Richard Ebeling on Monetary Policy and the Debt Ceiling

The following testimony was delivered before the House of Representatives Subcommittee on Domestic Monetary Policy and Technology, chaired by Congressman Ron Paul (R-Texas), on “Monetary Policy and the Debt Ceiling: Examining the Relationship between the Federal Reserve and Government Debt,” in Washington, D.C. on May 11, 2011

“I place economy among the first and most important virtues, and public debt as the greatest of dangers to be feared . . . To preserve our independence, we must not let our rulers load us with public debt . . . we must make our choice between economy and liberty or confusion and servitude . . . If we run into such debts, we must be taxed in our meat and drink, in our necessities and comforts, in our labor and in our amusements . . If we can prevent the government from wasting the labor of the people, under the pretense of caring for them, they will be happy.”

Thomas Jefferson

What is To Be Done?

The bottom line is, government is too big. It spends too much, taxes too heavily, and borrows too much. For a long time, the country has been trending more and more in the direction of increasing political paternalism. Some people argue, when it is proposed to reduce the size and scope of government in our society, that this is breaking some supposed “social contract” between government and “the people.”

The only workable “social contract” for a free society is the one outlined by the American Founding Fathers in the Declaration of Independence and formalized in the Constitution of the United States. This is a social contract that recognizes that all men are created equal, with governmental privileges and favors for none, and which expects government to respect and secure each individual’s right to his life, liberty, and honestly acquired property.

The reform agenda for deficit and debt reduction, therefore, must start from that premise and have as its target a radical “downsizing” of government. That policy should plan to reduce government spending across the board in every line item of the federal budget by 10 to 15 percent each year until government has been reduced in size and scope to a level and a degree that resembles, once again, the Founding Father’s conception of a free and limited government.

A first step in this fiscal reform is to not increase the national debt limit. The government should begin, now, living within its means – that is, the taxes currently collected by the Treasury. In spite of some of the rhetoric in the media, the U.S. need not run the risk of defaulting or losing its international financial credit rating. Any and all interest payments or maturing debt can be paid for out of tax receipts. What will have to be reduced are other expenditures of the government.

But the required reductions and cuts in various existing programs should be considered as the necessary “wake-up call” for everyone in America that we have been living far beyond our means. And as we begin living within those means, priorities will have to be made and trade-offs will have to be accepted as part of the transition to a smaller and more constitutionally limited government.

In addition, the power of monetary discretion must be taken out of the hands of the Federal Reserve. The fact is, central banking is a form of monetary central planning under which it is left in the hands of the members of the Board of Governors of the Federal Reserve to “plan” the quantity of money in the economy, influence the value or purchasing power of the monetary unit, and manipulate interest rates in the loan markets.

The monetary central planners who run the Federal Reserve have no more or greater knowledge, wisdom or ability that those central planners in the old Soviet Union. The periodic recurrence of the boom and bust of the business cycle demonstrates that there is no way for them to get it right – in spite of them saying, again and again, that “next time” they will get it right.

It is what the Nobel Prize-winning, Austrian economist, Friedrich A. Hayek, once called a highly misplaced “pretense of knowledge.” That is why in a wide agenda for reform, the goal should be to move towards a market-based monetary system, the first step in such an institutional change being a commodity-backed monetary order such as a gold standard.

And in the longer-run serious consideration must be given the possibilities of a monetary system completely privatized and competitive, without government control, management, or supervision.

The budgetary and fiscal crisis right now has made many political issues far clearer in people’s minds. The debt dilemma is a challenge and an opportunity to set America on a freer and potentially more prosperous track, if the reality of the situation is looked at foursquare in the eye.

Otherwise, dangerous, destabilizing, and damaging monetary and fiscal times may be ahead.

read the entire speech

A Return to the Gold Standard

Richard Ebeling writes:

Over the weekend of November 6-7, 2010, World Bank president, Robert Zoellick , proposed in a column written for the Financial Times that the global economy once more be linked to gold as an anchor to help maintain currency stability and reduce inflationary expectations in international markets...

