Monetary Mission Impossible, Part 5

The Fed’s only real role in the inflation equation is the prior emission of too much central bank credit in violation of Say’s Law. That is to say, when the latter is strictly observed demand follows production and income—so there is no excess demand and no inflation.

Consequently, the ultimate way to stop inflation is to shutdown the Fed’s printing presses and either:

• Close the Eccles Building and turn it into a homeless shelter, or

• At minimum, abolish the FOMC and return to a discount window based modus operandi based on the real bills doctrine upon which the Fed was founded in 1913.

Indeed, the real bills doctrine was the monetary companion of Say’s Law. The former held that the only paper to be accepted as collateral at the discount windows of the new Federal Reserve Banks was commercial bills backed by goods already produced and sold into commerce.

Yes, discount window loans collateralized by commercial paper in this manner would bring new central bank credit into existence. But, crucially, that would occur only after new supply of goods had already been generated and circulated in commerce and only if the collateral was self-liquidating and minimally risky (i.e due for repayment within a few months by sound borrowers).

In this context, government debt would have been the very worst type of collateral for new central bank credits. By definition, it represents a net decrement, not an addition, to supply, and is therefore inherently inflationary. And that’s to say nothing of the risk that government debt might eventfully accumulate to such massive levels as to become unrepayable.

Nevertheless, today’s $8.1 trillion of government issued and guaranteed debt on the Fed’s balance sheet originated early in the Fed’s history by the accident of World War I. Upon US entry in April 1917, Woodrow Wilson, who was a complete economic ignoramus and racist and warmonger to boot, made the deplorable decision to finance this utterly unnecessary war by enabling the Federal Reserve to indirectly discount billions of Treasury bonds at the lending windows of the 12 new reserve banks.