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Saturday, June 14, 2008

The Compound Interest Paradox Revisited - Edward Flaherty is a Troll

Table of Contents

Overview
The Federal Reserve
Free Market Banking
A List of Monetary Systems
Examples
Edward Flaherty is a Troll
Summary

I read SO MANY people citing Edward Flaherty that I feel obligated to write a specific post refuting his false arguments.

This is the most frequently cited article by Edward Flaherty. Here is a shorter version of the same thing.

Here is a point-by-point debunking of Edward Flaherty's false debunking.

Myth #1: The Federal Reserve Act of 1913 was crafted by Wall Street bankers and a few senators in a secret meeting.

Hypothesis: Bankers and senators met in secret on Jekyll Island, Georgia in 1910 to design a central bank that would give New York City banks control over the nation's money supply.

Facts: The meeting did take place, but plans for a return to central banking were already widely known. Regardless, the proposal that came out of the Jekyll Island meeting never passed Congress. The one that did, the Federal Reserve Act, placed control over monetary policy with a public body, the Federal Reserve Board, not with commercial banks.

Based on the sources I read, there *WAS* a secret meeting regarding the creation of the Federal Reserve. It's impossible to go back in time and check, so there's no way to resolve this disagreement.

Under the Federal Reserve, the New York City branch is firmly in control of the US monetary system. The regional banks are a decoy. The "open market operations" are performed by the New York branch of the Federal Reserve. This is where the real power of the Federal Reserve lies. On the "Open Market Committee", which sets the Fed Funds Rate target, there are 12 total members. There are the 7 members of the Board of Governors, appointed by the President for 14 year terms, and 5 presidents of the district banks, with the New York branch *ALWAYS GETTING A SEAT* (the other 4 positions rotate).

The Federal Reserve Banks are privately owned. Executives must be approved by the Board of Governors, but the executives are always appointed by the private investors who own the Federal Reserve. The Board of Governors is chosen by the President and confirmed by the Senate. However, the President *ALWAYS* chooses the nominee from a short list of candidates chosen by financial industry insiders. Someone who isn't part of the "in crowd" of the financial industry has NO CHANCE of being nominated. A President who disobeyed the financial industry would probably be unable to get his nominee confirmed by the Senate. Further, the Federal Reserve can cause recessions at will. A President that is hostile to the Federal Reserve will be unable to get reelected (or even survive long without being assassinated).

Besides, the argument against the Federal Reserve is unrelated to the means by which it was created. It's obvious that the Federal Reserve is immoral. Whether it was created as part of a conspiracy or not is irrelevant.

Myth #2: The Federal Reserve Act never actually passed Congress. The Senate voted on the bill without a quorum, therefore the Act is null and void.

Hypothesis: Supporters of the Federal Reserve Act knew they did not have the votes to win, so they waited to vote until its opponents left for Christmas vacation. Since a majority of senators were not present to vote on the bill, its passage is not constitutionally valid.

Facts: The voting record clearly shows that a majority of the senate did vote on the bill. Although some senators had left Washington for the holiday, the Congressional Record shows their respective positions on the legislation. Even if all opponents had all been present to vote, the Federal Reserve Act still would have passed easily.

I don't recognize any government laws as having legitimacy. The legitimacy of the Federal Reserve is the same as all other aspects of the government: ZERO. If you want a full technical analysis of the Federal Reserve's legality, there are several aspects.

First, the Federal Reserve Act was passed immediately before Christmas. Several influential Congressmen who were opposed to the Federal Reserve had already left for holiday. Congress had a tradition that says important legislation is not passed immediately before Christmas. Of course, government is arbitrary and can do whatever it chooses.

Second, the Constitution grants control over money to Congress. Congress does not have the right to delegate this power to a private corporation, the Federal Reserve. Similarly, it would be just as unconstitutional to turn over control of the US military to a private corporation. (Has that happened also? Is Blackwater effectively the US military now?)

Third, the Constitution says that states may only declare gold or silver as money. This ban does not extend to the Federal government. However, the intent is obvious. Further, states have been disallowed from issuing their own metal-based money that competes with the Federal Reserve. The false reasoning the Supreme Court used is that usurps Congress' money-printing authority.

