I received a fund raising letter from a group supporting Ron Paul and Jim DeMint in their effort to audit the Federal Reserve. In the past I have been critical of this plan ("From Bad to Worse"), and I still remain so. I know some Ron Paul supporters have disagreed with me on this, but I think this is a perfect example of two principles. First, any law you pass will give the same powers to the other side as it gives to you, at least over time. Second, no law should exist which depends too much on the right people holding power.

Now, let me make a few things clear. Anyone reading this blog should know I think the Federal Reserve is a terrible idea. It is marginally better than the fully centralized banks of many other nations, but not that much. By maintaining some small amount of independence of the banking sector it keeps the government from fully controlling banking outright, and that does provide some check¹. In addition, though many will disagree, by granting control to an unelected panel it is a little more immune to pressures of the moment than an elected body would be².

However, that is not to say the Federal Reserve is a good thing. Far from it. It was created as a response to the negative outcomes of previous federal banking regulations, which were themselves the response to previous bad state banking regulations, and the consequences of the disastrous Second Bank of the US fiasco. ("The Inflation Engine", "The Limits of Technocracy", "Sorry, President Jackson", "The Best Historical Example", "Be of Good Cheer") Though at each step the free market was blamed, it is clear this is almost the perfect example of the "cycle of compassion", each past intervention demanding the next new and larger step. ("The Cycle of Compassion", "Recipe For Disaster", "The Endless Cycle of Intervention") It is also the textbook case of blaming the free market for the failures of government. ("How To Blame the Free Market")

I won't go into everything in great detail here, as I have written about it at length in "Why Gold?", "Bad Economics Part 7", "Bad Economics Part 8", "The Inflation Engine", "Explaining Past Crashes", "A Thought on the Clinton Surpluses", "Monetary Issues Made Simple Part I", "Monetary Issues Made Simple Part II" and elsewhere, but as it is essential to understanding why I find this audit such a bad idea, I suppose I should give a brief synopsis of what is wrong with the Fed.

Basically, the biggest problem is that our currency is simply paper backed by the say-so of the federal government. We continue to accept it out of habit, and because the governments of the world accept it for payment, and because we have no other viable medium of exchange, but it really lacks any value. Some argue gold only had value because it was money, but that is nonsense, as you an see from the many gold artifacts from nations where gold was NOT money, as well as the gold contacts in your air  bag and gold fillings in teeth. Gold has real value independent of its role as money, little printed scraps of paper (or ones and zeroes in a database) do not. ("Why Gold?", "Bad Economics Part 8") Gold also had one other benefit, it took effort to increase the supply of gold, unlike printed bills. So even with fractional reserve banking, there was a real check on the amount of monetary expansion, unlike the present system where inflation can proceed unchecked right up to the point of collapse.

And that is the second problem with the Federal Reserve. It was inevitable fiat currency would require a central source of money creation, but even before we went off gold, the Federal Reserve was the central point of inflation, and that was a bad idea. Likewise, the preceding banking system, which created multiple tiers of banks, allowing one tier to inflate upon the inflation of another tier, was a predecessor of this. In all these cases, the problem was that inflation was centrally controlled. Under a free banking system it is still possible for individual banks to act badly, to over expand their notes against inadequate reserves, but it is very unlikely that will become a general phenomenon, and impossible it would be universal. The present system makes EVERY mistake universal. And that is a very bad thing. ("Consolidation and Diffusion")

Finally, and probably most significant for our discussion, the Federal Reserve is a political animal. The system of appointing governors tends to reduce the direct political influence of the president and congress, but even the limited current audit powers allow congress to effectively bully the Federal Reserve into complying with their wishes concerning the money supply, and those wishes are almost always pro-inflation³. And so, though the long, staggered terms do help insulate the governors somewhat from political pressures, there is the inevitable push for ever increasing inflation. Not to mention the fact that current economic theory tends to be rabidly pro-inflation, be it "liberal" Keynesianism or "conservative" monetarism, it all favors an expansionist, managed currency, differing only in the degree of inflation. And, of course, the nature of the Federal Reserve itself, which requires a constant stream of government debt to function, and which assumes a regularly expanding money supply, which make it very difficult to practice anything approaching sensible money management. ("Alan Greenspan's Hubris, "The Inflation Engine", "A Reason to be Afraid", "The Limits of Technocracy")

So, I am hardly a fan of the present Federal Reserve system, and I agree, clearly, that the present bailouts, TARP and other similar measures were a waste of money and did more harm than good, if they did any good at all⁴. So, why do I oppose a measure intended to rein in such abuses?

