Has the Federal Reserve been a failure?

Here is a very interesting long paper from December 2010, which I discovered and wanted to share. It digs deep into the premise under which Federal Reserve was formed in 1913. Since then, over the course of multiple worldwide military conflicts, a depression, multiple recessions and recoveries, it has been an omnipresent (seemingly invisible) presence in the lives of millions. Many people may not be actively aware of its day to day existence, or understand how it works in detail, or have just taken its activities for granted. (Cue Wizard of Oz: Pay no attention to that man behind the curtain!) If you live on this planet and participate in global markets, the Federal Reserve does have an impact on your life. Discussion here will mostly be focused on US population, and anyone else dependent on US Dollar as the basis of their transactions.

Although the paper below has 84 pages, from pages 48 onwards it's mostly references and charts. So it's not as long as it appears on first look. I'm quoting the most interesting snippets from my perspective:

Has the Federal Reserve been a failure?

From Page 3, talking about marathon inflationary forces created by the Fed :

The Fed has failed conspicuously in one respect: far from achieving long-run price stability, it has allowed the purchasing power of the U.S. dollar, which was hardly different on the eve of the Fed's creation from what it had been at the time of the dollar's establishment as the  official U.S. monetary  unit, to  fall dramatically.

From Page 38, talking about whether there are any potential alternatives for present course of Federal Reserve, or should we be resigned to status quo? Note that the language is somewhat academic, but the point being made is very crucial :

Coming up with alternatives to the Fed today takes more imagination. Assuming that there is no political prospect of replacing the fiat dollar with a return to the gold standard or other commodity money system, for the dollar to retain its value some public institution must keep fiat base money sufficiently scarce. In this respect at least, our finding that the Fed has failed does not by itself indicate that it would be practical to entirely dispense with some sort of public monetary authority. But neither does it indicate that the only avenues for improvement are marginal revisions to Fed operating procedures or additions to its powers. On the contrary, the Fed's poor record calls for seriously contemplating a genuine change of regime.

 And finally, the damning assessment in "Conclusion" on Page 48 which I was waiting for :

Available research does not support the view that the Federal Reserve System has lived up to its original promise. Early in its career, it presided over both the most severe inflation and the most severe (demand-induced) deflations in post-Civil War U.S. history. Since then, it has tended to err on the side of inflation, allowing the purchasing power of the U.S. dollar to deteriorate considerably. That deterioration has not been compensated for, to any substantial degree, by enhanced stability of real output. Although some early studies suggested otherwise, recent work suggests that there has been no substantial overall improvement in the volatility of real output since the end of World War II compared to before World War I.

Along these lines, here is a very interesting article from January 26 which caught my eye. It appeared in the Wall Street Journal, of all places; which is surprising considering persistent Keynesian inclination of that paper.

Regardless of the discussion of current political happenings in that article, it has never been my intention to publicly endorse any parties/candidates in this blog. Obviously, that doesn't mean I don't have my opinions one way or another. It's just that for the purpose of this blog, I want to keep it uncluttered of political/election/partisan talk, and focus on policies/substance. That's all. 

Federal Reserve, the Need for a Stable Dollar (and Presidential Candidate US Congressman Ron Paul)

The most interesting snippet from this article - which is very much along the lines of above paper - is quoted below.

Dollar weakness doesn't work at all for economic well-being. The corollary to the Fed's policy of manipulating interest rates downward at the expense of savers is declining median incomes. It's no coincidence that inflation-adjusted median incomes rose in the sound-money booms of the Reagan and Clinton administrations and fell in the weak-dollar busts during the Carter, Bush and Obama years. When the currency weakens, the prices of staples rise faster than wages, hurting all but the rich who buy protection. The economy and median incomes would do much better if the Fed said simply that it would set interest rates as best it could in order to keep the dollar's value strong and stable in coming decades, with the goal of attracting capital, maintaining price stability and encouraging full employment. Yet the Fed is adamant that somehow business confidence will benefit by the Fed sharing its guesses on equilibrium interest rates—which after all are far from a science—but not its vital thinking on the future value of the dollar.

And finally, the "announcement" from January 25 by Fed Chairman Ben Bernanke which makes you shake your head in bewilderment :

Ben Bernanke says: No Interest Rate Hikes till 2014!!

Which leads me to my concluding rant:

The idea that a bunch of bureaucrats working on behalf of private bankers could sit in a room, and in Soviet Politburo style make fundamental decisions about long-term interest rate direction is an anathema to fundamental principles of capitalism and free markets. The very basic principles of demand-supply economics, elasticity of free markets, that's what is supposed to determine equilibrium conditions for interest rates. This same elasticity of free markets is supposed to dictate trade patterns. Under those basic conditions, the markets are supposed to DICTATE interest rates. What we're witnessing with arbitrary long-term interest rate decrees is an exactly opposite system flipped on its head : A bureaucracy cooking up interest rates, which dictate market conditions. By definition, the Federal Reserve is behaving as the croniest of the bunch for basis of crony capitalism.

Here is an even more ridiculous fact: Completely unrelated to its original charter from 1913 founding (howsoever dubious that itself might have been), Fed has now even made dictating US employment/unemployment conditions as its charter! What in the name of capitalism is going on with that?

Here is the bottom-line: It doesn't matter how many bureaucrats arbitrarily decide to dictate interest rates and unemployment numbers. It doesn't matter how many cronies working for governments/private banks/lobbies cook up these numbers. In the end, the markets are all ruthless and unforgiving. Demand-supply equations of worldwide markets, physical/human resource limitations, natural calamities, man-made military conflicts, all of these factors are very unforgiving. It doesn't matter how big bailouts are engineered by which cronies. The markets eventually drown out all cronyism. The downside is, when markets are forced to return to their fundamental principles in ruthless manner, they bring misery to lives of countless number of ordinary people. Very select few at the top of crony-pyramid are able to take advantage, before the fundamental market forces come crushing. As a hint, imagine if interest rates are forced to rise to more honest values, how much of havoc it will cause in private banking industry. I hope to elaborate more on that point in near future.

By the way, along the lines of Ben Bernanke's cooked up zero interest rates, I have intended to blog about flurry of refinancing activity for quite a while. As a personal disclaimer, yours truly has taken part in such refinancing of whatever debts on occasion. My objective was to discuss the true value of such refinancing from macro-perspective. The premise being: Long-term predictability of fiat-currency's purchasing power (in terms of physical goods and services) is very bleak. In that context, how much impact would it really make if an individual household reduces their mortgage obligations from $2800/month to $2740/month, if long-term purchasing power of that $2740 is hard to predict? On a macro-level, these low-interest conditions are nothing but an illusion. Anyway, due to time constraints and length of this blogpost, I'll leave that discussion for another post on another day.