Federal Reserve Thoughts - Why it Should be Abolished

I originally wrote this article for the Ron Paul wiki, and I broke it up into several pieces and copied it here.

http://wiki.ronpaulpresshub.com/index.php?title=Federal_Reserve

The Federal Reserve is Unconstitutional

The Constitution grants the right to coin money to the Federal government. It does not allow the government to delegate that authority to a private corporation.

The Constitution also says Congress may "coin" money. It doesn't say anything about paper. That's probably the reason Federal Reserve Notes say "This note is legal tender" and Treasury-minted coins don't say that.

Of course, decisions by a corrupt Supreme Court have said that the Federal Reserve and Federal Reserve Notes are perfectly valid.

The Federal Reserve is a Price Fixing Cartel

The Federal Reserve's primary mission is to "fix interest rates". In practice, the Federal Reserve sets interest rates at a far lower level than what they would be if interest rates were allowed to float. This is, in effect, a huge government subsidy to the financial industry, paid by the average person in the form of inflation.

Why shouldn't the financial industry pay market rates for its supplies (money) just like every other industry?

To fix interest rates at a specific rate, currently 5.25%, is as ridiculous as fixing the price of oil at a specific price, say $10/barrel. The government could, if it wished, force the price of oil to $10/barrel by printing enough money to pay oil producers the difference between $10/barrel and the fair market price. The oil industry would love it, because it would guarantee they could sell all the oil they drilled. The average person might appreciate cheaper oil, but they wouldn't realize they were paying the costs anyway via inflation.

The economic distortions caused by artificially low interest rates are far worse than the economic distortions an artificially low oil price would cause. The costs are carefully hidden from the average person, but they are paid via inflation. Just like the oil industry would love government-subsidized artificially low oil prices, the financial industry loves government-subsidized artificially low interest rates.

Just like an artificially low oil price would enable an oil company to sell all the oil it could, artificially low interest rates allow financial companies to sell all the loans they can. Because loans are priced artificially low, when a business does a cost/benefit analysis of the merits of the loan, the loan is usually the best financing option. Cheap loans allow businesses to expand, but that expansion comes at a cost of inflation paid by everyone else.

Without artificially cheap loans, alternative financing methods would be more common. Selling equity or paying for growth from earnings would be much more attractive if loans were fairly priced.

The Government Ceded its Money-Printing Authority, Seignorage Privilege, and Sovereignty to the Federal Reserve

When the Federal Reserve was set up, Congress was stripped of its power to directly print money itself. The Federal Reserve fixes interest rates at an artificially low level. If Congress was allowed to directly print and spend its own money, this would cause market interest rates to rise, which would be contrary to the Federal Reserve's goal of keeping interest rates artificially low.

The privilege of seignorage, the profit gained by printing new money, rightfully belongs to the government. The Federal Reserve has effectively transferred all seignorage profit away from the government to the financial industry. Since the economy grows at a rate of 2-4% per year, the government could directly print and spend 2-4% more money without causing inflation. This profit rightfully belongs to the government, and not to the financial industry.

The growth rate in the economy would likely be higher if a fair monetary system were instituted.

When Congress ceded its money-printing authority to the Federal Reserve, it was the functional equivalent of Congress ceding sovereignty to the Federal Reserve. It's as if Congress signed a treaty of surrender to the international banking cartel. As part of the surrender, all US citizens were sold as slaves via the income tax.

The Federal Reserve Causes the Federal Budget Deficit

The Federal Reserve forbids the government from putting new money into circulation by directly spending it. Instead, new money is put into circulation via loans, either loans to the government or loans to the financial industry. However, when new money is created via debt, the money to pay off the interest on that debt is not simultaneously created. This means that debt always increases exponentially faster than the money supply.

Because the net total debt in the economy is always increasing, the only way that private citizens could have any money at all is for the government to have a huge debt.

That was the problem during the Great Depression. The Compound Interest Paradox sucked all the money out of the private sector. During the boom in the 1920s, artificially cheap debt encouraged speculators to borrow, expanding the money supply. The banks who controlled the Federal Reserve could see in advance what was going to happen. They were able to stop issuing loans and convert their holdings to cash before the money supply crashed. They had enough cash to survive while others were forced into bankruptcy. Then, they were able to buy assets at a bargain after the money supply crashed. The only way to reintroduce money to the private sector (i.e. stop deflation), was to have the government start deficit spending. This deficit spending in turn forced the government off the gold standard.

