George Will’s November 30, 2024, column asked the question as to what, exactly, is the purpose of the Federal Reserve System. This is a reasonable concern, especially given the way governments throughout the world have been using their central banks to spend money like drunken sailors on leave. Unfortunately, although Will pontificated for 750 words or so, it was evident that, while he clearly intended the title of his column to be rhetorical, he himself has no realistic idea of the role or function of a central bank, much less any bank other than a bank of deposit.
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| George Will |
Will went on at some length about how the federal government has used the Federal Reserve System to finance various programs and policies, some good, some bad, but none of them indifferent. What caused him concern was not government manipulation of the financial system through control of the central bank, however, but the prudence and scope of specific manipulations.
Will contrasted Paul Volcker’s reaction to an attempt by President Reagan to issue an order to the Federal Reserve (which Volcker refused to obey), with Jerome Powell’s using the central bank to flood the country with what (in our opinion) constitutes a tsunami of counterfeit cash. At the same time, Will revealed he simply does not understand how a central bank operates, and by implication, how the financial system with the commercial banking system as its mainstay, operates. Will, in fact, does not know what either a commercial or central bank is, or what either one does.
This is nothing against Will. Most academics and virtually all politicians have no idea how banks operate or what a central bank is supposed to do. Central banks were never intended to finance government anything. That they do is 1) an accident of history, and 2) a misunderstanding of money, credit, banking, and finance, a misunderstanding spread by the virtual global hegemony of Keynesian economics . . . which is based on an egregious misunderstanding of money, credit, banking, and finance.
Founding of the Bank of England
The Accident of History
Back in the seventeenth century, the merchant bankers of London had a great idea. Why not a bank for banks? This would ensure that there was always sufficient liquidity (“accommodation”) for capital projects and that the pound sterling banknotes issued by one bank were the same value of the pound sterling banknotes issued by all other banks.
Unfortunately, a bank — even a central bank exclusively for other banks — needed a royal charter . . . and that meant the organizers of the new Bank of England had to agree to buy “government stock” with the gold and silver they had set aside to use as reserves. In other words, because the British government wanted the cash, they demanded a bribe. This got the Bank of England into financing government, which was never the intention.
Fast forward to 1844. The Bank of England came up for recharter. In exchange for the recharter, the Bank of England had to agree to become the exclusive money machine for the British government. This was because the people in power didn’t understand money, credit, banking, and finance, and went with the “Currency Principle,” which we have covered extensively on this blog.
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| FDR signing New Deal legislation |
The Misunderstanding
Although it was devastating, the British Bank Charter Act of 1844 was not the main villain of the piece. That is reserved for John Maynard Keynes and the “New Deal” in the United States in the 1930s.
The Federal Reserve was established in 1913 to provide an elastic, asset-backed reserve currency and ensure adequate accommodation for agriculture, industry, and commerce. It was never intended to finance government, but to get government out of the financial system entirely except for certifying and setting the standard for the currency. The system was designed to be self-regulating and reactive, not proactive.
Then came Keynes. His theories require as much government control over the economy as possible, even to changing the value and the definition of money by (as he put it) re-editing the dictionary.” There are other, huge problems with Keynesian theory, but his monetary errors have caused total financial disaster throughout the world, bringing it to the verge of total meltdown.
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| John Maynard Keynes |
For example, the amount of debt is not a problem, because it doesn’t have to be repaid. Oh, really? With this sort of belief floating around, it’s easy to understand why crypto currencies are so popular, even though they are for the most part virtual commodities with no existence in the real world. The entire world is stumbling along, living in a financial fantasy, hoping against hope that Keynesian Kraziness is finally going to work if we just try harder.
No, the Keynesian system won’t work because it can’t work. It is based on the mathematical impossibility of the Currency Principle — in mathematical terms expressed by a single equation with THREE dependent variables. If you remember high school algebra, you will realize instantly this is nonsense; it CANNOT work. That’s all.
That is why George Will’s concerns, although real, are focused on an illusion. He is wondering why a system that cannot work isn’t working. What’s the solution? Not to be simplistic, but the only way out is to adopt the Economic Democracy Act. The monetary reforms alone would buy a generation of time, while the whole package would put the world on a solid foundation, at least financially.
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