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Fighter of Inflation

Posted by Ender on March 31, 2009

Proponents of the Federal Reserve say that you need the Fed to control monetary supply and inflation. In our series on the Federal Reserve we argued that the Fed itself creates inflation. So, in light of recent events it appears that the Fed is doing its best to “control” inflation. Here is how they are doing it; by spending or lending $12.8 trillion of cash/credit. Yes, that is a TRILLION. Let’s put that into perspective:

1. That is about forty two thousand dollars per individual living in the US. That’s a good thing right?

2. It equals about 90% of the US’s GDP (2008). (GDP is the total amount in dollars of everything produced in the entire country.) That’s a good thing right?

Inflation?  Not on his watch

Inflation? Not on his watch

So, how does this fight inflation? Don’t look at me for an answer because I don’t have one. My question is, are they done destroying our currency and economy? “FDIC Chairman Sheila Bair warned that the insurance fund to protect customer deposits at U.S. banks could dry up because of bank failures.” Oh…well I guess we can all take respite that the Fed is there to control this kind of stuff.

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The Federal Reserve: How it Hurts You-Part 5

Posted by Ender on March 25, 2009

This is Part 4 of of a series on the Federal Reserve. In Part 1, we discussed Money, Fractional Reserve Banking and a brief history of the Federal Reserve. In Part 2, we discussed Inflation. In Part 3, we discussed the Austrian Business Cycle. In Part 4, we discussed the Tech Stock Bubble.

Moral Hazard

What is Moral Hazard?  Wikipedia has the following definition “Moral Hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.”  If you threw a party without your parents’ knowledge in high school you probably experienced moral hazard.  The kids that you invited over most likely did not treat your house like you did.  They broke vases or windows or any other cliché object in the house because they knew they would not bear the responsibility for their actions.  For all those nerds out there who never threw a party like this just watch Can’t Hardly Wait or any other teen movie for an example.

Risky? Sure, but no Moral Hazard

Risky? Sure, but no Moral Hazard

How does the Fed create a Moral Hazard?  The answer lies in a term you may have heard before, which is “lender of last resort.”  A lender of last resort will lend to banks or institutions that cannot find a lender on the open market.  The first problem with this is that the Fed can be lender of last resort and not absorb any of the cost associated with it.  They can just print money in order to finance these bailouts.  The Fed does not have to act like a normal business and borrow money to give to the bankrupting companies.   

The second problem with this is that having a lender of last resort encourages risky behaviors by banks and other businesses.  These banks know that the Fed will be there to bail them out if things go sour.  They can ignore sound business practices to an extent because they are not taking the full burden of the risk.  Hulsmann writes, “To sum up, bailouts through monetary policy socialize the costs of bad investment decisions. This creates a moral hazard on the side of all the beneficiaries. Financial agents can worry less about risk and concentrate on possible profits. They become exuberant and turn to excessively risky business practices such as reducing the equity ratio.”  This sounds remarkably similar to what we have been hearing about AIG, Fannie Mae, et al during this financial crisis. 

Some probably doubt that Moral Hazard exists, but how can this be?  The Fed has a long history of bailing out companies in trouble.  If you recall, in Part 4 we discussed how the gpvernment bailed out LTCM during the Tech Boom.  More recently, they bailed out AIG.  The Fed has proven over and over that it will rescue companies and ultimately make the taxpayer pay for their mistakes. 

Price Fixing

If you ask any Free Market advocate if we should just fix the oil price at $1.75 per gallon they would invariably look at you like you were crazy and scream NO!  You would likely get the same answer with any good from cheese to cars.  However, for a reason I cannot comprehend, some of these same “Free Market advocates” will argue FOR the Fed to fix the interest rates and discount rates.  Why would this ever work?  It seems to me that they do not understand they are actually arguing that we need to socialize part of the Free Market in order for it to work.

The Bliss of Price Fixing

The Bliss of Price Fixing

Ron Paul writes “One of the primary means the Federal Reserve uses to stimulate the economy is manipulation of the federal funds rate and the discount rates, which are used as benchmark rates throughout the economy. The interest rate is the price of time, as the value of a dollar today and the value of a dollar one year from now are not the same. Just like any price in the market, interest rates have an important informational signaling purpose. Government price fixing of the interest rate has the same deleterious effects as price controls in other areas.”  We have discussed these effects in nearly every part of this series on the Federal Reserve. 

