WEBVTT NOTE War and the Fed 1 00:00:00.000 --> 00:00:04.000 20th century was the era of total war. 2 00:00:04.000 --> 00:00:12.000 Limitations on the scope of war, first built up over many centuries, had already begun to break down in the 19th century. 3 00:00:12.000 --> 00:00:16.000 They were altogether obliterated in the 20th. 4 00:00:16.000 --> 00:00:22.000 And of course, the sheer amount of resources the centralized states could bring to bear in war, 5 00:00:22.000 --> 00:00:32.000 and the terrible new technologies of killing that became available to them made the 20th century an era of almost unimaginable horror. 6 00:00:32.000 --> 00:00:41.000 It isn't terribly often that people discuss the development of total war in tandem with the development of modern central banking, 7 00:00:41.000 --> 00:00:48.000 which, although antecedents existed long before, also came into its own in the 20th century. 8 00:00:48.000 --> 00:01:06.000 It's no surprise that Ron Paul, the man who in public life who has done more than anyone else, to break through the limits of what is permissible in polite society to say about both these things, has also been so insistent that the twin phenomena of war and central banking are linked. 9 00:01:06.000 --> 00:01:15.000 Quoted, it is no coincidence, Dr. Paul said, that the century of total war coincided with the century of central banking. 10 00:01:15.000 --> 00:01:28.000 He added, if every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I'm certain it would end very quickly. 11 00:01:28.000 --> 00:01:37.000 The problem is that the government finances war, says Dr. Paul, by borrowing and printing money rather than presenting a bill directly in the form of higher taxes. 12 00:01:37.000 --> 00:01:43.000 When the costs are obscured, the question of whether the war is worth it becomes distorted. 13 00:01:43.000 --> 00:01:48.720 For the sake of my remarks today, I take it as a given that Murray Rothbard's analysis 14 00:01:48.720 --> 00:01:52.320 of the true functions of central banking is correct. 15 00:01:52.320 --> 00:01:57.920 Rothbard's books, The History of Money and Banking in the Colonial Era to World War II, 16 00:01:57.920 --> 00:02:03.160 The Case Against the Fed, The Mystery of Banking, What Has Government Done to Our Money, provide 17 00:02:03.160 --> 00:02:07.280 the logical case and the empirical evidence for his view. 18 00:02:07.280 --> 00:02:12.780 And I refer to you those sources for additional details, and of course they're all available 19 00:02:12.780 --> 00:02:21.780 For now, I also take it as uncontroversial that central banks perform three significant functions for the banking system and the government. 20 00:02:21.780 --> 00:02:28.780 First, they serve as lenders of last resort, which in practice means bailouts for the big financial firms. 21 00:02:28.780 --> 00:02:37.780 Second, they coordinate the inflation of the money supply by establishing a uniform rate at which the banks inflate, thereby making the fractional reserve banking system 22 00:02:37.780 --> 00:02:44.100 Banking System, both less unstable and more consistently profitable than it would be without 23 00:02:44.100 --> 00:02:48.540 a central bank, which by the way is the reason that banks have always clamored for central 24 00:02:48.540 --> 00:02:49.540 banks. 25 00:02:49.540 --> 00:02:55.940 Finally, they allow governments via inflation to finance their operations far more cheaply 26 00:02:55.940 --> 00:02:59.860 and surreptitiously than they otherwise could. 27 00:02:59.860 --> 00:03:05.580 As an enabler of inflation, the Fed is ipso facto an enabler of war. 28 00:03:05.580 --> 00:03:10.060 Looking back on World War I, Ludwig von Mises wrote in 1919, 29 00:03:10.060 --> 00:03:17.140 one can say without exaggeration that inflation is an indispensable means of militarism. 30 00:03:17.140 --> 00:03:22.820 Without it, the repercussions of war on welfare become obvious much more quickly and penetratingly. 31 00:03:22.820 --> 00:03:27.820 War, weariness, would set in much earlier. 