But in spite of Wolf's concerns, it can be argued the costs of a gold standard are far less that the costs that have been imposed on society from a century of gross mismanagement of the monetary system by governments around the world. Since 1914, when the Federal Reserve System came into operation as America's central bank, and the beginning of the First World War that same year, the world has experienced severe inflations, including a number of hyperinflations, and the rollercoaster of several booms and recessions, including the Great Depression of the 1930s and the current global economic downturn.

Placing the fate of the world's monetary system in the hands of monetary central planners, who have had all the discretion imaginable through their control of paper money instead of gold, has not secured an inflation- or recession-free economic environment...

Finally, Wolf's concern that a real gold standard would tie the hands of governments and central banks from having the discretionary authority to manipulate the monetary system should be considered a "plus," not a minus. Only the most doctrinaire Keynesian can deny or fail to see that past recessions and the current economic downturn were all preceded by unsustainable booms resulting from monetary expansions and interest rate manipulations that threw savings and investment out of balance, artificially stimulated misplaced construction projects, and misdirected labor into employments that became unprofitable to maintain once the inevitable financial and investment bubbles burst...

Monetary central planning has worked no better than any other form of central planning over the last one hundred years. The world's central bankers – just like the central planners in the old Soviet Union – just do not have the knowledge, wisdom and ability to successful manage the monetary system of a market economy...

The return to a market-based money such as gold, therefore, is both possible and desirable. And it would be most effective in acting as a barrier against any further government abuses of the monetary system, if such a return to gold was introduced through the freeing of banking and financial markets from the heavy-hand of government, as well.

The next phase of our post-communist world may very well require the end to monetary socialism, which is what central banking really represents.

read the entire essay

Central Banking and Central Planning

What is being ignored is the more fundamental question of whether the Fed should be attempting to set or influence interest rates in the market. The presumption is that it is both legitimate and desirable for central banks to manipulate a market price, in this case the price of borrowing and lending. The only disagreements among the analysts and commentators are over whether the central banks should keep interest rates low or nudge them up and if so by how much...

At the heart of the problem is that fact that the Federal Reserve’s manipulation of the money supply prevents interest rates from telling the truth: How much are people really choosing to save out of income, and therefore how much of the society’s resources – land, labor, capital – are really available to support sustainable investment activities in the longer run? What is the real cost of borrowing, independent of Fed distortions of interest rates, so businessmen could make realistic and fair estimates about which investment projects might be truly profitable, without the unnecessary risk of being drawn into unsustainable bubble ventures?

Unfortunately, as long as there are central banks, we will be the victims of the monetary central planners who have the monopoly power to control the amount of money and credit in the economy; manipulate interest rates by expanding or contracting bank reserves used for lending purposes; threaten the rollercoaster of business cycle booms and busts; and undermine the soundness of the monetary system through debasement of the currency and price inflation.

Interest rates, like market prices in general, cannot tell the truth about real supply and demand conditions when governments and their central banks prevent them from doing their job. All that government produces from their interventions, regulations and manipulations is false signals and bad information. And all of us suffer from this abridgement of our right to freedom of speech to talk honestly to each other through the competitive communication of market prices and interest rates, without governments and central banks getting in the way.

read the entire essay

My thoughts: An outstanding essay explaining why the Fed is doing more harm than good.

Richard Ebeling Essays

Richard Ebeling is one of the best commentators on economics.

Click here for the list of FEE essays.

The Current Crisis and the Austrian Theory of the Business Cycle June 2008

Freedom and the Right of Self-Determination May 2008

Ebeling on Obama and Fiscal Irresponsibility

President Obama is hosting a “fiscal responsibility summit” on February 23 that has the goal of reining in the projected growth in government spending in the years and decades ahead. Any such reform, however, will require a dramatic change in the role of government in American society...

Even before the stimulus package was passed earlier this month, the Congressional Budget Office was estimating that the Federal government’s budget deficit for the current fiscal year would be at least $1.2 trillion. If we now add the hundreds of billions of dollars in additional government spending in 2009 due to the stimulus bill and the bailout for bankers, automakers, homeowners, Washington could be facing a budget deficit this year that approaches $2 trillion. This would be equal to two-thirds of the entire Federal budget in fiscal year 2008...

