The New York branch of the Federal Reserve (the one responsible for conducting Open Market Operations to expand the central bank’s balance sheet) has recently sought to open itself up for public critics to visit the bank and “unburden themselves of their criticisms.” Author of the popular financial newsletter “Grant’s Interest Rate Observer” and unceasing Fed critic Jim Grant took to the mound on March 12. The full text of his speech can be read here (via Zerohedge), but I will highlight some of the gems.
You are lucky, if I may say so, that I’m the one who’s standing here and not the ghost of Sen. Carter Glass. One hesitates to speak for the dead, but I am reasonably sure that the Virginia Democrat, who regarded himself as the father of the Fed, would skewer you. He had an abhorrence of paper money and government debt.
It enflamed him that during congressional debate over the Federal Reserve Act, Elihu Root, Republican senator from New York, impugned the anticipated Federal Reserve notes as “fiat” currency. Fiat, indeed! Glass snorted. The nation was on the gold standard. It would remain on the gold standard, Glass had no reason to doubt. The projected notes of the Federal Reserve would—of course—be convertible into gold on demand at the fixed statutory rate of $20.67 per ounce. But more stood behind the notes than gold. They would be collateralized, as well, by sound commercial assets, by the issuing member bank and—a point to which I will return— by the so-called double liability of the issuing bank’s stockholders.Was Senator Glass that naive to think the Federal Reserve, with its monopoly over currency production, would not become a tool for Wall Street to use to enrich itself? Did he seriously think the gold standard would last forever as power was centralized with the bank’s creation?
As you prepare to mark the Fed’s centenary, may I urge you to reflect on just how far you have wandered from the intentions of the founders? The institution they envisioned would operate passively, through the discount window. It would not create credit but rather liquefy the existing stock of credit by turning good-quality commercial bills into cash— temporarily. This it would do according to the demands of the seasons and the cycle. The Fed would respond to the community, not try to anticipate or lead it. It would not override the price mechanism— as today’s Fed seems to do at every available opportunity—but yield to it.Absolute power corrupts. To those who understand the nature of the state, the Fed’s abrogation of power is unsurprising. If the pricing system is a decentralized process of consumers and producers “making a deal” over goods and services offered, giving an institution and a few men the authority to legally override such a mechanism must create chaos. Injecting liquidity (an overly technical term for money) unbacked by prior savings wreaks havoc on the intertemporal coordination process of entrepreneurs attempting to gauge the consuming patterns of the public. It does untold damage on one’s ability to economize. What has emerged from the planners at the Fed trying to goose the economy is a financial system dependent on constant money creation as it tries to anticipate what the central bank’s next move is in order to profit.
The search for “some sort of vague stabilization” in the 1930s has become a Federal Reserve obsession at the millennium.
Ladies and gentlemen, such stability as might be imposed on a dynamic capitalist economy is the kind that eventually comes around to bite the stabilizer.
“Price stability” is a case in point. It is your mandate, or half of your mandate, I realize, but it does grievous harm, as defined.
For reasons you never exactly spell out, you pledge to resist “deflation.” You won’t put up with it, you keep on saying—something about Japan’s lost decade or the Great Depression. But you never say what deflation really is. Let me attempt a definition. Deflation is a derangement of debt, a symptom of which is falling prices. In a credit crisis, when inventories become unfinanceable, merchandise is thrown on the market and prices fall. That’s deflation.This is completely on point. Endeavoring to create stability in a naturally dynamic, but stable in the long term, process is no better than totalitarian communism. In fact, central banking and the socialization of credit was one of the tenets of Marxist communism. For those who only propose low interest rate policies in times of economic stagnation, it must be asked: if artificially or suppressed interest rates are so good, why not employ them all the time? Why not socialize credit completely ad infinitum? But of course this is their true heart’s desire: for socialism ultimately.
But note, please, that the suppression of interest rates and the conjuring of liquidity set in motion waves of speculative lending and borrowing. This artificially induced activity serves to lift the prices of a favored class of asset—houses, for instance, or Mitt Romney’s portfolio of leveraged companies. And when the central bank-financed bubble bursts, credit contracts, leveraged businesses teeter, inventories are liquidated and prices weaken. In short, a process is set in motion resembling a real deflation, which then calls forth a new bout of monetary intervention. By trying to forestall an imagined deflation, the Federal Reserve comes perilously close to instigating the real thing.This is the true lesson central bankers and their supporters are incapable of learning. As Mises declared, “There is no means of avoiding the final collapse of a boom brought about by credit expansion.” The various bouts of credit expansion employed by the Federal Reserve and its partners in crime around the world never serve as an economic remedy. They are mere dopamine injections to keep the parts of the economy they view as invaluable in a state of liquidity ecstasy. But drugs must wear off and so does the cheap money less Bernanke and crew want hyperinflation to take hold. What comes next is recession and depression depending on the degree of built up malinvestment. This means a contracting money supply and a hoarding of money which increases its value and prices fall. Inflation must necessarily lead to deflation when the bust finally manifests itself. There is no stopping this yet central bankers will try to with further credit expansion. But if it weren’t for this unbacked credit expansion to begin with, deflation would not be viewed as a threat.
I myself draw more instruction from the depression of 1920-21, a slump as ugly and steep in its way as that of 1929-33, but with the simple and interesting difference that it ended. Top to bottom, spring 1920 to summer 1921, nominal GDP fell by 23.9%, wholesale prices by 40.8% and the CPI by 8.3%. Unemployment, as it was inexactly measured, topped out at about 14% from a pre-bust low of as little as 2%. And how did the administration of Warren G. Harding meet this macroeconomic calamity? Why, it balanced the budget, the president declaring in 1921, as the economy seemed to be falling apart, “There is not a menace in the world today like that of growing public indebtedness and mounting public expenditures.” And the fledgling Fed, face to face with its first big slump, what did it do? Why, it tightened, pushing up short rates in mid-depression to as high as 8.13% from a business cycle peak of 6%. It was the one and only time in the history of this institution that money rates at the trough of a cycle were higher than rates at the peak, according to Allan Meltzer.
But then something wonderful happened: Markets cleared, and a vibrant recovery began.There is a reason the Depression of 1920-1921, which was the result of inflation engineered during World War 1, is never taught in school. It provides a stark contrast to the Great Depression that lasted for over a decade and was marked by unprecedented government intervention. The public school system, by virtue of it being “public,” must perpetuate the myth that Franklin Roosevelt saved capitalism. How else do you breed future government parasites, excuse me, workers? How else do you convince children that the government is there to soften the excesses of heartless capitalism? How else do you keep the masses fooled?
The Depression of 1920-1921 is a purposefully forgotten lesson in both public schools and universities as it is a clear cut example of a market fixing itself absent government intervention.
The whole speech is well worth reading as Grant, in his usual wit and humor, offers a few suggestions on what he would do if he were Federal Reserve chairman. Unfortunately, such a fantastic prospect is highly unlikely considering the amount of money, printed or non-printed, which rides on the Fed’s current policy of easing indefinitely.
We can all be thankful that Jim was able to travel into the depths of Mordor to return alive though!