Arguing the legality or Constitutionality of the Federal Reserve is pointless. At this point, the Supreme Court isn't going to declare that the government has been operating illegitimately for 100 years. Government has no legitimacy, so arguing the legitimacy of the Federal Reserve is pointless in comparison.

The *MORAL* argument against the Federal Reserve is much more important than the legal argument.

Myth #3: The Federal Reserve Act and paper money are unconstitutional.

Hypothesis: The constitution does not specifically grant Congress the power to create a central bank, therefore it cannot legally do so. The constitution also forbids paper money and requires all money to be either gold or silver coin. Therefore, both the Federal Reserve and its paper money currency are unconstitutional.

Opinion: A central bank is a reasonable use of the constitution's 'necessary and proper' clause, according to many federal court and Supreme Court rulings. Although the constitution forbids States from making anything but gold or silver a legal tender, it places no such restriction on Congress.

I addressed this point immediately above.

The framers of the US Constitution forbade states from declaring anything other than gold or silver as money. They did not put this restriction on the Federal government, but I consider that to be a technicality. The intent is obviously that only gold or silver were to be money.

Arguing the legality or Constitutionality of the Federal Reserve is pointless.

Remember: Just because the Supreme Court or a Federal appeals court says something is acceptable, doesn't automatically mean it's true. Just like Congress and the President were subverted, the court system was also subverted.

The *MORAL* argument against the Federal Reserve is much more important than the legal argument.

Myth #4: The Federal Reserve is a privately owned bank out to make a profit at the taxpayers' expense.

Hypothesis: Each of the 12 Federal Reserve banks is a privately owned corporation. Like any firm, their main objective is to maximize profits. They do so by lending the government money and charging interest. They manipulate monetary policy for their own gain, not for the public good.

Facts: Yes, the Federal Reserve banks are privately owned, but they are controlled by the publically-appointed Board of Governors. The Federal Reserve banks merely execute the monetary policy choices made by the Board. In addition, nearly all the interest the Federal Reserve collects on government bonds is rebated to the Treasury each year, so the government does not pay any net interest to the Fed.

This is entirely missing the point. The point of the Federal Reserve is not profits to the Federal Reserve banks themselves. The point is the massive subsidy to the financial industry and large corporations in the form of negative real interest rates.

I address interest on the national debt it "The National Debt - Who is the Creditor?"

Myth #5: The Federal Reserve is owned and controlled by foreigners.

Hypothesis: Major European banks and investment houses own the Federal Reserve. From across the Atlantic they dictate monetary policy for their own benefit.

Facts: No foreigners own any part of the Fed. Each Federal Reserve bank is owned exclusively by the participating commercial banks and S&Ls operating within the Federal Reserve bank's district. Individuals and non-bank firms, be they foreign or domestic, are not permitted by law to own any shares of a Federal Reserve bank. Moreover, monetary policy is controlled by the publically-appointed Board of Governors, not by the Federal Reserve banks.

It is unknown who actually owns the Federal Reserve.

The Federal Reserve is probably mostly owned by US corporations. However, with anonymous corporate ownership, how could you tell who are the true owners of the Federal Reserve?

For example, Citigroup could own shares in the Federal Reserve, and foreigners could own a controlling interest in Citigroup.

Unless you provide a full list of which corporations own the Federal Reserve *AND* a full list of the shareholders of each such corporation, you DON'T KNOW who really owns the Federal Reserve.

Myth #6: The Federal Reserve has never been audited.

Hypothesis: The Federal Reserve consistently resists attempts to audit its books. This is because any independent inspection would reveal the Fed's treachery.

Fact: Independent accounting firms conduct full financial audits of the Federal Reserve banks and the Board of Governors every year. The Fed is also subject to certain types of audits from the Government Accounting Office.

The Federal Reserve's open market operations have never been audited. The full details are carefully kept secret.

Myth #7: The Federal Reserve charges interest on the currency we use.

Hypothesis: Federal Reserve Notes, the currency we use in the United States, are evidence of the debt of the U.S. government to the Federal Reserve. The central bank charges the government interest for this currency, thereby diverting billions of dollars from the Treasury that could be used for other things. The government could print its own money and avoid the Fed's interest.

