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Things that Aren’t Persuasive

November 20, 2009

# 1 on my list: today’s Op-Ed by Rep. Ron Paul and Sen. Jim DeMint. I agree with Paul and DeMint on a lot of things, and I’m not about to accuse them of violating Reagan’s 80% rule, but I think they are on the wrong side of the question of the Fed’s independence. A blow-by-blow debunking:

For nearly a century the Federal Reserve has operated in the shadows, away from the prying eyes of Congress, journalists and the American people. Created in 1913, the Fed was given enormous responsibility to protect the value of our currency. Yet in the last 96 years the U.S. dollar has lost more than 95% of its purchasing power.

First of all, nowhere in the 1913 Federal Reserve Act is there any mention of the Fed as a “protector of the value of our currency.” Too many politicians on all sides believe that a strong dollar is an unambiguously good thing for the U.S. economy, forgetting the importance of exports to our GDP and the fact that a stronger dollar makes them less competitive overseas (incidentally, this is one of the most nefarious costs of the Chinese government’s insistence on maintaining a dollar peg: by making our currency artificially stronger than theirs, our exports have a hard time breaking into China’s domestic market, while their goods cheaply flood ours). Second, the claim that the US dollar has “lost more than 95% of its purchasing power” is debatable at best, and an outright mis-attribution of responsibility to the Fed at worst. One could make the argument that the U.S. dollar has lost a lot of its value relative to 1903 in the sense that a movie ticket that used to cost a dollar might cost you $10 today. But that type of analysis is overly simplistic, and the exact number will anyway depend on the “basket of goods” you use to measure the dollar’s purchasing power. For instance, you could argue there’s been an infinity% improvement in the dollar’s purchasing power relative to iPhones, since you couldn’t get an iPhone in 1903 no matter how much you paid. The average U.S. consumer has no doubt changed the types and relative quantities of goods they purchase on a weekly basis since 1903. Perhaps more significantly, however,  even if you were to argue the 95% statistic is accurate, you can’t pretend (like Paul and DeMint do) that this is all the Fed’s fault. The long-term “erosion” in the dollar’s value relative to the cost of a loaf of bread has a lot more to do with price pressures from commodities (including the oil shocks in the 1970s), the advancement of U.S. technology such that we should expect goods to be more expensive, the rise of other nations like China and India and the inflationary pressure this added world demand adds to goods’ prices, and the extraordinary growth performance of the U.S. economy over the last century.

While the Fed is more transparent now than it was 20 or 30 years ago, there is still a long way to go. If the Fed were fully transparent, organizations such as Bloomberg and Fox News wouldn’t have to sue its board of governors to receive materials that should be available through Freedom of Information Act requests. These include information on which banks and companies received loans and for what amounts after the 2008 financial meltdown.

Except that providing information on which banks/companies received loans and in what amounts runs directly counter to the entire purpose of such loans. The Fed is not withholding that information because it doesn’t want people to know it’s secretly propping up Goldman Sachs or something crazy like that, but rather because making public what companies used their lending facilities would indicate a clear signal to investors and depositors which institutions are were/in trouble and which weren’t/aren’t. This would create modern-day bank runs as depositors and creditors rushed to take their money out of those institutions that received support from the Fed, and it is not a stretch to suggest that these bank runs would then become endemic, crushing what little remained of functioning financial markets at the height of the crisis. To the extent that preventing bank runs and financial panics is a public good, the Fed’s refusal to tell Paul and DeMint which firms received loans is not only permissible, but also clearly correct. Besides, what are Paul and DeMint going to do with that information other than try to pillory the Fed with more conspiracy theories about Lloyd Blankfein secretly pulling the strings of the government for bailouts?

One puzzling assertion made by the Fed and its supporters is that the Federal Reserve has some sort of independence from the government and independence in undertaking monetary policy. Nothing could be further from the truth. The Federal Reserve is a government-created banking monopoly, and its top decision makers are appointed by the president and confirmed by the Senate. If they do not perform satisfactorily in the eyes of politicians, they will not be renominated.

This is perhaps the most patently absurd part of the piece. The Federal Reserve is a central bank, something which every other developed nation in the world has and maintains. So while strictly a “government-created monopoly,” it’s a government-created monopoly in the same way that the U.S. Armed Forces is a “government-created monopoly” in national defense. Moreover, while it’s true that Fed Governors are appointed by the President and confirmed by the Senate, they serve for 14-year terms and cannot be fired by Congress. While this is not quite the insular lifetime term that a Supreme Court Justice receives, it’s pretty close, and it means once appointed, Fed Governors are not beholden to the demands of any particular constituency in Congress. Even more ridiculous, Fed Governors can only serve one term, so the concept of “re-nomination” is completely irrelevant (though the 4-year Chairman terms can include the same person). Moreover, the Fed Governors only constitute 7 of the 12 votes on the Federal Open Market Committee (the monetary policy decision-making body of the Fed). The other 5 are made up of regional Federal Reserve Bank Presidents, who are chosen and approved by the regional banks with no input from Congress. While I’m sure Paul and DeMint would probably see the Regional Fed system as fundamentally flawed anyway, they still can’t argue with a straight face that the Fed is not specifically designed to be politically independent. If you want an explanation for why the Fed’s independence is a normatively good thing, check out this previous post.

