Federal Reserve [TWFan55 vs Viking Prince]

[Viking Prince]

As the proponent, I shall get the debate started:

First a very brief history as to why we have a central bank:

The reason for a central banking system is for government control and responsibility for the nation’s money supply. The Federal Reserve is not the first central banking system in the USA. Alexander Hamilton was instrumental in the first central bank and was opposed by Thomas Jefferson. There was a fundamental split in the politics of the time between agricultural interests and city business interests. Eventually the populist rural interests won out with President Andrew Jackson. From 1836 to 1913 the country had no central bank. This was a period with private bank issued currency backed by hard commodity reserves (when honest bankers issued the currency). Eventually the civil war forced both the USA and the rebellious states to issue uniform government currency and set standards for national banks. Without the central banking function there were still panics and runs on the national chartered banks. Liquidity was still a problem.

The Federal Reserve System resolved these problems by consolidating the private national banks into the Federal Reserve System. Now a Central Bank would control liquidity and act as a lender of last resort. The constituent private banks within the system would act as agents of the US Treasury for issuance of Treasury Notes and Bonds. The Federal Reserve would issue currency backed by US Treasuries and commodity deposits (chiefly gold, but also for periods – silver). The commodity backing was ended under the Nixon administration.

The Federal Reserve System is necessary for a modern economy.

The need for a single currency in circulation, bank standards, a lender of last resort, an orderly market for issuing and maintaining liquidity in US Treasury Bonds and Notes are all necessary attributes of any central banking system. A return to non central banking with all of the problems associated with panics, banking reserves, allocation of liquidity between competing national banks is not in the national interest.

Link to Commentary Thread

[Twfan55]

Well, let me begin to counter with this. The FedRes created the Great Depression, and is currently leading us into the Greater Depression through manipulation of the money supply. The solution to years of cheap credit and the bubbles that credit creates is NOT more cheap credit to blow up more bubbles. As we see today, the bubbles the Fed creates eventually pop, resulting in a depression and the search for yet another bubble to prop up today's economic system.

Today's system is a man addicted to heroin. This addict needs more and more of the heroin to get the high or in this case, the drug-like hallucination of economic prosperity. Through the manipulation of the money supply, the Federal Reserve creates booms which lead inevitably to busts. For example, in recent times, the FedRes burst the tech bubble and proceeded to inflate the housing bubble.

This leads me to state how eventually the addict overdoses and dies due to the usage of a massive amount of the drug, comparable to the one last bubble and final hallucination of economic prosperity. The addict is already suffering from the lows of several popped bubbles. The final, largest use of the drug or massive final bubble results in an extreme high and death, much like the future of the US economy if we continue the path we are on.

Now, on to the issue of the central bank solving the issue of bank panics. During the days of the great depression, more than a decade after the creation of the Central Bank, there were still many bank runs on banks.

The Federal Reserve System is necessary for a modern economy.

The need for a single currency in circulation, bank standards, a lender of last resort, an orderly market for issuing and maintaining liquidity in US Treasury Bonds and Notes are all necessary attributes of any central banking system. A return to non central banking with all of the problems associated with panics, banking reserves, allocation of liquidity between competing national banks is not in the national interest.

Once again, there is fault in this theory due to the false understanding of history along with the lack of mainstream understanding of today's problems. The monopoly on currency held by the FedRes removes all competition with that currency, and allows the FedRes to inflate at will and leaves the people little alternative to escape from the infamous "Inflation Tax". On the broad topic of banking standards, I would request you provide more information on the standards you refer to. Next, on the issue of the lender of last resort, the fatal flaw is the arguement itself. It encourages malinvestment and moral hazard. If big banks know they will recieve a bailout package although they have failed, it leads to the lack of consequence for that bad decision.

The FedRes does not need to control the market. This alludes to my previous point of the downfall of the addict to heroin and his addiction to the drug which represents the FedRes' harmful addiction to an economy based on bubbles.

Although you say that "A return to non central banking with all of the problems associated with panics, banking reserves, allocation of liquidity between competing national banks is not in the national interest" a decentralized system shows more benefits to America at large through the choice of currency, competition and variety in banks, and economic freedom in general.

Finally, I would like to conclude with this comical video from Newstopia that explains the revolving door system of the FedRes.

[Viking Prince]

There are a great many points to be made. I am going to focus on one piece of your opening remarks in the spirit of not producing a thesis paper and completely flooding the debate:

Many actions by the government made conditions worse in depressions and panics. This need not be an argument against the existence of a central bank, but can be simply an argument for better management of the system.

You give the example of manipulation of the money supply to create asset bubbles. This is certainly a possibility. Recent experience seems to support this. This is the eternal debate regarding easy credit and how to expand the economy. Again this is not limited to the existence of a central bank. Asset bubbles are not well understood. We can clearly see there existence after their formation, but we do not really understand why they appear. Examples from history include tulips and spices.

