WEBVTT NOTE The Fed and the Political Business Cycle 1 00:00:00.000 --> 00:00:13.000 Milton Friedman some years ago said that a government institution that is not guided in its behavior by politics is as likely as a barking cat. 2 00:00:13.000 --> 00:00:22.000 And with regard to the Fed, I believe that one of the reasons why we can have an institution like this that persists for a decade after decade, 3 00:00:22.000 --> 00:00:25.440 despite destroying a large part of our economy, 4 00:00:25.440 --> 00:00:28.060 creating economic instability, 5 00:00:28.060 --> 00:00:32.360 creating several generations of inflation 6 00:00:32.360 --> 00:00:34.920 is that the public or a large part of the public 7 00:00:34.920 --> 00:00:37.080 believes it's a barking cat. 8 00:00:37.080 --> 00:00:39.000 It believes that the head of the Fed 9 00:00:39.000 --> 00:00:41.600 is sort of like the man in the Wizard of Oz. 10 00:00:41.600 --> 00:00:43.640 He's behind a curtain, he's pushing buttons, 11 00:00:43.640 --> 00:00:46.040 pulling levers and his foot is pumping something 12 00:00:46.040 --> 00:00:47.720 and he's just keeping the economy going. 13 00:00:47.720 --> 00:00:51.320 He's just keeping things going and he's benevolent. 14 00:00:51.320 --> 00:00:52.880 He's a benevolent dictator. 15 00:00:52.880 --> 00:00:54.800 He acts in the public interest. 16 00:00:54.800 --> 00:00:57.840 And of course he's omniscient, like the Wizard of Oz. 17 00:00:57.840 --> 00:01:01.720 And this has been created, this idea in the minds 18 00:01:01.720 --> 00:01:05.640 of a lot of the public, largely by the economics profession. 19 00:01:05.640 --> 00:01:07.340 And I'll give you an example of it. 20 00:01:08.720 --> 00:01:13.720 Paul Samuelson, his textbook was the biggest selling textbook 21 00:01:14.120 --> 00:01:16.800 in the field of economics from 1948 22 00:01:16.800 --> 00:01:18.920 until around the early eighties. 23 00:01:18.920 --> 00:01:22.440 and all the other textbooks were pretty much clones of his. 24 00:01:22.440 --> 00:01:26.500 And so several generations of people who studied economics, 25 00:01:26.500 --> 00:01:28.440 which includes all of the journalists 26 00:01:28.440 --> 00:01:31.100 who write about economics for the most part, 27 00:01:32.120 --> 00:01:36.000 were educated by Samuelson or Samuelson clones. 28 00:01:36.000 --> 00:01:41.000 And here's what a late edition, 1989 edition 29 00:01:41.080 --> 00:01:43.720 of Samuelson's book said about the Fed. 30 00:01:43.720 --> 00:01:46.240 The Federal Reserve's goals are steady growth 31 00:01:46.240 --> 00:01:49.360 in National Output and Low Unemployment. 32 00:01:49.360 --> 00:01:52.080 Its sworn enemy is inflation. 33 00:01:52.960 --> 00:01:55.240 If aggregate demand is excessive 34 00:01:55.240 --> 00:01:56.760 so that prices are being bid up, 35 00:01:56.760 --> 00:01:59.600 the Federal Reserve Board may want to slow the growth 36 00:01:59.600 --> 00:02:02.720 of the money supply, thereby slowing aggregate demand 37 00:02:02.720 --> 00:02:03.820 and output growth. 38 00:02:03.820 --> 00:02:06.720 If unemployment is high and business is languishing, 39 00:02:06.720 --> 00:02:09.020 the Fed may consider increasing the money supply, 40 00:02:09.020 --> 00:02:11.100 thereby raising aggregate demand 41 00:02:11.100 --> 00:02:14.000 and augmenting output growth, period. 42 00:02:14.000 --> 00:02:16.880 In a nutshell, this is a function of central banking, 43 00:02:16.880 --> 00:02:20.200 which is an essential part of macroeconomic management 44 00:02:20.200 --> 00:02:24.000 in all mixed economies, the Wizard of Oz basically. 