The Origin and Purpose of the Federal Reserve


By Patrick   Follow   Tue, 27 Mar 2012, 1:40pm   5,163 views   21 comments
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By Dr. Michael Hudson. Republished with his permission from http://michael-hudson.com/2012/03/federal-reserve-system/

Prior to the Federal Reserve’s founding in 1913, U.S. monetary policy was conducted by the Treasury. Like the Fed, it had district sub-treasuries that performed nearly all the financial functions that the Fed later took over: providing credit to move the crops in autumn, managing government debt, and so forth.

But after the severe 1907 financial crisis, a National Monetary Commission was reformed. Under the then-Republican administration, it recognized a need for more active government intervention to prevent future financial crises. It also recognized the desirability of moving away from the Anglo-Dutch-American system of “merchant banking” based on short-term lending against collateral in place, or for shipping of goods already produced. The National Monetary Commission’s longest volumes were on the great German industrial banks, and Republican policy aimed at bringing banking into the industrial era, to provide long-term funding after the model of German and other Central European banks.

However, the leading bankers sought to use the crisis as an opportunity to grab power for Wall Street, away from the Treasury. In this sense, the Fed was founded in large part to take monetary control away from Washington’s elected officials and appointees, and privatize the supply of money and credit.

So its place in the U.S. financial and economic structure is to allocate credit, primarily to serve Wall Street financial interests. That explains the insistence on the financial class here and abroad in insisting on an “independent” central bank. It means that instead of serving the public interest, it serves the interests of the banking class. The hoped-for transformation of commercial banking into long-term industrial banking was not achieved.

Can we imagine the global economic system without Federal Reserve today? If yes/no, why?

As David Kinley’s book for the National Monetary Commission pointed out a century ago, nearly all the financial functions performed by the Fed already were performed by the national Treasury. In more recent times, Milton Friedman and his University of Chicago colleagues suggested that the entire Fed could be reduced to a single desk inside the Treasury. The “Chicago Plan” of the 1930s urged Treasury control, as does Congressman Dennis Kucinich’s current bank reform.

There is no inherent need for a monetary agency to exist outside of the national government, except to serve the interests of the financial class as distinct from those of government, industry and labor. And the banking sector’s business plan is to load down real estate, labor, industry and the government with as much interest-bearing debt as possible.

Some people in the US (especially supporters of the congressman Ron Paul) believe that the Federal Reserve is the reason of serious problems within the American financial system. Do you agree with this claim?

The Fed is a reason for serious problems, but not the only reason. Unfortunately, Ron Paul’s proposal opposes paper credit itself, whether issued by the Fed or the Treasury. He wants to return to the gold standard and clash government spending – in effect, to create an economy without government. So what he actually advocates is not only the end of the Fed, but the end of a functioning credit and tax system. The idea is otherworldly and has no possible chance of being enacted, because it would cause a vast debt default as a result of plunging prices, incomes and employment.

Contrary to most of European central banks the Federal Reserve is quite autonomous and has some private aspects. Doesn’t it give too much power to this financial structure? Or maybe this power is part of the checks and balances within the American political system? If yes, what is its precise role and place?

The Federal Reserve is private in name only. Its heads are appointed by Washington, but Wall Street has veto power over it (as it has over the appointment of major Treasury and other regulatory agency officials). So the problem is not that the Fed is technically owned by its stockholders, but that Wall Street has gained overpowering control over government itself.

The financial sector has sought to dismantle checks and balances, making it protect Wall Street even as financial interests diverge from the promoting of economic growth and rising living standards.

What is the priority for the Fed leadership: solving national American problems or serving the interests of the global system?

The Fed is officially supposed to perform two functions: First, to promote “price stability.” This means in practice, fight against wage inflation and preserve sufficient unemployment so that wages will not increase. The “prices” that are supposed to stabilize are the price of labor (wages) and commodity prices.

Meanwhile, the Fed seeks to inflate asset prices, above all real estate prices. Under Alan Greenspan, the aim of the Bubble Economy was to inflate housing prices by enough so that homeowners could borrow the interest to pay the bankers each year, and even enough to spend on consumer goods that their stagnant wage levels were not sufficient to buy. The result was to vastly increase the volume of debt – and debt service became a rising element of prices throughout the economy. Debt-leveraged housing prices ended up absorbing about 40 percent of typical family budgets, and a rising share of corporate income as well, leaving less for spending on current production of consumer goods and capital goods.

