Mr. Crassus, Meet the Federal Reserve


Marcus Licinus Crassus became the 8th richest person world history by hiring arsonists to set fire to houses in Rome while waiting around the corner with firemen. When the fire appeared uncontrollable, Crassus would approach the owner of the house with his firemen, giving them the ultimatum, “Give me your house at below market value or watch it burn to the ground.” Only then, if the owner agreed would he put out the fire.
Marcus, meet the Federal Reserve.

The Federal Reserve, who were the arsonists that started this financial fire with their loose monetary policies causing the current financial crisis, have now become the new firemen in charge of the financial markets.

Yesterday, Barack Obama announced that he was going to put the Fed in charge of overseeing systemic risk in the economy, derivatives, executive pay, the mortgage-backed securities (which were the primary fuel the housing boom and the credit crisis), and hedge and private equity funds for the first time.

And, all the while, the Fed Board of Governors stood in the background yelling, “Burn baby, burn!”

Once again, the government’s policies are directed at creating another short-term unsustainable bubble instead of trying to fix the long-term problem that put America into this mess in the first place, loose credit. Now even more loose credit is what the American people are going to get.

Ever since Rahm Emanuel uttered the words, “You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you think you could not do before,” the Obama Administration has pushed for more government spending along with (as ALG has reported) pressuring the Federal Reserve to use the printing press to help ease the enormous debt.

What will the Federal Reserve do when their own policies delude the banks into once again issuing loans that they shouldn’t have? Most likely, they will take a page out of the Obama playbook and divert the blame.

After the Obama Administration’s attack yesterday on the private sector, it is clear that the blame is put on market “recklessness and greed” and not the bumbling Fed bureaucrats who birthed this mess.

When the next bubble bursts in the Fed’s lap, they too will divert the blame toward market “recklessness and greed,” and God only knows what will come next. (Can you say “Novaya Ekonomicheskaya Politika?”)

The real answer, of course, in preventing another financial crisis is government transparency paired with less regulation, not more. With transparency, less regulation will follow. But there is one major obstacle stands in the way, government granted monopolies.

When the Fed was setting fire to the U.S. economy, they had (and still have) a monopoly on the U.S. currency. Just as when Crassus’ men were setting fire to Roman houses, he had a monopoly on the fire-fighting equipment.

Clearly, giving any organization a government-granted monopoly to any commodity –be it U.S. dollars or bucket brigades — without any transparency is a policy as duplicitous as it is dangerous. It virtually guarantees miscreance and sows the seeds of its own destruction.

It’s a little late for the good people of Rome. But, it’s not too late for the American taxpayer. Right now, a bill in the House of Representatives — H.R. 1207 — would, for the first time ever, empower Congress to audit the Fed. If passed it will provide much-needed transparency to an inordinately mysterious organization that, after Obama’s plan goes through, will be able to exercise ironclad control over every facet of the United States economy.

Which means that for American taxpayers – forced to watch their meager earnings go up in flames – the price of Obama’s Pyrrhic Victory will be ashes in their mouths.

Justin Williams is a Contributing Editor of ALG News Bureau.

Published in: on June 19, 2009 at 5:34 pm  Leave a Comment  
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The Ongoing Presidential Policy of Inflation

In every major United States presidential election until the early 1990’s, monetary policy was a major hot button issue. And believe it or not it even captured the popular fancy. For example, The Wizard of Oz written by L. Frank Baum, a populist sympathizer, portrayed the struggles of the movement to add silver to the American currency in his book with metaphors and symbols.

But what most people do not know is that this movement was actually fomented by a group of people who simply owed a lot of money and decided to lobby for a policy of inflation.

As a result, the Federal Reserve Act of 1913 actually began a new era of monetary policy in the United States with one primary motivation in mind: controlling inflation. The politicians, conniving as usual, had figured out an easy way to finance their debt… the printing press.

So those who wanted to rein in the recklessness decided that by making the Federal Reserve independent from Congress, they could prevent skyrocketing inflation. But, as so often occur with “the best laid plans of mice and men,” what actually happened was an inflationary credit boom that created the “roaring twenties” and a bust which the world coined “the Great Depression.”

