Monopoly Money

In a press release today the Federal Reserve used its Federal Open Mouth Committee, or rather the Federal Open Market Committee forum to report that “economic activity has continued to pick up.” How nice that Federal Reserve chairman, Ben Bernanke, and a small group of advisors who wield such amazing power over the wealth of millions of Americans as well as those who hold dollars off-shore, would announce such important news.

The Federal Reserve System has monopolistic power in many ways. It is a unique resource of a good we all must use, namely, dollars. Dollars are the intellectual property of the United States, differentiated from other currencies and are regulated by the U.S. government. That is not to say we cannot use other currencies; I suppose we could all go out and purchase Euros but I think we would have a problem buying groceries at Smith’s utilizing any currency other than dollars.

Our textbook points out that Congress established the Federal Reserve System in 1913 as the sole supplier of U.S. currency and “As of December 2004, $170 billion worth of U.S. currency was in public circulation. …It has been estimated that about two-thirds of the U.S. currency circulates outside the United States.” (Png 2007: 200). Png also points out that the Federal Reserve does not have monopolistic power outside of the U.S. where many currencies are used.

The dollar has historically been the benchmark currency in the world and weathered massive counterfeiting operations and retraction of exports. I guess it is due to our past productivity and positive trade associations that the dollar has been able to stay strong. However, with current trade imbalances, the dollar is sinking. Add to that massive deficit spending which further erodes the value of the dollar and the emergence of “better” backed currencies and the dollar is no longer number 1.

The Federal Reserve, in connection with U.S. monetary policy is unchecked by anyone who is not a member of the Board of Governors (or the White House which controls re-appointment and/or Senate needed for confirmation). By raising the amount of money in circulation in the U.S., the Federal Reserve is effectively reducing the value of dollars in today’s pockets, savings vehicles and securities holdings. So when monetary policy is influenced/controlled by tax-and-spend politicians our currency continues to be devalued and we could be in serious trouble.

Monopolies are inefficient and by nature lead to deadweight loss. There is a value for what is lost to consumers and what monopolies fail to take from the table. Does the monopolistic nature of currency mean that it would be more efficient to have more than one type of currency or recognize other nations’ currency?

November 4, 2009 Federal Reserve Bank Press Release

1 comment:

Dr. Tufte said...

Rebecca - I think you've been drinking the Kool-Aid ;)

There are a lot of conspiracy theories out there about the Federal Reserve. All of them are unfounded.

1) The Federal Reserve system is probably the most decentralized agency in Washington. If you tend to think the people in D.C. are only concerned about what happens on the coasts, then the Federal Reserve is the best friend you've got. They are the only part of our macroeconomic policy apparatus that has large numbers of people on the ground around the country.

2) Yes, the Federal Reserve does have monopoly power. But, this is over the issuance of the monetary base, not of "dollars" or anything like the entire money supply. In fact, they're not a very big player in the creation or destruction of money.

3) Even though the Federal Reserve has some monopoly power, it doesn't have any ability to capitalize on that power for its own profit. It's "power" is analogous to being able to change two $10 bills into one $20 in the blink of an eye. That isn't something people pay much for. As a matter of fact, when the Federal Reserve was created, there wasn't much complaint about giving them this monopoly because one of the problems with the monetary system then was that there was no profit in doing this so no one in the private sector was adequately taking care of it.

4) Being "number 1" isn't all it's made out to be. In this case, being the reserve currency for the world means that people outside the U.S. use our dollars to support their systems. This is the flip side of the statement that most of the currency is outside the country. The effect of this is to make our central bank less powerful within our own country. If you're worried about the domestic power of a central bank, the best defense is in fact for it to be providing the reserve currency.

5) "... Monetary policy is unchecked by anyone who is not a member of the Board of Governors". What??? Monetary policy is formulated by the Board of Governors - they are close to one and the same. The Federal Reserve is regarded as quasi-governmental because Congress and the Executive Branch cannot exercise much control over them. That doesn't guarantee good outcomes, but the evidence is overwhelming that having political officials in charge of central banking leads to much worse performance.

6) The refrain that the Federal Reserve has flooded the economy with dollars, and this will inflate away our incomes and wealth, is common. It does have some basis. However, inflation tends to arise from an increase in dollars as an attempt to increase wealth. Instead, what the Federal Reserve system has done over the last year is swap out other forms of wealth with dollars. This need not be inflationary because wealth held in the private sector hasn't changed - only its liquidity has increased. Central banks have considerable experience with this sort of action; a good example is the hundreds of billions of dollars of cash put into circulation in the days after 9/11. The trick to avoiding inflation is to reverse the process in a timely fashion. There's ample evidence that the Federal Reserve can do this successfully, but we'll have to wait and see if they can do it successfully.

7) Economists - including quite a few people who work for the Federal Reserve System - are aware of the history and possibilities of doing without a central bank. It is possible, and there are good arguments for going in that direction (although I don't think that the pros outweigh the cons).

In sum, I think it is stunning that anyone would be worried about the Federal Reserve at all. Even if there are dark forces at work pulling the strings to empower their conspirators, the Federal Reserve would be about the last place you'd look for them. It's hard to find an institution better designed to not engage in such nonsense anywhere in the world.