Debating Alternatives to the Fed

LAS VEGAS—The Federal Reserve is in the crosshairs of critics for slashing interest rates and arguably triggering a worldwide financial crisis, but no clear consensus seems to be emerging about anything to replace it that might be an improvement.

The idea of abolishing the Fed and finding another way to conduct its functions became a topic for a lively panel discussion Friday here at FreedomFest that featured speakers who took turns directing verbal barbs at the U.S. central bank. However, the Federal Reserve Bank System performs a number of important roles that left the panelists speculating about ways that it still could be salvaged.

The Fed was created by lawmakers in 1913 due to the failure of the nation’s banking system to effectively provide funding to troubled depository institutions and to limit the economy’s vulnerability to financial panics.

Criticism of the Fed has mounted since the onset of the global financial crisis that led central banks around the world to intervene to avoid the collapse of major financial institutions. The Fed specifically floundered in meeting its stated duties of setting policies that maximize employment, stabilize prices and provide moderate long-term interest rates.

Unemployment instead is close to 10%, while housing prices soared and then plunged, after the Fed set historically low interest rates.
“I, for one, would love to abolish the Fed but something must be created to succeed it,” said Richard Rahn, senior fellow of the Cato Institute and chairman of the Institute for Global Economic Growth. He also acknowledged that elimination of the Fed would require someone, or an alternative institution, to determine what the United States should use as legal tender and how to define it.

Weighing Alternatives to Money
One option would be to find an asset produced by the private sector to serve as a commonly accepted currency. However, he questioned whether gold could be used effectively as a substitute for the federally issued money used today.

Richard Mayberry, a financial author who wrote the introductory economics book, Whatever Happened to Penny Candy?, opined that interest is growing in using investments, such as stocks, as substitutes for money. Such assets would need to be “very liquid” and accepted as a substitute for money in transactions, he added.

As people are getting more and more afraid of paper currencies around the world, they are becoming more open to using stocks and other assets as alternatives, Mayberry said.

Austrian-born economist Friedrich Hayek once pointed out that money from the start should have used a commodity that is perceived by people to have value, Mayberry said. As central banks around the world try more “crazy things,” these alternatives could catch on, he added.

Fomenting Mob Violence?
The Fed is in the process of “committing suicide and I don’t want to get in its way, Mayberry said. It is creating many problems that are leading the United States toward a major crisis that ultimately may cause mobs to “burn down the Fed,” he added.

Peter Schiff, chief global strategist at Euro Pacific Capital who also is seeking the Republican nomination in Connecticut for the U.S. Senate, said that he wants to see a return to the constitutional monetary system that America’s founding fathers envisioned. He suggested using gold and silver coins as currency, as well as letting people use debit cards that would base the price of transactions on a precious metal such as gold.

“Now, when the economy grows, money supply grows; when the economy contracts, money grows even faster,” Schiff said.

As a result, the Fed currently contributes to inflation, Schiff said. He added that lowered prices would benefit everyone.

However, the U.S. government needs to stop operating at deficits that are funded by printing more money, Schiff said.

Rahn countered that reduced prices will not solve that nation’s economic ills.

Japan has had deflation for 20 years and it has been no panacea, Rahn said.

Jerry Jordon, another panelist who formerly headed the Federal Reserve Bank of Cleveland between March 1993 and January 20003, said the U.S. government should denationalize its 8,000-ton gold stock. Private gold repository banks could be created to let private citizens store the gold that they may end up owning in such a process, he added.

Defending Regional Federal Banks

Despite warranted criticism of the Fed in Washington, the Federal Reserve banks across the country do good work, Jordan said. He also acknowledged that there may be problems with the Federal Open Market Committee.

However, Jordan also questioned whether the Fed actually could be abolished, without a viable substitute in place.

“How do we start to get rid of it, since there is no alternative?” Jordan said.

Schiff opined that if the Fed cannot be abolished, it should be reformed. One change that he suggested would be to restrict what it could buy.

“It only should be allowed to buy high-quality commercial paper,” Schiff said. Right now, the Fed can buy a variety of debt that includes mortgages, he said.

Most developed countries have a central bank that serves functions similar to those performed by the Federal Reserve. According to the Fed, its key roles encompass:
• Setting the nation’s monetary policy by influencing the monetary and credit conditions in the economy;

• Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system, while protecting the credit rights of consumers;

• Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets; and

• Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including taking part in operating the nation’s payments system.