January 22, 2007
The Power to Create Money Posted by John Steele Gordon at 12:10 PM EST Barney Frank, the new chairman of the House Financial Services Committee, is a very liberal Democrat. That’s fine with me, as the people of his district reelected him last year unopposed, which would seem to indicate strong support. And he is also, by all accounts, highly intelligent and a killer debater. But, as quoted in George Will’s recent column in the Washington Post, Rep. Frank has some scary things to say. Quoting Will: “The Fed, says Frank . . . , should not be considered ‘above democracy’: ‘We can debate whether Terri Schiavo’s life should be recognized as over’ and other fundamental questions of existence, ‘but God forbid anybody in elected office should talk about whether or not we need a 25-basis-point increase’ in interest rates. ‘Somehow that’s sacrosanct. No, it isn’t. It’s public policy.’ . . . Frank says Congress should not intervene in monetary policy . . . ‘unless.’ By monitoring whether the Fed’s governors act as they said they would when they were being confirmed, Congress would be ‘setting the predicate for intervention if they act otherwise.’” The Fed, of course, is the Federal Reserve System, the country’s central bank. It is run by a board of seven governors who are nominated by the President and confirmed by the Senate to fourteen-year terms. The chairman and vice chairman are chosen from among the governors by the President, again subject to Senate confirmation, and serve four-year terms. The term of office of the governors is so long (two and a third times as long as the term of a senator, and seven times as long as a congressman’s term of office) precisely to insulate the board from politics. The reason is that the Federal Reserve possesses an awesome power—the power to create money—and history shows as clearly as clear can be that politics and the power to create money should be separated. Indeed history abounds with examples of the disaster that inevitably comes to pass when politicians control the money supply. Governments are always short of money, regardless of how rich the country may be. There is always an infinite demand for government services and grants, and the politicians have to choose which to fund and which to say no to. Politicians, regardless of whether they are of the left, right, or center, hate saying no their constituents. They’d rather say no to someone else’s constituents. Since the money to give out to grateful voters must ultimately come from ungrateful voters in the form of taxes, politicians are forced to make choices and just hope to choose well enough to get reelected. It should never be forgotten that politicians, first, last, and always, are in the reelection business. So if they possess the power to conjure money out of thin air, the temptation to do so, sooner or later, will prove irresistible. Politicians are as human as the rest of us, after all. Exactly how the money is conjured has changed over the years. In the ancient world, the money supply consisted of coins of a given weight of metal—copper, silver, or gold. It didn’t take the kings and emperors long to figure out that if they used just a little less precious metal and a little more base metal in the coins they minted, leaving the face value the same, they could mint more coins and thus spend more money. At first, they probably got away with it. But as the coinage became more and more debased, as the kings kept trying the same trick over and over, the people caught on and took action: prices went up. In the third century after Christ, the Roman Empire, its coinage debased to a fare-thee-well, suffered a severe economic crisis that the emperor Diocletian tried to cure with a new coinage and, since he didn’t have enough precious metal, price controls. The new coinage helped considerably, but the price controls were evaded through black markets and barter, as price controls always are. As paper—backed by assets—began to replace metal as the basis of money, politicians, when they could, began to print their way out of problems. The “Continentals” issued by the Continental Congress to pay for the Revolutionary War were backed by nothing but vague promises for the future. They soon degenerated into worthlessness, and the phrase “not worth a Continental” was part of the American lexicon for a hundred years. Alexander Hamilton established the Bank of the United States, modeled on the Bank of England, which was privately owned despite its public functions as a central bank, to take the power to create money out of the hands of the government. Hamilton minced no words as to why: “It appears to be an essential ingredient in its structure, that it shall be under private not a public direction—under the guidance of individual interest, not of public policy; which would be supposed to be, and, in certain emergencies, under a feeble or too sanguine administration, would really be, liable to being too much influenced by public necessity.” Although the Jeffersonians destroyed Hamilton’s Bank of the United States and its successor, the Second Bank, politicians did not acquire the power to create money, which fell into the hands of the regular banking system (although the federal government issued $450 million in “greenbacks”—paper money not backed by precious metal—to help finance the Civil War). Because the United States lacked a central bank from 1836 until 1913, the business cycle in this country was much more pronounced than in most European countries, alternating between the sky’s-the-limit boom and deep depression. Finally it was recognized, even by the heirs of Thomas Jefferson, that an economy as large and diverse as that of the United States had to have a central bank to control and protect the banking system and, therefore, the power to create money. It took a while to get it right, and the modern Fed only emerged in the New Deal. But while politically insulated, the Fed itself has sometimes been too influenced by “public necessity.” Under Arthur Burns in the 1970s, the Fed focused on accommodating the government’s ever-increasing borrowing needs and rapidly increased the money supply to keep down interest rates. The result was the worst peacetime inflation in the country’s history and a stagnating economy. It was only when Paul Volcker became chairman and focused on controlling inflation rather than interest rates that the situation changed. The result was, first, the most severe recession of the post-war era—the inevitable hangover after the monetary bender of the 1970s—and then a nearly uninterrupted 25-year period of low inflation and ever increasing prosperity and wealth creation (which is by no means the same thing as money creation), the most prosperous quarter-century in the history of the American economy. If ever there was a situation to which the if-it-ain’t-broke-don’t-fix-it doctrine should be applied, it is the political independence of the Federal Reserve. Someone please tell Barney Frank.
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