The second function the Fed was supposed to perform was to promote full employment. Mr. Greenspan made it clear that he believes that this is incompatible with the ideal of price stability. He pointed out before Congress that the virtue of loading down homeowners, college students and others with debt was that they were afraid to go on strike or even complain about working conditions or seek higher wages, for fear of being fired and missing a mortgage payment or credit-card payment. Going on strike or losing as job would threaten them with loss of a home, and an immediate increase in the credit-card interest rates and penalties that they had to pay. So the Fed became the leading administrator in Wall Street’s war against labor.

Under Mr. Greenspan’s tenure and that of his successor, Ben Bernanke, the Fed has overseen the greatest shift of wealth n American history since the Robber Barons.

Finally, the Fed has taken over the functions of government by threatening to close down the economy if the government does not bail out the banks at taxpayer expense, and protect the wealthy 1% against losing money.

How different were the three last Fed chairmen? Who was the most successful?

Paul Volker came from the Chase Manhattan Bank. In the late 1970s he coped with the U.S. balance-of-payments deficit (stemming mainly from overseas military spending) and consequent the inflationary pressures by raising interest rates to 20%, thereby plunging stock market and real estate prices.

His successor, Alan Greenspan, was a Wall Street lobbyist and a follower of Ayn Rand. Diametrically opposite from Paul Volcker, he pressed to deregulate the economy and sponsored the financial bubble to pump enough credit (debt) into the economy to enable debtors to pay the banks the interest that was mounting up. As a bank lobbyist in control of the banking system, he “freed” the bank from government control – and promoted the greatest debt bubble in U.S. history.

Ben Bernanke was an academic, not a banker but sufficiently brainwashed in neoliberal, pro-Wall Street ideology to be trusted by the banks to flood the economy with credit in an attempt to re-inflate the bubble economy so as to pull real estate prices out of negative equity – thereby saving the banks from their bad loans. Instead of writing down debts, the Fed made sure that no bank would lose, or even be prosecuted for the financial fraud that has risen to epic proportions over the past decade. My UMKC colleague Prof. Bill Black calls this phenomenon “criminogenic.” So in effect, Mr. Bernanke is as much a bank lobbyist as Mr. Greenspan.

In this sense, both Mr. Greenspan and Mr. Bernanke were successful in steering U.S. financial policy to benefit Wall Street by loading down the economy with debt, and then using public credit to bail out the banks and pass the losses onto taxpayers. But this “success” is leaving the U.S. economy debt-ridden and uncompetitive internationally, because its industrial producers face such heavy debt charges that they are priced out of world markets for most products except for military arms, agriculture and high-technology monopoly goods and patented motion pictures and entertainment.

The existence of the Federal Reserve: does it match with the ideas of the classical liberalism? How liberal is this institution?

The Federal Reserve is antithetical to the classical liberal aim of using financial and tax policy to minimize the economy’s cost of production. From the Physiocrats and Adam Smith through Ricardo, John Stuart Mill and the Reform Era, the aim was to minimize land rent (by either taxing it away or nationalizing the land), monopoly rent (by price regulation or by keeping natural monopolies in the public domain) and interest or other financial charges that were payments for special privilege.

Acting on behalf of the banks, the Fed has sponsored the un-taxing of real estate and monopolies, as these have become the major bank customers. And by deregulating Wall Street, the Fed has underwritten the overgrowth of unproductive credit – credit extended not to finance industrial capital formation, but simply to speculate and to transfer ownership of assets already in existence.

The guiding philosophy of the Fed is to inflate prices of assets in order to expand the market for real estate loans (which account for some 80 percent of bank loans in the United States), corporate takeover loans and speculative “casino capitalist” loans for foreign-currency and interest-rate arbitrage.

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  1. uomo_senza_nome


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    1   2:07pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike (1)  

    Patrick says

    He wants to return to the gold standard and clash government spending – in effect, to create an economy without government. So what he actually advocates is not only the end of the Fed, but the end of a functioning credit and tax system. The idea is otherworldly and has no possible chance of being enacted, because it would cause a vast debt default as a result of plunging prices, incomes and employment.

    I don't think Prof. Hudson is fully right on this. I don't think Ron Paul actually wants the entire system to be abolished overnight. Of course that would cause a massive depression on a world scale and Ron Paul is fully aware of that. What I see him propose recently (even during the most recent banking committee meeting) is the idea of competing currencies. I think that's a brilliant idea.

    Let gold and silver freely float against all fiat currencies and remove all capital controls (such as punitive taxes) on the sale of physical gold/silver. In fact, if we do that -- people will start saving in these entities, which can serve better as a long-term store of value (no deterioration in purchasing power). Debt is not a long-term store of value

    Of course, Dan will argue that there has been tremendous increase in purchasing power in gold due to huge run-up in prices. But this huge run-up is mostly related to the QE and liquidity injection programs which gold anticipates. So much liquidity sloshing around and it's bound to cause price volatility in these metals.

