Money From Nothing, But Nothing Free

By Dennis Fischer

“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” Vladimir Lenin

According to Aesop, an old Shepherd, alarmed by the cries of an approaching enemy, urged his Ass to flee or else be captured. The indolent Ass identified his dilemma as a Morton’s Fork and rebutted, “…what matters it to me whom I serve?” For the working class, a change in government changes nothing of substance.

Indeed, the status remains quo with our leaders in government and on Wall Street, despite the financial meltdown of last year and a new administration whose campaign slogan was “Change we can believe in.” Our politicians still borrow and spend, as if tomorrow will not happen, while Wall Street profits, as though yesterday never occurred.

But neither could so blithely pursue their respective agendas without the Federal Reserve System or ‘Fed’, the quasi-private central bank that has controlled our nation’s money supply since 1914. The denominator common to these three arbiters of our economy is debt -- the fuel for deficit spending, the lever beneath excess returns and the foundation of our money supply.

The Fed emerged in the aftermath of the Bank Panic of 1907 and subsequent formation of the National Monetary Commission to investigate ways to reform the banking system. In 1910, Senator Nelson Aldrich, chairman of the commission, organized a clandestine meeting at a private resort on Jekyll Island, Georgia, with Assistant Treasury Secretary A. Piatt Andrew and five leading financiers of Wall Street. The need for secrecy was great because the public distrusted the big banks in New York City and their intimate ties with leading industrial conglomerates of the era. Breaking this ‘money trust’ was a common political campaign promise at the time, so the full participation of this trust in bank reform was vigorously concealed for several years.

Based on many of the ideas conceived on Jekyll Island, the Federal Reserve Act was passed in 1913. A network of twelve Federal Reserve districts was established to provide local presence and divert concerns over the concentration of financial power in New York City. Each of these district banks is owned by commercial banks in their respective geographies, through ownership of non-transferable restricted stock. Our government is connected through the seven-member Board of Governors in Washington D.C. These governors, nominated by the President and confirmed by the Senate, are charged with oversight of the Federal Reserve System and serve 14-year staggered terms. The longevity and term structure of these appointments were intended to separate the governors from current politics.

With an original charter to furnish an elastic currency, provide liquidity and establish more effective supervision of banking in the United States, the Fed has greatly expanded its authority over the years. Today, it has broad mandates to pursue maximum employment, stable prices and moderate long-term interest rates; supervise and regulate banking institutions to ensure the safety and soundness of the nations banking system; plus maintain the stability of the financial system and contain systemic risk.

The primary tools that the Fed uses to address these objectives are monetary policy, bank regulation and as the lender of last resort through its discount window. Monetary policy includes setting the interest rate that banks charge each other on overnight loans (the federal funds rate), and also the interest rate it charges as a direct lender (the discount rate). Through the Federal Open Market Committee (FOMC), money supply may also be adjusted in attempts to stimulate or slow down the economy. The FOMC can infuse money into the system by purchasing government debt from banks or other institutions. Conversely, the Fed can contract money supply by selling government debt from its internal holdings.

Money injected directly by the Fed into the economy through open market operations is called ‘high-powered’ money because it may induce a geometric expansion in total money supply as it disperses throughout the banking system. Under our nation’s fractional reserve system, banks are only required to hold a small (under 10%) portion of their accumulated deposit liabilities in reserve to meet withdrawals, under the centuries-old theory that not all depositors will withdraw their money at once. The remaining 90%-plus of deposits may then be used to make loans. As the process of making loans and taking deposits is repeated in smaller increments at the same or different banks, over $10 in total money supply may be created for every $1 of high-powered money.

But this high-power money from the Fed is generated with a keystroke and is backed by nothing tangible. The ability to create money from nothing was abetted when the dollar was decoupled from the gold standard. In 1933, President Roosevelt nationalized gold and gold certificates owned by private citizens and abrogated contracts with payments specified in gold. Thereafter, Federal Reserve notes were redeemable in ‘lawful money’. In 1971, President Nixon rescinded the Bretton-Woods agreement and prevented foreign holders from exchanging

Federal Reserve notes for gold. This completed our nation’s transition to a full fiat currency -- its value based on a promise that it is ‘legal tender for all debts, public and private’.

Our government embraces fiat money. It can simultaneously fund pork-bloated appropriation bills and endless land wars in Asia, even as it undertakes massive new social programs -- without the restraint of a money supply backed by scarce resources. As our profligate politicians continually spend beyond the national means, they borrow the money rather than raise taxes. This allows them to skirt accountability for deficit spending and simultaneously cement their popularity at home.

