In a recent article, Army Improperly Awarded $150 Billion KBR Contract, a writer concluded, “Travesties such as this are only compounded by the immense debt created by this war, and the fact that our children will be paying it off for decades.” The second link was to an article intensely critical of the Federal Reserve, “Who’s Responsible for the National Debt?” A few weeks later, the same writer went overboard trying to ridicule Ron Paul and his followers for, among other things, wanting to get rid of the Federal Reserve.
“Who’s Responsible for the National Debt” explains how the Federal Reserve Act of 1913 provided the means for government to sell generations of Americans into slavery to the national debt. And yet, the writer went bonkers anyway, calling Ron Paul an extremist and a kook, for wanting to abolish the Federal Reserve, and horrors, because an alternative currency coin dealer, Liberty Dollar, put the presidential candidate’s face on some of its coins. What are we to make of people who rail against the very things that Ron Paul does but call him a kook for proposing to do something about it?
The way I understand people who take these positions is to assume they believe the solution is to vote better people into office: not to reform the laws, not to reform or eliminate government agencies, not to allow private competition with the government, not to reduce the size of government, and not to adhere to the Constitution. There’s nothing wrong with the system; it’s all about choosing the “right” people.
What is difficult for me to understand is how otherwise well-informed people fail to see it is not just the people they elect that matters. Political institutions themselves cause much of people’s bad behavior. To some it’s fine to say the Founding Fathers understood that, and that is why they established checks and balances in the Constitution. Modern people, however, are pretty blasé about that old “piece of paper”. So, let me tell you about the Stanford University Prison Experiment of 1971. It is quite famous in the history of psychology. The results of the experiment are said to support situational attributions of behavior rather than dispositional attribution. That’s fancy talk meaning situations cause participants' behavior, rather than anything inherent in their individual personality. Put ordinary people in a situation where the rules mimic a traditional prison environment and with breathtaking speed you get people who would normally treat their neighbors quite nicely become sadistic guards and abuse prisoners.
Politically, the implications of the principle are obvious. Maybe that is why politicians, patriots, and pundits generally avoid mentioning it. Kind of puts a damper on election coverage to say, “None of these eight candidates are going to make a difference.”
But like it or not, the choice is this. Create a flawed political institution, and it doesn’t matter who the participants are, the result will be abuses unless someone reforms the system. So, there is no point in electing a president who is not a principled reformer. Even then, there is a risk that the candidate will not turn out to be who he said he was (or she). Also, the system itself will resist reformation. Or, the new president might succumb to institutional pressures inherent in the new job. But, if you do not elect a principled reformer, there is practically no chance the government will spontaneously reform itself, unless outside competition or revolution forces it to change.
Getting back to the Federal Reserve, our national bank that issues Federal Reserve Notes (FRNs), the basic unit of which is the dollar, it is a grossly flawed part of our political-economic system, a cartel of private banks. The FRN perpetually loses its value because it is backed by nothing except the point of a gun. These phrases I’m sure will tend to press many people’s hot buttons, so they deserve an explanation at length.
1. The FRN perpetually loses its value. What gives the FRN whatever intrinsic value it has? There is scarcity, which depends on how many are created. For most people, including me, the creation of FRNs is a complex and difficult to understand process, difficult to pin down. It takes research and patience to figure out, and it would take too long to explain in detail here, however, it is worth learning about if you have the time. The Fed does not really need to use a printing press. It can create money electronically, and part of this money creation is done to fill the gap when the government has made more promises than it can keep and cannot otherwise pay its bills. Another part of FRN creation is done simply to tinker with the economy. For more information go to the educational website Wizards of Money. Suffice it to say that the Fed can create money any time it wants, and there is profit in doing so, because insiders at the Fed will always know the timing of their monetary tinkering and how it will affect markets in advance, the first ones to get their hands on the “new money” will get the most benefit, and there is no public oversight or control of the Fed. So, the Fed will always create a lot of FRNs. There more there are, the less each one is worth. Inflation is what I am talking about.
