information problem of the barter value of millions of goods without having to resort to a proxy trade good. Modern commodity and currency markets are the cutting edge of this evolution.

Rather than "hour of labor" standard she initially proposed.

Free banking results in kajillions of currencies - each bank issues its own. (You can actually still by these banknotes - they are very cool). Free banking was outlawed because of the belief that it drove inflation and corrupted the money supply, because each bank was free to print as many of its notes as it wanted.

With e-currency and massive transparency, though, I wonder if the fundamental problem of free banking in a paper age hasn't been solved.

[bill]

The Depression was caused by the bankers through the use of the Margin Loan. They loaned and loaned and loaned people money to by stocks on margin, then when they were ready (after all the rich people had been told to get out of the market), they called in all those loans ,which the borrowers couldn't pay, and crashed the market.

[MikeP]

The Depression was caused by the bankers through the use of the Margin Loan.

Wow. Was that what caused it? Well, since the rules on margin loans have since been tightened, we can dispense with the Federal Reserve then, can't we.

[robc]

In the future, I think our computers will communicate to us the "price" of any item in terms of the amount of time we as individuals would have to work in order to barter for any particular amount of any good.

Time doesnt work for the obvious reason, my time is worth more than yours. 🙂 Im not willing to trade 1 hr of my work for 1 hr of yours.

Productivity is the metric. Its simple, we as a whole cannot consume more than we produce and it applies on the individual level (accounting for transferring of production/consumption).

So, what we need is a universal measure of production, I suggest the Quatloo.

[MikeP]

OK you libertarians... how can you support a system that is not free?

Uh, who are you talking to? Are there bands of libertarians roaming the streets holding up "We ? The Fed" signs?

Perhaps you mistake the fact that, of the top twenty issues libertarians (a) are concerned about and (b) can do something about, getting rid of the Federal Reserve is somewhere around number nineteen.

Articles such as this one may change (b) and thus move the ranking up somewhat.

[JParker]

People are romantic about gold but you can get many of the same benefits with any commodity based currency as long as it is convertible. Gold is the traditional medium for very good physical reasons.
One could argue that so called fiat systems must be backed up with a commodity if they are to be successful. The dollar has been backed up with the military power of the United States. So we have an H-bomb backed currency. For example, Witness the decline of the ruble as the Soviet military imploded.
From the perspective of liberty there must be a free market in money. Money is whatever the buyer and seller agree it to be. Be it wampum, gold, or magic cards. Just as something is worth what somebody will pay for it.

[zig zag man]

"In the future, I think our computers will communicate to us the "price" of any item in terms of the amount of time we as individuals would have to work in order to barter for any particular amount of any good."

Dear Mr. Tax Man;

Please accept these chickens and bushels of wheat as payment of my taxes. My computer indicates that these commodities are equal in value, I just don't have the cash right now.

Sincerely,
zig zag

That will be interesting.

[zig zag man]

My hourly rate is:

16 chickens/hour.

[JParker]

Dear Mr. Tax Man;

Please accept these chickens and bushels of wheat as payment of my taxes. My computer indicates that these commodities are equal in value, I just don't have the cash right now.

Sincerely,
zig zag

That free money would make the collection of taxes (theft) difficult/impossible is a good reason to convert.

[MikeP]

The 1800s were racked by a number of financial crises that usually had to do with a sudden influx of gold into the system.

Actually, the financial crises had more to do with state-chartered banks printing more money than they could back, resulting in runs on their reserves and collateral runs on other currencies as well.

The nice thing about the federal reserve is that we don't have to worry about the money supply suddenly increasing for the random reason that someone just struck the motherload.

If that is the worry, then you base your currency on a bundle of commodities rather than on gold alone. As Shannon Love notes, advances in communication and trading mean that people could trade in this currency as paper or as the commodities without ever leaving their desks. The unlikely event of someone striking the mother lode will not effect the price of the money much at all.

[robc]

If that is the worry, then you base your currency on a bundle of commodities rather than on gold alone. As Shannon Love notes, advances in communication and trading mean that people could trade in this currency as paper or as the commodities without ever leaving their desks. The unlikely event of someone striking the mother lode will not effect the price of the money much at all.

I think the key is a bunch of interchangeable currencies, each backed by differnet commodities (or bundle). With computing power, up-to-date values of each currency are easy to keep track of.

I think a SPYder backed currency might do well. Although it isnt very stable short term.

[Jay D]

How many motherlodes are left? I suppose when the Chinese become the first people to land on the moon they may discover it is made of gold under a layer of white dust.

[bill]

@MikeP

Why do you think the rules on margin loans were tightened in the first place? It's called "obfuscation". The powers that be don't want you to know the true cause of things. It's a lot like how the English and American bankers financed Germany during WW1 until their purpose was served then cut them off. Of course you're probably a guy who still believes Iraq had WMD's.

[robc]

Jay D,

If someone finds a cheap way to get gold out of sea water, that what be the motherlode of motherlodes.

[Brandybuck]

The dollar has very rarely been backed by 100% gold, especially during the heyday of the "gold standard". That's because we had fractional reserve banking: banks would issue more money than their reserves.

[MikeP]

Why do you think the rules on margin loans were tightened in the first place?

