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And this is not a criminal enterprise?

A few evenings ago I came across this graph. Some of you may also have seen it recently as it seems to be one of those things which is making the rounds:

Inflation starts with the Fed.
The Fed and inflation.

It shows inflation as we know it pretty much begins with the creation of the Fed. The buying power of a dollar slowly appreciated between the founding of the US and the start of the Fed; over the next century that value has plummeted. As we are wont to say here at Samizdata: “The State is not your friend.”

You can read more about it here.

32 comments to And this is not a criminal enterprise?

  • Paul off the beach

    Largest thieft in history.

    ( Oh, somebody smeared oil on wood pulp and called the thieft leagal? Never mind, right? )

  • Richard Garner

    Yes, there is a graph that looks something like this in the late Harry Browne’s 1995 campaign book Why Government Doesn’t Work labelled something like “How the Fed Has Helped Stabilise Prices.” He knew his sarcasm, did that Harry Browne!

  • For this plot to be meaningful in terms of inflation, the vertical axis needs to be plotted on a logarithmic scale.

    Best regards

  • Laird

    I have a few technical problems with this analysis, and one big one.

    First of all, the Consumer Price Index isn’t necessarily a good measure of inflation. Note the period covered: it starts prior to the Industrial Revolution, so all the benefits of moving from an agrarian economy to an industrial one are “baked in” to the calculations. Of course purchasing power increased during that period; that’s what industrialization did, and why it was successful. Second, I don’t see any evidence that the various panics and depressions in the 18th and 19th centuries are reflected in this graph. Where is the currency devaluation/repudiation after the Revolutionary War (which spawned the phrase “not worth a Continental”)? Where is the huge inflation of the Civil War, or the effect of the collapse of the Confederate currency? Indeed, I have serious doubts about the accuracy or reliability of the data prior to the 20th century.

    All that said, there in certainly no doubt that inflation has become a serious and pernicious problem. But drawing the line in 1913 (at the creation of the Fed) doesn’t really seem borne out by the graph. A better point (it’s hard to be exact with the lack of detail provided) would seem to be the US entry into WW2, which is hardly surprising. And the real inflection point is clearly when the US went off the gold standard; inflation (as measured by the CPI) has been nearly a vertical straight line since then. That’s the point at which the government was freed of any semblance of restraint over its debasement of the currency. The Fed is a handy scapegoat, and obviously was the instrument by which this massive inflation was unleashed, but the real culprit has to be Congress and its unbridled spending.

    From the evidence of this graph, dismantling the Fed isn’t the answer; tying the dollar to some external standard (gold or something [anything!] else) is.

    [Cue llamas for his predictable response.]

  • Sigivald

    Laird: Making the dollar into metal-backed money rather obviates the need for a Federal Reserve, doesn’t it?

    I mean, the Fed’s entire job, at the grand level, is to manage the money supply, typically to keep inflation low (lately to keep deflation from happening, perhaps) – but without fiat money you can’t really do that very effectively.

    It’s not like you can just issue more dollars when they’re backed by a scarce resource (and of course you can’t really contract the supply effectively, when a dollar is equivalent to X grams of gold, because even if outside gold isn’t “really a dollar”, it’s hard to make a real distinction if there’s demand for more money).

    It also makes fractional reserve banking awkward, is my understanding, so I’m not sure the Fed would have any job at all if the Dollar was gold-backed again.

    (My take is more along the conclusions of Mises and Hayek, that while a Gold standard would have some salutary effects, there is practically no going back – with the added note that inflationary policies are no longer popular as they were when Mises wrote The Theory of Money and Credit, and an inflationary craze was the biggest danger he was warning of.

    It’s also unclear that the disadvantages of a gold standard (or equivalent) don’t outweigh the impossibility of an inflationary policy.)

  • TomC

    This is a good explanation of the connection with the arguments mentioned above.

  • Laird

    Well, somehow the Federal Reserve found something to do duing the roughly 60 years between its creation and the elimination of the gold standard. And we had fractional reserve banking during that period.

