I assert that a managed, flexible money supply is better than a non-managed and inflexible one, if the goal is to avoid systemic liquidity issues.

It does seem as though inflation is a desirable concomitant of a fiat-currency (although I'm not clear on the theoretical inevitability of this characteristic). If so, and some inflation is the price we pay for a flexible currency regime, I submit that the trade-off is worth the cost.


To all readers interested in the topic, I recommend "Panic on Wall Street: A History of America's Financial Disasters", by Robert Sobel. Therein described is a remarkable pattern of harvest panics in the 19th century which really drives home the desirability of flexible finance.

Wow. I suppose we should then conclude that the (seemingly) inevitable corruption inherent in monetary (mis)management is also a necessary evil, so long as we can avoid the occasional "disaster." We sure seem to have avoided this one, all thanks to flexible monetary policy. Flexible finance is certainly desired by those holding the reigns and by those first in line at the trough; I've yet to witness a compelling argument that substantiates the disproportionate wealth distribution promoted by our financial system, at least from an egalitarian perspective (and no, I'm not promoting any sort of wealth redistribution, although that is, empirically, an inherent side effect of managed monetary policy.)

I will agree that systemic liquidity crises pose risks of their own, and a central bank whose only role involves responding to said liquidity issues may be an ideal solution. If history has taught us anything, however, the oligarchs typically find a way to abuse the situation. Does that mean that we should abandon flexible monetary policy altogether? I can't answer that, although I would contend that the Federal Reserve system, as originally designed (under which monetary policy was managed on a regional basis,) worked better in theory. In modern practice, however, the law of one price generally negates any efforts intent on localized management of interest rates. In addition, I see no way of ensuring that the positions of authority granted to the annointed few charged with overseeing monetary policy are not abused in ways (and at scales) that would prove impossible under a fixed monetary regime. Give me a flexible monetary system that contains controls denying the priveleged few the ability to loot the public coffers and I'll support it. The second central bank of the U.S. was abolished because of such abuses, and it is likely that the third will fall for the same reasons.

I am glad minyanville has taken on the discussion of monetary policy and its relation to the Federal Reserve. I don't think however all angles are being discussed. I think this article is written very well but sounds like more like opinions than points in an argument. I mean placing all the blame on the Federal Reserve for the financial disasters is hardly rational.

The hubris of the Federal Reserve to think that their policies are "best" falls in line with the hubris of others who feel that their policies are "best".

I also think it is not accurate to combine all the different aspects of our current economic system and blame it on the fed..

We might as well just blame it on the RAIN like milli vanilli.

Robert, much of what you say makes sense. There certainly is a pattern in the history of American governance, moving away from agent's discretion and toward inflexible guideline style governance, precisely because of allegations of corruption. This has good and bad effects. (Consider, briefly, sentencing guidelines and their associated "unintended consequences", as one example.)

That said, I don't think monetary policy can be managed under an inflexible rule-based regime. I believe the monetary policy problem is too complex, and poorly understood, for that. I'm afraid we will need human beings in the decision loop for the foreseeable future.

Where I cannot agree with your thesis: you allege corruption at the Fed, for the benefit of some favored few. I am not aware of compelling evidence for that thesis. And you seem to feel such corruption is inevitable under the current system.. could you elaborate on that ? Are your objections rooted in the plain fact that any person having financial expertise comes inevitably from some province of the world of finance ?

"
When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates. The "Fed" succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's.
"
Alan Greenspan - Gold and Economic Freedom 1966

"Where I cannot agree with your thesis: you allege corruption at the Fed, for the benefit of some favored few. I am not aware of compelling evidence for that thesis. And you seem to feel such corruption is inevitable under the current system.. could you elaborate on that ? Are your objections rooted in the plain fact that any person having financial expertise comes inevitably from some province of the world of finance ?"

