Federal Reserve
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The Federal Reserve System (also the Federal Reserve or commonly, "The Fed") is the central bank of the United States. It was created by the United States Congress through the passing of the Owen-Glass Act, signed by President Woodrow Wilson on December 23, 1913.
The Federal Reserve System is composed of a central Board of Governors in Washington, D.C. and twelve regional Federal Reserve Banks located in major cities throughout the nation. Alan Greenspan currently serves as the Chairman of the Board of Governors of Federal Reserve.
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Roles and responsibilities
The main tasks of the Federal Reserve are:
- Supervise and Regulate banks
- Implement Monetary Policy by buying and selling U.S. Treasury Bonds
- Maintain a strong payments system
- Feds cannot issue U.S. Treasury Bonds
Other tasks include:
- Economic education
- Community outreach
- Economic research
Organization of the Federal Reserve
The Federal Reserve is comprised of a board of governors. The 7 members of the board are appointed by the President and confirmed by the Senate. Members are elected to terms of 14 years, with the ability to serve for no more than one term. A governor may serve the remainder of another governor's term in addition to their own full term. The Federal Open Market Committee (FOMC) comprises the 7 members of the board of governors and 5 representatives selected from the Federal Reserve Banks. The representative from the 2nd District, New York, is a permanent member, while the rest of the banks rotate on two and three year intervals.
The current members of the Board of Governors are:
- Alan Greenspan, Chairman
- Roger W. Ferguson, Jr., Vice-Chairman
- Edward M. Gramlich
- Susan Schmidt Bies
- Mark W. Olson
- Ben S. Bernanke
- Donald L. Kohn
Interest rates
The Fed implements monetary policy largely by steering the federal funds rate, also called the overnight rate, using open market operations. This is the interest rate that banks charge each other for overnight loans to each other. This in turn influences the prime rate which is usually about 3 percentage points higher than the federal funds rate. This prime rate is the rate that most banks price their loans at for their best customers.
Lower interest rates stimulate economic activity by lowering the cost of borrowing, making it easier for consumers and businesses to buy and build. Higher interest rates slow the economy by increasing the cost of borrowing. (See monetary policy for a fuller explanation.)
The Fed usually adjusts the federal funds rate by 0.25 or 0.50 percentage points at a time. From early 2001 to mid 2003 the Fed lowered its interest rates 13 times, from 6.25 to 1.00 percent, to fight recession. In November 2002, rates were cut to 1.75, and many interest rates went below the inflation rate. On June 25, 2003, the federal funds rate was lowered to 1.00 percent, its lowest nominal rate since July, 1958, when the overnight rate averaged 0.68 percent. Starting at the end of June, 2004, the Fed started to raise the target interest rate in response to concerns about the potential for increased inflation from a too-active economy. As of October, 2004, the rate is at 1.75 percent following a series of small increments.
Who owns the Federal Reserve?
The Federal Reserve claims that nobody owns it – that it is an “independent entity within the government.” The Federal Reserve is subject to laws such as the Freedom of Information Act and the Privacy Act which cover Federal agencies but not private corporations; yet Congress gave the Federal Reserve the autonomy to carry out its responsibilities insulated from political pressure. Each of the Fed's three parts – the Board of Governors, the regional Reserve banks and the Federal Open Market Committee – operates independently of the federal government to carry out the Fed's core responsibilities. Once a member of the Board of Governors is appointed, he or she can be as independent as a U.S. Supreme Court judge, though the term is shorter.
As the nation's central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. The Fed's financial independence arises because it is hugely profitable due to its ownership of government bonds. It returns billions of dollars to the government each year. However, the Federal Reserve is subject to oversight by the Congress, which periodically reviews its activities and can alter its responsibilities by statute. Also, the Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government.
