Organized Crime

Ever since its founding in 1913 the Fed has portrayed itself as an “independent” agency operated by selfless public servants striving to centrally plan the U.S. economy through monetary policy. In reality, however, a non-political government enterprise is as likely as a cat that barks like a dog or a dog that meows. Yet the myth of the “independent” and apolitical Fed persists and the economics textbooks have helped perpetuate the myth for decades.

From 1948 until the 1980s the biggest-selling principles of economics textbook was Economics by Paul Samuelson. It sold over four million copies and was used to teach generations of college students their basic economics. There were a few exceptions, but most other textbooks were mere clones of Samuelson’s book, amplifying Samuelson’s influence on the economic thinking of the average, college-educated person. The 1989 edition of Samuelson’s text, co-authored with William Nordhaus, said this about the Fed:

The Federal Reserve’s goals are steady growth in national output and low unemployment. Its sworn enemy is inflation. If aggregate demand is excessive, so that prices are being bid up, the Federal Reserve may want to slow the growth of the money supply, thereby slowing aggregate demand and output growth. If unemployment is high and business languishing, the Fed may consider increasing the money supply, thereby raising aggregate demand and augmenting output growth. In a nutshell, this is the function of central banking, which is an essential part of macro-economic management in all mixed economies.

Perhaps the second largest-selling economics textbook during the Samuelson era was Economics by Campbell McConnell, which echoed Samuelson’s view of Fed bureaucrats being selfless (and quite ingenious if not omniscient) public servants faithfully pursing “the public interest.”

Because it is a public body, the decisions of the Board of Governors [of the Fed] are made in what it perceives to be the public interest . . . the Federal Reserve Banks are not guided by the profit motive, but rather, they pursue those measures which the Board of Governors recommends . . . . The fundamental objective of monetary policy is to assist the economy in achieving a full employment, noninflationary level of total output.

Note that the Fed is evaluated by these textbook authors according to its supposed good intentions. There was never any serious analysis of the Fed’s actual record in achieving these glorious objectives in either of these textbooks. One would look in vain, for example, to find a chart showing that by 1989 decades of price inflation caused by the Fed had caused the U.S. dollar to lose some 90 percent of its value since the Fed’s inception in 1913. The above statements are mere wishes, not statement of facts. Like all government institutions, the Fed has always been manipulated by politicians for their benefit, first and foremost, not for the benefit of the “public interest,” which in any event is impossible to define and exists nowhere but in the heads of naïve, state-worshipping commentators like Campbell McConnell.

The Fed as a Political Tool

When the Fed was founded it was controlled by two groups, the Governors’ Conference, composed of the twelve regional Fed bank presidents, and the seven-member Federal Reserve Board in Washington. In 1935 the Fed was reorganized to concentrate nearly all power in Washington with the Federal Reserve Board. President Franklin Roosevelt succeeded in “packing” the Federal Reserve Board just as he attempted to “pack” the U.S. Supreme Court after the Court ruled the First New Deal (1933–1935) to be unconstitutional. So much for an “independent” and apolitical Fed.

Roosevelt appointed Marriner Eccles, a strong supporter of irresponsible deficit spending and inflationary finance, as Fed Chairman. Eccles supported such fiscally-irresponsible policies even before John Maynard Keynes provided an academic rationalization of them with his famous book, The General Theory of Employment, Interest and Money, first published in 1936. The Roosevelt Fed was most likely controlled during those years by Eccles’s political mentor, Treasury Secretary Henry Morgenthau, Jr., and thus ultimately Roosevelt himself.

It should be obvious to anyone that presidents are always inclined to politicize the “independent” Fed with their appointment powers: they will appoint as Fed chairmen people whom they believe will promote policies that are to their liking and, most importantly, will help them remain in office. Congress also has a hand in the inherent politicization of the Fed by letting presidents know whether or not it will support and vote for the president’s appointee.

A history of Fed politicization was published in the April 1978 edition of the academic Journal of Monetary Economics by economist Robert Weintraub. Weintraub showed how the Fed fundamentally shifted its monetary courses in 1953, 1961, 1969, 1974, and 1977—all years in which the presidency changed hands. Fed policy always changes to accommodate presidential preferences, for Fed Chairmen must do so if they wish to be reappointed.

For example, President Eisenhower let it be known in public speeches that he wanted slower growth of the money supply. The money supply grew by only 1.73 percent during his administration, the lowest rate in a decade. Then President Kennedy announced publicly that he advocated faster monetary growth. From January 1961 to November 1963 the basic money supply grew by 2.31 percent.