I am not asserting that the Fed is, in and of itself, inherently corrupt. I would, however, note that the string of financial "bail-outs" have the hint of preferential treatment for certain elements of the U.S. financial system. Under the current system where the Fed's actual authority is vague (to say the least) in scope, the potential for abuse is omnipresent. While I cannot rationally imply that the Fed's intention has been to act on the behalf of a select few to the detriment of others, the appearance of such collusion betrays a great deal. Why was it imperative to funnel money through AIG in order to honor its CDS counter-party obligations when Lehman was allowed to fail? Why backstop the financial system to the tune of (up to) $24-trillion when nearly all private debt could be extinguished for such a sum? Why permit taxpayer-subsidized institutions to charge exorbitant spreads to the individuals who are effectively providing them with life-support in order to make these institutions whole when they could merely be nationalized and liquidated via the "Swedish solution"? The U.S. certainly needs a financial system, but it does not need one composed of our current failed institutions who seem content to tax us through the bailouts that we have provided them and through increased fees and penalties. I can't elaborate on all of the abuses of the Fed in short order, so I would instead direct you to the erudite, if heated, discussions and analyses performed by Mish Shedlock and Karl Denninger.

An institution that backstops entities that have shown a complete disregard for humility in their manipulation and abuse of the financial system (and yes, I am one of those "Goldman Sachs has waaaay too much power and influence for our own good" folks) has shown a type of camaraderie with said entities. The central bank should not ally with those it intends to regulate and govern, especially when those institutions are not hallowed "liquidity providers" but are instead glorified gambling houses. Joseph Stiglitz has offered numerous criticisms of the current bailouts and methodologies employed in recent attempts at stabilization; Paul Volcker has even questioned the legality of the Bear Sterns "takeover." Will someone please tell me why these concerns are unfounded?

I don't object to financial regulators and managers coming from the world of finance; coming from that world (or should I say, acting within that world,) I am biased in favor of financial professionals managing such a system. I also know that absolute power corrupts absolutely, and numerous financial professionals have only operated under a for-profit model. At what point do these individuals focus their aim on sustainability and stability, as opposed to profit generation for their prior employers - is such a perspective paradigm shift even probable? The objective of the central bank is NOT to ensure the profitability of select investment banks, yet current circumstances betray that notion. If you are wanting for facts, the 'Ville certainly offers a plethora of articles supporting the above assertion.

I liken my concerns to those of Mr. Practical, in that I feel the Fed has elected to provide taxpayer subsidies to institutions that do not have priorities consistent with those of the Fed. I would contend that the Fed has been either complicit, complacent, or both in its regulatory responsibilities in recent years, and I fail to understand why. The notion that "no one" saw this coming is patently false, and I would question why the Fed overlooked such developments. Claims of ignorance appear to be no more than mere excuses when billions of dollars in profits were made under the credit bubble and are still made today, albeit via involuntary taxpayer subsidies. To stay on topic, however, perhaps the Fed is not corrupt and is merely doing what seems rational from the perspective of its directors. The fact, however, that the Fed has not offered 0.5% interest refinancing to troubled home-owners, when it has done so for those anointed members with access to its discount window (I understand the discrepancy between short and long-term interest rates, but bear with me,) indicates that Fed has the profitability of the current banking system at heart. How is ensuring the profitability of insolvent (under 2008's FAS 157) institutions consistent with managing inflation and low employment?

"I would contend that the Fed has been either complicit, complacent, or both in its regulatory responsibilities in recent years, and I fail to understand why."

I should have written: I would contend that the Fed has been either complicit, complacent, or both in the development of substantial largess within the banking system and its failure to uphold its regulatory responsibilities in recent years, and I fail to understand why.

Interesting comment Robert.
Although I would add to your comment that if you take the standpoint of your own which looks to be utilitarianism via socialism (i.e. the masses should have more wealth) then Yes the Fed is inherently corrupt because access to newly created purchasing power is given to the Financial world prior to inflation taking hold.

What I found the most interesting about the whole thing was this line: "indicates that Fed has the profitability of the current banking system at heart"
If the banking system just prints money then what does profitability of the current banking system mean? It's like someone telling the king that what he is doing is agents the law, it's not possible, because he is above the law.

