An Overview of the "Audit the Fed" Debate

The debate over H.R. 1207 and S. 604 is achieving quite a bit of publicity. I would like to compile some of the questions and resources surrounding it. To be clear - the audit gives the Government Accountability Office (GAO) additional power to examine

• The Fed’s discount window operations
  
• Funding facilities
  
• Open market operations
  
• Agreements with foreign banks and governments

With that said, lets take a look at the arguments for, and against, auditing the Fed.

Why should we audit the Fed?

In The Case Against The Fed, Murray Rothbard argues that the Fed enjoys a greater secrecy and independence than even the CIA.

The CIA and other intelligence operations are
under control of the Congress. They are accountable: a Congressional committee supervises these operations, controls their budgets, and is informed of their covert activities. It is true that the committee hearings and activities are closed to
the public; but at least the people's representatives in Congress insure some accountability for these secret agencies.

...

The FederalReserve System is accountable to no one; it has no budget; it is subject to no audit; and no Congressional committee knows of, or can truly supervise, its operations. The Federal Reserve, virtually in total control of the nation's vital monetary system, is accountable to nobody—and this strange situation, if acknowledged at all, is invariably trumpeted as a virtue.

...

So: if the chronic inflation undergone by Americans, and in almost every other country, is caused by the continuing creation of new money, and if in each country its governmental "Central Bank" (in the United States, the Federal Reserve)
is the sole monopoly source and creator of all money, who then is responsible for the blight of inflation? Who except the very institution that is solely empowered to create money, that is, the Fed (and the Bank of England, and the Bank ofItaly, and other central banks) itself?

Rothbard's first chapter is excellent, and highly relevant to this post. I would strongly recommend reading it in its entirety.

Ron Paul articulates:

Claims are made that auditing the Fed would compromise its independence. However, by independence, they really mean secrecy. The Fed clearly cherishes its vast power to create and spend trillions of dollars, diluting the value of every other dollar in circulation, making deals with other central banks, and bailing out cronies, all to the detriment of the taxpayer, and to the enrichment of themselves. I am happy to challenge this type of “independence.”

They claim the Fed is endowed with special intellectual abilities with which to control the market and that central bankers magically know what the market needs. We should just trust them. This is patently ridiculous. The market is a complex and intricate thing. No one knows what the market needs other than the market itself. It sends signals, such as prices, that should be reacted to and respected, not thwarted and controlled. Bankers are not all-knowing and cannot ignore the rules of supply and demand. They might act as if they are, but their manipulation of the market just ends up throwing it wildly off balance, which gives us the boom and bust cycles.

They claim the Fed must remain apolitical. No organization is apolitical that relies on the President to appoint the Chairman. In fact, it is subject to the worst sort of politics – power to create trillions of dollars and affect the value of every dollar in the country without the accountability of direct elections or meaningful oversight! The Fed typically enacts monetary policy that is favorable to particular administrations close to elections, to the detriment of long-term considerations. They do this partly because of the political appointee process for the Chairmanship.

Ron Paul recently articulated the conflict between the people and the Central Bankers in this appearance on MSNBC:




Over at Campaign For Liberty, Peter Orvetti asks "What's the Establishment Got to Hide?"

A dollar today is worth less than one-twentieth what it was worth on the day the Federal Reserve was created 96 years ago. Yet over all that time, the unelected Fed has never had to face the full scrutiny of our elected representatives that other powerful agencies must. Even our intelligence agencies must report to Congress -- but not the Fed, which has helped rack up an $11 trillion national debt, and an additional $13 trillion in dubious loans and bailouts.

The Fed will not say where that money is going. Chairman Ben S. Bernanke has refused to tell Congress, and why should he? There is no means to compel him, and no way to find out what he’s been doing. The Federal Reserve Transparency Act would change that.

C-SPAN covers an excellent debate with Tom Woods and others (including Warren Coats, former IMF official) on the pros and cons of auditing and abolishing the Federal Reserve. The basic positions are:

• Audit and abolish the Fed and replace it with private commodity money and private banking.
• Strip the Fed down to the sole task of protecting the value of the dollar.
• It is too impractical to end the Fed without creating economic instability, so another plan is needed.