Now if you think this sounds familiar to the current financial crisis with the housing boom and bust, you are not alone. Nor are you observing an exception to the rule.

The Federal Reserve, since it’s founding, has fostered a constant uncontrollable policy of inflation. But since they claim that they are independent, they insist that the inflation is not due to political pressures.

This, of course, is completely false.

Economist Thomas DiLorenzo finds that the Federal Reserve board has been little more than the President’s handmaiden time and time again. For example, when President Jimmy Carter wanted a strong growth in the money supply to further social welfare programs, Americans saw a jump in inflation to 8.5 per cent. Later, Ronald Reagan, wanted to stop Carter’s damaging policies and stabilize the American economy. He called in newly appointed Fed Chair Paul Volcker. And lo and behold, the “independent” Fed reversed its policies.

So, if the Federal Reserve gives in to the pressures of the President, then why is it that mainstream scholars believe that the Fed is independent? Well, the confusion begins at the divide between instrumental versus goal independence.

It’s true that the Federal Reserve has the independence to set day-to-day monetary policy without any interference, which is called instrumental independence. But the President can heavily influence and direct the goals of monetary policy, thereby making the instrumental independence worthless.

The President does this by exercising his powers of appointing the members to the Board of Governors. This board is comprised of the most powerful players in the Federal Reserve. With only five of the seven positions filled, President Obama now holds an enormous amount of power because he could add two votes to an already small board, making the current members less powerful and insisting his own appointee further his political goals.

Already, with the massive new amounts of spending, there is no doubt that Obama has been leaning on the Fed Chairman Ben Bernanke to help finance all of the new bailouts and outright spending sprees to pay the debt.

The argument is that the United States needs to provide liquidity, or more cash, to the banks so that they can continue lending out money. What is going to inevitably occur, of course, is another boom period followed by a catastrophic bust.

All the while, the American people sit in the dark, while their money is being continually devalued by the Federal Reserve’s printing press, which will cause an artificial unsustainable boom and allow Obama to claim to be economic savior. Then, when the massive bubble eventually—inevitably—bursts, Obama will be either out of office, or (particularly if the mainstream media shameless idolatry continues) simply out of reach.

Perhaps, the last best hope for preventing all of this is the passage of H.R. 1207. The bill now gathering growing support in Congress to audit the Fed already has a staggering 227 supporters. If it reaches 300, Nancy Pelosi will certainly have to hold a vote.

And the beleaguered American people—victims of the “independent” Fed’s obstinacy for well nigh a full century—will finally have a prayer.

Justin Williams is a Contributing Editor of ALG News Bureau.

Timmy Wonka and the Chocolate Factory

Written by Justin Williams from

The Federal Reserve Board, at the behest of Treasury Secretary Tim Geithner, has now decided to initiate a new program that will lend up to $1 trillion dollars for anything from student loans to small business bailouts. And his began the ultimate blurring of the lines between a commercial bank and the role of the Federal Reserve.

It is all to be done under a new program known as the Term Asset-backed Securities Loan Facility, or TALF, created in October of last year. Significantly, TALF was set up not by Congress—which is, of course, answerable to those whose tax dollars it spends. It was created by the Fed itself, which is answerable to …well, itself. Commercial banks, which traditionally made TALF like loans, are defined as financial intermediaries. The Federal Reserve is supposed to be the lender of last resort. This means that the job of commercial banks (i.e. Bank of American, Wells Fargo, and BB&T) is to match those who are willing to save their money with those who are looking for a loan.

The Federal Reserve, on the other hand, is supposed to protect the fractional reserve banking system by supplying cash when banks get in trouble and people try to withdrawal all their assets at once. Now with Geithner’s new TALF plan, the Federal Reserve is in direct competition with these commercial banks. In short, in yet another major step in fulfilling the administration’s socialist agenda, the government is now preparing to use its fiat money printing press to compete with individual’s savings at private banks.

And there is no doubt that the Fed, having a monopoly on the printing press, will be able to destroy any attempt by the banks to fight back. For example, if Bank of America loans out money and the loan defaults, they lose money and learn that they should make their lending practices stricter. This is how the financial free market is supposed to work. If the Federal Reserve loans out money and the loan defaults, all they have to do is print money to make up for the loss. Commercial banks cannot print money they must raise their money from depositors, which is any person who holds a savings account or a CD.

