Criticism of the Federal Reserve
The Federal Reserve System (also known as "the Fed") has faced various criticisms since it was authorized in 1913. Nobel laureate economist Milton Friedman and his fellow monetarist Anna Schwartz criticized the Fed's response to the Wall Street Crash of 1929 arguing that it greatly exacerbated the Great Depression. More recent prominent critics include former Congressman Ron Paul and economist Murray Rothbard, both of whom argue that the Fed exacerbates inflation by creating money "out of thin air."
An early version of the Federal Reserve Act was drafted in 1910 on Jekyll Island, Georgia, by Republican Senator Nelson Aldrich, chairman of the National Monetary Commission, and several Wall Street bankers. The final version, with provisions intended to improve public oversight and weaken the influence of the New York banking establishment, was drafted by Democratic Congressman Carter Glass of Virginia. The structure of the Fed was a compromise between the desire of the bankers for a central bank under their control and the desire of President Woodrow Wilson to create a decentralized structure under public control. The Federal Reserve Act was approved by Congress and signed by President Wilson in December 1913.
In The Case Against the Fed, Murray Rothbard argued that, although a supposed core function of the Federal Reserve is to maintain a low level of inflation, its policies (like those of other central banks) have actually aggravated inflation. This occurs when the Fed creates too much fiat money backed by nothing. He called the Fed policy of money creation "legalized counterfeiting" and favored a return to the gold standard. He wrote:
|“||[I]t is undeniable that, ever since the Fed was visited upon us in 1914, our inflations have been more intense, and our depressions far deeper, than ever before.
There is only one way to eliminate chronic inflation, as well as the booms and busts brought by that system of inflationary credit: and that is to eliminate the counterfeiting that constitutes and creates that inflation. And the only way to do that is to abolish legalized counterfeiting: that is, to abolish the Federal Reserve System, and return to the gold standard, to a monetary system where a market-produced metal, such as gold, serves as the standard money, and not paper tickets printed by the Federal Reserve.
The Federal Reserve Board was created to control, regulate and stabilize credit in the interest of all people. . . . The Federal Reserve Board is the most gigantic financial power in all the world. Instead of using this great power as the Federal Reserve Act intended that it should, the board . . . delegated this power to the banks.
Representative Louis T. McFadden, Chairman of the House Committee on Banking and Currency from 1920 to 1931, accused the Federal Reserve of deliberately causing the Great Depression. In several speeches made shortly after he lost the chairmanship of the committee, McFadden claimed that the Federal Reserve was run by Wall Street banks and their affiliated European banking houses. In one 1932 House speech (that has been criticized as bluster), he stated:
Mr. Chairman, we have in this country one of the most corrupt Institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve banks; . . . This evil institution has impoverished and ruined the people of the United States . . . through the corrupt practices of the moneyed vultures who control it.
Many members of Congress who have been involved in the House and Senate Banking and Currency Committees have been open critics of the Federal Reserve, including Chairmen Wright Patman, Henry Reuss, and Henry B. Gonzalez. Representative Ron Paul, Chairman of the Monetary Policy Subcommittee in 2011, is known as a staunch opponent of the Federal Reserve System. He routinely introduced bills to abolish the Federal Reserve System, three of which gained approval in the House but lost in the Senate.
Congressman Paul also introduced H.R. 459: Federal Reserve Transparency Act of 2011, This act required an audit of the Federal Reserve Board and the twelve regional banks, with particular attention to the valuation of its securities. His son, Senator Rand Paul, has introduced similar legislation in subsequent sessions of Congress.
Great Depression (1929)
Milton Friedman and Anna Schwartz stated that the Fed pursued an erroneously restrictive monetary policy, exacerbating the Great Depression. After the stock market crash in 1929, the Fed continued its contraction (decrease) of the money supply and refused to save banks that were struggling with bank runs. This mistake, critics charge, allowed what might have been a relatively mild recession to explode into catastrophe. Friedman and Schwartz believed that the depression was "a tragic testimonial to the importance of monetary forces." Before the establishment of the Federal Reserve, the banking system had dealt with periodic crises (such as in the Panic of 1907) by suspending the convertibility of deposits into currency. In 1907, the system nearly collapsed and there was an extraordinary intervention by an ad-hoc coalition assembled by J. P. Morgan. In the years 1910–1913, the bankers demanded a central bank to address this structural weakness. Friedman suggested that a similar intervention should have been followed during the banking panic at the end of 1930. This might have stopped the vicious circle of forced liquidation of assets at depressed prices, just as suspension of convertibility in 1893 and 1907 had quickly ended the liquidity crises at the time.
