Understanding "The Fed"

The Federal Reserve

Republican presidential candidate Ron Paul can, and should, be admired as a taxpayer advocate and wary watchdog over federal government waste and mismanagement.

Unfortunately, his well known 2002 proposal to abolish the Federal Reserve, for which he is lionized by many conservatives, is based on a profound misunderstanding of The Fed, its function and its purpose.

That was apparent yesterday when Federal Reserve Chairman Ben Bernanke testified before the House Financial Services Committee and was questioned by Congressmen Paul and others.

We always fear what we don’t understand. Its high time all of us better understood The Fed.

The Dual Mandate

Price stability and Maximum Employment
– Ben Bernanke, U.S. House of Representatives testimony, 2/29/2012

Chairman Bernanke repeated that statement numerous times during yesterday’s testimony. That is the dual mandate set forth by Congress that The Fed is charged to uphold. The Fed has a variety of “tools” at its disposal to fulfill its dual mandate authorized by Congress.

The price stability mandate means The Fed is authorized to take action to prevent either inflation or deflation, usually by adjusting interest rates on loans to member institutions.

This first mandate was part of The Fed’s original charter. Before that, particularly in the late 1800s, prices were highly unstable and depressions, then called “panics“, were common. The Fed was created in 1913 to stabilize financial markets and prevent panics.

The maximum employment mandate was added later. The Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 is the primary act passed by Congress that solidified this Federal Reserve System mandate. Its straightforward purpose is to institute fiscal policies that promote job growth.

Purpose of The Fed

The Federal Reserve System’s duties fall into four general areas:

• Conduct the nation’s monetary policy
• Supervise and regulate banking institutions
• Maintain the stability of the financial systems and contain systemic risk
• Provide financial services to depository institutions, the government and foreign central banks

Those duties are guided by the dual mandate. All four areas were stretched to the limit and beyond over the last four years in response to the Great Recession.

The Fed is the central bank of the United States.

Congressional Pontification

Yesterday’s testimony by Bernanke before the House (and today’s testimony before the Senate) is used by Congressmen and Senators to make speeches and score what they hope will be political points supporting their particular biases.

Asking substantive questions is a secondary purpose.

During testimony, Congressmen demonstrated appalling ignorance. These are the people we elected to oversee The Fed. Voters have not done their job selecting representatives very well.

To his great credit, Chairman Bernanke handles Congressional political axe grinding with amazing patience, grace and understanding… no matter how many times he has to give the same answer to the same questions asked in different ways and from opposing political positions. Bernanke deftly avoided making political judgments when prodded.

The man deserves the Presidential Medal of Freedom for all that. I’d have probably called some Congressmen idiots to their face.

Every committee member present  – and there were a bunch! – regardless of party, stood on their soap box and preached.

Congressman Ron Paul

Congressman Paul, like the others, wandered aimlessly through his 5 minute allotted time. He asked Bernanke if he did his own shopping. (answer: yes) At one point he pulled out a silver coin and pointed out how much more it is worth now than just a few years ago. He once again asked Bernanke if he would consider an alternative metal-based money standard.

Bernanke kindly said that Congressmen Paul was free to buy as much gold or silver he would like and hold onto it if he wanted to.

What he did not say is you cannot fulfill the price stability mandate under the gold standard. That is why it was done away with back in the 1930s.

Even much-misunderstood “quantitative easing“, the so-called printing of paper money, is necessary to maintain price stability. A nation’s money supply must balance with its true wealth to maintain price stability.

Congressman Paul, like many Americans, cannot grasp that concept.

Conclusions

Its a scary thought, but it is clear from yesterday’s House testimony that most members of the House Financial Services Committee do not understand The Fed, how it works or what it does.

It appears from their questioning that Congress thinks the Federal Reserve System is a contrivance to be manipulated to meet a political objective.

The scariest part of all is that the Federal Reserve System is under the direct supervision of the legislative branch of government. It can only do what is authorized by Congress.

Congressman Ron Paul goes one step further. He treats it with deep seated mistrust and believes it should be abolished and that we return to the gold standard.

Though it is advisable to always maintain a healthy skepticism of big government, we need to fully understand what we oppose before we throw the baby out with the bathwater.

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