Bronze-level article

Federal Reserve

From RationalWiki
(Redirected from Federal Reserve System)
Jump to navigation Jump to search
The Eccles building, the Fed's headquarters. (Fedquarters?) This is where the banksters plot to sell your children into debt slavery.
Some dare call it
Conspiracy
Icon conspiracy.svg
What THEY don't want
you to know!
Sheeple wakers

The Federal Reserve, often referred to as "the Fed," is the central bank of the United States, established in 1913 by the Federal Reserve Act. The Fed sets and implements monetary policy in the United States through various complex mechanisms broadly referred to as "open market operations," which generally involve selling or purchasing federal securities on the financial markets in order to achieve a desired outcome, such as moving the market short-term interest rate to a desired level. Actions taken by the Fed may also have the practical effect of changing the proportion of reserves that a bank must keep on hand to cover deposits, which in turn affects the money supply. Through the use of these various mechanisms, the Fed endeavors to manage inflation, avoid deflation (which can have disastrous consequences for an economy), and generally encourage moderate, stable economic growth that is minimally susceptible to a "boom/bust" cycle.

This is, of course, all extremely complicated, even for financial professionals. Worse, it's boring. Conspiracy theorists therefore offer a more exciting and easily digestible version of events, in which the Fed is a front for a shadowy cabal to fund wars and enforce the iron will of the Jewish banking conspiracy. Not only is this much more exciting, it can also be understood by watching a bunch of YouTube videos over the course of a weekend, as opposed to all of that boring crap that takes serious academic study to truly wrap your head around.

Oh, the irony! The chairman of the Federal Reserve Board for two decades (1986-2006) was Alan Greenspan, a former disciple of Ayn Rand.

Origins[edit]

From 1836, when the Second Bank of the United States lost its congressional charter, to 1913, when the Federal Reserve Act passed, the U.S. was without a central bank.[1] Major financial panics (and their accompanying recessions) occurred in 1873,[2] 1884, 1893, 1901, 1903, and the Panic of 1907Wikipedia led to a demand that Congress take action. The Aldrich Commission was dispatched to make a study and, shortly after its final report was made, Congress changed hands from the big-government Republicans[3] (those were the days) to the more grassroots-oriented and anti-federalist Democrats. Instead of one central bank located in New York as the Commission recommended, twelve regional banks were created throughout the country, with a Board of Governors, which is the bank's present form.[4]

What does it do?[edit]

2019 meeting of the Federal Reserve Board of Governors (your evil financial overlords).

The purpose of the Federal Reserve has evolved since its creation. When created, the Fed was a decentralized central bank and its primary tool for conducting monetary policy was the Discount Rate. Since WW2, it has gained more independence, become more centralized, and has developed a much clearer mission.[5] In the 21st century, its primary objectives are protecting the economy from inflation, ensuring financial stability, and keeping unemployment low. The Federal Reserve is responsible for controlling the amount of cash money in the United States and sets monetary policy while acting as a "banker's bank". In reality, a good deal of money creation occurs outside the Federal Reserve, and it can only indirectly influence the money creation process. While the Federal Reserve is often accused of "printing money", it can only create digital bank reserves. The Federal Reserve cannot actually create any physical currency. That process is undertaken by the Bureau of Engraving and the Bureau of the Mint.[6] The Fed's only major involvement is getting the physical currency into circulation. Additionally, the Federal Reserve System supervises and regulates some banks, offers banking services, and engages in economic research.

The Federal Reserve has 12 branch banks (Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco). They help move currency into circulation, conduct economic research, enforce regulations, hold deposits, and loan money to banks within their respective regions. This money is then lent at an interest rate to banks who then lend it to people and businesses.

Open Market Operations[edit]

The most commonly used mechanism to influence the economy, and most discussed in finance media, OMO are intended to influence inflation and interest rates. The Fed buys bonds[7] which speeds up the money creation process and induces inflation by putting more money into the economy. Buying bonds also increases their price because the price of bonds has an inverse relationship with their yields; this reduces interest rates.[note 1] Conversely, it can sell Treasury Bonds to take money out of the economy and slow down the money-creation process. The Fed, being less accommodative in supplying reserves (Federal Reserve Notes), makes it more costly to borrow. Previously, the money supply was effectively in the hands of various private companies and Wall Street movers and shakers (e.g. JP Morgan during the panic of 1907).

The Discount Rate[edit]

The 2nd tool is the Discount Rate. This is the rate of interest the Federal Reserve charges banks for the loans it gives out.[8] It was a much more potent and important means of conducting policy before the Monetary Accord Of 1951.

