The House of Representative’s Subcommittee on Domestic Monetary Policy is holding a hearing Tuesday morning called “Improving the Federal Reserve System: Examining Legislation to Reform the Fed and Other Alternatives.” There will be two Congressmen and five professors addressing the Committee about the Federal Reserve, but the highlight should be Dr. Jeffrey M. Herbener’s testimony, which was released yesterday. Herbener, a Professor of Economics at Grove City College, makes a brilliant and detailed case against the Federal Reserve and the justifications used to defend central banking, while providing much-needed alternatives.
The Federal Reserve attempts to establish interest rates (the price of money) and regulate the money supply. But as Herbener argues, this is impossible because a central bank lacks the profit-and-loss price mechanism of the market that is so essential to rational economic calculation. “By subjecting all production, including that of money and baking, to the test of profit and loss, the market renders an integrated system of production that economizes the use of all resources for society at large,” Herbener writes.
Money, like any other good, is subject to the law of supply and demand and only the coordination of the pricing mechanism can determine the right amount of money in the economy. Without the regulation that the market provides, “production of fiat paper money must be regulated by policy;” in other words, by political influences and considerations rather than the desires of producers and consumers.
Defenders of the Federal Reserve make three central claims about paper money that supposedly trump market-based money: that it keeps price levels stable, that it prevents price deflation, and that it can accelerate economic growth. As Herbener explains, nothing could be further from the truth.
“Price stability” actually makes the task of entrepreneurs more, not less difficult. The changing price of money, regulated by people’s demands, can easily be anticipated by entrepreneurs in the same way that the prices of goods and services change. “Entrepreneurs can earn profits and avoid losses by anticipating these changes just as well as changes in prices of other goods. If they anticipate rising prices for goods overall, then they will increase their demands for resources by bidding up wages today. Likewise, lenders will insist on higher interest rates today.” Additionally, “two of the periods of most rapid economic growth in U.S. history were from 1820-1850 and 1865-1900,” where the purchasing power of the dollar doubled.
Central banking supposedly prevents price deflation, where consumers withhold their consumption in anticipation of even lower prices, which then restricts production and employment. Herbener smashes this Keynesian fallacy, arguing “people in the real world can only obtain the services of goods by buying them. They choose at some point, to buy a good even if they expect its price to fall further. This happens every day in markets for consumer electronics as people buy tablet computers, cell phones, and so on knowing that prices will be lower and quality higher in the future.” Falling prices of consumers goods, which benefit the middle-class and poor, are actually one of the best aspects of a recession! Unfortunately, the Federal Reserve, especially in the housing market, keeps trying desperately to keep prices artificially high.
Lastly, there is the claim that a central bank accelerates economic growth. But by regulating interest rates by political consideration and not the market, the Fed produces boom-and-bust cycles, not real growth. “Credit expansion suppresses interest rates below the levels determined by people’s time preferences and increases funds for investment beyond the amount determined by people’s preferences for saving.” Capital comes not from a printing press, but from production and savings, in that order. From the extraction of raw materials to the purchase of the final product at the register, every step must pass the profit-and-loss test. This is how capital, and real economic growth, is created.
I know economics can be a bit dry sometimes, but understanding these basic concepts is absolutely vital. And this is where the massive growth and influence of the Ron Paul campaign is so important. Although he is sweeping state delegates left and right in the presidential race, his real impact has been and will continue to be the spread of sound economics. Can you imagine a House hearing on the Fed with an Austrian free market economist like Herbener without Paul? Or Fed Chairman Bernanke hosting a press conference defending his printing presses against the wave of anti-Fed sentiment?
The rock of secrecy that has protected the Fed, fractional-reserve banking, and the pyramiding of debt is finally being lifted, and the American people don’t like the little they have seen so far. Thanks to Paul, rational economists like Herbener and many more defending sound money, liberty, and free markets finally have a voice. This, more than anything, is Paul’s legacy.