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“Where he’s wrong is in his analysis of the benefits of a Fed. It is an incumbency protection racket. It works to protect banks from the free market effects of their bad moves and it protects them from a nefarious government which manipulates markets to benefit political cronies.”

More nonsense, of which you do have an impressive storehouse.

In the late 1800s/early 1900s JP Morgan used to act as America’s “central bank”, the lender of last resort to other banks. He wasn’t doing this out of his benevolence, he did it to prevent the banking system and the whole economy from cratering. A major collapse would damage his bank as well despite it being the largest in the country by a wide margin.

During bank runs otherwise perfectly solvent banks could be wiped out because they could not quickly convert their assets into the cash demanded by their panicked depositors. They needed a ‘banker’s bank’ to give them temporary loans so that they weren’t wiped out by a short term crisis.

A bank experiencing a run had to fire-sale its assets to get liquid, which had the effect of gutting the value of similar assets held by other banks. It set in motion a vicious, systemic spiral. Morgan had been lending money to other banks when he could in order to halt panics.

As America industrialized the monetary economy became a much larger factor than during the previous agrarian era. Morgan realized that no one bank was going to be able to continue to fulfill the role that he had been playing so after the Panic of 1907 he organized a national monetary commission, which has been a goldmine for conspiracy nuts ever since. Jekyll Island all that other stuff.

The monetary commission would recommend legislation that would give a legal basis to what Clearinghouse Associations had already been doing during panics to keep banks from being wrecked in a bank run. Clearinghouses had been issuing a sort of script in lieu of money when there was a sudden extreme demand for currency. This technically was counterfeiting, but since the script would extinguish when the run was over it was a gray area. Instead of dubious Clearinghouse script the Fed could extend credit to banks based on the Real Bills Doctrine or against Treasuries offered for loan.

Anyway this is/was the rationale for creating the Fed. It’s not the “incumbency protection racket” of some people’s vivid if ill-informed imagination. It replicated behavior that private banks were already doing, but it provided a structured legal basis and some government oversight- as originally constructed the Federal Reserve Board had two Treasury Dept members, although it has had none for many years.

There are legitimate criticisms to be made of the Fed but someone making the claim that everything worked just fine before the Fed is simply very ignorant of American monetary and banking history. Spending some time with Friedman and Schwartz’s ‘A Monetary History of the United States’, James Grants’ ‘Money of the Mind’, Chernow’s ‘House of Morgan’ could begin to dispel the cloud of darkness.

Anyway this is/was the rationale for creating the Fed.

And improving education was the rationale for the Dept. of Education, and preventing hunger was the rationale for creating Foodstamps, promoting home-ownership was the rationale for the CRA, Fannie and Freddie, and protecting Americans was the rationale for porno-scans at the airport and creation of DHS. What's your point exactly?

They are all just massive, failed, hugely corrupted institutions of the Progressive desire to herd the population, while insiders loot money through the back-door. And the FED is the first among all, because you can't run a Progressive-state without a fiat currency and politicized interest rates.

Pelham, ignoring the ad hominems, is again partly right. We do need a dynamic and effective credit market to support a growing economy, particularly one that is large and diverse.

Given what we know about human nature - emotional decision making, short-sightedness and naturally self-interested - America’s economic history proves we will at some point in time need a lender of last resort (LOLR). Prudence gives way to exuberance and your lovely tulip bulb really isn’t worth a king’s ransom.

Mackay’s book is a great read: http://www.amazon.com/Extraordinary-Popular-Delusions-Madness-Crowds/dp/1463740514/ref=sr_1_1?s=books&ie=UTF8&qid=1417006199&sr=1-1&keywords=extraordinary+popular+delusions+and+the+madness+of+crowds

Thematically, we as conservatives prefer a market based response because, as previously noted, men are not angels. The political model depends on a disinterested, apolitical, iron-willed, neutral party to do the right thing. What we have now in our Fed is the political model of a LOLR. Are there alternatives?

First, what is the goal or the model we want? Well before the creation of the Fed it was known what constraints a LOLR should operate under. 19th century ‘economists’ Henry Thornton and Walter Bagehot developed the well-proved classical theory of LOLR. It’s been supported strongly by modern research. The Bank of England followed the classical theory strictly and very effectively keeping the British Pound a solid and stable currency during the 19th century.

Here’s the main points of classical theory:

1) protect the money stock instead of saving individual institutions;

2) rescue solvent institutions only;

3) let insolvent institutions default;

4) charge penalty rates;

5) require good collateral;

6) pre-announce these conditions before a crisis so that the market knows exactly what to expect.

Found here: http://en.wikipedia.org/wiki/Lender_of_last_resort#Summary_of_the_classical_theory

Read the whole thing for a more complete background: http://en.wikipedia.org/wiki/Lender_of_last_resort

We want the above six points to be followed and obviously they’re not being followed. Moral hazard is rampant and it’s transferring further harm to the system. Is there a free-market response? I say, take a second look at a system of bank clearing houses with the above as a codified legal format in which they operate.

We know that the Congress via our Constitution coins money. Is the Fed the best way to do that or is there a better system?