Robert, I offer this thought on why the largest banks, all with New York operations (and including non-banks, such as GS), were the focus of the financial bailout (I've said this before,so excuse me if you'd read this before.). The financials powers-that-be, the Fed and the US Treasury, are defending one market, to the last ditch; and that is the Treasury auction market. I don't know if you recall the short-sale bans of last year, but I found it telling that the first ban enacted banned shorting the 19 large financials which are "primary dealers" (an official designation within the Treasury auction system). It is also noteworthy that some of the first liquidity enhancement security purchases were done thru Treasury auction-related facilities.

Bottom line, my friend. Without "primary dealers", who are (to all appearances) not owned by the government, the Treasury auction system could collapse. That calamity would effect both the United States, and the global financial system;badly, and in ways that cannot be foreseen.

That's the "why" of it. imho.

James,
Great article.
But I am not so sure about the end-game. Uncle Ben is trying to reflate the debt bubble, but no bubble in history has ever been successfully reflated (John Mauldin). If he succeeds there will be high inflation.
To me the more likely path is sustained deleveraging. The debt bubble was built up since the early 80's. Now it will unwind for the next 10-20 years, thereby lowering GDP(see Mish and Prof. Steve Keen) in that time period.
If on top of that we add peak oil effects (in 2011,13,15), then we would have price inflation in all energy related goods (energy, food, materials). But if these prices rise fast enough, they will cause an even deeper recession. The consumer will have no discretionary money, and will spend most of their income on the basics.
In conclusion my best guess is a long period of weak growth, followed by recessions within this period. All of it caused by the continuous expansion of credit and debt by the FED since the early 80s. The credit/debt will contract, and if peak oil hits then the contraction of credit/debt will be even greater and faster, with high energy prices reducing wealth at an even faster pace.

But no one can predict the future.

Adam: I'm not advocating socialism, though should we have socialism, should it not be for the masses as opposed to the plutocracy? I'm merely viewing this from an egalitarian angle. I am first and foremost not an advocate of socialism or wealth redistribution in any shape, and your point on instructing the lawmakers is a salient one. I am fundamentally opposed to our current plutocratic system, as such systems are characteristic of banana republics and ailing societies in general. Robber barrons are still barrons, and perhaps my desire is to see them topple before we do as a society. I am certain that my concerns are irrelevant, as the kings of the land will do as they please. The consequences of their excesses are and will be to our detriment.

David, you seem to be asserting that we are in a catch-22 of sorts. Without the primary dealers, the treasury system collapses, impoverishing us all. With the primary dealers made whole, we all suffer, albeit (as I am deducing you believe) to a lesser degree. I contend that such a system is unsustainable, in that the bailouts are likely to increase in scope and scale, which may ultimately result in a collapse of the treasury market as the end scenario regardless. It appears as though the elite are merely biding time with which to loot the treasury before the inevitable collapse. If I have to pick a scenario (given the notion that both roads lead to a substantial decline in American standards of living and apparent wealth,) I would opt for path that does not result in the enrichment of failed WallStreet institutions along the way, specifically when that enrichment has been achieved without a contribution to our general economic health as a nation.

Until the bad debt is liquidated, there can be no sustainable recovery; those who have the most to lose in the event of current financial institutions failing are members of the current power structure. As these individuals have already proven their inability to manage risk, why do we continue to enrich them at our expense? Stiglitz said it best, as he asserts that we could have produced several well-capitalized state-run institutions (once again, not an ideal scenario) for the price of bailing out several still-undercapitalized institutions. Why would those institutions not become the de facto primary treasury dealers? I think Adam (above) has the right idea: the kings make the rules, and who are we to accuse them of any wrongdoing when they determine right from wrong? I'm merely addressing the argument from the perspective the mainstream media and governmental officials promulgate, which is one of claimed ignorance, incompetence, and good intentions. Of course, I don't buy any of that. I'm rather certain that unimaginable fraud and outright theft have taken place, and we're being presented with dog and pony shows designed to distract, confuse, and delude.

