By Martin Hutchinson
Contributing Editor
Money Morning
A debate over the future of the U.S. Federal Reserve is taking place in the halls of Congress.
On one side is U.S. President Barack Obama and his plan to expand the authority of the Federal Reserve. In addition to its current powers, Obama plans to give the Fed regulatory authority over large financial institutions that are considered "too big to fail."
On the other side is U.S. Rep. Ron Paul, R-TX, who has gathered 250 signatures for a proposal to audit the Federal Reserve. This audit, by Paul's own admission is only a down payment towards his overriding goal of abolishing the central bank.
So who's right? Should the Federal Reserve have more authority or less? And what will the outcome mean for investors?
The call for greater Fed power comes, as might be expected, from those who think the Fed has done a good job managing the financial crisis. Their view is that the Fed – by swelling its balance sheet by about $1.4 trillion and more than doubling the monetary base in less than a year – prevented deflation from taking hold in the economy and saved the banking system, which was in dire danger of collapse.
To those with this mindset, it makes sense for the Fed to act as the primary regulator of banks and investment banks that pose a systemic risk to the U.S. financial sector.
But the problem with this plan is that any potential rescues would not be carried out on the Fed's dime, but on that of the Federal Deposit Insurance Corporation (FDIC). That means a collapse in the banking system would actually benefit the Fed by allowing the central bank to ramp up its balance sheet to replace all of the banks' losses and ensure that its chairman makes the nightly news every evening.
Even for those who are not staunch believers in Nobel Prize-winner James Buchanan's public choice theory, the incentives seem to be wrong. It would make more sense to put banking system regulation firmly under the FDIC, which is responsible for paying up if anything goes wrong.
It's not likely that an empowered Fed would impose tight restrictions on the big banks. Instead, the central bank's governance would probably become a prime example of "regulatory capture," by which spineless regulators exist mainly to do the bidding of the very institutions they're supposed to be regulating.
Since the rest of us are dependent on the Fed's monetary policy to survive economically, and need bank regulation that will keep the biggest banks from picking our pockets every few years, we don't want the Fed to become a subsidiary of Goldman Sachs Group Inc. (NYSE: GS) – something that seems likely under the Obama proposal.
On the other hand, Paul's bill appeals to those like myself, who believe the Fed has consistently run an over-expansionary monetary policy since the mid-1990s.
The credibility of this theory has been undermined by the fact that inflation has been kept under wraps, but this month's consumer price index (CPI) and producer price index (PPI) figures – up 0.7% and 0.5% respectively – suggest that another surge in prices may not be far off.
As we go through the fall, the months of price declines in late 2008 that were caused by the collapse of energy and commodity prices will cause year-over-year inflation to trend higher. That, in turn, is likely to raise gold prices and Treasury interest rates, causing bond market panic and inevitably changing the public perception of the Fed's performance.
So if the Obama administration wants to give the Fed new powers and extend Chairman Ben Bernanke's term in office (which ends in January 2010) they had better do so quickly.
In any case, Paul's proposal to audit the Fed would bring central bank operations more under the control of politicians, who supposedly would be able to expose unpopular goings-on and unexpected losses in the Fed's operations. That's why it has attracted bipartisan support.
But rather than simply auditing the Fed or abolishing it, as Paul proposes, there is a much better case for giving the central bank a new mandate, whereby its obligation to maintain monetary stability is given precedence over all other obligations.
Under the Full Employment Act of 1978, it has a dual obligation to maintain employment and monetary stability. A new mandate that prioritized monetary stability would force the Fed to follow the policies of former Federal Reserve Chairman Paul Volcker. That would mean keeping interest rates well above the rate of inflation, thereby favoring savers over borrowers.
As investors, we should thus oppose the Obama administration's plans for the Fed, which seem likely to perpetuate the rent-seeking of Wall Street's biggest banks. We should also be suspicious of Paul's bill to audit the Fed, since that would bring it more closely under the control of elected politicians. History has shown that politicians cannot be trusted with the ability to create money out of thin air.
Instead, we should back plans to pass legislation that "Volckerizes" the Fed on a permanent basis, making monetary policy sound, eliminating the risk of inflation, and raising the rates we earn on all of our savings to a level that pays us adequately for providing banks and other borrowers with our money.
In the end, the ability to earn decent returns on savings and keep the result is the most important capitalist freedom of them all.
News and Related Story Links:
- House.gov – Ron Paul's Speeches and Statements:
Abolish the Federal Reserve
- Wikipedia:
Regulatory Capture
- Wikipedia:
Public Choice Theory
As an investor for more than 35 years it is painful for me to say that the "investment community" has become equally as "suspicious" as the elected politicians. I believe that the general public community sees the investment community as morally and ethically deficient and it will take quite some time for any financial commentator to be taken seriously. I, for one, will be very cautious to criticize others before considering the purity of my own motives.
It's time for the Fed and Obama both to take a hike.
Ron Paul for President!
Apply the controls available, without inventing new ones, and refrain from creating a Nation dependent on its government (through politicized cronyism) for financial success. Prosperity has no address on that road.
http://pacificgatepost.blogspot.com/2009/07/bernanke-and-super-fed-say-its-over.html
Make changes at the top and in the structural controls over money creation.
I'm surprised that people actually have opinions without even better knowing the crux mechanisms and motivations of the current economic system when this information is all freely available (watch the 'Zeitgeist Addendum' which is free on their website).
