Sunday, November 21, 2010

Who Said We Need A Fed?

Mitchell Langbert, Ph.D.

In early July of this year, Representative Maurice Hinchey, who had co-sponsored a bill that aimed to require an audit of the Federal Reserve Bank, voted against the bill that he had co-sponsored.  According to Representative Ron Paul, 114 congressional Representatives flip-flopped on an elementary requirement of transparency for an institution that affects you every single day.  Representative Hinchey and so many of his colleagues flip-flopped because the bill threatened powerful banking and Wall Street interests.  Hinchey deferred to Wall Street. 

No issue is of greater importance to you than the Federal Reserve Bank. Yet, there is scant discussion of it in the Democratic Party media.  If you believe the media and university economists, the Fed is, to quote Churchill, “a riddle, wrapped in a mystery, inside an enigma.”  Churchill so described the Soviet Union, and he said that the key to understanding it was the USSR’s national interest.  The key to understanding the Fed is Wall Street’s and the money center banks’ financial interests.  Once you recognize that the Fed does not serve you and does not serve the United States but serves commercial banks, Wall Street and hedge funds, you can begin to understand the Fed’s function.  It is not to cure unemployment or to cause or reduce inflation (it generally causes inflation).  Rather, it is to transfer wealth from you to financial interests. Representative Hinchey stands on the side of the Fed, not on your side.


In the nineteenth century there was much debate about a national bank.  In the 1820s and 1830s workers opposed it.  In his classic, Pulitzer Prize-winning book, Age of Jackson, Arthur M. Schlesinger describes the Loco Focus and the Workingmen’s Parties of the period.  These were parties of workingmen who opposed banking “monopolies”, that is, banks as we know them.  President Jackson disliked the Second Bank of the United States because he had lost money in a speculative venture and knew that there is a tight link between central banks and financial bubbles.  That was true in the days of the South Sea bubble following the creation of the Bank of England and is true today with the Fed and the stock and real estate bubbles of the past 75 years (since 1935 there have been recurring bubbles in the stock and real estate markets, and they have become more extreme over time).

In the mid to late nineteenth century some farmers and “Progressives” advocated re-adoption of a central bank.  Farmers are in part real estate investors, and the central bank (the Fed) aids real estate.  Historians tend to overlook this motivator for western agriculture’s late 19th century support for a central bank.  But in his Age of Reform and elsewhere Richard Hofstadter notes, when not discussing the sensitive and partisan issue of banking, that farmers were in large part real estate speculators.  Twentieth century American historians, loyal to the New Deal, saw farmers as real estate speculators when not discussing the central bank, but saw them as needy debtors when discussing Populist support for the central bank.

Characteristics of Deflation in the Gilded Age

If you read Democratic Party newspapers you have probably heard that deflation (falling prices) is bad.  But common sense tells you to look for lower prices.  Although there was debate at the time, the long deflation during the late nineteenth century (known as the Gilded Age) had these attributes:  

  1. There was a heavy immigration into the country as foreigners, such as my own ancestors from Austria-Hungary and Russia, heard that the streets of America were “paved with gold.”  In fact, America had a gold standard and workers were becoming wealthier.
  2. The real hourly wage, the best indicator of the average worker’s welfare, what they can buy based on an hour’s work, increased at a two percent per year pace.   Workers were saving more and living better than ever before in 1890.  
  3. There was rapid technological, economic and business innovation. The economic historian and, under Lincoln, first head of what is now called the Internal Revenue Service, David Ames Wells, detailed the innovation in his 1889 Recent Economic Changes.  Just a handful of the thousands of innovations and inventions during that period were: the electric light; motion pictures; the phonograph; the telephone; the basic technology for radio and television (1897); the Alternating Current that powers all of your home appliances; remote control; and the mass production of automobiles.
  4. Asset prices were NOT increasing.  Deflation meant that real estate values fell. Stocks in 1935 were selling for about the same price as they had in 1885.  In the late 19th century Wall Street’s influence was diminishing.

