The Fed: America’s Boom & Bust Machine
Written by Thomas DiLorenzo on April 9, 2024 Published in the April 29, 2024 issue of the New American magazine. Vol. 40, No. 08
Reprinted with permission from TheNewAmerican.com
The Federal Reserve Board (“The Fed”), created in 1913, is the U.S. government’s preeminent central-planning vehicle. It exerts control over the supply of money in the economy and regulates almost all aspects of all financial markets. It is essentially a legalized counterfeiting operation and a financial central-planning bureaucracy.
The Fed increases the supply of money in circulation by purchasing billions of dollars of government bonds (“quantitative easing”). It also regulates the “fractional reserve” banking system, whereby banks are required to maintain in reserve only tiny percentages of the loans they make. This percentage is called the “reserve ratio.” At a reserve ratio of say, two percent, a bank with $10 million in reserves can then lend 50 times that amount, or $500 million.
When banks make too many bad loans, the Fed, with help of the U.S. Treasury, frequently bails them out. This is horribly destructive to the American free-market system, which is supposed to be a profitand-loss system. Profits tell a business that it is serving its customers well; losses say the opposite. With Fed-orchestrated bailouts, however, profits are private but losses are “public,” or paid for by taxpayers one way or another. This encourages even more of the reckless risk-taking that led to the losses in the first place, something that economists call a “moral hazard problem.” After the real-estate market crash of 2008, the Fed organized the $10 billion bailout of Goldman Sachs, as well as other big banks, and their insurance companies such as AIG ($180 billion). It then increased the overall money supply twice as much in 13 weeks as it had in the previous 100 years! It was that “easy money” policy that pushed interest rates to nearly zero and caused the real-estate bubble in the first place. All Fed-created bubbles eventually burst and cause a bust, or a recession — in this case the “Great Recession” of 2008.
Fed bureaucrats profit personally from creating inflation and boom-and-bust cycles. When they purchase government bonds with “money” created out of thin air (electronically), the interest on the bonds is what is used to pay for the salaries and perks of the Fed bureaucracy. There is a congressional requirement that the Fed return all “excess revenue” over its expenditures to the Treasury, but that creates an incentive for the Fed bureaucracy to spend rather lavishly on itself (large staffs, luxurious offices, private jets, expense accounts, world travel, etc.), so that very little is left over for the Treasury. It is also a built-in incentive to create inflation and boom-and-bust cycles by expanding the money supply too much through bond purchases. The more inflation, the greater the budget of the Fed Written by Thomas DiLorenzo on April 9, 2024 Published in the April 29, 2024 issue of the New American magazine. Vol. 40, No. 08 Page 2 of 9 bureaucracy, and the public be damned. This positive correlation between monetary inflation and spending by the Fed bureaucrats on themselves was even documented in a 1983 research article published in the prestigious American Economic Review by economists William Shughart and Robert Tollison. To Fed bureaucrats, inflation pays — literally.
Former Representative Ron Paul (R-Texas) was met with fierce opposition when he proposed legislation to audit the Fed, which raises the question: If Fed spending is in the “public interest,” why can’t the public see what the Fed is spending money on? Wouldn’t the public like to see what its public servants are doing with their money? Every once in a while, some information does see the light of day, however.
In the mid 1990s, a Government Accountability Office investigation revealed that the Fed had more than 25,000 employees, its own air force of 50 Lear Jets and cargo planes, a full-time curator to oversee its massive collection of paintings and sculptures, hundreds of billions of dollars’ worth of assets, and lavish salaries. Even the head janitor at the Fed was paid $163,800 per year plus benefits, and that was nearly 30 years ago.
The Fed’s Destabilization Policies
The supposed purpose of the Fed is to “stabilize” the economy by moderating inflation and unemployment, thereby smoothing out the peaks and troughs of the business cycle. It has failed miserably in that task over the past 110 years. Economists Lawrence H. White, George Selgin, and William Lastrapes surveyed 195 scholarly academic journal articles about Fed performance from an historical perspective (published at cato.org). On the subject of price inflation, they concluded that “The Fed has allowed the purchasing power of the U.S. dollar … to fall dramatically. A consumer basket [of goods and services] selling for $100 in 1790 cost only … $108 … in 1913,” the year the Fed was created. But by 2008, the year of the study, the price had soared to $2,422.
The highest rates of inflation in history (1973-1975 and 1978-1980) occurred on the Fed’s watch. Prices also became more unpredictable after the Fed was created, making it harder for businesses (and families) to plan their expenses. Moreover, “the Fed has largely succeeded … in eliminating deflation.” God forbid that you should pay less for your next car or your next house.
The elimination of deflation by the Fed is based on a gross misunderstanding of economic history. From the end of the Civil War to the turn of the 20th century, the American industrial revolution resulted in a lower consumer price index during that roughly 35-year period. Yes, there was deflation — and it was all a good thing, because it was caused by more production, more jobs, more products invented, and a better standard of living. It also resulted in greater purchasing power for wage earners by increasing their “real wages.” Lower prices for consumers makes every dollar go further.
The current Fed obsession with eliminating deflation and avoiding it at all costs ignores this supply-side explanation of deflation caused by increased production and prosperity, and falsely assumes that all deflation is caused by recessions or depressions and the lower spending levels they entail. It’s Great Depression economics, but we are no longer in the Great Depression. Former Fed Chairman Ben Bernanke was famous for espousing this incorrect view of deflation while championing a policy of always keeping the inflation rate at two percent per year or higher.
