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Proposition of Value:

The Federal Reserve fiat-monetary and banking system hampers the more

inherently stable and productive free-market.

Jordan Inman

Student ID: 603263892291805

yonoid818@hotmail.com

Date of Submission: 11/16/09

Word Count: 2000

Danielle Fernandez

Sec. 27507

C228 Argumentation & Public Advocacy

In 1999, shortly after the passage of the Financial Modernization Act which repealed the

banking restrictions in the Glass-Steagall Act of 1933 and endowed banking, securities, and
insurance companies with greater powers (Gramm-Leach-Bliley Act), Ralph Nader happened to

board a flight along with then-Secretary of the Treasury Lawrence Summers. Nader posed him

the question, “Do you think the banks have too much power?” to which Summers replied, “Not

yet.” After this meeting, Nader and other consumer advocates teamed with Summers and his

staff in a short-lived attempt to convince president Clinton to reconsider consumer rights that

were impeded under the act, but Clinton and Congress “were [in no] mood to revisit this heavily

lobbied federal deregulation law…” (Nader). Summers is currently the director of president

Obama’s National Economic Council and is probably in step with the president’s opinion that the

act “led to deregulation that helped cause the crisis” and “cleared the way for companies that

were too big to fail” (Paletta and Scannell). Nader, coming from the left, points to “unwise

mergers, acquisitions, and other unregulated risky financial instruments laced with limitless

greed [and] casino capitalism” (Nader). What is especially intriguing, though, is the assent held

by Austrian School economists that such a “free-market friendly” law was in fact little more than

mercantilist favoritism and a seed for catastrophe:

With Glass-Steagall, Congress put its finger on and mitigated the tendency and

temptations of banks to create massive costly externalities to society, in this case, by

holding bundled mortgage-backed securities which were deemed safe by rating

agencies but which ultimately failed the market test. The Act would make perfect sense

in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit

insurance; but in the world as it is, this "deregulation" amounts to corporate welfare for

financial institutions and a moral hazard that will make taxpayers pay dearly. (Ekelund

and Thornton)

In this state of affairs, one simply cannot afford to argue in terms of regulation and deregulation

because what is dysfunctional is the system itself.


Pointing out that the total worth of the U.S. economy has grown enormously since the

inception of the Federal Reserve to justify its presence stumbles over the post hoc, ergo propter

hoc fallacy (i.e. just because A happened before B doesn’t mean A caused B) and fails in its own

logic when ignoring the enormous growth for the previous century under the auspices of a

relatively free-market, decentralized banking, and a gold standard. So a natural question might

be, “Does the United States really need a central bank that prints a fiat currency in order for the

economy to function properly?” In a true free-market system, unsound investments are left to fail

under their own demerits and make way for more adept and stable market players. With a 100%

reserve standard backing everyone’s money, more risky endeavors are not undertaken until the

necessary savings can pay for them and because of these savings (ironically) lower interest rates

come with time as well. The Federal Reserve fiat-monetary and banking system is what stands

firmly in the way of the more reasonable and naturally self-regulated path.

I will cover some of the Federal Reserve’s functions and abilities, explain how an ideal

free-market system works, proceed to show how these two forces are in conflict with one another

and conclude that the current financial system is dysfunctional in its objectives of stability and

growth.

November 1910 – a small party of powerful men from the New York banking community

including representatives of companies like J.P. Morgan, National City Bank, and Bankers Trust

Co. surreptitiously left on a “duck hunt” getaway to Jekyll Island off the coast of Georgia. This

gathering is where much of the Federal Reserve Act (Federal Reserve Act, HR7837), passed over

the Christmas recess of 1913, was conceived and drafted (Whitehouse). The act granted the new

central bank power to “furnish an elastic currency” and have unprecedented oversight of banking

in the U.S.; its powers have greatly expanded since. According to its own self-published

Purposes & Functions, the Fed was established in order to “provide the nation with a safer, more
flexible, and more stable monetary and financial system” (Federal Reserve System). This more

“flexible” or “elastic” currency has succeeded in stripping the dollar of 95% of its value

(*Williamson), has been used to transfer money to the privileged as the new money is received

first by those at the top before prices have risen, and makes possible money-sucking projects like

wars and a failed bureaucracy of healthcare. As for the “more stable financial system” that the

Fed was supposed to provide following the Panic of 1907, we have had succeeding “panics” (the

older usage for recession) in 1918-19, 20-21, 23-24, 26-27, 29-33, 37-38, 45, 48-49, 53-54, 57-

58, 60-61, 69-70, 73-75, 80, 81-82, 90-91, 2001, and the one we’re drudging through today

(National Bureau of Economic Research).

