The Fed and Congress: Two Drunks Holding Each Other Up

Estimated Reading Time: 5 minutes

The Federal Reserve Board is one of the most difficult institutions to understand, yet it has an outsized influence on the way we live and conduct our politics.

It is nominally a private institution owned by the banks it supervises whose governors are appointed by the President of the United States and confirmed by the Senate, which is supposed to make it independent, but it is completely wired into the needs of the Treasury Department and the political parties in power.

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The Board itself, representing some of the 12 Federal Reserve districts, is supposed to be in theory a heterodox group of economists and bankers, yet often they vote in unison. Between the limited terms they serve, presidential appointments, district representation and congressional oversight the Fed has all the appearance of an institution with a separation of powers but with none of the actual substance.

Whew! Like we said.  It is very difficult to understand. Moreover, the embedded conflicts of interest are multiple and obvious.

To confuse matters more, its chairman and governors often speak in riddles like the oracle of Delphi in cryptic language, which has created a cottage industry in FedSpeak, a financial language intended to mislead as well as inform. Needed translators are then hired by cable television stations to intuit the meaning of the FED’S arcane pronouncements.

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When called before congressional committees, the testimony of the FED Chairman is often even more abstruse. During one such appearance, Alan Greenspan famously said, “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.”

FED pronouncements can often be used to move markets, so-called jawboning. The risk is a misspoken phrase that can cause billions of dollars to be lost by some and gained by others. Knowledge of what the FED might say has to be closely held, of course. No one would dare use such power for personal financial or political gain, would they?

The internal conflicts of interest are significant and worrisome.  But probably most important is the potential for the abuse of power. The very notion of a central planning agency dictating the amount of money and its cost is a monstrous amount of power to put into the hands of unelected bureaucrats, who often exercise more actual power that carry more consequences than the decisions made by the elected representatives of the people. How can the people of this great republic get accountability?

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A free people, ruled by unelected potentates, not only seems like a contradiction in terms, it is a contradiction in terms.

A central planning agency that destroys the price discovery mechanism of a free market, dictating results different than those rendered by real supply and demand, is not a market system. If this too seems like a contradiction, it is. What we basically have is a powerful central planning board, essentially accountable to no one, that cancels out the free market it is supposed to conserve.

Then, there just is the basic problem of all central planning, what  Hayek called, “the fatal conceit.” How can the FED know exactly the amount of money to put in the system, what interest rates should be, when they should rise and when they should fall? In fact, they don’t and they can’t.  There is considerable evidence that economic cycles are more violent, severe, and more frequent with the FED at the wheel than when the market did the driving.

The risk of abuse of power gets even greater when we see “mission creep.”  Clearly, the FED is headed in that direction with statements that inflation, employment, and financial safety are no longer its sole responsibility, but now they want to get into race relations (promote equity) and climate change.  Having failed on its primary responsibilities, it now wants to regulate the temperature of the earth!

The FED is supposed to regulate the banks, which technically own them. But we move from one financial crisis to the other, requiring multiple bailouts with taxpayer money creating continual moral hazard, which seems to result in even worse behavior from the banks. So much for their vaunted regulation, it would seem.

The FED is supposed to protect the value of money. As John Maynard Keynes wrote in 1919, “Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch its currency…Lenin was certainly right.  There is no subtler, nor surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.”

So, on that front too, the FED has not done a great job. Debauch is an interesting word in this regard. Starting with 100 cents on the dollar in the year of the FED’s founding in 1914, the current dollar is worth a tad under 4 cents.  That averages about 3.09% inflation per year or 2,575.53 %, which uses dubious government measures of inflation. It has been a slow slide in value interrupted on occasion with a rapid slide in value. But here we are today with prices over 26 times higher since they began to scientifically manage things.

Now all of these failures could be addressed by Congress. But the Congress itself is now absolutely beholden to the FED. When Congress spends more than it takes in, the FED through complex maneuvers, essentially prints the money (it creates money to buy government bonds), allowing Congress to spend its head off.

Even more frightening, we now seem to be in a cycle where what was once emergency measures are now the norm. It is stimulus in war, stimulus in peace, stimulus everywhere and always.

Any hint, statement, or policy move, that suggests an end to zero rates and liquidity up the wazoo, results in a “taper tantrum” that causes markets to collapse. Like the fellow who painted himself into a corner, it is not clear how we get out of this fix the Fed and Congress have put us in.

The market you say will increase interest rates to discipline the wayward spending, the so-called bond vigilantes. But by buying huge quantities of government debt, the FED holds interest rates down, thus removing any marketplace discipline imposed on Congress. So, Congress does not need to balance the budget. Hell, they don’t even need to have a budget. They simply float from one continuing resolution to the next. Deficits grow and grow. Congress gets to spend and spend and the FED monetizes and monetizes.

Congress you might argue, with political leadership, will discipline itself at some point, even in the face of all this free money that removes both marketplace discipline and budgetary discipline from the equation. And the evidence for that proposition? In just the last 100 days, Democrats are proposing $6 trillion in new spending. This clearly seems to be considerable evidence to the contrary.

Congress knows deep down, that if they spend more than received in tax revenues, the FED will be there to either buy the debt with money created out of nothing or the Treasury will print the money to see that government checks don’t bounce.

The FED and the Treasury are joined at the hip. Where is the independence of the central bank? Between the two of them, fiscal and monetary discipline goes out the window.

The FED has removed both political and market discipline from Congress. And Congress, needing the FED to finance its ridiculous excesses, is not about to discipline the FED.  They are like two spending drunks holding each other up under the street light. They need each other and protect each other. Who is protecting us?

 

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