The Fed has also, for the past three decades, been required to engage in monetary policy with the goal of maintaining stable prices and full employment. Since the natural trend over time is for prices to decrease, a mandate to maintain stable prices is a mandate to pursue an expansionary monetary policy and inflate the money supply to counteract the lower prices we would expect from increased productivity.

A close second in the “Absurdity” category of all the parts of the Op-Ed. The “lower prices we would expect from increased productivity” is again a gross simplification. For one, technological developments (like the enhancement of medical technology from leeches to chemotherapy) means that not all goods should necessarily be decreasing in price over time, since technological developments may add value and hence add to their price. Not only that, but new goods may be added to the basket of goods purchased by US consumers (recall the iPhone example from above) that are necessarily higher-priced by their nature, whether due to high materials cost inputs, high brand value, transportation costs (in the case of imports), or a high level of technological expertise and hence labor cost for highly skilled workers. Besides the fundamental error Paul and DeMint make in assuming that prices should decline over time, they also miss the significant values that exist for maintaining a stable and low rate of inflation. First and foremost, it protects against the threat of deflation and deflationary spirals that can ruin a country’s economy. Second, it provides a basis for low long-term public expectations for inflation, crucial to maintaining a stable currency value. Finally, it provides an incentive for investment rather than just hoarding money underneath the proverbial mattress, since the value of a dollar not employed towards productive investment will slowly decline over time due to low but positive inflation. Thus, even if we were to grant Paul and DeMint their absurd claim that the Fed is raising prices in contrast to what fundamentals predict, that might not be such a bad thing.

Each congressman who questions the chairman receives only a few minutes in which to ask questions and receive answers. Having been on the receiving end of Alan Greenspan’s notoriously obtuse “Greenspan-Speak” answers and Ben Bernanke’s similarly convoluted statements, we can assure you that the process is completely ineffective at getting any real answers.

No matter how direct the questions are, Fed chairmen answer with a vagueness common to bureaucrats. The whole process is window dressing for public consumption, not any sort of attempt to exercise oversight or gain any real insight into the Fed’s actions.

What is needed is a full audit of the Fed, something that has never happened. We need to know who the Fed is giving money to, what types of securities are being purchased and what backs those securities, how much money is being paid for those securities, etc.

Wait, doesn’t this sound kind of like EVERY SINGLE OVERSIGHT HEARING FOR EVERY SINGLE GOVERNMENT AGENCY OR CABINET DEPARTMENT? Yes, oversight hearings are a joke, but that’s no reason to target the Fed in particular. Plus, Fed chairmen actually generally give more valuable testimony than Cabinet secretaries: they report Fed expectations for economic growth, comment on relevant public policy issues (Alan Greenspan famously used his hearings to argue for a balanced budget, something we as conservatives should support), and explain further the Fed’s rationale for certain decisions. What’s more, you can read the minutes of every FOMC meeting and discussion right here, so again, the Fed is not deliberately hiding anything, and in fact is disclosing a lot more than most Cabinet Departments or even military commanders. What Paul and DeMint are really after is more opportunities to make soapbox speeches against the Fed’s existence, and the Fed is under no obligation to grant them that.

While Rep. Mel Watt’s (D., N.C.) efforts to audit the new lending facilities authorized to bail out private firms such as AIG is a step in the right direction, it is still just a first step. These facilities have the same effect on the money supply as securities purchased through open market operations. Why should securities placed on one line of the Fed’s balance sheet be subject to audit while the exact same securities placed elsewhere on the balance sheet are not subject to audit? The loopholes need to be closed.

Why? For the same reason cited above – the lending facilities were created in a unique and tumultuous time in financial markets, are temporary, and include anonymity as a crucial part of their function.

In coming weeks we plan to offer companion amendments to legislation already before the House and Senate that will open the Fed up to a complete audit. The amendments set a six-month time lag on the publication of previously unreleased audit data to address the Fed’s concerns that actions undertaken in support of monetary policy would immediately be politicized. The transcripts and minutes of the Federal Open Market Committee meetings would continue to be made public at the Fed’s discretion, with unpublicized details of meetings not subject to any additional scrutiny. Finally, the amendments make clear that the purpose of the audits is not to interfere with or dictate monetary policy.

Curiously, a not-totally-ridiculous policy proposal that contrasts sharply with the oozing paranoia of the rest of the piece. The 6-month time lag is a good idea if audits are absolutely necessary, but the fact is that any publication of the audit data they’re looking for, no matter how lagged, will greatly inhibit the Fed’s ability to use their emergency powers in future crises by making all decision-making subject to questions about what Congressmen like Ron Paul would say if they saw what the Fed was doing. In that sense, no matter what kind of flowery amendment language exists to the contrary, such audits will interfere with and, to some extent, dictate monetary policy.

As strong opponents of government intervention into the economy, we do not want to see Congress directly dictate monetary policy. But while the Fed is involved so heavily in monetary policy and its actions so heavily influence the future of our economy, it is necessary that it be fully transparent. Interventions into the economy on the order of trillions of dollars cannot continue to escape public scrutiny. American taxpayers deserve better.

Free market believers should be supportive of the Fed’s role as a guarantor of the integrity, rules, and property rights of the market system, even when that role implies some necessary lack of full disclosure.

It’s a shame that too many Republicans see the Fed as a bad thing rather than a flawed but ultimately vital part of our macroeconomy. We should try to do better, and debunking the myths and half-truths offered by Paul, DeMint, and others is the start of that process.

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