What people need to understand is that Money itself is a good, perhaps the most important good, in the Free Market.  We allow (for the most part) the market to determine prices of other goods, so why not money?  Why allow the Fed to fix interest rates so insanely low that it hurts the economy and the individual? 

Paul goes on to say, “Under Chairman Greenspan’s tenure, the federal funds rate was so low that the real interest rate (that is the nominal interest rate minus inflation) was negative. With a negative real interest rate, someone who saves money will literally lose the value of that money.”  This destroys the effort of the individual to save money for the future.  The Fed’s price fixing is not the answer to whatever problem people think it might be stopping. 

Conclusion

The Fed, as argued throughout these articles, is an immoral force in the Free Market system.  It steals from the individual through inflation, it causes misery through booms and busts, it encourages companies to engage in overly risky behavior and is unaccountable to the American people.

A lot of research went into this series, here are some of the sources and further reading for those interested.
Inflation
Postrel, Fed Up
Coster, Socialist Man
Williams, Counterfeiting vs Monetary Policy
White, Inflation
Hazlitt, What you should know about inflation
Mises, Economic Freedom and Interventionism
Paul, The Inflation Tax
Busts
Thorton, Economics of Housing Bubbles
Karlsson, Yes, Greenspan Did It
Englund, The Fed and Housing
Other
Sowell, Bailout
North, Moral Hazard
Hulsmann, Moral Hazard

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The Federal Reserve: How it Hurts You-Part 4

Posted by Ender on March 20, 2009

This is Part 4 of of a series on the Federal Reserve.   In Part 1, we discussed Money, Fractional Reserve Banking and a brief history of the Federal Reserve.  In Part 2, we discussed Inflation.  In Part 3, we discussed the Austrian Business Cycle.

The Tech Boom  (Cliff’s Notes at the Bottom)

The Backdrop

A few factors occurred prior to the actual bust cycle of 1995-2001 played a part in the bubble. The first was the Plaza Accord of 1985, which was an agreement between the G-5 powers (France, Germany, Japan, UK and the US) to “subsidize U.S. exporters by artificially lowering the exchange rate of the U.S. dollar.” (Callahan) This pulled the US out of the recession of the early 90s, by 1993 the stock market began to rise and the Fed in an effort to battle inflation started to raise their rates. From late 94 to early 95 the rate rose from 4.73 to 5.53.

In 1995, the US, Japan and Germany decided to bail out the Japanese manufacturing industry by agreeing to the Reverse Plaza Accord, which reversed the lowering of the exchange rate established in the original Plaza Accord. This is the problem with trying to control aspects of the economy. The “solutions” only cause more problems in the future. To help Japan, the three countries decided to subsidize German and Japanese products for the American buyer. To do this they lowered the Japanese interest rates, increased Japanese purchase of US Treasury bonds, Germany and the US purchased dollars as well. “Driving the dollar up against foreign currencies would allow the U.S. government to maintain a stance of monetary ease without raising the CPI, since the artificially lowered price of imported goods would tend to counter the price-raising effect on the increased liquidity.” (Callahan) They did this in an attempt to hide what would be rising prices from the CPI (Consumer Price Index.) Although they hid the extra liquidity from the CPI it had to manifest itself somewhere. One of the places it ended up was the US stock market.

In the middle of 1995 through early 96 the Fed lowered its interest rates from 6 to 5.22. Japan also lowered its rate from 1.75 to 0.5. This led to a situation where Asian investors could borrow yen to invest in US securities and make profit with no risk. The arbitrage situation created here further drove up the price of financial instruments in the US.

Scary, But True

Historically, the full employment level leads to an unemployment rate between 5% and 6%. During one of the longest “booms” in the Federal Reserve’s history the rate fell below 5% and stayed below until 2001. It bottomed out at around 3.9%. The chairman during this time of prosperity was Alan Greenspan. He took the lowering of the unemployment rate along with the growth in productivity to mean that we as a nation had reached a new level in economic progress. It was dubbed the “New Economy.” History buffs or extremely old readers of this site might recall that the US has gone down this path before. Anyone willing to guess when the term “New Plateau of Prosperity” was coined? Anyone? Well it was developed in the 1920s, (coincidentally?) prior to the Great Depression. Whether through arrogance or ignorance I know not, but Greenspan thought the macroeconomics of old no longer applied and there did not have to be a bust after a credit induced boom.

