It's Time for the Austrian School to Rethink the Business Cycle

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My new book, Who Needs the Fed?, is an acknowledged tribute (p. xvii) to Ludwig von Mises's classic, The Theory of Money and Credit. Though I read it years ago and enjoyed it, it was only after a second read during the writing of Who Needs the Fed? that I really came to appreciate its genius.

That's why it was and is a thrill to see a review of my new book from the Mises Institute's Jonathan Newman. While his write-up is very critical, and suggests misunderstandings by me that in my estimation reveal his own about money, banking and credit, Newman was very gracious. So have members of the Austrian School been in general. I'm a big fan.

Though I'm not one of the Austrian School's own, books by Carl Menger, von Mises, and Henry Hazlitt are always where I am. Their genius is unrelenting, so when Joseph Salerno asked me to present (video of my speech here) at the Mises Institute last year, he "had me at hello" as it were. My reverence for Austrian thought is endless, but at the same time I occasionally disagree. Most of those disagreements were laid out in my book that Newman reviewed.

It should be stressed once again that Newman was very gracious. He could have dismissed the book out of hand, but instead made a point to praise it as a whole. His review isn't so much a review as it's a comment on my areas of disagreement with the Austrians, or as I sometimes refer to today's great thinkers from the School, "modern Austrians." I'm grateful to Newman for having taken the time to read and write about my book, but in light of his stridency about my own alleged misunderstandings of money, credit, banking, and the Fed, I wanted to be sure to respond to his critiques. Not surprisingly, I feel he missed the point while mis-analyzing much along the way.

Newman is correct that Who Needs the Fed? (from now on let's refer to it as WTNF) makes "a convincing case that the Federal Reserve is wholly unnecessary." That's certainly true, but any sentient being could make a case against the Fed. As the book makes clear, the Fed can't and doesn't act as lender of last resort to solvent banks despite its creation over 100 years ago being about just that, it's a tragically bad regulator of banks, and then it couldn't credibly set the rate at which banks lend to one another on its best day. Even if it could, its role in the price that is an interest rate is completely superfluous.

What Newman leaves out in his praise is that while I'm all for ending the Fed simply because it doesn't and never has served any useful purpose, my analysis in the book is that even if we don't end it, market forces are ending it for us. Maybe one reason Newman left the latter portion of the argument out of his critique is that while it's to some degree informed by information gleaned from Austrian scholars, my position that market forces will end a not-so-powerful Fed for us shows why some modern Austrian thinking about the Fed, banking and credit is flawed. Please read on.

Newman praises my mentions of Silicon Valley, Hollywood and the music industry (Taylor Swift most notably) to make my case about "the importance of allocating resources to profitable uses," but that was not the purpose of those chapters. Figure that it's shooting fish in the most crowded of barrels to talk about letting market forces dictate the flow of capital to its highest uses. My point with those examples was to reveal something entirely different: that while the Fed arrogantly and naively presumes to dictate credit flows, in the real economy credit is allocated as though the Fed doesn't exist. My book is an optimistic one that calls into question all the academic rants about the central bank. Why do we flatter it with so much unearned attention?

Austrians are not alone in decrying "easy" and "excess" credit from central banks, but in the real world, and as evidenced by the many billionaire venture capitalists and investment bankers, there's generally no such thing as "easy" or "excess" (no such thing as "excess" at all, in truth) access to the economy's resources. Only academics and economists untouched by the commercial world could believe in what is so plainly unreal. Entrepreneurs and businesses know the real story about the eternal slog that is finding resources to animate even the best ideas.  They don't pay princely sums to financiers because they're feeling generous.  