45 00:02:24.000 --> 00:02:27.880 After Samuelson's book began to wane in terms of sales, 46 00:02:27.880 --> 00:02:30.720 and then an equally bad book took its place 47 00:02:30.720 --> 00:02:33.600 by Campbell McConnell as the big seller. 48 00:02:33.600 --> 00:02:37.360 And there were quite a few clones of that one too. 49 00:02:37.360 --> 00:02:39.640 Thankfully today, in 2005, 50 00:02:39.640 --> 00:02:42.680 there are quite a few other books that are much better. 51 00:02:42.680 --> 00:02:46.920 But here's what Campbell McConnell said about the Fed, 52 00:02:46.920 --> 00:02:49.240 because it is a public body, 53 00:02:49.240 --> 00:02:52.120 that is because it is a part of government. 54 00:02:52.120 --> 00:02:53.360 I'm quoting him. 55 00:02:53.360 --> 00:02:55.960 The decisions of the Board of Governors are made 56 00:02:55.960 --> 00:02:59.440 in what it perceives to be the public interest. 57 00:02:59.440 --> 00:03:01.260 The Federal Reserve banks are not guided 58 00:03:01.260 --> 00:03:02.600 by the profit motive, 59 00:03:02.600 --> 00:03:04.880 but rather they pursue those measures 60 00:03:04.880 --> 00:03:07.680 which the Board of Governors recommends. 61 00:03:07.680 --> 00:03:10.260 The fundamental objective of monetary policy 62 00:03:10.260 --> 00:03:11.680 is to assist the economy 63 00:03:11.680 --> 00:03:16.840 in Achieving a Full-Employment, Non-Inflationary Level of Total Output. 64 00:03:16.840 --> 00:03:22.140 And so that's what generations of economic students have been taught. 65 00:03:22.140 --> 00:03:24.440 And of course, this filters in through the whole society, 66 00:03:24.440 --> 00:03:28.400 through the journalism profession and everything else. 67 00:03:28.400 --> 00:03:31.820 And I think it's been inherently sort of dishonest 68 00:03:31.820 --> 00:03:35.080 because there was a long history of the federal government 69 00:03:35.080 --> 00:03:39.360 being involved in money and banking prior to the Fed. 70 00:03:39.360 --> 00:03:43.440 and not to mention the history of the Fed itself 71 00:03:43.440 --> 00:03:46.360 that these textbook authors wrote about. 72 00:03:46.360 --> 00:03:48.320 And from the very beginning, 73 00:03:48.320 --> 00:03:50.320 federal involvement in money and banking 74 00:03:50.320 --> 00:03:53.080 was thoroughly political. 75 00:03:53.080 --> 00:03:55.040 The first bank of the United States 76 00:03:55.040 --> 00:03:58.000 created by Alexander Hamilton. 77 00:03:58.000 --> 00:03:59.360 It wasn't like the Fed, 78 00:03:59.360 --> 00:04:02.960 but it was the first federal government bank. 79 00:04:02.960 --> 00:04:06.440 The first head of it was a US Navy captain 80 00:04:06.440 --> 00:04:08.160 named William Jones, 81 00:04:08.160 --> 00:04:10.400 who had no banking experience at all 82 00:04:10.400 --> 00:04:13.260 and had just personally gone bankrupt, 83 00:04:13.260 --> 00:04:14.760 but he had political connections, 84 00:04:14.760 --> 00:04:17.120 therefore he was the right man for the job 85 00:04:17.120 --> 00:04:18.960 to run the Bank of the United States. 86 00:04:21.040 --> 00:04:22.960 And then the Bank of the United States, 87 00:04:22.960 --> 00:04:25.680 by the time we got to the 1820s, 88 00:04:25.680 --> 00:04:27.840 many of you know there was a big showdown 89 00:04:27.840 --> 00:04:29.820 between President Andrew Jackson 90 00:04:29.820 --> 00:04:31.840 and the head of the Bank of the United States. 91 00:04:31.840 --> 00:04:34.920 And it was all over the politicization 92 00:04:34.920 --> 00:04:36.480 of the Bank of the United States. 93 00:04:36.480 --> 00:04:39.680 Roger B. Taney, who was the Treasury Secretary at the time, 94 00:04:39.680 --> 00:04:43.160 he was later the Chief Justice of the United States, 95 00:04:43.160 --> 00:04:44.000 said of the bank, 96 00:04:44.000 --> 00:04:47.420 it has patronage greater than that of the government. 