Essentially, in the monetarist view, the Great Depression was caused by the fall of the money supply. Friedman and Schwartz note that "[f]rom the cyclical peak in August 1929 to a cyclical trough in March 1933, the stock of money fell by over a third." The result was what Friedman calls "The Great Contraction"—a period of falling income, prices, and employment caused by the choking effects of a restricted money supply. The mechanism suggested by Friedman and Schwartz was that people wanted to hold more money than the Federal Reserve was supplying. People thus hoarded money by consuming less. This, in turn, caused a contraction in employment and production, since prices were not flexible enough to immediately fall. Friedman and Schwartz argued the Federal Reserve allowed the money supply to plummet because of ineptitude and poor leadership.
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again.
Friedman has said that ideally he would prefer to "abolish the Federal Reserve and replace it with a computer." He preferred a system that would increase the money supply at some fixed rate, and he thought that "leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement".
In contrast to Friedman's argument that the Fed did too little to ease after the crisis, Murray Rothbard argued that the crisis was caused by the Fed being too loose in the 1920s in book America's Great Depression.
Global financial crisis (2007–08)
Some economists, such as John B. Taylor, have asserted that the Fed was responsible, or at least partially responsible, for the United States housing bubble which occurred prior to the 2007 recession. They claim that the Fed kept interest rates too low following the 2001 recession. The housing bubble then led to the credit crunch. Then-Chairman Alan Greenspan disputes this interpretation. He points out that the Fed's control over the long-term interest rates (to which critics refer) is only indirect. The Fed did raise the short-term interest rate over which it has control (i.e. the federal funds rate), but the long-term interest rate (which usually follows the former) did not increase.
The Federal Reserve's role as a supervisor and regulator has been criticized as being ineffective. Former U.S. Senator Chris Dodd, then-chairman of the United States Senate Committee on Banking, Housing, and Urban Affairs, remarked about the Fed's role in the present economic crisis, "We saw over the last number of years when they took on consumer protection responsibilities and the regulation of bank holding companies, it was an abysmal failure."
Republican and Tea Party criticism
During several recent elections, the Tea Party movement has made the Federal Reserve a major point of attack, which has been picked up by Republican candidates across the country. Former Congressman Ron Paul (R) of Texas and his son Senator Rand Paul (R) of Kentucky have long attacked the Fed, arguing that it is hurting the economy by devaluing the dollar. They argue that its monetary policies cause booms and busts when the Fed creates too much or too little fiat money. Ron Paul's book End the Fed repeatedly points out that the Fed engages in money creation "out of thin air." He writes:
|“||The fact that the Fed can create trillions of dollars and distribute them to its cronies without congressional oversight should shock us all.||”|
He also agrees with Friedman and Bernanke that the Fed caused the Great Depression, but in a different way:
|“||The fault [for the Depression] indeed does lie with the Federal Reserve—but obviously for opposite reasons. It was the credit expansion of the 1920s causing the stock market bubble that was the real cause of the crash.||”|
Private ownership or control
According to the Congressional Research Service:
Because the regional Federal Reserve Banks are privately owned, and most of their directors are chosen by their stockholders, it is common to hear assertions that control of the Fed is in the hands of an elite. In particular, it has been rumored that control is in the hands of a very few people holding "class A stock" in the Fed.
As explained, there is no stock in the system, only in each regional Bank. More important, individuals do not own stock in Federal Reserve Banks. The stock is held only by banks who are members of the system. Each bank holds stock proportionate to its capital. Ownership and membership are synonymous. Moreover, there is no such thing as "class A" stock. All stock is the same.
This stock, furthermore, does not carry with it the normal rights and privileges of ownership. Most significantly, member banks, in voting for the directors of the Federal Reserve Banks of which they are a member, do not get voting rights in proportion to the stock they hold. Instead, each member bank regardless of size gets one vote. Concentration of ownership of Federal Reserve Bank stock, therefore, is irrelevant to the issue of control of the system (italics in original).
According to the web site for the Federal Reserve System, the individual Federal Reserve Banks "are the operating arms of the central banking system, and they combine both public and private elements in their makeup and organization." Each bank has a nine-member board of directors: three elected by the commercial banks in the Bank's region, and six chosen – three each by the member banks and the Board of Governors – "to represent the public with due consideration to the interests of agriculture, commerce, industry, services, labor and consumers." These regional banks are in turn controlled by the Federal Reserve Board of Governors, whose members are appointed by the President of the United States.
