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     Dec 6, '13


Century of Fed failure
By Noureddine Krichene

The US Federal Reserve is celebrating its centenary in the wake of one of its great financial blunders and in the midst of the highest uncertainty after trillions of dollars of money printing, near-zero-interest rates, high inflation, massive wealth redistribution via unlimited credit expansion, a stock market boom, massive unemployment, record fiscal deficits and public debt, endless


growing external deficits, exchange rate instability, and impoverishment of the population.

Real per-capita incomes have declined considerably. The gold price in 1913 was $20.67/ounce; it reached $1,800 in 2011, implying a dollar depreciation at 5% per year in relation to gold.

The Fed abolished the gold standard and replaced it with inconvertible paper so it can print money without any limit. When the government intervenes in the economy, the result is inevitably financial chaos, mass-unemployment, more government intervention, and more chaos.

The Fed is a planning agency in charge of every aspect of the US economy. It has the mandate of full-employment and has encouraged a housing boom and a stock market boom, financed record fiscal deficits, depreciated the exchange rate, and re-inflated prices.

Politicians and academics are cheering the Fed's unorthodox money policy. It is impossible to restrain the Fed and the politicians who are cheering it. The nightmares of 2008 caused by the Fed are quickly forgotten. The trillions of dollars bailout are also forgotten.

The Fed knows no prudential banking rules; it forces banks into bankruptcies, then it bails them by printing money and makes the destitute pay for the stolen wealth.

The Fed is pushing total credit above 400% of US GDP. No debtors will bear this debt burden; they will default as they did in the past. Even governments default on their debt. Banks will be bankrupted, and all creditors lose their wealth.

The Fed has pushed stock and house prices too high and has kept the US economy between the Scylla of a stock bubble crash and the Charybdis of hyper-inflation.

The dangers of a central bank and its corrupt nature have long been perceived in the United States. Opposing forces have quarreled over central banking ever since the US became independent. President Andrew Jackson terminated the charter of the Second Bank of the United States and the US enjoyed a long period of rapid growth and full-employment without any need for a central bank. This period of high performance showed literally that a central bank and has no contribution to make to the economy.

Financial crises due to bank credit expansion occurred during the 19th century; however, the recession and raised unemployment were very brief, as prices and wages fell on their own without the state blocking the market mechanism. Wall Street forces finally triumphed following the 1907 crash. The Fed was created to bail out bankrupt banks, keep interest rates low, and inflate, without any bound, the money supply.

Ever since its establishment in 1913, the Fed has practiced an inflationist policy in compliance with its nature. Politicians force interest rates to low levels to encourage borrowing, believing that low interest rates and unlimited borrowing lead to economic growth and full-employment. This led to the Great Depression with its devastation and World War II.

Because they forced low interest rates, politicians brought about a 25% decline in real GDP and 25% unemployment during the Great Depression.

There are no political forces willing to restrain the Fed and its fire will rage until it burns itself out. The Fed uses the same policies that cause a crash to make the economy recover from a crash. All the Fed can accomplish is inflation and wealth redistribution via credit, as shown by its disastrous century-long record.

How can one describe in concrete terms the role of the Fed in the economy? Imagine a plantation of cotton with a potential of producing 100 tons of cotton; an insect attack reduces its actual output to 50 tons. The more active the insects become, the greater the loss of cotton output. A similar image would be of a farm that potentially produces 100 tons of vegetables; however, a locust attack reduces its output by 50%.

This picture is easily confirmed by the Great Depression or the recent financial crisis with output falling and stagnating. While farmers perceive the insect attacks as a cause of their plight, US politicians and academics credit the Fed for the meager US economy performance. They believe that, without the Fed, the economy would have sunk into deep recession. Instead of recognizing that the Fed aborted recovery in 2009, they credit the Fed for saving the US from deep recession.

The Fed chairman and supporting politicians claim that Fed's mandate is to achieve full-employment in the economy. The century-long record shows that the Fed can only cause mass-unemployment. It failed to restore full-employment and sustained growth in 1930s and it is failing to do so now.

If a carpenter pretends to be or is appointed as a heart surgeon, he will never cure any heart patient; he may fool people for a while, but he will never change his true nature. In the same way, academics and politicians believe in ideologies no matter how farfetched and nonsense those are.

Fed chairman Ben Bernanke has been promising full-employment since 2008, but there is no delivery date; it is an open ended commitment. Full-employment may happen in 10 years or even at the next Fed's centenary.

He has kept pumping trillions of dollars into the system, yet without achieving his mandate. So waits patiently; there is no urgency. Yet, in reality, people work with deadlines - if your plumber does not fix the pipe within one hour, you fire him and call a competent one.

There is a delivery date in every transaction. Every merchandise has to be delivered on time. In the case of the Fed, there is no delivery date. The US Congress and politicians can wait for decades; they keep believing that the Fed will deliver on full-employment, and so they let the Fed chairman pursues his endless money printing and money disorder.

If a person cannot deliver, either he is incompetent and should be fired, or the task is not in his field.

Full-employment is very easy to attain and should have a short deadline for delivery. It was achieved in a very short-time during the 19th century following a credit crash. Prices and wages fell sufficiently and the economy recovered instantly. There was no government legislation that blocked price and wage adjustment as in 1930s and now.

Prices and wages have to fall following a boom that crashes. There is no recovery without price deflation. As soon as the government steps in to re-inflate, recovery is delayed and poverty and misery spread.

There is no need for monetary or fiscal policies aimed at achieving full-employment. With deployment of monetary and fiscal policies, the US was not able to return to full-employment during the Great Depression. In 1939, the rate of unemployment was 18%. Only war re-established full-employment.

This demonstrates that ultra-expansionary demand policies created no demand; they deflated demand. With war, warring governments forced labor to work for low wages and long hours. Governments ignored unemployment benefits, suspended minimum wage laws and overtime compensation, and forced labor into a war economy; full-employment was achieved.

The same policies are needed in peace time; with mass unemployment, the government should immediately suspend pro-labor laws and prevent any interference with interest rates and the wage and price mechanism.

President Barack Obama's record fiscal deficits and Bernanke's trillions of dollars of money printing have not created any additional real demand; they are purely redistributive - they redistribute existing income and wealth in favor of those who contribute nothing to the economy.

Without huge external resources, the US economy would have sunk deep into decline. The US can afford huge waste and inefficient policies as long as these policies are paid for with dollars as a reserve currency.

Burundi or Mauritania cannot afford the same inefficient policies. In those countries, there are no lifetime unemployment benefits nor government-reinforced minimum wage laws. People have to work for their own survival.

In the US, there is no incentive for work when a worker has food stamps, unemployment benefits, a luxury car and a luxury house, all bought on cheap loans to be paid later by the Fed or by inflation. If you work and make an income, you are guilty; you contribute to create an income gap; you face then huge penalty in terms of taxes and moral guilt.

Many eminent writers predicted the injurious role of the Fed. Ron Paul in his 2009 book End the Fed called for the dissolution of the central bank. Earlier writers made the same plea in 1930s and later.

A century-long record is enough to prove that the Fed can only cause injury; once damage is done, the Fed has never been able to repair it. The Fed may print trillions or zillions of dollars more and keep interest rates at zero level for another century, yet all it is doing is heightening uncertainty, destroying capital, destroying the value of the dollar, and making unemployment and poverty worse.

A century-long Fed record shows that next Fed century is not going to be any better. While the Fed's money printing is on extreme speed, the US real economy will remain under the shackles - of the Fed.

Noureddine Krichene is an economist with a PhD from UCLA.

(Copyright 2013 Noureddine Krichene.)







 

 

 
 



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