[This review was initially published on our old blog on October 12, 2009]

Congressman Ron Paul has just published his latest book, entitled End the Fed (NY: Grand Central Publishing, 2009). He writes:

The Federal Reserve should be abolished because it is immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty. Its destructive nature makes it a tool of tyrannical government. … The Federal Reserve’s monetary policy has brought us to where we are today – in a tragic economic mess.

Not a word of this is true. What brought us to the mess we are in is without doubt the economically illiterate Presidents of the United States and economically illiterate majority of Senators and Representatives of the Congress of the United States, in which “august” group Rep. Paul finds himself.

The Federal Reserve is the central bank of the United States, a quasi independent institution that Congress established in 1913 to regulate the supply of money and supervise the banks. Until its creation, money consisted of the banknotes issued by the individual private national banks which by law were redeemable in gold or in the coins and currency issued by the U.S. Department of the Treasury. When a recession occurred, caused usually by too many private banks making too many risky loans, they were faced with bankruptcy as they began to run out of gold or Treasury money. Most of the money in circulation or in the banks today consists of banknotes issued by the Fed.

Rep. Paul ignores the fact that while we were on the gold standard, we experienced the Great Depression, the panic of 1907, often credited as the principal reason for the creation of the Fed, not to mention the recessions in the 1890s, the 1870s, and the panic of 1857 and earlier periods of recession.

The Fed consists of a Board of Governors appointed by the President, currently chaired by Chairman Ben Bernanke, the Federal Open Market Committee which buys government bonds when the Board votes to increase the money supply and vice versa when it wants to decrease the money supply, twelve Federal Reserve Banks owned by the member banks in their districts, and the private member banks which are required to subscribe to non-transferable stock in the Federal Reserve Bank of its district.

Under the Full Employment and Balanced Growth Act of 1978, the Fed is charged in Section 108 with making an annual report to the Congress setting forth a review and analysis of recent economic trends, the objectives and plans of the Board and the FOMC with respect to the ranges of growth or diminution of the monetary and credit aggregates, and submit the report to the Senate and House committees on banking, finance, and urban affairs. The purpose of the act was to achieve and maintain full employment, growth, and “reasonable” price stability, with proper attention to national priorities.

Congress Caused this Mess, Not the Fed

Rep. Paul states, “I’ve written this book to explain why I think the system of Fed domination must come to an end.” According to the Full Employment Act, the Fed reports to the Congress. It is Congress that dominates the Fed not vice versa. You could make a much better case to abolish the Congress than the Fed. The Fed did not cause this mess; Congress did. It was Congress that passed the Community Reinvestment Act in 1977 and Presidents GHW Bush, Clinton, and GWBush who strengthened it.

Fannie Mae and Freddie Mac were encouraged to provide a secondary market for bad mortgages. Congress brought pressure on banks to make mortgage loans to unqualified borrowers. Why not make mortgages available to everyone? Democrats wanted the poor to own their own homes and Republicans wanted every family to own its own home because homeowners tend to be conservative.

The CRA enabled community groups like ACORN to blackmail the banks and to get paid by the U.S. government to do so! Wall Street soon saw a way to profit from such government policies, but when the housing bubble burst, the entire financial system was about to go under.

The Treasury used TARP money to bail out the banks and the Fed did as much as it could to reduce interest rates and increase the money supply to prevent a collapse of the economy. It has little to apologize for. Congress should apologize; the CRA has not even been repealed.

It is Congress that does the decision-making and the appropriating. And the Fed is bound by the rules of the game to do the best it can to minimize the harm that wasteful government expenditures cause.

Ron Paul Ignores Trade Deficits

The other major causes of our economics problems are our chronic trade deficits, which are also the primary cause of the dollar's weakness. These trade deficits on goods rose to the enormous sum of over $800 billion dollars in 2008, and cost 5 to 7 million industrial jobs, thus worsening the distribution of income.

