A Practical Approach to “End The Fed”: Free Banking

Kyan Howe
Economic Policy

I.   Introduction

Secretary of the Treasury Janet Yellen just warned Congress of a ‘catastrophic’ debt default. The U.S. Treasury General Account functions as the federal government’s checking and savings account held at the Federal Reserve https://archive.org/stream/pdfy-WHvRY_W83YNPF7Tv/End%20The%20Fed_djvu.txt(Fed). Now that Washington suspended the debt ceiling for two years, that account currently holds around $700 billion, which will soon reach $0 if the ceiling is not raised or suspended by July 31 this year. At the heart of congressional spending and the national debt lies the Fed. Throughout its 109-year history, the Fed has pursued a monetary policy in times of crisis, such as the Great Depression, Great Recession, and the COVID-19 pandemic. Though republicans claim to advocate for limited government, both they and democrat presidents maintain their unwavering support of the Federal Reserve’s market manipulation to bolster policy initiatives and congressional spending. Former Congressman Ron Paul spent his entire political career advocating for sound money. His paramount achievement is the “End the Fed” movement popularized by the Tea Party from 2008 to 2012. This paper discusses what it means to end the Federal Reserve System (Fed) and how best to approach a new theory of money in its absence. In light of the COVID-19 pandemic, the Fed has set the inflation rate at 7% and held interest rates at a nominal 0% to support stimulus packages and corporate bailouts such as the Coronavirus Aid, Relief, and Economic Security (CARES) Act and President Joe Biden’s American Rescue Plan — a recipe for disaster. Today, most Americans still know little about the Fed, blaming the free-market and supposed “lack of regulation” for panics and recessions — most notably the Great Depression and Great Recession. In order to End the Fed, the Congress must first repeal and abolish the Federal Reserve Act of 1913, deregulate commercial banks, and set up a legal framework that supports a free banking system.

II. The Nature of the Fed and its History

A cabal of six bankers conceived the creature that became the Fed on the eve of the First World War at the Jekyll Island Club — just off Georgia's coast. These six bankers included Senator Nelson Aldrich, Assistant Secretary of the Treasury A. Piatt Andrew, Senior Partner of JP Morgan and Co. Henry Davison, President of National CitiBank of New York Frank Vanderlip, Director of Wells Fargo Paul Warburg, and the first President of the Federal Reserve Benjamin Strong. Due to American distaste towards a central bank, these men created a "decentralized" bank consisting of 12 member reserve banks in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

Ever since its creation, the Fed has profited off the debt by promoting fractional-reserve lending, propped up "too-big-to-fail" banks, and arguably worsened financial panics with bubbles and busts (Paul). It is important to note that the Fed is not a government agency, rather a public-private partnership chartered by the Congress, resembling corporatism more than free-market capitalism. The Fed's pursuance of monetary policy through market manipulation —  quantitative easing, price stabilization, inflation, and other control measures, for instance — inherently serves its self-interest, designed to keep afloat large member banks that would fail in a free-market system, and support the Congress’ increasing deficit. Instead of reducing inflation, the Fed has repeatedly pursued a path of increasing the money supply during economic slowdowns to benefit its member and private banks as a "lender-of-last-resort." 

According to the Fed's website, its five main useful functions are to (1) transfer funds between banks, (2) conduct monetary policy, (3) regulate commercial banks, (4) act as lender-of-last-resort, and (5) control the money supply. In addition to these duties, the Fed supplies the federal government with the money necessary to finance extrajudicial military involvements and the Welfare State. Without a central bank and a sound currency tied to gold or silver, both areas of expenditure require the state to turn to its citizens to raise taxes — an unlikely feat. In effect, the Fed grants the federal government the authority to spend without the consent of the governed. Economic historians offer an astute observation that links the Fed's creation in 1913 to the United States' entrance into the first World War in 1917. With the first Federal Reserve Note (FRN) issued in 1915, the money supply became "elastic" (a currency that automatically increases and decreases in volume with business demands, unlike gold), marking the subject of fiduciary debates of the century prior — stretching back to Jackson. To put this into perspective, scholars estimate that only "21 percent of the [First World War] was funded through taxation" with the "remainder funded by Fed-backed borrowing (56 percent) and outright money creation (23 percent) for a total cost of $33 billion" (Paul, 66).

