Bernanke has the whole world in his hands

Federal Reserve Chairman Ben S. Bernanke has a big task ahead of him. He has to withdraw most of the $2.2 trillion the Fed created and pumped into the banking system since 2007 before a monster inflation strikes and robs of us our purchasing power. But he has to do it without sending the economy back into a recession in the process.

There, in a nutshell, is a powerful argument for abolishing the Fed and turning the monetary system over to the free market: Today our economic fate — and more — rides on the judgment essentially of one man. If he gets it wrong, we are all in the soup.

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Central banking is a form of central planning. To be sure, it is not the economywide planning that totalitarian regimes practice. But since money is one-half of every transaction in a modern economy, central monetary planning has more than a little in common with central economic planning.

Through interest rates, money emits signals that guide investors and entrepreneurs. In a free market, which would include free banking, interest rates emerge when people express the intensity of their preference for present goods over future goods (time preference) through decisions about consumption and saving.

An abundance of savings and the resulting lower rates for loans tell investors and entrepreneurs that people are putting more emphasis on future rather than present consumption. Long-term projects, which won’t yield consumer goods for a long while, now appear worthwhile.

On the other hand, when people reduce their saving and shift their emphasis to present consumption, interest rates rise, telling entrepreneurs to switch from longer-term to shorter-term projects.

Thus the market process coordinates decision-making by producers, investors and consumer/savers over time. It’s not perfect, of course, and errors are always possible. But what accounts for its remarkable success — when it is permitted to work — is its high degree of decentralization. The decisions of countless people acting on their local and specialized knowledge drives the process. Errors, like a few drops in the ocean, are unlikely to have a big impact on the entire system. People can hedge against the misjudgments of others.

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Contrast that to an economy with a central bank. Everyone is at the mercy of one man or a small group. While the chairman of the Fed can’t literally set interest rates — the international capital markets are huge and flexible — his policies can still have a huge impact on the economy.

Policies to pump fiat money into the banking system can help push interest rates lower, changing the calculus of investors, entrepreneurs, and consumer/savers. Projects that were not feasible at the natural (market) rate can look attractive at a lower rate. But that lower rate is the result not of real savings but rather of arbitrary Fed policy. The Fed can create money out of thin air, but it cannot create real resources. Thus the seeds of boom and bust are sewn.

Since the current economic debacle began, the Fed has created trillions of dollars, in part by buying up banks’ mortgage-backed securities that may or may not have value — the so-called toxic assets. Because of skittishness about the future, most of that money has been idle. The Fed encouraged the banks not to lend it by paying interest on reserves kept in the banks’ Fed accounts.

The problem now is that if confidence increases, and banks start lending the money, a new inflationary boom will erupt. If at that point the Fed starts selling assets to sop up the money, the apparent recovery would be thwarted and recession will return.

This is a sticky wicket for sure. The Fed put us in this mess, and now it has the job of getting us out unscathed. Why should anyone be confident that Bernanke and his colleagues know what they need to know to pull this off?

And when will we finally learn that when important matters are transferred from the marketplace to government, we foolishly trust our lives to a few fallible individuals? A false sense of security is worse than none at all.

Sheldon Richman is senior fellow at The Future of Freedom Foundation (fff.org) and editor of The Freeman magazine.