The interest earned by increasing the money supply via debt belongs to the government as seignorage profit. Currently, this profit goes directly to the financial industry.

The Federal Reserve Forced the US off the Gold Standard

Since the inception of the Federal Reserve, money could only be created via debt, and only the amount borrowed is created and not the money required to pay the interest. The Federal Reserve System guaranteed that total debt could only increase over time. This accumulated debt guaranteed that the government would eventually be forced off the gold standard.

The Federal Reserve is Responsible for the Economic Enslavement of Most Americans

The total amount of debt in the economy is far greater than the total amount of money in circulation. This guarantees that Americans will continually struggle to pay their bills. Through this mechanism, all surplus productivity is effectively drained from the people and turned over to the financial industry. The income tax is the other part of this mechanism, because it forces people to use dollars and enables the government to confiscate a large percentage of all wealth created by workers.

I am careful to manage my finances so that I have little or no debt. However, almost all the people around me are suffering under a crushing debt burden. Since I am competing with economic slaves for jobs, that effectively makes me an economic slave, even though I have no debt.

The Federal Reserve is a Private Corporation

The Federal Reserve is a private corporation. To a certain extent, its management is chosen by the President and Congress. However, it is carefully shielded from political influence.

The actual people who work at the Federal Reserve are chosen by the private corporations who own it. The Board of Governors has a yes/no vote on who actually works there, but the real power is still with the private ownership.

Further, even though there are 12 Federal Reserve banks, the real power lies with the New York branch, which is the one that performs the open market operations to keep interest rates artificially low.

Also, the Open Market Committee is separate from the Board of Governors. The Open Market Committee has the real power, because it is what sets the interest rate target. The Open Market Committee is appointed by the private corporations that own the Federal Reserve.

The Federal Reserve was Designed to be Unaccountable to the President or Congress

The Board of Governors serve 14 year terms, with 7 members elected every 2 years. This means that one President in a single term can only appoint two members. That means that a President who wants to fix the flaws in the system will have to wait until he has served 2 full terms and had an opportunity to appoint four members.

If it was discovered that the President was hostile to the Federal Reserve, interest rates would be raised, causing a recession. The media would blame the President for the economic problems and not the Federal Reserve. A President who is hostile to the Federal Reserve would have no chance of being reelected. In other words, the Federal Reserve cannot be controlled by the President.

Previous central banks were given a charter that automatically expired after 20 years, and then renewal was successfully fought. The Federal Reserve was given an indefinite charter and intentionally shielded from political pressure so that it would be very difficult for the President and Congress to fix the system.

If the Federal Reserve was only given a 20 year charter like the previous US central banks, do you really think it could have gotten its charter renewed during the Great Depression?

Even though the President nominates the Board of Governors, he chooses from a list provided by financial industry insiders. It would be unthinkable (and literal suicide) for the President to nominate someone who hadn't been approved by the international banking cartel.

The Federal Reserve Subsidizes Hedge Funds and Leveraged Buyouts

Due to their large asset base and risk management, hedge funds are able to borrow cheaply, paying slightly more than the Fed Funds Rate, currently 5.25%. Since interest rates are kept artificially low, the leverage hedge funds use allow them great profits. If a hedge fund uses 10x leverage, and interest rates are 3-5% below where they should be, that means that hedge funds can make 30-50% profits just from their use of leverage.

Artificially low interest rates also encourage leveraged buyouts. A company with a "clean" balance sheet (no debt) is penalized because it becomes a takeover target. This penalty exists because of artificially low interest rates. Artificially low interest rates mean that it's profitable to buy a company and load it up with debt to fund the purchase.

A company with a "clean" balance sheet is penalized because it's a takeover target. A company that loads up on debt is at risk for bankruptcy during the next deflationary recession. Either way, the banks wind up owning everything. In a bankruptcy, a company's equity is confiscated by its creditors, typically banks. Money that was artificially created by a bookkeeping trick is now converted into a tangible asset.

That's the reason activist hedge funds pressure companies with a "clean" balance sheet to borrow in order to pay a dividend or repurchase shares. If interest rates were priced fairly, it would not make sense to borrow to pay a dividend or repurchase shares. However, with artificially low interest rates, it pays to borrow to pay a dividend or repurchase shares. The interest paid on the loan is less than the expected inflation, and the loan itself causes additional inflation.