32 00:03:27.820 --> 00:03:34.060 No government has ever said, because we want to go to war, we must abandon central banking. 33 00:03:34.060 --> 00:03:40.500 Or, because we want to go to war, we must abandon inflation and the fiat money system. 34 00:03:40.500 --> 00:03:45.720 Governments always say we must abandon the gold standard because we want to go to war. 35 00:03:45.720 --> 00:03:50.880 That alone indicates that the restraint that hard money places on governments, precious 36 00:03:50.880 --> 00:03:56.700 metals cannot be created out of thin air, which is why governments chafe at monetary 37 00:03:56.700 --> 00:03:59.680 systems based on them. 38 00:03:59.680 --> 00:04:01.900 Governments can raise revenue in three ways. 39 00:04:01.900 --> 00:04:06.540 is the most visible means of doing so, and it is eventually, for that reason, meets with 40 00:04:06.540 --> 00:04:11.780 popular resistance. They can borrow the money they need, but this borrowing is likewise 41 00:04:11.780 --> 00:04:17.220 visible to the public in the form of higher interest rates. As the government competes 42 00:04:17.220 --> 00:04:23.300 for a limited amount of available credit, credit becomes scarcer for other borrowers. 43 00:04:23.300 --> 00:04:27.820 Creating money out of thin air, the third option, is preferable for governments, since 44 00:04:27.820 --> 00:04:33.500 Since the process by which the political class siphons resources from society via inflation 45 00:04:33.500 --> 00:04:38.620 is far less direct and obvious than in the case of taxation and borrowing. 46 00:04:38.620 --> 00:04:43.420 In the old days, the king simply clipped the coins, kept the shavings, and then spent the 47 00:04:43.420 --> 00:04:47.940 coins back into circulation at the same nominal value. 48 00:04:47.940 --> 00:04:52.460 Once they have it, governments guard this power jealously. 49 00:04:52.460 --> 00:04:56.540 Mises once said that if the bank in England had been available to King Charles I during 50 00:04:56.540 --> 00:05:01.420 and English Civil War in the 1640s, he could have crushed the parliamentary forces arrayed 51 00:05:01.420 --> 00:05:07.580 against him and English history would have been much different. Juan de Mariana, Spanish 52 00:05:07.580 --> 00:05:14.420 Jesuit who in the 16th and early 17th centuries is best known in political philosophy for 53 00:05:14.420 --> 00:05:21.860 having defended regicide in his 1599 work, Irregue. Casual students often assume that 54 00:05:21.860 --> 00:05:26.020 it must have been for this provocative claim that the Spanish government jailed him for 55 00:05:26.020 --> 00:05:31.520 for a time. But in fact, it was his treatise on the alteration of money, which condemned 56 00:05:31.520 --> 00:05:39.100 monetary inflation as a moral evil that got him in trouble. Think about that. Saying the 57 00:05:39.100 --> 00:05:44.180 king could be killed was one thing, but taking direct aim at inflation, the lifeblood of 58 00:05:44.180 --> 00:05:51.060 the regime, that was taking things too far. In those days, if a war was to be funded partly 59 00:05:51.060 --> 00:05:56.420 Covered by monetary debasement, the process was direct and not difficult to understand. 60 00:05:56.420 --> 00:06:01.820 The sequence of events today is more complicated, but as I've said, not fundamentally different. 61 00:06:01.820 --> 00:06:06.920 What happens today is not that the government needs to pay for a war, comes up short and 62 00:06:06.920 --> 00:06:09.780 simply prints the money to make up the difference. 63 00:06:09.780 --> 00:06:14.820 The process is not quite so crude, but when we examine it carefully, it turns out to be 64 00:06:14.820 --> 00:06:17.500 essentially the same thing. 65 00:06:17.500 --> 00:06:21.940 Central banks established by the world's governments allow these governments to spend more than 66 00:06:21.940 --> 00:06:24.520 they receive in taxes. 