However, I do not think the Federal Reserve actually does manipulate the money supply to create or manage asset bubbles. A May 15, 2008 speech by Federal Reserve Governor Frederic S. Mishkin gave titled, “How Should We Respond to Asset Price Bubbles?” seems to support my point. I recommend reading the speech (Source). I am presenting excerpts here:

Spoiler Alert, click show to read: 

Despite the clear dangers from asset price bubbles, the question remains as to whether central banks should do anything about them....

A special role for asset prices in the conduct of monetary policy requires three key assumptions. First, one must assume that a central bank can identify a bubble in progress. I find this assumption highly dubious because it is hard to believe that the central bank has such an informational advantage over private markets...

A second assumption needed to justify a special role for asset prices is that monetary policy cannot appropriately deal with the consequences of a burst bubble, and so preemptive actions against a bubble are needed....Yet there are several reasons to believe that this concern about burst bubbles may be overstated. To begin with, the bursting of asset price bubbles often does not lead to financial instability...Japan's experience is that the serious mistake for a central bank that is confronting a bubble is not failing to stop it but rather failing to respond fast enough after it has burst....

A third assumption needed to justify a special focus on asset prices in the conduct of monetary policy is that a central bank actually knows the appropriate monetary policy to deflate a bubble....Given the uncertainty about the effect of interest rates on bubbles, raising rates to deflate a bubble may do more harm than good.

This does not sound like the Fed is actively creating or manipulating the asset bubbles. That does not mean the Fed does not do anything, but the actions are indirect such as reacting to rapid changes in pricing and instability in markets due to illiquidity for example.

Government regulations to tighten or loosen credit were also present during the periods when central banking was not in effect. The National Bank charters are one obvious example. The active management of the value and availability of money is of course not limited to the current fiat system in place -- it is essential to a fiat system though. I am curious how you would manage this without a central banking function.

Additional comments on your opening remarks:

What do you mean by “choice of currency”? Are you advocating I begin to print VikingPrince Notes and go down to my local grocery? In practice, I have not handled more than a few hundred dollars of printed currency in the past year. I use digits on plastic which are only possible due to a central banking function and the creation of a uniform medium of exchange.

The banking system is decentralized. There are a large number of banks in competition with each other. There are also a wide variety of types of financial institutions – State chartered banks, credit unions, payday loans, consumer finance, credit cards, stock brokerages, etc. There are also choices as to where and how you participate in banking functions with the local grocery store, the internet, the local ATM, the traditional bank with marble teller windows, etc. But the debate is not about private banks nor is it about their regulation. It is about the existence and usefulness of a government central banking system.

I will return to your opening remarks later, but I do not want the debate to stall for several days as I work on responses.

Regards.

[Twfan55]

However, I do not think the Federal Reserve actually does manipulate the money supply to create or manage asset bubbles.

First of all, that is a misconception, and I will counter by citing this article about the Fed. Some excerpts are below

Source-http://www.fee.org/Publications/the-Freeman/article.asp?aid=8321

Spoiler Alert, click show to read: 

The Fed engages in a countercyclical policy: stimulate the economy when it begins to slow down and dampen it when it gets “overheated.” The Fed stimulates by injecting new money into the market, and takes away the stimulus by removing money from the economy. It injects new money into the system by buying Treasury bonds from banks, a process called open-market operations. When the Fed buys the bonds, private banks get the newly created money (called reserves). The forces of competition among banks flushed with new money drive down the price of borrowing—the interest rate—which increases consumption and investment, stimulating the economy.


The problem is that the Fed stimulated too deeply and for far too long. Responding to the recession of 2001, it lowered the federal funds rate (the Fed's main interest-rate target) from 6.5 percent in January 2001 to 1 percent in June 2003, kept it there for a full year despite the fact that the recession ended in late 2001, and then slowly brought it back up over the following two years. The monetary base, the fundamental measure of monetary liabilities created and directly controlled by the Fed, went up 30 percent between December 2000 and December 2004—a significant increase. That large amount of new liquidity first went into bank vaults, from where it was loaned out. The problem was that this liquidity was artificial: it did not consist of individuals' savings, their forgone consumption and sacrifices. It thus fooled most people into thinking that they had somehow escaped the bounds of scarcity—that they could have their cake and eat it, too.


Low interest rates made borrowing attractive, and people responded by buying homes either to live in or as investments, driving up demand and prices. Banks started cutting back on credit checks when doling out mortgage loans, a fact that some now blame for the bubble. And it is true that the bubble was most certainly exacerbated by securitization, which allowed banks to sell their mortgages to hedge funds and avoid holding risky loans. This created incentives for banks to seek out the high-risk marginal borrowers. Hence the infamous “NINJA” loans—No Income, No Job, No Assets.