    As to whether there is any “going back”, perhaps not. Who knows? I’m just saying that this chart, by itself, doesn’t argue persuasively for the elimination of the Fed, which was the original point being made.

  • Just eyeballing, it looks more like it took off after the publication of The General Theory, to me.

    Bear in mind that the central Keynesian principle is:

    “Aggregate Investment” drives the economy; the more aggregate investment there is, the more prosperity. But, saving is bad as it reduces aggregate consumption. Therefore investment lending should be created ex nihilo; in an ideal society in such quanities that the interest rate should tend as close to zero as possible.

  • It also makes fractional reserve banking awkward, is my understanding, so I’m not sure the Fed would have any job at all if the Dollar was gold-backed again.

    Not at all. Suppose you have some money in gold pieces (100gp) lying around that you don’t want to spend at the moment. You see an advert from Bank Of IanB- “lend us your money and we will pay you 5 gp per year for every 100gp you lend us!”.

    That’s a pretty good deal. You come to Bank of IanB, and sign a contract stating that you are lending us your money, and it will earn interest, on the understanding that we will be in turn making that interest by lending your money to other people, and that we will endeavour under normal circumstances to pay it back to you on demand, but there is a small risk involved. You are satisfied and lend us your money. Back of IanB then lends out 90gp to somebody else, at interest. They deposit it in another bank…

    We’ve now invented fractional reserve banking, with a fully metallic currency and no Fed.

    To stop it, you’d have to make it specifically illegal. Any free market will have loans, loan brokers and “fractional reserve”, which is just another name for loan brokerage.

  • True. Fractional reserve shouldn’t be a systemic problem it is today as long as the depositor is aware of it. Most depositors today are not aware of it.

  • veryretired

    The Fed was established after bank panics in the late 1890’s and again in 1911.

    Passed at generally the same time as the income tax, which was intended to regularize governmental funding and reduce tariffs, it was supposed to stabilize the monetary system, credit, and provide for the orderly flow of funds among banks.

    By the early 1920’s, banks were already failing in the western part of the country, and this wave finally reached Wall Street in 1929.

    The Great Depression was a collapse of the monetary and credit systems, the very elements that the Fed had been set up to stabilize.

    As has been well documented, a series of mistaken legislation and administrative errors followed, turning what might have been a moderate to severe recession into a decade-long, world wide depression.

    We are poised at the edge of a similar crevasse now, and many of the same critical intellectual and economic errors are being repeated, justified by the same scapegoating arguments.

    None of these alleged economic problems were, and are, in fact, economic at all—they are political disasters brought about by bad policy and erroneous theory.

    As the state relentlessly expands, rational economic decisions get pushed aside, replaced by ideological and vote-pandering practices that have no proven track record for any result other than worsening whatever problems exist.

    It is the ultimate lunacy to allow people who couldn’t manage a moderately sized grocery store to acquire the power to dictate the course of great and complex industies, or financial systems barely understood by anyone at all.

    There is a form of cosmic justice called reality, which does not suffer fools, and the ideological daydreams they pursue, gladly.

    That judgement, when it comes, will be harsh, and there will be no appeal.

  • TomC

    Ian, you are talking about lending a mere 90% of deposits. Fractional reserve banking under Central banks is about leverage of 10 times the amount on deposit. You can’t get away with this without the help of a cartel backed by the state. Have a look at this.

  • No TomC, fractional reserve banking is lending most of what you have borrowed to somebody else, while keeping a fraction as reserve. The multiplier occurs because the borrower may then lend what she has borrowed to another bank, who then lend most of that, and so on.

    The formulation of fractional reserve claimed; that if I lend the bank 100gp they then lend 1000gp is wrong. If banks could lend 10x what has been deposited, it’s quite obvious that the money supply would rapidly escalate to infinity; bank A starts with 1gp, lends 10gp to Bank B, Bank B then lends 100gp to Bank A, who lend 1000gp to Bank B, who lend 10,000gp to Bank A and so on ad infinitum.

    The two things are quite different.

  • Dale Amon

    Just my tuppence worth, if I were looking at a graph like this for any physical process, I would say it can be modeled roughly by three linear segments. One line is a constant; the second starts from the founding of the Fed and has a positively slope; and the third with a much larger slope starts with the decoupling of the dollar from gold in 1971.