67 00:06:24.520 --> 00:06:28.360 Borrowing allows them to spend more than they receive in taxes, too, but government borrowing 68 00:06:28.360 --> 00:06:34.580 led to higher interest rates, which in turn can provoke the public in undesirable ways. 69 00:06:34.580 --> 00:06:38.860 When central banks create money and inject it into the banking system, they serve the 70 00:06:38.860 --> 00:06:44.680 purposes of government by pushing those interest rates back down, thereby concealing the effects 71 00:06:44.680 --> 00:06:46.940 of government borrowing. 72 00:06:46.940 --> 00:06:50.880 But central banking does more than this. It essentially prints up the money and hands it 73 00:06:50.880 --> 00:06:55.460 to the government, though not obviously so directly. First, the Federal Government is 74 00:06:55.460 --> 00:07:00.780 able to sell its bonds at artificially high prices and correspondingly low interest rates 75 00:07:00.780 --> 00:07:05.580 because the buyers of its debt know they can turn around and sell it to the Federal Reserve. 76 00:07:05.580 --> 00:07:09.060 It's true that the Federal Government has to pay interest on the securities the Federal 77 00:07:09.060 --> 00:07:13.760 Reserve owns, but at the end of the year, the Fed pays that money back to the Treasury 78 00:07:13.760 --> 00:07:16.840 minus its trivial operating expenses. 79 00:07:17.840 --> 00:07:20.240 Trivial in terms of the federal budget, anyway. 80 00:07:20.240 --> 00:07:21.480 That takes care of the interest. 81 00:07:21.480 --> 00:07:22.960 And in case you're thinking, well, 82 00:07:22.960 --> 00:07:26.000 at least the federal government has to pay the principal, 83 00:07:26.000 --> 00:07:27.320 it really doesn't. 84 00:07:27.320 --> 00:07:29.300 The government can roll over its existing debt 85 00:07:29.300 --> 00:07:31.400 when it comes due, issuing a new bond 86 00:07:31.400 --> 00:07:33.640 to pay off the principal of the old one. 87 00:07:34.820 --> 00:07:38.400 Through this process, a process that not coincidentally, 88 00:07:38.400 --> 00:07:41.800 the general public is unlikely to know about or understand, 89 00:07:41.800 --> 00:07:43.440 the federal government is in fact able 90 00:07:43.440 --> 00:07:46.920 to do the equivalent of printing money and spending it. 91 00:07:46.920 --> 00:07:49.440 While everyone else has to acquire resources 92 00:07:49.440 --> 00:07:52.840 by spending money they earned in a productive enterprise, 93 00:07:52.840 --> 00:07:54.680 in other words, they first have to produce something 94 00:07:54.680 --> 00:07:57.480 for society and then they may consume, 95 00:07:57.480 --> 00:07:59.080 governments may acquire resources 96 00:07:59.080 --> 00:08:01.780 without first having produced anything. 97 00:08:01.780 --> 00:08:04.180 Money creation via government monopoly, 98 00:08:04.180 --> 00:08:06.660 this becomes another mechanism whereby 99 00:08:06.660 --> 00:08:09.160 the exploitative relationship between government 100 00:08:09.160 --> 00:08:11.120 and the public is perpetuated. 101 00:08:11.120 --> 00:08:17.040 Now because the central bank allows the government to conceal the cost of everything it does, 102 00:08:17.040 --> 00:08:21.240 it provides an incentive for government to engage in additional spending in all kinds 103 00:08:21.240 --> 00:08:23.960 of areas, not just war. 104 00:08:23.960 --> 00:08:29.720 But because war is enormously expensive, because the sacrifices that accompany it place such 105 00:08:29.720 --> 00:08:35.280 a strain on the public, it is wartime expenditures for which the assistance of the central bank 106 00:08:35.280 --> 00:08:37.540 is especially welcome. 107 00:08:37.540 --> 00:08:43.020 The Federal Reserve System, which was established in late 1913 and opened its doors the following 108 00:08:43.020 --> 00:08:49.140 year, was first put to the test during World War I. Unlike some countries, the U.S. did 109 00:08:49.140 --> 00:08:54.180 not abandon the gold standard during the war, but it was not operating under a pure 100% 110 00:08:54.180 --> 00:09:00.380 gold standard in any sense. The Fed could and did engage in credit expansion. 111 00:09:00.380 --> 00:09:05.020 On Mises.org, we feature an article by John Paul Koning that takes the reader through 112 00:09:05.020 --> 00:09:10.420 were the exact process by which the Fed carried out its monetary inflation in those early years. 