Sunday, September 23, 2012

Lew Lehrman and Jim Grant: Manage the Fed!

Ron Paul recently held another hearing on monetary policy, this one to explore the importance of interest rate signals in free markets.  This is a very worthwhile topic, as interest rates are the key signal to markets in identifying the market’s views of consumption now vs. consumption later – how much of current consumption goods are to be consumed today vs. used in means meant to support consumption in the future.

The two witnesses were Jim Grant and Lew Lehrman.  There were perhaps a half-dozen congressmen in attendance.  I could not find a transcript, so I offer no quotes from the hearing – all comments from the hearing are paraphrased from the testimony.  Any errors, therefore, are mine.

I was disappointed in this hearing, especially the testimony of Lehrman.  My disappointment centers on the answers to questions raised around the propriety of having a central bank.  Both witnesses found reason to support a role for an institution granted government monopoly protection in an area of the market where government intervention causes the most havoc and is the most destructive.

I will begin with Grant.  He suggests that the Fed ought to be in business to support an objective definition of the value of the dollar.  He did not say, but presumably by objective definition, he is suggesting the value of the dollar should be held constant to some underlying commodity or basket of commodities.  He went on to add that the Fed should not be shooting for specific target interest rates for various types of credit.  He would let the marketplace determine this.  Having said this, he would not get rid of the Fed, but the Fed should be doing much less than it is doing.

This is an impossibility that Grant is looking for.  The minute a non-market actor – introduced by the government and with all the protections both real and implied that this government backing provides – begins to act, there is no way to know what market interest rates would have been absent the introduction of this non-market actor.  If Grant is looking for the market to set the interest rate signals, why not just allow the market to set the interest rate signals?  Why is it necessary to have a non-marketplace actor involved in setting market derived interest rates?  There are no true market signals once this government-backed actor is introduced.

However, of the two witnesses, Lehrman was far more vocal.  It is not only that I disagree with his view on this subject, but his own words betray the possibility of successfully achieving this wishful objective.

Lehrman suggests that the Fed is an appropriate institution if it stays focused on buying business loans instead of government and mortgage loans – just like what Carter Glass intended when the system was designed in 1913.  As part of this charter, the Fed should maintain the value of the dollar to gold, and limit the commercial paper to maturities of 90 days or less.  Lehrman is describing the centralization of Real Bills.

Why is it necessary for the government to establish an institution to provide commercial credit, or even to facilitate the market?  Is there some reason this market cannot function without the government’s involvement?  And if it cannot, does it not suggest that the market does not view this means of extending credit as efficacious or efficient?

Lehrman emphasizes that the solution today is to embrace the original Federal Reserve Act of 1913.  He then immediately recognizes that the Fed followed this prescription for only a “very few moments” where it conducted itself in accordance with Article 1 of the Constitution sections 8 and 10. 

Here Lehrman enters into his own version of cognitive dissonance.  He recognizes that the original Fed charter was violated almost from the beginning.  Every apologist for the Fed, and specifically those who point to the original act as a good act, ignore this most basic issue: centralization and monopoly protection will lead to corruption of the system.  Once granted monopoly power, it was certain that the authorization would be expanded.  It was certain that the institution would be used for means beyond that which was intended.  There is no way to establish a monopoly and expect that the monopoly will remain within its fence – especially a monopoly over money, the most powerful monopoly on earth.

Lehrman then adds that the Federal Reserve should be guided by very careful rules, conducting its policies consistent with the activities of the free market and a free people.

How is this possible?  How can a few men, armed with statistics and data that do not in any case capture the possibilities of the human actors supposedly being measured, act in a manner consistent with the free market?  Proportionately, the power concentrated in these few men is far greater than they would enjoy in the free market.  How can this not be distortive?

Upon questioning by Ron Paul, Lehrman argues these purchases of short-term commercial paper would not be monetary inflation because the purchase of commercial bills goes to solvent firms.  They sell the goods and then repay the loans, which mature in not more than 90 days.   Further, this activity would not affect interest rates beyond what the markets would have done absent the Fed. 

I know Ron Paul doesn’t buy this.  First to the simple item – how can the Fed enter the market for commercial bills and NOT affect interest rates beyond what would have happened in a free market?  This is nonsensical.  As to the inflationary aspects, Mises dealt with this.  Expansion is expansion.

The issue of the Federal Reserve specifically, and central banking generally, is the monopoly.  There can be no rules designed that will withstand expansionary pressure by the institution and the constituents that would benefit from the expansion.  There can be no chance that the designers of the rules will not succumb to the temptation of gains to be had by allowing the rules to be bent, then stretched, then broken.

During the 1930s, Congress had a choice regarding the Federal Reserve and the violations committed almost from its introduction in 1914.  They could have punished it for the by-then-obvious fact that it greatly exceeded its charter, or they could have authorized it to act in the manner it had been doing in violation of its charter.  They chose the latter.

Jim Grant and especially Lew Lehrman somehow believe it will be different this time.  It will not.  To advocate any role for an institution with money-monopoly power, granted special privileges to compete in the market, is asking to be walked down the path we have already tread – with equal, disastrous results.

Either you believe in markets or you don’t.  Either you believe in price signals from markets, or you don’t.  There is no middle ground that will remain tame.  To varying degrees, these two witnesses are suggesting there is a middle ground.

Ron Paul wrote the book “End the Fed.”  He did not write “Manage the Fed.”  It is disappointing, and somewhat curious, that his singularly unique career in Congress would come to an end on such a note.

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