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Pittsburgh Tribune-Review: “Failed fed”

In my column for the November 26th, 2010, edition of the Pittsburgh Tribune-Review I reported on then-recent (and still-relevant) research done by George Selgin, Larry White, and Bill Lastrapes on the record of the Federal Reserve. You can read my column beneath the fold (links added).

Failed fed

In his 1960 classic “The Constitution of Liberty,” F.A. Hayek insisted that money can be supplied adequately only by government. By 1976, Hayek had changed his mind. In that year he published a monograph calling for (as its title reads) “The Denationalisation of Money.”

Supplying money, Hayek argued from 1976 until his death in 1992, is best left to private banks competing against each other for deposits. Entrusting government with monopoly control over the single most important good in a market economy — money — is a recipe for catastrophe.

Ask yourself (and answer honestly): If you possessed exclusive power to print dollars and spend them as you wish — and if you were allowed to imprison anyone who tried to compete with you in the money-supply business — might you be tempted from time to time to pay your bills not by working harder, but by simply rolling a few thousand more dollars off your printing press? When choosing between buying a new car or a luxury vacation to Tahiti, might you rescue yourself from the need to make this choice by printing enough money so that you can buy both?

You see the temptation.

And yet such power over the money supply is precisely what Uncle Sam possesses.

Uncle Sam delegates that power to the Federal Reserve — whose board of governors, fortunately, is insulated somewhat from politics. But only somewhat. The Fed, after all, was created by Congress, must report to Congress and from time to time is the subject of talk about being brought more directly under congressional control.

However, even if politics never enters into the decision-making of Fed officials, and even if those officials are guaranteed always to be the saintliest and most morally courageous human beings who ever breathed, having a monopoly money supplier is a very bad idea.

My George Mason University colleague Lawrence H. White and my former GMU colleague (now at the University of Georgia) George Selgin have devoted their prolific careers to studying the theory and history of central banking and its free-market alternatives.

White’s book “Free Banking in Britain” explains how free-market money-issuing in Scotland during the 18th and 19th centuries resulted in remarkably sound money. Selgin’s book “The Theory of Free Banking” explores in detail the reasons why competitive money issuers outperform a monopoly money issuer at supplying sound money and, hence, at avoiding problems sparked by too much (or too little) money creation.

Recently, White and Selgin (along with William Lastrapes) released a major study of the Fed’s actual performance since its founding in 1913.The title of the paper explains well the questions these scholars ask: “Has the Fed Been a Failure?

To sensibly answer this question requires a baseline against which the Fed’s actual performance can be compared. The ideal baseline, regrettably, is impossible to determine. That baseline would be knowledge of how the economy of the past 97 years would have performed if the Fed had never been created.

Nevertheless, Selgin, Lastrapes and White present a convincing case that the Fed likely made the economy worse and not better than it would have been had America been spared a central bank.

The first and most obvious issue to examine is the value of the dollar. From 1790 until 1913, the dollar lost 8 percent of its value. Since the Fed’s creation in 1913, however, the dollar has lost (so far) an additional 95 percent of its value. Given that one of the Fed’s mandates is to maintain price stability, such inflation is hardly evidence of successful performance. Clearly, the Fed has undermined the dollar’s value.

A Fed apologist might respond that a 95 percent loss of value over 97 years means that the average annual rate of inflation was quite modest. True. But this low average masks great volatility. Selgin and his co-authors found also that “The price level had … become less rather than more predictable since the Fed’s establishment.” And, therefore, “as the Fed has gained greater control over long-run price level movements, those movements became increasingly difficult to forecast.”

Given prices’ important role in regulating consumer and investor actions, it’s not surprising that Selgin, Lastrapes and White fail to find any evidence that the Fed has moderated swings in economic output.

Perhaps most significantly, the evidence also shows that Fed intervention has lengthened economic downturns — such as the one we’re currently in — without reducing their severity (even if we exclude the Great Depression from the data!).

Finally, the evidence shows that the Fed has done nothing to reduce the frequency of bank failures.

The overall assessment by Selgin, Lastrapes and White is stark: “The Fed’s failure has been chronic.”

It’s time we ponder more competitive alternatives to this monopoly central bank.


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