Government deficits have reached epic proportions since the dollar was totally divorced from the gold standard, ballooning our national debt from about $398 billion in 1971 to nearly $12 trillion today -- a thirty-fold increase in 38 years. Concurrently, the value of gold as measured in U.S. dollars appreciated by the same order of magnitude. According to the Congressional Budget Office, the President’s current budget proposal will add another $9 trillion in debt over the next ten years. If we allow that to happen, government debt will equal the projected market value of our nation’s entire output of goods and services in 2019.

Wall Street is also grateful for the system. When the Fed purchases government securities in open market operations, the sellers are big bank primary dealers in New York. These dealers can then leverage this high-power money by more than thirty times in their trading and investment operations, fueling abnormal returns during bull markets. As banks, they can also make loans and have access to cheap credit from other banks or from the discount window at the Fed.

Easy credit, leverage and lack of oversight are the prime ingredients of speculation. As the housing market collapsed in 2007, so did the unregulated collateralized debt obligations (CDOs) and Credit Default Swaps (CDSs) conjured by Wall Street. As many of these highly leveraged speculations were based on mortgages and other loans with little underlying equity participation, defaults had a snowball effect on their collapse.

And when these self-made speculative bubbles burst, the Fed stands ready to re-inflate them. This was previously demonstrated by the bailouts of the savings and loan industry in the 1980s and Long Term Capital Management in the 1990s -- both trivial affairs when compared to the systemic financial crisis of 2008. A ‘too big to fail’ mentality has taken root over the last 20 years and created moral hazard, as the big banks expect to be insulated from their own risky behavior.

But average Americans might be less sanguine about the nature of our money if they fully understood it. The dollar retained its purchasing power from the founding of our nation in

1776 until the establishment of the Fed in 1913. Since then, the dollar has lost over 95% of its purchasing power, with the most pronounced declines following the decoupling of the dollar from gold. As Fed Chairman Ben Bernanke agreed last year, inflation is a tax. However, this inflation tax is imposed in a subtle manner -- cloaked as rising asset prices rather than a debauched currency. It is also a tax levied without representation, since not one member of the Fed is a publicly-elected official. The only benefits of this insidious tax accrue to the oligarchy that created it.

And it’s getting worse. Median household incomes, adjusted for inflation, are below what they were ten years ago. Nearly two-thirds of total income growth during the economic expansion after the turn of this century was captured by the top one percent of wage earners. True unemployment may have risen to over 20%, including those discouraged from seeking work and those that have dropped out of the labor force over time. Foreclosure rates remain high and may edge higher as adjustable rate mortgages reset. Wealth is being squeezed from the middle class at an accelerated pace, as our leaders seek new ways to collateralize the future.

The performance of the Fed as measured against its own mandates has been execrable. Its pursuits of maximum employment and stable prices are a sham -- unless you enjoy the stability of a government job or the compensation levels of Wall Street. The Fed has clearly failed to supervise or regulate banks to ensure their safety and soundness. Instead, it encouraged financial deregulation and, along with our government and Wall Street, helped inflate the housing bubble and create a systemic crisis. The Fed and our government then bailed out the largest speculators on Wall Street with trillions of dollars in taxpayer IOUs to stave off total collapse. The Fed has pandered to the voracious spending appetite of government and the avarice of big banks while the rest of the population loses jobs, homes and net worth.

The Fed is not fully audited and is allowed to manipulate our money supply with limited transparency under the guise of independence. It is able to resist attempts to provide full disclosure regarding its activities just as our government rejects the notion of a balanced budget and Wall Street opposes regulation. This incestuous trio is linked by the umbilical cord of fiat money that has no value other than the collateral of borrowers. Much of this collateral has already been relinquished by those least able to afford it while the rest of us, whose fortunes have merely waned, await the next great squeeze from the tax constrictor.

Congress is charged with coining our money according to the constitution, but it has relinquished this responsibility to a central bank over which it has no direct control. While some economists espouse a return to the gold standard as a means to impose fiscal responsibility on our leaders, the volume of international trade and the potential to manipulate the gold reserves at central repositories are significant hurdles, as is the immediate and dramatic devaluation of the dollar that would follow such a move.

Instead, as Thomas Edison observed nearly 90 years ago, “If our nation can issue a dollar bond, it can issue a dollar bill. The element that makes the bond good makes the bill good also.” A fiat money issued directly by the Treasury would eliminate the Fed as an intermediary, reduce interest cost on the national debt it holds (currently near $2 trillion) and exert pressure on government to work toward a balanced budget by clearly exposing the wanton spending habits of politicians motivated solely by their prospects for re-election.

We are the Shepherds of our Asses and if they remain lazy and indifferent to change, a wagon load of Federal Reserve notes may one day fetch more as a novelty item on eBay than it will at a local store. Just ask our dollar compatriots in Zimbabwe.