Brian Grazer is one of the most talented film and television producers in the world (think Splash, Parenthood, Apollo 13, A Beautiful Mind, 24, Arrested Development), but he's turned down over 90 percent of the time when seeking the resources necessary to pursue his entertainment projects. If readers have the next great technological idea, they should be ready to hand over a big portion of their start-up first to venture capitalists, and then to potential employees in the form of stock options. Credit is exceedingly expensive in Hollywood and Silicon Valley, and those two locales are not alone. Michael Milken's fortune of the ‘70s and ‘80s arose from the fact that most businesses have historically not had access to the bank credit; hence the massive growth of high yield finance during Milken's heyday (before the feds tragically imprisoned this great capitalist) and since.

All of the above exposes Austrian notions of "easy" credit "multiplied" by banks in cahoots with the Federal Reserve as academic ideas not terribly reflective of market realities. Hollywood, Silicon Valley, along with the vast majority of U.S. businesses generally don't rate much in the way of bank finance; banks the allegedly powerful Fed's way of influencing the U.S. economy with "easy money." Missed by Austrians and other Fed critics is that the Fed itself is interacting with an aged banking sector that is contracting and that largely doesn't - nor can it - lend to dynamic sectors of the U.S. economy. Banks are increasingly yesterday's news (see Austrian scholar Thomas Woods' Meltdown for confirmation of the latter from someone on the inside) as a source of credit for most anything that matters in the economy, but the previous truth runs counter to Austrian mysticism about banks powerfully interacting with the Fed on the way to a multiplication of money and lending. Stated simply, Austrians can't have it both ways.

Newman writes that "Tamny holds an unworkable definition of ‘credit.'' Specifically, he's troubled by my definition of it as always and everywhere "real resources." Newman believes that my supposedly flawed definition causes my economic analysis to "break down." He's right that I may have a different view since economists and academics tend to view credit as "money," but my definition of credit as the accession of "real resources" mirrored how von Mises saw it. As he explained in The Theory of Money and Credit (TTMC), "He who tries to borrow ‘money' needs it solely [my emphasis] for procuring other economic goods."

It's not money we're borrowing, rather we're borrowing what money can be exchanged for. When we borrow money we're really expressing our need for capital and consumer goods like trucks, tractors, computers, desks, chairs, housing, entertainment, and most of all: labor. All of this is important, and may require a pause for more thought. When we seek "credit" we again seek access to real resources. Always. That's why credit is abundant in rich countries like the United States, but near non-existent in countries like Haiti and Cuba. If credit were money, or something that could be conjured out of thin air by central banks, then Haiti and Cuba would have as much money and the resources money can be exchanged for as the U.S. does. In truth, Haiti's creation of a central bank would prove meaningless, and wouldn't lead to any "credit" increase in the unproductive country. Credit is what we create in the real economy, not central banks. The Fed's size and overstated power is an effect of a large U.S. economy, not a driver of same.  The Fed quite simply has no private stash of resources that it can expand or shrink.  

It's on this that Newman's argument, and the one made by many modern Austrians starts to break down. Newman writes of "artificial credit expansion" wrought by "low interest rates," but the Fed has no credit to increase. Not only is credit very difficult to attain even for the best and brightest (see once again Hollywood, Silicon Valley, and the pay of investment bankers compensated handsomely because resources are always very tight), the Fed has no resources of its own to release into the economy. What the Fed "giveth" to the U.S. economy through a stodgy bank channel it takes from private sources first. If central banks could do what Newman et al think they can, the poorest of poor countries and governments would be clamoring to start them. Yet they'd still be poor. The Fed's always oversold power was and is an effect of U.S. prosperity, not a driver of it.  A central bank can create "money," but that in no way increases credit. 

When Austrians talk about central banks creating "excess credit," they're unwittingly making a Keynesian assertion.  Keynesians believe government spending boosts the economy, but governments can only spend what the private economy has produced first.  The Fed is no different.  It can't be repeated enough that it has no credit of its own.  It can't conjure resources on the way to "excess." Credit is what we have and what we create.  