Reserve Requirement[edit]

Finally, there is the "Reserve Requirement". Banks of a certain size are required to keep a predetermined amount of their total deposits on hand at all times, usually about 10%. Smaller banks are exempt from this. Keeping the requirement low allows banks to lend more.[9] The Fed very rarely changes the Reserve Requirement.

Other tools and procedures[edit]

Federal reserve assets held
  US Treasury securities
  Mortgage-backed securities
  Other assets

Ever since the Great Recession, the Federal Reserve has also introduced a few new unconventional tools. The first new procedure is its Large Scale Asset Purchases, more commonly known as quantitative easing. During a recession, a central bank tends to ease up on monetary policy and reduce interest rates. When short-term interest rates are already at their lowest possible point, the economy is considered to be at the zero lower bound. For some, this means the central bank is "out of ammo" and that there are no other effective monetary solutions to combating an economic recession and stimulating growth. However, through LSAPs, a central bank gets involved in the creation of large amounts of base money and begins purchasing medium-term securities and toxic assets to influence medium or long-term interest rates.[10] The Federal Reserve controversially engaged in three rounds of this since the Great Recession.[11] In general, the program is thought to have worked.[12][13] Worth noting is that LSAPs aren't really "purchases" in that they don't increase GDP because they aren't a form of spending. Rather, they are a kind of asset swap where banks accept large amounts of base money in exchange for assets they already hold.

The second major change in monetary policy was that the Federal Reserve began to pay interest on reserves (IOR) banks held with it in 2008. This is a fairly major new development and is an important reason why QE did not cause large amounts of inflation. Dramatically increasing the amount of money in the economy should lead to inflation, but by paying interest on reserves, the Federal Reserve gives banks an incentive to not instantly start loaning out all the new money they've received and directly injecting it into the economy. Increasing the money supply can calm panic in the banking world while keeping IORs high ensures banks lend more carefully. Theoretically, if the United States were to experience deflation, the Fed could charge a penalty rate on IORs and encourage banks to pull their monetary reserves out of the Federal Reserve System and start lending.

Maiden Lane, AIG, and aid to central banks[edit]

During the banking crisis of 2008, the answer to "What does it do?" became "buy loads of toxic assets from failing banks." The Fed created a number of dummy corporations (sorry, "special purpose vehicles") called Maiden Lane I, II, and III to buy up crap from Wall Street and government-sponsored entities Fannie and Freddie. Some question the legality of the Fed's actions;[14] however, the Federal Reserve Act of 1913—Section 13(3) gives it authority "under unusual and exigent circumstances" to extend credit to individuals, partnerships, and corporations.[15] A subsequent, full audit of the Fed revealed numerous alleged conflicts of interest in the deals.[16]

After drastically increasing the size of its balance sheet, in what became nicknamed the "backdoor bailout," the Fed was able to provide $3.3 trillion in liquidity and a peak of over $9 trillion in short-term loans and assistance to Wall Street firms and foreign central banks over several years. Total commitments were over $29 trillion,[17] an amazing feat considering the GDP of Earth is estimated at $70 trillion.[18]

Common arguments against the Fed[edit]

There are many criticisms of the Fed, varying in levels of coherence. Some criticism arises from a conspiratorial worldview that falsely attributes malicious motives to the Fed instead of incompetence or bad luck. The American monetary system is difficult to understand, even for someone in the financial industry and/or someone with an advanced degree. In fact, many principles that people were taught in schools before the 2008 crisis were turned on their heads (e.g., big bank debt was risk-free). The 2008 crisis and subsequent growing income inequality have furthered a greater distrust of the Federal Reserve.

Conspiracy theories[edit]

You heard it here, first, folks. Woodrow Wilson sunk the Titanic!

The Fed has been a frequent subject of conspiracy theories alleging the Fed deliberately creates inflation, recessions, and even the Great Depression, through manipulation of the money supply.[19] Father Coughlin, the John Birch Society, Liberty Lobby, Eustace Mullins, Pat Robertson, Alex Jones, Texe Marrs and several others have frequently expressed such conspiracy theories. Many of the popular claims made today are recycled from G. Edward Griffin's The Creature from Jekyll Island.[20][21] In some (but not all) cases, these conspiracy theories have an anti-Semitic component, alleging "Jews" secretly or openly control the Fed. These theories are, furthermore, sometimes tied into other conspiracy theories about the Trilateral Commission or the New World Order, or manipulation of the U.S. economy by the Rockefeller and Rothschild banking families.[22]