Because I learned that they had in the same high school history class where I learned that margin loans caused the Great Depression.

I've read some since then...

Hey, why do you think the banks had so much money to loan out on risky loans? Hint: It starts with 'F' and rhymes with "Federal Reserve".

[bill]

"Hey, why do you think the banks had so much money to loan out on risky loans?"

Because they were printing it as fast as they could so they could loan it on margin in order to crash the stock market.

[Neu Mejican]

Fyodor,

No, Neu Mejican, "emergent system," as it's being used here, does not include decisions made by a centralized authority

I am not working with some random definition of "emergent complex adaptive system" here, but a fairly rigorously, and widely understood definition. Economies are an excellent example of such, and will spontaneously off-load complexity across hierarchical levels in the system (both up and down). That means collections of individuals within the larger system will attempt to have the larger organizational structures deal with some of the complexity (set conditions for operation), while centralized hubs will distribute other aspects of complexity to lower levels of the system. Any view of an economy as being comprised only of individual transactions without the many layers of larger structural elements is not worth discussing.

[MikeP]

Because they were printing it as fast as they could so they could loan it on margin in order to crash the stock market.

Ah... Silly me. I couldn't see the conspiracy through all the incompetence.

[MikeP]

Any view of an economy as being comprised only of individual transactions without the many layers of larger structural elements is not worth discussing.

That may well be true. Nonetheless, free markets are fully capable of producing their own larger structural elements without government edict or force.

They may not be perfect -- but neither is government regulation. And actual market failures where any extra-market hand is desirable even in theory are truly few and far between.

[Derrick]

I am not working with some random definition of "emergent complex adaptive system" here, but a fairly rigorously, and widely understood definition. Economies are an excellent example of such, and will spontaneously off-load complexity across hierarchical levels in the system (both up and down). That means collections of individuals within the larger system will attempt to have the larger organizational structures deal with some of the complexity (set conditions for operation), while centralized hubs will distribute other aspects of complexity to lower levels of the system.

FWIW, this definitely happens in software development. Faced with an extremely complex task, programmers will often break it apart into vertical layers called "abstraction layers." Each layer interfaces with the ones above and below it.

One of the best examples of this is the ISO/OSI network model. Operating system design almost universally uses a layer model as well.

The end.

[Derrick]

Question: Does anyone here know of any visualizations of how markets work? I am working on a short animated film which illustrates how individual markets work, and how they all interconnect to form what we think of singularly as "the market." If any such visualizations already exist, I would be interested in seeing them. Thus far I have not been able to find any.

[Kennty]

One thing I'd like to get off my chest

In these debates, a large number of people conflate these three things:

1) the federal reserve
2) fiat money
3) fractional reserve banking

We have all three now; we did not have (1) until 1913 (but had various shorter lived prototypes before that). We switched to (2) for the final time in 1971, but had also gone through a few iterations before that. As far as I can tell, some form of fractional reserve banking has existed since Hamilton and the boys (as an aside, its seems impossible to find a site on this without it being a rant against it; I gotta think the idea of fractional banking goes back to the middle ages)

The various cycles of American economic history have been of course influenced by the presence , particular combination, and relative strength of the three. But I do not think they have been deterministic of this history. They play a part, but there are so many stronger political, technological and cultural elements in play at any time in US history to make the particular choice of the three decisive.

One last thing. We do have a market in money. As P.J. O'Rourke said, we can swap the mythical Dollar with the fantasy Euro, the Yeti Yen, etc.

[Neu Mejican]

MikeP,

That may well be true. Nonetheless, free markets are fully capable of producing their own larger structural elements without government edict or force...extra-market hand

Your point requires that there be a distinction in kind between government and the market, placing the government outside of the market.

I think the relationship between market and government is more properly held to be meronymic with the market being the larger structure with government contained as an element within it.

Shannon Love,

Actually my point is very relevant to yours...the beliefs of individuals are at the core of your argument, and are a major source of emergent larger structures in the larger system.

[TrickyVic]

"""Money is whatever the buyer and seller agree it to be. Be it wampum, gold, or magic cards. Just as something is worth what somebody will pay for it."""

That's part of the problem. What if I don't take qampum, gold, or magic cards? Or That your magic cards are only worth half a bird at my shop but maybe worth 3/4 of a bird the next town over.

Wasn't part of the reason for the establishment of a Republic was so there would be one single currency that had the same value anywhere throughout the colonies?

[marxbites]

Money evovled as the commodity most useful for trade over millenia, gold/silver were thus universally chosen by markets, not by ruler's edict (fiat).

It was what allowed the fruits of comparative advantage and division of labor that raised all boats concerned over the conundrum of the dual coincidences of wants under a barter system. Plus for all the reasons Au-Ag money was market determined as best, it is non-perishable store of value as guard against future losses or threats to ones survival. It is not a defaultable title to a real asset, it is one. If the crops failed, or grain stores rotted, one had savings to buy other foodstuffs to survive.

The Hard Money Issue in American Political History
http://mises.org/media/2844

The Creature from Jekyll Island: a Second Look at the Federal Reserve by Ed Griffin
http://uk.youtube.com/watch?v=.....re=related