Implicit in the modern Austrian argument is that absent the Fed, credit would lie relatively dormant thanks to a dearth of "excess" credit, no "artificial credit expansion" and no banks lending at "low interest rates." Not a chance. Credit would still be every bit as abundant in the U.S. economy (arguably more with the Fed no longer mis-allocating even a portion of the economy's resources) sans the Fed, and it would per the logic once again of von Mises himself in another one of his many endlessly brilliant books, Socialism. As he writes on p. 348, " the free economy there is neither unemployed capital nor unemployed labour." Mises was stating very clearly that "in the long run" the resources we call credit never lay idle.

In that case, credit expands not because of the Fed or banks allegedly goosed by the Fed, but because a growing economy creates a lot of credit; as in resources for the productive to vie for in the markets. Interest rates are the price of access to the economy's resources, and if Austrians think "artificially low interest rates" render access to the resources cheaper, then the Fed is the one government-associated entity in the history of mankind capable of making something abundant by virtue of decreeing it cheap. It's worth adding that entrepreneurs and businesses would pay the Austrian scholars quite a multiple of their present salaries in academia to find the central bank created "easy credit" they so confidently theorize about. That is so because venture capitalists and investment bankers charge a lot for their services owing to a truth that can't be stated frequently enough: in the commercial world in which the scholarly have very little interaction, credit is always and everywhere very hard to attain.

In suggesting quieter markets for credit absent artificial inducements from central banks, Austrians are making yet another Keynesian assertion. Keynesians decry saving because they assume it subtracts from consumption. No, when we save we merely shift our present ability to access consumption and capital goods to others. As Newman himself writes in his critique of my definition of credit, "a credit transaction involves the exchange of a present good for a future good." Saving is the act of not accessing or consuming what is available in the present in exchange for what is expected to be available in the future, but the act itself presumes that someone, somewhere wants what's available presently.

What this again reminds us is that consumer goods and resources don't lay idle, per von Mises himself in Socialism. Absent the Fed, there would logically be more economic resources available in the economy (thanks once again to less mis-allocation of present-day resources; meaning credit), hence more of the lending that we call credit transactions. The Fed is not only not the source of increased credit; logically it's a barrier to it its expansion the more that it acts in much the same way that government spending slows down economic expansion. Government intervention is always an economic negative, and this is true whether it's Congress or our central bank wasting resources. There's no short-term economic boost that can spring from government spending or Fed mis-allocation of resources. The previous statement runs counter to accepted Keynesian and Austrian wisdom which respectively says that spendthrift governments and overactive central banks can waste what we produce on the way to near-term and long-term (some Austrians say the ‘20s, ‘80s, ‘90s in the U.S., and the China of modern times are/were creations of easy central banks - see Chapter 11 of WTNF) economic booms.

Newman writes that the "major problems come when he [Tamny] says that the Federal Reserve cannot expand credit." Ok, well the latter is a tautology. Here Newman halfway acknowledges my definition of credit (one adopted from von Mises) and admits that the Fed cannot increase the real resources that people seek when they borrow money. No it can't. The Fed has no private stash. Its power is rather illusory. Not to Newman. He expresses trouble with my statement that "the Fed can't change the on-the-ground economic reality," and instead says that my previous assertion snuffs out my "otherwise fiery rhetorical message" about ending the Fed.

The problem with the above is that the book has no "fiery rhetorical message" about ending the Fed. While it again says the Fed should be ended with great haste for it serving no useful purpose, mine is not a son-of-Ron-Paul rant against the central bank. If so, it would never have been written, let alone published. Yelling polemics about the Fed are ubiquitous and tired at this point. My book contends that the Fed's power is oversold by its supporters and critics alike, and that much of the horrors ascribed to it (often falsely and incorrectly, see Chapter 20) would still exist without the Fed. WTNF makes plain that while the existence of the Fed is an offense to common sense, it's also true that its always overstated power is dying before our eyes. Let's be realistic, Congress is not about to "end the Fed" anytime soon. In that case, let's cheer on market forces that are ending what Congress won't.

