On Ron Paul and the Fed

What a way to start the day. Another interview on CNBC this morning with Ron Paul: Fed to Blame for Everything

Let me come clean: I basically share the man’s distrust of heavy concentrations of power. And I think that secular stability in the general level of nominal prices is probably a good idea too. Thus, it appears that we share a number of beliefs. So why does the guy make my eyes roll whenever I hear him speak?

His problem, in a nutshell, is this: He ascribes too much power to the Fed. The power in the U.S. resides in Congress. It is Congress that spends, taxes, and issues treasury debt. Traditionally, the Fed simply determined the composition of government debt between its interest-bearing (debt) and non-interest-bearing (money) components. What sort of power is this? (Especially in relation to the power of Congress).

Ah yes, but the Fed has greater power than this. It can “lend to its friends” and “let its enemies fail.” I presume he is talking about the Fed’s emergency lending facilities, all of which have now wound down, with a healthy profit for the U.S. taxpayer.

But I am missing the point: The Fed has the ability to create money “out of thin air!” Whenever I hear this expression, I chuckle. We all have the power to create debt out of “thin air.” When Microsoft creates shares to finance an acquisition, it creates the shares “out of thin air.” If you bum a beer from a friend and promise to repay him next week, you create a debt obligation “out of thin air.” Ooooo…”out of thin air!”

Evidently, Paul has been forecasting the current problems of the world since 1971 (the breakdown of the Bretton Woods system). Yep, there were certainly no problems prior to this. No inflation to speak of. Well, maybe a bit during the Korean war. And maybe a bit more during the Vietnam war. Oh, and let’s not forget Lyndon Johnson’s war on poverty. Fiscal strain, fiscal strain, fiscal strain…all the fault of the Fed, no doubt. This fiscal strain apparently had nothing to do with the breakdown of Bretton Woods…no, let’s just blame the Fed for going off the gold standard. As if Arthur Burns had more power than Richard Nixon.

To be fair to Ron Paul, his position appears to be this. It is not ultimately the fault of the Fed. It is the fault of those in Congress who would like to use the Fed as their personal piggy bank to finance their pet “great society” spending initiatives. What Paul would like to see is an institution that prohibits Congress from making sneaky appropriations through the inflation tax.

If this is his view, then I have some sympathy for it. But I think that his energy here could be better spent elsewhere: there are bigger fish to fry in the realm of fiscal policy reforms.

About David Andolfatto 91 Articles

Affiliation: Simon Fraser University and St. Louis Fed

David Andolfatto is a Vice President in the Research Division of the Federal Reserve Bank of St. Louis. He is also a professor of economics at Simon Fraser University.

Professor Andolfatto earned his Ph.D. in economics from the University of Western Ontario in 1994, M.A. and B.B.A. from Simon Fraser University. He was associate professor at the University of Waterloo before moving to Simon Fraser University in 2000.

His current research is focused on reconciling theories of money and banking. His past research has examined questions relating to the business cycle, contract design, bank-runs, unemployment insurance, monetary policy regimes, endogenous debt constraints, and technology diffusion.

Visit: MacroMania, David Andolfatto's Page

16 Comments on On Ron Paul and the Fed

  1. “When Microsoft creates shares to finance an acquisition, it creates the shares “out of thin air.” If you bum a beer from a friend and promise to repay him next week, you create a debt obligation “out of thin air.” Ooooo…”out of thin air!””

    When this happens, if I do not partcipate, it’s no loss to me. When the Fed creates money “out of thin air”, it leads to inflation which decreases the value of the dollar….affecting me immensely!

    Still missing the point, David?

    • Yes. So tell me what happens when the Fed prints a dollar and uses it to purchase an income generating asset? Like an MBS, for example, currently generating 6% return, as most Americans continue to pay their mortgages. Where is the inflation that you speak of, even though the monetary base has doubled? When Japan's base money supply was growing at well past 30% per annum in the early 2000s, where was the inflation? All I'm saying is that the answer to these questions is not so obvious. It's got a lot more to than simply being able to create money out of thin air.

  2. “His problem, in a nutshell, is this: He ascribes too much power to the Fed. The power in the U.S. resides in Congress. It is Congress that spends…”

    Congress couldn’t deficit spend at the rate it does without the Fed’s ability to print money. In fact, it encourages reckless spending because there is no obvious, short term consequence.

    Ron Paul’s issue is that the consequence, inflation, is hurtful to most Americans. It’s a stealth tax.

    The other issue is hyperinflation, which could ruin us all. The current system could lead to that if we’re not more responsible and start spending within our means.

    By the way, your snide attitude takes away from your point.

    • With the interest rate on short term treasuries close to zero, there is hardly any distinction to be made between money and bonds. The treasury can print all the bonds it wants. It is true that a weak Fed will capitulate to the demands of Congress and aggressively monetize debt. I am not sure how "eliminating" the Fed (what will happen, in fact, is that its powers will be transferred to Congress) would in any way help the situation.

      I will try to tone down the snideness.

  3. ya this guy should stop writing political pieces if he can’t understand printing of money and its affect on inflation. he should at least not make an ass out of himself by mocking someone 1000 times more versed on the subject.