Feeding the Bubble

Attempts to control the worldwide economy such as the Reverse Plaza Accord always end in failure. In the late 90s, Japan (among other Asian countries), Germany and Brazil all went through financial crises. The economies could not afford to keep subsidizing US imports. They began to collapse. In the US, the Long Term Capital Management hedge fund which had a large stake in the Russian and East Asian financial markets started turning losses instead of profit.

To stem the panic, the Fed dropped the rate from 5.56 to 4.63 in eight months including a rate cut in between its meetings (which never happens.) During this timeframe (Jun 98-Jan 99) the NASDAQ Composite (tech heavy) went from a low of 1419 to a high of 2193. The tech composite rose over 80% in 1999. Again in the final quarter of 1999 to stem Y2K panic the Fed cut rates below 4%. From September 1999 to March of 2000 the NASDAQ tech composite rose 83% to hi 5048.

It is important to note that just because instruments like the CPI aren’t showing increases doesn’t mean we don’t have an inflation problem. One important measure to look at during all of this are the monetary supply calculations. These are described as M0, M1, M2, MZM etc. During the Tech Bubble M2, M3 and MZM all dramatically increased. The most important one to look at is MZM. See the graph below:

MZM

From 1995 to 2000 it grew 52%, is there any doubt that this was feeding the bubble?

But What About The Berries?

Think back to the situation that resulted with the “berry receipts.” The same thing happened in the US economy during the Tech Boom. The economy was driven forward by both an increase in consumption and investment, which was fueled by the Fed. In the berry scenario, we saw that only a savings induced boom can be sustained. Was there an increase in savings during the Tech Boom? The answer is a resounding NO. Brenner writes “Between 1950 and 1992, the personal savings rate had never gone above 10.9 per cent and never fallen below 7.5 per cent, except in three isolated years. But, between 1992 and 2000, it plummeted from 8.7 per cent to -0.12 percent.”

“The divergence of investment demand and savings supply [characterizes] the ‘policy-induced boom,’ where monetary expansion drives a wedge between savings and investment.” (Callahan) This wedge causes businesses (and consumers) to start spending more on capital investments than would normally be deemed reasonable. Business equipment (up 74%), construction (up 35%) and debt (reaching 9.9% of the GDP vs 3.4% in the early 90s) all rose during this timeframe.

The Collapse

Architect of the Bubble

Too much investment and current consumption leads to price increases as business compete for resources, which are becoming more and more scarce. For instance in the Tech Industry, prices started rising for programmers, developers, office space and web domains. In an effort to cool the economy the Fed raised the interest rates. This coupled with the rising prices popped the Tech Bubble. The companies scraping by on cheap loans now started to take losses. The NASDAQ lost over 77% of its value. The drastic drops did not only affect lesser known tech companies. Qualcomm dropped from 136.12 (‘00) to 25.18 (‘02). Cisco dropped from 136.37 (’00) to 12.07 (’02). Yahoo dropped from 178.06 (’00) to 11.50 (’02).

This also affected business that supported the Techs. Construction companies who purchased capital goods such as real estate, cranes, dump trucks etc. because their demand was so high now have to pay for all that investment even though the demand dropped off. Computer manufacturers now have rising inventories and no one to sell to because the bubble burst. People who were hired to deal with the new business are now laid off because business fueled by inflation and easy credit has ceased.

Cliff’s Notes

Cliff's Notes

In short, the Fed tried to control the economy through interest rate manipulation and credit inflation. This is clearly evidenced by the MZM’s insane rise over the 6 year stretch along with the Fed’s rate dropping. The extra liquidity was hidden (for a time) from measurements like the CPI, however, it needed an outlet which ended up being the stock market. Due to non-economic factors much of the growth went towards the new and seemingly profitable Tech Stock industry. Once, the Fed stopped its tactics and prices started dramatically increasing the bubble burst.  Misery ensued.

In Part 5, we will wrap up and take a look at a few odds and ends.

For sources and further reading:

Austrian Business Cycle, Callahan
ABCT, Best
Greenspan: The Liar, The Fraud, Karrlson
The Dot-Com Future, Rockwell
He’s Forever Blowing Bubbles, North
Money and the Stock Market: What is the Relation, Shostak
Sound Money and the Business Cycle, Cochran

Posted in Capitalism, Conservatism, Economics, Liberty, Politics, The Federal Reserve | Tagged: , , , , , , , , , , , | 2 Comments »

The Federal Reserve: How It Hurts You-Part 3

Posted by Ender on March 17, 2009

This is Part 3 of of a series on the Federal Reserve.   In Part 1, we discussed Money, Fractional Reserve Banking and a brief history of the Federal Reserve.  In Part 2, we discussed Inflation.

