How to Replace the Federal Reserve

How to Replace the Federal Reserve

If we lived in North Korea, and someone suggested that we “end collective farming”, would she be suggesting that we starve to death? Obviously not. Privatizing an industry gives it life, makes it productive, and frees it to grow.

However, if we had never seen a private farm, we might have trouble imagining how people grow food without commissars and secret police helping them. The same is true of sound money; since Americans haven’t seen any since 1913, it’s hard for us to imagine how people create money without commissars and secret police… I mean without the Fed governors and secret FOMC meetings.

Money: the Root of All Economic Good

For most of civilized history, “money” has meant precious metals. Easy to carry, durable, and expensive to produce, they performed three functions:
1. Medium of exchange.

2. Store of value.

3. Method of economic calculation. Yes, there was some economic calculation before the switch to metal money, but coins are more accurate than cows and camels… and make it possible to easily compare cows, camels, computers, and all other goods.

Kings did not invent gold and silver money, they just stamped their faces on coins. But the value of the coins came from the metal, not from the ruler’s whims. Emperors like Diocletian occasionally tried to inflate their money’s worth, but the value always returned to the intrinsic worth of the metal content… which is why the overproduced and overvalued copper coins from Diocletian’s time still aren’t valuable even to collectors after 1700 years.

Banks have been expanding the apparent amount of money since ancient Greece. By loaning out money belonging to depositors, banks could collect more interest… until too many depositors wanted their money at the same time, which would bring the bank to a quick end. The banks also had to worry about kings and their infinite capacity to confiscate and spend bank’s reserves.

The solution for banks since Cleopatra’s time has been to team up with a government for protection. The bank keeps its money loaned out, making it harder for the government to confiscate it all, while the government protects the bank from angry depositors during bank runs. This pretty much summarizes banking history from 700 BC to 1783 AD (with a small exception during the period of Scottish free banking, when the banks had to stay solvent because the English government wouldn’t protect them from their depositors. People who think that bailouts make better bankers should study this 150-year period of stable banking).

If you want to learn all the gory details (and see why King Herod and Cleopatra were rivals), economist Jesus de Soto has been good enough to put his comprehensive history “Money, Bank Credit, and Economic Cycles” online for study.

Unfortunately, things didn’t change all that much after 1783. The king was booted out, but laws were still bent in favor of banks. Owners of grain elevators who loaned out the same wheat to ten different people would be locked up (probably in the loony bin). But banks could do the same thing with gold and be protected to greater or lesser degrees under state laws. This caused constant fluctuations in the money supply as banks inflated and then failed… but they were limited in the final analysis by the quantity of gold and silver. Except during the Civil War paper-money inflation, the dollar held value pretty well during the 1800s.

Finally in 1913, the large banks got the Federal Reserve Act passed. This finally allowed them to use the US government’s printing presses to cover any shortfalls. The removal of the discipline of gold made 20^th century money much less stable than 19^th, and put it on a steady path to oblivion. Since 1913, the dollar has lost nearly all its value, falling from 20 dollars per ounce of gold to 1600+ now.

However, the devaluation of the dollar isn’t the worst problem. The problem is that the value of the dollar is so unstable. Because the banks can lend out more money than they actually have, the quantity of money fluctuates every time someone takes out a loan!

The Federal Reserve can also make the dollar fluctuate by buying or selling assets. Any crazy “asset” at all; subprime loans, defaulted bonds issued by various dictators… the Fed could buy print money and buy used clunker cars if it wanted to. (Everyone still remembers how well that worked out, right?) According to a Bloomberg report, the Fed gives banks and other favored companies trillions of dollars at .01% interest… then those banks can just turn around and buy government bonds and pocket the difference in interest.

So, if we want money that won’t randomly change in quantity (or leak out to Goldman Sachs or UBS when we’re not looking), we have to end the Federal Reserve in its current form. Even the English central bank has given up on the concept of unrestricted fiat money. In a report released this week, the Bank of England calls for a return to money based on fixed rules instead of the whims of unelected banker cronies.

Ending the Fed

Privatization of the money supply is just as desirable as privatization of farming. However, since our economy is largely based on contracts that were signed based on quantities of Federal Reserve dollars, the first thing we have to do is prevent the quantity of dollars from rapidly changing. So the first step is to audit the Federal Reserve and make its operations transparent.

A transparent, stable Federal Reserve would free businesses to hire and make long-term plans. Right now businesses have no way to know how much a dollar will be worth next month, let alone in ten years. (A transparent Fed would be a more stable Fed, as there would no longer be an incentive for insiders who know the money-supply plans in advance to deliberately cause fluctuations… and they would no longer be able to directly transfer Fed funds to their companies).

Other nations have had “transparent Federal Reserves” for long periods of time. Hong Kong’s worked well for decades (until recently, when it was taken over by communist China and it started doing crazy stuff like buying a billion dollars’ worth of Thai bonds…) Google “currency boards”, there’s good evidence that transparency makes even fiat money systems much more stable.

You Want Stable Money? Make It Yourself!

The second phase of transition to stable money would be to get rid of all laws against competing private currency. The US and state governments would continue collecting taxes in dollars, of course. But there is no reason to stop individuals from saving or exchanging money backed by gold, silver, oil, or World Of Warcraft money.

We can no more know what money would evolve in a free market than North Koreans can know what their economy will look like when they join the free market (fewer Kim posters, we may guess). But we do know that the technology already exists for competing currencies. Visa, Mastercard, Ikobo, PayPal, etc. already transfer and convert the different competing fiat currencies. They would have no more trouble transferring money that was backed by commodities.

In fact, a modern commodity-backed money need not be restricted to the precious metals. (Monetary systems using only one commodity have occasionally been manipulated in the past, e.g. 1930s China). It could be backed by a combination of 20 or more storable products; gold, silver, uranium, oil, iron, copper, etc. Such multicommodity money would be very resistant to fluctuation. In fact, a multicommodity money might be more stable than gold.

So replacing the Fed isn’t hard to imagine after all. The only difficult detail is prying the printing presses out of the political hands that have held them since 1913. That may take a little work.

-Bill Walker