    To my eye, the Fed started the damage and the free float has just about wrecked the dollar as a stable currency.

  • Brad

    The establishment of the Fed was one of the first Statist functions that used the argument that what had gone before was untenable and Control was needed. As with all other State functions not only did it not solve the problem it was created to solve it created several others.

    Once the Fed was established, the Federal Government could more easily enter war at its own choosing, without actually having to finance it through persuasion of the masses, who likely could see for themselves the clear and present danger at hand.

    Also, by effective control of the money supply, the government found that it could borrow more and more and pay back debts with diluted dollars.

    Personally I think the paleo-fascistic motivations that existed in the US and Europe in the 1910’s (that led up to the conflicts a few decades later) manifested themselves in the US with the founding of the Fed. It was part of a series of movements by monied interests to found various boards of control over much of the economy for efficiency – the lynch pin of fascist thinking. Efficiency will bring on a new and glorious age of plenty for all (with the ersatz-nobility in control of the boards of course).

    Even more control was put into place for the war effort and some never went away. And the consequences of the Fed, bad politics, and the after effects of the war led to the collapse and the depression. So it was on several fronts of paleo-fascistic thinking that brought the US low, and the second stage of Rooseveltism that “fixed it” is still killing us today.

    And now, with our $55 Trillion accrual basis debt, the huge influx of new money into the supply over the last year, and our massive economic woes we are seeing the endgame of fascism – the complete control of the economy and all services. Every excuse are now used, just like “stabilizing money” was used nearly 100 years ago, for the State to take over everything.

  • One line is a constant; the second starts from the founding of the Fed and has a positively slope; and the third with a much larger slope starts with the decoupling of the dollar from gold in 1971.

    I think Ron Paul would argue (with some merit) that the third segment starts before the decoupling of gold, and the decoupling of gold was a consequence of the (inevitable) collapse of the Bretton Woods system and inflation running away.

  • spidly

    maybe we’ll go all Soviet and start pumping out potato-stamp quality currency like the central europeans were blessed with.
    Tiz deka Edami – USD1,000,000

  • You might want to look up the word “stability”. I don’t think it means what you apparently think it means.

    Okay, let’s indulge in a little ECON 101. What is the term for the buying power of a currency increasing? “Deflation.” Deflation is, by definition, not price stability.

    This, by the way, shows that the notion that there was price stability before the Fed is ignorant claptrap, based on your own table.

    Deflation is also, in the words of Will Cuppy, a Bad Thing. Why? Because when money is deflating, it reduces the urge on the part of the holders of money to invest: why take a risk with the money when you get a relative gain by keeping it in a mattress?

    So, instead we’ve had some inflation. What this means is that the buying power of money is decreasing; we all know that. It also means that people are encouraged to invest, because they want a return sufficient to exceed inflation.

    Here’s an interesting thing: when people are encouraged to invest, it counters inflation, because productivity tends to increase; you can make the same amount of stuff cheaper. Small amounts of inflation are self-limiting. On the other hand, even small amounts of deflation tend to be self-reinforcing — deflation discourages investment, which means productivity gains lead to more deflation, which means less is invested, less new stuff is invented.

    Now, obviously, if the Fed were perfect at its job, then there would be exactly 0.0 pct change in what one token of money can buy. Perfection here is impossible, however; the system has millions of degrees of freedom and and significant nonlinearities. It can’t be controlled to a fine level like that, Since deflation is a Bad Thing, and since we can’t control the economy (which, btw, is also a mathematical argument for eliminating command-control in economies: it’s mathematically demonstrable that it’s not possible to exert fine control predictably) then a small amount of inflation is preferable.

    So yeah, your money-tokens don’t buy as much, say, gold as they once did. On the other hand, we can travel cross country in hours for a cost in 1909 dollars of around $6.50 as a result of all the productivity-increasing investments we’ve had in the last hundred years.

    So,yeah, I’d say it’s not a criminal enterprise at all.

