Audit The Fed? Pros and Cons. . .

There has been a lot of disinformation surrounding the Federal Reserve. In fact, spreading disinformation about the Fed has become a cottage industry. The left originally viewed the Fed as the tool of international bankers bent on enslaving the world. In the 1950s, the John Birchers decided that the Fed was the agent of international communists. Fed-hate continues to run wild today in various groups. The Fed, apparently, is the secret cabal of the Bilderberg Group, the Communist Party, Zionist Bankers, and perhaps even a few extra terrestrials. Let’s cut through the garbage.

What Is The Fed?

The Federal Reserve was created by an Act of Congress on December 23, 1913. The Federal Reserve System consists of twelve Federal Reserve Banks located throughout the United States. These banks are governed by a seven member Board of Governors. The members of that Board are appointed by the President and are confirmed by the Senate. They serve 14-year terms and are term-limited to one term, unless they are appointed to complete an unexpired term, in which event they can be re-appointed to a full term.

Contrary to the rumors, the identity of every member of the Board and every officer and director of every Federal Reserve Bank is known and available to the public. In fact, their names are available online, see. e.g. Officers and Directors of the Federal Reserve Bank of Boston.

This, by the way, is one of the first lies told by anti-Fed people, that "no one knows who is on the Fed." I say lies because even when these people are confronted with the facts, they continue to deny them and simply move to more gullible audiences. Indeed, I had an interesting run in with one at Big Hollywood a few months back. Despite my presentation to him of evidence that he could verify with his own eyes that contradicted every single thing he claimed, he simply insisted on repeating his false claims over and over -- eventually accusing me of being “an agent of the Fed.” This is fairly typical behavior from this group.

What The Fed Does: Monetary Policy

The Federal Reserve has numerous responsibilities, but two are relevant here. The first is to handle “monetary policy” for the United States government. Monetary policy involves adjusting the prime interest rate, buying or selling bonds, and setting reserve requirements at banks to control the amount of money available to the economy and the “velocity” of money within the economy -- velocity means how often money gets spent.

In this regard, the Fed has been statutorily charged with holding inflation in check while also encouraging economic growth. European central banks, by comparison, generally are charged only with fighting inflation -- often leading to anti-growth policies.

Many people are upset that the Fed handles this function, and they argue that the Fed should be abolished. In the 1970s, they complained that the Fed caused inflation. In the 1980s, they complained that the Fed artificially kept the economy in check by overly-restricting the amount of money available in the economy. Now they complain that the Fed has created bubbles by allowing too much easy money to circulate in the economy.

There is some truth to each of these assertions as the Fed is not perfect. But the idea that eliminating the Fed would improve the situation is simply not accurate. The Fed was established to act independently of the political process; they are supposed to make their decisions based on the best available economic thinking. If the Fed was eliminated, the duty to handle monetary policy would fall upon the Treasury.

Unlike the Fed, the Treasury is a political creature. Shifting monetary policy to the Treasury would mean that the President, who is subject to election every four years -- and who seeks campaign contributions from people who could benefit directly from such decisions, would be deciding whether or not interest rates should be raised or lowered and whether or not liquidity (i.e. more money) should be injected into the economy.

Moreover, the Congress, which gets elected every two years -- and which seeks money from the same interests, would likely attempt to force the President’s hand whenever they felt the economy needed a boost. That’s a recipe for economic chaos and corruption.

But the other side of that coin is that the President and Congress are more directly accountable to the voters than the independent Fed. That's the trade off.

Incidentally, one of the arguments made for abolishing the Fed is that inflation has been be “out of control” since the Fed came along. But this is a red herring. First, looking at inflation in a vacuum is misleading because it is the comparison of wages to inflation that matters, not inflation itself. In other words, it doesn’t matter if bread costs 100 times what it cost fifty years ago if your income rose 100 times as well. Moreover, an examination of foreign currency exchange rates (a better measure of the value of the dollar than an examination of inflation) shows that the dollar has nearly doubled in value against all major currencies (and gold) in the past 100 years. Thus, the assertion that the Fed’s actions have hurt the dollar is completely wrong.

What The Fed Does: Discount Lending

The Fed also provides temporary loans to banks that are suffering from liquidity problems, i.e. those that are temporarily short of money. This is what they are talking about when you hear about banks “using the Fed’s discount window.” These loans are made at low rates and in secret to protect the identity of the bank. The fear is that knowledge that a particular bank was short of cash would cause people to try to get their money out of the bank, causing a run on the bank and collapsing an institution that likely only needed a short term loan.

The Audit Issue

This leads us to the audit issue. The conspiracy theorist claim that “the Fed has never been audited.” This too is a lie. The Fed is audited each year by independent accounting firms. For example, here is a link to the 2005-2006 audit conducted by KPMG. This audit is fairly typical of the independent audits normally conducted of banks or large businesses.

Moreover, Congress already has the right to audit the Fed, with one caveat. In 1970, Congress passed a law allowing the General Accounting Office to audit the Fed and all of its functions with the exception of the two mentioned above: the Fed’s decision making process for monetary policy and the Fed’s discount lending practices.

The reason the Congress did not allow the GAO to audit the Fed’s monetary policy decision making process was the fear that allowing such audits would interfere with the Fed’s independence. The thinking was the Congress would use these audits to pressure the Fed.

And even though the GAO cannot currently audit that function, this does not mean the Fed is acting in secret. The Fed releases the meeting minutes for each meeting of the Board of Governors which explain broadly the Fed’s thinking on monetary policy. It also releases reports for each region of the country, called the Fed Beige Book, which outline the Fed’s observations regarding all aspects of the economy in each of the Federal Reserve Bank regions. Finally, the Fed Chairman testifies on Capitol Hill on an on-going basis.

The Congress did not allow the GAO to audit the Fed’s lending practices for fear that this would reveal the banks who needed the Fed’s assistance with liquidity, which could cause runs on those banks.

Now the Congress is looking to pass a bill that would allow it to audit these two functions. The cons are those just identified. The pros are that the Congress, as the maker of our laws, should be able to know the thought processes employed by the Fed to make sure that it is acting in a manner which is consistent with the law and that the Congress can continue to support.

With regard to monetary policy, there certainly is a legitimate fear of a loss of the Fed’s independence. Once Congress starts tinkering, the Congress is unlikely to stop tinkering. Soon the Fed’s independence could disappear and we could end up with Congress directing the Fed to do its bidding. But the possibility that Congress may overreach is a poor excuse for denying Congress the oversight that is its responsibility under the Constitution. Not to mention that Congress could just as easily overreach now.

So perhaps allowing an audit is an excellent idea. It’s only the next step that becomes problematic.

With regard to auditing the discount lending practices, the same arguments apply, as well as the concern about creating runs on banks. If the current bill protects the secrecy of those banks that seek the Fed’s help, then an audit of these practices also should be supported. But if it does not, then the risk to the system, with banks avoiding seeking help to prevent possible bank runs, might be too potentially damaging to the banking system to allow.

In the end, those are the choices. There are no conspiracies, no secrets, no Zionist bankers or evil plots by our alien-masters. It is just the difficult trade-off between a process that is independent of political tinkering, but not responsive to voters, versus a process that would likely be more damaging to the economy but more responsiveness to the people.