113 00:09:10.420 --> 00:09:17.820 In brief, the Fed essentially created money and used it to buy war bonds, to add war bonds to its balance sheet. 114 00:09:17.820 --> 00:09:22.420 Benjamin Anderson, the austro-sympathetic economist that served at the time, 115 00:09:22.420 --> 00:09:26.920 quote, the growth in virtually all of the items on the balance sheet of the Federal Reserve system 116 00:09:26.920 --> 00:09:31.220 since the United States entered the war has been very great indeed. 117 00:09:31.220 --> 00:09:39.220 The Fed's accommodating role was not confined to the wartime itself. In America's Money Machine, Elgin Grossclose wrote, 118 00:09:39.220 --> 00:09:45.220 Although the war was over in 1918 in a fighting sense, it was not over in a financial sense. 119 00:09:45.220 --> 00:09:51.220 The Treasury still had enormous obligations to meet, which were eventually covered by a victory loan. 120 00:09:51.220 --> 00:09:55.220 The main support in the market, again, was the Federal Reserve. 121 00:09:55.220 --> 00:10:00.220 Monetary expansion was especially helpful to the US government during the Vietnam War. 122 00:10:00.220 --> 00:10:01.220 and some more. 123 00:10:01.220 --> 00:10:06.700 Lyndon Johnson could have both his great society programs and his overseas war, and the strain 124 00:10:06.700 --> 00:10:11.620 on the public was kept, at first at least, within manageable limits. 125 00:10:11.620 --> 00:10:17.900 So confident had the Keynesian economic planners become, that by 1970 Arthur Oaken, one of 126 00:10:17.900 --> 00:10:25.140 the decade's key presidential advisors on the economy, was noting in a published retrospective 127 00:10:25.140 --> 00:10:29.340 that wise economic management seemed to have done away with the business cycle. 128 00:10:29.340 --> 00:10:35.680 But reality could not be evaded forever, and the apparently strong war economy of the 1960s 129 00:10:35.680 --> 00:10:39.900 gave way to the stagnation of the 1970s. 130 00:10:39.900 --> 00:10:44.300 There is a law of the universe, according to which every time the public is promised 131 00:10:44.300 --> 00:10:48.820 that the boom-bust business cycle has been banished forever, a bust is right around the 132 00:10:48.820 --> 00:10:49.820 corner. 133 00:10:49.820 --> 00:10:55.620 The month after Oaken's rosy book was published, the recession began. 134 00:10:55.620 --> 00:10:59.620 The stock market has paid a steep cost for the inflation of the 1960s. 135 00:10:59.620 --> 00:11:04.260 The loss of life resulting from the war itself was the most gruesome and horrific of these 136 00:11:04.260 --> 00:11:07.820 costs, but the economic devastation cannot be ignored. 137 00:11:07.820 --> 00:11:13.500 As many of us well remember, years of unemployment and high inflation plagued the U.S. economy. 138 00:11:13.500 --> 00:11:16.740 The stock market fared even worse. 139 00:11:16.740 --> 00:11:22.020 Mark Thornton points out that, quote, in May 1970, a portfolio consisting of one share 140 00:11:22.020 --> 00:11:26.860 of every stock listed on the big board was worth just about half of what it would have 141 00:11:26.860 --> 00:11:30.120 been worth at the start of 1969. 142 00:11:30.120 --> 00:11:38.420 The high flyers that had led the market of 1967 and 1968, conglomerates, computer leasers, 143 00:11:38.420 --> 00:11:44.460 far-out electronics, franchisers, were precipitously down from their peaks. 144 00:11:44.460 --> 00:11:51.100 Nor were they down 25 percent like the Dow, but 80, 90 or even 95 percent. 