Because that won't be the outcome.

I guess that is a third principle I should have mentioned at the beginning. "Don't judge a book by its cover." I think I may have heard that one before, but it seems a good claim. Though, in my case, I think it cuts the opposite way the cliche is usually used. Most often it is intended to say "something may look bad, but be good", where in my case I intend it to mean "while X may claim to fix a problem, that claim does not mean it really does."

First, and most significantly, audits will not stop the government bailouts, the waste, the stimulus and so on. Other nations have central banks answerable to the government, and yet they have the same idiotic Keynesian stimulus plans. So there is no inherent protection against Keynesian foolishness in giving the government audit power. In fact, I would argue that a belief in Keynesianism is itself inherent in fiat currency and government banking. If you don't believe the government should "stimulate" through currency manipulation, then why create a fiat currency? Why allow for political management?

I understand, at least I think I do, the motives of these individuals in calling for audits. Their hope is that they will be able to use such audits to somehow show the Federal Reserve created these monetary problems through mismanagement, and show that the bailouts and such were unneeded. The problem is twofold. First, I doubt it would be as easy to show as they think. I can theoretically prove clearly that the whole system is a mistake, yet over and over monetarists and Keynesians challenge my theses and present their own "evidence". So the proof is not as clear as they think. Unfortunately, they are true believers, and true believers make bad judges of audience. They think the audience is just like them, will have their understandings, and in that, they are as mistaken as the would be dictators, who think every dictator will see things just as they do. ("The Inherent Disappointment of Authoritarianism")

But they misjudge their audience in a second, more important way. The hearings they plan will make C-Span look like a ratings smash. Oh, I am sure they think the public will be intrigued by an audit of the Fed, but here too they are misled. They think others find the topic as interesting as they do, and in their own circles, that might be true. But every politician should be required to spend a few nights in a blue collar bar, or talking to art students, or shopping at the mall. No matter what comes out of these hearings, two things will be true. Mostly, no one will care, not the public, not even politicians. Second, whatever comes out that seems vaguely important will be spun by both sides until any truth will be lost.

I know this sounds cynical, but it is not. I just know the public's interest and knowledge of economics. They will not be drawn in by obscure monetary questions, even if they relate directly to a major crisis. The only viewers will be the true believers on each side. And, whatever comes out of these hearings, it will only be a "smoking gun" if viewed using a specific theory. Under other economic theories, it will likely seem harmless. And so the end result will be an argument over which monetary theory is right. And I know from experience those sort of debates draw a dozen listeners at best.

Despite the high sounding purpose, I really think the new audit power will have absolutely no beneficial outcomes. And so, my third premise "don't judge a book by its cover." Despite the arguments in its favor, it is likely to produce none of those supposed benefits.

Which brings me back to my first two arguments: "whatever power you give yourself, you give the other side" and "never pass a law relying on the right people holding office". Granted, the current Federal Reserve system is a violation of both as well, but I think congressional audit of monetary decisions actually makes it worse⁵. So, to avoid one of those straw man responses ("So, the current system is perfect, and you wouldn't change anything?"), I don't think the current system is perfect, but that does not mean any change is a good idea, there is the possibility of going form bad to worse. Unless the change has definite benefits, or does no harm, then we would have to balance out the costs and benefits. And, as I have demonstrated that I see no benefit, then the system would have to be harmless to make the change worthwhile, and I see it as far from harmless.

Allow me to explain.

The problem is that "audit" power, like the power to hold "hearings" is often abused by congress. As we have seen repeatedly with tobacco companies, oil executives, or even the Federal Reserve with the current limited audit capabilities, congress will use those hearings to hold grandstanding inquisitions. Now, as with the audits of Ron Paul and Jim DeMint, no one cares or watches. But unlike the anticipated audits, the participants DO hear, and they take the messages to heart, and they understand what is expected of them. And so the hearings can be used as a very effective tool to intimidate the targets, allowing congress to set policy without officially acting.

And that is where I worry about this increased audit capability. It will allow congress to even more directly influence monetary policy.

Now, I know the counter argument, that the authors want to use it to stop abuses, to end bail outs and limit inflation, but the problem is, that relies upon the law being used by the "right people". It could just as easily be used by others to win populist points by pressing for softer money, easier credit and so on. As we have seen with the current circumstances, even explicit economic collapse will not stop congressional calls for soft money and easy credit, so why would this law not be used in the same way?

