Kill the Monster

by Thomas E. Woods, Jr.

A lot of people seem to believe that although the market economy is a swell system, it requires the equivalent of a Soviet commissar to be in charge of money and interest rates. This belief is altogether misplaced. The Federal Reserve System, or simply "the Fed," is both harmful and unnecessary.

Since the Fed was created in 1913 the dollar has lost at least 95 percent of its value. If the much-maligned gold standard had produced such a result we’d never hear the end of it, but in our system the Fed is, for whatever reason, curiously exempt from criticism. Under the Fed, therefore, people have lost an option they once had: accumulating savings in cash. Under a commodity standard, people could save for the future simply by accumulating precious-metal coins – which, back when they functioned as money, held or even increased their value. No one has that option any longer. In other words, only a fool would try to save by piling up dollar bills. Instead, everyone is forced to become a speculator, and to invest in securities markets they know little about and that can wipe them out entirely if times turn bad.

As early as the eighteenth century, Richard Cantillon identified distribution effects as another way inflation harmed the general public. The newly created money is injected at particular points. Whoever receives it first – that is, people who happen to be politically well connected – get to spend it before prices have commensurately risen, and these fortunate few thereby receive a windfall. By the time it trickles through to ordinary people, on the other hand, the general public has in the meantime been forced to pay the higher prices to which the new money gives rise.

Private and public debt have exploded under this system, especially since the collapse of Bretton Woods in 1971. No one has a right to be surprised when indebtedness skyrockets under a system in which credit can be created out of thin air.

The very existence of the central bank institutionalizes the problem of moral hazard. Moral hazard involves an actor’s willingness to behave with an artificially elevated level of risk tolerance because he believes any losses he incurs will be borne by someone else. Since there is no physical limitation on paper money creation, market actors know the paper money producer can bail them out if things go terribly wrong. They have been vindicated in this belief time and again. They will, therefore, be more reckless in their investment activity and speculation than they would in the absence of such a system.

We were once told that boom-bust business cycles were a thing of the past because, thanks to the Fed, we now had scientific management of the money supply. If anyone believes that today, I’d like to meet him. Artificially low interest rates courtesy of the Fed do not yield us a utopia of sunshine and kittens. To the contrary, they artificially stimulate capital-goods production and long-term investment. They thereby deform the structure of production into a configuration that the public’s freely expressed pattern of saving and consumption will be unable to sustain. When this phony boom inevitably collapses, it is "capitalism" that takes the blame – when in fact the Fed, a non-market institution, is the culprit.

I am interested in neither the saccharine promises nor the technical details of the alleged superiority of a monopoly fiat-money system. The Fed is the lifeblood of the empire, the great enabler of the perversion of the original American republic into the world’s largest and most powerful government. Even if the central bank did confer a net economic benefit, a contention the great Austrian economists F.A. Hayek and Ludwig von Mises strenuously denied (and indeed Hayek won the Nobel Prize in the process of denying), the alleged benefit could not possibly be worth the destruction of the American soul.

As it turns out, we don’t have to make that choice. When it comes to the Fed, justice, economic prosperity, and the values of the original American republic are joined together.

The Fed, its academic apologists, and the drones in our supposedly free press who demonize all dissent from the monetary status quo, have done our economy enough damage. For the sake of American freedom and prosperity, it is long past time that, in the spirit of Andrew Jackson, we killed the monster.

This is the opening statement I delivered in a debate last weekend at FreedomFest in Las Vegas on the topic "Fed Up with the Fed: Is It Time to Abolish?" Gene Epstein of Barron’s and I debated Warren Coats and John Fund. The debate will be televised on C-SPAN at some point in the future. I’ll post the date and time on the LRC blog and at my website as soon as it’s announced.

http://www.lewrockwell.com/woods/woods118.html

Is Woods' solution to revert to a gold (or other precious-metal) standard, or perhaps to tie the value of the dollar to industrial or other economic output (difficult now, with "our" industrial plants now mostly in China and India)?

Seems that, if the ZOG agreed to abolish the Fed, they'd first try to replace it with something just like it, in order to keep the rivers of currency flowing and to avoid the day of financial reckoning which we all face.

"KEVIN DOWD IS ONE OF THE LEADING free-market monetary theorists today. Along with Lawrence H. White and George Selgin, he has helped to revive and refine the case for abolishing central banking and replacing it with a market-based competitive free-banking system.


In 1976, Austrian economist Friedrich A. Hayek published a monograph, The Denationalization of Money, in which he called for an end to the government monopoly and control over money and for replacing it with private banks’ issuing their own currencies.

Eight years later, in 1984, Lawrence White published a book on free banking in Britain during the first half of the 19th century. This was followed in 1988 by George Selgin’s Theory of Free Banking: Money Supply under Competitive Note Issue. Since then both men have published widely in the mainstream economics journals, and they have written a number of other books that make the case for private, competitive banking.

