The following is a piece I wrote as a response to an editorial written in the Harrisburg Patriot News by Elizabethtown College economics professor Sanjay Paul. The piece, unfortunately, didn’t get picked up so I will reproduce it here. It’s written for the layman as a simple critique of Paul’s commendation of the Federal Reserve during the financial crisis- enjoy!
Elizabethtown College economics professor Sanjay Paul’s recent Patriot News article on presidential candidate Ron Paul, though favorable to the Congressman’s stance on intervention abroad, misconstrues his position on the Federal Reserve. Like many orthodox economists, Professor Paul sees the nation’s central bank as a force of mitigation in the event of an economic slowdown. Nothing could be further from the truth however.
First a short history lesson. The campaign for the Federal Reserve and legal cartelization of the banking industry dates back to the election of President McKinley who was supported by wealth bank interests. The Panic of 1907, caused by the inflationary policies of U.S. Treasury Secretary Leslie Shaw, provided the catalyst for a full blown crusade carried out by academics, public officials, and the banking elite. The Federal Reserve was ultimately a product of scheming for a governmental privilege by special interests including the Morgan and Rockefeller families. With the aid of Senator Aldrich of Maryland, the Federal Reserve Act was secretly hashed out at Morgan’s vacation estate known as Jekyll Island Club. As Nobel Prize winning economist Freidrich Hayek observed, “socialism has never and nowhere been at first a working class movement.”
Professor Paul characterizes Ron Paul’s objection to the Fed on dollar debasement alone when the Congressman’s opposition is far more complex. Yes, the Federal Reserve inflates and debases the value of the dollar through interest rate manipulation. That is the only tool the Fed, like all central banks, has at its disposal.
In 1912, economist Ludwig von Mises laid out a groundbreaking theory on the cause of the business cycle. In The Theory of Money and Credit, Mises identified that artificially low interest rates, not backed by an increase in savings and decrease in the public’s consumption level, entices investors to engage in otherwise unsustainable production lines. Central banks, which receive a legal monopoly over currency creation from their respective governments, use their printing presses to flood the market with money to suppress interest rates. Simple supply and demand dictates that as supply increase, the price of purchase falls. This money printing leads to asset bubbles like that recently witnessed in housing. Mises called the bursting of the bubble “the crack up boom” which is an unavoidable consequence of credit expansion.
When Fed chairman Alan Greenspan cut the federal funds rate from 6.5% in December of 2000 to an unprecedented 1% in June of 2003 and kept it there till June 2004, the stage was set for unsustainable boom in housing. The monetary base expanded, pushing down long term mortgage rates, and financed the inflationary bubble. Ironically, Greenspan’s housing bubble was a reaction to the bursting of the dot-com bubble he engineered years earlier by interest rate cutting in 1998 and subsequent monetary base expansion.
Despite clear evidence that the Fed is responsible for the boom-bust cycle, it has a more insidious role in the affairs of Wall Street. Whenever the New York branch of the Fed engages in open market operations (purchasing government bonds to expand the monetary base) it conducts transactions with 21 elite financial institutions known as “primary dealers.” These “dealers” include such saintly firms like Goldman Sachs, JP Morgan, and Citigroup.
Central banking apologists never mention this as they would be forced to rationalize their support for a system built on crony capitalism. After all, the whole point of monetary policy is to goose the economy. If money printing was neutral, it would affect all prices at once and not create a boom. But that’s not how an economy works and the purpose of the Fed’s open market operations is to inject Wall Street with newly created funds first before the rest of the economy sees it. This creates distortions, what economists call “Cantillon effects,” that boost some prices in terms of others and enriching the few as the money disperses.
Now Professor Paul claims inflation is currently a non issue despite the fact that the consumer price index is running at an annual rate of 3.4%. Energy prices are up 12.4% and food is up 4.6% compared to a year ago according to the Bureau of Labor Statistics. Inflation is only a non issue for those who don’t eat, drive, or heat their homes.
Though it’s true that current Fed chairman Bernanke carried out unprecedented monetary policy to fight the financial crisis, injecting the big banks with $16 trillion in loans is no better than giving a heroin junkie another fix. Papering over losses doesn’t solve the core problem of a financial sector addicted to easy money.
While Professor Paul rightly praises Ron Paul’s stance on foreign policy and civil liberties, he misses an all-important feature of the Congressman’s antagonism toward central banking. It goes far beyond currency devaluation as it involves the direct cause of the impoverishing business cycle.
Like the Ron Paul, Professor Paul could learn a thing or two by cracking open an Austrian economics treatise on a given Saturday night.