How The Fed Endangers the Economy

Editor’s note: The American Spectator is running an article by Bob Luddy, President of CaptiveAire Systems and Chairman of the Civitas Board of Directors. In it, Mr. Luddy explains how the central bank’s intervention in the economy actually causes more problems than it solves, and in fact may help lead to another financial crisis. The article can be found online at spectator.org, and is also available below:

The Fed’s Risky Uncharted Course

By Bob Luddy

The Federal Reserve Bank, also known as “The Fed,” was created in 1913 to regulate the banks and to ensure a stable dollar.

The Fed has strayed from its initial charter and is now the primary enabler of federal deficit spending and debt, which is now almost $20 trillion. The Fed’s primary tool is low interest rates, which distort financial decisions and expand the money supply, which leads to risky economic choices.

The Fed has created an additional intervention — purchasing debt instruments. These purchases have expanded the Fed’s balance sheet to almost four trillion dollars, a major market distortion. Some economists justify these interventions as necessary during times of crisis but, in the long run, Fed actions lead to inflation and massive federal debt, which will, if not corrected, lead to another financial crisis.

Ultra-low interest rates allow the federal government to borrow at will without having to pay market interest rates. If rates begin to rise, interest cost for the government will dramatically increase the yearly deficit.

The Fed decided some years back to create inflation of at least 2%. Inflation causes two major harms. The first is wage earners lose buying power as prices inflate. The second is that the government is able to repay debt with inflated dollars, which means that bondholders also lose because of the deflated value of the dollar.

The Fed’s creation of 2% inflation is an outrage and grossly unfair to wage earners, as noted in my TAS article in February 2016. It gets worse. We now have a proposal to inflate the currency to 4%, a suggestion by Olivier Blanchard, a Peterson Institute economist. This idea was initially ignored, but the Wall Street Journal reported last week that it “is getting new life.” The Fed is considering this idea is because it provides another monetary tool to manipulate the money supply and interest rates.

It should be clear that individuals and corporations that own hard assets could be rewarded by inflation. Everyone else, most of our citizenry, suffers and loses buying power.

Ludwig von Mises, very clear on this point in his 1944 book, Bureaucracy, stated that “economic interventionism is a self-defeating policy. The individual measures that it applies do not achieve the results sought.” The Fed is an excellent case in point.

In Mises’s view, “interventionism is an inherently unstable policy because it creates new dislocations that would seem to cry out for further interventions, which, in turn, do not solve the problem. The end of interventionism is socialism, a fate which can be logically avoided only by a sharp turn towards free markets.”

The Fed is purportedly independent, but in fact, it is part of the federal government, which exercises control in several ways. The President appoints the Fed governors and the chairman. Secondly, the Congress mandates two priorities for the Fed. The first is full employment and the second is stable prices.

It is imperative that the Fed return to its charter, regulating banks for stability and eliminating interventions to control short-term interest rates. Long-term interest rates are market driven. If the short rate were also market driven, inflation and mal-investment would be limited, leading to a stable, sound economy and monetary system.