It is a very good video, if you have the time I recommend it.

The Smith Family Foundation hosts a very similar debate with George Selgin, Peter Schiff, Steven Axilrod (former member of the Federal Reserve's Board of Governors), and a political science professor from Columbia University:



I just want to point out that at minute 58 Axilrod exposes the political interests of the Fed and its Board of Governors.

Why shouldn't we audit the Fed?

Too Big To Bail makes the case that to audit the Fed is essentially to end it, and we should not forget that ultimately it was Congress that created the Federal Reserve system and as such they should be blamed for it. In other words, we are to blame for it, and blaming Bernanke and the Fed for our woes is misplaced anger. As he states,

Don’t get me wrong. I think the idea of a Fed and fiat currency, are bad ideas. I just think we should stop the classic congressional game where we create a problem and then complain about the Fed as if they are to blame. We created the beast and now are not happy with it. We can pull the plug whenever we want. But doing so would be an admission that we screwed up, not the Fed. The issues everyone has seems to be with the institution per se. And we created the institution.

So within the very framework that we set up, the Fed’s argument in favor of independence seems to make perfect sense. Of course, I question the whole framework, but given the situation, it does make sense.

Fed Chairman Ben Bernanke speaks on the issue, and claims that the audit would nullify Fed independence -




And from his article in the WSJ:

The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence.

The Washington Post also thinks auditing the Fed is dangerous:

Though the bill has attracted 276 co-sponsors in the House and 17 in the Senate, it is wrongheaded in the extreme. By opening up the Fed's most sensitive interest rate and credit policies to public second-guessing, the bill would create a risk -- real and perceived -- of monetary policy bent to suit congressional overseers. This would destroy financial markets' faith in the Fed and, by extension, the value of the U.S. dollar, just as surely as a political "audit" of the Supreme Court's deliberations would undercut public faith in the justice system. ... The Federal Reserve Transparency Act is an unserious answer to a serious question.

If I may, the serious question is the existence of the Federal Reserve itself. As I find more sources I will update this post and continue to compile them. I hope this is a good start for you, though.

Who owns the Fed?

You would think this question would have an easy answer. Is it public or is it private? If it is public, we the people own it. If it is private, well, the shareholders own it. So who owns the Federal Reserve? Let me google that for you.

Here's what the Fed has to say about the matter:

"The Federal Reserve System is not "owned" by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects."

Maybe it is just me but that is confusing. Why is "owned" in quotations? So it is not a profit-making institution, but an independent entity within the government. If that is the case, why did a Federal District Court in California rule that the Federal Reserve is a private corporation? See here:

"Plaintiff, who was injured by vehicle owned and operated by a federal reserve bank, brought action alleging jurisdiction under the Federal Tort Claims Act. The United States District Court for the Central District of California, David W. Williams, J., dismissed holding that federal reserve bank was not a federal agency within meaning of Act and that the court therefore lacked subject-matter jurisdiction. Appeal was taken. The Court of Appeals, Poole, Circuit Judge, held that federal reserve banks are not federal instrumentalities for purposes of the Act, but are independent, privately owned and locally controlled corporations."

And further,

"Each Federal Reserve Bank is a separate corporation owned by commercial banks in its region. The stockholding commercial banks elect two thirds of each Bank's nine member board of directors. The remaining three directors are appointed by the Federal Reserve Board."

And,

"Examining the organization and function of the Federal Reserve Banks, and applying the relevant factors, we conclude that the Reserve Banks are not federal instrumentalities for purpose of the FTCA (Federal Tort Claims Act), but are independent, privately owned and locally controlled corporations."

It is worthwhile to read the ruling in its entirety, but "independent, privately owned and locally controlled corporations" doesn't seem to jive with "an independent entity within the government". Maybe the District Judge was confused. I certainly am. Lets see if this handy chart from the Richmond, VA Fed can help us...



