Who Needs the Fed? by John Tamny (Encounter Books, 2016); 224 pages.
I really don’t like to start a review with a quibble, but in this instance, I must. My quibble is with the title of the book, which makes it seem as though it is aimed only at knocking out support for the Federal Reserve System. That certainly is a worthy goal and Tamny accomplishes it, but the Fed is far from the sole or even the most important of his book’s targets.
A better, more revealing title would have been: “Who Needs Government Economic Meddling?” That is what this book is really about, and Tamny does an exemplary job of explaining why nothing government does beyond its limited “night watchman” functions can help us achieve prosperity. Greatly influenced by the Austrian School and especially Ludwig von Mises, Tamny argues that when we depart from laissez faire, the result must be the squandering of resources, the perversion of incentives, and a slowing of progress.
Central to Tamny’s analysis is his understanding of the term “credit.” Most people think that credit just means the borrowing of money and therefore believe that government policy can (and usually should) make credit “easier” for individuals and businesses by keeping interest rates low. Economic output and employment supposedly expand when government does that.
Tamny shows that those widely believed ideas are utterly mistaken. He writes, “Stated simply, credit is not money. If it were, ‘easy credit’ would be as simple as printing lots of money. In fact, credit is always and everywhere the actual resources — tractors, cars, computers, buildings, labor, and individual credibility — created in the real economy. Credit equals resource access.”
Given the facts that resources are scarce and that government can never have resources it hasn’t first taken from the productive sector, it is impossible for the government to make access to resources more available in general. All it can do is to cause them to be employed differently than they otherwise would be. Some resources can be directed into politically favored uses, but far from “stimulating the economy,” that puts them to low-benefit uses that make us poorer on the whole.
The only economically wise policy, Tamny shows, is for government “to free individuals to pursue their talents.” That alone can make credit truly more abundant.
Furthermore, Tamny points out, credit involves a transaction where there is a buyer and a seller. In the real world — unlike the fantasy world of politics and leftist economic theory — the way to make resources more readily available is not to lower their price, but to raise them so as to call forth more willing sellers. He illustrates that point with a well-chosen anecdote (a hallmark of his writing, by the way) involving a Taylor Swift concert on a summer night in Nationals Park in Washington, D.C.
Tamny’s wife attended the sellout concert and when it was over, more than 41,000 people all wanted transportation home at once. The (increasingly decrepit, government-run) subway system was jammed and while some taxis were waiting, the city limits how much they can charge and few drivers felt like going out on a hot night for one fare.
Fortunately, she had an alternative — Uber, which has the freedom to set its own prices. Its “surge” pricing brings out drivers who want to earn more by providing transportation services at peak demand times. Tamny makes the connection between Uber’s pricing and credit, writing, “Uber achieves an ‘easy’ supply of drivers for its customers not by making their services cheap but by doing the exact opposite. Pricing is the free market’s way of regulating the supply of the resources we deem credit.”
Credit-worthiness
Tamny also takes dead aim at the macroeconomic notion that credit can be either easy or tight in general. He observes that no matter how the government manipulates interest rates, whether a credit transaction will occur or not crucially depends on the credit-worthiness of the borrower — the person or firm that seeks resources.
Here, Tamny demonstrates his point by looking at the movie industry. No matter how low the government drives interest rates, he notes, credit is almost always “tight” in Hollywood. Huge numbers of movies are conceived and pitched to backers, but most never attract the essential financing. That is true even for directors with a record of success. At one time in Hollywood, Warren Beatty was able to attract credit on the basis of hits such as Shampoo and Heaven Can Wait. Then he directed the disasters Ishtar and Town & Country. Beatty quickly became “box-office poison.” The lesson, Tamny writes, is that “what the Fed presumes to do in fiddling with interest rates is, on the surface, of little consequence. No matter the Fed’s obnoxious conceit about how easy or hard it should be to access credit, financing a movie is difficult.”
Instead of praising politicians and Fed officials for helping the economy, we ought to praise those rare individuals who figure out how to enable people and firms to access credit who probably would not have otherwise been able to. Financial markets are not perfect, after all. One person who made them work better was Michael Milken. If there were a “Mount Rushmore for the greatest capitalists,” Tamny says that Milken would have to be on it.
Back in the 1980s, Milken figured out that there was a lot of money to be made in “high-yield finance,” later smeared with the term “junk bonds.” Going around the American financial establishment, Milken was able to finance a host of upstart firms including CNN, Turner Broadcasting, and Occidental Petroleum, i.e., he provided them with needed resources. He saw credit-worthiness where the traditional lions of finance didn’t — and thus made a fortune precisely because he put resources to better use. But the financial establishment, in cahoots with zealous “law enforcement” types (most notably, Rudy Giuliani) took Milken down with a prosecution charging that he was guilty of conduct that had never before been considered illegal. With the use of unscrupulous tactics, the government got Milken to plead guilty and his name is now tarnished. It shouldn’t be.