    Patrick says

    It means that instead of serving the public interest, it serves the interests of the banking class.

    While this may be seen as a disadvantage (and I agree partly to this), it is also an advantage because the political class is crazy than the banking class. If you give monetary authority of paper currency to political class, you get Zimbabwe.

    Patrick says

    Mr. Greenspan made it clear that he believes that this is incompatible with the ideal of price stability

    Completely true. The Fed should not have dual mandates. The Fed should be more like the ECB, with a single mandate of price stability. Employment really should be in the hands of the private sector, where labor is efficiently utilized.

    I don't see any bigger issues such as Triffin's Dilemma addressed here in this essay, because the Fed is at the heart of this Triffin Dilemma issue.

    Patrick says

    The Fed is a reason for serious problems, but not the only reason.

    How about the CON-gress?

  2. tatupu70


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    2   2:39pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    uomo_senza_nome says

    Let gold and silver freely float against all fiat currencies and remove all capital controls (such as punitive taxes) on the sale of physical gold/silver.

    Why can't you do that now? Who is stopping you from buying gold or silver?

  3. Honest Abe


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    3   2:46pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Buying gold or silver is not the same as letting them freely float against all currencies...is it?

    Which one of us is missing something?

  4. uomo_senza_nome


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    4   2:49pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    tatupu70 says

    Why can't you do that now? Who is stopping you from buying gold or silver?

    Long-term capital gain tax is 28% on collectibles. Read any IRS form for proof.

    Secondly, there's adequate proof that gold price is suppressed because of paper gold being sold as real gold. Source: http://www.gata.org/

    So as such it is heavily discouraged to buy precious metals, at least in the US.

  5. uomo_senza_nome


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    5   2:53pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Honest Abe says

    Buying gold or silver is not the same as letting them freely float against all currencies...is it?

    Exactly. They're not the same thing and that's my point.

    I think people of Western thought discredit gold and silver purely because they are paper bugs. They are of the easy money camp.

    Debtors and Savers .

    FOFOA's dilemma : When a single medium is used as both store of value and medium of exchange it leads to a conflict between debtors and savers . FOFOA's dilemma holds true for both gold and fiat, the solution being Freegold, which incidentally also resolves Triffin's dilemma.

    Return to Honest Money .

  6. Honest Abe


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    6   2:56pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Uomo, you're right on target, IMHO. BTW, I thought I was the only one to use the term "paper bugs"! Great minds think alike.

  7. uomo_senza_nome


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    7   3:21pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Ah, I see that Prof. Hudson is also an MMT (Modern Monetary Theory) advocate.

    The blogger FOFOA ripped apart MMT in his Moneyness post.

    Here's the thing, the act of government deficit spending without either counterbalancing taxes or Treasury sales to the private/foreign sector, and the act of Fed quantitative easing, both change the nature of the money supply in a way that all other "normal" activities do not. They debase "our money" by expanding "their money" in volume to ease their discomfort. And this kinda gets us to the driving thrust of MMT; that MMT sees little to no danger of this monetary plane debasement spilling out into the physical plane with deadly consequences for the dollar.

  8. Honest Abe


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    8   9:39pm Tue 27 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Patrick, don't you think its ironic that the Fed calls its committee the FOMC- the Federal Open Market Committee?

    Its not Federal, and has nothing to do with the "open market". The phrase open market would indicate market forces being allowed to exert themselves without any outside pressure.

    The Fed does NOT allow the open market to determine interest rates...they do. In other words, they IGNORE the open market and operate by artifically price fixing interest rates.

    Of course, if you or I did that we'd be jailed. We can't price fix - its illegal - but they can. We can't counterfeit - its illegal - but they can. We can't debase our currency - its illegal - but they can. We can't artifically manipulate interest rates - its illegal - but they can.

    Ron Paul is right (again) = Audit the Fed !!!

  9. taxee


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    9   12:55am Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Their name is the 'fed' for good reason. Money is worthless if you don't have the 'hungry' who are looking for work.

  10. tatupu70


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    10   5:33am Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Honest Abe says

    Buying gold or silver is not the same as letting them freely float against all currencies...is it?
    Which one of us is missing something?

    You--how is gold not freely floating? It is openly traded.

  11. uomo_senza_nome


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    11   8:17am Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    tatupu70 says

    how is gold not freely floating? It is openly traded.