Facts: The Federal Reserve rebates its net earnings to the Treasury every year. Consequently, the interest the Treasury pays to the Fed is returned, so the money borrowed from the Fed has no net interest obligation for the Treasury. The government could print its own currency independent of the Fed, but there would be no effective safeguards against abuse of this power for political gain.

This is entirely the whole point of the Compound Interest Paradox. Every dollar in circulation only exists due to a loan. The principal is created but not the interest.

The interest the Federal Reserve receives on Treasuries it owns is only a small slice of the massive subsidy the financial industry receives.

The Federal Reserve is not a check against abuse of the monetary system. The 12 people on the Federal Reserve Open Market Committee wield more economic power than the Politburo in the Soviet Union. Anyone who knows in advance what the Federal Reserve is going to do has the opportunity to profit immensely. In January 2008, the Federal Reserve announced a surprise 0.75% decrease in the Fed Funds Rate. People who knew in advance profited immensely.

Similarly, government directly printing and spending its own money is also abusable. However, free-market interest rates would be far preferable to the Federal Reserve negative interest rate subsidy.

The only fair monetary system is to completely remove all government regulation of money and banking. This would effectively mean a return to a gold standard or a gold/silver standard. Of course, this will not happen until the government collapses completely.

Myth #8: If it were not for the Federal Reserve charging the government interest, the budget would be balanced and we would have no national debt.

Hypothesis: When the government runs a budget deficit, it borrows the money from the Fed at interest. If the Fed did not charge interest or if the government simply printed its own interest-free currency, then we would have a balanced budget and no national debt.

Facts: The Federal Reserve banks have only a small share of the total national debt (about 7%). Therefore, only a small share of the interest on the debt goes to the Fed. Regardless, the Fed rebates that interest to the Treasury every year, so the debt held by the Fed carries no net interest obligation for the government. In addition, it is Congress, not the Federal Reserve, who is responsible for the federal budget and the national debt.

I address this in "The National Debt - Who is the Creditor?"

The national debt is a legal fiction. The US government is the issuer for dollars. You can have unlimited debt is the money you issue, without being forced into bankruptcy. Deficit spending by the Federal government is inflationary. However, more money is printed by the Federal Reserve and financial industry than is printed by Federal deficit spending.

Most of the benefit of printing new money accrues to the financial industry, and not the Federal government. Without the Federal Reserve, the government could directly print and spend money into circulation. Whenever Congress wants to, it could pass a law allowing it to directly print and spend money to pay down the national debt. The only problem with this method is fractional reserve banking. If Congress directly printed and spent $10 trillion, this would lead to $100 trillion in new money after the effect of fractional reserve banking.

The correct solution is a complete repeal of the Federal Reserve and all regulation of the banking industry. All the taxes and regulations that prevent people from using gold or silver as money also should be repealed. That is never going to happen.

Myth #9: President Kennedy was assassinated because he tried to usurp the Federal Reserve's power. Executive Order 11,110 proves it.

Hypothesis: In the months before Dallas, President Kennedy signed E.O. 11,110 which instructed the Treasury to issue about $4 billion of interest-free 'silver certificate' currency, thereby circumventing the Federal Reserve and the interest it charges. The Federal Reserve, fearful of further encroachments on its powers, had Kennedy killed.

Facts: Kennedy wrote E.O. 11,110 to phase out silver certificate currency, not to issue more of it. Records show Kennedy and the Federal Reserve were almost always in agreement on policy matters. He even signed legislation to give the Fed more authority to issue currency.

I have no idea why President Kennedy was killed. The people who organized it aren't going to come forward and admit it, now are they?

The motivations for killing Kennedy are independent of whether or not the Federal Reserve is evil.

E.O. 11,110 was an attempt to abolish/compete with the Federal Reserve. By issuing "United States Notes" directly into circulation, this runs contrary to the Federal Reserve's policy of negative real interest rates and economic debt enslavement.