As for Newman's belief that the Fed can in fact change the "on-the-ground reality" by increasing his more money-focused definition of "credit," readers would be wise to read my book. Indeed, if they believe the Fed capable of altering reality they might ask why a wholly politicized institution hasn't increased credit in the poorest of U.S. communities as a way of enhancing its stature in the eyes of an always "compassionate" Washington. The problem is that it can't.

To understand why, readers might open up Chapter Sixteen of WTNF and read about Baltimore. Imagine if the Fed, worried about persistent poverty there, were to buy bonds from Baltimore banks in order to increase money loans in the city. Loans from Baltimore banks would surely surge, but well outside Baltimore and probably the state of Maryland itself. Banks can't stay in business for long if they're lending in areas where productivity is very low, and by extension where individuals and businesses lack the means to pay the money borrowed back. Fed attempts to increase money loans in Baltimore or the so called "money supply" would fail between breakfast and lunch. Reducing all of this to the absurd, imagine if the Fed helicoptered billions of dollars into Baltimore, and even more ridiculous, imagine if all those billions were spent right in the city. If so, no business is going to pursue much expansion based on a helicopter drop of money. Instead, Baltimore businesses would bank their windfalls only for the money to once again be loaned well outside the city.

Newman further critiques my contention that "the Fed can't change the on-the-ground economic reality" because it flies in the face of the Austrian Business Cycle Theory. There he simply misunderstands how I view the world. I don't think the Fed can change economic reality, and one major reason is that I respectfully reject the Austrian Business Cycle Theory (ABCT). The latter contends that the boom/bust cycle in commerce is a function of "excessive" growth of bank credit fostered by "easy" rates of interest from the central bank. I find ABCT unserious. Quite explicit in ABCT theorizing is the Keynesian notion that producers create economic goods not with an eye on releasing them into the economy in return for something else, but instead to sit on them. ABCT presumes that Fed machinations increase available resources that would otherwise sit idle. Such a theory defies basic economics, Say's Law, along with Mises's essential point about the non-existence of unemployed capital and unemployed labor. We produce with an eye on exchanging what we've created for what we don't have. The Fed is not the inducement necessary to release the resources produced into the economy. We produce so that we can exchange.

Worse is the Austrian belief that banks tied to the Fed are the source of this increased credit. The obvious problem there is that as Thomas Woods makes plain in Meltdown, as of 2008 banks only represented 20% of total lending in the U.S. economy. I point out in WTNF that Woods' number is now dated; that banks only account for 15 percent of total lending now, and that number is in freefall. Even more damning to the ABCT is the simple truth that the most dynamic U.S. economic sectors are largely untouched by something so yesterday as banks and bank loans. Going back to Milken, his genius was finding finance for the promising industries and businesses shunned by traditional banks prone to lending conservatively toward what is established. All this is my way of saying "Of course" in response to Newman's argument that my views contradict the Austrian Business Cycle Theory. I unabashedly dismiss a theory that suggests central bank interaction with an archaic banking sector has any kind of substantive impact on the economy. More than Austrians would probably ever want to admit, Woods' findings about banks and lending, Mises's point about the employment of capital goods, and the very conservative lending style of banks all expose ABCT as a rather weak theory requiring more scrutiny from the Austrians themselves.

Returning to Baltimore, the Fed logically couldn't drive a lending increase there. What about countries? Monetarists argued that an increase in the supply of euros in Greek banks would have saved it from its implosion. Let's be serious. Any increase in the supply of euros in Greek banks would have quickly boomeranged to more productive stewards of always limited resources well outside Greece. Money and the resources it attracts goes where it's treated best. Always. This is very elementary. Once again, if rather politicized central banks could truly bend the will of an economy on the way to central-bank authored business cycles, then poverty in West Virginia would have been solved by now. Yet it hasn't been. Just as massive spending on Robert Byrd-named projects never moved the economic dial in the Mountain State, neither would have Fed-induced money supply increases. The money would flow out of West Virginia just as government largesse has left worthless government buildings and lightly driven roads behind as a monument to the failure of governments to stimulate anything that doesn't rate resources in the first place. Rest assured that the Fed can't do what Congress plainly can't.

