Why a Central Bank? Part 3: Modern Debates

This post was prompted by this review of Ron Paul's End the Fed and a subsequent online discussion. By virtue of my economics background, a friend asked me to chime in on why Ron Paul's solution to various economic problems should be discarded as easily as his opponents suggest. Parts 1 and 2 are here and here.

Having covered the background on what money does and how it does it, and followed that by looking at the long history of problems and attempted solutions to a well functioning monetary system in the US, we can consider Ron Paul's arguments. I have to admit up front that my knowledge of them is second hand; I have not read End the Fed for myself, although I have seen the list of consequences in the review and spoken to his supporters. As such, my responses below will be general, and I admit there is a margin of error. If any reader wishes to buy me a copy of the book, though, I promise to read it and respond in more detail (with a shout out to the purchaser as well).

What follows is the nine point list of consequences from ending the Fed mentioned in the review, with my own responses.

1. "It would bring an end to dollar depreciation." Not having read this sentence in context, I do not know whether this refers to the exchange rate between the dollar and other currencies or to problems of inflation. If the latter, then we have seen that eliminating the central bank does not guarantee the end of inflation, since matters of inflation and deflation then depend entirely on what controls money, whether it be commercial banks of the Congress or metallurgical market developments. Based on US history, eliminating the central bank would likely lead to an average deflation rather than average inflation, but this is at least as problematic as inflation and is more historically associated with recessions. If Paul means the former (exchange rate depreciation), then he is complaining about a problem that isn't even a problem. When the dollar deflates relative to other currencies, importing becomes expensive but we reap the gains of increased exports (as any seller on etsy can testify). What we need is a reliable trend in prices, whether it be up, down, or constant; there are many good substitutes for cash as a long-term store of value.

2. "It would take away from government the means to fund its endless wars." As we have seen, governments in general, and the US government historically, have never needed central banks to fund war debt. As long as the government has the Mint, they will have the power to fund wars, and as long as the government has guns, they will have the Mint. Actually, by putting a layer between the Congress and the ability to create money, a central bank actually reduces the capacity to fund endless wars, as long as the Bank is well managed. At its worst, though, a central bank fully accommodating the Congress acts as if no bank were intervening; we can't do much worse on this front than we have done in the Revolutionary War, War of 1812, and Civil War (both North and South) without any central bank. And in so far as expanding the money supply also funds the welfare state (a claim I would want empirical justification for, but it is plausible), what the Mint could do for war it could just as easily do for welfare.

3. It would "stop the business cycle." Given what we talked about last time, I think this requires little response. The complex reinterpretations of Murray Rothbard notwithstanding, I can't really see how anyone can look at the history of money and banking, especially US history, and not see that the business cycle is not at all caused by central banking. At its best, we have solid examples of well led banks, such as the second Bank or the Fed after Volcker's corrective measures, in which the bank greatly reduced the negative impact of the business cycle. It's true, a poorly run or politically associated central bank can make recessions worse, but that is an argument against crappy governance, not against governance itself.
 
4. It would "end inflation." I think I've basically covered this one under 1 above. Let me just reiterate that a predictable, low level of inflation is not actually a real problem in an economy, especially if the alternative is unstable deflation, as would almost certainly be the case in a growing economy with the gold standard. And while the ensuing political struggles could yield great literature like the next Wizard of Oz, I don't see how the economy would be improved by fighting to see who gets to control the monetary system.

5. It would "build prosperity for all Americans." I think we've seen through US history that the only way that the monetary system can help real prosperity is by being relatively stable and allowing citizens to reliably use money for its functions. A central bank that is well governed can do this, while a poorly governed central bank can hurt money's ability to function. Historically, turning over the monetary system to the whimsy of the Congress or the shifts in the gold market don't do much better than a poorly operated Fed could.

6. It would "end ... the corrupt collaboration between government and banks that virtually defines the operations of public policy in the post-meltdown era." We didn't talk about this much, but I think we're all aware that alliances between government and corrupt businessmen has always been a problem. Why Ron Paul thinks a central bank is needed to move money between the hands of businessmen, criminals, and politicians I have no idea. This is a great argument for making the central bank as independent of political and commercial influence as possible, but it is a poor argument for eliminating the Fed and directly turning over the power of printed money to politicians or businessmen.

7. It would "put the American banking system on solid financial footing" and "customers' deposits would be safer than they are today." Again, for banking systems to be solid and deposits to be safe, we need movements in prices to be steady enough that any changes can be written into contracts. If the ideal is constant prices, we need the amount of money in the economy to grow at the same rate as the rest of the economy, which is something gold can't accomplish. Only money that is designed to match output growth can do this effectively, which is after all why the US colonies started letting chartered banks print notes in the first place. What we need is reliable, good governance.

8. It would "end the way in which our electoral cycles have been corrupted by monetary manipulation." As mentioned in 6 above, criminals don't need a central bank to manipulate politics with their dollars. It's true that a poorly led central bank could make this worse, and there is some evidence of it at the Fed: in the 1970's, Arthur Burns seemed particularly susceptible to political pressure. But all this shows is that the man in charge matters, as Nixon himself demonstrated in a similar position. One wonders when Ron Paul's next book End the Presidency or a more pastoral End the Priesthood is coming out.

9. "The national wealth would no longer be hostage to the whims of a handful of appointed bureaucrats whose interests are equally divided between serving the banking cartel and serving the most powerful politicians in Washington." As I've mentioned a couple of times, this is a legitimate concern about how the Fed is managed. But why turning "the national wealth" over exclusively to the whims of either banking cartels, mining company managers, or powerful politicians makes things better.


As we've seen, the money supply will be governed by someone, one way or the other. The question is not whether to govern it, but who should be doing to governing. One of the brilliant results of having a central bank is that it can be managed by a Nicholas Biddle or a Paul Volcker, who resisted the powerful interests seeking control over the money supply. At their worst, central banks manage the money supply in the manner it would be managed if there were no central bank at all.

Given these constraints, and the fact that the president appoints the head of the Fed, I think we should be at least as concerned with who presidential candidates would appoint as Fed chairmen as we are with who they would appoint to the Supreme Court. But "ending the Fed" doesn't seem to really accomplish anything good, especially if you dislike politicians and businessmen having power over your life. In my view, the nature of money and the history of US banking speak out against eliminating the central bank in simpler, clearer language than even the eloquence of Ron Paul can counter.