145 00:11:51.100 --> 00:11:55.840 The Dow index, continues Dr. Thornton, shows that stocks tended to trade in a wide channel 146 00:11:55.840 --> 00:12:02.380 for much of the period between 1965 and 1984. However, if you adjust the value of the stocks 147 00:12:02.380 --> 00:12:07.380 by price inflation as measured by the consumer price index, a clearer and more disturbing 148 00:12:07.380 --> 00:12:12.620 picture emerges. The inflation adjusted, a real purchasing power of the Dow indicates 149 00:12:12.620 --> 00:12:19.180 that it lost nearly 80% of its peak value. And for all the talk of the Fed's alleged 150 00:12:19.180 --> 00:12:25.020 Independence, it is not even possible to imagine the Fed maintaining a tight money stance when 151 00:12:25.020 --> 00:12:30.620 the regime demands stimulus or when the troops are in the field. It has been more than accommodating 152 00:12:30.620 --> 00:12:35.100 during the so-called war on terror. Consider the amount of debt purchased every year by 153 00:12:35.100 --> 00:12:40.380 the Fed and compare it to that year's war expenditures and you will get a sense of the 154 00:12:40.380 --> 00:12:46.820 Fed's enabling role. Now, while it's true that a gold standard restrains government, 155 00:12:46.820 --> 00:12:51.380 It is also true that governments have had little difficulty finding pretexts, or chief 156 00:12:51.380 --> 00:12:54.580 among them, to abandon the gold standard. 157 00:12:54.580 --> 00:12:58.540 For that reason, the gold standard in and of itself is not a sufficient restraint on 158 00:12:58.540 --> 00:13:01.980 the government's ambitions at home and abroad. 159 00:13:01.980 --> 00:13:07.220 As we look to the future, we must cast aside all timidity in our proposals for monetary 160 00:13:07.220 --> 00:13:08.480 reform. 161 00:13:08.480 --> 00:13:13.300 We do not seek a gold exchange standard as existed under Bretton Woods. 162 00:13:13.300 --> 00:13:18.180 We do not seek to use the price of gold as a calibration device to assist the monetary 163 00:13:18.180 --> 00:13:21.780 authority in its decisions on how much money to create. 164 00:13:21.780 --> 00:13:26.740 We do not seek even the restoration of the classical gold standard, great though its 165 00:13:26.740 --> 00:13:27.740 merits are. 166 00:13:27.740 --> 00:13:33.780 In the 1830s, as Tom Woods pointed out, the hard-money Jacksonians coined the marvelous 167 00:13:33.780 --> 00:13:37.780 phrase separation of bank and state. 168 00:13:37.780 --> 00:13:39.380 That would be a start. 169 00:13:39.380 --> 00:13:44.100 But what we need today is the separation of money and state. 170 00:13:44.100 --> 00:13:47.060 There are some ways in which money is unique among goods. 171 00:13:47.060 --> 00:13:52.380 For one thing, money is valued not for its own sake, but for its use in exchange. 172 00:13:52.380 --> 00:13:57.860 For another, money is not consumed, but rather is handed on from person to person. 173 00:13:57.860 --> 00:14:02.820 And all other goods in the economy have their prices expressed in terms of this good. 174 00:14:02.820 --> 00:14:07.580 But there is nothing about money, or indeed anything else, that should make us think its 175 00:14:07.580 --> 00:14:13.640 Its production must be carried out by the government or its designated monopoly grantee. 176 00:14:13.640 --> 00:14:17.940 Money constitutes one half of every non-barter market transaction. 177 00:14:17.940 --> 00:14:22.500 People who believe in the market economy and yet who are prepared to hand over to the state 178 00:14:22.500 --> 00:14:29.160 the custodianship of this most crucial good ought to think again. 179 00:14:29.160 --> 00:14:33.580 Interventionists sometimes claim that a particular good is just too important to be left to the 180 00:14:33.580 --> 00:14:35.020 market. 181 00:14:35.020 --> 00:14:38.180 The standard free market reply turns this argument around. 182 00:14:38.180 --> 00:14:42.180 The more important a commodity is, the more essential it is for the government not to 183 00:14:42.180 --> 00:14:46.860 produce it, and to leave its production instead to the market. 184 00:14:46.860 --> 00:14:50.800 Nowhere is this more true than in the case of money. 185 00:14:50.800 --> 00:14:55.980 As Ludwig von Mises once said, the history of money is the history of government efforts 186 00:14:55.980 --> 00:14:58.820 to destroy money. 