Also in 1988, Kevin Dowd came out with a short monograph, Private Money: The Path to Monetary Stability, which was followed the next year by a longer book entitled The State and the Monetary System. In 1993, he collected 16 of his articles and published them as a book under the title Laissez-faire Banking. And in 1996, he published Competition and Finance: A Reinterpretation of Financial and Monetary Economics. He also edited an insightful collection of essays, The Experience of Free Banking (1992), in which seven authors recounted past episodes of free banking in countries around the world.

Now Dowd has brought together another collection of his articles and published them under the title Money and the Market: Essays on Free Banking. In the first half of the book, the theme is how a laissez-faire banking and financial system could successfully function and actually function better than the present system of central banking and government insurance of deposits.

In a lengthy essay entitled “The Invisible Hand and the Evolution of the Monetary System,” he explains how a monetary and banking system might have emerged and fully developed if government had not usurped control over money and its creation. He follows the argument of Carl Menger, the founder of the Austrian school, in explaining how money originated out of the inconveniences of barter, as people searched for indirect methods to attain their ends in trade. Historically, people have found that there are certain commodities in greater demand and that are more easily transported and divided to reflect agreed-upon terms of trade. Over time these tend to become the most widely used and generally accepted media of exchange. In other words, the market selects them as the money-goods.


Fractional-reserve banking
Over time people found it useful for safekeeping to store their gold and silver monies with goldsmiths, who would issue receipts as claims to the goods left on deposit. These receipts at some point began to be accepted in trade as money substitutes, as items “good as gold” that could be redeemed on demand. The goldsmiths developed into “bankers,” accepting deposits and issuing loans to borrowers. But they also discovered that they could issue notes — or money substitutes — for more gold or silver than was actually on deposit, because deposits and withdrawals were found to follow certain patterns that required very little actual gold money to be on hand for redemption purposes. And out of this discovery emerged fractional-reserve banking.


Dowd does not consider this practice illegitimate or harmful as long as banks are required to redeem all depositor claims on demand. For then, each private bank would have to avoid any excessive issuance of notes in the form of loans; otherwise they would run the risk of weakening depositor confidence in the bank’s ability to pay on demand when too many notes were presented for payment. The instability from a fractional-reserve system, he argues, has come from the government monopolization of the monetary system, which has resulted in the elimination of the historical “gold anchor” of note redemption, and from the ability of the government’s central bank to issue as many units of paper money as it desires with no direct or immediate “negative feedback” to stop the money-creation process.

He then develops his own theoretical conception of how a private competitive banking system could have moved away from a gold basis over time. Instead, he thinks that private banking would have shifted into offering to redeem notes in the form of baskets of commodities or financial assets. Other advocates of free banking have argued that such an evolution away from a commodity like gold would be unlikely to occur. But in practice there is no way of knowing exactly what consumers and depositors would desire as a commodity basis of a free monetary system until central banking is abolished and market transactors are allowed to make their own evaluations and choices.


Monetary central planning
Dowd is confident that international market forces are moving in directions likely to weaken the power of national governments to manipulate the money supply through central banking in the 21st century. This partly makes up the theme of the second half of the book. Technological advancements in the use and transfer of financial instruments and forms of media of exchange are slowly but surely reducing government control of money and money creation. The door will be opened to the development of a more market-based and market-created global monetary regime.


In this context, Dowd includes an essay, “What Role for Government?” that he wrote in 1993 in which he discusses the problems of monetary reform in the former Soviet-bloc countries, including Russia. Inflation, he explains, is easy to stop; the political authority simply must stop printing money. There would be an unavoidable stabilization crisis, given the distortions and imbalances the monetary inflation would have generated. But it need not be either prolonged or severe if the monetary authority generates the public confidence that inflation is over and will not recur. Then the market, if left free of interventions and controls, can bring supplies and demands into balance in a reasonable period of time.

In the 1920s, after the inflations during and just following the First World War, countries such as Germany, Austria, Hungary, and Czechoslovakia were able to recreate a degree of monetary order and stability by restoring, however incompletely, a gold standard as an anchor for their respective national currencies. With gold no longer in use by governments as the basis for their monetary systems, Dowd recommends the short-run benefits of currency boards. A currency board operates much like a gold standard: a government links its own national currency to a larger and stronger currency, such as the U.S. dollar or the German mark. The national currency may not be increased unless there is a net inflow of, say, dollars into that country’s banking system; and if there is a net outflow of dollars from the banking system, that nation’s central bank must decrease its national currency according to the fixed ratio established between its money and the dollar.

But Dowd argues that while establishing a currency board is a useful and effective way of eliminating a government’s independent power to increase its money supply, at most it should be viewed as a transitional step leading to a free, competitive banking system completely outside the control and regulation of the government. Indeed, he argues that even during the currency-board period private banks should be free to offer alternative monetary instruments in competition with the national currency issued by the government. Such instruments would reinforce and ease the process, leading to a fully nongovernmental monetary order.

In the introduction Kevin Dowd explains the simple outlook from which he approaches monetary issues: “I believe that markets generally work and governments generally fail; the invisible hand of the market is better than the visible hand of the state.” His analysis demonstrates that this is no less true in the arena of money and banking. Let us hope that he is right in his optimistic view of what the 21st century may hold in store for the possibility of a free banking system."

http://www.fff.org/freedom/1101j.asp