Shaky Constitutionality

Now let us examine the constitutional foundations for the Fed. Assistant professor of legal studies at the University of Pennsylvania Peter Conti-Brown summarizes his constitutional summary with three tenets: 

(1) The Reserve Bank presidents who sit on the FOMC are "Officers of the United States" for constitutional purposes;

(2a) The process for appointing Reserve Bank presidents does not conform to the requirements of Article II, § 2, clause 2, which governs the appointment of "Officers of the United States"; and/or

(2b) The process for removing Reserve Bank presidents violates the separation of powers, as interpreted by Supreme Court decisions addressing the removal of "Officers." (Conti-Brown)

The first question to answer is whether the Fed is "more like the Girl Scouts or the government." Answered directly, the Fed wields power and influence over the economy akin to the Congress's enumerated powers to coin and regulate monies and specie. Since 1971, the United States has operated fully under fiat currency — artificial money — that is nonconvertible to any standard and "literally and legally defined as Federal Reserve Notes" (Conti-Brown). Officially, the Federal Open Market Committee (FOMC) conducts monetary policy, regulates commercial banks, and controls the money supply, as laid out previously. 

However, under a gold standard and free banking, the FOMC’s role "would be diminished and might look different from purely public administrative work" (Conti-Brown). Federal statute grants the FOMC and Reserve Bank presidents the authority to make "authorizations, policies, and procedures" that govern how the FOMC manages and spends their $600 billion discretionary fund towards U.S. trading partners — compared to the federal government's $1.1 trillion (2008). Conti-Brown points out that "the scope of this authority," in addition to the Fed’s "impact on the global and national economies," indicates that "no other entity — private or public — can legally or functionally fill this role." The Fed, a private entity operating as a public-private partnership, wields a significant governmental power enumerated to the Congress.

The second question that arises is, "does the appointment and removal of bank presidents and governors violate Article II, § 2, clause 2?" Fed members and the FOMC (including bank presidents) are, for all intents and purposes, Officers of the United States. Naturally, their appointment process must adhere to the Founding Fathers' exact constitutional requirements. However, the process for removing Reserve Bank presidents violates the separation of powers, as interpreted by Supreme Court decisions addressing the removal of "Officers," since it does not follow the requirements of Article II, § 2, clause 2. In the Federal Reserve Act, the president appoints board governors that the Senate must approve. Supporters of the Fed's constitutionality correctly highlight that this process is unlike any other Presidential appointment. In the words of Conti-Brown:

The Appointments Clause itself contains an apt analogy: the president nominates, but the Senate must approve, before a candidate becomes an officer of the United States. It might well be that "[a]s a practical matter, the [Senators] can disapprove every nominee until [the President] send[s] them someone they like," but that doesn’t mean the Senate is making the appointment. (Conti-Brown)

When it comes to the appointment of Reserve Bank presidents, the president reviews nominees proposed by the governor, which the president then appoints and are approved by the board of governors. The Appointments Clause states that "the Congress may by Law vest the Appointment of such inferior Officers, as they think proper, in the President alone." This distinction is important since the Board of Directors initiates the appointment process, in direct violation. As for removability, that power remains firmly within the Fed itself. Suppose the president wishes to remove a bank officer. In that case, the process is as such: "U.S. President >> the Board of Governors >> to the Reserve Bank directors >> the Reserve Bank president.” Only the directors can “remove the Reserve Bank president for any reason at all” (Conti-Brown). In 12 U.S.C. § 248(f) of the Federal Reserve Act, it outlines the removal of a Reserve Bank president:

To suspend or remove any officer or director of any Federal reserve bank, the cause of such removal to be forthwith communicated in writing by the Board of Governors of the Federal Reserve System to the removed officer or director and to said bank.

Such a removal violates the principle set out in Free Enterprise Fund v. PCAOB. Furthermore, the word "cause" is not defined, and since the removal of a president must be "communicated in writing by the Board of Governors," it implies (as has been done in practice) that any reason is sufficient. Removal lies purely to the board's will, not with the President’s constitutional responsibility. 

Monetary Policy

Conti-Brown’s criticism of the Fed is one of the most sound and must be examined in greater detail — though that is beyond the scope of this paper. The Fed’s sheer economic and legal power needs further study. The FOMC and the Board of Governors subsidize weak banks, bail out Wall Street (i.e., Lehman Brothers in 2008, CitiBank, etc.) in times of panic, place harmful restrictions on private banks, and pursue a monetary policy that distorts market realities. Austrian economists blame the Fed for the 2008 Great Recession with its credit extensions and malinvestment into goods of the Higher-Order (stocks, bonds through quantitative easing, credit, etc.). During the Great Recession, private banks backed by the Fed granted risky loans to construction companies, which culminated in the housing bubble. Banks were willing to grant these loans due to the Fed’s holding of interest rates at an average of 6.3% in 2007 and 2008, thus masking the true economic reality as banks could not see the bubble’s warning signs. Murray Rothbard writes in his book America’s Great Depression that the primary cause of the Depression was the Federal Reserve’s expansion of credit into goods of the Higher-Order when consumer action indicated that credit should and does move from the Higher-Order to the Lower-Order (immediate consumption goods). The Fed and — to a significant extent — the Hoover and Roosevelt administrations carried out government actions that hampered market adjustment at the end of the 1920s. Those means include, but are not limited to:

(1) Prevent or delay liquidation. Lend[ing] money to shaky businesses, call[ing] on banks to lend further,

(2) Inflate Further...Further credit expansions create more malinvestments, which...will have to be liquidated in some later depression. A government "easy money" policy prevents the market’s return to the necessary higher interest rates (Rothbard).

