by Matt Kibbe
Here’s the rub. The government has zero money of its own. It’s not Santa Claus with a Midas touch. It can’t replenish Fort Knox on command. The government has to go out and get money from those who produce the things that make money valuable. When it wants to spend money that it does not have, it can do but three things. 1) It can raise taxes. 2) It can borrow money through the selling of government securities (i.e., promises to repay in the future). Or 3) it can simply print more dollars. Given his penchant for new spending, Barack Obama has gone for the full Monty. But even with all the administration’s new taxes and massive borrowing, printing money is the most destructive practice. It’s also the easiest, essentially a form of taxation without legislation and, at least until recently, little noticed by the public. The inherent complexity of currency manipulation through monetary policy makes it a tempting vehicle for government growth.
Enter the Federal Reserve, a quasi-governmental bank that controls the amount of dollars in the economy. Created in 1913, the Fed has a seven-member board of governors, appointed by the president and confirmed by the Senate. In addition, there are twelve regional Federal Reserve banks. The Federal Open Market Committee (FOMC) is the arm of the Fed that controls monetary policy. It is comprised of the seven members of the board of governors and the presidents of five of the regional reserve banks. The New York Fed is a continuous member of the FOMC; the other reserve banks rotate one-year terms. The FOMC influences interest rates by either buying or selling government bonds. When it wants to increase the money supply, it purchases long-term treasury bonds, which lowers interest rates and pumps more dollars into the economy. When it wants to decrease the money supply, it sells these bonds, which raises interest rates and reduces the number of dollars in the economy.
Most of the time, the denizens at the Fed’s grandiose headquarters on Constitution Avenue in Washington don’t like to admit that their manipulation is essentially a sneaky way to print more money, but occasionally they let the truth slip. In a March 15, 2009, interview on 60 Minutes, picked up by the researchers at Comedy Central’s The Daily Show, Federal Reserve Chairman Ben Bernanke—who now regularly denies that the Fed is printing money—admitted that “to lend to a bank . . . it’s much more akin to printing money than it is to borrowing.” “You’ve been printing money?” 60 Minutes asks. Bernanke replies: “Well, effectively.”16 This unchecked power gives the Fed monopoly control over our money supply. The more dollars we have in the circulation, the less valuable our money becomes; they are essentially stealing our hard-earned money through a hidden tax.
On the Federal Reserve’s main website, it says that the bank was founded “to provide the nation with a safer, more flexible and more stable monetary system.”17 The Fed’s original mandate was to establish a monetary system and furnish an “elastic currency.” But, as with every government creation, the scope of its power increased over time. In 1977, Congress passed the Federal Reserve Reform Act, which established the Fed’s “dual mandate”: maintaining stable prices and maximum employment. It has failed miserably at both of these stated missions. One reason is that neither mission can be reliably achieved with a printing press. Another is that the dual mandate is premised on faulty economics, introduced at a time when many economists thought there was a trade-off between unemployment and inflation that could be used to guide policy. However, the stagflation of the 1970s and early 1980s proved this theory wrong, as the era was plagued by both high inflation rates and high unemployment.
The goal of the Progressive Era was to increase government control over the economy, replacing the dispersed wisdom of free people with a government of experts empowered to plan a better society from the top down. The creation of a central bank was a key piece of the puzzle, along with a federal income tax. The fateful Federal Reserve bill was passed on the evening of December 22, 1913, when many congressional members were home on Christmas break. This sounds a lot like the dirty tactics used to pass Obamacare in 2010, doesn’t it? It concluded a terrible year for individual liberty, with the Progressive movement achieving some of the most destructive pieces of legislation in American history, including the federal income tax and the creation of the Federal Reserve.
SEXTILLIONS
LONG BEFORE HE WOULD CONTRIVE NOTIONS LIKE “AGGREGATE DEMAND,” even John Maynard Keynes understood that allowing governments to inflate the money supply unchecked would be devastating to a free economy. In by far his best book, The Economic Consequences of the Peace, Keynes wrote that “Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and while the process impoverishes many, it actually enriches some. . . . Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”18
It is beyond dangerous for the government to have monopoly power over money creation. Consider Zimbabwe. Back in 1980, one Zimbabwe dollar equalled a U.S. $1.47. Beginning in the early 2000s, the Reserve Bank of Zimbabwe fired up the printing presses to pump massive amounts of new Zimbabwean dollars into their economy to pay off debts to the International Monetary Fund.19 You can guess what happened next. Correct: rampant hyperinflation. In November 2008, Zimbabwe’s annual inflation rate was 89.7 sextillion percent.20 Does that sound like a made-up number? For future reference, it goes trillion, quadrillion, quintillion, sextillion. The last term is a 1 followed by 21 zeroes. Written out, 89.7 sextillion is 89,700,000,000,000,000,000,000. The inflation rate was so overwhelming that Zimbabwe’s chief statistician, Moffat Nyoni, declared it impossible to calculate.21
In 2008, the Los Angeles Times reported that, “Zimbabwe is about to run out of the paper to print money on.”22 Zimbabwe printed its first 100-trillion banknote, worth roughly $30 USD, in early 2009.23 Can you imagine walking around with a $100 trillion bill in your pocket? Zimbabwean children would traverse the streets with wheelbarrows full of cash. Tragically, the wheelbarrow was worth more than the mound of money it carried.