Inflation Not a Wonderful Life

Contrast the innovation in the Gilded Age with today’s business world. Companies increase profit by moving out of the country to seek low-wage labor in China and Indonesia. There is little interest in doing things better, only more cheaply.  Fundamental innovation began slowing soon after the establishment of the Federal Reserve Bank in 1913. Progress since the 1920s has capitalized on ideas that had been established in the Gilded Age.  These include Tesla’s wave concepts that led to radio, television and wireless.  Post 1980 innovation has been more rapid than during the New Deal era, but has been much slower than in the 19th century.

Similarly, the real hourly wage has not increased since 1970.  Inflation has eliminated the growth in the real hourly wage.  At the same time, stock and real estate prices have shot up.  This has resulted in income and wealth inequality as the beneficiaries of inflation have seen their stock holdings rise while the losers from inflation, workers, have seen their real wages frozen.  

The Democratic Party and Rockefeller Republicans blame income inequality on Ronald Reagan. But they overlook the decline in the real hourly wage that occurred in the 1970s, years before Ronald Reagan took office and directly following Richard M. Nixon’s elimination of the gold standard.

The Fed Has Caused Manufacturing to Exit

Recent history has seen manufacturing exit the nation.  As the Fed has expanded the money supply it has worked out a deal with foreign central banks to buy US bonds.  As a result, the dollar is propped up, making it stronger. The effect is that Fed policy has encouraged firms to exit the US. 

The reason is that every currency has value relative to every other currency.  For instance, a dollar is currently worth an exchange rate of 83 Japanese Yen. Let’s say a huge number of firms decide to move to Japan.  Demand for Yen would increase as the firms invest in Japan, while demand for dollars would decrease as the firms stop doing business here.  The lower demand for dollars would cause the value of the dollar to decrease.  That would make Yen more expensive relative to the dollar.  The firms moving to Japan would see their goods become more expensive in the US because of the low value of the dollar. Many dollars would be needed to buy Yen. Japanese goods would become more expensive.  That would end the migration to Japan.

The Fed and its sister central banks have not allowed that to happen. Firms have exited the US, reducing demand for dollars, but the dollar did not get weaker. The reason is that the Fed has made deals with the other nations’ banks for them to buy dollar-denominated assets, Treasury Bonds, artificially creating demand for dollars.  The result is that American workers have lost their jobs but foreign goods remain cheap. 

In response, university-based economists and Wall Street “experts” complain that there is “deflation” because of the cheaper foreign goods. The response is to advocate that the Fed print more money.  The printed money is placed into the hands of commercial banks and then hedge fund operators and Wall Street, who buy foreign commercial paper and profit from the spread between the interest rates here and in Japan and elsewhere. Income inequality is increased as wealth is transferred to wealthy Wall Street and hedge fund interests.  University-based economists hunker after appointments and Wall Street consultancies.

How the Fed Works

There are many good books on the Federal Reserve Bank, such as Murray N. Rothbard’s What Has Government Done to Our Money? and his Mystery of Banking, which are available online from the Ludwig von Mises Institute.  Rothbard makes clear that the basics of the Fed and banking are no mystery.  The kind of banking that America has is called fractional reserve banking.  It is so called because bankers can lend out ten dollars for every dollar that is deposited in the bank. The reserves are fractions of the deposits.  There is also banking that is not fractional reserve banking.  Were fractional reserve banking illegalized there would be reduced harm to the environment caused by over-development of real estate; the business cycle would be eliminated; stocks and real estate would fall in value; and over time innovation would increase as firms competed on the basis of ideas rather than access to credit.

