In his new book Who Needs the Fed?, John Tamny makes a convincing case that the Federal Reserve is wholly unnecessary.

Chapter after chapter, he offers examples of individuals engaging in credit transactions and explains how any government manipulation of these transactions is counterproductive or, at best, unnecessary.

From sports to Silicon Valley and Hollywood to Taylor Swift, Tamny reveals the importance of allocating resources to profitable uses. He argues that only individuals interacting in unhampered markets can perform such a task, and he calls upon Ludwig von Mises and Henry Hazlitt throughout the book to make this case.

Tamny is a fierce defender of free markets and he is as radical as Rothbard when it comes to taxation. I especially enjoyed his teardown of the supply-siders’ push to decrease marginal tax rates to increase total tax revenue.

The book has already received many good reviews, so I will take this opportunity to address some of the explicitly anti-Austrian points in his book. My critical remarks will take up the bulk of my review, but the space they occupy should not be considered proportional to my opinion of the book as a whole. Tamny is a great fellow-traveler of the Austrian school, and he certainly holds Mises and Hazlitt in high regard.

Tamny’s Definition of Credit

Money, banking, central banking, and monetary policy can be daunting to some. Tamny attempts to simplify these concepts down to their fundamentals, and, like a good teacher, he repeats his simple definitions enough for them to stick in the reader’s mind. Toward the end of the book, the reader can almost finish Tamny’s chapters for him, given an introductory prompt.

Sometimes, however, the definitions are too simple and they lose their ability to be used in meaningful economic analysis. Tamny holds an unworkable definition of “credit.” Starting in chapter 1 and maintained throughout, “credit” is always and only “real resources.” His justification is that borrowers do not borrow dollars to just “marvel at their crispness,” but to command real goods and services, even though the same could be said about money wages, money prices, or any sort of money income. He proceeds to use the term “credit” only in ways that are synonymous with “real resources,” which works without error some of the time, but not always.

The definition (credit = real resources) is a bad one because it doesn’t really get at the nature of what we know as credit or how it is meaningfully distinct from other market phenomena. Obviously, definitions are important in economics, and the evidence for this comes when Tamny’s economic analysis breaks down.

To be clear, a credit transaction involves the exchange of a present good for a future good. The goods do not have to be money and they do not have to be the same, but there must be a temporal separation. When present money is exchanged for future money, obviously the borrower and the lender are not ultimately considering the crispness or joy of having money, but what they can purchase with the money on the market. This, however, does not change the fact that money is what is exchanged.

Both real saving and artificial credit expansion increase the supply of present loanable funds and decrease interest rates. Both have real consequences on production and consumption throughout the economy. Tamny’s definition of credit prevents him from seeing this.

Is the Fed Just a Price-Controlling Bureaucracy?

The major problems come when he says that the Federal Reserve cannot expand credit. If “credit” is “real resources,” obviously Federal Reserve policy cannot increase the amount of real resources in the economy. In Tamny’s case, it leads him to the unfortunate conclusion that “the Fed can’t change the on-the-ground economic reality.” Not only does this snuff his otherwise fiery rhetorical message (why must we abolish an innocuous institution?), but it is also misleading, as anyone who is familiar with Austrian business cycle theory (ABCT) can attest.

In Tamny’s view, the Fed is just a large price-controlling bureaucracy that individuals will sidestep to the best of their ability. Their interest rate setting policies are similar to New Deal price controls in their economic consequences.

Tamny obviously cannot avoid naming the Austrian economists while making these claims. He accuses them of believing the Keynesian line that the government can create prosperity with expansionary monetary policy. He laments that this great school of thought in economics gets this one thing wrong. I’m happy to give him the good news: the Austrian economists he reveres so much are right about money, banking, and business cycles. Here’s why.

The Effects of Expansionary Monetary Policy

Expansionary monetary policy has deeper and broader effects than simple price controls. The Fed does not just decree a new, lower interbank loan rate. It floods loan markets with newly created money. Banks borrow the new money at very amenable rates and then use it to pyramid new loans to businesses and consumers. This is a stated goal of expansionary monetary policy — the Fed aims to “stimulate” spending throughout the economy.