The Zimbabwean dollar officially collapsed in April 2009.24 That month, the Freakonomics blog at the New York Times reported that “Zimbabwe’s currency has been essentially worthless in-country for months. Now the Zimbabwe dollar is officially worth more on eBay, where collectors can snap up a few trillion-dollar notes for less than $25.”25 Zimbabwe had to ditch its currency and start all over again.
Another example of hyperinflation was in Germany’s Weimar Republic. Before World War I, Germany had a fairly strong currency backed by gold, called, conveniently, the gold mark. About four or five marks could be exchanged for a dollar in 1914.26 That year, Germany abandoned the gold backing of its currency.27 Just as with Zimbabwe, it did this on purpose: to evade the repayment of massive debts. The Treaty of Versailles that ended World War I required Germany to pay heavy reparations to the Allies. The defeated Germans were on the hook for 132 billion marks, then worth $31.4 billion.28 That’s roughly equivalent to $442 billion in 2011. Critics argued that it would take a whopping 59 years to pay off the reparations, putting the final payment around 1978. They were wrong. It took Germany until October 3, 2010, to make its last payment.29
Most of the debt, however, was paid off in the first few years—with worthless paper. The Germans may have been beaten on the battlefield, but they knew how to evade their peacetime obligations. They just fired up the printing press. The consequences for the German people were disastrous. In 1923, 4.2 trillion marks could be exchanged for just one dollar.30 An automobile full of cash could not have bought a newspaper. The mark became so worthless that the German people used it as wallpaper, toilet paper, and a substitute for firewood.31
We are not experiencing a devaluation of currency that rivals Zimbabwe or the Weimar Republic yet. But it’s foolish to ignore the monetary policy mistak
es they made, which left their money virtually worthless. Printing excessive amounts of money out of thin air to pay off debts has harsh consequences.
Our national debt is more than $15 trillion, making the United States not only the most indebted nation in the world but the most indebted nation in the history of the world.32 But fear not; like Zimbabwe and Germany, we can just print more money to pay it off. Confirming this in an August 2011 Meet the Press interview, former Federal Reserve chairman Alan Greenspan said, “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.”33 It’s certainly true that the Federal Reserve can just print more money, or add a few more zeros on a balance sheet to create money out of thin air—but not without trashing our currency and our economy.
SEND IN THE CLOWNS
THE FEDERAL RESERVE’S MAIN WEBSITE SAYS THAT “OVER THE YEARS, its role in banking and the economy has expanded.” It now includes “maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.”34 In practice, the Fed’s machinations have produced systemic instability.
The Great Depression is a classic example of a Fed-generated boom and bust. The 1920s saw real economic growth with the nation’s return to a peacetime footing plus the Coolidge pro-growth income tax-rate cuts. But it also saw a stock market bubble fueled by Fed policy. In late 1929, that bubble gave way to what should have been a sharp, but short correction. Fed intervention (compounded by the big-government, redistributionist policies of FDR) turned it into a decade-long economic nightmare. Some of its political aftershocks are still being felt even today. Global depression helped to fuel global destabilization, war, and a resurgence of socialist regimes across the world.
The Fed hasn’t ended the business cycle; arguably, it has made it worse. According to George Mason University economist Lawrence White, “the classical gold standard of 1879–1914 functioned quite well without a central bank in the U.S., thank you very much. Despite the financial panics, which could have been avoided with banking deregulation, the business cycle wasn’t worse than under the Fed’s watch.”35
Many Americans likely believe that continuous boom and bust cycles are natural occurrences, part of the inevitable “business cycle.” But it’s not true. We would not experience such dramatic economic swings were it not for monetary policies that distort real prices and encourage bad investment decisions. Boom and bust cycles are inevitable, though, when government interventions confuse consumers and producers.
The single greatest contributor to financial crisis is the Fed’s manipulation of interest rates in ways that distort the true price of capital. When the Fed artificially lowers interest rates, it creates a false boom somewhere in the economy. The low cost of credit and unsustainable increase in money supply encourages businesses to greatly expand at the same time. It may seem as if businesses are overinvesting, but they are simply responding to false economic signals sent by the Federal Reserve. In retrospect, the businesses’ decisions are seen as a bad allocation of resources.
