Beating up on the Fed used to make you an oddball. Does it still?

Commentary about business and finance.
Nov. 9 2010 3:26 PM

Fed-Bashing Three Ways

Beating up on the Fed used to make you an oddball. Does it still?

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Even the bitterest Fed critics can occupy the second circle. For instance, Rick Santelli, the CNBC reporter often credited with inspiring the Tea Party, said in late October: "I'm not going to stand here and tell you I think the Fed ought to be disbanded. … I personally think this Fed's heart is in the right place, but they're out of control in terms of trying to accomplish what their noble purpose is."

Santelli's words are anathema to occupants of the third circle, who do not think the Fed's purpose is noble. Kevin Duffy, who co-manages a small hedge fund called the Bearing Fund, says that criticizing Fed policy, rather than the Fed itself, is "a bit like dismissing Stalin and Mao as well-intended but not the right men for the job." Duffy's camp wants to return to the gold standard in order to check the Fed's power to weaken the dollar—the scarcity of gold limits how much money the Fed can print—but even that is just a half step. Best of all, the third circle believes, would be to seriously curtail or abolish the Fed altogether.

The argument goes something like this: The very existence of the modern Fed creates artificial confidence that there's a government backstop to the banking system. Maybe that confidence has helped to make bank runs a relic of the past—but maybe the threat of a bank run wasn't such a bad thing, because it forced bankers to be disciplined. Jim Grant, the founder of Grant's Interest Rate Observer and a longtime Fed skeptic, titled a 1990 piece "Bring Back the Bank Run." (Grant puts himself in my third circle but notes that he is "not so much against the existence of the Fed as its nature," meaning that if Fed's role in the economy were tightly circumscribed, it wouldn't pose the same problems.)

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It's tempting to think of the members of the third circle as, well, oddballs. Certainly it seems pretty unlikely their aims will be realized. Not even the newly elected Tea Party candidates will necessarily back any major revamping of the Federal Reserve. When Ron Paul, the Republican congressman from Texas who is Rand's father and a hero to the third circle, was asked on CNBC on Nov. 8 whether his son was "Paul lite," he answered, "I think you have to wait and see how he's going to vote."

On the other hand, never underestimate the power of troubled economic times to make people rethink their beliefs. Paul also said that "a lot more people are looking at what we're talking about." In that same Bloomberg poll that found 60 percent of Tea Partiers favored reining in or abolishing the Fed, 45 percent of the general population favored the same thing. Murray Rothbard, the controversial libertarian economist who many consider the intellectual father of the anti-Fed movement, wrote in 1994 ("The Case Against the Fed") that if the Fed were to be abolished, then "the banks would, at last, be on their own, each bank responsible for its own actions. There would be no lender of last resort, no taxpayer bailout [italics mine]."

Hedge-fund manager Duffy lets his third-circle worldview inform his investment choices. And guess what? Between June 2002 and September 2010, his Bearing Fund returned 226.6 percent net of all fees, or 15.3 percent a year. That compares with a return of about 4 percent a year for the S&P 500, including dividends, over the same period. Maybe it's the rest of us who are the real oddballs.

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