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America’s banking system operates under the allegedly protective control of the Federal Reserve. But this guardianship has only exacerbated the country’s financial woes and misled investors as in the Great Depression and the Great Recession. The United States should disband the Fed.
Once upon a time, our country had a largely free economy, in which banks set their own interest rates. But in 1913, the government decided interest rates were crucial to the health of the economy, and it seemed awfully risky to leave them to the market. What if the free market got them wrong?
The 63rd Congress decided that such a possibility might trigger a recession — or worse, a depression — and created the Federal Reserve, ostensibly to provide a safer, more stable financial system and to set appropriate interest rates.
Regrettably, the government failed to consider what would happen if the Fed got interest rates wrong.
In a 2002 speech before becoming Fed chair from 2006 to 2014, Ben Bernanke admitted that the Fed “probably made the Depression worse than it otherwise would have been.”
In the decade immediately following the Fed’s formation, America came out of World War I. The Fed wanted to encourage post-war growth and industry, so they set interest rates low, and the economy took off, fueled by cheap loans.
During the Roaring Twenties, Americans began investing in the stock market in droves. Both institutional investors and the average Joe traded their savings for the promise of great future returns. Since borrowing was so cheap, many even took out loans to invest in the market (margin loans), hoping stocks would rise above the interest rate. All of the speculative borrowing and investing drove stock prices higher and higher.
The Fed watched stock prices soar and decided it needed to curb the nation’s enthusiasm. It raised interest rates sharply to disincentivize borrowing and encourage investment in the stock market.
This adjustment devastated those making margin loans, which suddenly needed much higher stock returns to break even. As some of them began selling, the desire to sell spread to other investors, and the market started to dip. Watching the value of their stocks drop scared still more investors, and the fear spread.
The stock market crashed in 1929. Millions of Americans watched their portfolios plummet in value. Those who borrowed to invest in the market defaulted on their loans. The banks lost money, and panic ensued. People worried the banks might run out of money and lined up outside banks, demanding their deposits back. Many banks that had lent out a fraction of the money they held ran out of cash to meet the demands of all the people seeking their deposits. Public confidence in the banking system collapsed.
The newly created Fed watched the economy flounder, but rather than stepping in or lending money to banks to stave off bank runs and panic, it remained passive. The Great Depression followed.
Perhaps the Fed was just young, brash, and reckless. Perhaps it learned its lesson, and the Great Depression was merely a cataclysmic growing pain.
Fast-forward to the years preceding 2008.
The United States economy had just stumbled after the collapse of the dot-com bubble. Again, the Fed attempted to encourage the timid market by slashing interest rates to 1%. Borrowing skyrocketed. People started buying new homes with cheap mortgages and watched their home prices soar. Speculators borrowed to purchase homes the same way they borrowed to purchase stocks in the 1920s.
In 2004, the Fed surveyed its work. The economy had indeed recovered from the dot-com bubble, but the Fed worried that the market might have gone a little far, drunk on cheap loans. The Fed began raising interest rates from 1% in 2004 to 5.25% in 2006 to curb the market’s excitement.
But the housing bubble was in full swing, spurred by cheap rates, and no gradual cooling would suffice. People began to default on their loans, and in 2008, the housing market crashed. The Fed could have pleaded inexperience in 1929, but had no such excuse in 2008.
The pattern is unmistakable. The economy stumbles, and the well-intentioned, albeit naive, Fed attempts to save it by slashing interest rates. Investors take advantage of low rates and, fueled by cheap loans, drive up prices. Everyone makes money until the Fed decides to hike interest rates. Crash. People lose money, and the Fed, feeling sorry for the economy, lowers rates again. Round and round the merry-go-round — pop goes the bubble.
Since its conception, the Fed has promised to be the guardian of the market, protecting it from excess and irrational exuberance. However, America’s two greatest financial disasters owe their severity to the Fed’s inability to wield interest rates in a competent fashion. Despite its abysmal track record, the United States economy remains shackled to the Fed. America must disband the Fed and return to free market interest rates in order to escape exacerbated boom-and-bust cycles, the fallacy of intervention, and the ineptitude of central planning.
Cassandra DeVries is a senior studying economics and mathematics.
