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Why the Fed Is Nothing to Celebrate

Mises Daily: Monday, June 23, 2014 by

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The Federal Reserve System turned 100 years old last December and Fed supporters have been celebrating ever since. In recent months, the Dallas Fed opened an historical exhibit, the Kansas City Fed released a documentary, and the New York Fed even started a Facebook page, all to commemorate the date.

The mainstream media has also been vocal, as CNN posted a piece claiming Janet Yellen’s becoming the first female chair is an “apt way to mark the anniversary,” while National Review published an article of their own. Although the two outlets differ on politics, it seems nearly everyone agrees the Fed has fulfilled its purpose: grow the economy and prevent economic downturns.

Simon Jack of BBC news recorded a short video along these same lines. He refers to the Fed as “one of the most powerful institutions on earth” and to the boardroom specifically as “the nerve center of the global economy”; indeed, as the “most important room in the financial world.” One could be taken aback at his excessive praise, except that these statements are largely true: the Fed runs a counterfeiting monopoly, making it powerful beyond belief.

Jack alludes to this fact, yet overall he asserts that the Fed is divorced from politics. This is beneficial, he says, because it “allows them to do radical things when necessary,” such as Paul Volker raising interest rates in the 1970’s to combat price inflation. Thus he cites a supposedly prevalent expression among bankers, investors, and even presidents: don’t fight the Fed.

It’s curious then that Fed chairs are appointed by the president and approved by Congress. To claim neither has power over the happenings down the road is preposterous. And just as the Fed is staffed with former officials of the big banks, the banks themselves are influential in presidential elections (as Goldman Sachs, one of Bush’s largest donors, was one of Obama’s too).

Realistically, both the Fed and the president (not to mention the banking elite) possess extraordinary power which can be enhanced when working together. As Jack vaguely explains, the Federal Open Market Committee (FOMC) determines the money supply, interest rates, and how much “quantitative easing” there should be: decisions with implications around the world.

Of course this is true, but throughout the entire feel-good discussion (and others like it) a main feature of the Federal Reserve System is left conspicuously unmentioned: fractional reserve-banking.

People deposit money at a bank under agreement that whenever they so choose, they can withdraw their money in full. For the bank to be able to fulfill this obligation, it must keep as reserves the total balance deposited by its customers. Banks, then, are nothing more than warehouses for money, issuing receipts (money substitutes) in exchange for deposits. If depositors seek to withdraw their cash but the bank doesn’t have it on hand, the bank will be deemed insolvent – an event referred to as a “bank failure.”

Before the Federal Reserve Act, banks often held only a fraction of their liabilities as reserves because by loaning out a portion of it — even though it was their customers’ property – they could make serious dough through collecting interest. The only problem they encountered were bank runs, when they received more claims for redemption than they had cash available. This meant default and bankruptcy, save some sort of outside help.

Murray N. Rothbard demonstrated thirty years ago in his masterful essay Origins of the Federal Reserve that bankers and big business in the late 1800s began to call for a central bank as a “lender of last resort,” an institution that had the power to perform “bail outs” through printing money. After a massive propaganda campaign, they finally got their way in 1913.

Rather than risk default through fractional reserve banking, the Fed guarantees the banks have nothing to worry about. Today the reserve requirement is only 10%, meaning for every dollar deposited, the bank can lend out (i.e., “create”) an additional 90 cents.

“New” money enters circulation in competition with “old” money, bidding up prices for the first goods bought with it. But prices exist in relation to one another, so even though some prices will rise first, eventually all will rise as the market restores its desired proportions. For this reason, the total size of the money supply is irrelevant: only a change in this quantity matters because it causes a redistribution of wealth to the first receivers of the new money (government, bankers, big business, etc.) from the public at large.

Before the Fed, banks got away with this wholesale rip-off only insofar as the public placed confidence in their solvency. The last century has been distinct with the banks filling their own pockets practically without end. Since 1913, the dollar has lost over 95 percent of its exchange value.

The only limitation now is the stability of the currency itself and, as Jack said, the crash of 2008 was followed by an “unprecedented program of printing trillions of dollars to stimulate the economy.” If it weren’t for legal tender laws — requiring official debts, as well as taxes, to be paid in national currencies — and for inflationary central banks around the world, the US dollar would have already collapsed because investors would have switched to sounder money. So much for the Fed as “guardian of the U.S. dollar.”

Until holders of US dollars understand that they are being robbed by the very people who claim to be protecting their money, more of the same will follow. And until then, the intellectual army of economists employed by the Fed and the big banks will be eager to keep the lies going and the people in the dark.

Contrary to the popular notion that the Federal Reserve has the public welfare in mind, the sober observer would have to conclude that the Fed is all about special privileges for the few at the expense of the many. The last thing to be seen is who can blow out more birthday candles in one breath: former Fed chairman Ben Bernanke or the newly-appointed Janet Yellen.