97 00:04:47.420 --> 00:04:49.080 And what did he mean by that? 98 00:04:49.080 --> 00:04:52.960 Well, he just observed what the bank was doing. 99 00:04:52.960 --> 00:04:55.720 During the 1828 election campaign, 100 00:04:55.720 --> 00:04:58.920 the bank of the United States spent more than $100,000. 101 00:04:58.920 --> 00:05:02.680 This is in 1828 of the bank's deposits, 102 00:05:02.680 --> 00:05:05.240 which were federal tax deposits, 103 00:05:05.240 --> 00:05:10.000 in support of Andrew Jackson's political opponents. 104 00:05:10.000 --> 00:05:12.880 It promised money to friendly members of Congress 105 00:05:12.880 --> 00:05:16.760 so they can spend on pork if they supported the bank. 106 00:05:16.760 --> 00:05:19.120 And they paid for the printing of Henry Clay's speeches 107 00:05:19.120 --> 00:05:20.320 in support of the bank. 108 00:05:20.320 --> 00:05:24.160 And they also paid for a newspaper ads that promoted 109 00:05:24.160 --> 00:05:26.560 the bank and smeared Andrew Jackson 110 00:05:26.560 --> 00:05:28.200 who was opposing the bank. 111 00:05:28.200 --> 00:05:31.080 So the whole history of federal involvement in banking 112 00:05:31.080 --> 00:05:33.920 has been a history, not of barking cats, 113 00:05:33.920 --> 00:05:37.120 but of political meddling by banks. 114 00:05:37.120 --> 00:05:42.120 And so FDR, when FDR came in, 115 00:05:43.720 --> 00:05:47.600 you know, he appointed as his head of the Fed, 116 00:05:47.600 --> 00:05:50.080 Mariner Eccles, who was a strong supporter 117 00:05:50.080 --> 00:05:51.720 of deficit spending. 118 00:05:51.720 --> 00:05:54.080 And Eccles had no financial background 119 00:05:54.080 --> 00:05:57.000 and did not even have a college degree at the time. 120 00:05:57.000 --> 00:05:59.120 But he was a political yes man. 121 00:05:59.120 --> 00:06:02.360 And he did what Roosevelt wanted 122 00:06:02.360 --> 00:06:05.800 so that FDR essentially ran the Fed. 123 00:06:05.800 --> 00:06:09.440 We'll talk about politicization of the Fed. 124 00:06:09.440 --> 00:06:11.800 You literally effectively had the president 125 00:06:11.800 --> 00:06:12.960 calling the shots. 126 00:06:12.960 --> 00:06:17.280 And thankfully, there's a lot of economics literature 127 00:06:17.280 --> 00:06:20.120 on the politicization of the Fed. 128 00:06:20.120 --> 00:06:22.940 It doesn't always make it down to the textbooks 129 00:06:22.940 --> 00:06:26.740 so that the general public can come to learn 130 00:06:26.740 --> 00:06:28.400 about the truth about the Fed. 131 00:06:28.400 --> 00:06:30.580 But I'll just summarize a few things 132 00:06:30.580 --> 00:06:33.420 that academics know about this, 133 00:06:33.420 --> 00:06:36.100 about the Fed being politicized. 134 00:06:36.100 --> 00:06:38.100 The late Robert Weintraub, 135 00:06:38.100 --> 00:06:41.740 who was quite a good monetary economist, 136 00:06:42.780 --> 00:06:44.260 did some research some years ago 137 00:06:44.260 --> 00:06:46.620 showing how the Federal Reserve policy 138 00:06:46.620 --> 00:06:49.580 fundamentally shifted its monetary policy course 139 00:06:49.580 --> 00:06:54.580 in 1953, 1961, 1969, 1974 and 1977. 140 00:06:56.420 --> 00:06:59.820 These are all years in which the presidency changed hands. 141 00:06:59.820 --> 00:07:02.820 And so the implication here of what's going on 142 00:07:02.820 --> 00:07:05.860 is that the Fed Chairman does whatever he thinks will take 143 00:07:05.860 --> 00:07:07.460 to help him get reappointed. 