When President Kennedy issued extra money, that caused interest rates to fall. Fractional reserve banking multiplies this extra money by 10x. With surplus bank reserves, the Fed Funds Rate falls. Normally, when the Federal Reserve "monetizes the debt", it makes a guaranteed riskless profit and subsidizes negative real interest rates at the same time. With extra money in circulation, the Federal Reserve would have to do the opposite to raise interest rates. It would have to sell Treasuries it had in reserve, losing money.

If the Federal government directly issues and spends money, without repealing or amending the Federal Reserve, the Federal Reserve could be bankrupted. The Federal Reserve would lose its ability to manipulate interest rates. Money directly printed and spent by the government prevents the Compound Interest Paradox from enslaving everyone.

Myth #10: Congressman Louis T. McFadden exposed the Federal Reserve scam in the Congressional Record.

Hypothesis: On the floor of the House in 1932, McFadden accused the Federal Reserve of costing the government enough money to repay the national debt several times over, of causing the Great Depression, and of many other terrible things.

Facts: McFadden was incorrect regarding the Fed costing the government money. However, later economic analysis agrees with him that Federal Reserve policy blunders had a substantial role in causing the Depression. However, his implication that this was done deliberately has no basis in fact. Moreover, for a dozen years prior to his rant, McFadden had been the chairman of the House subcommittee that oversaw the Federal Reserve. Why didn't he do anything to reform or abolish the Fed while he had the chance?

The Federal Reserve does cost the Federal government money. The profit gained by printing new money accrues primarily to the financial industry and large corporations, and not to the Federal government. Everyone pays the cost of inflation, but only a handful of people are the beneficiaries of inflation.

I read that Congressman McFadden *DID WANT* to reform or abolish the Federal Reserve. As only one vote, he was powerless to do anything. That's like asking "Why doesn't Ron Paul abolish or reform the Federal Reserve? He's on the House Banking Committee!"

There is evidence that insiders intentionally used the Federal Reserve to line their own pockets. A ton of people lost their homes and businesses during the Great Depression. A handful of insiders profited immensely. Insiders knew that interest rates would be jacked up in 1929, causing the Depression. Some large banks stopped issuing loans and converted their holdings to cash before the crash.

Myth #11: The Antidote to the Debt Virus

Hypothesis: All money is created only when someone takes out a loan. Therefore, there can never be enough of this debt-money in circulation to repay all principal and interest. This imbalance causes inflation, financial crises, social maladies, and will eventually destroy the economy unless there is a massive injection of "debt-free" money. This idea is from Dr. Jacques Jaikaran's book, The Debt Virus.

Facts: The hypothesis shows an incomplete view of how the banking system interacts with the economy. The system necessarily creates an amount of "debt-free" money equal to the interest on its loans. It does this whenever it pays operating expenses, dividends, or purchases assets. As a result, there is more than enough money in circulation to retire all bank-related debt.

This is entirely the Compound Interest Paradox. If you don't understand the Compound Interest Paradox, work out an example. Edward Flaherty says "The balance sheet of each individual bank balances. Therefore, there is no Compound Interest Paradox or Debt Virus." If you look at the books of society as a whole, the Paradox is obvious.

Whenever someone cites Edward Flaherty saying there is no Debt Virus, show them my page of examples. I have not seen any evidence that my examples are incorrect.

The reason the economy does not collapse immediately due the Compound Interest Paradox is that there is continuous inflation. There is always a shortfall of money to pay the interest, but new money is always being created. The people who get first dibs on this new money are the recipients of a massive government subsidy.

Myth #12: Exposing the Debt Virus fallacies

This article is a much more detailed critique of The Debt Virus than the previous article. The file is in PDF, so you will need to download your free copy of Adobe Acrobat Reader to view it.

I didn't bother reading this article. Let me know if you're interested in a detailed analysis of this nonsense.

Myth #13: Banks charge interest on money they costlessly create out of thin air.

Hypothesis: Through fractional reserve banking and double-entry accounting, banks are able to create new money with the stroke of a pen (or a computer keystroke). The money they lend costs them nothing to produce, yet they charge interest on it.