When Newman writes of the Fed's "expansionary monetary policy" allowing banks to borrow "new money at very amenable rates" only to use it to "pyramid new loans to businesses and consumers" he's yet again ignoring the reality revealed by colleagues of his like Woods (not to mention what WTNF offers) that banks are very much a rapidly shrinking source of loans. If they were doing what Newman presumes whereby they're "pyramiding new loans to businesses and consumers," then they would be an expanding source of the lending pie. Newman's theories are exposed as wholly incorrect by market realities, and some Austrian scholarship too. Were he active in the real world, were he more in touch with the credit realities of Hollywood, Silicon Valley, along with big and small businesses of all stripes, he'd realize that credit is very difficult to attain. If it weren't, we'd never have heard of the venture capital industry, Michael Milken, or billionaire financiers. They're rich precisely because the real price of credit has very little to do with any central bank and Ivory Tower theories about same.

Only in academia is credit "easy." That's rarely true in the real world, and it can't be stated frequently enough that the Fed cannot change the on-the-ground reality of difficult credit. It can at best swim with a tide of a boom never of its own making. Market forces are rendering the outmoded banks that Austrians oddly think drive the business cycle yesterday's news. With the decline of the banks so is the Fed's always overrated relevance in decline. Newman is not alone in missing WTNF's nuance. My book once again argues that the Fed will be ended by market forces no matter what. The Fed is an effect of prosperity, not a driver of it. The ABCT itself is discredited by observable realities that tell us government and its institutions can only weaken the economy the minute they obnoxiously intervene with an eye on stimulating it.

Newman writes that "Austrians do not claim that the Fed creates sustainable booms or new real resources," but that's exactly what they claim. The 1920s, '80s and ‘90s were boom periods, but to believe the Austrians the Fed's interaction with antiquated banks was the real driver. David Stockman is heroic to Austrian School thinkers, and to him China's boom is a creation of central bank excess. Goodness, if central banks were even a fraction as powerful as their critics in the Austrian School believe, every poor country in the world would be clamoring for foreign loans to start one. Doing so would once again prove meaningless.

Austrians spent the 20th century heroically discrediting central planning, but when economies boom in places like the U.S. and China on the logical way to massive credit creation, the very Austrians who so loudly decried communist central planning in the 20th century act as though central banks possess otherworldly power, and as evidenced by the prosperity in the U.S. and China, otherworldly skill at allocating an economy's resources. Sorry, but any visit to Shanghai, Beijing and poorer cities like Urumqi reveals gleaming skyscrapers that central allocation always failed to eventuate in the 20th century. Rest assured that central bankers didn't attain previously unseen investment skills in the 21st. Kashgar on China's border with Afghanistan lacks the skyscrapers that are ubiquitous in Shanghai. Would proponents of ABCT suggest that Kashgar lost a central-bank driven "credit lottery" that Shanghai somehow won?

Newman and others don't realize it, but they're joining the Keynesian camp when they suggest that central banks working in cahoots with the rapidly shrinking source of finance (this was as true in 1916 as it is in 2016) that is banking are creating artificial booms. Ignored by them is something they already know: governments have no resources. They can only mis-allocate the resources we've already created in the real economy. There's never a boom to speak of; not even near-term.

This is why government spending is always and everywhere an economic depressant: it is politicians mis-directing precious resources over private, market disciplined actors. Yet Keynesians believe the spending is the source of boom periods. No, it's at best an effect of boom periods. Governments backed by the productive can waste a lot of resources.

