For centuries pharaohs, emperors, and kings ruled and made ordinary people do whatever they wanted. The rise of political liberalism has changed our conception of power, arguing that governments exist to serve the people. A new book argues that we need to bring liberal principles to our money.

Government actions ultimately involve force, which liberalism supports is only legitimate if it serves the people. Governments today are taking some of the same actions as emperors. Taxation, for example, always involves armed men taking things from people. Taxation is theft unless the people consent to it; as America’s founders put it, “taxation without representation is tyranny.”

Governments took control of money before the liberal revolution; kings found it profitable to mint coins. Just as taxation looks like theft, government money creation looks like counterfeiting. And monetary creation is an illegitimate counterfeit if it is not subject to the controls of liberal democracy.

In “Money and the Rule of Law”, economists Peter Boettke, Alex Salter and Dan Smith (formerly of Troy University) argue that the Reserve’s uncontrolled powers over the US money supply violate the rule of law, an important element from the Liberal government. The rule of law means that the rules are applied equally to all; no one is above or below the law. The rule of law gives generality, predictability and robustness. They argue that “if money is subjected to arbitrary manipulation by public authorities, it is de facto tantamount to an infringement of property rights.”

A reply to Boettke, Salter and Smith could be, “But the Federal Reserve manages the money supply to keep our economy prosperous, for the benefit of all of us. Yet the evidence, the authors argue, is less clear than you might think. Between its creation in 1913 and 1933, the Fed essentially only managed the banking system. Yet he let a quarter of America’s banks fail between 1930 and 1933, turning a recession into a decade of the Great Depression.

The Fed also fueled the inflation of the 1970s, which reached 13% in 1980. The “Misery Index” – the sum of the inflation and unemployment rates – steadily exceeded 15%. By comparison, the Misery Index was 6 in 2019.

The Fed also made a significant contribution to the Great Recession. Ben Bernanke, chairman of the Fed in 2008, claimed that the Fed was simply acting as a lender of last resort. The authors completely refute this claim and argue that the unpredictable response – say, bail out Bear Stearns and then let Lehman fail – created most of the financial crisis.

The authors also show how the Fed’s expertise in guiding the economy is massively overstated. Discretionary monetary policy as described in textbooks requires accurate forecasting of the demand for money. But as former Fed Chairmen Paul Volcker and Alan Greenspan acknowledge, the Fed can’t even measure money supply accurately.

The understanding of economists comes from our models. The best models are still simplistic and it is difficult to deduce valid lessons for current economic events. But we don’t have any specialized expertise on things we can’t model.

As the authors detail, the Fed’s models contain notable omissions. Like money and financial institutions. The New York Fed’s forecasting model omits money; Boettke, Salter and Smith characterize this as “a factor waiver of the very economic problem that monetary authorities are supposed to handle.” Models without financial institutions offered little information about the financial crisis.

A truly limited government means limiting the discretion of the Federal Reserve. One solution is to impose binding rules on both the Fed and Congress. The rules should specifically restrict the creation of “liquidity and credit, except in specific ways which are general, predictable and robust”.

Three great 20th century free market Nobel laureates, Friedrich Hayek, Milton Friedman, and James Buchanan, have all written on money economics. As Boettke, Salter and Smith observe, each ultimately concluded that the power of central banks must be limited. “Money and the Rule of Law” offers an important argument for extending government limited to money.

Daniel Sutter is Charles G. Koch Professor of Economics at the Manuel H. Johnson Center for Political Economy at the University of Troy and host of Econversations on TrojanVision. The opinions expressed in this column are those of the author and do not necessarily reflect the views of the University of Troy.


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