You have to hand it to Rand Paul, a US senator from Kentucky and a repulican presidential candidate. While on the world’s stage and under the spotlight, he co-pens an opinion piece in today’s print edition of the Wall Street Journal (See If Only the Fed Would Get Out of the Way) that rings consistent with his father’s past desire to “end the Fed”. The article is well written and calmly explains why centralized government control of interest rates causes distortions in what otherwise would be a self-correcting system. The key point made by Mr. Paul and his co-author Mark Spitznagel, chief investment officer at Universa Investments and economic advisor to the Paul campaign, is this: an economy should go through cycles of growth and contraction – but by trying to limit the contraction part and smooth out average growth, or prevent recessions, the Fed creates a false situation that results in cycles that actually exceed the total of the natrual, or smaller cycles. In other words, we should permit small recessions – by seeking to avoid these we create an economy that is more easily sunk with massive crashed.
The article gives a great analogy with forest fires. A zero-tolerance policy was adopted bu the US Forest Service 100 years ago – all fires were to be prevented, or put out as fast as possible. For a while it looked like a good policy. But in 1988 a forest fire proved unstoppable and it took out 30 times more acreage of any previously recorded fire. Thus the zero-tolerance policy ended up making the whole system (the forest) a tinder box and so much more fragile. Thus the Fed drops rates at ever sign of economic trouble in order to stabilize growth, inflation and employment. It works or seems too, short term. Long term it creates a much more fragile system that yields much greater and painful busts.
In 2000 markets started to fall as the dot.com bubble burst. The Fed dropped rates in order to create a soft landing. These low interest rates created the foundation for what became our more recent financial crisis triggered from the housing bubble. So a series of medium sized busts were finally replaced with an unstoppable massive bust. And here we are.
I have read Ron Paul’s persuasive book, End the Fed. It is a short book but well written and explains the history of the Fed and gives you more details on the economic model the Federal Reserve system seeks to impress on the economy, but in laymen’s terms. It is well worth reading. Mr. Paul’s WSJ article would seem the son has his father’s passion for Fed restraint, though it has not yet come out on stage during any debates. I wonder if it will this evening?
For a really interesting understanding of the founding of the Fed, you have to watch this video of G. Edward Griffin: The Quigley Formula. It is jaw-droppingly good. And though Mr. Griffin is referred to by some as a conspiracy theorist, the underlaying facts he calls on – such as who attended the meeting (at Jekyll Island) where the Federal Reserve was first conceived, is frightenning. It beggars belief. I have since purchased “The Creature of Jekyll Island” but have yet to get to it. I am looking forward to the debate this evening.