The Austrian Business Cycle

Ludwig von Mises

This Guy Had the Foresight, Will You Listen?

In order to understand how these Bubbles are created, one must understand some basic economic principles found in the Austrian Business Cycle.  Dan Mahoney gives a simple example of a man stranded on an island who must pick berries in order to survive.  The man in question needs 12 berries per day to survive.  So, he goes on picking them.  Then one day he decides that he is tired of picking them by hand and wants to find an easier way to pick more berries.  He devises a plan of knocking the berries down with a stick and catching them in a net.  What would the cost of this investment be?  The cost in this situation is the berry-picking time he loses by building his stick and net.  Said differently, if he estimated it would take a full day to build his tools, he would lose 12 berries.  So we have reached a point, in this scenerio, where the man must take into account his time preference.  “Time preference is the extent to which people value current consumption over future consumption.”  If the man values eating the 12 berries more than potentially eating more as a result of his stick and net method, he will not make the tools.  Relating to what we learned about the fractional reserve no amount of berry tickets (gold receipts) printed is going to change his value of current consumption.  If his time preference falls and he decides he will only eat 10 berries a day he can now save the extra 2 berries.  If he does this for 3 days he will have 6 berries in his “bank.”  He can now spend half a day working on the new tools and half picking berries by hand.

Mahoney writes,”This same process of using savings to fund current production for future consumption goes on in more complex economies.  At any given time, the individuals in society are engaged in production to meet some “level” of consumption needs. In order for more lengthy—and, hence, if they are to be maintained, more productive—processes to be entered into, it is necessary that some individuals have refrained from consumption in the past so that other individuals may be sustained and facilitated in assembling this new structure, during which they cannot produce—and thus, not consume—consumption goods with the methods of the old structure.”

This Guy Also Had the Foresight, Listening Yet?

This Guy Also Had the Foresight, Listening Yet?

How is this process distorted by the Fed?  Through inflation or more specifically credit inflation the Fed makes “it appear that more means exist for current production than are actually sustainable.”  Entrepreneurs and investors are led to believe that the consumer has more money available to buy more goods than they actually do.  Consider the man on the island. If he was completely content to eat 12 berries a day he would never save or invest in the tools.  For the sake of the illustration, imagine that there were two men on the island and they both picked 12 berries a day.  One day, man A makes a berry receipt for 12 berries and gives it to Man B.  Man B sees that Man A has saved enough berries for him to not pick berries for a day and to create the net and stick.  At the end of the day he goes to redeem the reciept only to find that there are no additional berries.  He dies of starvation over night.  Now, what would happen if Man A had actually saved 12 berries?  Man B would have worked to create the net, redeemed his receipt at the end of the day and aside from the obvious intestinal unpleasantness brought on by a berries only diet, would have slept soundly.

What would this look like in a complex economy such as ours?  When the Fed artificially lowers interest rates it signals a change in consumer demand from current consumption to future consumption.  Which means companies should shift their use of capital to future output instead of current output.  This causes companies to start investing (through borrowing from the bank) in new capital goods whether they be new machinery, tools, real estate, research etc.  Demand for anything needed to perform the capital investments increases. 

For a more applicable example, let’s look at a typical construction company. Contruction companies start getting work orders to build new buildings. Business is booming so they build a new location on expensive real estate because they think the demand is permanent and the new location will spur more business.  They order supplies for all the new projects they are doing.  Their suppliers are running out of materials and place orders for large replacements because their business is booming.  And so on and so on, all the way down to the employees of all the related businesses buying Starbucks coffee on their way to work instead of making their own because of the raises or bonuses they received due to the booming business.  This scenario just described is a (fiat, fake, phony) credit induced boom and started on a false promise of future consumption.  Inevitably, resources start getting scarce because there was no real decrease in time preference made by the consumer.  Prices start rising as more companies are competing for the same materials.  Eventually, to battle inflation, our hero (read villain) the Fed, increases the interest rates.  Now all the companies that were depending on cheap loans for their liquidity start having trouble making ends meet.  It turns out there was no real increase in demand.

