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Fri, 14 December 2018 06:20:50
Ron Paul corners Fed chief on rates, Sri Lanka hit by rice prices: fuss-budget
19 Apr, 2008 22:13:31
By Fuss-Budget
April 19, 2008 (LBO) – Representative Ron Paul has cornered Federal Reserve chairman Ben Bernanke at a congressional hearing this month, on whether rate manipulation got the US economy in trouble - again.
A central bank's power lies in its ability to manipulate rates (usually lower them) by printing money when the market forces demand a higher rate.

This ability is very useful for governments in times of war and to finance programs to buy votes, but it is also the key problem with central banking that results in bubbles, high inflation and also personal financial ruin of ordinary people.

In a market driven economy, a central bank is an anachronism that can change the interest rates by bureaucratic decisions (monetary policy committee) rather than actual market forces that drive the demand and supply for credit.

In the US the Fed was established in 1913 amid stiff opposition, through a bill that was secretly promoted by the big banking families of the country.

The Fed allows big banks to have liquidity at will and be bailed out when they speculate and make mistakes with printed money at a huge cost to the rest of the economy in the form of inflation and currency depreciation.

This gives rise to moral hazard where banks are given incentives to take more risky bets when a central bank manipulates rates down, secure in the comfort that the same central bank or Federal Reserve will bail them out, when the assets they take bets on collapse (housing, mortgage securities).

This year the Fed has even bailed out Bear Stearns which was not even a clearing bank coming under its regulation, through JP Morgan.

Coincidentally it was a bailout of a bank by JP Morgan in 1907 that triggered the events that led to the creation of the Federal Reserve amidst stiff opposition from representatives who knew the dangers of fiat money and central banking.

But central banks were relatively benign under the gold standard, when their ability to print money was restricted by a link to gold, though a boom accommodated by the Fed during the 1920's later caused the great depression.

The link with gold was broken during the World Wars and re-established under the Bretton Woods agreement where the US dollar was tied to gold and other currencies were linked to the dollar.

Ultimately the US government defaulted on its obligations under the Bretton Woods agreement in 1973 when heavy money printing (and the Vietnam War) made it impossible to preserve the link with gold.

The US finally went to a fully fiat (paper) currency in 1973 after firing a global commodity bubble and oil shock.

For more than one and a half centuries before that gold was priced at 35 US dollars an ounce and there was no long-term 'inflation'.

But since 1973 the US currency has been debauched to 1,000 dollars an ounce of gold and the world is now in the grip of another massive 1973-style bubble which is bringing real misery to millions of poor people around the world in the form of higher food prices.

Meanwhile, the US is now printing more money to save its banking system (rate cuts) and chase an elusive concept called 'growth'.

In Asian dollar-linked countries like Sri Lanka which do not have an independently floating currency to counter US inflation, and is burdened with weak domestic monetary systems that creates their own inflation, people are suffering with high rice prices amidst the highest inflation it their history.

The forces of fiat money unleashed in 1973 were somewhat controlled by Fed chairman Paul Volcker but they were again let loose under Alan Greenspan (and now Bernanke) helped by US inflation index manipulation.

At a congressional hearing this month Fed chairman Bernanke was forced to make an admission by Ron Paul (see transcriptions below) to the shocking extent to which central banking rate decisions are a little more than guesswork.

Paul is one of the few politicians of the world who has an in-depth understanding of 'monetary policy', with the possible exception of senior ministers in Singapore who actually run that country's monetary authority.

He makes the point that central banks create 'growth' by keeping rates artificially low and giving rise to business cycles or bubbles which then burst spectacularly (like the sub-prime bubble).

This could sometimes happen when monetary policy is tightened or simply end up in a hyperinflationary collapse if no attempt is made to check the bubble.

The current global commodity bubble has been fired amidst the Iraq war.

After unhappy experiences with bubbles and business cycles many countries went for inflation targeting where the central bank is solely responsible for creating a low level of inflation (around 2-3 percent).

But the Fed still has a dual mandate of creating maximum employment and low inflation at the same time, which is identified as part of the problem with the US monetary regime.