However, banks were simply responding to the distorted signals in the real-estate markets. Finding themselves swimming in money, they did the only thing they could to get rid of it all: lower the standards on who could get the mortgage loans. As long as housing values were going up so rapidly, they couldn't lose by making loans, even to high-risk borrowers.
So if the Fed's expansion of liquidity is the cause of the current mess, can more of it save us? Indiscriminately pumping up liquidity will certainly lead to price inflation, of which there are now increasing signs. When the Fed last opened the money spigots, we saw the dollar plummet against all major currencies, leading to a dramatic rise in the price of oil, commodities, and food. The media and the politicians seem utterly oblivious to the monetary cause of these problems. We are already beginning to deal with the consequences of inflation: cost-of-living increases as prices rise faster than our incomes, destruction of our savings, difficulties setting long-term contracts under inflation uncertainty, and maybe most important, distortions of relative prices, making economic calculation by entrepreneurs and consumers much less reliable.

This article clearly states the problem with the theory that the Federal Reserve actually does manipulate the money supply to create or manage asset bubbles, so on to my explanation of choice of currency.

The issue of the one centralized currency which the FedRes produces is the issue of a large centralization itself. When you have one Super-Bank issuing the currency, the system will rise and fall together. When said currency is booming due to a central banking related bubble, the economy will have the drug-like hallucination of economic prosperity, but when the bubble eventually pops, the issue of the loss in value, for example, the housing market, causes not only a hurting economy, but a hurting middle class due to mislead decisions.

With several strong, diverse, currencies general economic stability is much more likely thanks to the free market. If one currency tanks and its strength decreases, the other currencies will have retained their values, resulting in as much stability as the owner of the currency chooses to have. A uniform system of exchange is still possible in a Free Market System without a central bank. This is as long as people accept the currency that has been issued. Although it would be very unlikely for a business to accept the VikingNotes, they have the freedom to and may choose to take that risk of accepting that currency. Realistically, a retailer or business has the choice to accept warehouse notes based on gold, illegally circulated monopoly money, (See Article 1 Section 10 of the U.S. Constitution) or interest free fiat currency issued by Congress. You can still buy items over the internet as long as the business accepts said currency. That is the beauty of a free market.

. There are a large number of banks in competition with each other. There are also a wide variety of types of financial institutions – State chartered banks, credit unions, payday loans, consumer finance, credit cards, stock brokerages, etc. There are also choices as to where and how you participate in banking functions with the local grocery store, the internet, the local ATM, the traditional bank with marble teller windows, etc.

Although these financial institutions seem to be in competition with each other, all of the above are still bound by the growing regulatory power of the FedRes in the United States. All use the same currency and are under same regulatory jurisdiction of the all-knowing government officials. This leads to conclude that the Free Market System can easily replace a Government controlled Central Bank when it comes to dealing with the economy.

[Viking Prince]

First, I must apologize for the time this has taken to respond. I have written this is an essay form and I have not carefully footnoted the text. I apologize for the length.

First, question to help direct the future direction of the debate. There are always hints when discussing the Federal Reserve System or Central Banking that these are not constitutional or that the precise form is unconstitutional. I need an affirmation that due to the debate question, that this is not an issue within the confines of this debate.

You first point was that the Federal Reserve created the Great Depression. This essay will only be directed to that point. I will post another segment dealing with other issues, but the blame of the Fed regarding the depression needs to be blunted.

The 1920’s had a great many economic forces converging for the first time in history. The speed of innovation and mechanization of many ordinary tasks had increased greatly.

This was especially true with agriculture since the end of the civil war in the 1860’s. The output per acre had increase as well as the acreages under cultivation. This agricultural revolution was due to costs dropping fast coupled with capital and equipment substituting for labor. The improved prospects for a farmer pushed production onto acreage that was more marginal. This was not strictly the Malthusian economic model since it was not tied to increased population, but was a significant reason for the country’s population increasing as well as standards of living.

The increased efficiency of the farms meant that labor that was not deployed into increased cultivation had to venture into the cities. The movement of farm labor and immigration was put to use as modern industry produced all of the appliances using electricity in the modern home as well as mining and transport industries. The beginnings of the consumer society was now maturing. The economy was coal based – railroads, steamships, and electric power generation needed increasing tonnage of coal.

Much labor was still backbreaking manual labor – mining, railroads, construction and even much of the factory work. This began to change with the 20th century. Fewer manual labor jobs were needed. The younger generation was getting a better education and was better suited for the new economy.

Now, three factors hit the rural economy – the WWI wartime boom had been converted back to peacetime uses and soldiers had returned to the family farms. The labor force was much more efficient and new job creation required skill and not just a strong back. This resulted in greater numbers of the least educated being displaced into the cities as farmers cut loose their hired hands and their families. The third factor was drier conditions in agriculture. This meant that the newest farms were failing. This meant the farms with the greatest debt. Even while farms were failing, the produce from the agriculture operations continued to rise and pushed prices down. Individual farmers had planned on output based upon previous prices and had borrowed capital to finance the equipment necessary.