These illustrations convey the main point of the Austrian Business Cycle: a savings induced boom is sustainable whereas a credit induced boom is not.  Initially, both an increase in savings at a bank and the central bank expansion of credit have the same effect.  It signifies a shift between current consumption value and future consumption value, which gives a signal to Investors that there are more loanable funds, thus more demand for future products than previously existed.  However, the outcomes are drastically different.  In a savings induced boom, the boom is backed by consumer preference to spend in the future.  In a credit induced boom, the boom is backed by an artificial interest rate, which in the end can only be sustained by printing more money or lowering the interest rate even further, to the detriment of individuals and the economy as a whole.

Theory is one thing, real life examples are another.  In Part 4, we will take an in depth look at the Tech-Stock Boom of the late 90s early 00s.

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The Federal Reserve: How it Hurts You-Part 2

Posted by Ender on March 5, 2009

This is Part 2 of of a series on the Federal Reserve.   In Part 1, we discussed Money, Fractional Reserve Banking and a brief history of the Federal Reserve.  It can be found here…in case you missed it.

Inflation

What is inflation?  From the American College Dictionary: “A substantial rise of prices caused by an undue expansion in paper money or bank credit.”  Henry Hazlitt writes,”The word ‘inflation’ originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean “a rise in prices” is to deflect attention away from the real cause of inflation and the real cure for it.”  (Hazlitt)

Inflation in Zimbabwe

Inflation in Zimbabwe: Maybe he can get a grain of rice...

How can the money supply be increased?  Using fractional reserve banking or no-reserve banking, the Fed can print money out of thin air and release it into the money supply.  There is no gold or value behind the new money printed, it is simply fiat money.  The other way money supply can be created is through credit.  The Fed, by artificially lowering the interest rates, can increase the supply of credit.  When monetary supply is increased with no increase in the supply of goods, prices increase.  Inflation causes the devaluation of each monetary unit’s worth.  Henry Hazlitt gives a concrete example:  “The total of money and credit so measured was $63.3 billion at the end of December 1939, and $308.8 billion at the end of December 1963. This increase of 388% in the supply of money is overwhelmingly the reason why wholesale prices rose 138% in the same period.”

Who loses when inflation occurs?  Ludwig Von Mises writes “inflation is detrimental to all creditors.”  He asks the question, “who is a creditor?  Does inflation touch only businessmen and financiers?”  (Mises) The answer is no.  If you save money in a bank you are a creditor, if you own a bond or T-bill you are a creditor, if you have an insurance policy you are a creditor.  The above examples probably include most people who are reading this, however, if you have Social Security taken out of your paycheck you are a creditor, this means 99.9% of you out there are creditors.  You are directly impacted by inflation.quote-11

How are you impacted?  The dollar you put into the bank, or buy a bond with, is worth more than the dollar you get back.  This makes sense  in light of what we learned above.  Two parties benefit from inflation.  The first is the debtor.  Obviously, the inverse of the situation above means that you can pay your creditor back with money that is worth less than the money borrowed.  The second is a little more complicated.  Inflation does not occur in a vacuum, meaning as soon as the devalued money is printed or credit created it does immediately raise prices.  So, the people who use the inflated money earlier in the cycle benefit more than those who receive later in the cycle.  If the Fed prints the money to fund project X the money is worth the most at the start. When it starts paying the vendors and those vendors start paying their vendors and employees, the money gradually loses value.  This means that the highest negatively impacted group is usually the individual.  The government and other elites benefit the most.  Once again, we are reminded of the founding fathers hesitancy to give power to the government because it harms the individual the most.

Good intentions resulting in bad outcome is a recurring theme when the liberal agendais applied.  This is just another example of it.  In fact, inflation hurts the people who liberals claim to help the most.  Inflation is used to fund or create all massive entitlement programs.  Unfortunately, low-income and fixed-income families or individuals bear the brunt of the devaluation of money.

In short, inflation is like a secret tax. The people being taxed have no say in the matter, and more often than not, no idea it’s happening.  The Government can expand its size, start programs, subsidize disastrous projects and do a number of other things that the voting public would never approve of if tax increases were needed to pay for them.