A transcript from the April 2008 congressional hearing in which Fed chairman Ben Bernanke participated is reproduced below:

Representative Paul: My concern is really philosophic. Most of us here deal with day to day, 'Is this regulation good, or is this regulation bad?' without realizing that the general rule is, when government creates a regulation, they create the need for two more regulations. And the same way when we allow our banking system to inflate the economy, it causes bubbles to occur and we have to inflate to prevent them from breaking and, you know, deflate. And we go on and on... perpetuating…

It seems to me that the basic question that we don't ask but should ask, is why we have a business cycle. And for a hundred years the conclusion had been in this country, philosophically and practically and at a political level, that it is a consequence of freedom. It is a consequence of capitalism. And therefore we need the government to save the people from their freedom: freedom of choice personally and a loss of civil liberties and a freedom of choice of businesses.

So could you tell me…is the business cycle a consequence of capitalism and freedom? Or is the business cycle..could it be that others who say it’s a consequence of government interference? Because that to me is the key question. And depending on how you answer that it depends on everything we do from here on out.

Fed Chairman Ben Bernanke: Certainly large parts of the fluctuations in the economy are from the free market. They represent changes in productivity for example. Changes in business activity.

There are probably also circumstances in which fluctuations are due to government intervention - government spending during wars for example.

An example that is particularly relevant to the current discussion is that during the 19th century the United States had periodic financial crises where banks would fail. And there would be sometimes effects in the broader economy.

It was dissatisfaction with that that led in 1913 to the creation of the Federal Reserve to try and stop these periodic financial crises. This created the set of consequences that you allude to in the sense that if you were going to give the Federal Reserve power over the financial system in a particular…

If there is moral hazard induced by that then for the protection you need to have some regulation to prevent the moral hazard from creating further distortions in the financial system. But I do agree that fluctuations often have private sector entrepreneurial components to it and we are neither able nor should we try to completely eliminate fluctuations…

Representative Paul (interrupting): Is the Federal Reserve contributing to the business cycle?

Chairman Bernanke: It has. It has at times. Most notably during the 70's when inflation got out of control Fed had to raise interest rates sharply to control inflation and resulted sometimes in slowdowns in real…

Representative Paul (interrupting): Does excessive credit and low interest rates cause mal-investment? Artificially low interest rates, which aren't market driven?

Chairman Bernanke: Well, the question is you know is the judgment where the interest rates ought to be. We have a mandate of course for maximum employment and price stability. We are trying to balance these obligations.

We could make mistakes and put the interest rates to the wrong place and that would have negative impacts. I agree. So we are doing the best we can to find the right place to put the interest rates. One that is consistent with the neutral rate. Or the rate that establishes the full employment in the economy.

Representative Paul (smiling): And some day we may try the market to determine the interest rates. Thank you.


Of late the growth rate of the US monetary base has fallen. This indicates that the Fed does not have to 'print' too much money to keep rates low and short term rates are falling partially because credit demand has collapsed.

This should be good news for the dollar. Also rising risk premiums have meant that at the longer end of the yield curve rate cuts are not having that much effect, which is also good news for inflation.

Bouquets and brickbats to fuss-budget(at) You may also use the response tab to comment directly.

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10. Ahmed May 07
Here is a blog of a man after your own heart in raising the alarm on fiat currencies.

It is amazing if you look at the posting dates how early he predicted the sub prime bubble.

9. George Apr 21
Bravo!! Very well written article. Properly identifying a problem is a big step toward resolving it. Excellent insight into the schemes of central banks and how their actions directly harm the middle class and the poor.
8. fuss-budget Apr 20
Hi Deane
The Paulites responding to LBO seems to be Americans not Sri Lankans.

Regarding the peg India does not have a hard peg. It has a soft-peg meaning it is trying to run a peg with a fractional reserve banking system with a reverse repo window. This means the RBI is amplifying inflation generated from the peg.

A hard peg however would have resulted in about 6 percent inflation under current conditions. Remember for Sri Lanka single digits is a dream come true.

This is precisely the problem we have in Sri Lanka.

The drawbacks of a currency board include a higher level of inflation when the anchor currency cuts rates, or tight conditions when they tighten which may not be in synch with ground conditions. But US rates are not 18 percent and US inflation is not 28 percent. So even in the worst US scenario we would be in the best Sri Lanka case, which was about 7.5 percent interest rates in 2003.