Already with the constant pressure from the Fed to push down current rates of interest, today’s savings accounts lack any significant real rate of return. After the Federal Reserve gets done destroying the competition, the commercial bank’s real (minus inflation) interest rates will be nonexistent. In other words, there will be no real incentive for Americans to keep their money in a savings account. But not to worry: the Fed has even more tricks up its sleeves. As it prints more money to make more loans, the nominal (before accounting for inflation) interest rate will naturally rise with inflation.

Then as in the 1970s, the nominal interest rate gives people the illusion that they are making more money in their savings account, which is actually being devalued by inflation. This, of course, is a double whammy—because what actually matters is the real interest rate. This is the true amount of wealth an individual is accumulating. For example, if John Taxpayer puts $100 dollars in his savings account then he would be very happy if he receives a 7 per cent rate of interest (2008 average rate was less than 1 percent). Both this means that every year the bank will pay him $7 dollars on that initial $100 dollars.

If the inflation rate is at 6 percent, which was the average in the 1970s, then John is actually only making $1 dollar a year making the real rate of interest only 1 percent. Though government hopes, John just won’t notice Secretary Geithner and the Federal Reserve both believe that they can delude the American people, by creating another unsustainable bubble by printing money and competing with (while destroying) American savings. It’s a bubble that will be much bigger than the last.

And, it’s not only a bubble we cannot afford; it’s one we cannot survive. Unfortunately, unless the fiscal conservatives in Congress step in, the only thing that the American people can do is watch as their currency disintegrates. Or as Austrian Economist Ludwig von Mises said, “Money, like chocolate in a hot oven, [will be] melting in the pockets of people.”

But unlike chocolate the American people will be left with anything but a sweet taste in their mouths – or for that matter, sound money in their devalued bank accounts!

Justin Williams is a Contributing Editor of ALG News Bureau.

The Myth of Bernanke’s Money Helicopter


When the Federal Reserve Chairman Ben Bernanke spoke at famed economist Milton Friedman’s ninetieth birthday, he praised the Nobel laureate for his work on the “permanent-income theory of consumer spending.” This seemed to demonstrate that he understood consumer spending was not dependant on current income, but instead was influenced by future expectations. But that was then and times change.

Earlier this year, Chairman Bernanke did a complete about face when he supported Congress’ efforts to plunge the United States into more debt in the name of a fiscal stimulus. Bernanke 2.0 said he believed that because of the strong likelihood that there would be an economic slowdown, “…consideration of a fiscal package by the Congress at this juncture seems appropriate.” So much for the Fed Chair’s monetarist root or at least so it seems. Fortunately, there is more to the story.

Chairman Bernanke 3.0 has now begun to denounce the massive government spending, doing a highly adept fiscal two-step. Bernanke now states that the United States “…cannot allow ourselves to be in a situation where the debt continues to rise; that means more and more interest payments, which then swell the deficit, which leads to an unsustainable situation.”

Yet through it all, while Bernanke spends time bouncing back and forth between Keynesianism and Monetarism, he completely misses the real problem, one for which he is directly responsible.

The Federal Reserve is currently using monetary policy to try to stimulate the economy, while the Congress is trying to use deficit spending, also known as fiscal stimulus, to stimulate the economy. The two now are apparently fighting over which they think would be most effective. What they do not realize is that the real solution is neither.

As Friedman showed in much of his work, “crowding-out” prevents a fiscal stimulus bill from ever being effective. “Crowding-out” means that since the government can only raise money from debt or taxes, all Congress is doing is uselessly moving money around.

Raising taxes to fiscally stimulate would just cause private sector spending to decrease, as they have less disposable income. Debt financed stimulus, which is what Congress has been doing, causes interest rates to rise thus making it harder for new private investment to sprout up. In other words, this debt actually causes the banks to be more hesitant to gives out loans, thus exacerbating the current financial problem.