So the member banks (commercial banks like Citi, JP Morgan, etc.) are the shareholders in the local Federal Reserve banks, and they appoint two-thirds of the board of directors which manage the local banks. Each banks' board of directors appoints a president, five of whom in turn sit on the Federal Open Market Committee. Stop me when I hit public ownership land, by the way. The Federal Open Market Committee is comprised of five presidents from regional banks, and seven members of the Board of Governors. The Board of Governors is appointed by the President and confirmed by the Senate. The Board of Governors appoints the other third of the board of directors at local Federal Reserve banks, and is advised by a Federal Advisory Council comprised of a representative from each of the twelve regional banks.

Aside from all the confusion, I don't see any public ownership in there at all. There is some public representation - the Board of Governors and their appointment of 1/3 of each banks' board of directors. That is not much. Anyway, who owns the Fed?

Here is an excerpt from an article written by former N.Y. Attorney General Eliot Spitzer on the cozy relationship between the N.Y. Fed and Wall St: (italics mine)

"Given the power of the N.Y. Fed, it is time to ask some very hard questions about its recent performance. The first question to ask is: Who is the New York Fed? Who exactly has been running the show? Yes, we all know that Tim Geithner was the president and CEO of the N.Y. Fed from 2003 until his ascension as treasury secretary. But who chose him for that position, and to whom did he report? The N.Y. Fed president reports to, and is chosen by, the Fed board of directors.

So who selected Geithner back in 2003? Well, the Fed board created a select committee to pick the CEO. This committee included none other than Hank Greenberg, then the chairman of AIG; John Whitehead, a former chairman of Goldman Sachs; Walter Shipley, a former chairman of Chase Manhattan Bank, now JPMorgan Chase; and Pete Peterson, a former chairman of Lehman Bros. It was not a group of typical depositors worried about the security of their savings accounts but rather one whose interest was in preserving a capital structure and way of doing business that cried out for—but did not receive—harsh examination from the N.Y. Fed."

Spitzer appears to be suggesting that Geithner works more for Wall St. than he does for the Fed. This quasi-conspiracy theory about Geithner is also advanced by former Assistant Treasury Secretary Paul Craig Roberts (@ 2:50) :

The Federal Reserve system has all the pomp and veneer of a government institution:

• The name implies a Federal agency
• The public face, Chairman of the Board of Governors, is appointed by the President
• It was created in name of the "public interest", to protect the value of the dollar and provide economic stability
  
• Has regulatory power over other private corporations
• Non-profit organization
• Has a special .gov web address
  

Despite these embellishments, the District Court of California found it to be a private corporation, and we don't know who the major shareholders currently are. So who owns the Fed? We don't really know. It sure isn't the American people. It appears to me that the Federal Reserve banks are by and large owned by member banks, possibly other foreign central banks, and are "directed" mostly by people who have ties to the banking industry. Can you see why conspiracy theories begin to emerge? Until we can have a proper audit of the Fed, we won't know who owns it.

Support Ron Paul's bill to audit the Fed. Why? 'Cause he pwns the Fed!

Keynes on Inflation

This is somewhat of a cross-post from Cafe Hayek, but I'd like to expound on it. John Maynard Keynes is an economist whose ideas have shaped government policy since the early 20th century. His ideas are the heart and soul of stimulus plans all over the world. Stimulus is supposed to be the antidote to massive deflation and the paradox of thrift. The government prints or borrows money for spending now, to "stimulate" the economy and improve private consumption rates. This policy is inherently inflationary, and it must be so. The only way to combat deflation is through inflation.

That being said, it is important to take a look at what Keynes himself said about the consequences of inflation:

By a continuing process of inflation, governments 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. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls . . . become 'profiteers', who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished not less than the proletariat. As the inflation proceeds . . . all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless. (from pages 220-233 of The Economic Consequences of the Peace (1919))

Some will point out that he begins by stating that a "continuing process of inflation", and that perhaps a one time stimulus would be good. Let's look at the value of the dollar after we completely abandoned commodity money in 1971. (chart from here)



Look at what happened to the cost of living when the USA went off the gold standard. We are clearly in a "continuing process of inflation". Let's look at the lower part of the graph for some interesting events in US history.