Ron Paul is absolutely right in trying to abolish the Central Bank. My only concern is if he'll ever be able to achieve this considering that erstwhile presidents have been wiped off when they attempted this in History…
I enjoy much of the info from Market Morning, but in this article, you more or less paint both options as equally bad. I'll trust Ron Paul over Ben Bernanke any day of the week! The Fed must be abolished before it bankrupts America. The Treasury, Goldman Sachs and the Federal Reserve are all in collusion together to separate Americans from their money and to achieve more power. Trust them at your peril.
If you can understand & know that the Federal Reserve is actually a private entity formed by private bankers, you will no doubt question and violently object to expand the authority of the Federal Reserve.
Barack Obama is doing exactly the opposite of what late President Abraham Lincoln (whom Obama shamelessly said is his idol) is doing – abolishing any form of Federal Reserve-liked institution.
Lincoln warned the American people:
"The money power preys upon the nation in time of peace and conspires against it in times of adversity. It is more despotic than monarchy, more insolent than autocracy, more selfish than bureaucracy. I see in the near future a crisis approaching that unnerves me, and causes me to tremble for the safety of our country. Corporations have been enthroned, an era of corruption will follow, and the money power of the country will endeavor to prolong its reign by working upon the prejudices of the people, until the wealth is aggregated in a few hands, and the republic is destroyed. "
Lincoln continued to fight against the central bank, and some now believe that it was his anticipated success in influencing Congress to limit the life of the Bank of the United States to just the war years that was the motivating factor behind his assassination.
Wake up AMERICA & unite AGAINST!!
NO Central Bank. No Volcker, no Summers and no helecopter Ben. Central Bank is already the annex of JP Morgan and a sub of Goldman. The Federal Reserve bank of NY has purchased all of the toxic debt, and is very weak. This is the best chance we have ever had to get rid of this Fed nonsense. Since 1919 our handlers have short changed this country by ruining our education system. We are the most perfect flock of sheeple. I really dont believe that our people want to be intelligent. It amazes me to read letters from older citizens crying about the new President. I laugh out loud and remember Reagan/Stockman, Bush/Chaney,Clinton/Gingrich. THE FED MUST GO!
If most developed countries have Central Banks and we abolish ours and let the markets alone determine our fate, are we not abdicating our position of influence in the world's Financial Community?
I trust no one for monetary advice who would state that we should keep the Federal Reserve, and try and clean it up. It has been an amoral private corporation for almost 100 years.
The Federal Reserve Hoax: The Age of Deception was published in 1980 by Wickliffe B. Vennard Sr., and should be required reading for all authors, (including Martin Hutchinson)writing money advice letters.
The perceived popular view of why the Federal Reserve was created was to stabilize the American economy. This is false.
The basic reason the Federal Reserve was established was to transfer the wealth of the American people into the hands of the stockholders of the Federal Reserve.
It was created for the purpose of coining and printing U.S. currency without the backing of gold or precious metal. This is pure fiat money.
It was also conceived for the purpose of subjecting the entire world into perpetual debt. By providing loans in any amount to both the U. S. Congress and private industry, for the purported intent of the stabilization of the economy and national security. As well as propping up faltering foreign countries and businesses, the Federal Reserve System has made debtors of the world.
Just as providing an infusion of currency into the economy, the Federal Reserve has become the chief instrument in contracting the nation’s money supply and increasing interest rates. This immense economic manipulating power has created and will continue to create various levels of economic panic, recession, and depression.
In other words, the Federal Reserve System is in total control of the financial climate of the United States for the purpose of it’s economic exploitation. Bearing witness to this charge is the fact that since the creation of the Federal Reserve System in 1913, the Fed has presided over the crashes of 1921, 1929, 1989, the Great Depression of 1929 thru 1939, recessions in 1953, 1957, 1969, 1975, 1981, Black Monday in 1987, a crushing 1,000 percent inflation, destroying over 90% of the dollar’s purchasing power.
G. Edward Griffin describes the purported objectives in his book, The Creature from Jekyll Island. It too is a must read.
Ron Paul is one of the few in congress who understands this history and knows it must go to relieve the stranglehold on the people of the United States.
In my opinion the Federal Reserve should be abolished. If any business had allowed itself to mess up its operations the way the Fed allowed the economy to founder they would be judged as total incompetants.
In the present situation we are being asked to give more responsibility to the agency that through its inaction allowed the current fiscal chicanery to fester.
"Too big to fail"and Fed "independence" are code words for allowing the Fed and its constituency on Wall Street to continue fleecing the public.
Volkerizing the Fed led to a continual erosion of purchasing power by the middle class, while their productivity rose. We have been there and tried that. Let's not go down that road again.
If all of this is true, or only half, Ron Paul must be crazy to be trying to fight it from inside Congress.
The only way we can take down the Federal Reserve is by violent revolt "a la" French Revolution; complete with a sharp Guillotine.
I to know what is going on with the fed, but believe me if ron does not succeed, or is assassinated like the rest who fort hard for the worlds freedom from these tyrants, then a world wide revolt , especially in the feds home base…America, is needed, revolt and i guarantee most of the worlds people will follow. I for one being australian would have my confidence in the american people restored instantly. And america has a really bad reputation simply because they sit by and let the fed take control over the world, it is there where it began, and there where it will end.