  4. “To be fair to Ron Paul, his position appears to be this. It is not ultimately the fault of the Fed. It is the fault of those in Congress who would like to use the Fed as their personal piggy bank to finance their pet “great society” spending initiatives.”

    It was a bit late in the article “to be fair”, but this statement seems to finally articulate some of Congressman Paul’s point.

    The point is pretty simple actually. If the Fed can create new funds without accountability or limit, Congress can fund whatever they want without concern.

    When Congress wants welfare or warfare they have to finance it. They have three options: tax, borrow, or inflate. Taxing gets them fired. Borrowing has eventual limits and an ever-increasing cost to future generations via interest. Getting the Fed to inflate the money supply is less visible, and seems painless – especially to the people who get the first use of those inflated dollars.

    Remove the Fed, and you force Congress to live within their means. Starve the beast.

    • Akston,

      With all due respect, you do not appear to know very much about the manner in which the Fed and its branch offices are audited. What you say about a "lack of accountability" is downright innaccurate. But it is a common perception. Please read up on it.

      I have sympathy for your second to last paragraph. The validity of your concluding statement depends on things. My own view is that Congress would simply take over the printing of money directly, as was the case in many points in history. The Fed, per se, is not the problem. Not the main problem, anyway.

  5. “But I am missing the point: The Fed has the ability to create money “out of thin air!” Whenever I hear this expression, I chuckle. We all have the power to create debt out of “thin air.” When Microsoft creates shares to finance an acquisition, it creates the shares “out of thin air.” If you bum a beer from a friend and promise to repay him next week, you create a debt obligation “out of thin air.” Ooooo…”out of thin air!””

    You are missing the point.

    When a company issues new stock the value of the existing stock decreases by the same percentage as the new issue. And everybody knows this and this is immediately priced in. When money is created out of thin air, this is not immediately priced in an it takes a while for the prices to adjust. During this process the parties who get the money first has an advantage over the ones that get it last.

    When you bum a beer from a friend nothing is created out of thin air. The beer exists. That is the only reason your friend can lend you the beer. If your friend could somehow create beer out of thin air, because he loved you so much then that would be analogous to the FED’s action. But since that is not possible, people create money thinking they are creating wealth (like beer).

    You need to learn a lot first to be able to have the right to chuckle at Paul’s comments.

    • Anon, I am not the only one who needs to learn something, apparently.

      An accretive aquisition financed by new equity need not be dilutive. This is Finance 101.

      When you borrow a beer from your friend, a debt IS created "out of thin air." You may, for example, have issued a promissory note. Such notes have circulated as money in the past.

  6. “I presume he is talking about the Fed’s emergency lending facilities, all of which have now wound down, with a healthy profit for the U.S. taxpayer.” => David Andolfatto

    David, you are not keeping up on “Recent Financial Events”:
    Recently Swap agreements have been entered into with:

    * Bank of Canada
    * Bank of England
    * European Central Bank (ECB)
    * Swiss National Bank
    * Bank of Japan

    According to, (and By), the Federal Reserve:
    http://seekingalpha.com/article/205283-uncertainty-on-the-streets?

    You Assessment Of “Governmental Profit” Is Unfounded; Do Not Put Ultimate Faith In “Statistical Accounting”.

    Profit Or Loss is “Determined By The Total Set”; Not Just One Aspect.

    If Banks And Governments Are Allowed To Have “Two Sets Of Books”, Through “Level 3 Assets” within the “Shadow Banking System”, Then “Full Accountability Is A Memory”.

    Consider This:
    http://seekingalpha.com/article/205392-why-we-don-t-need-central-banks?source=commenter

    To Assume Benevolence Is Foolish.

    • You make many assertions without backing them up (I do not mean this as criticism, simply that I do not know what you want me to look at exactly). You ask me not to put faith in statistical accounting. OK. So what do you put your faith in?

      I'll agree wholeheartedly with your concluding point though.

  7. When any company “creates shares out of this air,” usually by splitting the stock, it gives the shareholders shares to compensate them for the inflationary effect that the new shares have. If I own 100 shares of Microsoft, and they split it 2 for 1, I would now own 200 shares.

    The Federal Reserve doesn’t do that for me.

    • A stock split is inflationary. But if you read carefully, I was not talking about stock splits. I said, create new shares to finance a new capital project. This need not be dilutive. In fact, if the project is excellent, it will raise the value of shares.

  8. Yes, you seem to be missing the point on many levels. This article would have been much better if you would have only written the second to last paragraph. As Dr. Paul explained on CNBC, you cannot have the military industrial complex or the welfare state without the FED. The FED provides the money without any oversight or consent from the people. Otherwise, congress would have to directly tax the citizens to pay the bills.

    If you are still confused, read Akston’s post above. If that does not clear up for you, I’m sure many of us can recommend a reading list for you.

  9. Phillip: not only are you confused, you are naive as well if you think that the Fed is necessary to finance the "military industrial complex." Please do send me a reading list. I'll be happy to reciprocate the favor.

  10. From memory, old man Rothschild said, give me control of a countries money supply and I care not who makes the laws.
    His descendants now control 57% of the Fed’s equity, do they not?

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