How appropriate that this book by Ron Paul, End the Fed" (Grand Central Publishing: 2009), should come out the week that the price of gold reached $1020 per ounce and the dollar almost reached post World War II lows against other major currencies. These results, to Paul, just underscore his premise that a fiat money will, in the end, destroy itself, and on the way precipitate greater and greater crisis in the financial system, both domestically and internationally.
Early on, Paul gives us a chart that tells the whole story. It is a chart that presents the Purchasing Power of the U. S. Dollar from the year that the Federal Reserve System was established, 1913, to the present time. With the value of the dollar being indexed at $1.00 in January 1913 Paul writes: “We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.” That is, a dollar in September 2009 is worth less than $0.05 of what the purchasing power of the dollar was almost 100 years ago.
The one constant in this decline is…the Federal Reserve.
To Paul, the government and the banking industry are all of a package and have been sold as such since the beginning of discussions about the creation of a central bank in the United States. Historically, three reasons have been given for this relationship. First, banks must possess some kind of monopoly power, for financial intermediation cannot exist in a perfectly competitive environment. Thus, entry into the industry must be controlled by someone and that someone always turns out to be the government. But, having monopoly power gives the banks competitive advantages that allow them to earn extraordinary returns on invested capital.
Second, bankers always go too far and so they need to be regulated to protect themselves from their own actions. Thus, there need to be restrictions on capital, reserve requirements, lending standards and so forth.
Third, the supply of money within the banking system needs to be “elastic” so that banks can expand or contract credit in order to meet the needs of the business or farming community. This requirement can take one of two forms. In a farming community, farmers need funds in the spring season in order to plant crops and so banks must be able to extend loans to them in order to support the health of the local economy. In the fall after crops have been sold and farmers are flush with cash, the loans can be repaid and credit extension is reversed. Originally, this was one of the functions of the Fed’s discount window. Banks could borrow from the discount window in the spring to support the expansion of credit and then repay the borrowings in the fall as the farmers reduced their debt.
A second need to expand credit is the Fed’s role as the “lender of last resort.” Under normal circumstances customers of banks are routinely putting money into banks and taking money out of banks and these inflows and outflows usually offset one another. The problem comes when most customers want to withdraw their funds from a bank or the banking system. In its role as the “lender of last resort” the Fed opens up the discount window and supplies sufficient funds to a bank or to the banking system so as to allow banks to meet the removal of funds from the system. This is a primitive description of a “liquidity crisis.”
These basic reasons are the justification for the modern money and banking system and, to Paul, represent the underlying problems of a fiat money system. The first argument results in the “banking cartel” that he speaks of and accounts for the ability of these organizations to be very profitable. The second argument explains why the banking system and the government are so intertwined. It is in the interest of the banking system to protect its monopoly position and it is in the interest of the government to have a strong banking system. The two branches of the third argument help to account for the underlying existence of inflation in a fiat money system and the role the Fed plays in “saving” banks from failing. It is an easy step to go from providing an “elastic” currency to support seasonal swings in economic activity to providing an “expanding” money stock to support the economic growth of the economy as a whole. It is also easy to see how saving the banking system by opening the discount window can evolve into buying all sorts of “securities” to provide market support and into bailing out institutions by taking over their assets and putting them on the Fed’s balance sheet.
I have concentrated on these components of Paul’s argument because they are the foundation of most of what he presents in the book. The crucial issue to the author is that a system of fiat money supported by a central bank that can produce money out of thin air is going to eventually self-destruct. And, Paul argues, that is exactly what has happened in the United States and we are in the final stages of this self-destruction.
And who is the strongest proponent of this kind of a system? Well the banking industry is because they are protected, can earn enormous profits, and will get bailed out should things go wrong. Government also benefits because having a central bank that can create money out of nothing allows the government to basically spend at will because the central bank will ultimately underwrite all the spending that is not supported by the debt of the government. By government, Paul means Republicans, and Democrats, and bureaucrats. Affiliation doesn’t matter.
And, once you become part of this system you become a captive of the system. Paul presents two chapters that contain interactions with Alan Greenspan and Ben Bernanke. What he is trying to show is that once you get into a position of power you seem to lose all connection with reality in terms of how the world really works. However, it seems that being a part of the system just adds to your intelligence: “If Greenspan was cocky about the genius of central bankers, Bernanke is even more so.”
In closing, Paul gives several arguments as to why the system of fiat money should be abolished. First, there is the moral argument; a fiat money system destroys relationships, trust, and contracts. Second, there is no provision in the U.S. Constitution for a paper money; hence, a fiat money is unconstitutional. Third, a fiat money is not consistent with free market capitalism because it is really nothing more than backdoor economic planning. And, fourth, a fiat money system is contrary to the existence of liberty.
The answer to the dilemma: a gold system. But, that’s another story. There is a lot in this book I haven’t covered: history, polemics, biases, people, and so forth and the book is only 210 pages long. Read it!
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