The Federal Reserve cannot continue the boom permanently. An inevitable bust will always follow. The malinvestments fed by easy money are revealed, and wasted capital and economic losses incur as these misdirected investments are liquidated. In his classic book Human Action, Mises wrote:
the popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers’ stone to make it last.36
Peter Schiff draws a perfect analogy between an artificial boom and a circus that comes to a small town for a short time. During this time, the circus attracts a large crowd, which is a boom to local businesses. Now imagine that a local businessman mistakenly believes that the upturn in his business will endure permanently. He responds by greatly expanding his business, hiring new workers or opening a second location. All is well until the circus leaves town and the businessman is left with a large surplus of workers and capacity. He finds out he miscalculated when all the bad investments are exposed.37
The last decade in America has been a textbook example of a boom and bust cycle. Between 2001 and 2004, the Federal Reserve injected new credit into the economy, pushing interest rates to their lowest level since the late 1970s.38 The economy boomed as a result of the false economic signals to businesses with respect to demand for their products. These businesses responded by hiring more staff, buying more resources, investing in capital, and so forth.
The early 2000s marked the boom phase. Between September 2003 and December 2007, we experienced fifty-two months of uninterrupted job growth.39 Treasury Secretary Henry Paulson in March 2007 said that “the global economy is more than sound: it’s as strong as I’ve seen it in my business career.”40 He was certain it was true. On October 9, 2007, the Dow Jones Industrial Average closed at a record level of 14,164.53.41 Federal Reserve Chairman Ben Bernanke seemingly concurred, saying in January 2008 that “the Federal Reserve is not currently forecasting a recession.”42 At the time he spoke, the recession had already begun.
Just as Austrian business cycle theory predicts, the boom was followed by the bust, when the stock market crashed in October 2008.43 Some were quick to wrongly blame free market capitalism for the economic downturn. As economist Henry Hazlitt once said, “in a crisis and a slump . . . worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of ‘capitalism.’”44
Ted Forstmann, a private equity pioneer, gave a concise, perfectly “Austrian” explanation of the damage caused by easy money in a July 5, 2008, interview with the Wall Street Journal. Predicting the financial train wreck that was just months away, Forstmann said that he did not “know when money was ever this inexpensive in the history of this country. But not in modern times, that’s for sure.” Banks had “tons of money left,” after making loans and investments based on proper risk assessment and a reasonable expectation of returns. That’s when banks went into “such things as subprime mortgages.” About a year before he died, I had the opportunity to ask him if he had read any Austrian business cycle theory, referencing this interview’s foresight. I was sure he had. “No,” Forstmann said, with a somewhat mystified look on his face. He just understood a top-down corruption of market signals when he saw one.
The Federal Reserve has repeatedly attempted to “fix” the problem that it created. The official unemployment rate has hovered around 9 percent for the past two years.45 The central bank devised QE1 and QE2, which stands for quantitative easing parts 1 and 2, which is a more polite way of saying “printing money and then printing some more money.” As economist Thomas Sowell says, “When people in Washington start creating fancy new phrases, instead of using plain English, you know they are doing something they don’t want us to understand.”46 And the Fed has been busy; since 2007, their balance sheet has increased from roughly $850 billion to $2.7 trillion, which includes all the mortgage-backed securities and questionable assets the Fed has purchased—and you can be sure that any risk posed by these purchases will be borne by the taxpayer.47
“FULL FAITH AND CREDIT”
WHEN THE FEDERAL RESERVE WAS ESTABLISHED, MANY CHAMPIONED the fact that the new regime was creating an independent body that could establish monetary policy without influence from political interests. This fantasy—centralized power without the undue influence of special interests—is the political unicorn of progressivism. It’s
never, ever true. The 2008 bailout, and the various tranches of “quantitative easing” since, ably demonstrate just how responsive the Fed is, in fact, to political pressure. The facts were hard to ignore when the Federal Reserve used the full “faith and credit” of the United States to rush to the aid of the big banks on Wall Street.
Simon Johnson and James Kwak report in their book 13 Bankers:
Any modern economy needs a financial system, not only to process payments, but also to transform savings in one part of the economy into productive investment in another part of the economy. However, the Obama administration had decided, like the George W. Bush and Bill Clinton administrations before it, that it needed this financial system—a system dominated by the thirteen bankers who came to the White House in March. Their banks used huge balance sheets to place bets in brand-new financial markets, stirring together complex derivatives with exotic mortgages in a toxic brew that ultimately poisoned the global economy.48
As the housing bubble burst and the house of cards collapsed, Wall Street was on the first train to Washington. Treasury Secretary Paulson, a former Goldman Sachs chairman, and the then-chairman of the New York Federal Reserve and soon to be Treasury Secretary Timothy Geithner rushed to prop up their Wall Street allies: first through the $700 billion Troubled Asset Relief Program, then through the Fed’s special lending facilities, quantitative easing 1, quantitative easing 2, and other actions, the Fed propped up the failing banks, shifting their “troubled assets” over to the taxpayers. Since September 2008, when the crisis erupted, the Fed’s security purchases increased from $3.7 billion to $1.97 trillion. This pushed the Fed’s excess reserves up from $68.7 billion in 2008 to $1.47 trillion today.49