The Federal Reserve recently announced new measures to tackle the current financial crisis. They include helping J.P. Morgan Chase acquire Bear Stearns, lowering the discount rate and offering short-term loans to about 20 investment banks-- and they came only days after the government said it would inject $200 billion into the financial system.
These are the latest steps taken by the U.S. government to solve a problem created in large measure by the government itself. We have seen this movie before.
As a reaction to the bursting of the dot-com and telecom bubbles at the end of the 1990s, the Fed inflated the currency through the actions of its Open Market Committee. By June 2003, the policy of easy money was reflected in the drop of the federal funds rate to 1 percent. The loose monetary policy was maintained, with variations, for almost five years. The result was a fiction economy in which millions of people borrowed and consumed too much. The fact that mortgage loans were turned into sophisticated securities traded internationally made the fiction global.
Vargas Llosa places the blame where it belongs - at the Fed:
The history of the boom-bust cycle since the creation of the Federal Reserve in 1913 has been the deliberate increase of the money supply, the misallocation of resources due to the perverse incentives of inflation, and eventually the bursting of the bubble. It is the consequence of the Federal Reserve system, a central bank that confers upon a chosen elite -- the Federal Reserve governors -- the monopoly of money creation and the power to decide what amount of money is appropriate for an economy in which millions of people are making decisions they cannot anticipate.
Vargas Llosa believes, as I do, that the answer is to abolish the Fed, but he acknowledges that is unlikely:
It is time to think more boldly. If abolishing the Federal Reserve is politically inconceivable right now, there are less dramatic measures that can be taken on the road toward a definitive solution. The most obvious one is to simply stop using the Federal Reserve to inflate the currency.
If a crisis in which at least $400 billion has already been lost and millions of people have been badly hurt is not enough to set minds thinking audaciously, nothing will.
Politicians will never advocate that the Federal Reserve be abolished. Through inflation the Federal Reserve allows profligate politicians to spend more, expand the role of government and accrue more power over their constituents. Ultimately, the system will collapse due to excessive debt as all fiat money systems have in the past. I don't think we are there yet, but that day will come. The response of government when that happens will not be one that enhances freedom.