I thank you for the thoughtful retorts, however. The powers that be have wedged themselves beneath the cornerstones of our system by design. To extract them would cause the entire house of cards to come tumbling down, and it is with this fear that they continue to extort. Denninger has called it financial terrorism. Perhaps it is, but who dares to face the consequences of demolishing the house? Certainly no politician hoping to win temporary praise.

If the American people ever allow private banks to control the issuance of their currencies, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their prosperity until their children will wake up homeless on the continent their fathers conquered.

Thomas Jefferson in a letter to Albert Galatin

It makes sense that a managed flexible money supply provides liquidity (thereby facilitating improvement in living standard).

However I wonder whether a mismanaged flexible money supply would concentrate wealth so much that it hinders improvement in living standard by restricting purchasing power?

It is important that the "primary dealers" not be owned by the government; so that their transactions with the Treasury may be seen as "at arm's length", as the accounting idiom goes. So the government-owned (or even, I suggest, government-created) institution could never be a credible primary dealer. That's the theory, anyway.

"That's the theory, anyway." - Precisely.

Parag, monetary theory is hideously complex, and I do not claim to be its master. BUT - and here's my (first) point - it does not exist in a vacuum.

Stipulated: too much of the wealth of the nation has been concentrated in too few hands, and so purchasing power suffers. Yet at the same time, investment would rise, ceteris paribus; because that incremental wealth, in those few hands, does not need to be spent; short-term expendable cash magically is transformed into long-term capital, for the good of the whole (ultimately. Assuming it is employed productively. In theory.).

There is another answer to the question: competent monetary policy (and/or national economic management) allows for very small changes in inflation/deflation, and so has a very small effect on purchasing power. Incompetent versions, otoh, can lead to horrendous inflation (usually) and serious degradation of purchasing power - Wiemar Germany, current-day Zimbabwe, and, less seriously but surprisingly recurrent Argentina, provide examples of the phenomenon.

Excellent article, James, with elicited comments more well-done and flavorsome than typical of finer picnic baskets. These Minyans are smarter than the average bear!

Aside from the substance of the debate - and where are your replies, by the way? - a couple of quibbles are in order since even a great argument is weakened by debased hyperbole. While few could argue with much of what you say regarding the last two Chairmen, step back from

1) "Greenspan's unyielding belief in unfettered markets", which statement is sleight-of-hand, false witness and serves evil. It is pure Doublespeak as well as useful myth to the National Socialist Statists. Worse, it is silly and demonstrably false on its face. "Unfettered" markets don't have their interest rates and money supply dictated at whim by an unelected, unaccountable and unintelligible Beastie. The useful tools promoting Greenspan's "belief in unfettered markets" allow gargoyles like Barney "I explore Uranus" Frank, Chuckie Schumer and their twisted acolytes to blame the current "crisis" on "lack of regulation."

In my eyes, the Assault on Language and Promotion of Doublespeak should be quarantined to the fascist enablers and National Socialists who attempt to obfuscate their true intent (Bush, Paulson, McCain, Pelosi, Reid, Obamao, McCain, Holder, and McCain).

2) "What Dr. Minsky failed to address was that the Federal Reserve has been responsible for every financial crisis in the United States since 1913."

Really, I clicked onto this article because of the headline - for which I do not hold you responsible, knowing the rabid, freewheeling, Hearst-acolyte MV editors' history in this regard - and expected a crisis-by-crisis exposee or at least the salient mountaintops of the Fed's nefarious delvings in the '10s, '20s, '30s, '60s, '70s... at least 1987. Maybe '92, or... but NADA. All you gave us was the assertion, with no juicy soap-opera-quality naughty bits. Not even a strangely-positioned gerbil extracted from the bowels of the finance system.

James? Helloooo?

Minyans Fitzsimmons and Short, my thanks on behalf of us all on your erudite and polite exploration of the Fed's underpinning and role.