Where the monetarists, like Friedman and Bernanke, went wrong is supporting monetary policy as a safe alternative. They believed in printing money during a recession in order to prevent a contraction in the money supply, which is what they attribute as the primary cause of the Great Depression. Their reasoning (unsound as it may be) is that, unlike a fiscal stimulus, the newly printed money would be evenly distributed inside the economy.

This “Helicopter Effect” is supposed to give people the comforting vision of the Federal Reserve flying over the country throwing free money out the window, thus saving us from an economic downturn. This way the money would not discriminately go to special interests and everyone would be health, wealthy, and though certainly not wise enough to know they were being duped.

Granted it sounds good in touchy-feely theory. Unfortunately, it is poppycock, flapdoodle, and unmitigated balderdash in raw fact.

The Austrian School of Economics exposes this myth for what it is. Ludwig von Mises and Murray Rothbard both crushed this theory and show that the helicopter ends up being just as discriminatory as other politically mattered hijinks. Rothbard, in The Case Against the Fed, states that the Fed printing money is “…a process of transmitting new money from one pocket to another, and not the result of a magical and equiproportionate expansion of money in everyone’s pocket simultaneously.”

In the current financial crisis, the Fed caters to a clearly exclusive club that receives the money: mostly the big banks. Now with the threat of nationalization and massive governmental controls on the banks, the bankers will have no choice but to loan the new money out to whomever they are told to by the bureaucrats. And the bureaucrats, in turn, will favor those that are in the good graces of their political paymasters.

Now with the Fed being responsible for more than $7.76 trillion of financial “rescues” over the past 22 months, the chance of handing out that money indiscriminately is patently absurd. Men, after all, are not angels. Yet, thanks to the many government laws barring auditors from the Fed’s books, the American people (as well as their representatives in Congress) are unable to check and see if these discriminatory practices really do go on.

The Government Accounting Office cannot audit the Federal Reserve’s transactions with foreign governments and banks, transactions made by the Federal Open Market Committee, and they cannot even look at the discussions of major policy decisions. The Fed’s reserve banks have argued that they are private institutions, beyond the reach of any action including the Freedom of Information Act (FOIA). The Board of Governors simply refuses to comply, stating they are allowed to withhold “internal” memos as well as commercial and trade secrets information

In short, the Fed’s message to the American people is even worse than “give us your money—or else.” It’s simply “give us your money and there is no else.” Not even an “elsewhere”—since no other agency anywhere else in government has to power to rein in the Federal Reserve autocrats.

That is why Congress needs now to pass the bill to audit the Federal Reserve, their Board of Governors, and the Reserve Banks that was proposed on February 26th by Congressman Ron Paul. Since then it has gained 186 cosponsors, including 36 Democrats and 150 Republicans, and this number needs to continue to grow to ensure passage.

Without these audits, Chairman Bernanke and his Board will continue to pretend that they have some magical money helicopter that will indiscriminately hand out these newly printed fiat bills. And the once-respected “permanent income theory of consumer spending” will continue to give rapid way to the “eternal fact of Federal Reserve autocracy.”

Justin Williams is a Contributing Editor of ALG News Bureau.

The “Traction” Fallacy by William Anderson

Today’s article of the day comes from Campaign for Liberty:

In his recent book, The Return of Depression Economics, Paul Krugman makes a rather amazing claim when he says that almost any problem in the U.S. economy can be “solved” simply by printing money. Elsewhere in his semi-weekly column in the New York Times and in his blog, Krugman has called for “a credible commitment to fairly high inflation” as a means of economic recovery.

Now, in the country where I live, one generally does not need the government to “commit” itself to inflation. Indeed, governments will do that all on their own and don’t even need approval from economists and especially Krugman.

But while it might seem that calling for inflation is absurd on its face, I believe that I should try to explain the economic strategy that is behind the call for more inflation. The term Krugman and others have used is “traction,” but instead of being an appropriate analogy, I would say that this is a “strategy” to run the economy off the road altogether and impoverish much of the United States.

If I am going to use such harsh language, however, I need to be sure that I can explain why Krugman and others have used that analogy, and why they believe it will work. It won’t, of course, but nonetheless I should be able to explain why on both counts.

I live in a place that receives a lot of snow each winter, and our house is halfway up a steep hill. We used to have a rear-wheel-drive van and in order to be able to make it to our driveway when the snow was falling, I had to gain speed just before we hit the hill, or the van would slide back.