Also, along this line of thought, the official reason given by the Fed to tinker with the economy is to “stimulate, manage, or smooth out the bumps in the economy”. The rationale is basically that if people have more money to spend, they will spend it, and other people will engage in productive activity to capture those new dollars, or if the economy gets too warm or too cold, the Fed can tinker with the money supply, affect interest rates, and manage the situation. Unfortunately, it is just not true the Fed can beneficially affect the economy to a significant extent. Decades of data prove that underlying economic activity is minimally affected and boom/bust cycles are made significantly worse by the monetary tinkering of the Fed.
Although, the present value of the FRN is determined by its current scarcity, the FRN is destined to become less scarce each year as more dollars are created. To make it harder for you to see how many FRNs are being created the Fed recently eliminated its M3 money supply statistic. Its scarcity not being constant, the dollar perpetually loses its value.
2. The FRN is backed by nothing. Our money used to be backed by gold. There was no question what it was worth. You could redeem dollars for gold at a fixed rate of exchange. There is one and only one fundamental reason why the U.S. and the Fed went off the gold standard in 1933. The Fed printed more FRNs than the gold reserves could support at the fixed exchange rate. There is a term for that in the Constitution. It is called debasing the currency, and it used to be considered a serious crime. In ancient times, it was a crime deserving of the death penalty. In 1944, Bretton Woods established a system of fixed international currency exchange rates within narrow bounds in terms of gold. Again, the Fed printed more FRNs than the gold reserves could support, and the Bretton Woods agreement collapsed in 1971, at which time all connection between the U.S. dollar and gold was severed. In all fairness, other nations were debasing their national currencies, too. After going completely off the gold standard and fixed exchange rates in terms of gold, the FRN is now backed by nothing.
3. The FRN is backed by nothing except the point of a gun. Why do people use the FRN at all if it is perpetually losing its value and it is backed by nothing? The FRN is legal tender. Legal tender is not hard to understand. It means that if someone offers you FRNs to pay for something, unlike the Liberty Dollar coins mentioned earlier, you are required by law to accept FRNs as payment for goods and services. Federal law establishes legal tender status for the FRN. Refuse to accept them as payment or try to counterfeit them, and you are in violation of Federal law. Except for this legal status, the FRN would not have a leg to stand on. Given an alternative currency that maintains its value, or a tangible backing for the FRN, people would exchange the FRN for the alternative currency or the thing that backs it.
The FRN is also said to be backed by something called the “full faith and credit” of the United States. Legally, that means a commitment by the U.S. government to pay interest and principal on its debt, including pledging its full taxing and borrowing power. In other words, when the government makes more promises than it can keep with the funds it has, it borrows money and pledges to pay it back by raising taxes later or by borrowing even more money. The government effectively pledges that you the taxpayer will pay it back later, and if you do not agree to raise taxes next year, it will borrow even more money on your behalf to cover next year’s shortfall. So you, as a citizen and taxpayer, have no control over the indebtedness incurred on your behalf by the government, even if you manage to stop the government from raising taxes.
As the record shows, there is no limitation on the government’s ability to make promises it cannot keep. So, “full faith and credit” really means “credit”, as in the old “Please lend me more money … Yours for more credit” joke letters that used to make the rounds. You do not “owe it to yourself” as politicians have said in the past. You owe it to the people who hold the notes – T-bills and bonds, and the government will tax you to pay them. Today, a large part of the debt is owed to foreigners. The U.S. government for systemic reasons cannot and will not ever pay off the national debt.
The FRN is not scarce, politicians keep making promises they cannot fully pay for, the Fed keeps printing more and more of them, the national debt will never be paid off, the full faith and credit of the United States means more borrowing, and the FRN will become less scarce and worth even less in the future. Therefore, the only thing maintaining the value of the FRN is the legal tender law. And, the only thing backing up the legal tender law is the point of a gun.
OK, so you read all that and think, so what? You do not get the feeling that you are suffering because of some abstract argument about the Federal Reserve and the value of a dollar. Here are some reasons why you should: