Tuesday, June 15, 2010

That Ship Has Sailed

We hate to do it, but we have to interrupt our regularly scheduled rant for this important news bulletin. Yesterday's Wall Street Journal carried an editorial in its "Review and Outlook" section expressing serious concerns about the direction in which the Federal Reserve appears to be headed.

There is, for example, a definite possibility that credit could be allocated based not on the financial feasibility and present value of a capital project, but on the sex and ethnic background of the loan applicant. The Journal pointed out that this was how we got into the sub-prime mortgage meltdown in the first place.

Paradoxically, the Journal's concerns were expressed in terms of how such political credit allocation would affect the presumed independence of the Federal Reserve. In light of that, we felt compelled to send the editors a news flash: the Federal Reserve has not been independent since 1916, when it was hijacked by politicians afraid to raise taxes for their constituents, preferring to leave the bill for us to pay.

The following letter was shortened; we sent in only the first two paragraphs in the hope that it might get published. What follows is the full monty:

Dear Sir(s):

Your concern over the politicizing of the Federal Reserve is well founded, but late ("Review and Outlook," Wall Street Journal, 06/14/10). The Federal Reserve has been "independent" in name only since 1916. The Fed was diverted from its primary purpose of providing an elastic currency to meet the needs of the private sector by rediscounting qualified paper, and was used to finance America's entry into World War I. As Dr. Harold G. Moulton, first president of the Brookings Institution (1916-1952) noted, "Responsibility for the large use of bonds as a means of financing the war cannot . . . be placed primarily at the doors of the Federal Reserve system, the Treasury rather than the Federal Reserve officials being responsible for the methods of war finance." (Harold G. Moulton, Financial Organization and the Economic System. New York: McGraw-Hill Book Company, Inc., 1938, 392.)

With the New Deal and the effective loss of autonomy of the regional Federal Reserves, the concentration of power in the Board of Governors, the discontinuance of rediscounting for the private sector and the formal institution of the Open Market Committee, the federal government assumed near-total control of the financial system. (Ibid., 407-417.) As Moulton observed, "This shift is a reflection of the philosophy that not only is it a proper function of the Government to assume control over the entire credit system, but that only the Government can be depended upon to exercise such control in the interest of public welfare as a whole." (Ibid., 417.)

There are certain measures that could be implemented almost immediately to restore the independence of the Federal Reserve. One, restrict the Fed to rediscounting qualified private sector paper of member banks supplemented with limited open market operations involving private sector paper issued by businesses and non-member banks. Two, make the prohibition against monetizing government deficits more than a dead letter by forbidding the Fed to deal in either primary or secondary government issues. Three, institute a 100% reserve requirement by rediscounting all qualified loans for industrial, commercial, and agricultural purposes at the regional Feds.

Existing savings can be used to make loans to government and consumers, or for speculative investment. Any "new money" created by the extension of bank credit and discounting of bills of exchange must be restricted to properly vetted and financially feasible loans made for commercial purposes. These measures would go a long way toward restoring some sanity to the financial system, but one thing more is needed: a program to encourage widespread direct ownership of the means of production. One possibility is outlined in the two books co-authored by Louis O. Kelso and Mortimer J. Adler, The Capitalist Manifesto (1958) and The New Capitalists (1961). The subtitle of the latter is revealing, and illustrative of the incoherent mess into which a dogmatic faith in Keynesian economics has trapped the global economy: "A Proposal to Free Economic Growth from the Slavery of Savings."

Yours, etc.

If it's any consolation, we expect to have our new edition of Moulton's classic The Formation of Capital from 1935 ready for the printers sometime in the next couple of weeks.

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