Transparency in Monetary Policy

The Daily Reckoning PRESENTS: Congressman Ron Paul recently testified in front of the House of Representatives emphasizing the importance of transparency in how the Federal Reserve carries out monetary policy. We have the full text for you, below…

(BTW, Ron Paul has graciously agreed to sit for an interview in our upcoming documentary. And will be a featured guest at the Rim of Fire investment symposium in Vancouver in July. See details above…)


Statement for Hearing before the House Financial Services Committee, “Monetary Policy and the State of the Economy”

Transparency in monetary policy is a goal we should all support.  I’ve often wondered why Congress so willingly has given up its prerogative over monetary policy.  Astonishingly, Congress in essence has ceded total control over the value of our money to a secretive central bank.

Congress created the Federal Reserve, yet it had no constitutional authority to do so.  We forget that those powers not explicitly granted to Congress by the Constitution are inherently denied to Congress – and thus the authority to establish a central bank never was given.  Of course Jefferson and Hamilton had that debate early on, a debate seemingly settled in 1913.

But transparency and oversight are something else, and they’re worth considering.  Congress, although not by law, essentially has given up all its oversight responsibility over the Federal Reserve.  There are no true audits, and Congress knows nothing of the conversations, plans, and actions taken in concert with other central banks.  We get less and less information regarding the money supply each year, especially now that M3 is no longer reported.

The role the Fed plays in the President’s secretive Working Group on Financial Markets goes unnoticed by members of Congress.  The Federal Reserve shows no willingness to inform Congress voluntarily about how often the Working Group meets, what actions it takes that affect the financial markets, or why it takes those actions.

But these actions, directed by the Federal Reserve, alter the purchasing power of our money.  And that purchasing power is always reduced.  The dollar today is worth only four cents compared to the dollar in 1913, when the Federal Reserve started.  This has profound consequences for our economy and our political stability.  All paper currencies are vulnerable to collapse, and history is replete with examples of great suffering caused by such collapses, especially to a nation’s poor and middle class.  This leads to political turmoil.

Even before a currency collapse occurs, the damage done by a fiat system is significant.  Our monetary system insidiously transfers wealth from the poor and middle class to the privileged rich.  Wages never keep up with the profits of Wall Street and the banks, thus sowing the seeds of class discontent.  When economic trouble hits, free markets and free trade often are blamed, while the harmful effects of a fiat monetary system are ignored. We deceive ourselves that all is well with the economy, and ignore the fundamental flaws that are a source of growing discontent among those who have not shared in the abundance of recent years.

Few understand that our consumption and apparent wealth is dependent on a current account deficit of $800 billion per year.  This deficit shows that much of our prosperity is based on borrowing rather than a true increase in production.  Statistics show year after year that our productive manufacturing jobs continue to go overseas.  This phenomenon is not seen as a consequence of the international fiat monetary system, where the United States government benefits as the issuer of the world’s reserve currency.

Government officials consistently claim that inflation is in check at barely 2%, but middle class Americans know that their purchasing power–especially when it comes to housing, energy, medical care, and school tuition – is shrinking much faster than 2% each year.

Even if prices were held in check, in spite of our monetary inflation, concentrating on CPI distracts from the real issue.  We must address the important consequences of Fed manipulation of interest rates. When interests rates are artificially low, below market rates, insidious mal-investment and excessive indebtedness inevitably bring about the economic downturn that everyone dreads.

We look at GDP numbers to reassure ourselves that all is well, yet a growing number of Americans still do not enjoy the higher standard of living that monetary inflation brings to the privileged few.  Those few have access to the newly created money first, before its value is diluted.

For example:  Before the breakdown of the Bretton Woods system, CEO income was about 30 times the average worker’s pay.  Today, it’s closer to 500 times.  It’s hard to explain this simply by market forces and increases in productivity.  One Wall Street firm last year gave out bonuses totaling $16.5 billion.  There’s little evidence that this represents free market capitalism.

In 2006 dollars, the minimum wage was $9.50 before the 1971 breakdown of Bretton Woods.  Today that dollar is worth $5.15.  Congress congratulates itself for raising the minimum wage by mandate, but in reality it has lowered the minimum wage by allowing the Fed to devalue the dollar.  We must consider how the growing inequalities created by our monetary system will lead to social discord.

