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Who Will Benefit if We "End the Fed"?

Updated on February 16, 2012

Ron Paul and The Federal Reserve

Ron Paul, who is running for president, feels strongly that the United States needs to end the Federal Reserve and make headway to a return of the gold standard. The reasons Ron Paul feels strongly about ending the Federal Reserve are many, but the main ones I want to point out here are that the Federal Reserve is very inflationary with it's policies, has no congressional oversight, and independently sets interest rates. Since the inception of the Federal Reserve in 1913 and on through 2011, the dollar has lost 98% of it's value. This eats into the savings and investments of every American. As mentioned above, the Federal Reserve also has no oversight by the United States Government. It is never audited, nor do we know who all the Federal Reserve loans money to, or why. And finally, it has control of the setting of interest rates. Ron Paul has studied what is called Austrian Economics, which explain that boom times and the following recessions are in part the effect of credit and monetary expansion. They call it the business cycle. Naturally, there are many who criticize this stance, including Kyle Victor who writes for the Huffington Post.

The Criticisms and my Counterarguments

Victor Kyle has his criticisms about a gold standard, but they are not only his. Economists of the Keynesian school of thought express the same concerns. Here Victor Kyle pontificates:

The fact is, tightening monetary policy doesn't make the dollar 'stronger' at all: it just increases the dollar's value against foreign currencies. Nice as this may sound for those on holiday abroad, such an outcome would actually hurt the vast majority of Americans. Why? A more expensive dollar would harm America's export-oriented manufacturing sector: when the value of the dollar increases, so too does the cost of American exports, since their value is denominated in dollars. A more expensive dollar therefore damages the ability of American exporters to compete with foreign manufacturers, and the end result is more outsourcing of factories, fewer jobs for middle class Americans, and a slower economic recovery.

On the surface this seems like a good strategy, and it may work for a while, but I feel it is necessary to point out a couple of things. First of all, when the dollar is devalued, it is not only devalued against foreign currencies, it is devalued against gold. The fact that gold is hovering around $1,700.00 shows how little value the dollar has anymore. The dollar devaluation is actually harmful to most Americans because they lose more and more purchasing power from the dollars they do earn and try to save. Another thing to be aware of is that as the United States will devalue the dollar to improve exports, other countries will also attempt to devalue their currency to do the same thing. The net result? Less purchasing power for all workers the world over.

Kyle Victor and all Keynsians overlook what leads to true wealth and increased purchasing power. As mentioned in my article, What Will it Take to See Real Wage Increases?, a nation must do three things to improve their economy: 1) Save money, 2) Invest in profitable businesses, 3) And the investments must improve productivity. If the currency is devalued too much or too fast (actually a stable currency would even be better), it is very difficult for people to save, much less have anything to invest in. In the long run, this is a very destructive policy to follow.

Here is another point Kyle Victor wants to make:

But like any economic policy, monetary tightening would create both winners and losers. And while ordinary Americans would be the losers, the winners would be the usual darlings of the Republican Party: Wall Street and Wal-Mart. First, the financial sector would benefit enormously from an overvalued dollar because speculators make a profit by (among other things) buying up assets denominated in foreign currencies. When the value of the dollar increases against other currencies, the same amount of dollars can now buy more foreign assets than before, and hence the financial sector makes a larger profit. Second, the same logic explains how large corporations that import goods into the U.S., like Wal-Mart, would also benefit; when the value of the dollar rises against other currencies, a set amount of dollars buys more goods in China or India than it did before, and these goods can be re-sold in the U.S. at a profit.

Here is some twisted logic. To say that Wall Street will benefit from tight monetary policy? First of all, there is nothing wrong with speculators. They actually perform a very necessary function in the economy: they draw attention to distortions in the economy and smooth out market volatility (I'll explain this in another article). One other thing about speculators I want to mention: for every one that wins, one loses. You never hear about the losers in the media. The "Wall Street Darlings" do not make money when the currency is tied to gold from speculation. They can't. A gold backed money cannot be inflated and over leveraged. That is how Wall Street did it with all the financial instruments (called derivatives) they created. Wall Street would have to make money the old fashioned way. They would have to take the real money earned and invest it in profitable enterprises. As for large corporations making a big profit on tighter monetary policies. So what? If they are offering products at a price that many people can afford, so be it. I want to reiterate that inflationary practices that the Federal Reserve embarks on is what hurts most Americans. The dollars they earn do not hold their value, nor do wages keep up with inflation. With dollar devaluation the American wage earner loses.

Kyle Victor again:

When pressed on this point, Republicans may respond that their goal is only to defend America against high inflation, which they argue will result from quantitative easing. But this is nonsense. Inflation in America is running at near-historic lows- too low, indeed, to facilitate an economic recovery. Pace Glenn Beck, those losing sleep over the specter of hyperinflation in the U.S. ought to place their concerns elsewhere.

I have something to show you. Look at the chart below. This is the money supply from roughly 1913 to 2012. As you can see, the amount of money in the system has gone up just about every year, and it has shot up in 2010. This chart alone proves that we have inflation, nay very high inflation. The government tells us that inflation is low, running at under 2%. The chart suggests it should be higher. In truth, it is. Let me explain. The U.S. government changed the way it measures inflation around 1980. They do a few things differently now. For one thing, they no longer count food and energy in the CPI equation. Why? They claim it is because food and energy are "too volatile", so it can't be counted. The second thing they do is what is called a chain-weighted measure. This simply means that as goods become more expensive, families will substitute with cheaper goods to keep costs down. A common example is a family switching from steaks to hamburger. As the price of steaks go up, the family will switch to hamburger, which is cheaper. The government will claim that since they are both beef, they count as the same. Yet another sneaky thing they do is something called the "hedonic price calculation method". I will let Antony P. Mueller explain:

The idea behind hedonic price index calculation is to incorporate quality changes into prices. This way, a product may be on the market at a higher price, but when the product qualities have augmented more than the price in the eyes of the BLS, it will calculate that the price of this product has actually fallen.

From The Illusions of Hedonics.

What they are saying, in essence, is that when product prices are higher, but the product improvement is considered even higher, the calculated inflation rate will be lower. It is a rather arbitrary way of determining value. Most likely, the value will be overrated to make the inflation numbers lower.

For a more complete explanation, go here.

Upon closer inspection of calculating inflation, there is funny business going on. You cannot count on the figures given by the United States government. They say inflation is low, under 2 percent. begs to differ. Using the same calculation methods the United States used in 1980, our inflation rate is running close to 11%. If you find it hard to make ends meet, now you know why. When the United States embarks on money expansion and quantitative easing, hyperinflation can be the final result. Kyle Victor is wrong on this point. We do need to be concerned about inflation and potential hyperinflation.

Money Base


Final Thoughts

As of the writing of this article, Ron Paul is losing momentum in the Republican race, but his views for a gold standard and ending the Federal Reserve are important policies for the United States. The "elastic" money supply created by the Federal Reserve plays a big role in the boom and bust cycles of the economy (government policies also play a role, but that is another topic for another day). Until we get back to sound money and at least dramatically reform the Federal Reserve, we will always have booms, recessions, depressions, and I am afraid maybe even hyperinflation. None of these outcomes are good.


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