Dennis Fisher writes on economic outrages from Danbury, Connecticut.

SIDEBAR

DOLLAR JEKYLL AND MONEY DIED

For histories of central banking in the United States, formation of the Federal Reserve and

Jekyll Island, the following sources are recommended:

Johnson, Roger T. “Historical Beginnings … The Federal Reserve.” Federal Reserve Bank of Boston. Revised December 1999.

http://www.bos.frb.org/about/pubs/begin.pdf

Whitehouse, Michael A. “Paul Warburg’s Crusade to Establish a Central Bank in the United States.” Federal Reserve Bank of Minneapolis. May 1989.

http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=3815

To obtain a more complete explanation of how the Federal Reserve is organized, what it does and how our money is created, see the following:

Board of Governors of the Federal Reserve System. “The Federal Reserve System Purposes & Functions.” Washington D.C. Ninth Edition, June 2005.

http://www.federalreserve.gov/pf/pdf/pf_1.pdf

Nichols, Dorothy M. and Anne Marie L. Gonczy. “Modern Money Mechanics.” Federal Reserve Bank of Chicago. Revised June 1992.

http://www.bibliotecapleyades.net/archivos_pdf/money_mechanics.pdf

To research government debt and the President’s current long-term budget proposal, see the following:

U.S. Department of the Treasury, Bureau of Public Debt. TreasuryDirect®. Current and historical debt outstanding, updated daily.

http://www.treasurydirect.gov/NP/BPDLogin?application=np

Congress of the United States, Congressional Budget Office. “The Budget and Economic Outlook: An Update.” Washington, D.C. August 2009.

http://www.cbo.gov/ftpdocs/105xx/doc10521/08-25-BudgetUpdate.pdf

To explore the purchasing value of the dollar over time, unemployment statistics and the growing income gap in the United States, see:

MeasuringWorth. “Purchasing Power of Money in the United States from 1774 to 2008.”

http://www.measuringworth.com/ppowerus/

Bandyk, Matthew. “Is Unemployment the Worst Since the Great Depression?” U.S. News & World Report. August 27, 2009.

http://www.usnews.com/money/business-economy/articles/2009/08/27/is-unemployment-the-worst-since-the-great-depression.html

Saez, Emmanuel. “Striking it Richer: The Evolution of Top Incomes in the United States (Update with 2007 estimates).” University of California, Berkeley. Berkeley, CA. August 5, 2009.

http://elsa.berkeley.edu/~saez/saez-UStopincomes-2007.pdf

U.S. Department of Commerce, U.S. Census Bureau. “Historical Income Tables- Households”

Washington D.C.

http://www.census.gov/hhes/www/income/histinc/h05.html

U.S. Department of Commerce, U.S. Census Bureau. “Income Poverty and Health Insurance Coverage in the United States: 2008.”

http://www.census.gov/Press-Release/www/releases/archives/income_wealth/014227.html

Williams, John. “Shadow Government Statistics, Unemployment Rate – Official (U3 & U6) vs. SGS Alternative.” Updated monthly.

http://www.shadowstats.com/charts_republish#emp

For statistics on real estate foreclosures, the why they may increase, the following are useful:

RealtyTrac® Staff Report. “As Some Top Metro Forelosure Activity Rates Decrease, New Foreclosure Hot Spots Emerge in Q3 2009.” Irvine, CA. October 28, 2009.

Simon, Ruth and James R. Hagerty. “Delayed Foreclosures Stalk Market.” The Wall Street Journal. September 23, 2009.

http://online.wsj.com/article/SB125366552480532521.html#mod=WSJ_hps_LEFTWhatsNews?mod=dist_smartbrief

To see how Wall Street and our government have struggled through the financial crisis, see the following:

Lucchetti, Aaron and Stephen Grocer. “Wall Street On Track to Award Record Pay.” The Wall Street Journal. October 14, 2009.

http://online.wsj.com/article/SB125547830510183749.html

Associated Press. “Congress still slated to get automatic pay hike.” MSNBC. March 12, 2009.

http://www.msnbc.msn.com/id/29666229/

And for a glimpse of the Zimbabwean economy and the collapse of its dollar, see these:

Brulliard, Karin. “As Zimbabwean Dollar Dies, So Does a Lucrative Career.” Washington Post Foreign Service, The Washington Post. February 21, 2009.

http://www.washingtonpost.com/wp-dyn/content/article/2009/02/20/AR2009022003282_2.html

eBay auction for Zimbabwean currency:

http://shop.ebay.com/?_from=R40&_trksid=p3907.m38.l1311&_nkw=zimbabwe+100+trillion&_sacat=See-All-Categories

Tags: Dollar Devaluation, Financial Frauds

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