A critique of the Federal Reserve System

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.

 

4 thoughts on “A critique of the Federal Reserve System

  • March 1, 2014 at 8:31 pm
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    I can’t believe the Phoenix let this be published. It’s not that I have a problem with the opinions per se – it’s just that the author clearly has no idea what he’s talking about. There is so much wrong with this, I don’t know where to begin. He clearly has no understanding of how inflation works, not to mention how disastrous it would be if the Federal Reserve didn’t exist. You do realize that getting rid of the Federal Reserve would *increase* the booms and busts, right?

    I’d argue more, but I would say you need to at least take Econ 1. Even the anti-capitalist leftists at this school who get their economics from Das Kapital know more about economics than you do. (I’m not trying to make this a personal attack even though I recognize it is, it’s just that your article is so unbelievably wrong I don’t know what else to say).

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  • March 7, 2014 at 10:56 am
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    Could you expand on what is mistaken about this critique? I am in no position to support or deny the assertions but find the subject important and would appreciate more facts.

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  • March 13, 2014 at 12:52 pm
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    About your comments on Eric Yao’s post which identifies problems with the Federal Reserve Bank system:

    Your comments would be more meaningful if you stated specifically how and where you think the author was in error. Slamming a post with a generalization such as “the author clearly has no idea what he’s talking about” isn’t helpful. Your statement about what would happen if the Federal Reserve didn’t exist is more useful. It leads people reading your comment to consider the possibilities of having the U.S. Treasury, or other legally created organization, take over some of the tasks currently performed by the Federal Reserve Banking system.

    There are real evils that emanate from the Fed. For example, consider their admission that they caused the Great Depression in 1929 and the Great Recession from which we’re still trying to recover. Remember, a recession really continues until its associated rise in unemployment ceases to exist. The Fed doesn’t really benefit Americans who are not in the top 1% of the income distribution. The destruction of the middle class that is on-going could be offset by sending taxpayers a percentage of money created to respond to increases in GDP instead of turning the newly created funds over to billionaire-owned banks. Now there’s a tax cut.

    To solve our country’s financial problems it’s going to be necessary to “think outside the box”. The Fed doesn’t do that. As for causes of inflation, take a look at the manipulation of gasoline prices by the petroleum industry. Charging customers more money when there are no real increases in cost is clearly inflationary. Fortunately, conversion to the use of petroleum products derived from fracking coal shale relieves us from the middle eastern greed-motivated pricing we have seen until quite recently.

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  • March 19, 2014 at 6:53 pm
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    The declining purchasing power of a dollar doesn’t mean that much. Relative prices mean little.The purchasing power of 1 dollar is akin to 25 now, okay, but how long would it take for a worker @ prevailing wages to earn those amounts?
    Inflation of the American kind also substantially affects wealthy people, as it discourages saving in favor of present spending, though it also by that token discourages savings behavior that could lift a person out of precarious financial positions-in addition to their lost PP. But lost PP also includes the purchase of labor, which means lost wages. The only clear losers are everybody.
    The government has already turned a profit on most bailout money and will likely make all the money back. It’s not like we just gave companies cash. The government received substantial equity positions in return. The cost of letting industries fail would have destroyed more wealth and jobs than probably anything since the depression.
    As for debt liquidation, the only thing absent outright forgiveness that eliminates debt is inflation. Thus won’t inflation prove beneficial to those lower and middle class Americans with mortgages and loans?
    Also, a major inflationary cause is the fractional reserve system. If you propose to eliminate inflation you must also eliminate that. But consider, wouldn’t a static monetary system cede monetary control to the wealthy? How could we avoid feudalism?
    The currency system is untenable. No currency system survives.
    Most of all I think I, Alexander Shamilton, should be in charge of the Fed. Securities-backed currencies, think about it. Get to know it. Get to like it.

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