Thus, the Fed is supposedly a sworn inflation fighter, but its policy is to guarantee inflation!
Immediately upon its founding in 1913, the Fed created price inflation and a boom-and-bust cycle by doubling the amount of money in circulation between 1914 and 1920. The result was a doubling of the consumer price index in just six years and a depression, the first year of which, 1920, was worse than the first year of the Great Depression a decade later. GDP declined by 24 percent from 1920 to 1921, while the number of Americans unemployed more than doubled, from 2.1 million to 4.9 million.
America might never have entered into World War I if it were not for the Fed, which financed about a fourth of the cost of the war. Fed financing of war — and of all other government programs — creates what some economists call a “fiscal illusion” by which citizens are fooled into thinking that government programs such as war are less expensive than they actually are. Imagine the effect on public support for Ukraine’s war with Russia, for example, if the government announced that for the next round of “military aid” to Ukraine each taxpaying family would be sent a tax bill for $20,000 as their share. One would expect to see far fewer Ukrainian-flag bumper stickers on American cars.
More recently, after creating the “dotcom” bubble that burst in 2000, the Fed responded to the bursting of the bubble that it had created in the same way that it always does — by doubling down, and more, on even more money creation. The Fed under Alan Greenspan created more money between 2001 and 2007 than had previously been created in the entire history of the United States since 1776! An overwhelming amount of this money fueled the housing market, with interest rates once again pushed to historically low levels as part of the federal government’s policy of increasing “affordable housing” for minorities and lower-income home purchasers.
As economically destructive as Fed-orchestrated bailouts are to what’s left of the American free enterprise system, its current obsession with controlling interest rates is just as bad. Any college freshman who takes an introductory economics course is taught that price controls have myriad negative effects, and have had for literally thousands of years. Price ceilings cause shortages; price floors cause surpluses. Price controls deter investment because of the uncertainty involved in guessing what politicians will declare an acceptable price to be. Shortages breed bribery as a means of acquiring the short supply of goods, which always ends up benefiting the more-affluent at the expense of the lessaffluent. Price controls cause economic chaos, because they are based not on the economic realities of supply and demand but on the whims of politicians and bureaucrats.
Nevertheless, the thousands of economists employed by the Fed support its policy of price controls when it comes to the price of borrowing — the rate of interest. The Fed panders to the beneficiaries of low interest rates, such as the real-estate industry and its banking-industry partners, while inflicting great harm on the elderly and others who earn little or nothing on their savings or are forced to assume excessive risk by investing in stocks. It induces people to spend more and save less, which is not always the best personal financial advice, and it comes from an organization — the Fed — that touts itself as an expert in personal financial advice.
The Fed’s Academic Praetorian Guard
The Fed employs an army of academics who essentially serve as its publicists and propagandists. Professor Lawrence H. White published a 2005 article at Econ Journal Watch, an online academic journal, in which he noted that the Fed directly employed 495 full-time economists at the time, engaged 120 “leading academic economists” as paid consultants or visiting scholars, and brought more than 300 academic economists to its conferences each year. (Economist Murray N. Rothbard once quipped that your average academic monetary economist “would stab his mother to death with a fork for an invitation to a Fed conference”!)
The result of all this, Professor White found, was that 74 percent of all academic journal articles on monetary policy published in America were either in the Fed’s own journals or co-authored by Fed economists. He summarized the effects of this with a quote from Milton Friedman: “If you want to advance in the field of monetary research … you would be disinclined to criticize the major employer in the field.”
This is nothing new. From 1948 until the mid-1980s, the bestselling economics textbook in the world was Paul Samuelson’s Economics. Generations of economics students were taught by Samuelson’s text; most other texts were clones of his book. In it, Samuelson described the Fed as an institution run by angels or saints with the brains of Einstein and the magic touch of the Wizard of Oz. Here’s how Samuelson described the Fed’s functions:
The Federal Reserve’s goals are steady growth in national output and low unemployment. Its sworn enemy is inflation. If aggregate demand is excessive, so that prices are being bid up, the Federal Reserve Board may want to slow the money supply, thereby slowing aggregate demand and output growth. If unemployment is high and business languishing, the Fed may consider increasing the money supply, thereby raising aggregate demand and augmenting output growth. In a nutshell, this is the function of central banking, which is an essential part of macroeconomic management.
Even more comical is how Washington Post writer Bob Woodward compared former Fed Chairman Alan Greenspan to the maestro of an orchestra, smoothly waving his baton to guide economic prosperity. That’s how the Washington establishment thinks of itself: in charge of orchestrating the entire world. The book is entitled Maestro: Greenspan’s Fed and the American Boom. - Read More
As we wrap up our exploration of the Federal Reserve’s role in America's economic fluctuations, it’s clear that the impact of central banking extends far beyond mere monetary policy.
The cycles of boom and bust, heavily influenced by the Fed's decisions, shape not just the financial landscape but the real lives of millions.
Understanding this influence is crucial for anyone looking to navigate the complexities of investing and economic planning. As we continue to witness changes in policy and their effects on the economy, staying informed and adaptable will be key to thriving in an ever-evolving financial environment.
