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Back to the Blog Why Auditing the Fed is a Terrible Idea

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Coffee and Markets

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Francis Cianfrocca joins Ben Domenech for the Wednesday, August 19th edition of Coffee & Markets, a series of brief morning podcasts on politics and the marketplace.

This morning’s podcast focuses on Ron Paul’s call to “audit the Fed,” which has since been taken up by Republican Senator Jim DeMint. Our conversation this morning revolves around an interview with David Wessel of the Wall Street Journal at PBS. Wessel is economics editor for the WSJ, has shared two Pulitzer Prizes, and is writing a book about the financial crisis.

QUESTION: You talked on the NewsHour about how the Federal Reserve has, in essence, become the fourth branch of government. Many lawmakers say the central bank holds too much power and should be exposed to occasional audits by the GAO. Chairman Bernanke argues that the Fed is plenty open. Where do you fall in this debate?

DAVID WESSEL: I’m not in the business of favoring or opposing bills, but here are some facts. The Fed’s actions have revealed how much power it has, the power to create trillions of dollars in credit without getting anyone else’s OK and the power to lend massive sums when it deems it necessary (and to withhold such loans when it chooses.) It was the first responder to this financial conflagration; no one else had the ability.

That raises legitimate questions in a democracy, and that’s why Congress has been summoning Mr. Bernanke so often to explain what he did and why (and even publishing his e-mails.) In most capitalist democracies, however, the politicians have decided that they don’t want to have their hands on the interest-rate lever; they know that they have to face the voters frequently, and that will tempt them to juice the economy a little more now at the expense of more inflation later. So they’ve set up a central bank, insulated it somewhat from politics, and instructed it to raise interest rates even when it is unpopular to avoid unwelcome inflation.

Ron Paul, the Republican congressman from Texas, opposes that set up and is explicit about that. He’s the one pushing the bill to expand the Government Accountability Office’s power to audit the Fed. The GAO now audits much of what the Fed does — the loans to Bear Stearns, its bank regulatory activities, etc. But current law prevents the GAO from auditing interest-rate and other monetary policy decisions. That reflects the view that monetary policy makers need to be independent of politicians if they are to do their jobs. Mr. Bernanke says that if the GAO starts auditing monetary policy, it’ll inevitably lead to second-guessing the Fed and weakening its ability to do that part of its job.

  • RobertArvanitis

    The Fed has only one task, and that is to ensure the value of the currency, to avoid government “closet default” through inflation.

    When the Fed sticks to that task, and eschews all other meddling, then there will be no need to audit.

  • jMunny

    Mr. Cianfrocca,

    I really think you took Mr. Wessel's commentary out of context when you say “Why Auditing the FED is a Terrible Idea”. The gentleman states that he is just stating facts. The first set of facts are exactly why auditing the FED is a wonderful idea. Furthermore, the only opposition statements that he makes are words from Ben Bernanke and “most capitalist democracies”. I hardly find the reason of knowing you have to face the voter's frequently as a compelling argument against this either. Let the FED keep it's independence. They can have the lever, but I and millions of Americans want to know what the money is doing and where it is going.

    Also, inflation is unacceptably high as it is.

  • Charles_Easterly

    “Mr. Bernanke says that if the GAO starts auditing monetary policy, it’ll inevitably lead to second-guessing the Fed and weakening its ability to do that part of its job.”

    Perhaps Chairman Bernanke should first justify his institution's poor performance to date before he predicts the Federal Reserve's future inability to handle monetary policy.

    According to the Federal Reserve's website (http://www.federalreserve.gov/generalinfo/faq/f…), its responsibilities are as follows:

    1) “conducting the nation's monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices”

    2) “supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers”

    3) “maintaining the stability of the financial system and containing systemic risk that may arise in financial markets”

    4) “providing certain financial services to the U.S. government, to the public, to financial institutions, and to foreign official institutions, including playing a major role in operating the nation's payments systems”

    In my estimation, the Federal Reserve has abjectly failed to achieve objectives one through three. Yet the Central Bank is redistributing billions of our tax dollars and continuing an inflationary monetary policy which devalues the money we earn without any accountability whatsoever.