187 00:14:58.820 --> 00:15:04.120 Government control of money has yielded monetary debasement, the impoverishment of society 188 00:15:04.120 --> 00:15:10.520 Relative to the State, Devastating Business Cycles, Financial Bubbles, Capital Consumption 189 00:15:10.520 --> 00:15:16.120 because of Falsified Profit and Loss Accounting, Moral Hazard, and most remain to this topic 190 00:15:16.120 --> 00:15:20.840 today, the expropriation of the public in ways that they are unlikely to understand. 191 00:15:20.840 --> 00:15:26.800 It is this silent expropriation that has made possible some of the state's greatest 192 00:15:26.800 --> 00:15:33.680 enormities, including all its wars, and it is all these offenses combined that constitute 193 00:15:33.680 --> 00:15:40.920 a Compelling Popular Brief Against the Current System and in Favor of a Market Substitute. 194 00:15:40.920 --> 00:15:46.720 The war machine and the money machine, in short, are intimately linked. It is vain to 195 00:15:46.720 --> 00:15:51.580 denounce the moral grotesqueries of the U.S. Empire without at the same time taking aim 196 00:15:51.580 --> 00:15:57.420 at the indispensable support that makes it all possible. If we wish to oppose the state 197 00:15:57.420 --> 00:16:04.480 and all its manifestations, its imperial adventures, its domestic subsidies, its unstoppable spending 198 00:16:04.480 --> 00:16:11.220 and debt accumulation. We must point to their source, the central bank, the mechanism that 199 00:16:11.220 --> 00:16:17.300 the state and its kept media and economists will defend to their dying days. The state 200 00:16:17.300 --> 00:16:23.680 has persuaded the people that its own interests are identical with theirs. It seeks to promote 201 00:16:23.680 --> 00:16:30.080 Without their welfare, its wars are their wars. It is the great benefactor, and the 202 00:16:30.080 --> 00:16:35.680 people are to be content in their roles as its contented subjects. 203 00:16:35.680 --> 00:16:41.520 Ours is a different view. The state's relationship with the people is not benign. It is not one 204 00:16:41.520 --> 00:16:47.440 of magnanimous giver and grateful recipient. It is an exploitative relationship, whereby 205 00:16:47.440 --> 00:16:52.640 an array of self-perpetuating fiefdoms that produce nothing live at the expense of the 206 00:16:52.640 --> 00:16:55.200 The Toiling Majority 207 00:16:55.200 --> 00:16:58.540 Its wars do not protect the public, they fleece it. 208 00:16:58.540 --> 00:17:03.280 Its subsidies do not promote the common good, they undermine it. 209 00:17:03.280 --> 00:17:08.960 Why should we expect the production of money to be an exception to this general pattern? 210 00:17:08.960 --> 00:17:13.680 As F.A. Hayek said, it is not reasonable to think that the state has any interest in giving 211 00:17:13.680 --> 00:17:16.400 us a quote, good money. 212 00:17:16.400 --> 00:17:20.400 What the state wants is to produce the money or have a privileged position vis-a-vis the 213 00:17:20.400 --> 00:17:26.280 is the source of the money so that it can dispose largesse on its favored constituencies. 214 00:17:26.280 --> 00:17:29.040 We should not be anxious to accommodate this. 215 00:17:29.040 --> 00:17:33.720 The state does not compromise and neither should we. 216 00:17:33.720 --> 00:17:38.840 In the struggle of liberty against power, few enough will oppose the state in the conventional 217 00:17:38.840 --> 00:17:42.360 wisdom it urges us to adopt. 218 00:17:42.360 --> 00:17:47.300 Fewer still will reject the state and its programs, root and branch. 219 00:17:47.300 --> 00:17:53.420 We must be those few, as we work towards a future in which we are the many. 220 00:17:53.420 --> 00:17:57.220 This is our mission today, as it has been the mission of the Mises Institute for the 221 00:17:57.220 --> 00:17:59.360 past 30 years. 222 00:17:59.360 --> 00:18:05.540 With your support, we shall at this critical moment carry on publishing our books and periodicals, 223 00:18:05.540 --> 00:18:10.780 encouraging research and promotion of the Austrian School both in the profession and 224 00:18:10.780 --> 00:18:15.900 with the general public, and continue the training of tomorrow's champions of the economics 225 00:18:15.900 --> 00:18:16.900 of freedom.