Why Not Audit The Fed?

by John Hawkins | September 1, 2009 12:31 pm

It’s no secret that I am not a big fan of Ron Paul. Moreover, I don’t want to abolish the Federal Reserve, nor do I agree with his assertion that the Fed has been bad for the economy. The Fed was around all through the 20th century when the United States became an economic super power. With that in mind, it seems hard to argue that the Fed has been some terrible drag on the economy or has hurt the average American, who lives better than anyone else in the world, through failure to control inflation.

That being said, I think a good idea is a good idea, regardless of where it comes from and auditing the Fed would seem to me to be a good idea.

Why? Well, let me quote some things Ron Paul said that I do agree with[1],

Since its inception, the Federal Reserve has always operated in the shadows, without sufficient scrutiny or oversight of its operations. While the conventional excuse is that this is intended to reduce the Fed’s susceptibility to political pressures, the reality is that the Fed acts as a foil for the government. Whenever you question the Fed about the strength of the dollar, they will refer you to the Treasury, and vice versa. The Federal Reserve has, on the one hand, many of the privileges of government agencies, while retaining benefits of private organizations, such as being insulated from Freedom of Information Act requests.

The Federal Reserve can enter into agreements with foreign central banks and foreign governments, and the GAO is prohibited from auditing or even seeing these agreements. Why should a government-established agency, whose police force has federal law enforcement powers, and whose notes have legal tender status in this country, be allowed to enter into agreements with foreign powers and foreign banking institutions with no oversight? Particularly when hundreds of billions of dollars of currency swaps have been announced and implemented, the Fed’s negotiations with the European Central Bank, the Bank of International Settlements, and other institutions should face increased scrutiny, most especially because of their significant effect on foreign policy. If the State Department were able to do this, it would be characterized as a rogue agency and brought to heel, and if a private individual did this he might face prosecution under the Logan Act, yet the Fed avoids both fates.

More importantly, the Fed’s funding facilities and its agreements with the Treasury should be reviewed. The Treasury’s supplementary financing accounts that fund Fed facilities allow the Treasury to funnel money to Wall Street without GAO or Congressional oversight. Additional funding facilities, such as the Primary Dealer Credit Facility and the Term Securities Lending Facility, allow the Fed to keep financial asset prices artificially inflated and subsidize poorly performing financial firms.

The Federal Reserve Transparency Act would eliminate restrictions on GAO audits of the Federal Reserve and open Fed operations to enhanced scrutiny. We hear officials constantly lauding the benefits of transparency and especially bemoaning the opacity of the Fed, its monetary policy, and its funding facilities. By opening all Fed operations to a GAO audit and calling for such an audit to be completed by the end of 2010, the Federal Reserve Transparency Act would achieve much-needed transparency of the Federal Reserve. I urge my colleagues to support this bill.

To avoid any confusion, I want to note that the Fed is already audited on a regular basis by the GAO. The difference here will be that Congress will get a report on a full GAO audit.

Some people think that’s a bad idea because they’re afraid Congress might be tempted to interfere with the operation of the FED by what they learn in an audit[2],

The biggest threat to investors is no longer poor oversight and regulation of financial markets. Indeed, there exists a more immediate and dangerous threat today – the passing of Ron Paul’s H.R. 1207 bill and the inflationary consequences that it brings.

…How Does Auditing the Fed Cause Inflation?

Inflation is caused by a central bank that loses control of its money supply. There are two ways that a politically compromised central bank can lose control of its money supply.

Road to Inflation #1: Repeating the Political Cycle

When the central bank is not independent, politicians have historically pumped up the money supply (for temporary economic boost) shortly before an election to buy votes with a lower unemployment rate. After the election, the effects wear off, returning the economy to its natural rate of unemployment but at a higher inflation rate than before. Because it is hard to fight off inflation quickly, by the time the next election rolls around the economy has not been squeezed back to its original inflation rate. Politicians pump up the money supply again, this time from a higher base inflation. As this cycle repeats itself, the central bank loses control of the money supply.

Road to Inflation #2: Financing Government Spending

A central bank that lacks independence from politicians makes it tempting for the government to finance an inappropriately large portion of its spending through printing money. A central bank that promises to finance too much government spending also loses control of the money supply.

While I would agree with the author of that post that allowing Congress to get its fingers into the money supply would ultimately be ruinous for the country, I don’t think there’s any straight line that leads from an audit being done to Barney Frank, Nancy Pelosi, and Barack Obama telling the Fed to print more money.

Now, if there’s no compelling reason at all to audit the Fed, it might be better to keep Congress out of the process entirely. However, the Federal Reserve has been a particularly busy, busy little bee during this financial crisis. They’ve been moving around trillions of dollars’ worth of money and credit with zero accountability to Congress or the public.

While I don’t think we need to be told every time someone at the Federal Reserve dots an “i” or crosses a “t,” it is our money and there needs to be a little more transparency and accountability in the process. Allowing Congress to get a report from the GAO would seem to be the best way to do that. Perhaps it’s not an ideal solution, but given the amount of power and money the Federal Reserve is dealing with, “Just trust us” is no longer good enough.