Rep. Paul is proud of being a free trader. Free trade works when there are no barriers to trade as in the USA. It does not work when our trading partners like China pursue mercantilism as a policy, with all kinds of barriers to our exports and all kinds of subsidies to their exports to us, including refusal to let her currency fluctuate and to allow her citizens the dollars to buy our goods. (See our book, Trading Away Our Future, 2008).

Unilateral free trade is not a sound policy no matter what Ron Paul and his teachers of the Austrian school say. The purpose of trade is to buy goods one values more in exchange for goods of equal value one values less. Most American economists in academia unfortunately have been brain-washed to extol free trade. None of them face international competition, the same goes for Congressmen and their staffs and government employees.

The Fed and Money

Rep. Paul states that his great teachers belonged to the Austrian school of economics. I am in total agreement with the Austrian school that the growth of government is a threat to individual liberty. Yet someone has to produce goods and services that are worth doing and which the private sector cannot do, will not do, or cannot do as well, like public goods.

One of the services that the government must do if it is to be done well is to maintain the quantity of money at a level that promotes price stability and is adequate for sustained growth and full employment. An independent agency free from political bias is required. The Fed was created to do the job. I know of no agency or institution, certainly not the free market that is better structured to do the job. Federal consumption of goods and services plus investment as a proportion of GDP was 7.5 times greater in 2008 than it was in 1929. Not too bad a record.

The Fed when it creates money does so because it believes it to be necessary for growth of the economy, or to prevent unemployment, or to stimulate investment or consumption or both. Its decisions may be wrong but they are not always wrong. Given the growth of the economy since 1929, it has erred more by making money easier that by keeping the expansion in check. The median change in GDP from 1929 to 2008 was 3.6 percent annually. Not a bad record, we believe, given the number of negative years in depression and recession.

The Fed and War

Rep. Paul argues that central banks facilitate war: "It is no coincidence,” he argues, “that the century of total war coincided with the century of central banking.”

In his view, central banks make it easy for governments to raise money. Aside from the fact that nothing stops a government from printing money itself without issuing debt, the reason for wars has nothing to do with the supply of money. It would be more accurate to say that economic growth creates the ability to wage expensive wars. Financing wars by domestic debt or printing money simply allocates a larger share of the national income to the government to use as it sees fit.”

Governments do often finance their war on borrowed money. What is the central bank supposed to do? Veto the government?

Hitler argued that Germany needed “lebensraum” which he thought could only be accomplished by force. Economic growth is what enabled Germany to do as well or better post-war as territorial acquisition could or would have. Wars are the result of political decisions. We were involved in WW II? Did our central bank cause it? The German, the Bank of England, the French?

The Way Out

What does Ron Paul suggest we do after we abolish the Fed? He fails to make a philosophical or economic case for ending the Fed. His chapter entitled “The Way Out” continues to blame the Fed for our debt when it clearly was the Congress and the Executives that must bear the responsibility. He writes: “In a post-Fed world, we will still have the dollar, banks, ATMs, online trading, Web-based systems of fund transfer” and so on. “What will be added to the system will be vastly more financial options that are currently being kept at bay, including trading and contracting in many different currencies and new, sounder investment opportunities.”

Money would be “a market-created good that emerged out of trade … whether that be beads or animal skins or jewels or precious metals. Gold became money because it had all the properties people look for in a good money. Government had nothing to do with it.” “At the same time, the dollar would be reformed so that it again would be redeemable in gold.” Where will the gold come from?

Whatever this is, it is not economics. Physician, heal thyself, or take some courses in money and banking or even Econ 101 from a teacher who is not a member of the Austrian school. This book makes the Austrian school look bad. The book has no index, no footnotes. It is not a book worth reading.

We are attracted by the Rep. Paul’s consistent conservative record in the Congress on spending. We disagree on some foreign policy issues including his view that wars are all bad. We’re glad that we are not forced to speak German or pray to Allah. But thanks to the Congress, not the Fed, all of us had better be learning Chinese!