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May 1996
Volume 14, Number 5

Mad Fed Disease
Llewellyn H. Rockwell, Jr.

The Federal Reserve is the most powerful yet least questioned of all Washington institutions. It can make or break elections, bail out entire governments, send the stock market to the stratosphere, or bankrupt whole industries. Yet it operates with less oversight than the CIA.

In the past, politicians have only bowed and scraped when the Fed chairman testified before the Congressional committees. But that may change. The Fed may find itself on the hotseat after 79 years.

The Government Accounting Office released a report on the Fed just as Alan Greenspan was seeking Senate confirmation for his third term. The report pulled back the curtain, just a smidgen, on the Fed's notorious secrecy. Now some Senators are gearing up to give the Fed the what-for.

Among other revelations in the report is the fact that the Fed holds a heretofore secret "contingency fund"--that is, a slush fund--totaling $3.7 billion. It comes from money that the Fed has skimmed off the revenues gained from its open-market operations. Those revenues were supposed to be turned over to the Treasury.

And that's far from the only slush sluicing through the marble halls of the Fed's temple on Constitution Ave. From 1988 to 1994, spending on the Fed's lush lifestyle grew at twice the rate of inflation. There may be other such interesting facts, but we can't know for sure. The Fed has so far evaded a full-blown audit.

Mr. Greenspan protests the suggestion that the Fed is wasting taxpayer dollars. He points out that Congress doesn't appropriate any money to fund the Fed's operations. He's right in a narrow sense, but he's also counting on widespread ignorance of the Fed's operations to forestall further grilling.

The truth is the Fed doesn't need our taxes any more than a counterfeiter needs to rob the local gas station. The central bank can effectively print all the money it needs. And as the "lender of last resort," the Fed even controls the value definition of the dollar itself.

Just to get their juices flowing, Senators should do some reading in money and banking. Ideally, they would memorize Murray N. Rothbard's The Case Against the Fed, or show our anti-Fed film on the Senate's tv system. Central banking is a relatively new invention, and no one but a money socialist would say it has a good record.

In its never-ending quest to expand money and credit--a real contraction of money virtually never occurs--the Fed can lower the rate it charges member banks for loans, it can manipulate reserve requirements, or, most notoriously, it can buy Treasury securities on the open market.

It's this last action that proves so profitable. The Fed purchases Treasury securities--either directly or through favorite brokerage houses--and holds this debt as an asset. Working through its branch and member banks, it pyramids loans on top of these securities. The creditworthiness of the U.S. government--whose balance sheet would otherwise suggest Chapter 7--is entirely due to this power of the Fed.

The Fed can either be a minor or major buyer in the market, or it can play the key role in persuading foreign governments to buy and hold U.S. debt, thereby helping finance the U.S. deficit. In any case, this power is what creates the symbiotic relationship between the banking system and the government that makes a mockery of the Fed's alleged independence.

The real oddity--and this is where the power to counterfeit comes in--is where the Fed gets the money to purchase these debt securities. It creates it out of thin air, a trick made ever easier as the current paper money system replaced the restrictive gold standard.

If anyone tries this trick in the private sector, he's in the pokey. Look at the hysteria over the Montana Freemen. The U.S. military has considered bombing whole countries that are rumored to be producing phony dollars. The government says its new and surprisingly ugly $100 bill is necessary to stop counterfeiting. I call all this cracking down on the competition.

Now to the Fed's just-discovered $3.7 billion slush fund. It represents a small slice of the profits the central bank derives from exacting interest payments on the debt it holds. And who pays that interest? You and me, in the form of tax dollars that Congress allocates year by year. At the end of the year, the Fed gives some back and keeps the rest.

The original argument for creating the Fed was that it would eliminate banking crises, defined as economic downturns that cause banks to go belly-up and depositors to lose their money (and without doing away with fraudulent but extremely profitable fractional reserves). Well, after 1913, the recessions increased in frequency, the government became vastly bigger, and the dollar lost about 97 percent of its value. In one way or another, depositors have paid out more than ever.

The Fed's fingerprints are all over these trends. Every new dollar created by the Fed's operations--all other things being equal--waters down the value of the existing dollars in the economy. And an ever-cheaper dollar redistributes money from savers to debtors, and from the tax-paying middle class to the banks and government contractors that can spend the fresh money before prices rise.

If you doubt it, look at the private finances of one Fed board member, Lawrence Lindsey. He staged a tantrum when "Toys R Us" rejected his credit card application. But the Wall Street Journal reported that he's as leveraged as the government itself. Is he expecting inflation to pay his debts off?

Meanwhile, the Fed is becoming more aggressive as the nation's monetary mismanager. Who was it, after the peso fell, that burned up the phone lines demanding that Mexico be bailed out? Rush Limbaugh even got a call. Why, it was Alan Greenspan, who now seeks to be rewarded with another term, and resents any suggestion that the Fed's unbridled power is not entirely justified.

We hear that inflation is low, but look at the long-term trends. The dollar has lost about 75% of its value since Richard Nixon eliminated the last vestiges of the gold standard in 1971. Even at the present rate of inflation--and who believes that will last?--overall prices will be double when today's newborns enter the workforce, also laying the groundwork for future downturns.

We can't stop these trends by new and better appointments to the Fed. Differences among inflation "hawks" and "doves" are minute compared with the overriding institutional bias toward cheaper money, interest-rate manipulation, and brazen bailouts. And when Fed governors--including Mr. Greenspan--descend from the clouds to tell us their theories, they invariably resort to dumbed-down, discredited Keynesian doctrine about the trade-off between inflation and unemployment.

If we want to know why living standards are still falling, that curtain needs to be pulled back even more. If we want to stop the fall, we need to throw a monkey wrench into the money machine. The solution is a hundred-percent gold dollar, which would keep the government small, our money sound, and our economy stable. Best of all, under a gold standard, Lawrence Lindsey would be forced to pay his toy bills with his own money.


Llewellyn H. Rockwell, Jr. is president and founder of the Ludwig von Mises Institute


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