Enemy of the Economy: The Federal Reserve

            Central banking is an inherently un-American institution. At the Constitutional Convention, the delegates had struck out a provision for granting charters of “mercantile monopolies”, which would have included banks (McClanahan 46-47) and rejected giving the general government the ability to “emit bills of credit”—paper money (Rothbard, Conceived in Liberty 186). Attempts at central banking were always met with Jeffersonian backlash and ultimately killed by President Jackson in 1833. Thenceforth, America was central-bank-free for eighty years. Tragedy struck, however, in 1910, when, rejecting the wisdom of the Framers, a clandestine meeting of the country’s elites drafted a plan for a new bank, and President Wilson signed it into law in 1913; thus, was created a monster—the Federal Reserve System (The Fed). The Fed is a detriment to the economy—some effects are observed obviously, and others work in a rather sinister manner, the ripple effects running deep; however, one thing remains: the institution is a danger which must be stopped.

            Most understand that the economy is governed by the laws of supply and demand, and when the supply of a commodity increases, its utility falls. The same is true for money. The government strives to prevent alternative currencies, and the Fed is given the sole right to print money at will, unbacked by any metallic standard. It only follows that the more the Fed prints, the less its money will be worth, and further, the less can be bought with each unit (a decline in purchasing power). This act is the true meaning of inflation, and from its effect, we can see that the currency’s value is unstable, which hinders effective economic calculation; individuals’ cash holdings will be worth less, which disincentivizes saving (capital formation); and it is unethical, as value is being, in a word, stolen, and a legal code is necessary for fiscal growth. Unfortunately, the economic chicanery fails to end here, and the other effects of the Fed’s policies are insidious can only end in an impending disaster.

            The fresh money is not distributed to individuals equally. No! it enters the economy in certain places. The Fed releases the currency in two ways: (1) through artificial credit expansion—when the loan rate to member banks is lowered, thus lowering the lending rate throughout the economy and (2) through quantitative easing, in which the Fed purchases treasury bonds, and the money is used for government expenditures. Both methods pump money into industries which would not, if the Fed was removed from the picture, under free market conditions, see growth. Because of the Fed, the growth is artificial and illusory. This recurring phenomenon is known as the Austrian Theory of the Business Cycle. 

            Prices convey crucial information in the market economy, and the interest rate is a price; therefore, when the interest rate is manipulated, there is misinformation about the market. Seeking profits, investors allocate their wealth where it will afford them the highest dividends, which is also where consumers demand it. In the structure of production, there are higher-order, and lower-order goods; the lowest order are for the consumer, and the higher-order goods are for producing. Higher-order production takes more time, is costly, and furthermore, is considered less profitable under normal circumstances. This state should be reflected in the interest rate, i.e., if a society is not ready for more higher-order production, the rate of interest will be high, and if it is ready, the interest rate will be lowered. However, when the Fed intervenes with a lower interest rate, investors are given the false signal to invest in higher order manufacturing. The consumer goods industries will experience growth as well, but due to their less durable nature, the eventual damage will be less severe. As the misdirected investment proceeds, the economy will experience a boom.

            Because continuous inflation of the currency would lead to rapid devaluation, credit must eventually be contracted—loans restricted and a rise in interest rates. When that day arrives, the long-term production projects no longer appear profitable and the market actors must realize that what appeared to be growth, was only misdirected (malinvestment), and the economy must enter an adjustment phase. This a painful, but necessary step for returning to normal. The Fed caused the boom, and it caused the bust that ensued. Here are the consequences: harm to workers, e.g. lower wages and job loss, wasted capital (malinvestment), less goods available to consumers, and injured investors, who will have taken significant losses, if they have not been eliminated from the financial arena outright.

            To offer further validation of the theory, past crises can be observed, and historically speaking, the Fed has been at the helm of every financial crisis since its birth. Starting with the Great Crash of 1929, the institution was not idle in the Roaring Twenties—no, it was actively manipulating the money supply. According to economist Murray Rothbard in his book America’s Great Depression, in the boom, there was a 61.8 percent increase in the money supply (93), credit was expanded through artificially low interest rates (121), and when the crash hit, the losses were in higher-order capital goods industries (261). Understanding the theoretical framework, Austrians rightly saw the inflationary boom in the 1960s and the depression of the 1970s (Thornton 135). Going further, the Dot-Com Bubble was blown out of low interest rates and a money supply that increased by 52 percent from 1995-2000, and it went bust after the credit was contracted from 1999-2000 (Woods 81). Finally, and most recently, the Crash of 2008 can be attributed to theretofore the most inflation in American history between 2000 and 2007 (Woods 26), low interest rates, and special attention given to the expansion of loans in the housing market. Clearly, history is not on the side of the Federal Reserve.

             To conclude, the institution which should never have existed in the first place—the Federal Reserve—is a danger not a benefit to the economy. On the surface, it devalues American currency, bringing a host of problems, and beneath the surface, it creates artificial booms—distorting the correct allocation of resources and hurting producers and consumers alike. Its track record is one of failure, and does not create wealth, but destroys real growth. For these reasons, America must show the Fed the door, as its deserved end is long overdue. 

Works Cited

McClanahan, Brion T. How Alexander Hamilton Screwed up America. Regnery History, 2017.

Rothbard, Murray N. America's Great Depression. 5th ed., Ludwig von Mises Institute, 2013.

---. Conceived in Liberty Volume V: The New Republic, 1784-1791. Edited by Patrick Newman, Mises Institute, 2019.

Thornton, Mark. The Skyscraper Curse: And How Austrian Economists Predicted Every Major Economic Crisis of the Last Century. Mises Institute, 2018.

Woods, Thomas E. Jr. Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. Regnery, 2009.