Economists, and bankers, during the 1920s, were lured to a "stable price level." The Fed’s monetary policy prioritized the unviable idea since "general prices were more or less stable during the 1920s," which told "most economists that there was no inflationary threat." Thus, the 1929 market crash caught them by surprise. Benjamin Strong — one of the Fed’s creators and its first president — adopted the philosophy in 1922, going so far as to write: 

"it was my belief…shared by all others in the Federal reserve System, that [their] whole policy…would be directed toward the stability of prices so far as it was possible for [the Fed] to influence prices." 

Rather than the American "stabilization" from 1922 to 1929, the credit-control by the Fed was, in the words of economist D.H. Robertson, "a vast attempt to destabilize the value of money in terms of human effort by means of a colossal program of investment...but which no human ingenuity could have managed to direct indefinitely on sound and balanced lines." When comparing the Great Depression’s timeline to the 2008 housing bubble and other financial panics in between, it can be concluded that the Fed’s market manipulation and stated policy — remained unchanged — is directly responsible for the worsening of panics, bursting of artificial bubbles, and the prolonging of depressions. Rothbard’s Positive Business-Cycle Theory, as with Conti-Brown’s complete constitutional analysis, does not lay within this paper’s limited range. Simply put, the Fed’s monetary policy and money supply expansions and contractions led to malinvestment as it distorted the amount of liquid capital needed within the economy.

III. The Solution

What should follow after the abolition of the Fed? As with any policy shift, change must be gradual. The answer here is straightforward: free banking. Without the Fed, Clearing House Associations (CHAs) run the system that transfers funds between banks. A private entity known as the Clearing House Payments Company conducts 50% of all transactions between banks today. CHAs privately regulate its partner banks as there is a shared mutual interest between the banks apart of the CHA — one need only look to Scotland from 1714-1844, New England from 1820-1860, and Canada from 1817-1914. CHAs deem banks as sound lenders, require participating banks to furnish their balance sheets, and allow them to audit their books. Here we can briefly mention the Fed's last function (acting as lender-of-last-resort). Similar to a mutual insurance fund, CHAs fulfill this role due to the shared, private, contractual interest in keeping other banks afloat. Rather than a vast bureaucratic regulatory body, banks in this system refrain from holding inadequate reserves and granting risky loans to the markets' competitive force. Already, the first three and the fifth of the Fed's listed responsibilities can be taken up by the private sector, and more effectively at that. The Fed functions as the lender of last resort but, as examined before, CHAs hitherto fill that function and can replace the Fed's responsibility to do so. Lastly, monetary policy is a role that no actor should play. Under a gold or silver standard, with private mints and private banks self-regulating, decentralized market forces keep the quantity of money well maintained (Murphy). A currency that maintains an intrinsic value, such as gold, can regulate itself.  

In the Fed’s place, a return to the system previously in place for issuing paper money could quickly occur — the system Sweden and Hong Kong continue to utilize. That is, private banks issuing paper money to their customers. Through the CHAs and the granting of loans and other fiduciary media, banks ensured that other banks accepted their paper dollars, due to their proper treatment as a commodity, at face value. Businesses took no issue with the different banknotes in circulation as they were all redeemable in gold at various banks. 

Keynesians and central bankers argue that credit in a free banking system goes entirely unchecked since a central bank does not instruct banks to maintain a specific reserve requirement. Economist Donald Wells notes that these requirements average around "10% for banks whose deposits are greater than $122.3 million" (Wells). Firstly, existing FRNs can initially serve as a base money within the new system if the Fed were abolished. Individual banks "could increase [their] reserves by a lending policy more restrictive than that of its rivals" and "would find its notes and deposits presented for redemption in reserve money" (Wells). Competition between banks would ensure that reserves fluctuated as needed for that bank to succeed. However, the reserve base in a free banking system "could expand only if new reserve money entered from the outside" (Wells). The Treasury need not print FRNs, thus leaving gold or silver (or whatever is deemed standard, from crypto to plastic) as the most stable reserve. The ability for private banks to determine the number of reserve assets best enables them to adhere to their liquidity preferences.

