Fed Up

Ron Paul, 05.15.09, 07:10 PM EDT

Audit the Federal Reserve.

The Federal Reserve's recent and unprecedented actions in the realm of monetary policy have provoked a backlash among the American people. Trillions of dollars worth of loans and guarantees have been provided to Wall Street firms, while Main Street Americans suffocate under harsh taxation, the prospect of higher debt levels and increasing inflation. These events have awakened many Americans to problems with the Fed's loose monetary policy, the bubbles it has created in the past and the potential hyperinflation it might cause in the future.

One of the fallacies of modern economics is the idea that a central bank is required in order to keep inflation low and promote economic growth. In reality, it is the central bank's monetary policy that causes inflation and depresses economic growth. Inflation is an increase in the supply of money, which in our day and age is directly caused or initiated by central banks. All other things being equal, inflation results in a rise in prices. A so-called "mild" rate of inflation of 3% per year leads to a 56% rise in prices over a 15-year period. Even a "low" rate of inflation of 2% per year leads to a 35% rise over that same period. How is that conducive to long-term growth?

A common misconception is that the Fed is completely independent of political pressures. While the Fed has far too much authority to make agreements with foreign governments and central banks, or create temporary liquidity facilities, the governors and--more important--the chairman, are appointed by the president.

The chairman is the dominant figure within the Board of Governors and the Federal Open Market Committee, the public face of the Fed, and he must be reappointed by the president every four years, with the advice and consent of the Senate. Thus, his job security as chairman is dependent on keeping the president and the Senate pleased. Every time the chairman acts, it is with the knowledge that within four years he will be called to the carpet to account for his actions. This necessarily leads to a focus on short-term economic growth, reflected in the Fed's attempt to manage and publicize certain statistical economic indicators.

While I am a proponent of eliminating the Federal Reserve System altogether, I believe that as long as the Federal Reserve exists it should be fully audited. According to current federal law, the Fed's agreements with foreign governments and central banks--and, more important, its open market and monetary policy operations--are exempt from an audit by the General Accounting Office. As the GAO observed in the 1970s, the last time the issue of an audit really came to the fore, "We do not see how we can satisfactorily audit the Federal Reserve System without authority to examine the largest single category of financial transactions and assets that it has." The Fed has such broad power to intervene in the economy and to engage in agreements with foreign governments and central banks that it is unconscionable that such actions are exempt from oversight.

The Fed's open market operations are not at all neutral in allocating credit. The Fed creates new balances out of thin air and uses those new balances to purchase Treasury bills from banks. Thus the banking sector is the first to get the use of the new money created in these bank balances. As this new money circulates through the economy, prices rise, and individuals further down the chain experience a higher cost of living before their salaries rise.

The fact that a single entity, the Federal Reserve, engages in and has a monopoly on monetary policy has detrimental effects on the economy. As long as we try to keep up this fiction, that the Federal Reserve has a long-term focus, that attempting to fix interest rates will not distort the economy, and that the Fed can end a recession by injecting liquidity, we will never free ourselves from the booms and busts of the business cycle.

The necessary first step to restoring economic stability in this country is to audit the Fed, to find out the multitude of sectors in which it has involved itself and, once the audit has been completed, to analyze the results and determine how the Fed should be reined in. Proposals to push the Fed back into the shadows, or to give it an even greater role as a guarantor of systemic stability, are as misguided as they are harmful.

If Congress fails to scrutinize the Fed and the actions of its unelected bureaucrats, it will only have itself to blame as this country's economy crashes and burns.

U.S. Congressman Ron Paul represents the 14th district in Texas.