Abolish the Fed? And then what?

Title: The Dumbest Idea in the World

Abolish the Fed? Really?

In the land of dumb ideas, some stand head and shoulders above the rest. Like abolishing the Federal Reserve.

The idea is gaining credence because it is part of Rand Paul’s campaign for US Senate in Kentucky. Rand Paul is now talking about strict oversight of the Federal Reserve, but in the past he has discussed complete abolition of the Fed. This proposal is essentially the same as his father’s proposal to abolish the Fed and return the U.S. currency to the gold standard.

The idea is born of frustration with current conditions, but the cure would be far worse than the disease.

There are two basic problems with abolishing the Fed: history and reality. The Fed was established to prevent the wild swings in the value and supply of money in the 18th century. Without it there is no telling what would happen to the money supply. The other problem is that without the Fed the “market” would establish the value of money. But the market it no longer some pastoral vision from Adam Smith, with the exchange rate established by the farmer, the butcher and the greengrocer. Today the “market” is the international financial market, which is dominated by the central banks of major economic players and sovereign wealth funds of major economies. Abolishing the Federal Reserve would mean that the value of the American currency would be set by entities like the European Central Bank, the People’s Bank of China (which has more financial assets than any other public institution on earth)and Saudi Arabia’s sovereign wealth fund.  

Those who advocate abolishing the Federal Reserve say that the value of money would be more stable because it would be based on the gold standard. But the value of gold is not fixed; it is based on the value set by the commodities markets. People flee to gold for a sense of stability, but its value is set by supply and demand. If one nation or large fiscal entity wants to drive up the price, it could. Just look at what the Hunt brothers did to the price of silver in the 1980’s. While the United States has the world’s largest gold reserves, the Chinese and the Russians also have large gold holdings. If either decided to liquidate their gold reserves it could drive down the price of gold and essentially devalue the U.S. Dollar. And China has enough other assets (including U.S. Treasuries) that it could easily start buying gold, driving up its value and the price of the U.S. Dollar.      

I recognize the problems with the Federal Reserve, and the frustration over its opacity, but abolishing it is one of the dumbest ideas I have ever heard.

Some background data:

History of the founding of the Fed:

http://www.newyorkfed.org/aboutthefed/history_article.html

See also:

http://meganmcardle.theatlantic.com/archives/2007/12/the_good_old_days_werent_alway.php

http://meganmcardle.theatlantic.com/archives/2007/09/theres_gold_in_them_thar_stand.php

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