The Fed…one more time

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Everywhere I turn I hear more calls for “action” and “leadership” to “get the economy back on track.” I recently addressed the folly of desperate stimulus spending. Now I’m hearing demands for even more intervention from the Federal Reserve. It’s time to go over the problem with the Fed’s attempted management of the economy one more time. I wish I didn’t have to cover Fed-101 again, but as the President likes to say, I want to be perfectly clear. Apparently some people require more explanation.

The Fed attempts to steer the economy in several ways, two of which we’ll discuss here, (1) manipulating interest rates and (2) expanding the money supply. Absent the Fed, interest rates would be determined by the market. Banks would base their rates on availability of funds, risk (down payment, credit scores, collateral, etc.), and projected inflation (which would be less of a concern without the Fed anyway). Not everyone or every business would get a loan. Business startups or mortgages with little or no down payments or equity would move to the back of the line. These loans are the most likely to fail in the first place, and they shouldn’t be funded anyway.

Under our central banking system, the Federal Reserve makes funds available to banks and controls the percentage that can be loaned at any given time. The Fed also provides funds to banks and determines the interest rates, which directly affects the rates banks charge their customers. When the economy is sluggish, the Fed lower interests rates and makes more funds available to spur borrowing  to reignite the economy, but this provides an incentive for banks to make more credit available than the market can support. Sooner or later, loan defaults rise as a result. The left might blame greedy banks for this debacle, but the direct cause is Fed.

The second way the Fed intervenes is through expanding or contracting the money supply. This can be done by printing more greenbacks, but we see the same effect when the Fed changes bank loan requirements or intervenes in financial markets buy purchasing t-bills or other securities. Whenever the amount of money increases, each dollar in circulation is worth proportionally less. In other words, the Fed is TAXING YOU by reducing the value of your savings and increasing future prices whenever it expands the money supply.

In both instances, the Fed is borrowing from tomorrow’s prosperity to prime today’s economy. This is classic, flawed Keynesian logic. Keynes insisted on heavy government intervention during recessions and is famous for the quip, “in the long run we are all dead.” Unfortunately we’ve been going down this road since the 1930s, and today we are seeing the long term effects. We are not dead yet, but it seems like the economy is.

The ONLY way out of the current recession is to let the market sort it out. Congress and the Fed can do little to help other than stay out of the way. This means no moratoria on mortgage bankruptcies. The housing market is overvalued and must find its real market values before it can recover, painful as it may be. This means no bailouts. Weak companies must be allowed to fail and pave the way for new, stronger businesses.

This also means a massive overhaul of the Federal Reserve so that its ability to manipulate the economy can be severely curtailed, if not eliminated altogether. We’re probably a long way from making much progress on this front because most Americans don’t understand the long term damage the Fed inflicts on our economy. The Republicans will have an opportunity to lay the foundation if all goes well in two weeks. Let’s hope they don’t settle for the middle ground…again.

4 Comments

4 Comments

  1. BT  •  Oct 21, 2010 @4:18 PM

    i don’t know why this is so difficult for some people to understand. inflation is not a natural event. it happens each year because of the fed. its indirect taxation without representation and the fed is accountable to nobody. end the fed!!!!!

  2. Monte  •  Oct 21, 2010 @4:35 PM

    Hey JP, this is crap. If not for the Fed we’d be in a huge hole now. The government isn’t perfect but you talk liek we’d be better off if it didn’t do anything at all. A whole lotta greed got us into the Bush recession and it’s going to take time to get out and it isn’t going to be easy.

  3. Sammie  •  Oct 22, 2010 @9:04 AM

    Hey Monte, get beyond the talking points. Yes, we would be better off if the government left Washington and did nothing.

  4. jeff  •  Oct 23, 2010 @9:37 PM

    Monte go back and study the economy before we had a Fed. We didn’t have such wild boom and bust cycles and when we did have any, they ended quickly. Sure, greed contributed to the recent recession because credit was easy, but it didn’t cause it. And when you talk about greed, I hope you also mean the greed of all the people who took mortagages they couldn’t afford and the greed of the politicians buying votes with the easy credit policies they encouraged, in addition to the Walll Street greed