Does the Federal Reserve make the currency unstable?


One columnist says yes and trots out the evidence
Alvaro Vargas Llosa examines just what the Federal Reserve has done.

While the creation of the Federal Reserve was essentially a response to a series of bank runs, those crises were mild compared to the ones that were to follow. In 1913, the United States was under the gold standard. Although the government issued currency, the fact that currency was tied to gold meant the authorities could not manipulate the money supply easily. The Fed's initial mission was to guarantee the convertibility of deposits into currency on demand. A few decades later, the United States abandoned the gold standard and the Federal Reserve became the country's most powerful economic institution, exercising its monopoly in issuing currency based on the discretionary power of its board of governors.

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. A country's economy is the sum of millions of people making decisions that no single individual is in a position to anticipate. As economist Murray Rothbard showed in his book America's Great Depression, in the 1920s the Federal Reserve pumped up the money supply, expanding credit by more than 60 percent. Because the economy was very productive, this monetary expansion did not show up in the regular inflation figures. But, as is always the case with inflation, many resources went to the wrong kind of investments--until the crisis hit. The late Milton Friedman showed how the Fed made things worse by not providing the system with enough liquidity once the Depression was obvious.

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. 

Congress shares it's responsibility in the collapse of the subprime market, and it looks like Congress and the Bush Administration are ready to make the mess worse.

But the important thing here is to realize that by moving away from a currency linked to a measurable commodity, the Fed has made the economy that much more unstable. There is no reason why our currency can't be tied to a standard, or even multiple standards. Such currencies adjust themselves without government interference.

Oh, and the first part of the article touches on the Liberty Dollar disaster. There is another brief write up on that here, and an AP piece here. I haven't covered the Liberty Dollar story before because I am not familiar with NORFED and unbiased sources have been impossible to find.

— NeoWayland

Posted: Mon - December 3, 2007 at 12:08 PM  Tag


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