Matthew Propst
Economic Geography
I was going write a review on why Ben Bernanke should not have been re-elected as chairman of the Federal Reserve but I felt my point would be underappreciated without first knowing my personal opinion of the Federal Reserve along with basic understanding of the Federal Reserve. I decided to scrap what I had written about Bernanke and focus on the Federal Reserve as a whole. Here is an example of how monetary expansion (stimulus) works.
The US government needs some money and requests a loan from the Federal Reserve for 10 billion dollars. The Federal Reserve agrees to buy 10 billion in US treasury bonds. The US government then takes some pieces of paper, throws a design on them, and calls them treasury bonds. The treasury department attributes a value of 10 billion dollars and sends the bonds to the Federal Reserve. While this is going on the Federal Reserve is busy with their printing press as well but this 10 billion is not in treasury bonds but in Federal Reserve Notes (our current US currency). Both parties exchange the paper with the Federal Reserve receiving an “asset” and US treasury a liability. When the treasury department receives the Federal Reserve notes they deposit it into a bank account; the Federal Reserve notes are now considered legal tender money, adding 10 billion dollars to the US money supply. This is how money is created in our current monetary system (except electronically instead of physically). Let’s look at this from a different perspective.
Government bonds are debt. Government owes bond holder principle plus interest- easy concept. The government then takes this debt (bonds) and gives them to the Federal Reserve for Federal Reserve notes (money), that were created out of thin air, to put into circulation. In other words the “money” was created out of debt; i.e. Money=debt.
"Neither paper currency nor deposits have value as commodities, intrinsically, a 'dollar' bill is just a piece of paper. Deposits are merely book entries." — Modern Money Mechanics Workbook, Federal Reserve Bank of Chicago
Let’s go back to the 10 billion that has been created out of debt. This 10 billion is sitting in a bank account and becomes part of the banks reserve. Legal reserve requirements by the Fed equal a predetermined percentage of its deposits. Under current regulation this is 10% for most transactions. With the 10 billion dollar deposit, one billion is kept for the required reserve while the other 9 billion is an excess reserve and can be the basis for new loans. It would make sense that the 9 billion came from the original 10 billion but it doesn’t. As state in “Modern Money Mechanics”, a workbook circulated by the Fed to explain bank reserves and deposit expansion.
“If business is active, the banks with excess reserves probably will have the opportunities to loan the $9,000. Of course, they do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes (loan contracts) in exchange for credits (money) to the borrower’s transaction accounts.”
This means that 9 billion in addition to the 10 billion (19 billion total) is created out of thin air (monetary expansion) simply because there is a demand for loans and there is a 10 billion dollar deposit for reserve requirements. Let’s assume that someone borrows this excess reserve. They will most likely then deposit their loans into their own bank account and the process repeats. The 9 billion is now part of the banks reserve and 900 million is required while the 8.1 billion is excess requirements available for loaning. As this deposit/loan cycle continues it theoretically can create 9 times, or 900%, the original deposit. In this example 10 billion will turn into 90 billion. This new debt/money gets its value from existing money which as a whole loses value.
On the left is a graph of the purchasing power of the dollar since the passage of the mint act of 1792. Dotted line represents when the US currency was not backed by gold or another commodity but backed by the debt and faith of repayment from the US government. On the right is the percent change in the monetary base from 1961 to April 2009.
The Federal Reserve is not authorized by the constitution and is the culprit of this current financial crisis. The Fed delivered this crisis to us through artificially low interest rates achieved through inflating the money supply. Artificially low interest rates hurt the thrifty while promoting consumption and borrowing over savings and investing. Artificially low interest rates caused our current financial crisis but we are trying to use artificially low interest rates to get out of the recession.
What needs to be done to fix our financial system is dismantle the Fed and go back to the gold standard. If you want a free market and capitalism you can’t have a secret bank creating money and credit out of thin air.
“You have to choose [as a voter] between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold.” George Bernard Shaw
An abolishment of a central bank in the United States has happened before; here is a quote from Andrew Jackson after he abolished the second central bank in the United States.
“The bold effort the present (central) bank had made to control the government ... are but premonitions of the fate that await the American people should they be deluded into a perpetuation of this institution or the establishment of another like it.” Andrew Jackson
An audit of the Fed seems like a no brainer considering they are central planners of our economy. An abolishment of the Fed and return to gold stand will promote price stability and savings. In a capitalistic economy savings is required for real growth. Economic growth on only credit is artificial and requires a correction like in the Great Depression and now.
“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.” Thomas Jefferson
"We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system.... It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon." — Robert H. Hamphill, Atlanta Federal Reserve Bank
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