To the extent that businesses take the new money, their demands for factors of production increase, especially for new, longer production processes. Note that the Fed does not magically create new factors of production, but only works to increase demand for the present supply of factors. Therefore, the prices of these factors increase significantly, especially in capital goods industries.

Consumption increases concomitantly. Nominal incomes rise as the new money reaches consumers, spurring increased consumption. Thus there is an overall spree for the use of the economy’s present real resources, and nominal prices and wages rise accordingly due to the inflation. Everything feels great, but it cannot last.

The new lines of production undertaken because of the monetary expansion cannot be completed because the real capital required to do so simply does not exist. In fact, the amount of real resources in the economy has diminished through the consumption binge caused by false profits and rising asset prices. The increasing scarcity of capital drives up production costs and anticipated profits turn into realized losses. The structure of production, far from being bolstered, has been ravaged and neglected. The boom must then turn to bust as firms take losses and attempt to liquidate the malinvested capital and lay off workers. Wages and prices decline from their previous highs.

Tamny Misrepresents then Accepts ABCT (Accidentally)

This is far from Tamny’s representation of the Austrian position, yet after a tirade against the Austrians, he accidentally describes the gist of ABCT in passing:

While the Keynesians are up front about their belief that governments can expand the economic pie through excess spending, Austrians increasingly argue that governments can do something similar, through the issuance of “excess” credit. Quite simply, they can’t. Just as governments can spend only what they’ve taken from us first, similarly they can issue credit — meaning real resources — only that they’ve taken from us first. Whether it is by the government or the Fed, any attempt to boost credit amounts to its shrinkage, thanks to its mis-allocation, not its expansion. And it’s anti economic growth, not the source of booms, as some Austrians think. [Italics his, bold mine]

The bolded sentence is an inadvertent admission of the truth of ABCT. Austrians do not claim that the Fed creates sustainable booms or new real resources, but the opposite: unsustainable booms through the consumption and malinvestment of real resources. The expansion of credit (nominal) appears to be an increase in real savings, but it is all illusory. The temporary boom it engenders is not “economic growth” as Tamny mischaracterizes, but its opposite: economic decline and wealth destruction.

The Austrian account of the business cycle is coherent because it allows for a dissociation between real and nominal terms, which Tamny does not consider in his book, despite how essential this is not just for business cycle theory, but economics in general. Because of his strange definition of credit, he struggles to explain what exactly the Federal Reserve does when it engages in expansionary monetary policy. And he seems very confused when he claims that Austrian economists believe the Fed can encourage economic growth via expansionary monetary policy, when Austrians quite notoriously argue the opposite.

Fractional-Reserve Banking and the Money Multiplier

Another area of confusion involves his explanation and defense of fractional-reserve banking. Here again he explicitly challenges Austrian economists for getting it wrong:

Perhaps surprising is that members of the free-market Austrian school are the biggest critics of banks lending out the majority of deposits they take in. As the late Murray Rothbard, a true-blue Austrian, long ago put it, “Fractional reserve banks … create money out of thin air. Essentially they do it in the same way as counterfeiters.”

He offers an example to demonstrate how there is no such thing as a money multiplier:

To develop a better understanding of why this is much ado about nothing, sit at a table with four friends. Ask one of them to bring $100. Have this person lend $90 to his table neighbor, who then lends $81 to his neighbor, who lends $72.90 to his neighbor. What you’ll soon discover is that there’s still $100 sitting at the table after all the frenzied lending.

Indeed. Unfortunately, his example has nothing to do with fractional-reserve banking. What the friends are doing around the table are simple loan transactions. There are no deposits, no money substitutes, no fiduciary media, and no reserves. Just loans. Rothbard even included a similar example in his book, The Case Against the Fed, only to show that “The important point here is that money, whether it be gold or other standard forms of cash, has in no way increased.”

What happens in deposit banking is very different. Consider a deposit bank that has always kept 100% reserves. They function merely as a money warehouse. People deposit various amounts of money, which the bank safeguards and keeps in their vault. Upon any deposit, the bank issues tickets or receipts which may be brought in to redeem the money represented by the tickets. There is always a 1:1 ratio of money deposited to tickets. The tickets may then be used like the money they represent out and about in the economy, to the extent that others will accept them in exchange because they trust the bank that promises their redemption at par on demand.