GDP purportedly is now growing at 3.5%, and everyone seems pleased.  What we fail to understand is how much government entitlement spending contributes to the increase in the GDP.  Rebuilding infrastructure destroyed by hurricanes, which simply gets us back to even, is considered part of GDP growth.  Wall Street profits and salaries, pumped up by the Fed’s increase in money, also contribute to GDP statistical growth.  Just buying military weapons that contribute nothing to the well being of our citizens, sending money down a rat hole, contributes to GDP growth!  Simple price increases caused by Fed monetary inflation contribute to nominal GDP growth.  None of these factors represent any kind of real increases in economic output.  So we should not carelessly cite misleading GDP figures which don’t truly reflect what is happening in the economy.  Bogus GDP figures explain in part why so many people are feeling squeezed despite our supposedly booming economy.

But since our fiat dollar system is not going away anytime soon, it would benefit Congress and the American people to bring more transparency to how and why Fed monetary policy functions.

For starters, the Federal Reserve should:

Begin publishing the M3 statistics again.  Let us see the numbers that most accurately reveal how much new money the Fed is pumping into the world economy.

Tell us exactly what the President’s Working Group on Financial Markets does and why.

Explain how interest rates are set.  Conservatives profess to support free markets, without wage and price controls.  Yet the most important price of all, the price of money as determined by interest rates, is set arbitrarily in secret by the Fed rather than by markets!  Why is this policy written in stone? Why is there no congressional input at least?

Change legal tender laws to allow constitutional legal tender (commodity money) to compete domestically with the dollar.

How can a policy of steadily debasing our currency be defended morally, knowing what harm it causes to those who still believe in saving money and assuming responsibility for themselves in their retirement years?  Is it any wonder we are a nation of debtors rather than savers?

We need more transparency in how the Federal Reserve carries out monetary policy, and we need it soon.


Hon. Ron Paul
for The Daily Reckoning
March 14, 2007

Editor’s Note: Congressman Ron Paul of Texas enjoys a national reputation as the premier advocate for liberty in politics today. Dr. Paul is the leading spokesman in Washington for limited constitutional government, low taxes, free markets, and a return to sound monetary policies based on commodity-backed currency.

Dr. Paul is known among both his colleagues in Congress and his constituents for his consistent voting record in the House of Representatives. He never votes for legislation unless the proposed measure is expressly authorized by the Constitution. In the words of former Treasury Secretary William Simon, Dr. Paul is the “one exception to the Gang of 535” on Capitol Hill.

To learn more about Dr. Paul, see here:

Congressman Ron Paul

Uh oh…here come the clowns.

“The impact of losing 2.2 million homes, I suspect, will be in a lot of areas of our cities and towns that are already pretty hard hit, so we clearly want to look at it.”

What the chairman of the Senate banking committee wants to look at, is the same thing that Wall Street was eyeing yesterday…the thing was that so disagreeable it sent the Dow down 242 points…and, according to the English papers, upset stock markets all over the world.

And…”It’s going to get uglier,” said Angelo Mozilo, on TV yesterday. Mozilo is the CEO of Countrywide Financial – the nation’s number one mortgage lender.

The whole U.S. mortgage industry – with over $10 trillion outstanding – is already not prepossessing sight. It faces a ‘liquidity crisis’, Mozilo told viewers. There are more than $1 trillion in ‘subprime’ mortgages outstanding. Many of these are turning out as anyone with half a brain might have expected – badly. And yet, the mathematical geniuses who package and trade these things seem to have been caught unawares.

Take a look at the ABX index, where subprime-collateralized debt is traded. “[The ABX],” says the New York Times, “tracks how much it costs to insure a group of BBB- minus bonds based upon subprime mortgages. The index is a derivative which falls in value when the cost of insurance rises, so it can be seen as a proxy for the value of the underlying bonds”. With defaults in the mortgage business mounting, insurance costs have increased dramatically, sending the index into a spiral down. It has declined approximately 30% since January 1, 2007, and 7.4% literally overnight during the recent subprime crisis.

Yesterday was not exactly ugly…but nor was the picture as placid and pretty as it has been for the last few years. Mortgage payments are getting later…nearly 5% of them are delinquent. Among subprimes, the delinquency rate has jumped to 13.33%…with subprime ARMs (adjustable rate mortgages) at 14.44%.

Of the entire mortgage market, about a third is insured by the U.S. federal government – that is, about $360 billion worth. But according to Martin Hutchinson’s calculations, if the U.S. housing market goes down just 15% – a rather modest decline for such an immodest boom – the mortgage industry and its backers, lenders and investors would suffer a capital loss of about $1 trillion, with about a quarter of that amount in loans guaranteed by the federal government’s bagholder – Freddie Mac.