Because not everyone here expertly drives in snow, once in a while someone goes off the road or is stuck in a snow bank. One way to help that person to drive out is to throw dirt or ashes under the tires in order to give the vehicle traction. After throwing down the material, people then push the car from behind. Once the car has some forward momentum, it usually can get out of the snow on its own.

Likewise, Krugman and others like him (too many like him, as far as I am concerned) believe that the problem with the economy today is that people just are not spending enough money, and in their reluctance to spend, they have created a “liquidity trap.” Since the Keynesian construct of the “liquidity trap” has it being a self-perpetuating problem, the only way to steer the economy out of its present “snow bank” is to have an outside force — the government — give it a push or throw money under the wheels (instead of ashes) and then watch the economy take off again.

In the case of the present downturn, creating new bank reserves will not provide much of a push since new money cannot be created if banks are not making loans, and a period of economic uncertainty is not going to result in a surge of new lending. Thus, if the economy is to be given “traction,” the only way is for government to spend in a way that floods the economy with new money, forcing up prices through inflation. People will face the hard choice of holding onto their money and watching its value deteriorate, or spending in and enabling the economy to “take off.”

As people continue to spend, the spending sends signals to producers to make more goods, and then the economy is off to the races. And all it takes is a friendly shove from the government along with a blizzard of new dollars.

If the economy really were a circular flow and if there were such a thing as a “liquidity trap,” and the economy worked just as Keynesians claim, then perhaps such a strategy would make sense. (I am not endorsing inflation, but rather am giving Krugman and others their argument in an imaginary economy.)

However, as I have pointed out before, the economy is not a circular flow mechanism. It is not some sort of perpetual motion mechanism. It is an entity with real fundamentals, a real structure of production, and these are things that matter. If an economy were simply a blot into which people throw whatever they wish and out pops what we see today, that would be one thing; but it is quite another when capital matters, when the relationship of factors of production to each other and to consumer good matters.

In the Krugman/Keynesian view, production is an automatic thing. In fact, it does not even matter who or what entity is producing something. In Krugman’s world, a government-owned and operated economy will operate just as well as one based on private property and maybe even better, since governments are legally permitted to print money.

However, if ours is a world scarcity, a world in which prices tell us something about the demand for and the relative scarcity of all goods, be they producers’ goods, consumer goods, or our labor, then throwing a big pile of money into the mix will not give an economy “traction” any more than pushing the car further into a snowy ditch will enable it to pull out. In fact, a burst of inflation (or, better, a government “commitment” to debasing our money) only will further the malinvestments that now plague our political economy.

My sense is that the powers that be will listen to the Krugmans of the academic and political world instead of listening to people like Ron Paul. After all, they are the ones with the honors, they are the ones who populate the “elite” economics departments, and they are the ones who are laying out real-live “plans of action” by which the political classes can make it look as though they are doing something. Those of us who advocate the government stepping back and not “helping people” are seen as reactionaries and worse.

But even if Paul Krugman is popular and has his face on the cover of Newsweek, that does not mean he is correct. His argument that inflation will give the economy “traction” is clever and might even resonate with the political classes and the media, but even though his is a cunning argument, nonetheless it still makes no sense. An economy is not a blob, it is not a “circle of life,” and it is not even something that needs “traction.” Our economy is something that has been badly damaged precisely because of all of these clever policies of inflation and malinvestment that have benefited the political classes, and the only way that it can get any real traction is for the political classes to go back to ribbon cuttings and hanging out at the bars in the Beltway and stop trying to fix things.

Published in: on June 2, 2009 at 6:41 pm  Leave a Comment  
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While we all lose money, the Fed makes money?

This from the Economist:

“Last year the central bank reported a whopping $43 billion in operating income. That was more or less the same level as in 2007, but meanwhile short-term interest rates had plummeted, ending the year near zero. That should have clobbered Fed income, as rate cuts did in the early days of the last recovery in 2002-04 (see chart).

