From a small northwestern observatory…

Finance and economics generally focused on real estate

Archive for February 8th, 2012

A truly dumb idea

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First, there is virtually NO chance that this idea will come to pass, thank goodness.

SOME pundits propose shutting down the Federal Reserve.  I’m serious.  Presidential candidate Ron Paul considers it a central tenet of his philosophy.  He would put us back on a gold standard, which would mean that the government could only issue paper dollars if they were backed by gold holdings (i.e. — Ft. Knox), and would stand ready to buy gold at a stated price.  One assumes that gold coins would also circulate, although at today’s rates, the smallest gold coin available today (1/10 oz) would be worth about $150.  Hardly the sort of thing you’d use in a vending machine.

From an economists perspective, it’s impossible to imagine a 21st century nation — particularly one with the most complex economy in the world — to exist without a central bank.  In the first decade of the 20th century, the U.S. suffered a tremendous depression, much of which was driven by bank liquidity problems (and thus bank failures).  To address this, the U.S. Government established not one central bank but in fact a network of regional central banks, all of which would coordinate their activities via a central Federal Reserve Board.  Members of the Federal Reserve Board are appointed by the President and confirmed by the Senate for 14-year terms, a period of time selected to make sure that no ONE political party or political philosophy would dominate.  The members of this board, along with a rotating subset of the Presidents of the regional banks, form what is called the Federal Open Market Committee (FOMC).

The FED really only has two tools at its disposal.  Taken together, these tools are called “monetary policy”.  It can set the “Fed Funds Rate” which is the rate at which member banks can borrow money for short periods of time.  Since member banks borrow (and pay back) constantly, this is an extraordinarily important base-line for interest rates.  A rise in this rate would stimulate a rise in overall rates throughout the economy.  Currently, this rate is about a half percent — nearly inconsequential.  Clearly, the FED wants to keep rates low to stimulate the economy.  A hint of inflation in the market would probably stimulate a rise in rates, to slow the economy down a bit and thus negatively impact inflation.  The FED can also buy and sell government bonds, and in fact can force member banks to buy and sell bonds.  Buying bonds from the banks puts money into the economy that these banks can lend.  Recently, the FED has been buying long-term bonds and selling short-term, to “twist” the yield curve.

The Government also influences the economy through “fiscal” policy, exerted through the Treasury Department.  Keynesians would hold that the government can stimulate the economy via deficit spending.  In the current economic crisis, the Fiscal and Monetary roles heavily intersected, particularly in the TARP funding under President Bush, and continued under President Obama, which used the full faith and credit of the Treasury to prop up our failing banking system.  The FED was an active participant in that process, and indeed (as shown in the movie), Fed Chair Bernake really sold this process to Congress.  As expensive as it was, and despite the political ramifications, it is beyond belief that any thinking person would have allowed our banking system to collapse.  A few banks dying was inevitable (e.g. — Lehman Brothers), but the entire system collapsing would have put the U.S. in an intractably difficult position, probably carrying the entire world’s economy with it.

As pointed out in a CNBC report by Mark Koba this morning (click here for a link), its noted that a gold standard would both put limits on growth as well as impose short-run volatility.  The American economy would, at least for short periods, be held hostage to the whims of gold traders. Further, production of gold in the world is probably insufficient to sustain reasonable levels of growth.

In addition, removing a relatively independent FED from the scene would leave the Treasury Secretary in an intractably politicized position.  The U.S. has had 75 Treasury Secretaries over the past 225 years, from Alexander Hamilton to Tim Geitner. (Also 6 “acting” secretaries who were never confirmed by the Senate.)  Many — if not most — have been contentiously fought over.  (The first Treasury Secretary, Hamilton, was shot in a duel. The second was run out of office after being accused of setting fire to the State Department building.)  Given the current contentiousness that permeates Capitol Hill, the notion of subjecting the American economy to the vagaries of Congress every 3 years sounds like something out of a third-world country, much less the most important economy in the world.

Fortunately, this proposal hasn’t a ghost of a chance.  Nonetheless, the inanity of it begs our attention.

Written by johnkilpatrick

February 8, 2012 at 11:34 am

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