It seems like one of America's nutjob dominionists True Scholars of the Faith™ has come up with a new completely insane theory in 2011 about the Federal Reserve, borrowing some points from Lyndon LaRouche. Apparently, the Federal Reserve is now a foreign banking institution controlled by the British, and Britain is now firmly in control of (who else?) the Rothschild family. Through their control of the Federal Reserve, they are making the national debt increase (apparently the Federal Reserve controls fiscal policy) to the point where they can take their former colony back (apparently being indebted means England wins you). Only the Constitution Parteh can save you now![23]

Ownership[edit]

Because the regional Federal Reserve Banks are privately owned, and most of their directors are chosen by their stockholders, it is common to hear assertions that control of the Fed is in the hands of an elite. In particular, it has been rumored that control is in the hands of a very few people holding "class A stock" in the Fed... Individuals do not own stock in Federal Reserve Banks. The stock is held only by banks who are members of the system.... This stock, furthermore, does not carry with it the normal rights and privileges of ownership. Most significantly, member banks, in voting for the directors of the Federal Reserve Banks of which they are a member, do not get voting rights in proportion to the stock they hold. Instead, each member bank regardless of size gets one vote. Concentration of ownership of Federal Reserve Bank stock, therefore, is irrelevant to the issue of control of the system.
—G. Thomas Woodward, Congressional Research Service, 1996.[24]

There is also the misconception that the Fed is independent or private, sometimes called "no more federal than FedEx." This is not entirely true as it is a quasi-public entity. The Fed, like most central banks in the world, is considered "independent," which is basically a term of art meaning that its day-to-day operations are not overseen by the federal government; it's similar to how state broadcasters (say, the BBC) are protected from becoming propaganda outlets. However, its chairman and board of governors are appointed by the president subject to 2/3 Senate approval, with regular 30-day reporting and Congressional oversight,[25] and its mission of maintaining price levels and full employment is determined by Congress.[26]

The extent to which banks "control" the Federal Reserve is that they technically "own" it, but not in the way that shareholders own Microsoft. Since the Federal Reserve was created by Congressional charter, they are not organized like a normal corporation. Shareholder banks have no voting power, and all decisions are made by the aforementioned government-appointed policy wonks. Shareholder banks elect 6 out of the 9 members of each regional Federal Reserve Bank's directors, but these regional directors have no power over monetary policy; that power lies solely in the hands of the central Board of Governors.

However, the Board of Governors are appointed by lists that are given to the President by the staffs of banking committees of Congress and private sources. The most powerful of these groups are the financial institutions (which includes prominent members of the Fed itself) and the media corporations over which they have control. Thus, the appointment of these members is highly susceptible to political interests. The President does not select these people from his own personal address book nor does he ask the public to submit nominations.

Trouble with accounting identities[edit]

Yes, this is real, and TV Guide has an amusingly blunt description of it.[27]

Some monetary conspirators claim that the Fed creates money out of nothing and lends money to the government at interest, thereby stealing "the people's" money and selling us into debt slavery or some similar nefarious scheme to take over the US government. The way this works, however, is not quite the same as your regular commercial bank. The interest on debt held by the Fed actually goes to two places: one, the Fed pays itself out of this interest to cover its own operating costs, and two, the rest of the interest is rebated to the Treasury.[28] However, the Fed's version of dividends, paid out to its shareholder banks, are included in its "operating costs". So these shareholder banks do, in fact, skim money from this privileged arrangement.

Typically, Congress authorizes the U.S. Treasury to issue debt obligations, usually 90-day T-bills or longer-term bonds, to cover its operating deficit. The Federal Reserve then purchases these obligations out of its reserve account with Federal Reserve Notes, aka U.S. currency.

Pseudolaw[edit]

This usually ties into the above point. The basic idea is that the Constitution gives Congress the power to coin money, so the Fed is unconstitutional because it is not the Congress. This is a pseudolegal argument because the Congress may delegate its powers. This is similar to pseudolegal arguments made by gold bugs.[29] It also raises the question that if they were right, then do all 535 members of Congress (or 541, counting the non-voting delegates) have to personally make the coins and bills?

Congressional involvement[edit]

Sometimes a big deal is made of the fact the law bringing the Fed into existence was passed December 23, 1913, implying that most of the Congress was away for Christmas. The reality is quite different -- the House passed the law 298-60, with 76 not voting but with 34 announced pairs, while the Senate passed it 43-25, with 27 not voting but with 12 announced pairs.[30] For those not aware, an announced pair is where a member of the House or Senate who will be absent arranges with another member who who will be present and is on the opposite side of the issue to form a “pair” with the absent member, thus allowing the absent member to have recorded how he would have voted had he been present.[31] This means that at best only 42 more House members and 15 more Senate members could have said no to the creation of the Fed.

