Should the United States Abandon the Federal Reserve System?

Category: General 13

About the Author: Mr. Conrad is a retired college Economics Instructor who is hoping to remove a lot of the confusion, misunderstandings, and myths that surround contemporary economic thinking.

The Federal Reserve gives us the freedom to buy things now that we would otherwise have to wait for.

In looking at the Federal Reserve, it is important to note that this is a money system, not just a group of people sitting in a conference room controlling everything having to do with the US dollar.  The Fed is a system just like the government of the US is a system.  What that means is that no one controls it, and that it is much bigger than any one person or group of people could ever control.  They can guide it, influence it, even do immense damage with it, but it is just too large a system with too many variables, too much lag time required to implement changes, and too many unknowable factors to control.

In some ways, this should actually be reassuring.  Despite all the talk we sometimes hear about cabals of Bilderbergers or Illuminati who want to establish a New World Order by controlling our money, this is probably about as likely as Superman suddenly deciding to go on a crime spree!

But, it does mean that the system works slowly and imprecisely.  A point that I have made previously is that trying to influence the behavior of people and businesses in the economy by increasing and decreasing the amount of money in circulation is like trying to influence behavior by changing the thermostat.  You can turn up the temperature or turn down the temperature, but it just won’t have a uniform effect on everyone.  Some people like it hot, while others like it cooler; and many will even try to anticipate it or offset its influence.  But it does have certain predictable results.

When the economy is sluggish or struggling, the Fed can often help conditions by giving it a boost.  They can lower interest rates to make it easier for people and businesses to borrow money.  They can lower reserve requirements so that banks have more liquidity available with which to make loans.  And, they can put more money into circulation to make it easier for everyone to get some.

Many people, however, misunderstand this system, and even see the creation of more debt as something bad.  They see debt like getting cancer or eating something that isn’t good for you, when debt is really just spending money you will receive in the future right now and paying it back over some agreed upon period of time.  This allows us to have things now that we otherwise would have to wait for or might not even be able to have at all if we couldn’t save up the money to buy them.

Not only that, but it allows those who have excess money to lend it to us and receive interest for doing so. It is a way for people to make money by using their money to help others to have the things they want.  This is what investing is all about; using excess money you have to provide it to others who can’t and will pay you for the use of it.

Debt can certainly be bad. Just like a gun; if it is used improperly or given to the wrong person, it can be dangerous.  Not only can they get themselves into trouble, but they can get others in trouble as well.  However, debt can also be the most wonderful thing in the world if you want that new car, that new home, or even the money to build that new factory that will manufacture that product that you know people will want to buy.  Debt allows you to risk your future earnings against the circumstances that may prevent you from repaying it.

That’s where banks come into the picture.  They employ people who make decisions about who should be extended debt and who should not.  By assessing your “debt serviceability”, your ability to repay the money that you want to borrow, they will either make a loan to you or turn you away.

One of the most important factors in a system like this is the availability of jobs, income, and credit. If jobs are scarce, then income is scarce.  If income is scarce, then loans are more risky and fewer people and businesses qualify for them.  But another problem, which the fiat system resolves and the hard currency system does not, is the availability of credit.

While a hard currency system preserves the value of your savings, it does not expand the amount of money that is available.  The total amount of money in the system is limited by the amount of gold or silver that backs it.  This means that as the population expands or the number of businesses producing goods or the number of people working for those businesses increase, the money supply does not grow.  It’s like telling that teenage boy of yours who has grown from a tall and skinny twelve year old, to a strong and full-size seventeen year old linebacker on the football team, that he has to eat the same amount of food that he ate when he was twelve!  That boy is gonna be hungry!

That is the greatest deficiency of the hard currency system, it starves growth and investment while continuing to impoverish our domestic economy if it does not have a positive balance of trade.  The fiat currency system does not do that; it feeds the system money so that it grows!

Many people complain about high prices in the economy.  The price of gasoline skyrockets, the price of milk and cereal appalls us, the cost to heat and cool our homes and businesses squeezes our budgets ever tighter.  But not all price increases are bad. When you see the price of the home you own increase, you like that.  When the stock you bought at $12/share increases to $19/share, you like that.  When the money you have been putting aside for your retirement increases, you love that.  When the value of that classic car you restored increases, or the value of those stamps you’ve been collecting, or even that old walrus beanie baby that your Mom gave you when you were a small child, is now suddenly worth $12,000; you thank your lucky stars!

When the value of assets that we own increase, we like that.  When the value of commodities that we have to buy increase, we don’t like that. But, isn’t that just the yin and yang of the market?  If you’re buying milk and the price goes up, you don’t like it; if you’re selling milk and the price goes up, you do.  And, don’t those dairy farmers dislike it just as much when the cost of tires they have to buy goes up, but you like it a whole lot better when the wages where you work making those tires also go up?

There’s a fiat money myopia that pervades our economy.  Credit is essential to our economic survival in this modern world, and without it things would be much different.  It is true that we could survive with a hard currency economic system too, but it would be as austere and painful as having only those things that you can afford to buy with cash or what you have saved.  And, don’t we deserve more than that?

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