Tuesday, February 12, 2008

The Federal Reserve


By Richard E. Noble

The Federal Reserve was started in 1913 during the Wilson administration, after the Panic of 1907. The Panic of 1907 was the most devastating money crisis up until that time in U.S. history. Congress created, The National Monetary Commission, under the chairmanship of Senator Nelson W. Aldrich to investigate this disaster. Senator Aldrich was a very wealthy and powerful man. His son-in-law was John D. Rockefeller Jr. and Aldrich was a business associate of J. P. Morgan. The Aldrich Commission supposedly investigated the causes of the Panic of 1907 and associated bank failures and made recommendations to President Wilson which were used as the basis for the Federal Reserve Act of 1913.
The Federal Reserve would be an independent, central, banking system with the financial backing of the Federal Government. The Federal Reserve System would serve to organize the banking industry and provide security to depositors. It would be the bank of “last resort”. It would initiate monetary policy by controlling interest rates and money supply. It would loan money to member banks and to the Federal Government. It would provide for itself by charging interest for monies loaned to the member banks and to the Federal Government.
One controversy over this institution is with where or how does it get the money it loans? One might think that the Federal Reserve gets its money from the Federal Government. In which case, the Federal Reserve would be borrowing from the Federal Government and the U.S. Government would then be charging them interest. That is not the case. Instead the Federal Government borrows from the Federal Reserve and the Government pays the Federal Reserve interest for that service.
Instead of borrowing money from strangers, why doesn’t the Federal Government just print up its own money when it needs it?
Well, it seems that this is supposedly against the Constitution. The Federal Government, under the Constitution, is not granted the right to print up “paper” money. The Federal Government is allowed to coin money out of metal but not to print it out of paper. It seems that our forefathers had a good deal of trouble with paper bank notes before the revolution and then there was the Continental during the Revolution. As a result they decided to withhold that privilege from the Federal Government. That did not mean that independent banks could not print up paper notes.
Originally, individuals put their gold coins in vaults/banks and received a receipt. These paper receipts were then used as money. Why not? They were as good as the gold and silver coins that backed them. So it thus came about that bankers could print notes and thus manufacture paper money. Now the forefathers, in all their wisdom, did not say in their Constitution that the Federal Government could not “borrow” paper money. They said that the Federal Government could not “print” it. So there you go. The Federal Government is not allowed to print paper money but it is allowed to borrow paper money.
So then, why in the world would the Federal Government want to borrow paper money? Well, let’s say an emergency pops up, like World War II, or some such thing as that. The Federal Government needs a bunch of money quick. They could just raise taxes, but that takes time and annoys people – especially taxpayers. Instead they just go to the Federal Reserve and borrow a bunch.
But where does the Federal Reserve get all of its money? One might think that a bunch of rich bankers got together and put all of their money into the Federal Reserve Banking System and then they loan this money to the Federal Government. Not so. It is true that a bunch of rich bankers did get together, but it is not their money that they are loaning out. It’s the Treasury department’s money. But, you ask, I thought the Federal Government couldn’t print up any paper money? Well, it’s printing up the paper money, not for itself, but for the Federal Reserve. The Federal Reserve has given the Federal Treasury a Federal Reserve Check. The Treasury is printing up the money for the Federal Reserve as specified by the Federal Reserve Check. So then, once again we would assume that the Federal Reserve owes the Federal Government for the amount of this Check and therefore must pay the Federal Government interest. Not so. The Federal Reserve Check has been written to the Treasury with a U.S. Treasury Bond as collateral. The Federal Reserve Check simply represents the U.S. Treasury Bond that the Federal Reserve has in its vault.
Where did the Federal Reserve get the U.S. Treasury Bond that it is using for security to write the Federal Reserve Check to the U. S. Treasury? It got it from the Treasury Department. But, you say, I thought that the Federal Government was not allowed to print up paper money? It didn’t print up any paper money. It printed up a paper Treasury Bond. The Treasury is now printing up money for the Federal Reserve not for the Federal Government.
Okay, so the Federal Reserve now has all of this money that it had the Federal Treasury print up based on the collateral of the Federal Treasury Bond that the Treasury printed up and gave to the Federal Reserve. How does the U. S. government now get this money so that it can pay for World War II?
It borrows this money that the Treasury has just printed up, from the Federal Reserve and pays the Federal Reserve interest for the privilege. The Federal Reserve sells these bonds at the government’s specified interest rate to rich Americans and now foreign countries like our once biggest enemies China and Russia. It is this borrowing plus the interest owed that amounts to what is called our National Debt. This National Debt is somewhere in the neighborhood of nine or ten trillion dollars.
Why don’t we just pay off the National Debt?
Well, in order to pay off or collect all of our Treasury Bonds from the Federal Reserve, the Federal Government would have to call in all of the Federal Reserve Notes that have been printed, turn the Federal Reserve Notes in to the Federal Reserve and get the Treasury Bonds back. But if the Federal Government did this today, there would be no Federal Reserve Notes left in circulation, and consequently nobody would have any money. The whole world would be bankrupt and besides the Federal Reserve has already sold the Treasury Bonds to individuals and other nations.
Well why doesn’t the Federal government just print up the money and skip the Treasury Bonds and the Federal Reserve thus avoiding any debt? Because it is against the Constitution and it would create inflation.
But doesn’t the National Debt and borrowing the money create the same inflation plus build an impossible debt? Yes it does. But the government can deal with that by juggling the Cost of Living Index and explaining to people that even though a gallon of milk now costs them ten dollars instead of one dollar there has really been no inflation when you consider hedonics and the cost of foreign oil along with the price of tea in China.
But doesn’t inflation bankrupt the middle class? Yes it does, but it doesn’t matter as long as the middle class thinks that it is still middle class even when it is bankrupt.
Well, what if these individuals or other nations who have bought all these Treasury Bonds bring all of these Treasury Bonds back and want to cash them in?
In that case, the Federal Government will write up some new Treasury Bonds, give them to the Federal Reserve Bank as security, collect a Federal Reserve Check, have the Check printed up into Federal Reserve Notes, borrow the Notes from the Federal Reserve Bank and pay off all of the nations and individuals who want to cash in all their old Treasury Bonds with these new Federal Reserve Notes.
But what if they don’t want more paper?
What the hell do they want?
They want gold or silver or land or free pizza.
Well, take the damn Federal Reserve Notes and go buy some of whatever it is that you want. What’s the problem?
Ahh...I...I don’t know.
And then I thought the government has the right to mint coins without borrowing from the Federal Reserve and creating debt. So why don't they just mint enough coins to buy back all the Treasury Bonds. But then it costs the Federal Government two cent to mint every penny and a dime to mint every nickel because of the market price of copper and zinc. Man a government just can't win here.