Monday, July 04, 2011

Fix the Fed: Monetary Policy that works (better)

Ron Paul likes the gold standard. And he likes it for good reasons. Unfortunately, I think his positions lately on the Fed are doing more to hurt his credibility than to help it and he's squandering his opportunity in his role as a monetary policy subcommittee chair to get at the real problems behind the Fed. Here's why:

1. The Federal Reserve as a corporation owned by private shareholders has obvious conflicts of interest in performing independent monetary policy. Everything that the Fed has done, especially the last several years has not been in the interests of helping out the little guy and improving the economy. Instead, it has acted very predictably in saving many of its shareholders and their interests. ZIRP, QE I, QEII, TARP, FASBA manipulation, et all were all intended to slowly improve the balance sheets of the big banks through manipulation and front-running of the Treasury auctions. Big broker/dealers would buy newly issued treasuries and the Fed would buy these "On-the-run" securities at higher prices and the big broker/dealers would earn a spread to improve their retained earnings. This is why big banks have been much more successful at exiting TARP than smaller regional and community banks.

Now the impact of this policy is pretty easy to see. With money, when one wins through manipulation, another gets screwed. So the obvious loser is the US Government aka taxpayers. Taxpayers have suffered though monetary debasement all to improve the banks that caused the crisis in the first place.

2. A centralized clearing bank is not necessarily a bad thing. Much of the useful function of the Federal Reserve is to act as a clearing house and payments intermediary. This actually provides value, although in the free market this occurs anyways. The Fed is just a government protected monopoly on clearinghouses.

3. Credit money v. Gold money. This is the big debate. Credit money CAN work if there are penalties put in place for non-compliance and they are STRICTLY enforced. When I mean it CAN work is that the money supply will not inflate at the whims of central economic planners. You wouldn't see 2% inflation targets since the goal would be a zero inflation policy. Inflation would also be measured as a money supply issue rather than a consumer price issue that is easily manipulated.

The problem right now and the general problem with government sponsored entities is the lack of an enforcement mechanism. The Federal Reserve blatantly disregards its mandate for stable prices. Its obvious conflict of interest is to maintain the health of its shareholder banks first. Since congress created the Fed, it is congress' job to monitor the actions of the Fed to see if they are following these mandates and if they work. This is where Dr. Paul's 'Audit the Fed' bill comes in. An annual audit should be mandatory to determine if the Fed is in compliance with the powers enumerated by congress and whether its policies are acting towards compliance with its dual mandate.

The mandate issue is also a big problem. The full employment mandate has been used an excuse for the Fed saving European banks and participating in some very complex derivative transactions. The problem with the full employment mandate is that full employment FOLLOWS stable prices. In a volatile price environment (up or down) the price of labor has to be decreased to account for price risk. Business will be slow to hire when input costs are very sensitive. However, when prices are stable, businesses can budget for more full employment and stable input costs.

4. Finally, legal tender laws should be abolished. The Federal Reserve Note is the legal tender of the US government which basically forces everyone else to use it as currency when the constitution says gold and silver should be the money of the states. These legal tender laws lead to a whole host of issues that essentially force people into what would and should be voluntary interaction with the federal government.

So what should the action plan be? Here's a few items that I believe would be important in making the Fed more people friendly than big-bank friendly:

1. Add enforcement provisions to the Federal Reserve act that allow the federal government, the states, or the people to bring criminal charges against Federal Reserve agents that do not act within their enumerated powers.
2. Audit the Fed annually
3. Remove the employment mandate and enforce a ZERO INFLATION POLICY defined as the total supply of marked to market credit in the system.
4. The US government should purchase all equity of the Federal Reserve banks and make it illegal for any private corporation or individual to purchase equity in the central bank. This will remove any conflict of interest that leads to monstrosities like TARP and QE.

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