  • Andy H

    Because when money is deflating, it reduces the urge on the part of the holders of money to invest: why take a risk with the money when you get a relative gain by keeping it in a mattress?

    Uh, for a bigger gain.

    And people who want to minimize risk should be allowed to.

  • TomC

    Ian, with a Reserve requirement of 20%, $100 deposit can create $500. With a reserve requirement of 10%, $1000 can be created from thin air. The statuary reserve requirement in the UK is zero, while in the US it is 10%. The fact that many banks take several transactions to ratchet up to this level of leverage makes no difference to the argument. Yes, the two things are very different- your hypothetical example is not Fractional reserve banking, while reality is, and is made possible by Central Banking cartels and the absence of a gold standard, as described in the articles.

  • Paul Marks

    To reply to Dale’s question directly – it IS a “criminal enterprise”.

    Article One, Section Eight gives the Congress the right to “coin money” not to print it nor to invent it by the book keeping tricks (fraud).

    This was not a accident – “not worth a Continental” (the inflation of the fiat money of the Continental Congress) had shown that giving fiat money issuing powers to the government was a bad idea. So the new government was NOT given this power.

    As for a Central Bank – the Congress was given no power to have a “National Bank” or other such. Therefore it has no such power – the Tenth Amendment finishes the matter, if a power is not given to the Feds they do not have it.

    As for the States – they may only have “gold or silver coin” as legal tender. Nothing else.

    These matters are all clear (corrupt Supreme Court judgements, such as the second Greenback case, not withstanding) so YES the Federal Reserve is a criminal enterprise and those who control it are criminals.

    One pet complaint of mine……

    Please people do not talk about “metal backed money” or a “gold standard”.

    The gold or silver IS THE MONEY – it is not “backing” for the money. To treat it as “backing” leads to all sots of problems.

  • Paul Marks

    “Deflation” (in the sense of gradually falling prices) is NOT a bad thing.

    If people find better ways to produce goods and serves then prices will fall – this is a GOOD thing, not a BAD thing.

    Money should not be destroyed (a falling money supply – the old meaning of “deflation”), but a massive drop in the money supply is not caused by gold or silver vanishing. It is caused by a credit bubble bursting.

    If you want to prevent the credit money bust – DO NOT HAVE THE CREDIT MONEY EXPANSION BOOM IN THE FIRST PLACE.

    As for the late 19th century – one of the great myths of American history is that this was a bad economic period. In reality living standards vastly improved in the 1870s and 1880’s. Certainly recovery from the inflation of the Civil War was hard – but, over time people prospered.

    As for the Federal Reserve – it is still trying to maintain the property and other bubbles, it will not allow the malinvestments to be liquidated and markets to clear (as they did in 1921 and were not allowed to in 1929). This policy of refusing to allow markets to clear will end in tears – as it did after 1929.

  • TomC, the wikipedia article describes the process I described in which up to $1000 of credit arises from $100 of money. Whether that is hard money or not is irrelevant. The bank lends out most of the money loaned to them by depositors, and a fraction is kept in reserve. That is how it works. That is how I said it works, and that is what wikipedia says too. (There was an interesting argument a while back on their discussion page about whether it is the lending of a fraction, or the lending of a multiple, as it happens).

    You don’t think fractional reserve banking was only invented after the end of the gold standard, do you? A gold standard is merely the opportunity to convert the promisory bank notes into metal at a fixed rate.

  • Okay, let’s indulge in a little ECON 101. What is the term for the buying power of a currency increasing? “Deflation.” Deflation is, by definition, not price stability.

    …And thus we barrel into the errors of Keynesian thinking. Deflation defined by price level would be a situation in which all prices are falling- goods, labour, property, everything, and that can only be caused by a decrease in the money supply. In a free market with a fixed money supply, some prices would be expected to fall, and if you then make the mistake of taking an average, and believing that the average has a profound meaning, you then think there is a “fall in the general price level”.

