Objectivism & Economics, Part 10

The Fed. According to Jerome Tuccille, Alan Greenspan once testified in front of congressional committee that if it were up to him (i.e., Greenspan), the Fed would be abolished. But Greenspan quickly assured the committee that none of his colleagues agreed with him and nothing along those lines would ever be done. In taking this position, Greenspan was merely echoing a view that had long become gospel among his former associates in the Objectivist movement. “ [W]e need to end the government's ability to set interest rates and create inflationary booms—and their inevitable busts—by phasing out the Federal Reserve and allowing the United States to return to a gold standard,” writes the current President of ARI along with coauthor Don Watkins.

Now the real objection that Yaron Brook and other Objectivists have to the Fed is that it is associated with the government at all. It is the federal government’s bank run by the government’s appointees. The complaints about the government setting interest rates and creating inflationary booms and busts is merely an additional rationalization thrown in to strengthen their case. As such, it betrays a poor grasp of the relevant economic and political realities.

In denouncing the Fed, Objectivists tend to be ruled, not by intelligence, but by mere ideological pretension. Their identification of the Fed with “the government” constitutes their first error. It is important in such circumstance to look beyond words and other mere appearances and get at the actual realities. When Objectivists equate the Fed with the federal government, what can they possibly mean? What part of the government is the Fed beholden to? To the executive? To the legislature? To the judiciary? The answer is: the Fed is not beholden to any single authority in the Federal government. The Fed is an independent, quasi-private institution. The original legislation for the Fed intended for that institution to be entirely private. But this aroused fierce political opposition and so a compromised was arranged. Thus the Fed became a quasi-private institution that enjoys real independence from the federal government. The executive branch nominates those who control the Fed, but the nominations are spaced out in such a way that no single administration could ever gain control of the Fed by nominating their own people. As a matter of fact, the whole culture of the nomination process tends to favor choices approved of by Wall Street. Indeed, the Fed is far more likely to be pressured or influenced by Wall Street than by the federal government.

So if the Fed is not the creature of the federal government that it’s painted to be, what, then, is the objection to it? Objectivists might complain about the legal privileges enjoyed by the Fed. But it is not clear that getting rid of these privileges would get rid of the underlying problem. Even if the government had no official de jure bank, it would inevitably have a de facto bank that would enjoy many of the same privileges of a central bank.

Abolishing the Fed would not abolish the government’s need for banking. The government would merely have to do business with a private bank. Yet whichever bank the government decided to do business with would effectively become a central bank in all but name. It would, of course, have no legal privileges; but then again, it wouldn’t need them. The fact of doing the government's banking business would endow it with de facto privileges.

First of all, such a bank, holding, as it would, all the government’s wealth, could not be allowed to fail. No government would ever allow such a thing to occur. But once a bank find itself in a position where it won’t be allowed to fail, many of the other privileges of legally established central banks inevitably follow. Because it won’t be allowed to fail, the bank would become the lender of last resort. This would allow it to set a de facto equivalent of the discount rate, just as the Fed does today.

One privilege such a private bank would not enjoy is the ability to engage in Open Market Operations. While some laissez-faire ultras might regard this as positive benefit, it is actually nothing of the sort. The Fed’s ability to engage in Open Market Operations is its one redeeming characteristic. For even if no Fed existed, Open Market Operations would still take place; only, instead of being conducted by an independent body, they would be conducted by the Treasury, under direct supervision by the President himself. Anyone who believes that would constitute an improvement suffers from an egregious naivete. The one advantage that the Fed brings to the table is that it prevents the executive or the legislature from having direct control over Open Market Operations. How important is that? Very important. It is through Open Market Operations that monetary policy is conducted. Any control that the Fed has over real interest rates and inflation is almost entirely exercised by buying or selling government securities to banks. Now it is important to understand that Open Market Operations are not a consequence of the Federal Reserve. Any militarily powerful and solvent government would be able to conduct monetary policy, by virtue of the fact that is has ample revenues. All that money concentrated in one institution would give that institution an inordinate influence over the banking system, regardless of any “legal” prerogatives it may or may not enjoy. Objectivists are naive about this because they are more concerned with defending their ideological convictions than they are with understanding the sobering truths of government finance.