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Crushed by the Fed

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During a roundtable debate on a major cable-news outlet about how the Federal Reserve should handle the current credit crunch, one of the economic “experts” made a startling statement. He said, “The Fed has two jobs: to control inflation and to run the economy.” That such a statement is considered conventional wisdom is a stark indication of how firmly the ideas of socialism and central planning have taken root in America, and an unfortunate mile marker on Hayek’s road to serfdom.

Saying that the Fed controls inflation implies that inflation is a natural phenomenon. Nothing could be further from the truth. Inflation is not some natural rise in prices but instead an increase in the supply of money, which in turn gives rise to the general level of prices in the economy.

In 1913, Congress created the Federal Reserve System to provide the United States with an “elastic” money supply. The Fed does this by controlling the volume of money and setting interest rates. In other words, the Fed controls inflation only in that it has the ability to cause inflation. Believing that the Fed is necessary to control inflation is very much like thinking that criminals are necessary so that they can control crime rates.

Incidentally, before 1900, chronic inflation was not a problem in the United States; the purchasing power of a dollar in 1900 was very close to what it was in 1800. Since the Fed’s creation, however, the dollar has lost 95 percent of its purchasing power.

While the idea that the Fed controls inflation is factually inaccurate, the assumption that it runs, or should run, the economy is not only misguided but dangerous. A free-market economy is based on mutually beneficial, voluntary exchanges. Since no one is forced to participate, all of the parties involved in an exchange expect that their exchange will benefit them in some way.

On a large scale, the free market consists of millions of individuals making decisions about how to better their lives. In a free-market economy, the participants run the economy. The Fed doesn’t run the American economy; the American people do.

While the market has its own mechanisms to deal with criminal activity, if government has any legitimate role in a free-market economy it is solely in using its police power to minimize violent crime and fraud. Unfortunately, in many cases government is not only ineffective at stopping crime, it is a vehicle by which criminal activity is legitimized, legalized, and institutionalized. While criminal acts by individuals can have serious consequences, they are usually localized in nature, affecting relatively few people. Criminal activity that the government condones and encourages, on the other hand, causes systemic problems.

For example, if an individual prints money in his basement, it is counterfeiting. If the government uses the Fed to do essentially the same thing, it is completely legal. Since the Fed is the lender of last resort, it, along with government agencies such as the FDIC (which promotes the idea among account holders that all banks are equally safe) and the precedent set by previous bailouts such as the S&L crises in the 1980s, helped foster the current credit crunch.

Lenders and banks know that they can turn to the Fed to lend them money in case of a liquidity problem; or, if things get really bad, they can reasonably assume the federal government will bail them out. This knowledge allowed less-scrupulous lenders to begin engaging in irresponsible lending practices. To compete, more and more lenders were forced to adopt similar and even more irresponsible practices. Thus, intervention by the government led to the beginnings of our current credit problem. More intervention by the quasi-government Fed may ameliorate the situation for the time being, but in the long run, it will only make the problem worse.

None of this means that the sky is falling. Instead, it is being pushed earthward under the weight of trillions of dollars of increasingly worthless fiat currency. Either way, unless Americans eliminate government intervention in the economy and once and for all reject the bankrupt philosophy of central planning, eventually they are going to be crushed economically and financially.

This article originally appeared in the January 2008 edition of Freedom Daily. Subscribe to the print or email version of Freedom Daily.

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    Glenn Jacobs is a writer residing in Tennessee.