Kill the Fed and Restore Gold

Oscar B. Johannsen

[Reprinted from Fragments, July-September 1981]

Possibly the least popular official today in the gargantuan monstrosity known as the United States Government is the Chairman of the Federal Reserve System.

All manner of politicians, columnists, and economic soothsayers have willingly joined in a chorus of denunciation of this hapless individual. By so doing, these detractors drape around themselves a mantle of virtuous regard for their fellow citizens, for they point the finger of blame on him as the unfeeling wretch who is keeping interest rates high.

While he is the victim of all this calumny, little or none of it is directed against the institution of which he is the head -- the Federal Reserve System, popularly known as the Fed.

It is the nation's central bank. Although it has been in existence for almost seventy years, few people understand it, and those who do are engaged in a never-ending battle on how it should conduct its affairs.

It is the banker's bank -- the one which banks go to as the lender of last resort, when they are in need of funds. But it is more than that, for it issues what we call money and it exerts a large degree of control over credit.

By the imperial fiat of the Government, the currency of the nation consists of the paper money which the Fed issues. These are the Federal Reserve Notes we all carry in our wallets, and as the government has made them legal tender, they are considered to be money. (Actually, they are non-interest bearing debts of the Federal Reserve Banks issuing them. But these debts are never redeemed in real money. Real money in a highly sophisticated society like ours is gold. But for all practical purposes gold has been outlawed by the government as money.)

The Fed exerts its control over credit not only by increasing or decreasing the quantity of currency it issues but by increasing or decreasing the checking accounts which member banks must maintain with it. It does this by buying from, or selling government securities to, the member banks. If it buys bonds, it merely credits these accounts, and if it sells bonds, it debits them.

The combination of the Federal Reserve Notes (the currency) issued by the Fed and the checking accounts which the member banks must maintain with it is known as the Monetary Base (MB). Fundamentally this is the printing press money of the nation. Since the Fed can easily print Federal Reserve Notes or increase or decrease the checking accounts of member banks by simply crediting or debiting their accounts when it buys or sells bonds, it has fairly good control over the Monetary Base. This is the statistic which sophisticated monetarists watch.

Most people watch what is known as MI. This is called the nation's money supply. It consists of the paper currency (Federal Reserve Notes) plus the checking accounts the people maintain in depository institutions (banks).

But M1 is controlled to a great extent by MB, so by manipulating MB, the Fed controls M1 to a great extent although not completely. However, if MB increases, you can be reasonably certain that in the not too distant future MI will increase.

It is assumed that the Chairman has precise control and that all he need do, with the consent of his board, is perform the necessary manipulations, and the interest rates will come down. But, of course, he does not have the degree of control people assume he has, and even if he did, there is not much he can do about interest rates these days. He knows this, but most people do not. He is faced with a situation where he is damned if he does and damned if he doesn't. To bring interest rates down, one might say that all that is required is to increase the money supply by printing more currency or by buying more bonds, thereby increasing the accounts of the member banks, who would then be able to lend out more money. With more money in existence, with demand remaining relatively the same, interest rates should come down. But, and this is important, this will happen only when people have confidence in their money.

What has occurred is that the Fed has been constantly adding to the money supply year after year at a steadily increasing rate in order to keep interest rates down and to keep up the illusion of prosperity. But this increase in the money supply, with the production of goods remaining relatively the same, means that prices rise and keep rising. It is this increase in money, with the supply of goods remaining relatively constant, which is inflation. Simply put, inflation is too much money seeking too few goods.

With prices rising constantly, people eventually become aware that the purchasing power of their money drops each year. When this awareness becomes general, as it now has, it carries over to interest rates, for then these lenders demand a premium to compensate them for the loss in purchasing power. If they wish a 5% return on their money and they believe the purchasing power of the dollar will drop by 10% in a year, they will demand about 15% as the interest rate. They watch such money supply figures as MI and MB, and when they note that they are rising, they recognize that, as this additional money is spent, prices will rise, so they demand high interest rates.

If, on the other hand, the Fed actually ceases to increase the money supply or attempts to decrease it, then with less money available and demand remaining relatively the same, the interest rates will still remain high.

So, no matter what the Chairman of the Fed does, interest rates these days stay up. The only way they can come down is for a depression to ensue in which demand for money will drop precipitously.

But governments do not want depressions, and central banks are tools of governments. Thus, if a depression occurs, the government will bring pressure on the Fed to increase the money supply, no matter what happens to prices. This would amount to a short term stimulus, which may be sufficient to enable the existing government to be re-elected in the next election.

There is only one way to prevent the government from manipulating money and credit and that is for it to get out of the money and banking business. To do this, the government must be forced to permit the people to return to the use of gold as its money. And, coupled with this, the government must be pressured to permit banking to be truly a function of private enterprise, with banks privately owned answerable only to their depositors and stockholders, and not to the Fed. This means that, above all else, the nation's central bank must be eliminated. The battle cry of all interested in a sound monetary system should be: Kill the Fed and Restore Gold.