Member banks ("[a]bout 38 percent of the nation's more than 8,000 banks") are required to own capital stock in their regional banks, and the regional banks pay a set 6% dividend on the member banks' paid-in capital stock (not the regional banks' profits) each year, returning the rest to the US Treasury Department. The Fed has noted that this has created "some confusion about 'ownership'":
[Although] the Reserve Banks issue shares of stock to member banks...owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan….
In his textbook, Monetary Policy and the Financial System, Paul M. Horvitz, the former Director of Research for the Federal Deposit Insurance Corporation, stated,
...the member banks can exert some rights of ownership by electing some members of the Board of Directors of the Federal Reserve Bank [applicable to those member banks]. For all practical purposes, however, member bank ownership of the Federal Reserve System is merely a fiction. The Federal Reserve Banks are not operated for the purpose of earning profits for their stockholders. The Federal Reserve System does earn a profit in the normal course of its operations, but these profits, above the 6% statutory dividend, do not belong to the member banks. All net earnings after expenses and dividends are paid to the Treasury.
In the American Political Science Review, Michael D. Reagan wrote,
...the "ownership" of the Reserve Banks by the commercial banks is symbolic; they do not exercise the proprietary control associated with the concept of ownership nor share, beyond the statutory dividend, in Reserve Bank "profits." ...Bank ownership and election at the base are therefore devoid of substantive significance, despite the superficial appearance of private bank control that the formal arrangement creates.
One critique is that the Federal Open Market Committee, which is part of the Federal Reserve System, lacks transparency and is not sufficiently audited. A report by Bloomberg News asserts that the majority of Americans believes that the System should be held more accountable or that it should be abolished. Another critique is the contention that the public should have a right to know what goes on in the Federal Open Market Committee (FOMC) meetings.
- America's Great Depression
- Black Friday (1869) Covers the gold scandal of 1869
- The Case Against the Fed
- Causes of the Great Depression
- Criticism of the United States government#Criticism of agencies
- End the Fed
- Federal Reserve Police
- Fractional reserve banking
- Free banking
- Gold standard
- Great Contraction
- Murray Rothbard
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- Murray Rothbard (2007). The Case Against the Fed. Ludwig Von Mises Institute. p. 146. ISBN 978-0945466178.
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- Ron Paul (2009). End the Fed. Grand Central Publishing.
- E.g., H.R. 2755 (110th Congress); H.R. 2778 (108th Congress); H.R. 5356 (107th Congress); H.R. 1148 (106th Congress)
- "H.R. 2755: Federal Reserve Board Abolition Act". GovTrack.us. 15 June 2007.
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- Milton Friedman; Anna Schwartz (2008). The Great Contraction, 1929–1933 (New Edition). Princeton University Press. p. 28.
- Milton Friedman; Anna Schwartz (2008). The Great Contraction, 1929–1933 (New Edition). Princeton University Press. p. 11.
- Chang-Tai Hsie; Christina D. Romer (2006). "Was the Federal Reserve Constrained by the Gold Standard During the Great Depression?" (PDF). Journal of Economic History.
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- Milton Friedman; Anna Jacobson Schwartz (2008). The Great Contraction, 1929–1933 (New Edition). Princeton University Press. p. 247.
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- Ron Paul (2009). End the Fed. Grand Central Publishing.
- Ron Paul (2009). End the Fed. Grand Central Publishing. p. 10.
- Ron Paul (2009). End the Fed. Grand Central Publishing. p. 68.
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- Horvitz, Paul M. (1974). Monetary Policy and the Financial System (3rd ed.). Prentice Hall. p. 293. ISBN 9780135998861.
- Not to be confused with Michael Edward Reagan, the son of President Ronald Reagan.
- Reagan, Michael D. (March 1961). "The Political Structure of the Federal Reserve System". American Political Science Review. 55: 64–76. doi:10.2307/1976050.
- Mittra, S. (1970). Money and Banking: Theory, Analysis, and Policy. New York: Random House. p. 153.
- Poole, William (July 2002). "Untold story of FOMC: Secrecy is exaggerated". St. Louis Federal Reserve.
- Zumbrun, Joshua (9 December 2010). "Majority of Americans Say Fed Should Be Reined In or Abolished, Poll Shows". Bloomberg.
- Poole, William (6 October 2004). "FOMC Transparency" (PDF). Federal Reserve Bank of St. Louis Review. Federal Reserve Bank of St. Louis. 87: 1–9.
- "Remarks by Chairman Alan Greenspan - Transparency in monetary policy". Federal Reserve. 11 October 2001.
- "Remarks by Vice Chairman Roger W. Ferguson, Jr.—Transparency in Central Banking: Rationale and Recent Developments". Federal Reserve. 19 April 2001.