Democratic Hypocrisy Blocks Efforts to Audit the Fed

The Federal Reserve Transparency Act, better known as the Audit the Fed bill, failed in the Senate last week by a vote of 53 in favor and 44 against. (Note that the rules of the Senate effectively make 60 votes required to pass anything.) It is not surprising that the bill failed, but it is surprising how it failed. The vote fell almost entirely along party lines, with all but one present Republican voting in favor and virtually all Democrats voting against it. On its face, this seems confusing. The Republican party that gave us the legendary secrecy of the Cheney-Bush years voted in favor of transparency. Meanwhile, the Democratic party that talks ceaselessly about Wall Street's depravity and income inequality voted to shield an institution in the Fed that contributes directly to both. What can possibly account for this?

It's a obviously a bit depressing that a good bill like this cannot succeed, when horrible things get passed into law all the time. But there is a silver lining here, because it reveals how preposterous it is to be loyal to either political party. Neither Republicans nor Democrats have a consistent set of principles that guide their political positions. So if you happen to have consistent principles that matter to you--civil liberties, helping those in poverty, opposing war, etc.--chances are you'll wind up with strange bedfellows from time to time. The Audit the Fed bill is a perfect example of this. In order to see this and understand the full hypocrisy of the Democrats on this issue, let's take a deeper look at this issue.

Exposing Fed Monetary Policy
Critics of the Audit the Fed legislation correctly point out that the Fed already gets audited like any other institution. This is technically true, but it's also beside the point. The Department of Defense receives a financial statement audit too, but obviously that does not mean that Congress and the public shouldn't have some oversight of their activities. We don't apply that reasoning to any other aspect of the government; why should we apply it to the Fed?

Despite its name, this bill isn't really about conducting a financial statement audit of the Fed; it's about shining a light on the Fed's secretive monetary policy discussions and decisions. The Fed and its supporters have warned that making such discussions more transparent would harm the economy. But of course they're going to say that. Shadowy institutions will always fight to remain in the dark; otherwise they wouldn't be shadowy institutions.  Think of it this way. If everything is above board, then obviously releasing the details won't cause any harm. But if there is something sketchy going on that would outrage the public, well, then that's probably the exact sort of thing that needs to be public--such as the trillions of dollars made available to well-connected banks during the 2008 crisis.

Damaging Independence
When confronted with the straightforward arguments offered above, critics, such as Senator Elizabeth Warren (D), will argue that making monetary policy public risks jeopardizing the Fed's independence. You see, the Fed is technically a private entity that is supposed to be immune from the political mood of the day. In theory, this would allow the diligent economists at the Fed to make the monetary policy decisions they need to without worrying about the timing of the next election. Thus, according to mainstream economic thinking, this means that the Fed should expand the money supply* during depressions to stabilize the economy, and contract the money supply* during booms to prevent the economy from creating bubbles and collapsing. The much-hyped independence of the Fed is supposed to make this utopia possible.

But in practice, the Fed has not followed through on this strategy. During recessions, the Fed indeed expands the monetary supply to revitalize the economy. But during booms, the Fed pursues the exact same strategy, further expanding the money supply and exaggerating the boom. This, coincidentally, is precisely what the politicians would want the Fed to do. Pumping more money into the system during a boom perpetuates the appearance of a very strong economy, and incumbents perform well in elections under these circumstances. Of course, no one ever worries about the crash that invariably comes later.

If you don't find this policy trend compelling, perhaps it is useful to recall the political battle that took place when it came time for a Obama to pick a new chairperson of the Fed. Progressive Democrats supported and eventually nominated Janet Yellen, while many in the establishment preferred economist Larry Summers instead. But if the Fed is an independent organization that is immune from political considerations, why should it matter who leads it? Of course it shouldn't. So why was this such a row?

It turns out that Yellen and Summers had hinted that they would support different monetary policies. And ultimately, the candidate that succeeded was the one that wanted to implement a more expansionary monetary policy (the kind that helps the economy in the short-run).

Upon reading these details, a cynic might almost think the Fed is already politicized. Yet some specifically opposed Senator Rand Paul's Audit the Fed proposal on the grounds that it might lead politicians to try to influence monetary policy, an activity that already openly occurs.

Why Expansionary Monetary Policy Hurts the Poor
This fact is not widely understood, but it is intuitive once you understand the full effects of an expansionary monetary policy. We'll attempt to follow this through the full process to show the impact.

Expansionary Monetary Policy and Inflation
First things first. Expansionary monetary policy simply refers to a policy that causes more money to be added to the financial system. The mechanisms for how this occurs are not critical to understand.

Expansionary monetary policy has many effects, but one of the most direct effects is inflation. Adding to the amount of money to the system, does not add to the amount of goods available in the system as a whole. Thus, if more money represents the same amount of stuff in the economy, all else equal, it follows that prices will go up. These changes don't happen instantaneously and there are many other factors that may accelerate or delay the effect. But the end result is that prices will ultimately be higher.**

Ever since the Fed's came into being in 1913, we have seen a gradual decline in the value of the US dollar over time, or what is the same thing, a rise in the level of prices. At some point in your life, you've probably heard a crotchety old relative say they used to be able to buy a candy bar with a nickel. In fact, depending on how old they are, they might not be lying. Due to the impact of inflation, $0.05 in 1913 would be equivalent to $1.20 in the year 2015. Even if they're not centenarians, the disparity is still likely to be pretty shocking. And this is according to the US government's own inflation statistics.

One response to this might be who cares? We don't really want to carry around a bunch of coins all day. And who knows how much harder it would be to split a tab with friends if every nickel mattered? But if we set those issues aside, we realize this actually does create real problems.

