Monday, April 27, 2009

Stalking the Fed 

A local group asked me by email for thoughts on H.R. 1207, a bill that would ask GAO to audit the Federal Reserve and report to Congress. Below is my response to them (links added):
I am an economist who first wrote about governance issues of central banks in 1983. Since then I have written several articles about the central banks, including the Federal Reserve. I'm opposed to the Fed audit bill sponsored by Reps. Ron Paul and Michele Bachmann, among many others. ...

My work has centered on a central bank's independence from executive and legislative control. The received wisdom of central banking scholars over the last 25 years has been that the more independent a central bank is, the better it is at controlling inflation. Inflation works as a tax on people's holding of money; when a central bank is controlled by government, the government is better able to use money creation to augment the resources it can seize from the people. (It seizes by printing something for nothing called money and then buying goods from people for this paper. It creates a monopoly for money creation to support its ability to use this "inflation tax".) Leroy Laney, Tom Willett and I wrote one of the two first papers about this in 1983 in the Economic Review of the Dallas Federal Reserve Bank, and countless others have supported our findings since then.

Some central banks use internal auditing procedures. The Fed has an internal Office of Inspector General that provides an audit: , and that report also contains an audit statement by Deloitte and Touche. What H.R. 1207 proposes is to replace that audit with something controlled by Congress. I believe this is a mistake.

The use of an audit imposes legislative control on a central bank and reduces its independence. In the case of this bill, that audit would be a Congressional act and would invite the meddling of the Democratic majority, led by Barney Frank and Chris Dodd. I cannot see this as being a positive; they are more likely to interfere at the key moment coming up, when banks begin to lend again and the Fed must withdraw the extra reserves they injected to support the banking system over the fall and winter. They are far more likely to delay that withdrawal than speed it up. That delay will lead to extra inflation.
I'm not at liberty to quote the response from one of the supporters, but I can characterize the response as focused on some deeper issues of loss of control of the money supply to a "single world order". He also noted the loss of value of the dollar since the Fed's founding. I responded:
Thanks ... for agreeing that a more independent Fed would be better at controlling inflation. That is the only job it can do well, a lesson it has learned the hard way, at great expense to America. But it was not the Federal Reserve's decision to move us from the gold standard which would have protected the dollar's value. FDR suspended gold payments to individuals; Bretton Woods was signed by FDR; Nixon closed the gold window and ended BW. These were the decisions of Congress and the executive, the people you now want us to vest with the power to audit the Fed.

I would only reiterate that the bill puts an audit by government replaces a private audit, and permits that audit to make recommendations to Congressional leaders, including the leaders of the two banking committees, who happen to be the guys who did such a great job looking after Fannie and Freddie. As a matter of monetary policy, this is a bad idea.
Rep. Bachmann continues to focus on losses on the books of the Federal Reserve as if the money it is losing came from taxpayers, most recently on the Maiden Lane losses. Yet that money comes from funds the Fed has already gained by interest on Treasuries its collected in the past. That money was already paid out -- they are sunk costs to the government. If Rep. Bachmann and Rep. Paul would like the Fed to stop buying Treasuries, that is a different bill than the one proposed.

The audit bill is at base a stalking horse of Congress to remove the quasi-constitutional independence of the Fed. The history is quite clear, and it is to the detriment of those Republicans not named Ron Paul that they sponsor this bill. They are paving the way to higher inflation at the very time they decry the potentially inflationary impact of high budget deficits.

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