While agriculture was going through a huge transition – industry was finding new sources of capital as Americans of all economic positions invested in their futures. It used to be that you need cash to purchase stock, but now bankers were willing to lend the investor against the value of the purchased stock – margin stock purchasing. The leverage was not just a single stage though – trusts were formed to leverage the capital raised in the sale of corporate stock and bonds and the cash was used, again on margin, for the purchase of stock in other corporations.

Previous financial panics, recessions, and depressions were not going to be a good guide for the next one. This was now an economy that was highly leveraged, dependant on consumer purchases, and filled with low educated displaced families unsuited for the new jobs in a new economy. Keynes was partially correct – but he missed the problem of matching the unemployed to the new job opportunities.

The new Federal Reserve was also poorly positioned to assist in the new turmoil. There was the problem of lost consumer demand that was certainly not controllable by the new Federal Reserve System. Banks could not simply rewrite the farm loans – the business plans still needed water that was not available. Labor costs had risen and could not be substituted for repossessed farm machinery. Bank loans on failed draught stricken farms had almost no recovered assets. The real estate has no value if there will not be a farm on the land. The land value is greatly reduced to the value before farming was considered an option. The only real value is in the used equipment and that was usually only a salvage value. The labor was not even in the community – they had already moved to the cities for opportunity.

Banks were able to borrow from the Federal Reserve to meet temporary imbalances in depositor demands – such as planting season, industry payrolls at month end, etc. The Federal Reserve could not make up for lost reserves from loans that had gone bust. Since there was no depositor insurance – there were still bank runs. The movie It’s A Wonderful Life is a perfect example of another problem – the temporary cash pullout from the bank in the movie could have be backed by the Federal Reserve – if it had been a member. It was not a member. This was yet another weakness in the new system.

President Taft had opposed any Central Bank that gave an “unfair” advantage over state chartered banks. Some examples of an unfair advantage – fractional reserve accounting, lower cost deposits, lower capital requirements. These were also the features of a modernizing bank system. The loans were larger and thus more efficient to manage. The businesses were more professionally run and thus the risk of default was lower. Pres. Taft was attempting to preserve a banking system that was going to change and the state chartered banks were not going to remain in their current form. Most of the farm loans and small business loans were with the state charted banks – outside of the Federal Reserve System. A result of an attempt to keep a level playing field and a major error in the central banking system that was in place in the 1920’s.

There were many critics to the Federal Reserve in the days following the market turbulence in 1929 – the problem was the failed bank loans in the preceding decade and the displaced agriculture workers and immigrants that due to age and education were not employable in the new economy. The Great Depression was not fixed until these people had simply aged out of the labor force. Some say FDR did not solve the depression, it was WWII. Not correct, it was time – the 40 year olds in the cities unemployed in 1925 would be 60 during the war. The post war boom was a combination of pent-up demand, highly skilled labor returning to peacetime uses, two decades of innovation awaiting a new consumer economy, and all of the old guys on pension or deceased. The GI Bill also gave society a buffer of a few years as many soldiers improved education levels before entering the labor pool. Note – the Federal Reserve was neither the cause nor the solution to the Great Depression.

Does this mean that people cannot make judgment errors? No, of course not – mistakes are real possibilities whenever people need to make judgments and take actions. Could different actions have been possible? Yes. The Federal Reserve System is improved with time and more of the banking system is under the support and banking regulations of the federal government. This should be the final word in this debate on whether the Federal Reserve is responsible for lengthening the depression.

[Twfan55]

This should be the final word in this debate on whether the Federal Reserve is responsible for lengthening the depression.

First of all, I would like to reply to this statement with a quote from Fed Chairman Ben Bernanke during a speech given for Friedman's 90th Birthday.

I would like to say to Milton and Anna: Regarding the Great Depression, you’re right. We did it. We’re very sorry.

Basing my arguement on this point, I believe that FedRes is not beneficial in an economy not only because of the dangers of a centralization of power, but also because of the special interests and corruption in the system as shown in the Great Depression.

As previously stated by you before, better decisions could have been made by the FedRes. According to Friedman, the three reasons for the FedRes "mistakes" are shown below.

Spoiler Alert, click show to read: 

1) the Fed officials did not fully understand the disastrous consequences of letting so many banks go under. Friedman and Schwartz wrote that Fed officials may have “tended to regard bank failures as regrettable consequences of bank management or bad banking practices, or as inevitable reactions to prior speculative excesses, or as a consequence but hardly a cause of the financial and economic collapse in process”

2) Fed officials may have been acting out of their own self-interest since many of them were affiliated with large Northeastern banks. Bank failures, at least in the early stages, “were concentrated among smaller banks and since the most influential figures in the system were big-city bankers who deplored the existence of smaller banks, their disappearance may have been viewed with complacency”

3) The inactivity may have been caused by political infighting between the Federal Reserve Board in Washington, D.C., and regional Fed banks, in particular the New York district bank, which was the most important part of the system at that time.

