The Fed, War, Debt and Depression

Former Reagan OMB Director David Stockman has an interesting post regarding the Federal Reserve, Debt, and Depression. Here are some highlights from the article :

- Today's Federal Reserve is much more powerful and centralized than what was originally authorized in the Federal Reserve Act of 1913.

- The Fed is the primary supplier of funds for unnecessary wars (starting with World War I), courtesy of "temporary emergency" powers granted in World War I.

- The Fed, instead of the free market, sets the general level of indebtedness (credit) in the United States.

- When the Fed launched in 1913, the public debt amounted to 4 percent of GDP. It's now at about 90 percent.

- Over-investment in the 1920s, leading to the Great Depression, was orchestrated by the Fed.

Excerpts :

When Congress acted on Christmas Eve 1913, just six months before Archduke Ferdinand's assassination, it had provided no legal authority whatsoever for the Fed to buy government bonds or undertake so-called "open market operations" to finance the public debt. In part this was due to the fact that there were precious few Federal bonds to buy. The public debt then stood at just $1.5 billion, which is the same figure that had pertained 51 years earlier at the battle of Gettysburg, and amounted to just 4 percent of GDP or $11 per capita.

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And this brings us to the Rubicon of modern Warfare State finance. During World War I the US public debt rose from $1.5 billion to $27 billion—an eruption that would have been virtually impossible without wartime amendments which allowed the Fed to own or finance U.S. Treasury debt. These "emergency" amendments —it's always an emergency in wartime—enabled a fiscal scheme that was ingenious, but turned the Fed's modus operandi upside down and paved the way for today's monetary central planning.

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Having learned during the war that it could arbitrarily peg the price of money, the Fed next discovered it could manage the growth of bank reserves and thereby the expansion of credit and the activity rate of the wider macro-economy. This was accomplished through the conduct of "open market operations" under its new authority to buy and sell government bonds and bills—something which sounds innocuous by today's lights but was actually the fatal inflection point. It transferred the process of credit creation from the free market to an agency of the state.

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Accordingly, treasury bonds and bills owned by the Fed approximately doubled during the same 7-year period. [Federal
Reserve Chairman Benjamin] Strong justified his Bernanke-like bond buying campaigns of 1924 and 1927 as helpful actions to off-set "deflation" in the domestic economy and to facilitate the return of England and Europe to convertibility under the gold standard.

But in truth the actions of Bubbles Ben [Strong] 1.0 were every bit as destructive as those of Bubbles Ben [Bernanke] 2.0.

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Thus, the Great Depression was born in the extraordinary but unsustainable boom of 1914-1929 that was, in turn, an artificial and bloated project of the warfare and central banking branches of the state, not the free market. Nominal GDP, which had been deformed and bloated to $103 billion by 1929, contracted massively, dropping to only $56 billion by 1933.