The failures of fiat currency and the Federal Reserve

Fiat currency and the Federal Reserve have long been subjects of debate and criticism for their perceived failures in achieving key economic objectives.

This article dives into the main points of criticism surrounding these issues, focusing on the 7 key failures of the Federal Reserve including the following objectives:

• Inflation Control.

• Economic Stability.

• Financial Market Stability.

• Long-Term Economic Growth.

• Employment.

• Public Trust and Transparency.

• Currency Stability.

Who is the Federal Reserve?

The Federal Reserve, or the Fed, is viewed with skepticism and criticism. Established on December 23, 1913, with the signing of the Federal Reserve Act by President Woodrow Wilson, the Fed was intended to provide the United States with a safe, flexible, and stable monetary and financial system.

However, many economists argue that the Fed has instead introduced distortions and instability into the economy.

The creation of the Federal Reserve was largely a response to financial crises such as the series of recessions from 1929 through 1945 commonly known as the Great Depression, which saw bank runs and failures.

Prominent skeptical economists believe that economic panics, inflation, recessions, and depressions were largely the result of previous government interventions and the lack of sound money principles.

They argue that a central bank was not the solution but rather a step towards more significant government control over the economy, further distancing the monetary system from a market-based approach.

Centralized monetary control, one of the primary reasons for the Fed's establishment, is a point of contention for concerned economists. They argue that central planning of the money supply, as conducted by the Fed, leads to artificial interest rates and misallocations of resources.

The market should determine interest rates through the interaction of savers and borrowers, not through the decisions of central bankers. The Fed's ability to act as a lender of last resort is seen as promoting moral hazard, and encouraging risky behavior by financial institutions.

The Fed’s role in supervising and regulating banks is also criticized.

Market forces, rather than government oversight, should ensure the safety and soundness of the banking system. Free market economists believe that regulation often creates perverse incentives and unintended consequences, leading to less stability rather than more.

Furthermore, as noted by writer Joshua D Glawson, the establishment of a centralized payments system by the Fed is seen as an unnecessary intervention in what could be efficiently managed by the private sector.

The structure of the Federal Reserve System, which includes the Board of Governors, twelve regional Federal Reserve Banks, the Federal Open Market Committee (FOMC), and member banks, is viewed as an elaborate bureaucracy that distances monetary policy from the discipline of the free market.

Many contend that this structure consolidates power and decision-making in the hands of a few, rather than allowing decentralized market mechanisms to determine monetary conditions.

The functions of the Federal Reserve, such as conducting monetary policy, promoting financial system stability, supervising and regulating banking institutions, providing financial services, and promoting consumer protection, are all seen as forms of government intervention that disrupt natural market processes.

The Fed's manipulation of money (USD Federal Reserve Notes) and credit conditions leads to economic cycles of booms and busts. Some argue that true stability and prosperity can only be achieved through a return to sound money principles, such as those based on a gold standard or specie money made of gold itself, and the elimination of central banking.

In summary, the Federal Reserve is a central planning institution that creates economic distortions, encourages risky financial behavior, and undermines the natural regulatory mechanisms of the free market.

There needs to be a sincere return to a decentralized, market-based monetary system free from government intervention.

Now, let’s take a look at the 7 key objectives of the Federal Reserve and their respective failures to meet these objectives. In this section, we will cover the specified objectives, the specified references in the Federal Reserve Act, and how the Fed fails to achieve these. 

Inflation control

Objective:
Control inflation and maintain price stability.

Federal Reserve act reference:
"To maintain long-run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" (Federal Reserve Act, Section 2A).

Failure:
Despite its primary objective, the Federal Reserve has struggled with significant inflationary periods, notably in the 1970s and the post-2008 financial crisis period. Critics argue that policies like quantitative easing and low interest rates have led to asset bubbles and long-term inflationary pressures. The purchasing power of the dollar has significantly decreased over time, eroding savings and wages.

According to the Mackinac Center, the Federal Reserve has allowed the purchasing power of the U.S. dollar to fall dramatically, noting that a consumer basket costing $100 in 1790 cost $2,422 in 2008. This dramatic decline largely occurred after the gold standard was abandoned in 1971, allowing the Fed unchecked control over monetary policy​.

Insight:
In "The Case Against The Fed," Murray Rothbard notes, "The government and the central banks are inherently inflationary. The Federal Reserve, as the monopoly issuer of currency, has persistently increased the money supply, leading to continuous devaluation of the dollar and inflation."

Economic stability

Objective:
Promote economic stability and prevent severe economic downturns.

Federal Reserve act reference:
"To promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" (Federal Reserve Act, Section 2A).

Failure:
The Federal Reserve has been criticized for its role in major economic downturns such as the Great Depression and the Great Recession. In the 1920s, it failed to prevent the stock market bubble and subsequent crash. Similarly, policies in the early 2000s, including low interest rates and inadequate regulation, are seen as contributing factors to the housing bubble and the 2008 financial crisis. The post-crisis recovery has been slow and uneven, with extended periods of low economic growth and high unemployment. The Heritage Foundation notes that the Fed's low interest rates have repeatedly caused economic bubbles, including the dot-com bubble in the 1990s and the housing bubble in the 2000s​.