Now, continuing on your statement that different decisions in a time of crisis could have been made, some economists say if there was no corruption in the system or more knowledgeable people running the show, the Fed may have taken an action equivalent to a bailout today. Since the FedRes chose to do nothing, the problem supposedly grew because the lender of last resort was not there to swoop in and save the day.

Moving on, it may appear that I seem to be stating something very contradictory to the Austrian School of Economics, but I do not believe a bailout of such or any FedRes actions of a sort would have worked on the basis of the actions made by the FedRes today. The best solution would have been not to have a central bank in the first place. My reasoning for this statement is shown in the spoiler below.

Spoiler Alert, click show to read: 

Had the Federal Reserve System never been established, and had a similar series of runs started, there is little doubt that the same measures would have been taken as in 1907—a restriction of payments. That would have been more drastic than what actually occurred in the final months of 1930. However, by preventing the draining of reserves from good banks, restriction would almost certainly have prevented the subsequent series of bank failures in 1931, 1932, and 1933, just as restriction in 1907 quickly ended bank failures then. . . . The panic over, confidence restored, economic recovery would very likely have begun in early 1931, just as it had in early 1908.


The existence of the Reserve System prevented the drastic therapeutic measure: directly, by reducing the concern of the stronger banks, who, mistakenly as it turned out, were confident that borrowing from the System offered them a reliable escape mechanism in case of difficulty; indirectly, by lulling the community as a whole, and the banking system in particular, into the belief that such drastic measures were no longer necessary now that the System was there to take care of such matters.

-Milton Friedman

This leads me to state, as I said before, that the perception that the Fed does not cause Depressions is a misconception based on a distortion of history and a lack of mainstream knowledge on the issue.

[Viking Prince]

Perhaps you missed this at the start of my post, but it is essential to clear up before I proceed:

First, question to help direct the future direction of the debate. There are always hints when discussing the Federal Reserve System or Central Banking that these are not constitutional or that the precise form is unconstitutional. I need an affirmation that due to the debate question, that this is not an issue within the confines of this debate.

[Twfan55]

Perhaps you missed this at the start of my post, but it is essential to clear up before I proceed:

First, question to help direct the future direction of the debate. There are always hints when discussing the Federal Reserve System or Central Banking that these are not constitutional or that the precise form is unconstitutional. I need an affirmation that due to the debate question, that this is not an issue within the confines of this debate.

No, Constitutionality is not an issue because we are debating its necessity or lack there of in a modern economy. If you want to debate on the Constitutionality of the FedRes later we can.

[Viking Prince]

You are claiming the Federal Reserve does manipulate the money supply to create or manage asset bubbles. I have previously claimed and provided Federal Reserve Governor statement that is not the intention with the Fed’s decision making process. You have cited an article (Source) that showed the effect of Fed actions and not the intent of the Fed. I stand by my prior statements that this is not the intent of Fed policies.


Regarding the Fed and panics: You again focus on the great depression and that there were still many bank runs on banks. But the Fed was not properly equipped at that time to stop such panics and bank runs because of the limited scope of the Fed due to the compromise inherent in the legislation. People such as Pres. Taft whom I cited wanted a balance between state banking and federal banking.

The banking panic of 1893, for example, triggered the nation's worst economic depression to that time, and another severe panic in 1907 gave impetus to the Federal Reserve Act of 1913, which created the Federal Reserve (Fed) as a kind of "decentralized central bank" -- a classic compromise balancing both consumer and commercial interests and containing public and private elements.

The Fed proved unable to prevent the Great Depression of the 1930s, during which nearly 10,000 banks failed. But the Banking Act of 1935 provided several vital reforms. Among them was establishment of the Federal Deposit Insurance Corporation to insure bank deposits.

Source

This was a key to preventing such panics for two reasons. First, the safety of individual depositors protected those with little actual knowledge of the risks involved and the internal workings of different banks. Second, this broadened the control of the central bank to many more banks and become the standard for where citizens could confidently place money on deposit.

This was not a complete solution to the problem of future bank runs though since many institutions such as Savings and Loans, Credit Unions, small state charted banks, etc. were either by choice or by state regulation kept separate from the FDIC protections (and also regulatory restrictions on lending and reserves).

As you have pointed out – this does create a problem of moral hazard. You cannot take both sides of the argument though. You cannot criticize the Fed for not preventing panics and runs and also throw up the moral hazard argument when Fed actions prevent such actions by those that are lacking in knowledge and ability to differentiate the relative safety of one bank from another.

If you believe that the central bank is incapable of preventing such panics without creating a moral hazard, please provide a model or system that will accomplish such and not be a central banking operation. The price of taking on the moral hazard is more than offset by minimizing the effect of bank panics and runs today. The Northern Rock run is a perfect example of how a run can still happen when a central bank insurance scheme only covers a percentage of each and every deposit balance and not 100% coverage below a set minimum as FDIC does.