Freddie Mac, unfortunately, has only about $79 billion to draw from…which would leave it a little short. Seeing the handwriting on the wall and reading it without moving their lips, its executives announced that they would tighten standards. Henceforth, it would be harder to lay defective mortgage credits onto the feds…thus Mozilo’s comments. A ‘liquidity crisis,’ after all, doesn’t arise in the desert. Where there is no credit, no one expects credit. Where there is a flood of it, on the other hand, people come to rely on it. And where there is excess credit, people come to rely on it excessively.

How quickly a market can go from excess to shortage! We now see what can happen to the entire ‘flood of liquidity’ that buoys up everything from the prices of Bombay apartments to the art auctions at Christie’s. It can disappear in a trice. Then what happens to all those assets? Simple, they sink back to more reasonable prices…and then (because markets tend to overreact in both directions) to prices that are unreasonably low. So, you see, dear reader, there is much to look forward to.

But let us return to the U.S. Senate, just to laugh at the clowns. The gap between what the feds’ insurer has on hand, and the loss it is likely to be asked to cover…is approximately $150 billion – small change, to be sure. But where will it get the money? It is not as if the entire rest of the financial picture will remain as soggy as it is now – even as the mortgage industry dries out.

We saw yesterday that the Dow is likely to follow the mortgage industry. And the economy, too, is likely to feel the dry breezes blowing off the mortgage financing badlands. Just as the consumer’s water line is connected to the community reservoir, so is his individual consumer spending firmly attached to community house price trends. Come the parching winds and it is likely to curl up and blow away.

Still, the Daily Telegraph reports, “American politicians are considering an emergency bail-out of 2.2 million borrowers struggling with their mortgage payments.”

Are these the same politicians that are already adding half a trillion to the U.S. national debt in the next two years? Anything is possible. If the government – against all odds – can bring peace and prosperity to Iraq, surely it can stop a liquidity crisis…can’t it?

More news:


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis…

“And since the Fed CANNOT, let me repeat, CANNOT afford to raise rates right now with the subprime mortgage meltdown going on…guess what gets discounted? The dollar!”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig


And more thoughts…

*** First from Addison Wiggin in Baltimore:

“America really is an empire, though it is hotly denied.” So began Antoine Agtmael, the featured speaker at last night’s Empire Salon.

Not long ago, Daily Reckoning sufferer John Henry invited us to attend a series of lectures in Washington, DC.

John, a DC businessman, is a direct descendant of the famed revolutionary figure, Patrick Henry, he of “Give me liberty or give me death” fame. The Henry family is – and has been – concerned that the legacy of economic freedom and political civility left behind by their forebears is being squandered by the current administration.

In 2003, not long after the US invaded Iraq, John Henry and colleagues in the DC area began to gather in a salon format, modeled after the intellectual gatherings of Paris in the late 19th century. They formed a committee to save the republic and a salon to encourage debate. They call their monthly gatherings The Empire Salon.

We attended the latest chapter of the Empire Salon last night. The featured speaker was Antoine van Agtmael, the gentleman who actually coined the phrase “emerging markets” in the late seventies. The term sounded a lot better than the common vernacular of the time: Rugged Little Third World Countries.

Capital & Crisis editor Chris Mayer, who schlepped along to the Salon with us, diligently took notes on your behalf. He files this report:

“We view ourselves as the center of the universe,” Agtmael said, referring to Americans. “Well, that is a very questionable thing.” Antoine is the author of a new book, The Emerging Markets Century. He presented his uncomfortable thesis to a feisty audience that seemed to itch for a debate.

“We are being pushed off-center,” Agtmael maintained. Relying on insights gained from over “thirty years of living out of a suitcase and visiting all of these places” and years as a professional investor, he told the audience that the future is not a U.S.- or Euro- centric one. Emerging markets – such as China, India, Brazil, and Russia – will make up more than half of the global economy in the coming decades.

Yet many Americans still view such markets with prejudice. They look down on these markets as basket cases. Agtmael maintains we are still stuck in the 20th century and “don’t fully grasp how pervasive this shift is.” “You can make money by working off this prejudice,” Agtmael said. His book covers many companies from emerging markets that have become world-class companies and competitors. Some of his favorites now, from that list, include Brazilian aircraft maker Embraer and Argentine steel maker Tenaris.

Agtmael fended off long-winded questions and pointed comments from the peanut gallery and held his ground. What is the greatest risk to his thesis? Agtmael explains: “What am I worried about? That as we realize this gigantic shift we go the route of protectionism.”

If America should retreat into a cocoon of tariffs, quotas, trade treaties and the like, it’s a good bet the unraveling of the Empire shall unravel a bit quicker.