The average person knows that excessive hedge fund profits and leveraged buyouts are inherently unfair. They are unfair, but they're only made possible by artificially low interest rates. With fair interest rates, it would be much harder for hedge funds to rack up huge profits. Leveraged buyouts would be far less common, and would only make sense if the management of a company was truly incompetent.

The Federal Reserve Encourages Consolidation of Industries, Monopolies and Oligopolies

Because businesses are financed primarily by debt, the financial industry encourages consolidation because a monopoly or oligopoly is in a sound market position to pay off its loans. A larger business has an easier time borrowing money than a small business. A large business can borrow at a lower premium to the risk-free rate than a small business. That's why small businesses are squeezed out, due to the artificially cheap cost of borrowing. A small business owner tries to finance primarily through equity, using his earnings to grow his business. If a small business owner does borrow, he pays a higher interest rate. The small business owner is risking his entire business and sometimes the owner has to assume personal liability for the loan. A large business can borrow cheaply, and use the money to squeeze out competitors and then raise prices.

A small business typically tries to finance growth through equity, spending for growth out of profits. A large business can finance growth through debt. The large business is assuming less risk by taking on debt due to its size. Debt is artificially cheap, so debt financing gives the large corporation a huge advantage over small businesses.

The Federal Reserve Causes Boom/Bust Cycles in the Economy

During a boom cycle, people are encouraged to borrow and speculate due to artificially cheap debt. During the bust cycle, money is scarce and people have a hard time repaying their debt. A bust cycle is inevitable because money is only created via debt. As more loans are created during the boom cycle, those loans need to be repaid eventually. At some point, loan repayments exceed new loans and the bust cycle occurs. During the bust cycle, bankruptcies occur and some debt is converted to equity. Since debt is typically owned by banks, the banks eventually wind up owning everything.

The Federal Reserve states that its goal is to smooth out the business cycle, but that is impossible because it is the cause of the business cycle. There's no way that the Federal Reserve could keep the economy running by keeping interest rates fixed forever. At some point, loan payments would start exceeding the loans that were taken out, causing a recession.

The first business cycle induced by the Federal Reserve was the Great Depression. At that time, they didn't have the experience to know how to smooth out the cycle. As debt increases faster than the money supply, their ability to smooth out the business cycle will erode.

There were business cycles before the advent of the Federal Reserve. What happened was that the banks were informally colluding to simultaneously offer more loans or fewer loans. Large international banks were colluding and using fractional reserve banking to expand and contract the money supply. Large international banks were able to import/export gold to expand or contract the money supply. They didn't have the benefit of government-forced collusion that they do now, but they still did a pretty good job of creating business cycles to benefit themselves.

The Great Depression is explained as a consequence of largesse. Some people say a depression is the natural after-effect of an expanding economy. That is nonsense. The Federal Reserve is responsible for boom/bust cycles in the economy. Other countries also have boom/bust cycles, because they also have a corrupt monetary system and central bank.

The Federal Reserve Slows Economic Growth

Keeping interest rates at an artificially low level does not stimulate economic growth. Instead, it encourages wasteful spending on projects that aren't economically worth it.

Simple common sense says that the interest rate that maximizes economic growth is the interest rate determined by the free market. Artificially high interest rates would bring economic growth to a halt, because people would prefer to invest in government bonds instead of building things. Artificially low interest rates encourages wasteful spending; the cost is paid by everyone else in the form of inflation.

For example, suppose a corporation is considering borrowing $100M to build a factory. At an artificially low interest rate of 6%, it makes sense to build the factory. At an interest rate of 10%, which is what the free market rate would be, it would not make sense. With artificially low interest rates, the factory is built. In the meantime, everyone else experiences an extra $100M worth of inflation because of the extra money put into circulation by the loan. The inflation experienced by everyone else is more than the value of the factory. The effect of one single loan is negligible, but when you add up all of them it's a big deal.

The Federal Reserve Causes Volatility in the Stock Market

On a typical day, most stocks move up or down in unison with the indices, with a few exceptions for companies or industries that are moving on specific news. It is ridiculous to believe that a stock that was worth $50 yesterday is worth $48 today, with no substantial news released that affected that company or the economy as a whole.