You had mentioned:

The monopoly on currency held by the FedRes removes all competition with that currency, and allows the FedRes to inflate at will and leaves the people little alternative to escape from the infamous "Inflation Tax".

I will simply say that this is a semantic misstatement of what a central bank is responsible to do. There can be no competition in currency. That is the whole point of a medium of exchange. Competition in this sense is simply advocating a barter system. I do not think that you can create a monetary system where you have multiple choices of currency. Retailers do not want to make currency exchange functions between Euros, Canadian dollars, and US dollars. I cannot imagine adding the burden of accepting Twfan55 dollars, Viking Prince dollars and who knows what else.

The “inflation tax” is again simple semantic misstatement by those who oppose a fiat currency. There is no automatic inflation to the system by imposing an income tax that is paid in currency. There is an inflation of the money when the US Treasury finances deficit government spending – this is true with or without a fiat currency and with or without a central bank. Either the money is deflated or the bonds have no backing. Our system has the bonds backed the ability to simply print money. A non fiat system simply has the bonds default. You can make your own choice of systems. I choose to take the fiat system. Either system will still be outside the debate however. This is a debate on the value of a central banking system.

On the broad topic of banking standards, I would request you provide more information on the standards you refer to.

This is where the true value of a central bank exists. It is not to fix panics, but to prevent such problems in the first place. I suggest a reading of Chairman Bernanke’s May 17, 2007 speech involving sub prime lending. (Source)

Broadly speaking, financial regulators have four types of tools to protect consumers and to promote safe and sound underwriting practices. First, they can require disclosures by lenders that help consumers make informed choices. Second, they can prohibit clearly abusive practices through appropriate rules. Third, they can offer principles-based guidance combined with supervisory oversight. Finally, regulators can take less formal steps, such as working with industry participants to establish and encourage best practices or supporting counseling and financial education for potential borrowers.

This is clearly a central banking function. Again you can argue that the congress can simply write the laws and enforce such on a case by case basis, but the central bank is simply an executive branch component for achieving the implementation of the intent of Congress. A simple point can be made here. The central bank is what the federal government wants done. All federal banking operations, functions, regulations are simply bundled into a convenient term – a central bank. If you wish for any of these to not be a part of the central bank, you are really advocating that the federal government not be involved. You are then advocating a state based central bank or a free for all without regulation, oversight, monetary, or fiscal controls. What pieces of the central bank should be placed in a decentralized system?

I think this concludes my response to your second statement.

[Twfan55]

You are claiming the Federal Reserve does manipulate the money supply to create or manage asset bubbles.

Correct, as you can clearly see from my statements above.

I have previously claimed and provided Federal Reserve Governor statement that is not the intention with the Fed’s decision making process.

You have cited an article (Source) that showed the effect of Fed actions and not the intent of the Fed. I stand by my prior statements that this is not the intent of Fed policies.

My first response to this statement is nothing more than a quote.

In politics, nothing happens by accident. If it happens, you can bet it was planned that way.
-FDR

Being very blunt, the evidence I have previously presented leads me to a commonly used idiom. "Actions speak louder than words" You have presented a portion of a speech, and I have shown the result of the absurd actions of the FedRes. You say the effect of the Fed's policy's are not the true intentions, but true intentions lie only in ones mind. The good intentions you hint to are only assumed.

Now that my little philosophy points are finished, I will focus on your next statements.

Regarding the Fed and panics: You again focus on the great depression and that there were still many bank runs on banks. But the Fed was not properly equipped at that time to stop such panics and bank runs because of the limited scope of the Fed due to the compromise inherent in the legislation. People such as Pres. Taft whom I cited wanted a balance between state banking and federal banking.

This was a key to preventing such panics for two reasons. First, the safety of individual depositors protected those with little actual knowledge of the risks involved and the internal workings of different banks. Second, this broadened the control of the central bank to many more banks and become the standard for where citizens could confidently place money on deposit.

This was not a complete solution to the problem of future bank runs though since many institutions such as Savings and Loans, Credit Unions, small state charted banks, etc. were either by choice or by state regulation kept separate from the FDIC protections (and also regulatory restrictions on lending and reserves).

As you have pointed out – this does create a problem of moral hazard. You cannot take both sides of the argument though. You cannot criticize the Fed for not preventing panics and runs and also throw up the moral hazard argument when Fed actions prevent such actions by those that are lacking in knowledge and ability to differentiate the relative safety of one bank from another.

If you believe that the central bank is incapable of preventing such panics without creating a moral hazard, please provide a model or system that will accomplish such and not be a central banking operation. The price of taking on the moral hazard is more than offset by minimizing the effect of bank panics and runs today. The Northern Rock run is a perfect example of how a run can still happen when a central bank insurance scheme only covers a percentage of each and every deposit balance and not 100% coverage below a set minimum as FDIC does.

