Central Error

"A fool and his money are lucky enough to get together in the first place."
--Gordon Gekko (Wall Street)

Jim Grant, in recent testimony before the House financial services committee, cited the work of Henry Parker Willis. Willis was involved in the origin of the Federal Reserve back in the early 1900s.

As Grant observes, the Federal Reserve envisioned by Willis had gone of the rails almost as soon as it opened its doors in 1914. After watching the travesty that followed, Willis wrote his swan song The Theory and Practice of Central Banking to capture what he viewed as the proper role of central banking, and where the Fed had bastardized the concept.

To Willis, the proper role of a central bank was to function as a big commercial bank--particularly during times of systemic stress. Back then, commercial banks functioned to provide liquidity to industrial transactions. During times of stress back in the 1800s, commerical banks of the day would not step between short term transactions and fund them.

Willis thought that this should be the Fed's proper role. By providing short term credit, commerce would still be able to function and would be less prone to 'crash.'

While I'm not sure I agree with that logic, limiting a central bank's role to facilitating short term commercial credit is much more palatable than what is actually done today.

Today, the Fed's role is as central planner of the economy with a printing press to enforce policy. Willis was quick to point out the flaws of such a model--flaws that he witnessed first hand thru the unfolding of the 1920s and 30s.

Years back I undertook study of the founding years of the Federal Reserve. My main question was how could a country that valued free markets so highly approve such an institution of central planning?

Willis offers some insight as to why some may have been duped. Some may have believed, like Willis, that a US central bank could truly ease short term commercial credit crunches by providing liquidity to good money, self-liquidating commerical transactions. The Fed would accomodate the needs of the community, not determine what those needs would be.

Noble as that purpose might be, anyone in 1913 with a modicum of understanding about political economy should have clearly been able to grasp the naivety of such a scheme.