I regret to say that the United States may have never had a purely free-market in its

history, but we have come close during those select years in the 19th century when banking was

separated from state and the natural market money-of-choice, gold, was used as full reserve for

every dollar. The definition of free-market is simple; any concise definition like this one from A

Dictionary of Economics will do: “An economy…in which the parties choose the quantities and

prices traded without central direction” (“free-market”). The key is without central direction and

should take into account any form of intervention. Take skyrocketing tuition for example: In

1918, a blue-collar worker could earn $5 a day and be able to pay off a year’s tuition at Yale

after a month in a factory. Yale now costs $36,500 a year (up 50% in the last decade alone) and

the worker would have to toil for a year-and-a-half! Because of all the new government “help”

and agencies, like the Dept. of Education, costs have been exploding. All of the students bid

against each other with government money for slots in universities thus bidding the prices up;

whatever the price is, the university can cover it because they are guaranteed the loan from the

government. In effect, there is no incentive for lower prices or a free-market to rein in costs

(Schiff). What is a tangible example of a functioning free-market model in today’s world? The
internet is a system that grew (and is growing) exponentially out of market players who have

allocated resources (bandwidth) into thousands of highly-affordable separate networks that serve

as databases, stores, alternative banks (e.g. PayPal), social networks, ad infinitum, all functioning

under its own self-regulation and without any central planning.

The central character in most acts of economic intervention in today’s economy (almost

by default) is the Federal Reserve. This intervention into the market after witnessing a decline in

some crucial industry that the Fed fears is a sign of an unstable economy is not incapable of

mistaking an ordinary business fluctuation for potential catastrophe. A hypothetical example that

highlights the absurdity of this effort to stabilize might be finding an industry solely staked on

the Summer Olympics once every four years to be in dire need of stimulation in those years with

no Olympic games. Would it really help that particular industry to put products on the market for

which there is no demand? The reality is that these fluctuations are everywhere from cherries

being out of season to diaper sales during years of greater fertility and important industries like

agriculture, housing, and automobiles are no stranger to this type of movement. But the real

business fluctuation problem happens when everyone starts asking, “Where did this recession

come from?” or “Why did so many businessmen and investors all make mistakes at relatively the

same time?” This is what economist Murray N. Rothbard referred to as the “cluster of error” and

reminds us that “in the purely free and unhampered market, there will be no cluster of errors,

since trained entrepreneurs will not make errors at the same time” (Rothbard 17).

So the question remains, “How did the stock market crash?” One of the Fed’s basic

duties, again outlined in its Purposes & Functions, is the consequential job of “influencing

money and credit conditions” when it sees fit to do so. When the Fed decides to cut interest rates,

this means they are decreasing the amount banks charge when they borrow from one another.

The Fed does this by buying bonds from the banks which in turn increases the total reserves a
bank can lend out. This is where the fiat printing-press comes in handy and hides wealth

redistribution in the form of inflation. The banks now have excess reserves with which they must

lower their interest rates and reduce their lending standards in order to attract borrowers (Paul,

Chapter 6). In this environment, investments that otherwise would have been undesirable or too

risky can now be funded. This is where the “boom”, or false prosperity, occurs. The result,

similar to the “Olympic” example, is one of mal-investment that leads to misallocated resources,

losses, layoffs, and abandoned projects that need to be liquidated. The “bust” is when this reality

is uncovered and the bubble deflates in order to return to correct levels of production. Perhaps

the most fitting of all examples would be the recent sub-prime mortgage bubble that wrongly

encouraged people to buy more and bigger houses. Because Alan Greenspan and company

insisted on keeping interest rates at record lows (*”Monetary Policy Releases”), the housing

market actually appreciated for the first time during a recession while the ten-city composite

index rose an unprecedented 89% from June 2001 to 2006 (Standard & Poor’s).

In the aftermath of WWI, the U.S. had incurred nearly $25 billion of debt and in 1920

suffered an even greater plunge in GNP and job losses than the initial contraction of the Great

Depression in 1929 (Powell). So why have we never heard of a Great Depression of the early

twenties? Because, unlike today, ideas of economic intervention and Keynesian theories were not

popular and so the Federal Reserve was not involved in a correction effort. Instead, the Harding

administration decided to cut government spending in half, thus shifting the saving-

investment/consumption ratio in favor of saving and investment, speeding up the time it takes for

the economy to return to normal growth. President Hoover, on the other hand, was anything but

laissez-faire and mirrored FDR’s exacerbation of the downturn by delaying liquidation, fixing

prices, discouraging saving, subsidizing unemployment, and inflating further. With today’s

Federal Reserve System in such total and secretive command that they will not even allow for an
audit of their banks, disclosing where our money is spent, it should be no wonder we’re repeating

the same mistakes in handling economic crises.

It really is amazing to look at how waffling and inconsistent mainstream economic

thinkers are who often tie themselves by political lines. “If Paul Krugman was worried about a

$3 trillion budget deficit and a debt-to-GDP ratio of 4 percent six years ago1, a $9 trillion budget

deficit and a debt-to-GDP ratio of 40 percent today should have him preparing for financial

Armageddon”, quotes Benjamin Lee on the Nobel Prize-winning economist (Lee). Why should

we continue to listen to those voices who have led us astray in the past and endorse ideologies

that have dug us into this deep hole we’re in – a hole that only seems to get deeper and deeper?

Why not give the free-market a chance to do what it does best and return to some sense of

monetary sanity and restraint? I have a feeling the question that will eventually be on everyone’s

lips is “What have we got to lose?” That will be the day when the colonnade façade that is the

Federal Reserve System will come tumbling down.

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