Regulating the banks
Tamny then turns to the banking system and the Fed. If the book was iconoclastic before, it becomes even more so.
One of the central beliefs of Keynesian economic theory is that when government (through central banks such as the Fed) increases bank reserves by purchasing government bonds, the “new money” will be lent out to businesses. As the business borrowers then spend that money, its economic impact is “multiplied” as the dollars are spent by other parties in the chain of production. The multiplier theory is used over and over to justify not only “easy” money, but also governmental spending projects of all kinds.
Tamny reels the reader back to reality, again by pointing out that resources are scarce and therefore the “multiplier” is fiction. Bank lending cannot miraculously bring about rising prosperity because prosperity depends on making good use of resources, which cannot be “multiplied.”
Nor are banks necessary for credit transactions. The economy has evolved many ways of bringing together prospective borrowers and lenders that don’t involve banks. Yet Americans tend to focus inordinately on the supposed need for government to regulate banking. One of the fetishes among Democratic and Republican politicians alike has been on bank reserve requirements and safety. Seizing upon fears lingering after the 2008 financial debacle, politicians claimed that to avoid a replay, the government needs to make banks operate more “responsibly.”
To that, Tamny replies, “Banks shouldn’t face any reserve requirements because well-run banks don’t need them.” Like any business, talented banking professionals will find the best way to run — the optimal level of reserves to hold and the optimal level of risk to take in lending. Instead of government regulation, all we need, Tamny argues, is a free market in banking and an end to the “too big to fail” concept that protects poorly run but politically connected banks, Citibank being a prime example.
One aspect of government policy toward banking that should be done away with is deposit insurance — at least deposit insurance that is governmentally mandated through the Federal Deposit Insurance Corporation. The FDIC creates moral hazard that makes both depositors and bankers careless.
Tamny’s discussion of federal bank regulation is particularly timely, since both the Republicans and Democrats made a big point in their 2016 campaign platforms of calling for the reintroduction of the Glass-Steagall Act. That law, enacted during the Depression, mandated a separation between regular banking and investment banking, and the repeal of the law under Bill Clinton has been fingered as the cause of the financial meltdown in 2008. Tamny shows that idea to be sheer folly, since the line between lending and investing has become increasingly indistinct and the financial debacle was caused by government mandates that forced high-risk housing loans. “It was the hybrid bank/investment banks operating post Glass-Steagall fashion (think of J.P. Morgan and Bank of America) that were best positioned to weather the 2008 crisis,” he writes.
Finally, the market has created so many new kinds of financial services and institutions that today, about 80 percent of business borrowing takes place outside of the banking system. Credit transactions occur all the time without government regulation. We are moving into the era of, as Tamny puts it, “Uber for lending.”
The last resort
And now, what about the Fed?
The big argument that props up its existence is that there supposedly must be a “lender of last resort” for banks that are desperate for funds. Wouldn’t it be terrible if we didn’t have the Fed to “save” troubled banks?
Actually, we would be far better off without it, Tamny argues. Banks, like all other businesses, need the discipline of profit and loss; when they lose money, they ought to go out of business to release the resources they are using badly so that other enterprises can put them to better use. “For the government to prop up what the markets don’t want, it must punish the companies that markets do want,” he writes.
Besides that, banks that find themselves short of cash have options besides borrowing from the Fed. If that was ever a justification for the Fed, it certainly isn’t any longer.
What the Fed “accomplishes” is to keep down the cost of government borrowing so that politicians can continue their innumerable plans for buying votes and transforming the nation according to their visions. It has done that, Tamny writes, by extracting trillions from the banking system so it could buy federal debt and mortgage-backed securities. That is to say, it enables the political class to transfer scarce resources away from the competitive, productive sector of the economy and into their favored uses. That makes the nation poorer.
Americans would be far better off if they could get rid of the Fed, completely deregulate the financial industry, and return to sound money that can’t be manipulated for short-run political gains. That means restoring the constitutional money, which is gold.
Who Needs the Fed? is a wonderfully, endlessly iconoclastic book. Each and every page challenges the conventional economic thinking, including some conventional Austrian thinking. While Austrian economists have largely pinned the blame for the recent housing bubble on the Fed’s “easy credit” policies, Tamny points out that there were housing bubbles in the past when the Fed was not pushing interest rates as low as possible. His explanation is that when the Fed drives down the value of the dollar, it attracts capital into seemingly safe but not very productive sectors such as housing. (Among Tamny’s insights is that housing really is not an investment, but a consumption item.)
If you want to be prepared to make the strongest, most radical arguments against government economic meddling of all kinds, this is a book you must read.
This article was originally published in the January 2017 edition of Future of Freedom.