No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eleven: Money, Money, Money! 261 central bank acts as the “lender of last resort.” If a banking run occurred in the U.S. for example, the bank could appeal to the Federal Reserve to provide additional currency to meet withdrawals. Since the Federal Reserve can print an unlimited quantity of currency, any individual bank run is not important. When the U.S. was under a gold and silver standard, the Fed was obligated to redeem its currency for precious metals. Thus there was some limit to monetary expansion; if the overall system expanded too much, people would demand gold and silver and those reserves would exit the system. Consequently, prices were effectively stable during the gold standard period prior to the creation of the Federal Reserve in 1913. The U.S. abandoned the gold standard in 1933 (for individual redemptions), and completely in 1971 (to include international trading partners). Since that time, prices have risen dramatically as shown in Figure 11.3 . FRACTIONAL RESERVE BANKING EXPLAINED With the creation of central banks, the banks in effect become a cartel a nd are protected from the disciplinary nature of bank runs, since the central bank can always loan them currency to meet any withdrawal requirements. As long as the banks inflate at the same LENDER OF LAST RESORT—TO WHOM? “But it must be admitted that it is almost certain that by far the most powerful reason leading to the maintenance of Government intervention in the banking sphere, at a time when it was on the decline in other industries, was that power over the issue of paper money, whether such power is direct or indirect, is an exceedingly welcome weapon in the armoury of State finance.” -Vera Smith, Rationale of Central Banking Figure 11.3, Consumer Price Index Growth. [Consumer Price Index for All Urban Consumers: All Items (CPIAUCNS). Source: U.S. Department of Labor: Bureau of Labor Statistics. Shaded areas indicate U.S. recessions. 2013 research, stlouisfed.org. ] As measured by the CPI, data from the Federal Reserve show that the dollar has lost approximately 96% of its value since the Fed was established almost 100 years ago. In the 100 years prior (1813-1913), the value of the dollar was stable (inflation during wars, gentle deflation otherwise). Note the especially large rise after the U.S. fully abandoned the gold standard in 1971. 1920 1910 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 0 40 80 120 160 200 240 U.S. completely goes off gold (Index 1982-84=100)