What is really happening with stock market volatility is that it's volatility in the supply of money. With much more debt outstanding than money in circulation, slight changes get amplified. It's not that the stock went down 2% in one day. It's that the supply of dollars went down 2% in one day; it happened to be a day where more loans were being repaid than new loans were issued.

The Federal Reserve Gives Profits to Insiders

Someone who knew in advance what the Federal Reserve was going to do would have the opportunity to profit immensely.

When the Federal Reserve was first created, artificially low interest rates created the boom in the 1920s. People were encouraged to speculate due to artificially low interest rates. At that time, the Federal Reserve did not publish its interest rate target or reveal its intentions to the public. The Federal Reserve insiders knew that interest rates were going to rise and this would case a depression. They knew to stop issuing loans and convert their holdings to cash before everyone else knew the crash was coming. Then, they were able to buy assets cheap during the depression. They bought up stocks and the debt of good companies at a huge discount to its fair value. They intentionally prolonged the depression, keeping interest rates high, until Roosevelt became president so he could receive credit for ending the depression.

Nowadays, the Federal Reserve is under more public scrutiny. Still, someone who knew about even a 25 basis point move in interest rates would have the opportunity for a huge profit.

The Federal Reserve Ceased Publishing M3

The Federal Reserve decided unilaterally that it would stop publishing M3. The official reason that it was too hard to collect the information. That reason is silly, because instead of publishing it weekly or monthly, they could publish it quarterly or annually, which would still be sufficient disclosure. The Federal Reserve stopped publishing M3 because the huge foreign holdings of dollars would have been too embarrassing.

Ron Paul tried to get Congress to force the Federal Reserve to resume publishing M3, but failed. He said that the other members of Congress didn't understand the issue.

The Federal Reserve Has Never Been Properly Audited

The Federal Reserve has had superficial audits, so it can genuinely claim to have been audited. However, its open-market transactions have never been audited. It has successfully resisted all attempts to audit them or have them made public.

The Federal Reserve Claims that its Records are Immune from the Freedom of Information Act

On its website, the Federal Reserve claims that the details of its open-market currency operations are immune from the Freedom of Information Act. Why would they make that claim unless they had something to hide?

The reason the Federal Reserve wants nobody to see their open market transactions is that they don't want anyone knowing that they primarily act to keep interest rates artificially low. Also, I suspect that the Federal Reserve is intentionally keeping its profits low so it doesn't have to return too much surplus money to the government.

The Federal Reserve Fixes Long-Term Rates and Short-Term Rates

The Federal Reserve only directly fixes short term interest rates. The Federal Reserve claims that it allows the market to determine long-term interest rates. However, because the Federal Reserve is expected to continue fixing interest rates in the future, this affects long-term bond yields. If the 10 year bond yield is 4.8%, that means that the market expects the average short-term interest rate over the next 10 years to be 4.8%. That is approximately guaranteed by predicting the Federal Reserve's policies.

If the expected average future Fed Funds rate and the Treasury yield didn't match, then professional traders working in the "free market" would perform an interest rate swap and correct the discrepancy.

The Federal Reserve Does not Manage the Debt Demand

The Federal Reserve manages the money supply, but that's only half of the picture. It also should be managing the debt demand.

Due to the Compound Interest Paradox, the total debt can only grow exponentially faster than the money supply.

Sound monetary policy would have the total money supply be greater than the total debt.

The Federal Reserve Has Stolen the Social Security Trust Fund

Interest rates are kept at an artificially low level by the Federal Reserve. The Social Security Trust Fund is invested in government bonds. The yield of these bonds is kept artificially low. If Treasury bonds earned a true market rate, which is 3-5% more than the current rate, then the Social Security Trust Fund would not be insolvent.

Besides, the whole point of Social Security is not "is there money around to pay the benefits". The real question is "does our economy have enough surplus productive capacity to support retired people"? Due to artificially low interest rates, the productive capacity of the economy will always be greater than the aggregate purchasing power. The government could, if it wanted, fund Social Security by deficit spending or printing new money. The surplus productive capacity is there; there just isn't money around to buy it.

A government surplus is deflationary. A government deficit is inflationary. A government can't store value by holding money in a special account, because there's no intrinsic value to the money.