For those who value liberty that gives security over the myth of security that undermines liberty, it seems that Minyan Short's compelling points require a compelling answer:

1) "Why backstop the financial system to the tune of (up to) $24-trillion when nearly all private debt could be extinguished for such a sum?"

2) "...those who have the most to lose in the event of current financial institutions failing are members of the current power structure. As these individuals have already proven their inability to manage risk, why do we continue to enrich them at our expense?"

These two questions rend the heart of any defense of current Fed or Administration (or prior Administration) policies. Defense of the "free man" concept is precisely that which must be squished, and IS squished, by the Fed and Admin policies which bail out our Keepers while requiring us to not only meet their "counter-party risk" but to pay them bonuses for the privilege.

In my less-than-humble opinion, Minyan Short, it is less a question of Socialism v. Free (read Shackled) Markets than a simple "Too Connected to Fail v. NOT" system.

The plain inference is that small businesses and individuals are "Too Unconnected to be Made Whole" and that is why a general bailout of all private debt will never happen, even were it to lead to the Mother of Sustainable Economic Growth. Control trumps prosperity. Targeted bailouts are the only way to increase control.

It is very obvious but what can we do or what needs to be done?

I agree, of course. I was attempting to frame the argument in the terms presented to the masses, but the fact of the matter is that our handlers attempt to pull the wool over our eyes daily. By and large, they appear to be succeeding. If history has taught us anything, however, such games can only last for so long. I merely fear for the collateral damage done when the "you know what" hits the fan. The excesses of the priveleged few will prove disastrous for them, but at what cost to the rest of us beyond the initial theft? We certainly live in interesting times.

My article was called The Federal Reserve Must Die. MV only wants 2,000 word or less articles. My original article is 7,300 words, so you only got a taste. For the full version, go to:

www.TheBurningPlatform.com

"In his famous 2002 “Helicopter Ben” speech, Bernanke previewed exactly what he'd do as Federal Reserve Chairman". Of course. That's exactly why he was appointed Chairman. The Powers of Finance knew full well that they were creating conditions that would sooner or later require Bernanke's depression-fighting skills. 2002 would have been a great time for the Fed to have used its powers to prevent the creation of the bubble that's now costing us so much. The Powers of Finance weren't about to allow their Fed to cause an early end to the party they were enjoying so much.

This article is right on the mark, expecially when it names the Fed's beneficiaries.

First published on February 27, 2009 on www.open.salon.com

http://www.opensalon.com/blog/dean_petkanas/2009/02/27/black_hole_sun

A much better title to be sure. Wonder why MV wrote a crummier one?

Anyway thanks for the link, I shall enjoy reading the unedited version.

:) Fair enough. I like that there has been so much discussion on this topic. Unlike the article writer I feel that proclaiming the "end" is far fetched and our debate would be mute because chaos would ensue and basic necessity is all that matters after that.

I think both you and David would agree that the wealth distribution in the US is becoming that of a third world… The rich and the poor are separating while the middle class is disappearing. I agree with most anti-federal reserve statements but its difficult for most to separate wealth from monetary policy and so most anti-fed arguments go in the direction of socialist lovers verses the socialist haters.

I have a question for you. Many have made the statement (including this author) that the boom cycle that just occurred was bad and thus the Fed is the reason and the reason should be uprooted.

Many homes were built with cheap money created by the fed.
So... here is the question. Which end of the above equation is wealth? The home or the money? If Money is wealth then yes deflation is destroying wealth because there is no more access to cheap money, but if the Home is the wealth then no wealth has been destroyed and we are better off then we were before.

Capitalism by default creates poverty because of private ownership. To say the standard of living has not improved for those in poverty and middle class during the Fed's tenure is hard.

Dear Thomas,

I wish you weren't such an introvert and just say what's really on your mind.

Truly speaking, I got a lot more out of your scathing reply than I did the article itself. I hope to see more of your opinion in days to come.

Ron