144 00:07:07.460 --> 00:07:08.880 If there's a new president comes in 145 00:07:08.880 --> 00:07:11.380 and he wants tight money as opposed to easy money, 146 00:07:11.380 --> 00:07:13.860 that's what he'll get or vice versa. 147 00:07:13.860 --> 00:07:16.660 And for example, when Eisenhower 148 00:07:16.660 --> 00:07:18.480 wanted a slower monetary growth, 149 00:07:18.480 --> 00:07:23.180 the money supply grew at 1.73% during his administration. 150 00:07:23.180 --> 00:07:25.600 Kennedy came in, he wanted faster money growth, 151 00:07:25.600 --> 00:07:28.300 he got it, 2.31%. 152 00:07:28.300 --> 00:07:31.660 Lyndon Johnson, of course, he wanted faster yet 153 00:07:31.660 --> 00:07:33.220 to finance the Vietnam War. 154 00:07:33.220 --> 00:07:36.280 The money growth doubled to 5%. 155 00:07:36.280 --> 00:07:38.500 And this was all under the same Fed Chairman, 156 00:07:38.500 --> 00:07:40.500 William Chesney Martin. 157 00:07:40.500 --> 00:07:43.300 And so he had no consistent ideology or theory 158 00:07:43.300 --> 00:07:45.260 of his policy. 159 00:07:45.260 --> 00:07:48.860 It's basically whatever his boss wanted. 160 00:07:48.860 --> 00:07:51.920 Although we're told that the Fed is independent, 161 00:07:51.920 --> 00:07:54.200 it's not really. 162 00:07:54.200 --> 00:07:57.080 When Arthur Burns came in as head of the Fed, 163 00:07:57.080 --> 00:08:04.080 His main objective at one point, of course, was to get Richard Nixon re-elected. 164 00:08:04.560 --> 00:08:08.360 And so Burns' staff told him in the fall of 1972 165 00:08:08.360 --> 00:08:12.460 that the money supply was forecast to be growing 166 00:08:12.460 --> 00:08:17.580 for that quarter, the last quarter, at 10.5%, 167 00:08:17.580 --> 00:08:19.760 well, the third quarter rather, at 72. 168 00:08:19.760 --> 00:08:23.240 So Burns made sure that the money supply grew even faster 169 00:08:23.240 --> 00:08:27.680 and 10.5% in the third quarter of 72. 170 00:08:27.680 --> 00:08:30.500 And that was the fastest for any one year 171 00:08:30.500 --> 00:08:33.200 in about 30 years at that point. 172 00:08:33.200 --> 00:08:36.840 And so, and then President Ford came in 173 00:08:36.840 --> 00:08:38.960 and he had some of you remember his 174 00:08:38.960 --> 00:08:40.840 Whip Inflation Now program. 175 00:08:40.840 --> 00:08:44.240 Does anyone have a win button, Whip Inflation Now? 176 00:08:44.240 --> 00:08:47.240 I remember these things, you can hand out these buttons, W-I-N. 177 00:08:49.680 --> 00:08:52.280 So as the Fed complied, they reduced the money growth 178 00:08:52.280 --> 00:08:54.160 to 4.7%. 179 00:08:54.160 --> 00:08:55.680 Jimmy Carter came in, of course, 180 00:08:55.680 --> 00:08:58.760 he wanted inflationary finance. 181 00:08:58.760 --> 00:09:01.760 And so they upped the growth rate to 8.5%. 182 00:09:01.760 --> 00:09:06.760 And then during the last year of Carter's administration, 183 00:09:08.400 --> 00:09:11.120 the money supply grew at 16.2% 184 00:09:11.120 --> 00:09:14.260 in the five months preceding the election. 185 00:09:14.260 --> 00:09:15.840 And of course, in a failed attempt 186 00:09:15.840 --> 00:09:18.400 to get Jimmy Carter re-elected. 187 00:09:18.400 --> 00:09:20.960 And so a lot of what goes on here, 188 00:09:20.960 --> 00:09:23.720 There's an economist named Edward Kane, 189 00:09:23.720 --> 00:09:26.600 who makes a very persuasive argument, 190 00:09:26.600 --> 00:09:29.320 to me I think, that the Fed sometimes serves 191 00:09:29.320 --> 00:09:31.520 as sort of a political scapegoat 192 00:09:31.520 --> 00:09:33.600 for the administration in office. 