The Fed has the power to create money out of thin air. It does this by buying US Treasury bonds.  Contrary to some recent claims in videos, government debt is not essential to the Fed’s money creation power, although in practice it is closely linked.  The Fed can print money and use it to buy automobiles.  But in practice it uses the counterfeit it creates to purchase treasury bonds from banks.  When the Fed deposits the money it creates out of thin air in the bank’s account at the Fed, the bank can then lend up to 90% of that deposit.  The borrower deposits his loan in his bank. That deposit then serves as a reserve for a further loan of up to 90% of the 90%, or 81%.   The process continues.  Ultimately, the banking system can lend $10 for every dollar the Fed creates.  Both the commercial banks and the banking system are legally allowed to counterfeit money.  The Fed counterfeits the reserves and the commercial banks counterfeit up to ten times the reserves.

A large share of this process occurs in New York City in money center banks. In turn, banks like Citigroup lend to Wall Street.  Much of Wall Street’s business, such as mergers and acquisitions, depends on the counterfeit money.  If Wall Street is good at what it does, it profits from the counterfeit.  If it is poor at what it does, it loses (as we saw with the sub-prime crisis).  In either case you get poorer because of the Fed’s printing money.

The reason you get poorer is that the Fed increases the amount of money in existence so that your money is worth less. Unless you’re one of the people who gets the hot new money, you lose.  In practice, the money goes in part to home buyers and small business but it goes disproportionately to Wall Street and corporate America.  As the money circulates food and housing prices are bid up because there is more money in circulation.

Stock Market’s Gain Is Your Loss

The Democrats say that they favor the poor but they were the party that created the Federal Reserve Bank under Woodrow Wilson and the first party to give the Fed unfettered power under Franklin D. Roosevelt.  The Republicans followed suit, with Richard M. Nixon finally abolishing the gold standard respecting international payments, the last restraint on the Fed’s ability to counterfeit.  There has been a 75 year bull market in stocks since Franklin D. Roosevelt abolished the gold standard.  Because of the Fed, financial interests have grown rich to a degree unimaginable in the 19th century. With one or two exceptions, such as John D. Rockefeller, the hedge fund operators of today dwarf the “robber barons” of that era in terms of wealth. Unlike the robber barons, today’s hedge fund operators produce nothing of value.

The Democrats’ and Rockefeller Republicans’ decades-long support for the Fed belies their claims that they serve the poor.  Only the wealthy, people like George Soros, Michael Bloomberg and Mrs. Paul Pelosi, can afford to own large amounts of stock. By expanding the money supply the Fed supports the stock market.  This occurs because the additional money reduces interest rates. Lower interest rates make the value of future dividends worth more.  At one percent interest a divided of $1 paid in one year is worth about 99 cents today, while at ten percent interest a dividend of $1 paid in one year is worth about 90 cents today.  By expanding the money supply the value of future dividends from stocks is raised. This causes the stock market to rise.  

Because of the New York Times Democrats and Rockefeller Republicans, the stock market has risen to unprecedented heights.  But the value of the new money diminishes.  The Fed, realizing that Wall Street might be harmed by a declining stock market, has drastically increased the amount of money it is printing, so-called Quantitative Easing or QE-2.  As the Fed revs up the printing presses, the American Republic starts to look like the Weimar Republic of 1920s Germany.  This has been a century-long process that Austrian economists such as Ludwig von Mises, Friedrich Hayek and Murray Rothbard have been predicting for the past 85 years.   

Mitchell Langbert is associate professor of business at Brooklyn College. He blogs at


Hridaynath said...

We absolutely do not need the feds. You are so right professor!

I still remember the time when they were bailing out these corporations crooks and you told us "Too big to fail? Let them fail, Let GM fail so one day we will have good cars once again" People these days do not believe in hard work! because they do not like to fail. Failure is a part of success. You work hard, you fail, and you try again, but harder and more intelligently this time. Thats why we have version 2.0 and 3.0 because people want to improve but by looking at the way the Feds are functioning, it doesn't look like we are improving, instead our lifestyle is continuously declining, we have more credit card debts than any country in the world!!!

I just love your blog. Thank you

Anonymous said...

Why are you silent on the TSA pat downs. Your libertarian silence is deafening.