The Fed: The ‘Elephant in the Room’ of Financial Regulation

Posted: May 14, 2015 12:01 AM

I can usually count on the ‘unholy trinity’ of the American ‘lamestream media’ – ie the New York Times, Washington Post and Huffington Post – to point me in the right direction on positions and narratives. That direction would, of course, be to the opposite of theirs. Earlier this year, a column in WashPo stated in typical ‘Left elitist’ disgust and ridicule that: “Not this again. Calls to ‘Audit the Fed’ are back.”

Yes, such calls are back. In fact, they never went away and have been around for a very long time. The somewhat longer reason for this, is the subject of this column. The shorter reason for this (and for all other ‘untouchable’ statist institutions and central plans of our so called ‘betters’ on the Left) was nicely summed up by one of the 1974 Nobel Laureates in Economic Sciences as follows:

“The curious task of economics is to demonstrate to men [and women] how little they understand about what they imagine they can design.” – Friedrich von Hayek

Besides Doctors Ron and Rand Paul, there are a number of other economically literate voices around the country and the world leading the “[c]alls to ‘Audit the Fed’ ”. These voices are not driven by fears of any “[c]onspiracy theories” as WashPo implied (which is a regularly trotted out and well worn strategy of the Left to discredit and silence their critics and threats, as well as creating distracting ‘straw men’ supposedly representing the Right).

One of the many real voices of the Right on this issue is the Competitive Enterprise Institute (CEI). Not too long ago they published some questions in a WebMemo to (then nominee and prospective) Chair of the Federal Reserve Janet Yellen (which are still pertinent today and will be for some time to come). CEI’s questions covered the following topics: Controlling Inflation; Quantitative Easing (QE); The Dual Mandate; Basel III; Dodd-Frank; Regulatory Complexity; Causes of the Financial Crisis; and Auditing the Fed.

In terms of ‘Auditing the Fed’, the CEI pointed out that: “Transparency is vital to every aspect of government. The Federal Reserve, which makes multi-trillion dollar decisions, should be as transparent as possible.” They then state and ask the following: “There is bipartisan support for a full audit of the Fed by the Government Accountability Office, which conducts such audits for virtually every other agency. Would you support such an audit?

Even the great Neoclassical School economist Milton Friedman “[w]ould support such an audit”. This is according to Professor Steve Hanke of the Cato Institute, who recently suggested as such.

This suggestion is also backed up by Friedman’s classic book “Money Mischief: Episodes in Monetary History” in which he concluded: “… inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” He also added that: “The behavior of the quantity of money is the senior partner, the behavior of output the junior partner.” But that: “… the rate of monetary growth does not have a precise one-to-one correspondence to the rate of inflation.”

The Fed is at the center of both the American and international monetary systems, and thus is the ‘elephant in the room’ of not only financial regulation but (even more worryingly) of inflation or the rising ‘cost of living’ as well as the ‘Boom-Bust-Malaise Cycle’ (or ‘BuM Cycle’ for short). Let me try to take you through some of the logic, according to many Austrian School economists.

Virtually every market transaction involves money. Money is exchanged for goods and services => in a mutually beneficial way (always expected, and mostly realized) => as objective means to various subjective ends => at a financial profit for businesses and psychic profit for consumers (always expected, and often realized).

Money isn’t neutral however, it impacts market price formation as the ‘sort of’ forgotten 3rd dimension to pricing. The other two dimensions are the largely familiar quantities supplied of and demanded for goods and services (including, in turn, all of the related influences on them like: competition and substitution; up-and-down-stream supply chains; time and interest; innovation and physical capital; fashion and tastes; etc … plus, of course, government intervention, like regulation).

Prices are pressured to go down when say supplies and/or competition go up. The opposite pressure takes place when the money supplies under the Fed monopoly go up – ie prices go up. This is inflation, which is felt by people as the rising ‘cost of living’.

The other pressure (which is really the same pressure, felt differently over time) is for massive ‘malinvestment’, popularly known as investment ‘bubbles’ or economic ‘booms’ which always lead to ‘bursts’ or ‘busts’.

Malinvestment tends to come first (with the few benefiting from more money, and revenues greater than costs), with inflation following later (with the many hurting from more money, and costs greater than revenues). The Fed and other government entities usually then step in again and (largely) unintentionally create long lasting recessions or depressions like the current ‘Obama-nemia’ or ‘Great Malaise II’. And thus the ‘BuM Cycle’ is completed.

In other words, the Fed (along with its ‘partner in crime’ of fractional reserve banking) is the main culprit driving the ups-and-downs of the business cycle and the rising ‘cost of living’ – ie unemployment and inflation. The Fed as financial regulator and other government entities (as did their precursors in earlier centuries) then make the ‘booms’ higher (and sometimes longer) and the ‘busts’ lower (and almost always longer) through Dodd-Frank style regulation and other largely anti free market interventions.

It is thus very doubtful that Yellen or any future Fed Chair would answer positively to the CEI’s question of “Would you support such an audit?” (even one appointed by the GOP, at least the ‘establishment’ side). But this question still needs to be asked, and asked repeatedly, to Presidents, Congress, the Courts and especially to the American people. Why? Because the Fed is incentivized to drive the ‘BuM Cycle’, largely in order to increase government power and redistribute wealth. This was ironically pointed out a long time ago (in a country far far away) by a very influential ‘Left elitist’ mathematician who said:

“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” – John Maynard Keynes