First of all, I am not taking both sides of the arguement. To clarify the statement I made regarding the lack of power to take decisive action, I said that even if the FedRes had the power to take the action you had claimed was needed, they would have wasted a large amount of money and would have done little to solve the crisis.

Onto the moral hazard point, the FDIC is a soft version of Socialism in which failure is rewarded. To the people, tax money is redistributed to others who have failed to educate themselves on the basic workings of a bank. On the business side of things, the FDIC rewards the banks for making too many risky loans. This allows banks to take the money the depositors placed in the bank with little or no consequence. Although everything may seem O.K. the tax money of others is being given to those that partook in the malinvestment.

Hypothetically, say China, Bill Gates, and Donald Trump decided to place all their money in one 100% insured FDIC account in the Bank of America. Bank of America crashed and FDIC, insuring these people, would have to get their money back. Would you like your tax dollars and/or your grandchildren's to be used to pay for these peoples failure to make a safer decision? I certainly would not.

You had mentioned:

The monopoly on currency held by the FedRes removes all competition with that currency, and allows the FedRes to inflate at will and leaves the people little alternative to escape from the infamous "Inflation Tax".

I will simply say that this is a semantic misstatement of what a central bank is responsible to do. There can be no competition in currency. That is the whole point of a medium of exchange. Competition in this sense is simply advocating a barter system. I do not think that you can create a monetary system where you have multiple choices of currency. Retailers do not want to make currency exchange functions between Euros, Canadian dollars, and US dollars. I cannot imagine adding the burden of accepting Twfan55 dollars, Viking Prince dollars and who knows what else.

This medium of exchange you speak of can be decided by a Free Market System. The only thing that has to be done is enough business and people say that they will accept this form of currency. This currency can be fiat and issued by a central bank, backed by gold and issued by the King of England or drawings of spiders I copied on my printer. This is the beauty of a free market. if the medium of exchange currency tanks, another one will soon take its place.

The “inflation tax” is again simple semantic misstatement by those who oppose a fiat currency. There is no automatic inflation to the system by imposing an income tax that is paid in currency. There is an inflation of the money when the US Treasury finances deficit government spending – this is true with or without a fiat currency and with or without a central bank.

Either the money is deflated or the bonds have no backing. Our system has the bonds backed the ability to simply print money. A non fiat system simply has the bonds default. You can make your own choice of systems. I choose to take the fiat system. Either system will still be outside the debate however. This is a debate on the value of a central banking system.

I agree with this statement for the most part. The inflation tax is not a real official tax of sorts, but a concept that shows how a fiat currency is more easily abused than one backed by a precious metal to fund deficit government spending. It can take place with a central bank or not, but a central bank makes it much easier to abuse the fiat system. It is much harder to hold accountable a psuedo-government official than a legitimate elected one.

This is where the true value of a central bank exists. It is not to fix panics, but to prevent such problems in the first place. I suggest a reading of Chairman Bernanke’s May 17, 2007 speech involving sub prime lending.

This is clearly a central banking function. Again you can argue that the congress can simply write the laws and enforce such on a case by case basis, but the central bank is simply an executive branch component for achieving the implementation of the intent of Congress. A simple point can be made here. The central bank is what the federal government wants done. All federal banking operations, functions, regulations are simply bundled into a convenient term – a central bank. If you wish for any of these to not be a part of the central bank, you are really advocating that the federal government not be involved. You are then advocating a state based central bank or a free for all without regulation, oversight, monetary, or fiscal controls. What pieces of the central bank should be placed in a decentralized system?

If you say the FedRes job is to prevent such problems, isn't the best way to prevent a problem not to create one? The problem with the subprime mortgage market is cheap credit. The federal reserve is trying to fix the problems of today and prevent the problems of tomorrow caused by too much cheap credit with the addition of more cheap credit.

What I am advocating is a decentralized system that does not reward failure. The congress would regulate banks in a fair way and manage the monetary supply in a way that they could be held accountable. I am not advocating state banks either, but like I said before, a decentralized system that is fairly regulated and managed according to the Austrian School of Economics is ideal over any system that has been proposed.

[Viking Prince]

I am going to focus on one point from your post:

...a decentralized system that is fairly regulated and managed according to the Austrian School of Economics is ideal over any system that has been proposed.

You claim to be an advocate of the Austrian School, but this is not incompatible with a central banking function. The Austrian school focuses on personal decision processes and the utility derived from economic actions. The school is indifferent to the monetary system that is used. If this is not true, I would certainly like the references.

Central banks were a common part of the economic scene in the late 19th century and not a focus of discussion by Menger or Hayak. The banking systems of the time were commodity based and not fiat. Again – are you suggesting that a commodity based monetary system is preferred? This does not preclude a central banking system as we have previously agreed.