But it did not, for two reasons. First, to shore up financial markets the Fed has pumped up its balance-sheet—its total assets were $2.2 trillion on December 31st, more than double their level of a year earlier. Second, it has been trading in low-risk, low-return Treasury debt and buying higher-yielding private debt—discount loans to banks, commercial paper, and mortgage-backed securities, for example.”

Are you kidding me? Not only the Fed can debase our currency, print as much money as it wants, cause booms and busts at will, but they also make money on the recession. Tell me if this makes any sense! Oh wait, they can print as much money as they want, so how can they ever lose money?


Published in: on June 2, 2009 at 12:38 pm  Leave a Comment  
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Ron Paul’s Economic Theories Winning GOP Converts by David Weigal

Today’s article of the day comes from the Washington Independent:

From time to time, a few members of Congress—as many as 10, sometimes fewer—gather with Rep. Ron Paul (R-Texas) to eat lunch and hear from an author or expert whose opinion he thinks is worth promoting. They grab something to eat off of a deli plate. They take notes. They loosen up and ask questions.

“It’s not all that easy for the other members to get here,” Paul said in an interview with TWI, sitting just outside of his office before heading back to Texas for a few days. “It’s just that there’s so much competition. Once they get here and they get going, they all seem to enjoy it.”

A funny thing has started happening to Paul since his long-shot presidential campaign ended quietly in the summer of 2008. More Republicans have started listening to him. There are the media requests from Fox Business Channel and talk radio, where he’s given airtime to inveigh on sound money and macroeconomics. There is HR 1207 , the Federal Reserve Transparency Act of 2009, a bill that would launch an audit of the Federal Reserve System, and which has attracted 112 co-sponsors. When Paul introduced the Federal Reserve Board Abolition Act just two years ago, no other members of Congress signed on.

And then there are the luncheons. The off-the-record talks have brought in speakers such as ex-CIA counterterrorism expert Michael Scheuer, libertarian investigative reporter James Bovard, iconoclastic terrorism scholar Robert Pape, and George Washington University law professor Jonathan Turley. Perhaps the most influential guest has been Thomas Woods, a conservative scholar whose previous books include “The Politically Incorrect Guide to American History” and “Who Killed the Constitution?: The Fate of American Liberty from World War I to George W. Bush,” and whose current book “Meltdown” has inspired Rep. Michele Bachmann (R-Minn.) to question Fed Chairman Ben Bernanke and Treasury Secretary Tim Geithner about economic fundamentals.

Paul’s unexpected and sudden clout with his fellow Republicans — even some of Paul’s staff have been surprised with the momentum of his “Audit the Fed” bill — come as the GOP engages in a tortured internal dialogue about its future. Since January, no small number of new coalitions have formed between current members of Congress, former advisors to President George W. Bush, and perennial party leaders such as former Gov. Mitt Romney (R-Mass.) and former Gov. Jeb Bush (R-Fla.). Few of those conservatives, however, have spent much time criticizing the very foundations of America’s modern economic system and worrying about a 1929-style crash. Few of them had a drawer stuffed with off-brand economic ideas and forgotten libertarian texts, ready to explain what needed to be done. Ron Paul did, and as a result the ideas that made the Republican establishment irate enough to bounce him from a few primary debates are more popular than ever. (more…)

The Harding Way by Thomas E Woods Jr.

Today’s article of the day comes from The American Conservative:

When Barack Obama urged passage of his so-called stimulus measure in February, he claimed that only bold government action would prevent the economy from slipping into a deep depression. In making that argument, he was only repeating the conventional wisdom, according to which markets are not self-correcting—except in the very long run—and state intervention is necessary to revive economic activity.

Economic theory can tell us why these claims are incorrect and why, in fact, even the appearance of prosperity that those measures can produce causes still greater damage and leads to a more severe correction in the long run. But we can also refer to the testimony of history. In particular, the depression of 1920-21, which most people have never heard of, is an example of the resumption of prosperity in the absence of government stimulus, indeed in the face of its very opposite. If economies cannot turn around without these interventions, then what happened in this instance should not have been possible. But it was.

During and after World War I, the Federal Reserve inflated the money supply substantially. Once the Fed finally began to raise the discount rate—the rate at which it lends to banks—the economy slowed as it started readjusting to reality. By the middle of 1920, the downturn had become severe, with production falling by 21 percent over the next 12 months. The number of unemployed people jumped from 2.1 million in 1920 to 4.9 million in 1921.

