IN ONE of Washington's long-running charades, the supposedly independent Federal Reserve is always cast as the chaste virgin, untouched by fawning politicos.
In reality it is as pure as the driven slush.
In hopes of igniting the economy the Fed, under White House and congressional prodding, has pushed the discount rate -- the interest rate the Fed charges commercial banks for short-term loans -- to a 29-year low.
This raises embarrassing questions about Fed independence. Has it again become a victim of political indiscretion, operating as a branch of a president's re-election campaign?
Indeed, in a Wall Street Journal interview published last week, Secretary of the Treasury Nicholas Brady lent credence to that view when he said he would support legislation that would heighten Congress's role in Fed decision-making -- and thus further politicize the Fed.
We shouldn't be surprised. Our central bank, which determines the money supply, is a government monopoly. It is impossible to remove politics from anything the government owns, manages or regulates.
Thus, the Fed has been subject to political manipulation since its inception in 1914.
During World War I the Treasury, to reduce the cost of financing the war, got the Fed to keep interest rates low.
The result was an explosion in the money supply and the worst inflation since the Civil War followed by a severe postwar depression.
That was the first of many boom-and-bust cycles America has suffered as a result of politically motivated Fed policies.
In 1971 America threw off the last vestiges of the gold standard, which limited the Fed's policy-making latitude; that freed the Fed to pursue a more activist monetary policy -- to manipulate the money supply in order to fine-tune the economy.
Since then the Fed has become more prone to bending to the political winds.
Not surprisingly, America has gone through two major real-estate booms (1971-1973 and 1982-1989) followed by busts (1974 and 1991-1992), the most rapid inflation of commodity prices in a century (1976-1980), the worst deflation of commodity prices (1980-1982) since 1919 and swings in stock-market prices reminiscent of those of the 1920s and 1930s.
Other countries have experienced similar whipsawing of their economies, largely attributable to central banks' manipulation of the money supply: Europe's stagflation of the 1970s, the Japanese stock-market bubble of the 1980s and its rupture in this decade.
Isn't there a more satisfactory means of determining the money supply?
The former Fed chairman, Paul A. Volcker, said in a 1990 speech that central banks were "not the cutting edge of a market economy," that central bankers "were Johnny-come-latelies," that "central banking is almost entirely a phenomenon of the 20th century" and that, when established, "central banks were looked upon and created as a means of financing the government" (usually to fight wars).
What should we do?
In his 1976 book "Denationalization of Money," Friedrich A. Hayek, a Nobelist in economics, said government monopolies are by nature politicized and produce shoddy goods at high cost, and that money produced by central banks is no different.
To improve the quality of money -- preserve its purchasing power -- he said central banks should be privatized and private suppliers of currency such as commercial and investment banks and travelers-check issuers should be allowed to compete with one another freely.
Before 1914, dollars were issued by banks. Under a return to such a private, market-driven competing-currency system, the purchasing power of money would improve as sound dollars drove out less sound ones.
Countries with such systems -- Scotland from 1716 to 1845, Canada from 1817 to 1934 -- had impressive records of restraining inflation and thus preserving high-quality currency.
Countries least burdened by unnecessary government regulations experienced few bank failures and were immune to peacetime panics.
Those more heavily regulated -- America from 1782 to 1914 -- experienced more difficulties, but their records still compare favorably with today's central banking systems.
Now that government monopolies in telecommunications, postal service, railroads and so on are being privatized and made competitive worldwide, it is time to abolish the Fed.
Steve H. Hanke is professor of applied economics at Johns Hopkins University.