The main attack against a central banking system seems to be the injection on money supply into the system. The criticism seems to be that the injection does not affect all assets equally. This seems to be your criticism of low interest rates and asset bubbles. I will take the liberty in assuming that you mean artificially low rates and not low rates in general. This is a valid observation, but not a serious criticism though. This is more likely another attack on a fiat based monetary system and not a criticism of central banking.

Injections of capital are an essential part of a fiat system. The distortions created are not really different that other distortions to a monetary system. Technological innovation has the same effect. Discoveries of new mineral deposits also have this effect. The economy is always being distorted by change. Such distortions are also possible by speculation and attempts to corner markets by individuals. Your desire for a banking system that does not distort the economy is not possible. If this is true, please explain your reasoning.

I might add that humans do indeed create errors and the level of capital in the system can be at an incorrect level due to human intervention. This is still a problem in a commodity based system also. Constraints of capital expansion do indeed limit economic activity. A commodity based system has the constraint of not being able to increase capital as the economy expands. I prefer the flaws of human judgement in a central bank fiat system over the contraints on expansion in a decentralized commodity based banking system.

[Twfan55]

I am going to focus on one point from your post:

Central banks were a common part of the economic scene in the late 19th century and not a focus of discussion by Menger or Hayak. The banking systems of the time were commodity based and not fiat. Again – are you suggesting that a commodity based monetary system is preferred? This does not preclude a central banking system as we have previously agreed.

Yes, I prefer a commodity based system. Central bank or not.

The main attack against a central banking system seems to be the injection on money supply into the system. The criticism seems to be that the injection does not affect all assets equally. This seems to be your criticism of low interest rates and asset bubbles. I will take the liberty in assuming that you mean artificially low rates and not low rates in general. This is a valid observation, but not a serious criticism though. This is more likely another attack on a fiat based monetary system and not a criticism of central banking.

As you said in an earlier post, the Fed was a bundle of the powers given to branches of the government in one neat little package. Unfortunately, as we realize today, there is a catch to a central bank. It is a lack of accountability. A Congressperson or Treasurer can be replaced relatively quickly, but a psuedo-governmental official such as Helicopter Ben or any of the previous Fed Chairman require nothing less than an act of God to remove them from their position.

Injections of capital are an essential part of a fiat system. The distortions created are not really different that other distortions to a monetary system. Technological innovation has the same effect. Discoveries of new mineral deposits also have this effect. The economy is always being distorted by change. Such distortions are also possible by speculation and attempts to corner markets by individuals. Your desire for a banking system that does not distort the economy is not possible. If this is true, please explain your reasoning.

On the topic of mineral deposits, your statement is true, look at Spain 100 years after the conquering of the gold-laden Aztec Empire. Anyway, what I want is a banking system that lets the Free Market decide the economy instead of distorting the concept of a Free Market with regulation and artificial changes.

I might add that humans do indeed create errors and the level of capital in the system can be at an incorrect level due to human intervention. This is still a problem in a commodity based system also. Constraints of capital expansion do indeed limit economic activity. A commodity based system has the constraint of not being able to increase capital as the economy expands. I prefer the flaws of human judgment in a central bank fiat system over the constraints on expansion in a decentralized commodity based banking system.[/quote]

We can debate monetary systems in another debate, but let me say this, the fiat system is fine, it is the ease of abuse that is its fatal flaw.

[Viking Prince]

It appears then -- a change to the federal reserve central banking system that allows GAO audits would then resolve the main point of contention between our positions to date. I would agree that transparency is preferred with all government activities. This is the best check against human errors which we are all capable of making.

The debate may actually end at this point -- unless you have some additional points to make. I will leave to you for a final summation or if you wish to continue.

I think I have moved slightly -- maybe not in ways that you can detect though.

regards.

[Twfan55]

I would like to conclude with this. In this debate, I opposed the notion that a central bank was not necessary, and counterproductive for a modern economy. The Federal Reserve could be replaced by Congress and the Treasury working together, allowing more transparency, or preferably, a more free market system.

If the United States continues to allow the counterproductive Federal Reserve to stay in operation, it will continue purposely leading Americans to the drug like sensation of economic prosperity and serving only the elite. As I have stated above, the Fed creates the bubble, giving Americans the sensation of a prosperous economy, but eventually the bubble pops, there is a crash and then a depression which is only "solved" by another bubble being formed. Today's failing system can only continue for so long until the final major collapse, which I believe we are seeing the beginning of today with the major inflation of the monetary supply and artificially low interest rates. A free market system would not allow the Federal Reserve to create such problems, and would allow people to be responsible with their own money, making for a much more stable and prosperous economy.

To those that have read this entire debate. I hope you have learned something, as have I also. I wish to thank Viking Prince on the great debate.

[Viking Prince]

Twfan55 had the last word. I will also thank him for his efforts. I am certain I learned as much if not more than he did. I think this was a good first start for us. Takes a great deal more work to give a reasoned debate than firing off in the pit. Thank you.

Regards.

[Каие]

Debate over, good show lads.