This is where morals and logic must take us:

“1. Theft is immoral. 2. Inflation is theft. 3. Fractional reserve banking is inflationary. 4. Central banking is government-guaranteed fractional reserve banking.”  Gary North

As if prices rising and devaluation of your money isn’t enough, the Fed through inflation, also causes Booms, Busts and Bubbles.  Look forward to part 3…

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The Federal Reserve: How It Hurts You-Part 1

Posted by Ender on March 3, 2009

In a recent post at TruPolitics.net, a self described liberal expressed his pride that his ideology created the Federal Reserve.  The average American does not fully know what “the Fed” is and does.  All they hear about is the Fed raising or lowering interest rates, but really have no clue as to how this affects their daily life.  If they really knew how the Fed destroys wealth, creates poverty and creates the same “bubbles” that they blame Wall Street for, would they really brag about its invention?  Would they really want to take credit for the misery it has caused?  Surely, they would not.  So how can the Federal Reserve really cause this much damage?  Two concepts need to be defined in order to understand how the Federal Reserve hurts you: money and fractional reserve banking.

Money

What is money?  According to Webster’s Dictionary money is “something generally accepted as a medium of exchange, a measure of value, or a means of payment.”  What this means is that it is an object that is worth something to most people.

Example of Money

Prior to money, people would use the barter system to exchange goods or services.  In this system I would give you three bunches of grapes if you fixed my shoes.  But what would happen if I wanted my shoes fixed but you did not want any grapes?  I would be out of luck.  So, money was created where I could sell my grapes for money and then exchange it to you for the shoe repair. 

Money was usually something of great value like gold that was easily divisible.  People would take this gold, or what have you, to a banker who would give them a deposit receipt.  This receipt would be proof to whoever the receipt was exchanged with that they could go to the bank and exchange it for the amount of gold on the receipt.  Pretty simple right?  Now that we have a basic understanding of money we can investigate how the Federal Reserve is destroying the money in your pocket and in your bank account, even as we speak.

Fractional Reserve Banking

Originally, banks would only give out receipts for which they had deposits.  Said differently, if the bank had 100 ounces of gold it would only give out receipts of 100 ounces of gold.  What would happen in the bank gave out 200 ounces worth of receipts or even 1,000 ounces of receipts?  The practice of keeping a reserve less than 100% of receipts distributed is called Fractional Reserve Banking.  This policy fraudulently inflates the money supply, which in turn, devalues money and increases prices.  Does this seem logical to you?  Would any other industry get away with what is essentially counterfeiting?

The History of the Federal Reserve

Trivia
Q: Which founding figure on a piece of our current currency created the first central bank?  (highlight for answer)

A: Alexander Hamilton ($10 bill)

The founding fathers understood the extreme danger centralized power posed to Liberty.  Thomas Jefferson was vehemently against the creation of a central bank.  Jefferson and his ilk knew that having a monetary system that could not be manipulated by the government would place rigid boundaries on the size of the government.  Living under the tyranny of the British Empire taught them to be ever vigilant in keeping the government small and out of their lives.  They also knew that the Liberty they enjoyed in America stemmed directly from its economic freedom.

Thomas Jefferson

Thomas Jefferson

Jefferson abolished the first central bank.  A second federal bank was created in 1816, which was later destroyed by Andrew Jackson.  Jackson led the country back to the gold standard in 1834.  Abraham Lincoln started to print his own paper money during the Civil War, however, the US was able to move back to the gold standard in 1879.

In 1896, a movement towards a central bank was led by J.P. Morgan and John Rockefeller.  Why would two titans of industry want something that would erode the value of the money they made?  “They wanted cheap credit and inflated money supply to finance the expansion of their empires” (Mises) In 1907, there was a run on some New York banks.  People found out that the banks were using the fractional reserve method, which frightened depositors into withdrawing their money.  J.P. Morgan bailed out the banks with $35 million of his own money.  (Guess who one of the banks was…Bear Stearns, funny huh?)  Using the fear of bank runs and bailouts Morgan, Rockefeller and the extremely progressive (read fascist) President Woodrow Wilson pushed the idea of a central bank on Wall Street and the public.

The reason people don’t know a lot about the Federal Reserve is that most of it activities are done in secret.  The Federal Reserve Act was written in secret.  The parties involved pretended they were going on a hunting trip in Georgia, but instead spent the week writing the Act.  The Federal Open Market Committee, which decides whether to increase or decrease money supply, is ironically completely closed.  There are no transcripts of what transpires in their meetings only brief summaries are released.

The US continued down the path of Fractional Reserve banking until 1971 when Richard Nixon stopped redeeming gold for paper.  Currently, we have unbacked currency.  So, how does the Fed impact you?  Look forward to Part 2.

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