The Fed and the Political Business Cycle

0:00Milton Friedman some years ago said that a government institution that is not guided in its behavior by politics is as likely as a barking cat. And with regard to the Fed, I believe that one of the reasons why we can have an institution like this that persists for a decade after decade, despite destroying a large part of our economy, creating economic instability, creating several generations of inflation is that the public or a large part of the public believes it's a barking cat. It believes that the head of the Fed is sort of like the man in the Wizard of Oz. He's behind a curtain, he's pushing buttons, pulling levers and his foot is pumping something and he's just keeping the economy going.

0:47He's just keeping things going and he's benevolent. He's a benevolent dictator. He acts in the public interest. And of course he's omniscient, like the Wizard of Oz. And this has been created, this idea in the minds of a lot of the public, largely by the economics profession. And I'll give you an example of it. Paul Samuelson, his textbook was the biggest selling textbook in the field of economics from 1948 until around the early eighties. and all the other textbooks were pretty much clones of his. And so several generations of people who studied economics, which includes all of the journalists who write about economics for the most part, were educated by Samuelson or Samuelson clones.

1:36And here's what a late edition, 1989 edition of Samuelson's book said about the Fed. The Federal Reserve's goals are steady growth in National Output and Low Unemployment. Its sworn enemy is inflation. If aggregate demand is excessive so that prices are being bid up, the Federal Reserve Board may want to slow the growth of the money supply, thereby slowing aggregate demand and output growth. If unemployment is high and business is languishing, the Fed may consider increasing the money supply, thereby raising aggregate demand and augmenting output growth, period. In a nutshell, this is a function of central banking, which is an essential part of macroeconomic management in all mixed economies, the Wizard of Oz basically.

2:24After Samuelson's book began to wane in terms of sales, and then an equally bad book took its place by Campbell McConnell as the big seller. And there were quite a few clones of that one too. Thankfully today, in 2005, there are quite a few other books that are much better. But here's what Campbell McConnell said about the Fed, because it is a public body, that is because it is a part of government. I'm quoting him. The decisions of the Board of Governors are made in what it perceives to be the public interest. The Federal Reserve banks are not guided by the profit motive, but rather they pursue those measures which the Board of Governors recommends. The fundamental objective of monetary policy is to assist the economy in Achieving a Full-Employment, Non-Inflationary Level of Total Output.

3:16And so that's what generations of economic students have been taught. And of course, this filters in through the whole society, through the journalism profession and everything else. And I think it's been inherently sort of dishonest because there was a long history of the federal government being involved in money and banking prior to the Fed. and not to mention the history of the Fed itself that these textbook authors wrote about. And from the very beginning, federal involvement in money and banking was thoroughly political. The first bank of the United States created by Alexander Hamilton. It wasn't like the Fed, but it was the first federal government bank.

4:02The first head of it was a US Navy captain named William Jones, who had no banking experience at all and had just personally gone bankrupt, but he had political connections, therefore he was the right man for the job to run the Bank of the United States. And then the Bank of the United States, by the time we got to the 1820s, many of you know there was a big showdown between President Andrew Jackson and the head of the Bank of the United States. And it was all over the politicization of the Bank of the United States. Roger B. Taney, who was the Treasury Secretary at the time, he was later the Chief Justice of the United States, said of the bank, it has patronage greater than that of the government. And what did he mean by that?

4:49Well, he just observed what the bank was doing. During the 1828 election campaign, the bank of the United States spent more than $100,000. This is in 1828 of the bank's deposits, which were federal tax deposits, in support of Andrew Jackson's political opponents. It promised money to friendly members of Congress so they can spend on pork if they supported the bank. And they paid for the printing of Henry Clay's speeches in support of the bank. And they also paid for a newspaper ads that promoted the bank and smeared Andrew Jackson who was opposing the bank. So the whole history of federal involvement in banking has been a history, not of barking cats, but of political meddling by banks.

5:37And so FDR, when FDR came in, you know, he appointed as his head of the Fed, Mariner Eccles, who was a strong supporter of deficit spending. And Eccles had no financial background and did not even have a college degree at the time. But he was a political yes man. And he did what Roosevelt wanted so that FDR essentially ran the Fed. We'll talk about politicization of the Fed. You literally effectively had the president calling the shots. And thankfully, there's a lot of economics literature on the politicization of the Fed. It doesn't always make it down to the textbooks so that the general public can come to learn about the truth about the Fed.

6:28But I'll just summarize a few things that academics know about this, about the Fed being politicized. The late Robert Weintraub, who was quite a good monetary economist, did some research some years ago showing how the Federal Reserve policy fundamentally shifted its monetary policy course in 1953, 1961, 1969, 1974 and 1977. These are all years in which the presidency changed hands. And so the implication here of what's going on is that the Fed Chairman does whatever he thinks will take to help him get reappointed. If there's a new president comes in and he wants tight money as opposed to easy money, that's what he'll get or vice versa.