Winners and Losers from Inflation
One problem with inflation is that it doesn't impact everyone equally. The new money that exists in the economy doesn't fall from the sky, giving everyone an equal shot to get some. Rather, it enters the economy primarily through the financial sector--banks and investment banks.

This matters because the people who get the new money first are the ones who benefit most from inflation. They get to spend the new money before prices have adjusted to account for the extra money. So let's say the investment bankers (group A) earn 50% extra profits in January based on the new money and can now spend more at their favorite restaurants, spas, and golf courses before any of their prices have changed. The owners of these restaurants, etc. (group B) have earned 30% extra profits based on the new money, and now in February, they can spend on their favorite grocery stores, movie theaters, etc (group C). Since some time has passed, prices for group B will be a little higher than they were in January (say, 15%), but the group is still better off. Group C starts earning extra profits (say 5%) thanks to extra business from B, but now it's April and other prices in the economy have already risen by 50%. Thus, even though Group C is technically "earning more money" on paper, they're actually worse off in reality.

The above numbers and time frames were made up, but that is ultimately how the process works. There's a kind of trickle down effect, where the people that get the new money last lose the most. And since poor people don't tend to have a lot of connections to the high-powered financial sector, they're usually the ones that get hit by inflation. In this way, the Fed's official policy goal of causing a steady increase in inflation tends to transfer wealth toward the financial sector and away from the poor.

Punishing Saving
The other problem with inflation is that it can create a powerful disincentive for individuals to save. And the higher the inflation, the stronger the disincentive. If I know a dollar I have today is going to be worth only 95 cents tomorrow, I'm less likely to save that dollar. I want to spend it today instead, when it's worth more.

A possible savings solution to the inflation problem is the interest-bearing savings account. As long as the bank pays an interest rate equal to or greater than the rate of inflation, I may be inclined to save again. Even if I'm not making much money, I can at least keep it safe from losing value.

But what if the Fed sets interest rates very low, as they have for the past several years? Now, if I want to save, I don't have any option that even keeps pace with inflation. Dissatisfied with the idea of knowingly losing money in a conventional savings account, therefore, I have to look for other ways to save money that can give a better return. I may get drawn into investing in the volatile stock market, hoping to ride the wave of stock price increases. Alternatively, I may decide to not save at all and just focus on consumption.

Notice how different this is from an economy that doesn't have new money entering the system to cause inflation. When there's no inflation, the average person can effectively save for the future by literally just saving money, either in a savings account or in physical form. There is virtually no risk of loss, short of robbery or their bank failing outright. And since, all things equal, production processes tend to get more efficient over time, this means that prices actually fall over time. The same amount of money in the economy, but with more stuff to buy, would tend to produce declining prices. This offers a reliable and safe option that encourages saving and discourages speculation in risky assets.

In an inflationary environment, however, the average person is likely to save less and put what savings they do have into more speculative investments like real estate or the stock market to avoid losing money to inflation. Ironically, since many people share this same problem, this forces more money into the investment market and drives prices higher than they otherwise would be. This in turn creates a bubble, and makes the market more unstable and prone to crashing. Thus, not only is it more likely that the average person will put money into speculative investments, it is also more likely these markets will crash hard when the boom ends, taking almost everyone's money down with it.

I say almost everyone, because very wealthy investors have a way to avoid the worst consequences. Wealthy investors can afford to hire sophisticated teams to ensure their investments are well-protected against risk. If they are wealthy and well-connected enough, they also have the opportunity to be bailed out by the government, as has happened numerous times in the past. All of this helps prevent rich individuals from getting wiped out to the same degree as everyone else when the next crash comes.

Finally, since the entire system encourages people to invest in stocks, bonds, and other investments that are sold by brokers, this artificially increases the amount of business received by those brokers. This is yet another benefit provided to the financial sector by expansionary policies.

Thus, we see that the general outcome of the Fed's expansionary monetary policy is to hurt the poor. Poor people's efforts to move upward are frustrated by the lack of reliable ways to save and the incentive to just consume. Meanwhile, the wealthy have unique abilities to protect themselves against instability of the markets that the average investor will not. And at each step of the process the financial sector is directly enriched.

It's tough to imagine a proposal that is more directly opposed to the purported priorities of the Democratic Party than the Fed's expansionary monetary policy. It benefits Wall Street at the expense of middle- and working-class. And the Democrats just voted to protect it from any scrutiny.

Summing Up
In the final analysis, one finds it difficult to exaggerate the hypocrisy of the Democrats on the Audit the Fed bill. Two members of the left, Senator Bernie Sanders and Senator Tammy Baldwin, were admirably willing to break with the President and support the bill. And they should absolutely be commended for doing so.

But for the rest of the Democrats, there's simply no excuse. Voting against Audit the Fed was a vote against governmental transparency, against social mobility, and in favor of more income inequality. So if you care about any of those issues, it turns out the Republicans were actually on your side on this one.

Of course, if you consider yourself a progressive, this doesn't mean you should run out to change your affiliation tomorrow or, so help me, pledge your support for Trump or Cruz. But it does mean you should reconsider being loyal to either party.

*The Fed has a few different tools to expand or contract the money supply, but the details of those mechanisms aren't necessary critical to understand. For the purposes of this article, just know that expanding and contracting the money supply mean exactly what they sound like they mean--increasing the amount of money in the economy or decreasing it.

**Technically, all we can say for sure about the nature of inflation is that prices will be higher than they otherwise would be. How much prices rise depends on how much and how quickly new money is added and how quickly the economy is growing. In recent US history, the net effect has been a small absolute rise in consumer prices. To simplify our discussion, we're assuming an absolute increase as well.