    The least we should accept is a proper level of transparency so that we will see where our money is going, and to whom.

    Best regards,

    Charles

  • http://www.importanceofphilosophy.com BeingJohnGalt

    Well said, jMunny.
    And unfortunately, there are currently no existing capitalist democracies. The closest we have ever come to capitalism was the US in the late 19th century. It was the height of prosperity and creativity for all Americans… Then the Gov started meddling and regulating, then the FED was created. It was all down-hill after that.

  • http://www.importanceofphilosophy.com BeingJohnGalt

    Right on, Charles! I fully agree.

  • http://twitter.com/DPCrandall Daniel Crandall

    Before there was the call to “Audit the Fed,” the Campaign for Liberty's (a continuation of the Ron Paul for Pres. campaign, just as Organizing for America is a continuation of the Obama for President campaign) popular bumper sticker was “End the Fed.” This led me to understood the “audit the Fed” meme as a 'foot-in-the-door' tactic by the Campaign for Liberty folks. I think their hope is that an audit will show how corrupt and out of control the Fed is that the only “reasonable” action is to shut it down. Talk to any active Paul supporter about auditing the Federal Reserve and that person will inevitably tell you that the Fed is unconstitutional and should be shut down.

    And when I ask Paul supporters, “Okay, let's say we end the Fed. Then what?” At this point most of them haven't a clue what would happen next. When Ron Paul got on the topic at a Seattle event he all but admitted that there would be a period of financial chaos but eventually things would shake out (but he was still vague on how exactly that “shake out” would occur). I'm glad he can be so comfortable with chaos. I tend to think that it is just that kind of thing which leads to much bigger social problems, not the least of which could be politically inspired violence.

  • esclavier

    Uh… You're joking right? I consider myself a libertarian, but to characterize the late 19th century U.S. as some utopian free market society, while ignoring the existence of the robber barons, massive monopolies, abysmal working conditions, and repeated economic disasters (such as those in 1873, 1884, 1890, and 1893) is plain idiotic.

  • http://www.importanceofphilosophy.com BeingJohnGalt

    Uh, sorry esclavier, but the working conditions were not abysmal for the time, compared to the alternatives. There were other options, but as long as you dismiss the fact that all developing economies go through a similar period during this particular transitional phase, it's no wonder you see it as you do.

    Utopias do not exist and I don't claim that everything was perfect. There were some railroads, for example, that used their connections in government (non-capitalism) to form coersive monopolies that used laws to limit competition and allowed them to take advantage by jacking up prices and providing horrible service. This happens in all cases where government is used in such a maner.

    Without government intrusion, coersive monopolies are impossible. The only way for a company to keep the lion's share of customers is to offer the best product/service for the best price. If they don't, then someone else will. Funny you consider yourself a 'libertarian' but you don't know the difference between the two.

    As for the panics, there is a good deal of evidence to show that these were engineered by well-placed rumors on the part of the money-trusts with heavy government influence and a treasury secretary that let the printing-press hum.

    Speculators have to take some of the blame, though, for being naive and stupid. Some of the responsibility falls flatly on unthinking speculators who set themselves up for failure by taking risks that they paid for by aqcuiring loans that had the stipulation that at any specific time, the bank could demand the full payment of the loans. Just as with the recent housing bubble, there was a stock market bubble and investors far and wide took these risky loans, figuring they could get rich and pay them off without a problem. Well, when they were busy being bullish, JP Morgan and his buddies started selling off large amounts of stock and signalled a panic, and their trusts then called-in their loans. As the floor dropped out of the market, the speculators were forced to dump as much of their stock as they could. Luckily for JP and his friends in NY, they were there to 'help out' by buying up the excess at pennies on the dollar (and buying out many smaller competitor banks that did not see this coming).