Just the same, central banks can simarly only mis-direct resources already created in the private economy, but not nearly as much as Austrians would give them credit for. Modern Austrians in thrall to the ABCT see booms as a function of Fed machination, but as logic dictates the boom periods would be even greater absent central bank meddling just as the U.S. economy would be exponentially more prosperous right now absent so much government spending. The resources are wasted either way. Keynesians and modern Austrians get it backwards. If they doubt this, they need only consider how much in the way of "open market operations" a central bank in Honduras could conduct. The Fed's swagger is not its own, and it can't stimulate short-term booms any more than government spending can. Austrians ought to trust their own brilliant instincts. Government is a barrier to growth. Always.

Austrians see boom periods like the internet ‘90s as effects of central bank ease, but once again they miss the on-the-ground reality. The Fed interacts with banks.  Yet banks aren't the source of Silicon Valley finance, and they aren't precisely because just about every Valley concept dies. Nearly every one. Banks can't risk depositor money on concepts that have a near 100% failure rate. Banks are heavily exposed to housing consumption for the opposite reason. Houses are real, they can can be repossessed. Banks are a very conservative form of finance despite what is commonly believed. The idea that they might be the source of booming economic activity in the most economically advanced country in the world defies common sense.

No, the internet boom was the creation of intrepid investors much as the pre-Fed automobile boom (99% of the 2,000 carmakers incorporated in the early 1900s went belly up) was. The Fed interacts (the interaction is overstated as will soon be revealed) with banks that have little to do with the economic dynamism that drives booms. The ABCT is rooted in a vision of an economy that hasn't existed for well over 100 years, and likely never did.

All of which brings us to fractional reserve banking. Who knows why, but some members of the great Austrian School have bought into a bit of mysticism popular among academics that banks, for being "banks," multiply money. Where does one begin?

First up, it's only natural that banks loan out the deposits they pay for. They're borrowing money from savers at a rate of interest (a liability in accounting terms), and they're able to pay interest on deposits by virtue of them making loans (assets) at a higher rate of interest. If banks didn't lend out the funds deposited within them, they wouldn't be banks. Better yet, they would go out of business. Their purpose in paying for deposits is to lend those deposits out. Austrians oddly see what is basic as a form of inflation whereby "money" is multiplied. Yet banks do no such thing. They simply pay for deposits, then lend them out. What is very simple and involves assets and liabilities has Austrians convinced banks are counterfeiters.

By the "money multiplier" illogic that generates so much confusion among a subset of Austrians, the owner of apartments multiplies apartments when he rents them out. No, the number of apartments stays the same. When an apartment owner rents them, he's giving up access to same over a period of time. Banks and money are no different. When we deposit money in the bank we're giving up use of that money for a time.

Austrian confusion seemingly springs from what happens when people save. When they do they're once again giving up access to the resources that money can command. That's why people "save," or "put money in the bank." They're handing over use of that money for the near, and sometimes very long term. Quoting von Mises in Socialism, "To maintain and accumulate capital involves costs. It involves sacrificing present satisfactions in order that greater satisfactions may be obtained in the future. Under Capitalism the sacrifice that has to be made by the possessors of the means of production, and those who, by limiting consumption, are on the way to being possessors of the means of production."

Per von Mises, money saved is transferred to others. It's not multiplied. If for being saved in banks dollars were multiplied, no rational individual would deposit money in banks. No one would simply because saving would be a fool's errand as banks multiplied away the value of money deposited. But they don't. When you deposit money in the bank you're giving up use of it, or in von Mises's words "sacrificing present satisfactions in order that greater satisfactions may be obtained in the future." If banks multiplied our money on the way to inflated worthlessness, they wouldn't exist. Banks cannot create money, rather they can only lend it out. They pay for dollar deposits so that they can make loans with same.

If banks didn't lend out the money on deposit, they would be "money warehouses" as opposed to banks. Furthermore, depositors would pay the warehouses a fee to house their money as opposed to receiving interest on monies deposited. Austrians say that the tautology that is banking multiplies money, and that banks should instead warehouse it.

