By: Mark Spitznagel
December 26, 2013
One hundred years ago, on Dec. 23, 1913, the Federal Reserve Act was signed into law, giving the United States exactly what it didn’t need: a central bank. Americans had gone without one since the 1836 expiration of the charter of the Second Bank of the United States, which Andrew Jackson famously refused to renew. Not to be a party pooper, but as this dubious centennial is observed, we should ask ourselves: Has the Fed been friend or foe to growth and prosperity?
According to the standard historical narrative, the U.S. learned a painful lesson in the Panic of 1907 that a “lender of last resort” was necessary lest the financial sector be at the mercy of private capitalists such as J.P. Morgan.
A central bank—the Federal Reserve—was supposed to provide an “elastic currency” that would expand and contract with the needs of trade, and that could rescue solvent but illiquid firms by providing liquidity when other institutions couldn’t or wouldn’t.
If that’s the case, then the Fed has obviously failed in its mission of preventing crippling financial panics. The early years of the Great Depression—starting with a stock market crash that arrived a full 15 years after the Fed opened its doors—saw far more turmoil than anything in the pre-Fed days, with some 4,000 commercial banks failing in 1933 alone.
A typical defense acknowledges that the Fed botched its job during the Great Depression, but once the wise regulations of the New Deal were put into place and academic economists realized just what had gone wrong, it was relatively smooth sailing from that point forward. It would be silly, these apologists argue, to question the advantage of central banking now that we have learned so many painful lessons, lessons that Fed officials take into account when making policy decisions.
What about the excruciating pain of the recent past, dubbed the Great Recession of 2008-09? In the five years from 2008-12 almost 500 banks have failed. What would history need to look like for people to agree that the Fed has not done its job?
But wait! The Fed is necessary to the promotion of stable economic growth—or so convention wisdom says. The idea here is that without a central bank, the economy would be plagued by wildly oscillating business cycles. The only hope is a “countercyclical policy” of raising interest rates to cool an overheating boom, and then slashing rates to turn up the flame during a bust.
In actuality, the Fed’s modus operandi has been to trick capitalists into doing things that are not aligned with economic reality. For example, the Fed creates the illusion, through artificially low interest rates, that there is both higher savings and higher consumption, and thus all assets should be worth more (making their holders invest and spend more—can you say “bubble?”). The perpetuation of this trickery only delays the market’s eventual, and often precipitous, return to reality.
Many economists now recognize that the massive housing bubble of the early and mid-2000s was caused by the artificially low interest rate approach of the Greenspan Fed, enacted in response to the dot-com crash (itself the ostensible result of artificially low rates). At the time, this was viewed as textbook pro-growth monetary policy; the economy (allegedly) needed a shot in the arm to get consumers and businesses spending again, especially after the 9/11 attacks.
It appears those “textbooks” are wrong. Economists Selgin, Lastrapes and White analyzed the Fed’s record and found that even focusing on the post-World War II era, it is not clear that the Fed has provided more economic stability compared with the pre-Fed regime that was characterized by the National Banking system. The authors concluded that “the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.”
In other sectors, we don’t normally defer to a committee of a dozen experts to set prices. Yet this is what the Fed does with its “open market committee” that routinely sets a target for the “federal funds rate” as well as other objectives. If we all agree that central planning and price-fixing don’t work for computers and oil, why would we expect it to bring us stability in money and banking?
On this, the 100th birthday of the Fed, it’s time to ask ourselves: Wouldn’t we be better off without a central bank?
—By Mark Spitznagel
Mark Spitznagel is the founder and chief investment officer of the hedge fund Universa Investments and author of “The Dao of Capital: Austrian Investing in a Distorted World” (Wiley, 2013).