    You do realize that there's a whole paper gold derivative structure that obscures the physical price right?

    All paper is still a short position on gold .

  12. Auntiegrav


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    12   9:54am Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    The guiding philosophy of the Fed is to inflate prices of assets in order to expand the market for real estate loans (which account for some 80 percent of bank loans in the United States), corporate takeover loans and speculative “casino capitalist” loans for foreign-currency and interest-rate arbitrage.

    This can be simply shortened to "The fed policy is to inflate prices." Inflating prices gives the illusion of perpetual growth and a delusion of increasing value of assets.

    In the end, it comes down to what will be useful between people and in the future. Money is a tool which accelerates the use of resources, but it doesn't create any more than there actually are. Money "policy" is a false policy, based on something that isn't a sensible commodity of value. The value lies in what backs the money. Inflating prices and monetary policies encourage people to leave their real living skills behind them and join in the fray of monetary civilization, rather than human society and circumstances. Most of what we now do as humans is unnecessary and useless, and the inflated money supply is a reflection of unnecessary and useless activities that simply consume resources in order to increase the flow of money (or even create the illusion of increasing flow via inflation).
    Growth-based economics is a detachment from real economic activities, which follow resource-based needs and supplies. Any group of people working together needs to have some idea what the end product is, yet as a society, we only have "Growth" as our end product. This is no better than "love" as a goal. The sales pitch is the product.

  13. uomo_senza_nome


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    13   11:12am Wed 28 Mar 2012   Share   Quote   Permalink   Like (1)   Dislike  

    Auntiegrav says

    Money is a tool which accelerates the use of resources, but it doesn't create any more than there actually are.

    Well said.

    The monetary plane is so far away from the physical plane, it will drive us dizzy.

    This is not going to end well.

  14. Auntiegrav


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    14   1:19pm Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    uomo_senza_nome says

    This is not going to end well.

    As Sherm said (psychopathiceconomics.com), "One day people are going to wake up and realize what the fuck rope was made for—while it will put and end to this happy horeseshit it won’t be a pretty time."

  15. Patrick


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    15   6:02pm Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    taxee says

    Their name is the 'fed' for good reason. Money is worthless if you don't have the 'hungry' who are looking for work.

    Brilliant! Never heard the Fed dissed that way before, but it's exactly correct IMHO.

    It's all about control over labor. Forcing them to work for you.

  16. Patrick


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    16   6:12pm Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    Honest Abe says

    Patrick, don't you think its ironic that the Fed calls its committee the FOMC- the Federal Open Market Committee?

    I actually agree with Honest Abe on all of his comment about the Fed.

    The Fed exists primarily to prevent the free market for interest rates from harming the 1%.

  17. TMAC54


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    17   7:42pm Wed 28 Mar 2012   Share   Quote   Permalink   Like   Dislike (1)  

    Patrick says

    in 1907 it recognized a need for more active government intervention to prevent future financial crises.

    AAAAAND we have GUBMINT !

  18. tatupu70


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    18   4:25am Thu 29 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    uomo_senza_nome says

    tatupu70 says

    how is gold not freely floating? It is openly traded.

    You do realize that there's a whole paper gold derivative structure that obscures the physical price right?

    All paper is still a short position on gold .

    And how does that stop you from buying physical gold?

  19. uomo_senza_nome


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    19   9:47am Thu 29 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    tatupu70 says

    And how does that stop you from buying physical gold?

    tatupu, your stupidity is amazing.

    It stops me from discovering the true physical price. Nothing stops me from buying physical gold, but all these capital controls and obscuring price discovery tactics discourage people from buying it.

  20. tatupu70


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    20   10:19am Thu 29 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    uomo_senza_nome says

    tatupu, your stupidity is amazing.

    lol. One of us is stupid. The article doesn't detail any capital controls or obscuring discovery tactics. I completely disagree with the claim that gold derivatives drive down the price of gold. That is just plain wrong.

    So, you don't like that gold returns are taxed at 28%. What else is stopping you from buying gold?

  21. uomo_senza_nome


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    21   10:22am Thu 29 Mar 2012   Share   Quote   Permalink   Like   Dislike  

    tatupu70 says

    The article doesn't detail any capital controls or obscuring discovery tactics.

    Obscuring tactics is the paper pyramid structure of gold derivatives built off from the physical gold. It is quite clearly illustrated in the article.

    tatupu70 says

    I completely disagree with the claim that gold derivatives drive down the price of gold. That is just plain wrong.

    Then you have closed your eyes.

    http://jessescrossroadscafe.blogspot.com/2012/02/what-is-spot-price-of-gold-and-silver.html

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