• 1860-1865: Funding the civil war creates massive inflation.
• 1913-1920: The Fed is created, an agricultural depression occurs.
• 1930-1940: The Great Depression.
• 1940-1945: Funding WWII.
• 1970-1980: End of Bretton-Woods
• 1980-present: Stable 2-3% inflation

There is a divergence in the two graphs, as inflation appears to be stable at 2-3%, the cost of living skyrockets. If inflation is low and constant why would the cost of living grow so rapidly? What is the cause? Not allowing a deflationary force to manifest is to create an inflationary force. Before 1940 we had alternating periods of deflation and inflation, which gave us stable average prices over time. There basically has been no net deflation since 1940, only varying degrees of inflation. That is why the cost of living has gone up year after year. You can thank these guys.

To your left you'll see a table charting the declining value of the dollar since the creation of the Federal Reserve in 1913. The dollar lost 50% of its value (you need twice as many dollars for the same purchasing power) between 1913-1920, 1920-1970, 1970-1980, 1980-2000. From 1913-2008 the dollar has lost ~95% of its value.

Now that continuing process of inflation is clear, lets revisit some of the consequences that Keynes' spoke of:

• Governments can, in a hidden way, arbitrarily confiscate the wealth of their citizens.
  
• Typically the poor and middle class lose money while foreign and domestic banks and other financial institutions profit from inflation.
  
• When the poor and middle class see this arbitrary rearrangement of riches, it is blamed on capitalism.
• Eventually the relationship between creditors and debtors is so distorted that the debtors will never possibly be able to pay back what they owe, and so the two terms become essentially meaningless.

Keynes is saying that inflation can be dangerous. Not in the mere sense that people will lose value of their money, but that it undermines the entire system of capitalism! Nowadays, deflation is a dirty word. In the not so distant future inflation will be the dirty word. The truth is that there are no dirty words in economics, but in politics. This is what is happening in the USA. Furthermore, the politicians are acting on the assumption that we are not in a "continuing process of inflation" and thus a one time "stimulus" would possibly work. Keynes implies that is an exceedingly dangerous assumption.

Happy birthday John Maynard Keynes
June 5, 1883 - April 21 1946

Fresh produce from the link farm - 5.20.09

Russia's revisionist history, gold coming out of ATM's, our soon to be booming auto industry, and Ron Paul's state of the union address, sort of.

1. "He who controls the present, controls the past. He who controls the past, controls the future."

2. Why auto sales will skyrocket.

3. Where gold comes out of ATM's.

4. Current conditions or just a bad dream?

What is money? (Part II)

Last time we demonstrated that wealth is only created through production. That eliminated the possibility of money as wealth, but did not shed any further light on what the nature of money is. To continue our investigation we have to consider a new scenario.

The original scenario analyzed the economy of a single man isolated from others. What dynamic emerges when we introduce more people into the picture? There are two possibilites: either each man fends for himself and is responsible for producing all of his needs, from housing to food to health, or there is a division of labor. As society transitions from a single man to a village, each productive citizen specializes in a particular good or service. One man may become a fisherman, another may harvest wheat berries, still another may tailor clothes. This division of labor improves the quality and variety of goods for everyone.

Yet there still exists a logistical problem. How does the fisherman acquire his new trousers (because back then they didn't wear pants they only wore trousers)? He trades his fish directly to the tailor. This is known as barter exchange. This will solve the problem for some cases of exchange, but it soon becomes apparent that not everyone wants what the other party is offering. If the tailor has no taste for fish, then the fisherman will be pressed to find a new commodity that does suit the tailor's taste. So the fisherman finds out that the tailor wants butter, trades some of his fish with the dairy farmer for butter, returns to the tailor and exchanges his butter for the new threads. Problem solved. This process is called indirect exchange and in this case the butter is the medium of exchange.

Notice how the medium of exchange in this case was itself a useful commodity. This is an important point to remember.