Although the vote would have passed even had everyone been present, some whale.to denizens claim that legislating on one of the last days of the session circumvented the possibility of challenges and debate.[32][33] Why Congress would meet on days it thought off-limits when the two houses could, each with the consent of the other, choose to adjourn is beyond them.[34]

Austrian school and free banking proponents[edit]

Much of the opposition to the Fed in non-conspiratorial circles (though there is some overlap) comes from the Austrian school, who are free-banking proponents and generally draw on Ludwig von Mises' arguments against central banking. Ron Paul is particularly known for his multi-decadal anti-Fed crusade in Congress. In short, they claim that the Fed creates the business cycle through the expansion of the money supply which leads to "market distortion" and "malinvestment" due to easy money.

Ignoring lessons from the US Free Banking Era (1837 to 1864)[edit]

A privately-issued banknote from 1863. (Surely reviving this practice wouldn't cause any problems).

The biggest flaw with the free-banking proponents is they either are ignorant or ignore the many problems seen in the Free Banking Era of the US.

The first problem was that during this era, banks issued banknotes based on the gold and silver in their vaults, effectively printing money. Since these banknotes could only be redeemed at face value at the bank that issued them, the result was the actual value of the note decreasing the further from the bank it got. Then there was the issue that if the bank failed, these banknotes became worthless. This made any form of long-distance commerce difficult, if not impossible.

The second problem was since the laws were set up by the individual states, there was no consistency with regard to reserve requirements, interest rates for loans and deposits, capital ratios, or anything else. Worse, enforcement of what laws there were was highly variable within a state. This resulted in some states what was later called "wildcat banking," where the banknotes were not backed by precious metals at all but by mortgages or bonds.[35] In other words, the exact same problems as are claimed regarding the Fed but with even less oversight.

Ignoring the original Great Depression (1873–79 or 96)[edit]

Before the Crash of 1929, the term "Great Depression" referred to the period of 1873–96 which was marked by deflation (largely because the US shifted from a bimetallic standard to a de facto gold standard in 1873) and the rapid industrialization of the country. The term Gilded Age is also applied to this period and sometimes in a pejorative manner -- a shiny golden cover hiding a rotting or rotted core. The deflation that marked this period is why some wanted to return to a bimetallic standard, as hammered home in William Jennings Bryan's Cross of Gold speech in 1896. Even the shorter range of 1873–79 stated by the NBER is longer than the 1930's Great Depression by 22 months. This era is now called "the Long Depression"; the lesson it gives us is that switching over from a bimetallic standard to a gold standard (which the Coinage Act of 1873 effectively did) triggers deflation for extended periods of time.

After the establishment of the Fed[edit]

The US only saw three major banking crises after the establishment of the Fed (Great Depression, S&L crisis, 2008 financial crisis) and only two since the creation of federal deposit insurance, compared to one about every decade prior to that.[36] The business cycle had also seen shorter and smaller contractions.

Essentially, what this demonstrates is that the minority of libertarians[37] and Austrian schoolers who believe in free banking, like Ron Paul, seem to love the idea of going back to the 19th century and having us all stuff gold bricks under our mattresses every time it looks like there's going to be a run on the bank.

Congressional criticism[edit]

Louis Thomas McFadden, a former United States Congressman and a former Chairman of the United States Banking and Currency Committee who believed that Jewish bankers were plotting with others against the United States, testified before Congress in 1934 outlining his criticism of the Fed. He also submitted a petition for articles of impeachment against the Board of Governors of the Federal Reserve Banking System for numerous criminal acts including conspiracy, fraud, unlawful conversion, and treason.[38] These charges went exactly nowhere.

Ron and Rand Paul have been trying to shove legislation requiring an audit of the Fed and a review of its monetary policy (apparently independence from the political bickering on the Hill is a bad thing, after all) through Congress since 2011. Although three versions of this legislation have passed the House, they all failed miserably in the Senate. The 2015 version was a fail, with Bernie Sanders even voting on it.

See also[edit]

External links[edit]

Notes[edit]

  1. Bonds are always issued with a fixed interest rate. If new bonds are being issued with a higher interest rates, the only way for current bond holders to remain competitive if they want to sell is to change the selling price of their bonds. If you bought a $100 bond that yields 3%, but most new bonds are being issued at 5% you can't change the interest paid on the bond, you can only sell it for $60 so that it earns a similar rate of interest.