Under the Hanke/Schuler model it is suggested that a currency board law provides to break the peg after 2 years of 20 percent inflation.

A floating rate with inflation targeting would push up our living standards quicker but there may be severe pressure on the export sector.

A US dollar peg is the easiest to implement and the most painless on the export industry. A better alternative is the Euro in terms of living standards.

A peg to the Singapore dollar would be optimal since they do the hard analysis to counter the negative effects of anchor currency monetary slippages and it is also an export oriented economy.

Brunei has a Sing dollar peg. It is no accident that Brunei, Singapore, Hong Kong and Japan Australia and New Zealand are the richest nations in Asia Pacific. They either have floating rates or currency boards based on floating currencies.

But a currency board has bigger advantages in the sense that it imposes a hard budget constraint, and forces government to be efficient. That gets rid of the need to to public enterprise reforms as well as much of the corruption and mad policies that you have seen in this country since the creation of a central bank.


7. Deane Apr 20
Interesting to see a lot of Sri Lankan Paulites. The Paul vs. Bernanke video referenced in the article can be found on YouTube.

A question, as usual, to Fuss, Given all this, do you still back a hard peg with the USD to tackle Sri Lanka's worries of inflation?

Recently, I saw a piece from the very reasonable Ajay Shah offering exactly the opposite advice (as far as i can tell) to tackle rising inflation In India. (see Video )

I realize the inflation is at a very different levels in SL and India, but any thoughts?

6. TJ Apr 20
Nothing the other 3 talk of will help me personally, only hurt. One day we will wake up and fix the underlying problems facing this country. Like social security and medicare. Take a look at those programs, and you will see how our government has set the people up for failure.
5. Chuck Apr 20
Your article is spot on. Ron Paul is the only real choice for President of the United States.
4. Sam Apr 19
Fuss-Budget, Thank you for the clear article on central bank interest rate manipulation. You succinctly included a brief history of the creation of the Fed, described how a gold standard constrained the Fed, and described current monetary (inflation) problems. I appreciated how you also included the human interest - high food prices hurt the poor.

It is interesting that Ron Paul speaks of these problems, while the other presidential candidates - Obama Clinton McCain speak of printing more money to give more handouts - which will cause more inflation.

Thank you.

3. Bill Apr 19
Paper money 101. For those that aren't familiar with it, here is a piece written by non other than Mr. Alan Greenspan in 1966.

The final paragraph pretty well sums it all up and until enough people realize this monetary fact, none of the current economic woes will subside... period.

The reason why a majority of our nations population does not understand (or want to understand) this: currently, roughly 65% - 70% of the population receives some kind check from uncle fathead. Government, by nature, is not productive, i.e.; it costs money to operate.

It does not EARN money.. it does not produce any goods or services unless they are paid for by the private sector! On a spreadsheet, government would be in the liabilities column.

The private sector pays the bill for government to exist. Now envision the percentages above on a scale and one can see how an out-of-control paper money ponzi scheme, coupled with increasingly bloated government spending programs can quickly drive the private sector (we the people) into poverty-stricken servitude. Whoever prints the paper fiat money into existence gets all goods & services for free... and whoever gets stuck with that paper fiat money in the end will get nothing for it.

How much longer do you expect to play hot potato without getting burned? It is up to us to stop participating in this fraud at every level.

There are no "entitlements". Think you've paid into "the system" long enough that it owes you something?... as if you've earned it in some way? BS!!

"Well I've been paying into so-n-so for X years so I'm entitled to..." BS!! "Money has been taken from my paycheck for X years so I'm entitled to..." BS!!

I hate to be the bearer of dire tidings but any labor that you committed to any "entitlement" program is long gone... it was gone the minute it hit the FEDS coffers. Bottom line; stop participating.

If you follow the rope attached to that "entitlement", you'll find it leads to a noose custom fit for you.

2. Publius Apr 19
Unfortunately Ron Paul is marginalized by the political and media establishments in the US. He seems to be one of the few politicians that understands economics and the importance of protecting civil liberties.
1. ellen Apr 19
This is the best summary I've read so far. It helps to fill in some gaps in my understanding. Thank you!