To evaluate the history of the Federal Reserve System, we cannot help but wonder, whither the Fed? and to consider wherefore its reform—even what and how to do it. But first let us remember whence we came one century ago.
The End of the Classical Gold Standard
No one knew better than Jacques Rueff, a soldier of France and a famous central banker, that World War I had brought to an end the preeminence of the classical European states system and its monetary regime—the classical gold standard. World War I had decimated the flower of European youth; it had destroyed the European continent’s industrial primacy. No less ominously, the historic monetary standard of commercial civilization had collapsed into the ruins occasioned by the Great War. The international gold standard—the gyroscope of the Industrial Revolution, the common currency of the world trading system, the guarantor of more than 100 years of a stable monetary system, the balance wheel of unprecedented economic growth—was brushed aside by the belligerents. Into the breach marched unrestrained central bank credit expansion, the express government purpose of which was to finance the colossal budget deficits occasioned by war and its aftermath.
The Rise of Discretionary Central Banking
With the benefit of hindsight we can see that quantitative easing (QE) was actually inaugurated with World War I. We can see also that discretionary central banking in the United States coincided with the founding of the Federal Reserve System. After the banking panic of 1907, the Federal Reserve Act of 1913 was designed to provide “an elastic currency” but also to reinforce the international gold standard. Thus, Federal Reserve sponsorship of floating exchange rates in 1971 would become one of the great ironies of American monetary history.
To interpret the financial events associated with the Great War and their effect on the ensuing 100 years, my colleague John Mueller and I have highlighted two crucial events of 1913. First, of course, was the establishment of the Federal Reserve System, and second, the publication by the young John Maynard Keynes of his book, Indian Currency and Finance. The inauguration of the Federal Reserve and the intellectual foundation provided by the monetary ideas of Keynes, taken together, soon gave rise to a perfect intellectual and financial storm—a storm which would last a century.
The Federal Reserve has arrived at last. Exhibit A: The tremendous number of people interested in who would be confirmed as the new Fed Chairman last January.
For monetary geeks like me, it’s an exciting development. It gives me a chance to talk about topics I’ve been interested in for decades, but now with more than two people.
I sincerely hope to use this column to broaden the conversation surrounding the Federal Reserve. Over time, I’ll talk about the usual topics – quantitative easing, tapering, interest rates, etc. But there’s so much more to monetary policy than these narrow issues. What about the very purpose of the Fed itself?
Stock and bond traders spent most of last year in a state of high anxiety over what would happen when the Federal Reserve began "tapering" its monthly $85 billion purchases of Treasurys and mortgage-backed securities. But when the tapering was actually announced in December, the Dow Jones Industrial Average rose sharply, apparently out of relief from all the suspense. Today, after various fluctuations including last week's swoon, the Dow is pretty much where it was back then.
The taper this month will take the purchases down to $55 billion, $30 billion in Treasurys and $25 billion in the tainted mortgage-backed securities that were the product of Uncle Sam's "affordable housing" fiasco of the 2000s. So far, the worst fears of the markets haven't happened.
Why not? One reason may be that the Fed isn't tapering as much as the numbers might indicate.
It is commonly said by Americans that the harder they work, the further they fall behind.
Well, they’re right.
Since 2000, household median income measured by the Census Bureau has only averaged 1.77 percent growth. In the meantime, the prices of staples like food and energy have been skyrocketing.
Oil is up at an average annual rate of 16.18 percent since. Food is up 6.8 percent a year.
Of course, the Bureau of Labor Statistics consumer price index would have you believe that inflation has only averaged 2.43 percent a year since then. But, even then, wages are not keep up with that measure.
Leaving that aside, what we are witnessing today is the wholesale destruction of the American middle class by inflating them into poverty. Every year that goes by, their purchasing power is diminished.
The new Federal Reserve chairman, Janet Yellen, gave a policy speech today at Chicago, where, in a startling gesture, she mentioned three working individuals by name — Jermaine Brownlee, Vicki Lira, and Doreen Poole. They lost their jobs the Great Recession and have been struggling ever since. It was a refreshing, even affecting demarche by Mrs. Yellen, who has made a return to full employment a public priority. She underscored her sincerity by telephoning Mr. Brownlee and Ms. Lira and Ms. Poole before delivering her speech.
All the greater the sense that the three — and the millions of unemployed or underemployed Americans like them — deserve a more radical, more courageous initiative than the bromides they got. Like a look at whether the Federal Reserve itself is part of their problem. We are now in the sixth year of an employment crisis that has consumed an entire presidency. The month that Barack Obama acceded, January 2009, the unemployment rate was at 7.8%, according to the Bureau of Labor Statistics. It reached 10% in October of that year and, while it has slid down somewhat, it has yet to fall below 6.5%.