    Many prices would not be expected to fall. For instance, property prices have no particular reason to fall, as property doesn’t get more efficient. Neither will the wage of a worker whose productivity has not fall need to fall. This is one of the great Keynesian errors. If the price of a loaf of bread falls because the baker has improved his efficiency, there is no requirement for a cut in the wages of the man buying the bread, any more than one would cut somebody’s wages because personal computers are cheaper than they used to be.

    Likewise there is no requirement for a cut in the wages of the workers at the bakery. The price cut has been achieved by improving their efficiency- that is more loaves can be made with the same or fewer workers, so again there is no wage cut.

    When efficiency improves, that should benefit purchasers of goods. “Price stability” destroys the whole point of efficiency improvements. If price stability in computers had been maintained we’d still be paying £10,000 for a 286.

    Which leads to the other obvious point, which is that products change over time. I can’t buy the model of computer I would have purchased 20 years ago. It is obsolete. The thing I buy today may still be called a “PC” but is an almost entirely different product in terms of function and technology. How are the wise owls maintaining “price stability” to decide what new products should be at the same price as the old, obsolete ones? This is obvious in terms of computers, but the same is true of everything, including bread. The bread I purchase now is different to the bread I purchased twenty years ago, and both are different to the bread purchased from a local bakery a century ago.

    Price stability is fools gold.

  • Excellent – thanks Ian.

  • Laird

    Ian has it exactly right, which is why in an earlier post I noted that the CPI “isn’t necassarily a good measure of inflation”. It’s no better for deflation, either. That said, I agree with Charlie that deflation (properly measured) is indeed a bad thing, and that given the impossibility of managing the money supply so finely that you have neither one a small amount of inflation is preferable. It’s much easier to deal with, for all of us.

    In deference to Paul in the future I shall try to refer to “gold-backed currency” rather than “gold-backed money.” OK? Because I have no problem with carrying around pieces of paper rather than lumps of metal (in fact, I prefer it) as long as those pieces of paper are backed by something more tangible than politicians’ promises.

  • Laird, I’m mystified how you could say I am “exactly right” and then agree with Charles’ Keynesian voodoo.

    the impossibility of managing the money supply

    You can’t manage the money supply. Stop dickering about with it. Leave it alone!

    As I pointed out, “deflation” as some prices in the market is natural and normal, and nothing to be scared of. As Paul Marks has pointed out, when they talk of “deflation” under Keynesian economic regimes, they are actually referring to collapsing credit bubbles, which are the unavoidable consequence of artificial credit expansion by central banks.

    There is no “deflation” problem to avoid!

  • Laird

    I was agreeing with your definition of deflation as the falling of all prices, not just average prices. The CPI doesn’t measure all prices, and as you pointed out has no way to correct for improvements in efficiency, substitution of new products, etc. I thought that was the point you were making. If I misunderstood, and you would like me to withdraw my agreement, I’ll be happy to do so, because I still think that deflation (properly measured, as a shrinkage of the money supply) is a bad thing.

  • Laird, are you talking about deflation of the credit supply? How do you intend to avoid that after a bubble bursts? More credit? Stimulus cheques? Money printing?

  • Paul Marks

    As a boy (and I mean as a child – I was a serious minded boy) I considered the posibility of a final bailout.

    The government would print (litterally print it – not have the Bank of England write a cheque to itself) and GIVE these notes (as a present) to the banks, on condition that they were used to make sure that total loans (etc) were 100% covered by cash deposits – and that no more credit expansion would take place.

    Serious students of the Austrian School will be noting all the errors in my youthful position outlined above (which I, much later, found out was not even orginial – varous members of the old, interwar, Chicago School had thought of it all decades before I was born) – however it was not the economics errors that led to me giving up the position (I did not know enough economics at the time to see that there were any errors – I was that ignorant), it was the POLITICS.

    Governments do not bailout banks to end credit expansion – they bailout banks to MAINTAIN AND EXPAND the bubble “boom”.

    Even now the British and Amercian governments are doing all they can to “support house prices” and all the rest of the nonsense.

  • Nuke Gray

    So THAT’S where the IPCC hockey stick went to!

  • Penn

    The Fed’s criminal inflationary enterprise was inspired by – surprise, surprise! – Milton Friedman.

    That according to Reason Magazine.