Interesting there is that by the very admission of Austrians like Tom Woods, banks are a shrinking source of lending. And as Chapter 13 in WTNF reveals in detail, banks are also losing to countless savings vehicles that don't count as traditional banks. USAA is an insurer, but it's where more and more individuals save. So are money market accounts at brokerages, so are credit unions, so are Uber-style lending companies like LendingClub. When Austrians decry fractional lending they're not only ignoring what makes a bank a "bank" in the first place, they're also ignoring the myriad saving options in the U.S. and around the world created by market forces. That being the case, and if saver health is so very compromised by a lack of money warehouses desired by Austrians, why haven't market actors created the latter? Austrians are adamant about the horrors of fractional lending and the alleged "money multiplication" shame that all of this implies for the economy, but they're also properly revential of market signals. Yet never explained by them is why market actors haven't created en masse the money warehouses they deem so essential to market health.

Per von Mises once again, to save in a bank involves "sacrificing present satisfactions." Ok, but if banks were truly taking dollars saved and multiplying them, then market realities indicate that no sane saver would ever deposit money at a bank. The relatively low rates of interest long offered by banks are surely not enough to entice savers bothered by what Austrians strangely deem "multiplication." Individuals save for reward, not evisceration.

Of course, if banks were multiplying money as Austrians presume, the productive would never seek money to animate any kind of entrepreneurial vision. Explicit in the Austrian view of banking is that $100 deposited in Bank A is loaned to another individual who deposits (assuming a 10% reserve requirement) $90 in Bank B, and then Bank B lends $81 to an individual who deposits the funds in Bank C. To Austrians $100 deposited with a bank quickly becomes $271; presumably on the way to infinity. The productive wouldn't seek dollars in a world of banks if Austrian mysticism were correct simply because dollars would have no exchangeable value. But they do. Missed by Austrians focused on the lending of money among many is that with the previously mentioned scenario, there's still only $100. To save is to give up use of money to someone else.

Not only is the Austrian view of banking factually untrue, it's defied once again by the logic of Mises himself. As he put it in TTMC, "He who tries to borrow ‘money' needs it solely for procuring other economic goods." That the productive still seek money in exchange for their production and also to fund their ideas in our hyperbanked world of the present is a market signal of the staggering absurdity behind the arguments made by Newman and others. Are these academics really so smart, and the most talented entrepreneurs in the world really so dim as to take dollars, euros, yen and Swiss francs in return for their production despite banks and central banks allegedly having multiplied those currency units into worthlessness?  Would these same entrepreneurs really seek dollar financing if banks were actually multiplying away their exchangeability? 

That dollars, euros, yen and francs are most abundant in the richest parts of the world is another rather inconvenient market signal that's never been explained by the mystics who believe the act of banking has rendered money worthless. Yet so is logic itself an inconvenience. Banks for being banks don't have magical powers. If they did, as in if they could multiply money, they wouldn't represent only 15 percent - and falling - of total lending in the U.S. economy. The story for banks, and by extension the Fed, gets worse and worse by the day. What they would give to be able to "multiply" money, let alone be relevant. Only one new banking company has opened since 2010. It is called Bank of Bird-in-Hand, and it opened in Amish country. If banks could multiply money as Austrians laughably contend, and if their benefactor in the Fed were truly powerful, does anyone honestly think this number would be so low?

Near his conclusion, Newman asks "How can one argue for fractional-reserve banking, but against the central bank that holds the fragile system together? Without the Fed, fractional-reserve banking leads to bank run after bank run..." Newman will eventually yearn to have the previous quote back, as will the Mises Institute where he's presently studying. Newman is again a gracious, book smart person in the middle of an amazing year of learning as a 2016 Mises Institute fellow. The problem is that academia tends to be very far from commercial realities.

