The Creature From Jekyll Island

“The conspiracy theorists are right:  There really was a conspiracy.”
—Michael D. Bordo, Rutgers Professor of Monetary Economics
Over this past weekend, the Federal Reserve held a centennial anniversary of the clandestine meeting of Wall Street bankers and Washington politicians that resulted in the creation of the Federal Reserve Bank in 1913. 
In November 1910, the unholy alliance of a half-dozen power brokers pretended to go on a “duck hunt,” but actually conspired to create the first central bank since President Andrew Jackson vetoed the charter of the Second Bank of the United States in 1832.  Since then, the United States operated on a decentralized state banking system. 
Participants included Senator Nelson W. Aldrich (the Rockefeller connection), Assistant Secretary of the Treasury Department A. P. Andrews, banker Benjamin Strong, and financier Paul Warburg (known as the father of the Federal Reserve). 
No press was present.  Only first names were used, so as to avoid publicity.  They met in secret because of a long-standing public distrust of big bankers, money trusts, and Wall Street brokers.  They were known as the “First Names Club,” and another Ben—Benjamin Strong, the Fed chairman in the 1920s—later joined the First Names Club. 
The idea was to design a “lender of last resort” to deal with financial crises like the Panic of 1907.  J. P. Morgan bailed out the New York banks and prevented a depression, but what was to happen when he died?  Morgan died in March 1913, providing the impetus to push through the Federal Reserve Act in December 1913.
The conspirators didn’t get everything they asked for with the Federal Reserve Act.  They wanted a European-style central bank run by Wall Street; the bill that Senator Aldrich pushed through Congress never even used the term “central bank.”  The Act appointed the Treasury Secretary to serve as Fed chairman; it wasn’t until 1933 that the Fed chairman became independent of the Treasury. 

Of course, the irony is that the Fed failed miserably in the 1930s in its first major test of serving as lender of last resort.  As Milton Friedman concluded, the Fed acted “ineptly,” allowing the money supply to collapse by a third.  “Far from the depression being a failure of the free-enterprise system, it was a tragic failure of government.” 
Since then, the Fed has erred on the side of inflation in fear of causing another Great Depression and has failed to control inflation or the business cycle. 
Now, 100 years later, we find ourselves in a similar predicament.  In 1907, we suffered a banking panic.  In 2008, we suffered the Financial Crisis of 2008.  The cause:  The Fed’s easy-money policies and its failure to regulate the banking system properly, which it perpetrated by allowing subprime lending.
Now, Fed chairman Ben Bernanke (the new Benjamin Strong) says that he has learned the history lessons of Milton Friedman.  In 2008-’09, he and the Reserve Board injected trillions of new dollars into the system to keep it afloat.  Instead of falling, the money supply went through the roof. 
No doubt Milton Friedman would have approved of this decision to save the banking system.  But how would he feel about it now? 
If Milton Friedman were alive today, he would oppose two major policies by the Fed.  (I knew Milton Friedman, and was the last person to have lunch with him in San Francisco before he died in late 2006, and I can tell you that Ben Bernanke is no Milton Friedman.)
First, he would object to the Fed’s artificially lowering interest rates, its so-called ZIRP (zero interest rate policy).  Friedman did not believe the Fed should manipulate interest rates.  He wanted the market to set rates. 
Second, he would oppose “price inflation” targeting.  Last week, Bernanke announced a controversial decision to engage in a second round of “quantitative easing” to the tune of $600 billion.  Why?  To fight unemployment and increase inflation.  Bernanke wants to “target” price inflation from its current 1% to 2-3%.  He says we are suffering from deflationary fears. 
Friedman supported a stable monetary policy: keep the money supply growing at a steady rate.  He opposed the constant switching from easy money to tight money by the Fed. 
Monetary economist and Fed historian Allan Meltzer, who also knew Friedman well, states it best:  “The banking system has over $1 trillion of excess reserves.  We do not need more monetary stimulus.  We need programs that get the banks to increase lending and businesses and consumers to increase spending.  Reducing uncertainty and restoring confidence are the place to start.” 
The Austrian economists, such as Ludwig von Mises and Friedrich Hayek, go one step further: The Fed’s latest round of inflation not only raises prices but is likely to create another unsustainable asset boom like the one that got us into trouble in the first place.  It may not create a bubble in real estate this time, but it could cause an unsustainable boom in gold and commodities, and in emerging markets.  As Mises and Hayek state, “Inflation is never neutral.”