Facts: The banking system is indeed able to create money with a mere computer keystroke. However, a bank's ability to create money is tied directly to the amount of reserves customers have deposited there. A bank must pay a competitive interest rate on those deposits to keep them from leaving to other banks. This interest expense alone is a substantial portion of a bank's operating costs and is de facto proof a bank cannot costlessly create money.

A bank's ability to create money is completely decoupled from customer deposits. Banks with surplus reserves lend them to other banks. Banks with a shortage of reserves can borrow from other banks. The rate large banks charge each other for reserves is called the "Fed Funds Rate". Practically every day, the Federal Reserve repurchases Treasury Notes to increase the supply of bank reserves. The Federal Reserve will always create enough new bank reserves so that the Fed Funds Rate equals its target rate.

All a bank accomplishes by taking customer deposits is that it can lend them to other banks at the Fed Funds Rate, or it avoids having to borrow at the Fed Funds Rate.

A bank is restricted by its "net capital requirement". Suppose a bank is allowed to use a leverage ratio of 20x. This means that for every $1M in book value a bank has, it is allowed to issue $20M in loans. Leverage ratios are typically in the range of 10x-100x, depending on the type of debt. Bank regulations determine how much leverage banks are allowed to use for each type of asset. Since money is ONLY created by banks, this means that a certain % of the economy's capital is GUARANTEED to be owned by banks; otherwise, that money could not be created.

Myth #14: "Lawful money" is only gold or silver coin as prescribed by the constitution.

Hypothesis: The constitution specifies that only gold or silver coin may be used as money, also known as 'lawful money.' All other forms of money, particularly paper money, are illegal.

Fact: The term 'lawful money' does not refer to gold or silver coin, but to types of money which the government would permit banks to use when tabulating their reserves. These types of money included, but were not limited to, gold and silver coin.

This is a legal technicality. I don't recognize the US Constitution as having legitimacy, so why should I care if it allows unbacked fiat money or not.

The requirement that only gold and silver are money applies to states. The Constitution does not say what the Federal government is allowed to use as money. It's implied that the Federal government is also restricted to only allowing gold or silver as money, but a corrupt Congress, President, and Supreme Court think otherwise. A Constitution is useless when the people who make laws and sit in courts are corrupted.

Arguing the Constitutionality of unbacked fiat debt-based money is missing the point. The current monetary system is immoral, which is sufficient reason to boycott Federal Reserve Points.

When arguing against the Federal Reserve and the income tax, a "Constitutional" argument is missing the real point. The Federal Reserve and income tax are *IMMORAL*. The Constitutional argument is much less important than the morality argument.

I've also seen this article by Edward Griffin frequently cited. Surprisingly, Edward Griffin says "There's no such thing as the Debt Virus." Edward Griffin is wrong.

6 comments:

Barry b. said...

FSK,

Excellent, Excellent post. But....I don't have time to read the whole thing so I've bookmarked it and will read the rest of it tonight. I'm currently reading 'the age of turbulence' - greenspans bio. The Federal Reserve is 'immoral' - that's a very important point that I think is perhaps, the most overlooked. It's amazing what people are willing to give up in order to achieve undeserved prosperity....

I'll holla later

b

Anonymous said...

Good article. Others have refuted Flaherty(who seems to have a spam machine!) as well like Paul Grignon and Edward Griffin. Returning to the gold standard would not be a good idea though, see excellent doco: The Money Masters on googlevid. http://video.google.com/videosearch?q=the+money+masters&emb=0&aq=f#

jg said...

Isn't the gold standard just another way to artificially control the monetary system for the benefit of those with the most wealth?

Also, within the system we currently have, would it be feasible to enforce a full reserve banking with a fiat currency to address the issues at hand?

Cheers,
JHG

Ben Steigmann said...

Could you refute Flaherty's article "Myth #12: Exposing the Debt Virus fallacies"?

Blissentia said...

Actually, you already refuted it with your examples.

Anonymous said...

In your answer to Myth #2 you say:

"I don't recognize any government laws as having legitimacy."

In your answer to Myth #14 you say:

"I don't recognize the US Constitution as having legitimacy,"

I say:

"I don't recognize any so-called logic or reasoning in this blog as legitimate"

What a waste...

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