7:13And for example, when Eisenhower wanted a slower monetary growth, the money supply grew at 1.73% during his administration. Kennedy came in, he wanted faster money growth, he got it, 2.31%. Lyndon Johnson, of course, he wanted faster yet to finance the Vietnam War. The money growth doubled to 5%. And this was all under the same Fed Chairman, William Chesney Martin. And so he had no consistent ideology or theory of his policy. It's basically whatever his boss wanted. Although we're told that the Fed is independent, it's not really. When Arthur Burns came in as head of the Fed, His main objective at one point, of course, was to get Richard Nixon re-elected.

8:04And so Burns' staff told him in the fall of 1972 that the money supply was forecast to be growing for that quarter, the last quarter, at 10.5%, well, the third quarter rather, at 72. So Burns made sure that the money supply grew even faster and 10.5% in the third quarter of 72. And that was the fastest for any one year in about 30 years at that point. And so, and then President Ford came in and he had some of you remember his Whip Inflation Now program. Does anyone have a win button, Whip Inflation Now? I remember these things, you can hand out these buttons, W-I-N. So as the Fed complied, they reduced the money growth to 4.7%.

8:54Jimmy Carter came in, of course, he wanted inflationary finance. And so they upped the growth rate to 8.5%. And then during the last year of Carter's administration, the money supply grew at 16.2% in the five months preceding the election. And of course, in a failed attempt to get Jimmy Carter re-elected. And so a lot of what goes on here, There's an economist named Edward Kane, who makes a very persuasive argument, to me I think, that the Fed sometimes serves as sort of a political scapegoat for the administration in office. And I'll just read you what Edward Kane says about this. Whenever monetary policies are popular, incumbents can claim that their influence was crucial in their adaptation, their influence over the Fed.

9:46On the other hand, when the monetary policies prove unpopular, they can blame everything on a stubborn Federal Reserve and claim further that things would have been worse if they had not pressed Fed officials at every opportunity. In return for this favor, the Fed is allowed to amass a huge slush fund by earning interest income from the government securities it purchases through its own open market operations. And what he's talking about there is that the way the Fed actually finances its own salaries and buildings and its operations is the interest that it earns on the securities that it owns. And so there's a built-in incentive to put money in circulation, okay? And to accumulate these securities because the interest earned on the securities the Fed holds is how it funds itself, how it funds itself.

10:38And it funds itself very well. There was a general accounting office report on the Fed several years ago. And then some of the things that it mentions is that the Fed had, at the time, it had 25,000 employees, runs its own air force of 47 Lear jets and small cargo planes, fleets of vehicles, including personal cars for 59 bank managers, a full-time curator oversees its collection of paintings and sculptures of the Fed, it held, I thought this was a misprint in the Wall Street Journal, but it wasn't, the article said the Fed held spent $51 billion in accumulated assets as of 1996. And it was the time it was building itself, several very expensive buildings.

11:28And even the head janitor of the Fed, who has a very fancy title, he's the support services director, makes almost $200,000 a year in salary and fringe benefits. And so, you know, there's a little, I'm suspicious, I'm beginning to think there might be some self-interest involved here in the Fed behavior. I'm getting cynical in my older age, I guess. Of course, there is a political constituency for inflation. There's a low interest rate lobby, the real estate industry, the financial institution industry, construction unions. And so there certainly is a motive for a low interest rate expansionary monetary policy that we all end up suffering for.

12:16Okay, and so that's basically the story I wanted to tell, since I only had 20 minutes. Basically what I wanted to say is that I think the reason why we have, if you consider this historically, from whatever data the government has collected on prices, consumer price index, the price level was about the same in 1913 when the Fed was created, as it was in 1789 when the Constitution was ratified. There were ups and downs, there were the business cycle, but there wasn't general inflation in general over that whole period. But since then, of course, the price level is about 15 times higher at least, and we've had much more severe ups and downs than we ever did in years prior to that.

13:04And I recently was reading a book about, I've been doing some research on the fateful year of 1913, And we've got the Fed, the income tax, the 17th Amendment, which calls for the direct election of senators and a few other awful things at the same time, all of which consolidated more and more power in the central government. And one of the writers on the history of the income tax commented as an aside that, thank goodness, the Fed came in in 1913, Because if not, we may not have been able to enter World War I and pay for it and pay for it. And he's exactly right. We may not have been able to finance World War I. And so it's more than just the Fed has created inflation and economic stability.

13:51The advocates of central banking have always looked at central banking and money creation as a means of financing an American empire that would span the entire world. Well, I've studied the National Currency Acts that occurred during the war to prevent southern independence, as I call it, in the 1860s. And the advocates of the National Currency Acts, which was the end result of a 70-year battle over government banking in America, clearly came right out and said that one of the reasons they were for this is they wanted to turn the American government into something that would pursue empire. They didn't want it to be a limited constitutional republic. They wanted it to be an empire that would rival the British Empire.

14:37And they knew they needed a central bank of sorts to finance that. And that's exactly what happened at that time. And the national currency ads were the precursor of the Fed, which came along, of course, in 1913. And so it's more than just economic instability. It's international mischief-making that can end up costing thousands or millions of lives to the extent that it gets us involved in wars, and of course war is the mother of the state, as the old saying goes.