Photo: Gage Skidmore via Flikr
All but one Republican in the U.S. House of Representatives voted in favour of a law that would “Audit the Fed,” in essence buying into Ron Paul’s dubious theories about economics.The Democratic party was split on the vote, with 89 supporting and 97 rejecting the bill.
This battle is not a matter of “conservatives” versus “liberals”—in reality, it’s a political power play that demonstrates how little politicians understand about what the Federal Reserve does and how our monetary system functions.
First, a little primer on how the Fed works: Presidents of the regional Federal Reserve banks around the country meet with a few other high-level Fed officials eight times per year to release their latest decision on monetary policy. Monetary policies directly control the supply of money available to the system, and indirectly influence the rate at which banks lend money (which, in turn, is thought to influence the unemployment rate).
Paul essentially believes that the Fed in its current form shouldn’t exist. His official website supporting the bill alleges, “The Federal Reserve is an enormously destructive and unaccountable force in both the U.S. economy and the greater global economy.”
Indeed, Paul believes that the U.S. should go back to the gold standard, which would at least prohibit the Fed from having any influence over unemployment in lieu of price stability (as it turns out, the conjecture that the gold standard would actually bring price stability is debatable).
Paul takes a small step towards this goal with his audit the Fed bill, which would allow Congress to influence and potentially overrule the Fed’s monetary policy decisions.
If a glance at Europe—where the European Central Bank is incapable of stopping the crisis because it lacks significant independent powers—isn’t enough to convince you that Paul is delusional, then read on.
Essentially, the bill would drastically reduce the Fed’s ability to make forward-looking changes to the money supply or to purchase Treasury bills, by allowing Congress to review and “audit” monetary policies that the Fed currently keeps under wraps.
All these decisions would ultimately become subject to Congress’s scrutiny, and thus political. Monetary policy decisions are made behind closed doors for the express purpose of hiding who is voting for what, in part because Congress has the power to impeach Fed officials and mostly because it allows them to make decisions as economists and not politicians.
Should such changes be instituted, we would become reliant on the economic outlooks of politicians and Fed members’ political leanings rather than those of economists to control complex financial decisions. Congressmen and lobbyists with their own motives would have unprecedented knowledge about individuals on the board, which is now controlled by a group of scholars and financial professionals.
Now, Ron Paul and his crew would allege that the Fed is not actually independent, and makes decisions behind closed doors in order to secretly bow to the whims of those who would have the country inflate its way out of debt.
“He wants secrecy, he doesn’t want independence,” Paul said of Bernanke in an interview with Bloomberg.
Further, Paul and his camp allege that the Fed was created to be subservient to Congress:
The Fed was created by Congress and remains subject to full oversight and regulation by Congress—up to and including abolishing it altogether! The Fed’s hyped “independence” is largely a myth created by Fed officials and its Wall Street/financial sector supporters who benefit from its lack of transparency. The Fed is independent from the Executive Branch (Treasury Department), but not from Congress. H.R 459 does not change or set monetary policy: it merely grants Congress retrospective access to the information used to determine and carry it out, so Congress can properly understand, oversee, and evaluate the Fed.
This completely misrepresents the purpose of the Fed.
The Fed was created in order to introduce stability into the financial markets after the crisis of 1907 threatened to tear it apart. At that time, the world used the gold standard, and the effects of poor banker behaviour magnified the asymmetric flow of money into some locations (foreign and domestic) and not others, leading to a series of bank runs. J.P. Morgan ultimately stepped in to rescue some failing trust companies with his own money and had to do so overnight with no help—and barely any attention—coming from Congress and Washington.
The basis for the existence of the Fed is that bankers realised that they needed oversight beyond Congress and the people, which didn’t really understand financial activities and failed to step in at the necessary moments in a timely manner. Whereas Congress spends months bickering over its own budget, the Federal Reserve is able to make landmark decisions in the course of a day or two.
Furthermore, whatever conspiracy theorists may believe, the Federal Reserve does indeed make monetary policy decisions independent of Congress. Obviously, Fed officials consult with political leaders in order to get a better sense of where the economy is headed. But their decisions are made behind closed doors, for the reasons mentioned above.
However, had Bernanke truly had some political love affair with Obama, QE3—and the subsequent stock market rally—would likely have been instituted months ago. It’s also worth noting that President George W. Bush, and not Obama, actually appointed the man in the first place, knowing full well that his academic writings favoured strong policy action by central banks in times of need.
Bernanke has expressed a willingness for deeper oversight of some of its activities by Congress—just not the ones Paul seeks to curtail. Indeed, the Chairman has welcomed deeper inspection, particularly of the Fed’s regulatory capabilities. The economics of central banks and monetary policy is a relatively new invention; they have evolved over the last hundred years from meaningless to important keepers of global stability.
However, introducing politics into the Fed is nothing more than an attempt to kill it. Allowing Congressmen to weigh in and influence policy decisions that they cannot understand (and they prove how little they know about money every time Treasury Secretary Timothy Geithner or Bernanke testify in front of their committees) would render the Fed incapable of actually acting on the data it sees, not the whims of the populace (the vast majority of whom never even studied economics).
(I mean, do you really want Michelle Bachman (R-MN) controlling the U.S. money supply? I didn’t think so.)
In all likelihood, a Congress-run Fed would do the exact opposite of what it should—it would keep interest rates high and restrict lending in times of crisis because savers are at risk and it would bend to bankers’ requests to lower interest rates in market booms when everyone is doing well, thereby creating bubbles.
Ron Paul’s accusations are based on his desire to become Andrew Jackson reincarnate, to revert back to a U.S. of populist values that was not involved in the global economy, not just to limit the Fed. The fact that the entire House Republican Party agreed with his plan—with the notable exceptions of the opposing Bob Turner (R-NY) and abstaining Steve Stivers (R-OH)—should indicate their failure to understand the importance of the Fed and willingness to believe in policy that would for all purposes kill it off.
It’s one thing to disagree with the Fed’s decisions; it’s another to eliminate it altogether.
Or maybe House Republicans just wanted to cause a political stink. Either way, it’s for the best that this bill is dead on arrival in the Senate.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.