The Treasury and the Trust Funds use a 75-year time horizon in their projections. They estimate that the current present value of unfunded liabilities for both Social Security and Medicare over the next three-quarters of a century totals nearly $43 trillion. Social Security makes up $6.6 trillion of this amount and Medicare costs comprise the remaining $36.3 trillion...

In 2008, the Gross Domestic Product (GDP) of the United States was around $14 trillion. This means that government would need to have sitting in an account collecting interest a sum equal to three years of U.S. GDP. Obviously, Uncle Sam does not...

After all, in his inaugural address on January 20, President Obama said: “The question we ask today is not whether our government is too big or too small, but whether it works — whether it helps families find jobs at a decent wage, health care they can afford, a retirement that is dignified.”

In other words, our new president takes for granted that it is the role and responsibility of the government to paternalistically provide decent paying jobs, medical care and retirement pensions for the entire population of the United States. And he clearly had no interest in or concern with broader political philosophical questions of whether government is “too big” versus “too small.”

His premise that government has these interventionist and redistributive roles to play in society define the terms of the debate in his mind. The Federal government is to be an even larger Welfare State than at present; the only issues open to debate are figuring out ways it can fulfill this role in a more effective and cost-efficient manner, if possible...

This can only come about by asking the questions that President Obama has taken off the table: What are the individual rights and responsibilities of the citizenry for their own personal affairs? What are the limited and legitimate functions of a government in a free society? And how is that proper balance between individual liberty and constitutionally restrained government to be restored?

read the entire essay

Capitalism is the Solution

Not only is the capitalist system not responsible for the present economic crisis, but any attempt to severely hamstring or regulate the market economy out of existence would only succeed in undermining the greatest engine of economic progress and prosperity known to mankind...

The recession has its origin in years of monetary mismanagement by the Federal Reserve System and misguided policies emanating from Washington, D.C. For the five years between 2003 and 2008, the Federal Reserve flooded the financial markets with a huge amount of money, increasing it by 50 percent or more by some measures. The St. Louis Federal Reserve Bank has tracked the impact of this monetary expansion on interest rates...

The easy money and government-guaranteed house of cards all started to come tumbling down last year, and with a huge crash during the last six months. Now, the same people in Washington who produced the mess we are in say that they need more regulatory authority to repair the very financial and housing markets their earlier actions so severely undermined.

And the same Federal Reserve System that produced the monetary excesses that generated the artificial bubbles that have now burst is busy flooding the financial markets with even more newly created money. Over the last five months they have increased the Monetary Base (cash in the system and bank reserves for loans) by 95 percent and M-1 (cash and checking deposits in banks) by almost 40 percent at an annualized rate. The concern, therefore, should not be deflation, but the likelihood of very serious price inflation over the next few years.

Trillion-dollar Federal bailouts and “stimulus” packages will only prolong the agony and delay any real economic recovery. Any government-created jobs will be at the expense of private sector employment opportunities, and will disappear as soon as the government projects come to an end.

The capitalist system is a great engine of human prosperity. It creates the profit incentives for industry and innovation that over the last half century has literally raised hundreds of millions of people out of poverty around the world. The competitive process of supply and demand brings the productive activities of tens of thousands of businesses into balance with the demands of all of us as consumers, both here in America and around the globe.

There is no economic system in all of history has had the same ability to do so much material and cultural good as the open, competitive free market. But the capitalist system cannot do its job if government interferes with its operation. Burdensome government taxes, heavy-handed government regulation, misguided government spending, and mismanagement of the monetary system only succeed in gumming up the works like so much sand in the machine.

The best pro-active policy the Federal government can undertake right now is to accept that its own past policies have caused the economic crisis we are in, and leave the market alone to rebalance itself and reestablish the basis for sustainable growth and employment in the years ahead.

read the entire essay

My thoughts: Brilliant. Only government thinks repeating the mistakes of the past represents solutions.