References[edit]

  1. Roughly corresponding to the Gilded Age so beloved among certain libertarians.
  2. The Panic of 1873Wikipedia spawned the 1873-'79 Long DepressionWikipedia
  3. Essentially the progressive Republicans who were the heirs to the Radical Republicans and the predecessors of the Rockefeller Republicans; Theodore Roosevelt-types.
  4. The Balance of Power: The Political Fight for an Independent Central Bank, Kansas City Federal Reserve Publications, 2012, pp. 21-29
  5. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1540-6261.1952.tb02484.x
  6. https://www.newyorkfed.org/aboutthefed/fedpoint/fed01.html
  7. The Federal Reserve buys Treasury Notes and Bonds on the open market by issuing Federal Reserve Notes aka. an "accommodative stance." Milton Friedman describes Federal Reserve Notes as "receipts for taxes paid."
  8. https://www.federalreserve.gov/monetarypolicy/discountrate.htm
  9. http://www.auburn.edu/~johnspm/gloss/reserve_requirement
  10. https://www.hoover.org/research/reviving-japan
  11. https://www.marketwatch.com/story/fed-ends-qe3-and-sends-upbeat-signals-on-economy-2014-10-29
  12. Gagnon, Joseph, et al. "Large-scale asset purchases by the Federal Reserve: did they work?" (2010).
  13. Gilchrist, Simon, and Egon Zakrajšek. "The Impact of the Federal Reserve's Large‐Scale Asset Purchase Programs on Corporate Credit Risk". Journal of Money, Credit and Banking 45.s2 (2013): 29–57.
  14. Chad Emerson. The Illegal Actions of the Federal Reserve: An Analysis of How the Nation's Central Bank Has Acted Outside the Law in Responding to the Current Financial Crisis. William & Mary Business Law Review, vol. 1, iss. 1
  15. Read it
  16. Federal Reserve Audit Highlights Potential Conflicts of Interest, Washington Post
  17. $29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient, James Felkerson, University of Missouri–Kansas City, December 2011.
  18. World Bank. [1]
  19. Actually, it does do these things, but not quite in the way conspiracy theorists mean. The Fed sets a "target rate" of inflation through open market operations to set interest rates. The Fed does not have all-powerful control over inflation (or deflation) as conspiracists allege; its operations are merely one factor influencing the value of currency. Similarly, in an attempt to head off excess inflation, the Fed may overreact, tighten up too much and induce unemployment, possibly creating a recession (again, this is due to the fact that the Fed cannot perfectly micromanage the economy, not that it's deliberately causing these problems).
  20. The Creature from Jekyll Island by G. Edward Griffin
  21. G. Edward Griffin and the Fed: Is Glenn Beck about to do another swan dive into the deep end of conspiracism?, Dave Neiwert, Crooks and Liars
  22. Jewish "Control" of the Federal Reserve: A Classic Anti-Semitic Myth, Anti-Defamation League
  23. The Scion of Zion! (you may need to scroll down a bit)
  24. "Money and the Federal Reserve System: Myth and Reality". Report No. 96–672 E. Congressional Research Service, Library of Congress. July 31, 1996.
  25. Federal Reserve Bank Ownership, FactCheck
  26. The Fed's dual mandate dates to a 1946 act, Washington Post.
  27. Conspiracy: The Secret History - Masters of the Universe, The Secret Birth of the Federal Reserve - Full Cast & Crew. TV Guide.
  28. Myth #8
  29. The Importance of the Federal Reserve, Joint Economic Committee Report, Mar. 1997
  30. The Federal Reserve Act of 1913 - A Legislative History, Law Librarians' Society of Washington, D.C.
  31. Pairing in Congressional Voting: The House and Voting and Quorum Procedures in the Senate, CRS Report for Congress
  32. http://www.whale.to/b/m_ch_3.html
  33. http://query.nytimes.com/mem/archive-free/pdf?res=9802EFD6103FE633A25751C2A9649D946296D6CF How it actually went down
  34. http://www.llsdc.org/assets/FRAdocs/fra-lh_v51-cr-1487-1488-sen.pdf For bonus points, some of the actual "circumvented" debate.
  35. Investopedia definition
  36. See the Wikipedia article on List of banking crises.
  37. Even Friedman didn't want to get rid of the Fed. He actually proposed replacing it with a computer that would just spit out money as economic growth occurred.
  38. http://home.hiwaay.net/~becraft/mcfadden.html