193 00:09:33.600 --> 00:09:36.800 And I'll just read you what Edward Kane says about this. 194 00:09:36.800 --> 00:09:39.880 Whenever monetary policies are popular, 195 00:09:39.880 --> 00:09:42.380 incumbents can claim that their influence 196 00:09:42.380 --> 00:09:45.000 was crucial in their adaptation, 197 00:09:45.000 --> 00:09:46.400 their influence over the Fed. 198 00:09:46.400 --> 00:09:48.200 On the other hand, when the monetary policies 199 00:09:48.200 --> 00:09:50.840 prove unpopular, they can blame everything 200 00:09:50.840 --> 00:09:53.440 on a stubborn Federal Reserve and claim further 201 00:09:53.440 --> 00:09:55.280 that things would have been worse 202 00:09:55.280 --> 00:09:59.100 if they had not pressed Fed officials at every opportunity. 203 00:09:59.100 --> 00:10:00.840 In return for this favor, 204 00:10:00.840 --> 00:10:04.180 the Fed is allowed to amass a huge slush fund 205 00:10:04.180 --> 00:10:06.840 by earning interest income from the government securities 206 00:10:06.840 --> 00:10:10.600 it purchases through its own open market operations. 207 00:10:10.600 --> 00:10:12.560 And what he's talking about there 208 00:10:12.560 --> 00:10:16.560 is that the way the Fed actually finances its own salaries 209 00:10:16.560 --> 00:10:19.340 and buildings and its operations 210 00:10:19.340 --> 00:10:21.100 is the interest that it earns 211 00:10:21.100 --> 00:10:23.660 on the securities that it owns. 212 00:10:23.660 --> 00:10:25.820 And so there's a built-in incentive 213 00:10:25.820 --> 00:10:29.900 to put money in circulation, okay? 214 00:10:29.900 --> 00:10:31.700 And to accumulate these securities 215 00:10:31.700 --> 00:10:34.060 because the interest earned on the securities 216 00:10:34.060 --> 00:10:37.100 the Fed holds is how it funds itself, 217 00:10:37.100 --> 00:10:38.340 how it funds itself. 218 00:10:38.340 --> 00:10:40.060 And it funds itself very well. 219 00:10:40.060 --> 00:10:42.040 There was a general accounting office report 220 00:10:42.040 --> 00:10:44.940 on the Fed several years ago. 221 00:10:44.940 --> 00:10:48.260 And then some of the things that it mentions 222 00:10:48.260 --> 00:11:18.260 is that the Fed had, at the time, it had 25,000 employees, runs its own air force of 47 Lear jets and small cargo planes, fleets of vehicles, including personal cars for 59 bank managers, a full-time curator oversees its collection of paintings and sculptures of the Fed, it held, I thought this was a misprint in the Wall Street Journal, but it wasn't, the article said the Fed held 223 00:11:18.260 --> 00:11:23.260 spent $51 billion in accumulated assets as of 1996. 224 00:11:24.060 --> 00:11:26.020 And it was the time it was building itself, 225 00:11:26.020 --> 00:11:28.660 several very expensive buildings. 226 00:11:28.660 --> 00:11:31.420 And even the head janitor of the Fed, 227 00:11:31.420 --> 00:11:32.820 who has a very fancy title, 228 00:11:32.820 --> 00:11:35.540 he's the support services director, 229 00:11:35.540 --> 00:11:39.740 makes almost $200,000 a year in salary and fringe benefits. 230 00:11:39.740 --> 00:11:44.180 And so, you know, there's a little, I'm suspicious, 231 00:11:44.180 --> 00:11:46.420 I'm beginning to think there might be some self-interest 232 00:11:46.420 --> 00:11:48.940 involved here in the Fed behavior. 233 00:11:51.940 --> 00:11:54.980 I'm getting cynical in my older age, I guess. 234 00:11:54.980 --> 00:11:58.660 Of course, there is a political constituency for inflation. 235 00:11:59.620 --> 00:12:02.820 There's a low interest rate lobby, the real estate industry, 236 00:12:02.820 --> 00:12:07.340 the financial institution industry, construction unions. 