From 1929 onward, Herbert Hoover and then Franklin Roosevelt tried to fight an economic depression by making labor costlier to hire. Warren G. Harding, on the other hand, said in the 1920 acceptance speech he delivered upon receiving the Republican nomination, “I would be blind to the responsibilities that mark this fateful hour if I did not caution the wage-earners of America that mounting wages and decreased production can lead only to industrial and economic ruin.” Harding elsewhere explained that wages, like prices, would need to come down to reflect post-bubble economic realities.

Few American presidents are less in fashion among historians than Harding, who is routinely portrayed as a bumbling fool who stumbled into the presidency. Yet whatever his intellectual shortcomings—and they have been grotesquely exaggerated, as recent scholars have admitted—and whatever the moral foibles that afflicted him, he understood the fundamentals of boom, bust, and recovery better than any 20th-century president. (more…)

Central Banks Cannot Easily Maintain their Independence by Gary Becker

Today’s article of the day comes from the Becker-Posner blog:

Most richer nations nowadays, and many developing nations, have “independent” central banks, such as the European Central Bank and the Federal Reserve Bank. “Independence” cannot be precisely defined, but it is supposed to indicate that the central bank of a country has the freedom to make decisions which the government, represented by the Treasury in the United States, does not like. The purpose of independence is to allow monetary policy to be decided independently of fiscal policy, although obviously even independent banks and governments may respond in consistent ways to broad economic events, such as the present recession.

The motivation for having an independent central bank is the many occasions in the past when subservient central banks accommodated the government’s desire to spend more without raising additional taxes. Central banks accommodate fiscal authorities essentially by buying government securities that help finance government spending. In return for receiving government debt, a central bank would either directly print additional currency that governments can spend, or it would create reserves in commercial banks that lead to an expansion of bank deposits and monetary aggregates, such as M1. Either way, inflation would result from this monetization of the government debt, often severe inflation and even hyperinflation. Hostility to rapid inflation led to the political support behind giving central banks much greater independence from fiscal authorities.

The history of the Federal Reserve’s transition in and out of independence is illuminating (see Allan Meltzer’s book, A History of the Federal Reserve, 2003). The Fed fully and enthusiastically compromised its independence from the Treasury during World War II. It bought large quantities of government debt to help the government finance the large wartime deficit. Inflation from the resulting big expansion of the money supply was suppressed through wage and price controls. This inflation became open after removal of these controls at the end of the war.

For a half dozen years after that war was over, President Truman and the Treasury pressured then much more reluctant Fed officials into maintaining the Fed’s subservience. Eventually, however, the Fed regained its independence in the famous Accord reached in March 1951. Nevertheless, the Vietnam War, the Great Society Program, and the reinstitution of wage and price controls by Richard Nixon in the early 1970s led to later erosions of the Fed’s independence.

Inflation is looming on America’s horizon By Martin Feldstein

The article of the day comes from the Financial Times:

The US last week showed its first signs of deflation for 55 years, prompting inevitable fears of further deflation in the future. Yet the primary reason for the negative rate of US inflation is the dramatic 30 per cent fall of commodity prices. That will not happen again. Moreover, excluding food and energy, consumer prices are up 1.8 per cent from a year ago. That is the good news: the outlook for the longer term is more ominous.

The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president’s budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years.

There is ample historic evidence of the link between fiscal profligacy and subsequent inflation. But historic evidence and economic analysis also show that the inflationary effects can be avoided if the fiscal deficits are not accompanied by a sustained increase in the money supply and, more generally, by an easing of monetary conditions.

The key fact is that inflation rises when demand exceeds supply. A fiscal deficit raises demand when the government increases its purchase of goods and services or, by lowering taxes, induces households to increase their spending. Whether this larger fiscal deficit leads to an increase in prices depends on monetary conditions. If the fiscal deficit is not accompanied by an increase in the money supply, the fiscal stimulus will raise short-term interest rates, blocking the increase in demand and preventing a sustained rise in inflation.

So the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases. (more…)