Indeed, what Newman would learn were he to step inside a well-run bank is that it's unheard of for a successful institution to go to the Fed for a loan. Assuming a "bank run," well run banks have myriad private sources of cash they can borrow from. Any banker could have told him this, and he'll soon enough know it. Successful banks make it a practice of avoiding the Fed as much as possible. To go to the Fed for funds during a "bank run" is an admission of bankruptcy. That's why no well-run bank does what Newman naively presumes to be a regular practice.

It's not fair to Newman that he's got to bear the brunt of my response here. Figure that most who decry fractional lending fall into the same trap as he has. Believing that banks wouldn't make loans without the Fed, they assume that fractional lending is only possible when banks are backed by a central bank. Nothing could be further from the truth, and if Newman had simply contacted any banker or anyone passably knowledgeable about finance ahead of penning his attempted critique, he could have been saved from what is the inevitable error among Austrian critics of banking. It can't be stressed enough that it's unheard of for solvent banks to go to the central bank for a loan. But poorly run, insolvent banks do.

And there's the other trap that Newman has fallen into. Already of the totally mistaken belief that well-run banks regularly run to the Fed for loans, he's similarly of the belief that the Fed is what holds the banking system together. That the Fed strengthens the banking system. Readers should continue to return to Newman's concluding quote in bold as a reference. Newman couldn't have it more backwards.

Only the bankrupt go to the Fed for loans, and to the extent that the Fed saves them, the banking system itself is weakened. Indeed, Austrians in their hatred of the Fed and banking constantly contradict themselves. If the Fed had bolstered the banks and allowed them to "multiply" money and loans, then logic yet again dictates taht banks wouldn't be shrinking as a source of loans. Just the same, if the Fed truly enabled so much risky behavior on the part of the banks, then they would be increasing their market share as opposed to fighting feverishly to maintain their rapidly disappearing economic footprint.

Missed by Newman is that solvent banks don't need the Fed, but they suffer the Fed's strangulation of banking in total; strangulation that springs from the Fed and politicians regularly bailing out the weak. What's important here is that the power and economic heft of banks has shrunk a great deal since 1913. The Fed, for it propping up the weak while regulating all banks as though they're weak, has harmed the banking system, not helped it as is assumed by Newman. He's not alone in believing what market forces indicate is totally incorrect, and the burden shouldn't solely fall on him. Many an Austrian has once again fallen into the trap that he has whereby he asserted that quality banks regularly borrow from the Fed, and that the Fed has boosted the strength of the banking system. Quite the opposite.

If banks in cahoots with the Fed could do what Newman and others think they can, they wouldn't be dying before our eyes. Jonathan Newman was once again very gracious to take the time to write about my book. He's no doubt a smart person, and I can't wait to read and learn from his commentary for a long time ahead. The problem with his critique is that it revealed someone who read it with substantial academic blinders on.

Who Needs the Fed?, while very critical of the central bank, argues that market forces will end for us what Congress likely will not. A central bank mis-informed by countless absurd theories trying to influence the economy through a banking sector that is the living definition of yesterday's news cannot long last in any relevant way. This is all to the good.

The mistake among some Austrians is that they too, like those at the Fed, still think banks matter economically. They really don't. Neither does the Fed by extension. Unknown is whether Austrians will acknowledge what market signals (see Chapters 13 and 17) and their own research tell them. The latter is particularly useful if acknowledgement of reality forces them to shed ridiculous notions of "easy" and "excess" credit, central bank and banking driven business cycles, and the ability of vanilla deposit institutions to "multiply" money. One can hope. I certainly remain a fan of the legendary Austrian School.


John Tamny is editor of RealClearMarkets, Director of the Center for Economic Freedom at FreedomWorks, and a senior economic adviser to Toreador Research and Trading ( He's the author of Who Needs the Fed? (Encounter Books, 2016), along with Popular Economics (Regnery, 2015).  His next book, set for release in May of 2018, is titled The End of Work (Regnery).  It chronicles the exciting explosion of remunerative jobs that don't feel at all like work.  

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