    Later, JP and his friends used their government allies to securely plant themselves in our wallets by planning and getting passed the current Federal Reserve System.

  • http://www.importanceofphilosophy.com BeingJohnGalt

    Actually Daniel, Dr. Paul's idea is to phase-out the Fed, while getting rid of the legal tender laws and allowing competing currencies such as gold and silver. This would vastly limit any 'chaos' attributed to a sudden vanishing of the Fed.

  • esclavier

    You originally said: “It was the height of prosperity and creativity for all Americans,” which is ludicrous on its face. In your response, you've offered no evidence to support that assertion.

    “[W]orking conditions were not abysmal for the time”

    So, it was fine (back then) for children to work in coal mines and operate dangerous factory machinery?

    “Without government intrusion, coersive monopolies are impossible”

    “Coersive” as in using the threat of force to compel patronage, maybe. But a monopoly need not be “coercive” to impact you in a highly negative way. You may have been able to avoid them of your own free will in the 19th century by never traveling anywhere or in the 1970s by never using the telephone, but they are still monopolies that exert total control over a sector of the economy, and prevent truly free enterprise. Milton Friedman wrote, “When technical conditions make a monopoly the natural outcome of competitive market forces, there are only three alternatives that seem available: private monopoly, public monopoly, or public regulation. All three are bad so we must choose among evils.”

    You say, “There were some railroads, for example, that used their connections in government (non-capitalism) to form coersive monopolies that used laws to limit competition and allowed them to take advantage by jacking up prices and providing horrible service. This happens in all cases where government is used in such a maner.”

    In the 19th century, there was no alternative to railroads for bulk or personal transportation, and due to the static nature of rail infrastructure, it was easy to form technical monopolies. Government may have worsened the situation, but it did not create it. It also did not solve it through the Interstate Commerce Commission, but that's another story altogether.

    Yeah, the Fed sucks, but the reason it was created was largely due to the economic crises of the late 19th century. And then it sh*t the bed in the Great Depression. That doesn't make the gold standard better and it doesn't make the 19th century more prosperous or creative by comparison. You are romanticizing an era that was different, but not substantially better (in the areas you cite) for individual liberty.

  • esclavier

    You originally said: “It was the height of prosperity and creativity for all Americans,” which is ludicrous on its face. In your response, you've offered no evidence to support that assertion.

    “[W]orking conditions were not abysmal for the time”

    So, it was fine (back then) for children to work in coal mines and operate dangerous factory machinery?

    “Without government intrusion, coersive monopolies are impossible”

    “Coersive” as in using the threat of force to compel patronage, maybe. But a monopoly need not be “coercive” to impact you in a highly negative way. You may have been able to avoid them of your own free will in the 19th century by never traveling anywhere or in the 1970s by never using the telephone, but they are still monopolies that exert total control over a sector of the economy, and prevent truly free enterprise. Milton Friedman wrote, “When technical conditions make a monopoly the natural outcome of competitive market forces, there are only three alternatives that seem available: private monopoly, public monopoly, or public regulation. All three are bad so we must choose among evils.”

    You say, “There were some railroads, for example, that used their connections in government (non-capitalism) to form coersive monopolies that used laws to limit competition and allowed them to take advantage by jacking up prices and providing horrible service. This happens in all cases where government is used in such a maner.”

    In the 19th century, there was no alternative to railroads for bulk or personal transportation, and due to the static nature of rail infrastructure, it was easy to form technical monopolies. Government may have worsened the situation, but it did not create it. It also did not solve it through the Interstate Commerce Commission, but that's another story altogether.

    Yeah, the Fed sucks, but the reason it was created was largely due to the economic crises of the late 19th century. And then it sh*t the bed in the Great Depression. That doesn't make the gold standard better and it doesn't make the 19th century more prosperous or creative by comparison. You are romanticizing an era that was different, but not substantially better (in the areas you cite) for individual liberty.