237 00:12:07.340 --> 00:12:10.220 And so there certainly is a motive 238 00:12:10.220 --> 00:12:13.620 for a low interest rate expansionary monetary policy 239 00:12:13.620 --> 00:12:16.120 that we all end up suffering for. 240 00:12:16.420 --> 00:12:23.820 Okay, and so that's basically the story I wanted to tell, since I only had 20 minutes. 241 00:12:23.820 --> 00:12:30.120 Basically what I wanted to say is that I think the reason why we have, if you consider this historically, 242 00:12:30.120 --> 00:12:36.020 from whatever data the government has collected on prices, consumer price index, 243 00:12:36.020 --> 00:12:41.920 the price level was about the same in 1913 when the Fed was created, 244 00:12:41.920 --> 00:12:46.720 as it was in 1789 when the Constitution was ratified. 245 00:12:46.720 --> 00:12:50.320 There were ups and downs, there were the business cycle, 246 00:12:50.320 --> 00:12:54.020 but there wasn't general inflation in general over that whole period. 247 00:12:54.020 --> 00:12:58.720 But since then, of course, the price level is about 15 times higher at least, 248 00:12:58.720 --> 00:13:04.520 and we've had much more severe ups and downs than we ever did in years prior to that. 249 00:13:04.520 --> 00:13:11.120 And I recently was reading a book about, I've been doing some research on the fateful year of 1913, 250 00:13:11.120 --> 00:13:21.120 And we've got the Fed, the income tax, the 17th Amendment, which calls for the direct election of senators and a few other awful things at the same time, 251 00:13:21.120 --> 00:13:25.120 all of which consolidated more and more power in the central government. 252 00:13:25.120 --> 00:13:35.120 And one of the writers on the history of the income tax commented as an aside that, thank goodness, the Fed came in in 1913, 253 00:13:35.120 --> 00:13:41.360 Because if not, we may not have been able to enter World War I and pay for it and pay for it. 254 00:13:41.360 --> 00:13:43.040 And he's exactly right. 255 00:13:43.040 --> 00:13:46.440 We may not have been able to finance World War I. 256 00:13:46.440 --> 00:13:51.960 And so it's more than just the Fed has created inflation and economic stability. 257 00:13:51.960 --> 00:13:57.840 The advocates of central banking have always looked at central banking and money creation 258 00:13:57.840 --> 00:14:03.480 as a means of financing an American empire that would span the entire world. 259 00:14:03.480 --> 00:14:12.480 Well, I've studied the National Currency Acts that occurred during the war to prevent southern independence, as I call it, in the 1860s. 260 00:14:12.480 --> 00:14:22.280 And the advocates of the National Currency Acts, which was the end result of a 70-year battle over government banking in America, 261 00:14:22.280 --> 00:14:31.180 clearly came right out and said that one of the reasons they were for this is they wanted to turn the American government into something that would pursue empire. 262 00:14:31.180 --> 00:14:34.460 They didn't want it to be a limited constitutional republic. 263 00:14:34.460 --> 00:14:37.700 They wanted it to be an empire that would rival the British Empire. 264 00:14:37.700 --> 00:14:42.180 And they knew they needed a central bank of sorts to finance that. 265 00:14:42.180 --> 00:14:44.860 And that's exactly what happened at that time. 266 00:14:44.860 --> 00:14:51.940 And the national currency ads were the precursor of the Fed, which came along, of course, in 1913. 267 00:14:51.940 --> 00:14:54.420 And so it's more than just economic instability. 268 00:14:54.420 --> 00:14:59.820 It's international mischief-making that can end up costing thousands or millions of lives 269 00:14:59.820 --> 00:15:07.820 to the extent that it gets us involved in wars, and of course war is the mother of the state, as the old saying goes.