Insight:
In "Secrets Of The Temple," William Greider writes, "The Federal Reserve's control over monetary policy has led to a boom-bust cycle, with periods of artificial booms followed by inevitable busts. The central bank's attempts to stabilize the economy often lead to greater instability."

Financial market stability

Objective:
Ensure the stability of the financial system.

Federal Reserve act reference:
"To maintain the stability of the financial system and contain systemic risk that may arise in financial markets" (Federal Reserve Act, Section 12B).

Failure:
Frequent asset bubbles and financial crises have undermined financial market stability. The dot-com bubble in the late 1990s and the housing bubble in the mid-2000s are examples of where Fed policies of low interest rates and easy credit contributed to speculative excesses. The Fed's crisis responses, often involving bailouts, are criticized for creating moral hazard and encouraging risky behavior by financial institutions​​.

Long-term economic growth

Objective:
Support conditions that foster sustainable long-term economic growth.

Federal Reserve act reference:
"To promote sustainable growth and a high level of employment, production, and real income" (Federal Reserve Act, Section 2A).

Failure:
The long-term economic growth rate in the U.S. has been sluggish, especially in recent decades. Critics argue that the Fed's focus on short-term fixes, such as lowering interest rates, has failed to address structural issues like productivity stagnation and income inequality. The emphasis on consumption-driven growth, supported by easy credit, has led to high levels of consumer debt​​.

Employment

Objective:
Promote maximum employment and stable prices.

Federal Reserve act reference:
"To promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" (Federal Reserve Act, Section 2A).

Failure:
While the Federal Reserve can influence short-term employment levels, its ability to sustain long-term employment growth is limited. The U.S. has experienced periods of high unemployment, particularly during economic downturns. Critics argue that the Fed's monetary policy alone is insufficient to address structural unemployment and that its actions can sometimes exacerbate job losses by causing economic instability​.

Public trust and transparency

Objective:
Maintain public trust through transparency and accountability.

Federal Reserve act reference:
"To provide the public with a full and accurate account of the Federal Reserve's activities and their effect on the economy" (Federal Reserve Act, Section 10).

Failure:
The Fed has faced criticism for a lack of transparency and accountability. Decisions are often made behind closed doors, and the complex nature of monetary policy can make it difficult for the public to understand and scrutinize Fed actions. This opacity can lead to a perception of the Fed as unaccountable and serving the interests of financial elites rather than the broader economy​​.

Currency stability

Objective:
Maintain a stable currency to facilitate trade and investment.

Federal Reserve act reference:
"To regulate the issue and retirement of Federal Reserve notes" (Federal Reserve Act, Section 16).

Failure:
The value of the U.S. dollar has declined significantly since the abandonment of the gold standard in 1971. This depreciation reflects a loss of purchasing power and undermines confidence in the dollar as a stable store of value. Internationally, the fluctuating value of the dollar creates uncertainty in global trade and investment​​.

Government intervention and business cycles

During the COVID-19 pandemic, government intervention significantly disrupted the natural economic adjustment processes.

In the past, economist Murray Rothbard highlighted various ways government intervention could hinder economic recovery, including inflating further, keeping prices and wages artificially high, and subsidizing unemployment​​.

The Fed's response during the COVID-19 pandemic involved substantial monetary interventions, including purchasing long-term Treasuries and mortgage-backed securities (MBS) and maintaining near-zero interest rates. These actions aimed to stimulate the economy but also contributed to significant inflationary pressures and asset bubbles​​.

Conclusion

While the Federal Reserve and fiat currency have played critical roles in modernizing the U.S. economy and providing flexible monetary policy tools, they have also faced significant challenges and criticisms.

Recurring themes of inflation, economic instability, financial crises, slow long-term growth, and transparency issues highlight areas where the Federal Reserve's policies and the fiat currency system have struggled to meet their objectives.

These criticisms fuel ongoing debates about the best approach to monetary policy and the potential merits of alternatives such as a return to a commodity-backed currency system or other forms of sound money.

Research by the Mackinac Center, the Heritage Foundation, the Cato Institute, and the Mises Institute suggests that the Fed's performance, particularly in terms of price stability and economic volatility, has not lived up to its original promise, indicating the need for a systematic exploration of alternatives to the current monetary system​​.

As Ludwig von Mises eloquently put it:

"The people of all countries agree that the present state of monetary affairs is unsatisfactory and that a change is highly desirable… The destruction of the monetary order was the result of deliberate actions on the part of various governments. The government-controlled central banks and, in the United States, the government-controlled Federal Reserve System were the instruments applied in this process of disorganization and demolition. Yet without exception, all drafts for an improvement of currency systems assign to the governments unrestricted supremacy in matters of currency and design fantastic images of superprivileged superbanks… The inanity of all these plans is not accidental. It is the logical outcome of the social philosophy of their authors​.”