Actually, investing the Social Security Trust Fund in the stock market or in gold wouldn't have been such a stupid idea. Then, there would have been actual real value stored, rather than a bookkeeping fiat money trick. Purchasing gold and silver actually makes more sense than stocks, because gold is the traditional store of value. There is one objection, that the government shouldn't be involved in the market. Social Security should be insurance, independent of the market. On the other hand, if there was a stock market crash, deficit spending by the government would be needed to reintroduce money into circulation, so it would make sense to invest the trust fund in the market and have the government guarantee the benefits with deficit spending, if necessary.

The Federal Reserve Has Stolen the Retirement Savings of Most Americans

The average person near retirement is advised to keep a substantial amount of his savings in bonds. Because interest rates are artificially low, a person who invests in bonds receives a far lower interest rate than he would receive if interest rates were determined by the market. Since interest rates are artificially low by 3-5%, this means that the Federal Reserve steals 3-5% of all money invested in bonds each year, and turns that money over to the financial indsutry.

The Federal Reserve Discourages Saving by Most Americans

Interest rates are artificially low, and the average person keeps his savings in a bank account. The interest the average person receives is insufficient compensation for the loss in value over time to inflation. The reward for saving is sufficiently low to discourage saving.

Also, because of the Compound Interest Paradox, there just isn't enough money in circulation to allow for every American to have savings. Money is created via debt, so one person's savings must be offset by a greater debt by someone else or by the government.

The Federal Reserve is Responsible for the Resentment of the Average Citizen Towards the Wealthy

The average person intuitively, and correctly, believes that any wealthy person must have earned his money due to the suffering of others. Logically, that makes little sense, because someone who produces something valuable benefits everyone and should be rewarded. However, because debt always increases faster than the supply of money, one person can have great wealth only if a lot of other people are in debt. There isn't enough money in circulation to simultaneously pay back all debts, so anyone with a lot of money has it at the expense of many other people in debt.

In other words, the average person has intuitively figured out the unjust nature of the system. They can't point to the specific reason, the Federal Reserve, because the Math is complicated, the average person is intentionally kept ignorant about Math, and the details are carefully hidden. In a properly functioning monetary system, one person's wealth would not be guaranteed to come at the expense of the suffering of many others.

If there was enough money in circulation to simultaneously pay back all debts, then you wouldn't have so many people forced into bankruptcy.

The Federal Reserve Has not Returned its Profits to Congress

The Federal Reserve was originally supposed to return its profits to the government. As indicated in a previous post, the Federal Reserve can make a guaranteed riskless profit. However, I suspect it keeps its profits artificially deflated to avoid turning money over to the government. As the Federal Reserve builds up a cash surplus, instead of printing money to buy Treasury bonds, it just directly buys them with cash. This deflates its apparent profits. The Federal Reserve's open market transactions have never been audited, so it's impossible to say what's really happening.

Abolishing the Federal Reserve Might be Necessary to Prevent Total Worldwide Economic Collapse

Debt can only grow exponentially faster than the money supply, due to the Compound Interest Paradox. When money is created via debt, only the principal is created and not money to make the interest payments. As debt grows exponentially faster than the money supply, eventually the total debt will be huge compared to the money supply. Then, even a slight change in interest rates will have a dramatic effect on the total money supply. Pretty soon, the Federal Reserve might lose its ability to stabilize the economy via interest rate manipulations. As the debt grows, there is a risk of more severe oscillations between deflationary recessions and inflationary booms.

Government debt isn't included in money supply statistics. However, government debt counts as money for all practical purposes, because there is a liquid market where government debt can be traded for cash. The Federal Reserve doesn't have a trick for reducing the total amount of government debt, and huge government debt is needed to allow the private sector to have any money at all.

Since the US economy is intricately linked with the world economy, a collapse in the US would have a severe effect on other countries as well.

Maybe Total Worldwide Economic Collapse is a Good Idea

Perhaps it would be better if the current fiat money system completely collapsed. The collapse would be caused by people switching to alternative monetary systems and avoiding income taxes.

Perhaps the only fair solution is a complete collapse of the current economic system, and the destruction of all dollar wealth and stock market wealth.

The people who think they're the economic and political leaders had their chance to fix the current economic system. They could have fixed the current system and protected their wealth. There have been plenty of people who have warned them about the defects in the current system. They had the chance to clean up their mess, and they neglected their responsibility. The people who think they're the economic and political leaders deserve to lose their wealth and power.