Then the video engages in a long rejection of central banking, and calls for a return to the gold standard. There are several related themes that the Mises Institute cites:
- The Federal Reserve Board of Governors (FRB) is not accountable to anyone. No one audits their operations; they can buy and sell assets as they please. You cannot obtain a transcript of their deliberations; they only publish a brief summary.
- Inflation is baked in to the current banking system--300% in the 25 years after Nixon ended Bretton Woods! But you don't want a low inflation environment; you want the currency you own to gain value over time. Only a deflationary environment can provide the confidence that investors and entrepreneurs need to do their part for economic growth.
- Central banking is the cause of all economic booms and busts. It leads to booms and busts because the presence of a "lender of last resort" removes the need for banks to lend prudently during the good years.
- History shows that a return to the gold standard will stabilize the economy; for example, sound money was the impetus for a pleasant 18-year expansion from 1879 to 1896. On the other hand, the video implicates central banking as the ultimate cause of the Great Depression.
- The members of the Federal Reserve Board are appointed by the President and confirmed by the Senate. Opinions vary as to whether this provides enough accountability for the Board, but the appointment/confirmation process certainly mitigates the problem. In addition, the video is dramatically wrong about the availability of transcripts for the FRB's meetings; they have been available since 1994. The video was produced in 1996, so there is no excuse for this misleading argument.
- Central banking's promotion of monetary inflation is not the only cause of the boom/bust cycle. Any time investors believe that outsized profits can be gained from some new resource, technology or business practice, they stampede into the capital market and produce a rush of new lending. This is a boom cycle, and it doesn't need the assistance of central banking. The Holland tulip craze, the 19th century railroad boom, and the 21st century housing boom were driven primarily by investors' appetites for enormous and easy returns. The video praises the reliability of a market-regulated currency, but in point of fact the rush into the housing market by Wall Street lenders and Main Street borrowers that we saw during W's early years is but the latest example of how the market can drive a currency boom. An earlier example, provided by the video itself, is how the long expansion after the Civil War was followed by a decade's worth of instability that culminated in the Crash of 1907. That crash in turn led to the birth to the Federal Reserve during a 1910 meeting of Wall Street titans on Jekyll Island. Of course, the fact that 18 years of boom followed by a decade of instability and bust occurred when the Fed did not yet exist is an extremely strong refutation of the video's argument, but the producers rise to the challenge of completely overlooking this inconvenient fact.
- While few are happy during the bust after a boom, Daniel Gross argues that the boom/bust cycle is critical for a healthy economy. Booms often give us infrastructure (like telegraphs, railroads, and fiber-optic cable) that can boost production for decades. Of course, not all booms are of equal value (think tulip bulbs and vacant housing), but you've got to expect some chaff with the wheat. At the risk of redundancy, I again point out that booms are what happen when investors get excited about emerging opportunities; history has proven that you can't have marvelous new opportunities without a boom/bust cycle.
- Do not believe the video when it states that you want your money to gain value over time. The years 1929 - 1940 saw the greatest increase in the value of money in American history; this period is also referred to as the Great Depression. The link between increasing money value and severe economic depression is quite obvious. If the value of goods I can buy with money will increase over time, I have no incentive at all to invest it; I can get a risk-free increase in value just by stuffing my money in a mattress. So from the viewpoint of society, when the value of money is increasing, investment naturally falls sharply. Furthermore, this fall in value can be a vicious circle: as the value of money increases, investment drops; as investment drops, economic activity drops; as economic activity drops, the value of money in hand goes up; as the value of money in hand goes up, investment drops more, etc. This, in a nutshell, is how the Great Depression happened.
- The video attacks fractional reserve banking from pillar to post, but it is impossible for a conversion to the gold standard to eliminate fractional reserve banking. Here's why: the world's outstanding gold reserves are but a tiny fraction of the world's economic output. As long as the reserve assets on hand are but a fraction of the lending in the economy, there will be fractional reserve banking. It is mathematically impossible to have any form of banking other than fractional reserve banking when aggregate reserves are lower than aggregate deposits. "Well, we'll just revalue gold so that banking reserves and demand deposits are in equilibrium," Ron Paul might reply. While that is possible, I'm not sure I want to give a windfall profit of $15 trillion to a handful of mining companies.
- The video proclaimed (in 1996) that the federal budget had been in deficit every year since Nixon ended Bretton Woods. Of course, just like it seems you have to wash your car to enjoy a rainfall, no sooner was this video released than our country enjoyed a string of impressive budget surpluses from 1996 to 2001. Of course, the Republican Congress and President put an end to that with a huge tax cut and out-of-control military spending in the years 2001 and following, but that's a different story.
- The video proposes that investors will lend their gold to banks for (negotiated) fixed periods of time at a fixed interest rate, and the banks will in turn will lend to creditworthy borrowers. Congratulations, Mises Institute, you have just invented the Certificate of Deposit (CD).
- The video proposes that banks will charge fees to depositors for holding their savings and demand deposits, instead of earning profits by lending a portion of the deposit money. In other words, the Mises Institute proposes to kill fractional reserve banking. Of course, this would decrease the availability of capital dramatically, which would starve our economy of the resources needed to pursue new investment opportunities. In other words, the Mises Institute's proposal would provoke a downturn so colossal that we would rename the 1930s as the "Mild Disappointment."
- It is true that deposit insurance and the Fed's discount window serve as a "lender of last resort," which can encourage private lenders to take some imprudent risks. However, the alternative is not some nirvana where all investors and lenders are perfectly rational. Rather it's a system where you and I will be afraid to put our savings in a bank for fear that some crazy loan officer will lend it to his visionary cousin Marvin's real estate company, and we'll lose the capital we painfully gathered for decades as we raised our families. And if you and I are afraid of putting our money in savings accounts, it will be the 1930s all over again.
EDIT: I have corrected the inadvertant misspelling of the name of Mises Institute. Thanks, Thom!