Critics also fear a deflationary trend in free banking "as the money base could grow only through additions to the gold or silver stock" (Wells). However, the same critics ignored financial innovations encouraged by free-market competition as they can and will better economize the base money, resulting in higher turnover rates and increasing public confidence in banks' ability to honor redemptions. For example, a Scottish bank during the 1800s was able to operate with "specie reserves of only 0.5 percent of assets, revealing that the public may not demand specie when assured of its availability" (White, 141). According to Wells, free banking promises to end inflationary tendencies since it is more flexible with prices and wages. Moreover, Robert P. Murphy, an economist at the Mises Institute, attributes gold's 'deflationary bias' as "one of its virtues." Gold's "long-term predictability in monetary policy has definite advantages," and the "best thing the monetary authorities can do is provide a currency with stable purchasing power" (Murphy). 

Merely abolishing the Fed without a legal framework to allow private banks to replace the current system is, as many would agree, foolish. The first step is the complete deregulation of the banking system. That is, to "remove all legal obstacles to the production of 'outside' base money plus all restrictions on private banking" (Wells). Those restrictions include the Dodd-Frank Consumer Protection Act enacted in 2010 along with: 

(1) a prohibition on the minting of private coins; (2) a sales tax on the purchase of commodity monies; (3) a capital-gains tax on the holding of non-dollar currencies; and (4) uncertainty regarding the upholding by courts of the payment of a contract in anything but dollars, even when gold is specified. (White, 297-98)

Such deregulation allows entrepreneurs to establish new banks, thus promoting market competition, as laid out in previous sections. Wells lays out a method for ending the Fed throughout his work:

(1) cease open-market operations and discounting; (2) buy back its stock from member banks by crediting their reserve accounts;" and the Congress must "(3) send all government securities and gold certificates to the Treasury for cancellation; (4) move the treasury account to the commercial banking system; (5) let foreign central banks move their accounts wherever they wish; (6) phase out the Fed's check-clearing system" over the course of one year and allow commercial banks to assume the clearing functions as they branch out. (Wells)

In order to carry out this timeline, the Congress needs to instruct the Treasury to oversee the process and undertake some of the Fed’s responsibilities for a time until the Executive drafts policies encouraging, not forcing, banks to employ free banking practices. Ron Paul’s famed H.R. 2755 laid out a one-year dissolution period. Though instead, after the dissolution, the government could remain entirely out of the banking practices and simply allow a return to free banking. 

IV. The Gold Standard

This paper has intermittently touched the topic of gold and silver specie. A gold standard is not the most perfect system or theory of money, but that being said, no one person, theory, or system on Earth is perfect. Throughout history, gold and other precious metals remained firm as the most commonly accepted medium of exchange; this will undoubtedly hold for generations to come merely because gold retains its value and fluctuates in relation to the markets’ needs. The claim against a gold or silver standard of any kind argues that gold is rigid and restrictive and possesses a "volatile deflationary bias." As such, these standards are inherently dependent on the pace of mining in resource-rich countries such as Russia, South Africa, and China. Murphy astutely notes:  

To criticize a monetary system based on gold as "rigid" only makes sense if you believe that printing green pieces of paper makes a country richer. After all, the only rigidity enforced by the gold standard is on the central bank's use of the printing press. (Murphy)

This is a relatively basic economic concept: more banknotes do not equate to greater wealth. Mutual exchange of lower or higher-order goods and financial and fiduciary media usage generate wealth (along with a long list of other possibilities). A gold standard, as examined previously, regulates itself and places the same "restriction" on government "in the same way that the Bill of Rights limits the discretionary power of the feds" (Murphy). The only difference here is that the government must maintain a fixed dollar and gold exchange rate. However, the principle of preserving Human Freedom is the same. Now, what does the gold standard’s "deflationary bias" genuinely indicate? It means that the dollar’s purchasing power does not fall over time — in fact, it increases. New Keynesians and other economists not within the Austrian or Chicago schools admit that the "best thing" any monetary authority, central or free, can provide is a currency with a stable purchasing power such as gold.

V.  Conclusion

The Fed, throughout its unconstitutional and economically foolish history, only supports the ultimate reason to terminate its "authority." This "creature of the Congress" funds record "stimulus" packages, the welfare state, and extrajudicial military engagements via financial fiat. Numerous "control-devices" allow the Fed to aid and abet state power expansions and destabilize the dollar. Monetary policy, in the past century, injected artificial bubbles, exacerbated busts leading to (and causing) the Great Depression, the 2008 Recession, and the COVID-19 Recession. We must remember, however, that the Fed and the expansive bureaucracy are merely symptoms of flawed philosophies. To treat the symptom that is the Federal "reserve," immediate attention must be placed on the money and banking question.

Kyan Howe

Kyan Howe is a high school senior, researcher, and an YIP Policy Intern interested in Law, economics, philosophy, etymology, and ancient languages. He has written a number of research papers on renaissance occultism and economics. This article is an extended version and of a previous paper, and the culmination of 2 years of research. Originally from Boston, he currently resides in Texas.