Not since 1833 have there been calls to abolish a United States bank. At the time, it was President Andrew Jackson who succeeded in abolishing The Second Bank of the United States. Today it is Congressman Ron Paul of Texas who is calling for an end to the Federal Reserve.
Paul lays out his thesis in his new book, End the Fed, in which he calls for an audit, and then an end to the Federal Reserve. I recently interviewed Rep. Paul about ending the Fed, his thoughts on the dollar, and financial regulatory reform.
Paul thinks the Fed is the root cause of the financial crisis and what permitted exorbitant risk-taking by companies ranging from Bank of America (NYSE: BAC) to Citigroup (NYSE: C) and from Morgan Stanley (NYSE: MS) to AIG (NYSE: AIG). He believes abolishing the Fed would spur people to save more and become more prudent with their finances because free market forces, instead of a central bank, would set interest rates, limiting the amount of credit in the economy.
He is in favor of returning to the gold standard and believes an end to the Fed will put an end to the dollar's long-trending depreciation. Paul also calls for more regulation on the government and not the markets.
What follows is an edited transcript of the interview.
Jennifer Schonberger: In the wake of the financial crisis, some in Congress want to give even greater power to the Fed. You want to abolish the Fed. Why?
Congressman Ron Paul: Because they caused all the trouble. A monetary policy of easy credit and artificially low interest rates was the main source of the financial bubble, and the correction is always trying to fix what the Federal Reserve has done. The only way you can address the business cycle and prevent wild swings in the business cycle is by addressing the Federal Reserve and how they cause nothing but mischief.
Schonberger: Would you put something else in place of the Fed, or revert to a laissez-faire approach and let the free market forces play out?
Paul: Yes, I believe in free markets. We don't have free markets and haven't had them. So it's convenient for people to blame the free market for the problems, but that's a fallacy. In a free market, capital would come from savings. People put their money in a savings account or something of real value, and that determines the interest rates.
When people don't save, like we as a nation have not saved for many decades, there is this illusion that there is still so-called capital, or money made for investments. [In reality] that capital came from a computer at the Federal Reserve. Therefore it sent the wrong information to businesses and savers, claiming that there was a lot of savings out there. Based on that, people overinvested and built too many houses. It's the Federal Reserve that sends out the incorrect information.
Schonberger: So this would be a world with less credit, would it not?
Paul: Yes, there would be less credit, but it would still be steady growth. You would never have periods of economic tumult if you had economic growth of 4% or 5% -- so you would never have the temptation to turn it off. … There would be enough credit, but there wouldn't be an excess amount. … It would be determined by the marketplace rather than by the artificialness of the Federal Reserve.
Schonberger: In terms of getting people to save more, what are your thoughts on the consumption-based value-added tax that's been talked about recently?
Paul: It'd be a disaster. Most people from the Keynesian side are always arguing that the main driving force of the whole economy is consumption. In free market economics, it's savings, building capital, and buying things that have value. Consumerism can be artificial if it comes in the form of easy credit from the Federal Reserve. So, if you're going to try to stimulate consumerism, and on the other hand tax it, it doesn't make any sense at all.
Schonberger: What is the biggest downside risk to abolishing the Fed?
Paul: I don't know of any risk. The biggest challenge is that people might not understand it. If there are problems they might blame the problems on getting rid of the Fed. The problem would really be coming from the fact that we had it … The first year would be tough. The problems would be due to the fact that the Fed would cause so much harm in the correction phase, which is always necessary.
Schonberger: Our economy is increasingly tied to economies around the world. What would eliminating the Fed mean for the global economy?
Paul: It depends what you replace it with. If you allow the market to replace it with commodity money and make sure various countries believe in free trade, tariffs should go down, and free trade should reign. You should be able to have much freer travel, so it would be a real move towards globalism and global trade. If only one country does it, there's more of a challenge, and only the person who goes onto the gold standard would benefit.
Schonberger: You're of the belief that abolishing the Fed will thwart the dollar's long-trending depreciation. Explain to me how that works.
Paul: There's no dilution factor. In my book, I use the example of when I was a kid and my dad always had to check to make sure the milk wasn't diluted. Sure, it stretches the milk, but it doesn't stretch the quality. This would be the most important thing for eliminating the problems that the Fed has created.
Governments want to spend more than they have and go to war when they shouldn't, and the only way they can finance it is through the printing press. The period of time when the world accepted a notion of an international gold standard was a time of tremendous economic growth.
Schonberger: You've introduced HR 1207, the Federal Reserve Transparency Act, in which the Comptroller General audits the Fed and then gives a detailed report to Congress. What are the odds for passage? Do you think you'll be able to get legislation through the House this fall?
Paul: It's very, very popular. Every Republican in the House has signed on, and 111 Democrats have signed on. We have over 290, which in theory means that it could pass under suspension because we already have two-thirds in Congress as co-signers of the bill. … It depends on the opposition, but I think there's a very good chance it will get passed.
Schonberger: Are you at all concerned that auditing the Fed would open up the central bank to the political process and subject the bank to making monetary policy decisions based on lobbyists, politicians, and special interest groups, rather than the necessary economics?
Paul: That's the argument the opposition uses. But they want to use the political influence that they already have because it's been in secret. If you have a political influence of a company like Goldman Sachs (NYSE: GS) that can manipulate the benefits toward them and away from Lehman Brothers, that's political, too.
It's been known for decades that the chairman of the Federal Reserve Board always accommodates a president and tries to have the right part of a cycle come up for election time. But, the audit bill has nothing to do with managing monetary policy.
Schonberger: Briefly, Congressman, how should we reform the financial regulatory framework besides ending the Fed? In terms of regulatory structure, what about ending the SEC? Certainly the SEC dropped the ball, as did the CFTC. How do we rectify the system?
Paul: I admit the SEC was a total failure. Now people have this moral hazard of saying "It's OK, the SEC has looked at their books." That encourages people to make mistakes. People should be much more cautious.
What you want is more regulation of the government -- the Federal Reserve and on Treasury -- not to interfere in the markets. We should let bankruptcy laws work. The most important way to regulate markets is to never prop up the bad investments. Regulation should be defined as enforcing contracts, no fraud, and making sure the government doesn't interfere for the benefit of special interests.
Let state laws take care of fraud cases. Insurance and ratings would all be market-oriented.
