On December 23, 1913, President Woodrow Wilson signed into law the Federal Reserve Act to establish the third central banking system in the US, which facilitates funds transferring between banks, issues paper money, regulates commercial banks, lends as a last resort, and conducts monetary policy. The blueprint was drafted in a secret 1910 meeting on Jekyll Island off the coast of Georgia between US Senator Nelson Aldrich, Assistant Secretary of the US Treasury Piatt Andrew, and five members of the “money trust.” Significant parts of the Aldrich Plan, patterned after British and German central banks, were merged into the Act. A century later the quasi-public, semi-private Federal Reserve has continued to exacerbate political and socioeconomic problems by creating boom and bust cycles and inflating the money supply at will.
The Austrian business cycle theory offers a beautiful explanation of the boom and bust phenomenon. First, the boom is begun when a central bank creates fiat currency from thin air and lowers the federal funds rate. Attracted by the new cheap credit and incentivized by a prisoner’s dilemma, businesses embark on long-term projects. The businesses overinvest in capital-intensive production and misallocate resources from consumer goods industries to capital goods industries.
The wasteful malinvestment is masked by the facade of economic expansion. But when consumers return to demand saving and consumption at prevailing interest rates, the growth halts and a painful adjustment arrives as a recession. Unemployment rises as businesses lay off workers to cut costs and avoid losses. Then central banks and legislatures usually engage in quantitative easing and stimulus spending. However, printing and deficit spending more money is counterproductive because such policies distort incentives and prolong the depression and recovery. The only solution is time for debt liquidation and readjustment.
Many people and economists disagree with the Austrian theory — social science is innately subjective. But undeniable is the inflation accrued throughout the last century. According to the Bureau of Labor Statistics, the US dollar has lost over 95 percent of its value since 1913. The cumulative rate of inflation of the dollar is 2,253 percent; an item priced 1 dollar in 1913 would be 23.53 dollars today. Inflation has negative effects: shoe leather and menu costs, hoarding, wage spirals, and losses in allocative efficiency. Another telling fact is that inflation hurts the poor and middle class the most. As inflation rates hover around 2 percent in recent years, the poor lose much more utility from losing 2 cents of purchasing power per dollar than do the wealthy.
The inflation tax is also a hidden theft of wealth from the poor to the rich. When at the nadir of the Great Recession banks and corporations that were “too big to fail” reached the brink of bankruptcy, Congress passed a bill to bail out the institutions. The Federal Reserve created the money to fund the bailouts at the expense of taxpayers, many of whom were just deprived of housing through foreclosures. It is convenient for the wealthy ruling classes that the poor are more immediately concerned with food, shelter, and income stability than with political economy, and thus can be exploited with little electoral blowback.
Former Congressman Ron Paul’s Federal Reserve Transparency Act easily passed the House of Representatives in 2012, but is dying in the Senate due to Majority Leader Harry Reid’s refusal to allow a floor vote. A full audit of the Federal Reserve would make transparent to the public in numerical terms the exact damage done since the Great Recession, including bailouts of foreign banks and corporations. After great public outrage at the elucidated corrupt activities, Congress, which singlehandedly created the monster and has the sole power to end it, might consider legislation to abolish the Federal Reserve. If the bill is passed and signed by the President, then standard-backed money, clearinghouse associations, free banking, and currency competition will emerge. These would help the people by preserving the regulatory roles of a central bank but eliminating its disruptive monetary policy and power to inflate — booms and busts will slowly smooth, and inflation will be low and limited regionally.
In January 2014, Janet Yellen was confirmed as the Chair of the Federal Reserve. Her “meet the new boss, same as the old boss” tenure promises quantitative easing infinity and more social inequity and unaccountable fraud. But systemic reform requires an overhaul of popular opinion. Some economics students do not know about the different schools of thought. Some citizens have never even heard of the Federal Reserve, let alone explored its history and influence. Broad changes in education are needed to effect a watershed like banking decentralization.