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The Fed's official mandate is to
promote maximum employment and price stability. Since changes in employment
levels are effects of changes in the pace of economic growth, this
effectively means that the Fed's official mandate is to promote maximum
economic growth and price stability. Which naturally prompts the question:
how could a committee with only interest-rate and money-supply manipulation
tools fulfill such a mandate? Or, of more relevance to the current situation:
how could bureaucrats help a weak economy to become strong when they are
armed with only the ability to manipulate the price of credit and the money
supply?
According to information
presented in the mainstream media and the Fed's own press releases, the Fed can
help strengthen a weak economy by providing "more accommodation";
in other words, by injecting more money into the economy and by pushing down
on interest rates. But this just raises other questions, such as: how could
pushing the interest rate below the market level and increasing the quantity
of the medium of exchange possibly help generate real/sustained economic
progress?
The answer, we're told, is that
these actions would lead to more lending and more economic activity. But
while it is probably correct to assert that there would be more lending and
activity if interest rates were at lower levels and the supply of money were
growing more rapidly, it is wrong to presume that such a turn of events would
be beneficial. An increase in lending, for example, would only benefit the
economy if it led to the funding of projects that made economic sense, but
projects that make economic sense will usually get funded if interest rates
are left alone. Therefore, there will be a tendency for any additional
lending promoted by the Fed's suppression of interest rates to fund projects
that do not make economic sense, resulting in the less-efficient use of
resources. Injecting new money into the economy will also tend to result in
the less-efficient use of resources. This is because it will distort relative
prices (some prices rise earlier and faster than others in response to an
increase in the money supply), leading to the misdirection of capital towards
the parts of the economy that happen to experience the earliest and fastest
price increases.
The point is that more lending
and more activity is only beneficial if it is productive, but Fed
"accommodation" will tend to result in non-productive lending and
activity. This means that the more the Fed intervenes in the market in an
effort to promote maximum economic growth, the weaker the economic structure
will likely become.
The upshot is that per-capita
economic growth and rising living standards can only be achieved via an
increase in productivity, but when the Fed tries to help by making monetary
conditions ultra 'easy' a likely result will be a reduction in the rate of
productivity growth. Consequently, the last thing the US economy needs right now is a more accommodative Fed.
Let's now turn to price
stability, the second component of the Fed's overall mandate. Whereas a basic
knowledge of economic theory is needed to understand why the Fed can only
reduce the economy's long-term growth potential through its monetary
machinations, for an appreciation of the Fed's inability to promote
"price stability" we need do nothing more complicated than take a
glance at the historical record.
Exhibit A in the case against
the Fed's ability to promote price stability is the 96% reduction in the US
dollar's purchasing power since the 1913 establishment of the Fed. This
compares rather unfavourably with the 0% reduction in the US dollar's
purchasing power during the 100 years prior to the Fed's creation. Exhibit B
is the following chart from our 26th November 2008 commentary, which points
to increasing INSTABILITY in the financial markets since the creation of the
Fed.
Chart Source: www
sharelynx.com (with some notes and lines added by us)
So, it seems that in practice
the Fed accomplishes the opposite of its official mandate. The US economy could therefore grow faster, with greater price stability, if the Fed were
eliminated.
But even if the Fed's failure to
accomplish its official mandate becomes increasingly obvious, the Fed won't
be eliminated anytime soon. This is because the Fed's official mandate isn't
its actual mandate. It is clear to us that the Fed's actual mandate is to
promote relentless monetary inflation, thus facilitating the expansions of
the government and the banking industry.
Steve Saville
www.speculative-investor.com
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