Rothbard explained the switch from 100% to fractional-reserve banking this way:

For at this point, the deposit banker may think to himself: “For decades, this bank has built up a brand name for honesty and for redeeming its receipts. By this time, only a small portion of my receipts are redeemed at all. People make money payments to each other in the market, but they exchange these warehouse receipts to money as if they were money (be it gold or government paper) itself. They hardly bother to redeem the receipts. Since my customers are such suckers, I can now engage in profitable hanky-panky and none will be the wiser.”

[…] In short, the banker counterfeits warehouse receipts to money, and lends them out. In that way, insofar as the counterfeiter is neither detected nor challenged to redeem in actual cash, the new fake receipts will, like the old genuine ones, circulate on the market as if they were money. Functioning as money, or money-surrogates, they will thereby add to the stock of money in the society, inflate prices, and bring about a redistribution of wealth and income from the late to the early receivers of the new “money.”

While this scenario is simple to understand, it is a bit more complex than Tamny’s example of the friends sitting around the table. To get closer to the real modern fractional-reserve banking system, the friends would have to issue new pieces of paper that represent the dollars deposited each time the dollars or new paper tickets trade hands. After a few steps, the friends could add up all of the original dollars and all of the pieces of paper that represent money substitutes to see the growth in the money supply.

Tamny Advocates for a 0% Reserve Requirement

This misunderstanding has led Tamny to advocate a 0% reserve requirement, which legally allows banks to inflate without any mathematical upper limit on money supply growth. According to Tamny, “Banks shouldn’t face any reserve requirements because well run banks don’t need them.” With 0% reserves, Taylor’s $100 deposit is Travis’s $100 loan, which is Rosie’s $100 loan, and so on ad infinitum.

While this doesn’t happen in practice in countries where there is no minimum reserve requirement, what it insures is that banks will inflate via fractional-reserve lending to the greatest extent possible. And since the new fiduciary media is lent into existence, it triggers a business cycle as outlined above.

Tamny asserts that we can trust banks to limit themselves because an irresponsible bank would be eliminated from the market (including the total loss of all the depositors’ money) or would be able to borrow from other banks to meet depositors’ redemption demands. This sort of “correction” mechanism, however, is beside the point. It actually paves the way for banks to cartelize and form central banks, as will be shown below.

He is totally confused regarding the fundamental difference between a deposit and a loan and he is asking for monetary and financial chaos, not soundness or stability. In Tamny’s ideal world, there would be no such thing as a real deposit at a bank, just loans to financial intermediaries (who fancy themselves “banks”) with no guarantee, no collateral, and no insurance.

Fractional-Reserve Banking and Central Banking are Best Friends

Of course, inflation is just one of many consequences of fractional-reserve banking. Notice that the entire system is very fragile. Each bank cannot redeem everybody’s deposits on demand. In a 10% reserve scenario, the holders of the tickets (including depositors, those who have accepted the tickets in exchange, and other banks) need only request one cent more than 10% of their deposits to shut down the bank.

In practice, such an event triggers a larger bank run and the money supply collapses as a result. Modern banks have therefore cartelized and collude through, you guessed it, central banks like the Federal Reserve to ensure no one bank inflates significantly beyond the others and to guarantee that other banks will accept their receipts and will not try to redeem the fake receipts at the other banks. Of course, this doesn’t mitigate the problems of fractional-reserve banking — it perpetuates and institutionalizes the problems instead.

Therefore, Tamny’s rhetorical message is arrested once again. 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 while the money supply takes a rollercoaster ride. With the Fed, the money supply makes a steady climb, causing relentless inflation and business cycles. Tamny, who argues that money should be a stable measure of value (another source of disagreement with Austrians), therefore cannot reconcile many of the points he makes in his book.


My recommendation is for Tamny to take a closer look at his heroes, Ludwig von Mises and Henry Hazlitt, especially regarding money, inflation, and business cycles. He should also give Rothbard and modern Austrians a second chance, for they have only clarified and expanded Mises’s seminal and brilliant contributions. Tamny would strengthen his rhetorical message and resolve his inconsistencies in so doing. The outcome would be an even clearer and more powerful demolition of the central bank we all know and loathe.


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