Which is why I proposed by two other rules. Anything you gain can be used by the other side, and don't rely on a law being used only by the "right people". It seems to me, too much of this new law relies upon it being wielded by Ron Paul and Jim DeMint, and it completely ignores how it could be used by others who might gain the new audit power as well. And that is a very dangerous way to rule.

Before anyone objects that the current Federal Reserve Board is every bit as arbitrary, I grant that is true. But, it is also slightly less immediately political. Of course it is open to congressional and presidential influence, and can enact arbitrary decisions, but unlike congress, the governors are not subject to elections every two or six years, and may be able to resist urges to inflate farther when the economy is in free fall, just to buy votes. It is not a great hope, but it is more likely than that congress will show the same restraint.

And that is my worry about the bill. Instead of moving toward eliminating the Federal Reserve, or even creating a predictable system, say a fixed growth rate of the money supply, it, intentionally or not, creates an even more politicized money supply. It moves us in precisely the wrong direction, and worst of all is proposed by those who should know better.

Even if Ron Paul and Jim DeMint get what they want, and the public suddenly takes great interest in their audits, and interprets the hearings as they wish, what do they gain? For maybe ten years they will act as a restraint on the worst abuses of the Federal Reserve. And then? When they leave office? Others take the reins and start pushing in the other direction, and we have a money supply which responds to the clamor of the mob even more directly.

It just doesn't seem to make sense. Even the best case is not worth the risk, and I am certain the best case is so unlikely as to be impossible. Most likely, we will gain nothing, and it will cost us dearly to get it.

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1. It is clear the federal government recognizes this, or they wouldn't have bothered with the whole TARP boondoggle to take over the banking sector. It is clear they find private banks an impediment as well.

2. There will be those who argue "congress SHOULD control it, for the people", but they must be big fans of the 17th amendment. The Federal Reserve was established, in a way, to mirror the senate, a body with longer terms, not dependent on popular election, and so not swayed by momentary passions. It was a bad idea, but better than the alternative. As I will discuss later. Admittedly, this indirect control was offered as a sop to critics, since similar safeguards for the senate itself were destroyed shortly thereafter with the 17th amendment, but even if ti was a token gesture, it did end up providing some real protection, for similar reasons the senate's lack of direct popular elections provided protection against momentary passions. ("Why I Am Not A Libertarian", "The Benefits of Federalism", "What we need", "The Problems of Spending and Taxes")

3. I won't go into it here, but it is a political truth that favoring debtors will always buy votes. While it may be true big corporations (and the government) hold more debt than private citizens, citizens always think debtors are the "little guys", so debt relief has populist appeal. In addition, they think of their bills as debt, and forget the bonds and pension funds they rely upon are their claims on others' debt (until it comes back to bite them later). In addition, debt relief can easily win the support of debt-ridden corporations and their lobbyists, which never hurts a politician's reelection chances. And finally, because the government is chronically the largest debtor of all, debt relief always helps out Uncle Sam. Which is why it is very rare to find a politician opposed to any pro-debtor measure. (The one exception I can recall was the Bush-era bankruptcy reforms, though that was an aberration, and, in a self-serving touch, was hardest on those attempting to avoid student loan obligations.)

4. At the time of the various TARP, stimulus and bailout bills, I argued against them quite vocally, as shown in my posts "Clarification of My Opposition to the Bailout ", "Place Blame Fairly, Regardless of Party", "How AIG and GM Ruined Any Chance at a Less Intrusive Bailout" and "Living Large During the Good Times". So I clearly agree these were useless, costly mistakes. Still, as I will argue, it does not follow that we should accept any measure which claims to fix them.

5. Actually, any audit power granted to congress is risky, as we have seen from countless politicized hearings, both of the Fed and other "evil" industries such as oil and tobacco. Congress is fond of using "audit" power to threaten companies with grandstanding hearings. But more of that in the proper place.

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POSTSCRIPT

My earlier thoughts can be read in "From Bad to Worse" and "A Bit of Clarification". As mentioned above, my general thoughts on monetary theory can be found in "Monetary Issues Made Simple Part I" and "Monetary Issues Made Simple Part II". And, finally, my arguments for the gold standard can be read in ""Why Gold?"", "Bad Economics Part 7" and "Bad Economics Part 8". All ar elinked above, but as there are so many links, it seemed best to extract the