President Lyndon Johnson demanded even faster monetary growth to help finance his expansion of the welfare state coupled with an expansion of the warfare state with the Vietnam War. Money supply growth more than doubled to 5 percent during the Johnson administration as the Fed accommodated his wishes just as it had done with his predecessors. These wildly-varying rates of monetary growth all occurred under the same Fed chairman, William McChesney Martin, who obviously was more interested in pleasing his political masters than in implementing an independent and consistent monetary policy. Ironically, during this time economist Milton Friedman and his “Chicago School” colleagues became famous for advocating a “monetary rule” whereby the money supply would grow annually by a fixed percentage. It is ironic because Friedman and his Chicago School colleagues prided themselves as being astute political analysts as well as good technical economists. Indeed, Friedman’s colleague George Stigler was awarded the Nobel Prize in economics for, among other reasons, his research in the economic analysis of governmental behavior. With such a reputation as students of politics as well as economics, one would think that Friedman would have recognized the folly of believing in an apolitical Fed that could ever implement his “monetary rule.”

William McChesney Martin’s successor, Arthur Burns, was such a staunch supporter of President Richard Nixon’s that he lost all professional credibility by endorsing Nixon’s disastrous wage and price controls (a gimmick that Nixon thought would help his reelection chances but which is universally condemned by academic economists). Even though his staff informed him in the Fall of 1972 that the money supply was forecast to grow by an extremely inflationary 10.5 percent in the third quarter of that election year, Burns saw to it that the money supply grew even faster than that. The growth rate of the money supply in 1972 was the fastest for any one year in the post World War II era up to that point and helped reelect Richard Nixon. This was an example of what economists call the “political business cycle”—the phenomena whereby monetary and fiscal policy are used to pump up the economy temporarily just before a national election to give the public a perception of increased prosperity in hopes that they will vote for the incumbent politicians.

When President Ford called for slower growth in response to the price inflation that was ignited by the Burns Fed under President Nixon, the Fed complied with a 4.7 percent monetary growth rate. Then when Democratic President Jimmy Carter publicly announced his wishes for faster monetary growth, Burns once again complied by stepping up the growth rate to 8.5 percent annually. Carter did not reappoint Burns, but the Fed tried to help Carter get reelected just as it had assisted Nixon by pumping up the money supply at an annual rate of 16.2 percent in the five months preceding the 1980 presidential election according to Robert Weintraub’s research.

President Reagan personally met with Fed Chairman Paul Volcker to let Volcker know that he would support slower monetary growth to deal with the inflation rate that was in the 13 percent range at the time. Volcker dutifully complied and his successor, Alan Greenspan, developed the reputation of being perhaps the most “accommodating” (to presidents) Fed chairman of all time. As Robert Weintraub warned, a Fed chairman who ignores the publicly-stated wishes of a president does so at his own peril.

Politicians do not always pressure Fed chairmen to assist with their reelections alone and by themselves. They are often doing the bidding of all the special-interest groups of the welfare/warfare state that benefit from government spending programs financed through money creation and price inflation (which is usually blamed on “greedy corporations”). These special-interest groups, in turn, provide votes and campaign “contributions” for the politicians. As economist Robert J. Gordon of Northwestern University wrote in the academic Journal of Law and Economics in 1975 in an article about the “demand for inflation,” the acceleration of monetary growth (and subsequent price inflation) “are not thrust upon society by capricious or self-serving government, but rather represent the vote-maximizing response of government to the political pressure exerted by potential beneficiaries of inflation.”

The Fed plays politics with Congress and the executive branch in other ways as well. Writing in the Journal of Monetary Economics in 1980, economist Edward Kane described how the Fed sometimes volunteers to function as a political scapegoat for politicians, in return for being allowed to amass a huge slush fund by earning interest income from the government securities that it purchases from its open-market operations. As Kane wrote:

Whenever monetary policies are popular, incumbents can claim that their influence was crucial in their adaptation. On the other hand, when monetary policies prove unpopular, they can blame everything on a stubborn Federal Reserve and claim further that things would have been worse if they had not pressed Fed officials at every opportunity.

The myth of the “independent Fed” is a smokescreen that is intended to keep the public in the dark about the true functions of the Fed as a financier of the political careers of congressional and executive branch incumbents and of the welfare/warfare state that enhances and consolidates their power. The talk by economists about how the Fed supposedly promotes economic stability is flatly contradicted by the Fed’s historical record of failure to stabilize either prices or unemployment. It is uninformed hokum at best and intentionally-crafted propaganda at worst.