More on the Empire Salon to come…

Also, if you haven’t had the chance, see:

Empire of Debt

*** Chris Mayer, btw, will be one of our featured speakers at the Rim of Fire investment conference in Vancouver in July. Conference champ, Bruce Robertson explains:

“We spare no expense bringing you the best experts and their top advice. And we put them to work – no sales pitches, no teases, just in-depth analysis and specific recommendations you can bank on.

“In fact, if you missed last year’s Symposium, you missed a chance at some top-of-the-line gains. Commodities guru Rick Rule shared the name of a small metals miner operation in Mexico and Peru. Since then the shares have more than doubled in value, up an incredible 147%.

“Resource Trader Alert editor and MarketWatch columnist Kevin Kerr revealed that he expected big things in the frozen orange juice market. Frozen concentrated orange juice went on to have a record year – taking some futures options contracts as high as 355% in under two months!

“International investment expert Dan Denning recommended a speculative play on Delphi Corp…. an auto-parts supplier. If you listened in, you had a chance to buy shares for $1.25. Today, they’re up 117% – and looking for more! Investment U’s Alex Green offered three conservative ways to play the Asian boom. Just six months later, all three are up double-digits – showing an average gain of 27%!

“As you may have noticed, that’s a pretty diverse set of recommendations. But that’s not all. We also host a bunch of the most outrageous thinkers in the financial world today. The event is always contentious. And this year promises to be the same. Profits are one thing… but  sometimes a good debate is almost as satisfying. No matter who you are, what your goals are, or even how you choose to invest – you’ll discover a trove of useful information in Vancouver.”

[Ed. Note: What? The Rim of Fire Investment Symposium. Where? Vancouver, BC,… When? July 24-27th, 2007.  To secure your seat on the Rim of Fire, call Barb at Agora Travel at 800-926-6575.]

*** Back to Bill Bonner in the land of cheese, wine and good chocolate:

“The real worry lies much deeper than share prices,” writes Anthony Hilton in the Evening Standard in London. Hilton believes the real worry is that we don’t know what to worry about.

“This is the first truly modern financial crisis, the first born of the age in which we live. For the past five years, cheap money from America and Asia has been lent and relent with less and less concern about whether it will ever be paid back, because new financial products – credit derivatives – allowed those lending the money to insulate themselves from the possible loss by selling the risk to default to other people.”

“Three out of four mortgages that are made, are made by a person who is not employed by a bank or savings and loan,” added Fed governor Susan Bies in February. Ms. Bies meant to look on the bright side. All this extra activity by extra participants, she thought, made the whole lending world less risky. The risk, such as it is, was thought to be spread around.

But to whom? How? And how much? And how might it be brought under control?

To the first three, the appropriate responses are ‘we don’t know’ three times. But to the last one the answer is: It will be brought under control by the natural contraction of the credit expansion. That same ‘liquidity crisis’ that now threatens subprime will someday threaten the whole mortgage industry…and then the whole economy. Always has. Always will. What goes up, must come down.

Still, the ‘we don’t know’ answers probably hide bigger problems and more expensive resolutions than we are used to. In the old days, if credit seemed to be expanding a little to quickly, it was brought into line quickly too. The Fed merely instructed member banks to tighten credit. Banks, then, were the source of credit. When they tightened, the easy credit disappeared.

Now, credit comes from many sources – some of them relatively unknown to the average investor as well as to the average banking regulator. The potential uncontrolled run-up of credit is much greater (which is what we have been seeing for the last few years). But so is the potential uncontrolled rundown too (a preview of which we just saw). Mr. Hilton is of the opinion that there is more to come – an opinion shared by your editor.

*** We love democracy. It is more entertaining than any other system of government…and you can laugh at it without going to jail (at least, you could before the passage of the Patriot Act).

Our friend Michel tells us about a hot election campaign:

“…One promises change without disruption…another promises disruption without change… Umaru Yar’Adua (Democratic Peoples’ Party), Chief Emeka Odumegwu Ojukwu (Progressive Grand Alliance) Orji Uzor Kalu (Peoples’ Progressive Party), Chris Okotie (New Democratic Party), and don’t forget General Muhammadu Buharih (Peoples’ Party) and Alhaji Atiku Abubakar (Congrèssional Action).

“This last candidate is affectionately nicknamed the ‘glutton for money’ and is particularly critical of the government’s record, namely: The disappearance of the railroads, the 28 million children who are missed by the school system (out of a total of 34 million supposedly in school), malaria, leprosy and tuberculosis rising to double digit rates, spectacular increase in kidnapping, and importing 100% of the oil needed in the country, despite the fact that the nation is the world’s third largest oil producer!”

Which is this example of democracy in action? Nigeria…

The Daily Reckoning