An interesting question can be raised at this point. Are all mediums of exchange created equal? Is there any significant difference between the various possible mediums? In his book "What Has Government Done to Our Money?", Murray Rothbard says the answer is no. He explains that the commodities that are chosen as the medium of exchange are more marketable than other commodities. In other words, they are readily sold. He lists several categories that make one commodity more marketable than another: Divisibility, durability, and transportability.

In the example above, butter is used as a medium of exchange with excellent divisibility, poor durability, and fair transportability. A cow might be considered to have poor divisibility, but strong durability and transportability. It is clear that over time certain commodities will rise to the top, and those will be the ones with the greatest marketability. Rothbard argues that gold and other precious metals eventually become the most widely used commodity as a medium of exchange. Gold and other precious metals wind up becoming money. The truth is that all of these various commodities are money, but not all monies are created equal, because they are not all equally marketable.

To illustrate the properties of money lets examine one more scenario. Assume we live in a society where gold is the preferred medium of exchange. Lets say that a new technology emerges which confers a tremendous social benefit but must use gold. If the net effect of this new technology sufficiently damaged the marketability of gold, a different commodity would inevitably take its place. Perhaps platinum, or maybe tungsten carbide. In other words, the marketplace would choose a new medium of exchange to compete with gold. History does bear this out with the emergence of silver and copper coins.

To summarize: Money is always a commodity in itself, and the commodity that finds itself in greatest favor for use as the medium of exchange is one that is most marketable at that time. Money is not confined to one commodity, the marketplace will use whatever varieties of money necessary to expedite trade.

This is a satisfying account of the origin of money, but there are still questions. What is our money? How do we make the leap from commodity money to paper money? Lastly, we still haven't gotten any closer to understanding John Adams' statement. We will look further into these questions next time.

What is money? (Part I)

"All the perplexities, confusion and distress in America arise, not from defects in their Constitution or Confederation, not from want of honor or virtue, so much as from the downright ignorance of the nature of coin, credit and circulation." -- John Adams

What is so mysterious about money? We trade pieces of paper, transfer digital money back and forth and to the average person this system seems to work quite well. We can go into any number of stores and take out some paper which they will gladly accept in return for something useful. What was John Adams talking about? Why do we need to know what money is if we can just know that it works? In order to answer these questions we have to go back to the beginning. Way back.


Consider the case of a shipwrecked man on a desert island. While searching the wreckage for useful items, he finds a suitcase half buried in the sand. Upon opening the suitcase he discovers $1,000,000 in pristine, freshly minted Federal Reserve Notes. He's rich! Now if he could just locate that desert island supermarket, he'd be set for life... Well, he died so lets consider the case of a shipwrecked man on a different desert island. This time, when he opens the suitcase he sees 1000 oz. of neatly stacked pure gold bars. Rockefeller! ... He died too. Some years later a third man gets shipwrecked on this desert island, but when he scours the wreckage he finds a suitcase filled with tools. Hammers, chisels, saws, the works! With these tools and a little labor he was able to start production of a sturdy shelter. Soon afterward he produces buckets to catch rainwater and spears to fish with. After weeks and months of production, he was rich! He had a steady supply of fish to eat, a shelter over his head, a fire pit to keep him warm at night, clean drinking water, and even wooden planks for engraving - to express his artistic sense.


What makes us rich? Is it money? Clearly not. The third man was wealthy due to one thing only - his production. To be even clearer: the source of his wealth lay in his tools, the means of production, also known as capital. If he had no capital, he could have no production. If he had no production, he would be no different than the first two men. He would be dead. Once again, wealth is created through production, which is facilitated by capital.

While we can now see that capital is the source of our wealth and not money, we still have not begun to understand what money itself is. Seeing as how the lone man on a desert island has no use for it, we're left to ask: what is money useful for? When does it acquire value? Perhaps money is more mysterious than we originally thought. Next time we'll dive into "the nature of coin, credit, and circulation" more deeply. If for no other reason than to understand what John Adams' was getting at!