Subprime Loans and Abolition of the Federal Reserve Bank

O'Reilly's bluster signifies nothing because he is not willing to discuss underlying causes. We cannot "fix it" if we do not understand the reasons for banking losses (and O'Reilly's claim that there is a CRISIS! is not true. (H/t Larwyn and Stop the ACLU for video clip.)

From the 1820s until 1913 there was no Federal Reserve or central bank. From 1913 to 1932 the Fed had restricted power to expand and contract the money supply. Even so, with that limited power, the Fed managed to create the Great Depression that began with the stock market crash of 1929. Rather than reconsider the Fed's existence, the American political establishment at that time used the high unemployment that Hoover's and Roosevelt's Progressivism caused as pretext to remove all restrictions on the Fed's money-creation power. In the twentieth century, the American economy has been considerably less innovative than it had been in the nineteenth. The Fed has allocated capital in directions that accord with the banking establishment's preferences rather than entrepreneurs'. This effect combines with high income and other taxation to squash innovation.

The Fed has the power to create money, which it does primarily through purchase of bonds from commercial banks. The banks then lend a multiple of the reserves the Fed deposits. As a result, banks profit handsomely from new money. The chief borrowers, hedge funds, large corporations and government, also benefit. As the dollars circulate, more money chases more goods, but the increase in goods is less than the money supply increase. The reason is that the next project is less productive than the last. As the money supply expands, the less valuable projects receive funding. Artificially depressed interest rates facilitate otherwise impractical projects. As the quantity of money increases, bankers become eager to invest since low returns are sufficient to cover their costs.

Similarly, as the Fed "prints money" the stock market is invigorated because lower interest rates increase the present value of future earnings. Interest rates go down because the amount of money goes up. Wall Street and hedge funds benefit from the fresh money because investors are drawn to the market as it inflates. Naive speculators are the victims, not the cause of this process. The Fed is the cause. As well, mortgage borrowers benefit as do homeowners and other real estate investors.

As the money the Fed creates circulates, prices begin to rise because low quality projects are not worth the counterfeit dollars that funded them. Sub-prime loans are an extreme example of this. Rising prices help some, such as debtors. The wealthy, the owners of stocks and hedge funds were helped when the banks lent the hedge funds money. Losses they subsequently sustain due to inflation are offsets to their gains from Fed counterfeit. The inflation losses are less than the investment gains because the fresh money was distributed in a more concentrated way among a few hedge fund managers while the price increases are diffused over all Americans.

Part of the rationale for the Fed's existence is its "expert" management. William Greider's "Secrets of the Temple" is full of naive hyperbolic awe of the Fed's abilities. Similarly, the Economist Magazine recently ran an article praising the "expertise" of the Fed's economists. However, the Fed's historical track record is dismal. The Fed has overseen a long term reduction in innovation, the Great Depression, the 1970s stagflation, and now multi-trillion dollar banking losses for which the average American is asked to further subsidize commercial banks and investment companies who have been milking them dry for decades.

The nineteenth century did just fine without the Fed. The 20th century saw several major economic disasters (there was one in the late 1910's right after the Fed was founded) and a slackening of American innovation. The late twentieth century saw an explosion of misallocation of wealth to Wall Street and real estate development funded through commercial banks. This misallocation seemed to make America richer in the last two decades because houses and cars were getting bigger, but in reality it made America poorer because we could not really afford those houses or SUVs.

The economists at the Fed are responsible for massive misallocation of resources. Their "paper economy" approach has lead to bad ethics, bad investments, less innovation and massive diseconomies of scale, as the very large financial conglomerates that have been picking Americans' pockets now come to them with hat in hand.

The debate about abolition of central banking was diffused throughout America in the 19th century, and although most Americans lacked high school degrees, they well enough understood what was at stake. As education rates increased, Americans' ability to discuss this issue declined. Americans became docile to the claims of quackish professionals who, like the good people who run the Fed, know more about less, and the less they know is irrelevant to practical reality.

The abolition of the Federal Reserve Bank would improve life for all except the economic elite. Investment bankers, real estate developers and hedge fund managers would suffer and would oppose this step. The media, from Bill O'Reilly and Rush Limbaugh on the right to to the editors of the New York Times on the left, do not merely oppose such a step. They find discussion of it threatening because their employers, Rupert Murdoch and the Ochs Sulzbergers, are direct beneficiaries of the system. For instance, O'Reilly's Spin Zone emphasizes the role of "speculators" in causing inflation (a nonsensical distortion that goes back to the days of the Roman Emperor Diocletian in fourth century Rome, which was an inflationary period due to debasement of the currency) but O'Reilly has never once mentioned the Fed. O'Reilly's spin is more vicious than MS-NBC's. At the end of each show Mr. O'Reilly says that he looks out for his viewers. A con man who claims to be honest, Mr. O'Reilly's spin is worse than Chris Matthews's and Keith Olbermann's, buffoons who openly spin the news.

The Federal Reserve Bank ought to be abolished. It is a failed institution, a Progressive Rube Goldberg device that has caused one financial debacle after the next even as it has transferred wealth from the average American to the wealthy.