The Fed's near-zero interest rate policy has punished savers without producing a strong recovery. Two bills in Congress would rein in the central bank.

 

By GEORGE MELLOAN

 

Two bills now before Congress make it clear that legislators are finally giving serious attention to a much-needed reform of the Federal Reserve System.

 

The most recent effort is the Sound Dollar Act (H.R. 4180) introduced in the House in March by Rep. Kevin Brady (R., Texas), vice chairman of the Joint Economic Committee. A companion bill was put before the Senate by Mike Lee (R., Utah). The Sound Dollar Act has far more hope of passage than the more radical H.R. 1098, introduced by Rep. Ron Paul (R., Texas) last year. H.R. 1098 would repeal the legal tender laws, end the Fed's monopoly on money creation, and allow the private production and use of gold and silver as specie.

 

The Sound Dollar Act, though more modest in its goals, would be a good start in reforming the way the U.S. dollar is created and managed. It would give the Fed a single mandate: to maintain price stability. The present dual mandate, which adds maintaining full employment as a requirement, never made any sense when it was enacted during the Carter administration in 1978. That has been amply demonstrated by the experience of the last three and a half years.

 

The Fed doesn't have the capability to maintain full employment and its efforts to do so have produced nothing but trouble. That mandate is the justification the Fed has cited for the near-zero interest rate policy it adopted in 2008 and promises to continue through 2014.

 

How has that worked out? We are suffering through one of the weakest recoveries on record. Unemployment remains above 8% and would be even higher were it not for the number of workers who have given up looking for a job. Meanwhile, the Fed's near-zero interest rate policy has reduced returns on the savings of individual investors and given managers of defined-benefit pension funds multibillion-dollar headaches as they struggle to earn enough on their portfolios to meet their obligations.

 

The Fed's policy clearly hasn't provided "full employment." What it does do is give the federal government cheap financing, currently only 2% on 10-year Treasurys, nearly one point less than inflation. It thus supports the current administration's profligacy, which has added $4.9 trillion to the national debt since it came to power. Federal debt has risen 72% since the Democrats took over Congress in 2007. That's why Rep. Barney Frank (D., Mass.) and other "progressives" in Congress have already mounted a tooth-and-nail campaign against Mr. Brady. They of course still insist that their main interest is "full employment."

 

Eliminating the dual mandate would be a good first step, but Mr. Brady doesn't stop there. His bill is also a move to partly depoliticize the Fed. It would give all 12 regional Federal Reserve bank presidents a permanent vote on the Federal Open Market Committee, which sets monetary policy. Currently only the New York Fed president has a permanent vote. There are only four other voting seats for presidents and they rotate among the other 11 regional banks.

 

The change would mean that the 12 presidents, who are appointed by boards of directors made up of local bankers and business leaders in their regions, would outnumber the seven governors, who are appointed by the president of the U.S. with the advice and consent of the Senate. In other words, the Federal Open Market Committee would become more responsive to the opinions and needs of the private sector and less to the political pressures applied by Congress and the White House.

 

This is a not a sure-fire fix. Private interests beg for easy money, too. But the regional presidents, by and large, have a better feel for what's happening in their home regions than the Fed governors sealed up in their Beltway cocoon. That's been demonstrated recently by the fact that it's been regional presidents who have been the only dissenters against Fed Chairman Ben Bernanke's determination to maintain the near-zero interest rate policy through 2014.

 

Mr. Brady's Sound Dollar Act would also end another pernicious step taken by the Fed after the 2008 crash: credit allocation. The Fed bailed out the banks and housing industry by mass purchases of the toxic mortgage-backed securities that were responsible for financial sector freeze-up. The Sound Dollar Act would limit the Fed to purchases of Treasury securities.

 

Decision makers would have to find ways other than credit allocation to clean up messes made by ill-considered government policies, such as the federally enforced subprime lending that poisoned the mortgage-backed security market in 2008. There were indeed other ways available in 2008, but Mr. Bernanke, New York Fed President Timothy Geithner (now Treasury secretary) and Treasury Secretary Henry Paulson chose the easy way out.

 

The Sound Dollar Act is full of good ideas, but it can't become law until next year and only then if there is a new president and a more favorable Congress. The dollar crisis may not wait. The Fed has become the lender of first resort to a financially irresponsible government. As the Fed creates new money to finance massive federal deficits, further price inflation is a sure bet. Congress is finally getting serious, but it's very late in the day.

 

The Wall Street Journal