The twelve regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized much like private corporations—possibly leading to some confusion about “ownership.” For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold or traded or pledged as security for a loan; dividends are, by law, limited to 6 percent per year.[1]
The Federal Reserve System, frequently referred to as simply the Federal Reserve Bank, was created via the Federal Reserve Act of 1913 which "established a new central bank designed to add both flexibility and strength to the nation's financial system. The legislation provided for a system that included a number of regional Reserve Banks and a seven-member governing board. All national banks were required to join the system and other banks could join. The Reserve Banks opened for business in November 1914. Congress created Federal Reserve notes to provide the nation with an elastic supply of currency. The notes were to be issued to Reserve Banks for subsequent transmittal to banking institutions in accordance with the needs of the public.
Criticism
The Federal Reserve Bank is the focus of much criticism and even, at times, conspiracy theories. Some critics say that the name was intentionally chosen to deceive and fool the U.S. citizens into acceptance. Such critics claim that the Federal Reserve's real purposes are (1) to make a profit by "skimming" a small percent of the 10 trillion dollar U.S. economy; (2) to redistribute wealth through the sales and purchase of the U.S. national debt (currently about 7 trillion dollars); and (3) to fix currency exchange rates with other country central banks throughout the world to generate an additional $1 billion dollars a day in profits; (4) to cartelize the banking industry; (5) to monopolize the creation of new money; (6) to redistribute wealth through the process of inflation.
Some of these critics say that the U.S. Congress was tricked by the world elite into creating the Federal Reserve System in 1913 for the purpose of money control through inflation (invisible taxation of the masses), extremely high and profitable interest rates, and outright taxation through the creation of liens and bonds paid for by U.S. citizens. These critics argue that, through unconstitutional changes in law, the words income (corporations) and wage (people's paychecks) were redefined. Taxation enforcement (Internal Revenue Service) could now force U.S. citizens to pay taxes, and fees and fines under penalty of law, possible arrest and imprisonment.
Other critics, usually seperate from the first class of critics, feel that the federal reserve and the government collude to mistate the inflation rate, causing it to appear lower to investors than what it is, and then are able to borrow money for lower than the inflation rate, thereby creating a "hidden tax". This genre of conspiracy theory is fundamentally different than the some of the other ones because it assumes that the Fed and the US government are conspiring together, rather than against each other.
Fractional reserve banking
According to critics, "fractional reserve banking" amounts to fraud and theft, and central banking is the method by which this fraud and theft are cartel-ized and institutionalized.
Originally, a bank was a warehouse, a safe place to store valuables, especially gold and silver money. A fee was charged for the service, and warehouse receipts were issued as a claim ticket on the valuables stored. Because everyone knew that these receipts were "as good as gold", the receipts themselves began to be traded as money.
Bankers noticed that on any given day, only a small fraction of the warehouse receipts were redeemed for money, so the unscrupulous among them began printing counterfeit receipts, i.e. receipts that were not matched by an actual deposit of gold or silver. The bankers were then able to either spend the counterfeit receipts themselves, or loan them out and charge interest. Thus the total supply of money could be enlarged very easily, and was an obvious method to enrich the unscrupulous bankers, say critics. The cost of this enrichment was saddled on everyone else, who now found their existing money to be worth less and less as the overall supply of money grew greater and greater.
The more counterfeit receipts that were printed and circulated, the more people would show up to redeem them in gold or silver, the more the actual bank reserves would be depleted until, at some point, the bank would be bankrupt and legitimate depositors would be left holding receipts that were irredeemable. A situation where depositors showed up to the bank in large groups to demand their money became known as a “bank run” or a “run on the bank”. Clearly, the legitimate depositors were victims of fraud and theft, while whomever printed counterfeit reciepts was guilty, assuming the story to be true.
Critics of central banking, sometimes dismissed as "conspiracy theorists", enlarge the story to include several competing banks. Each bank begins issuing its own warehouse receipts, now known as “paper money”. Paper money is called "fractional money" when only a fraction of the total supply of money is backed by a precious commodity. Bank owners have a strong incentive to create as much fractional paper money as possible, because it is an effective method of self-enrichment. However, if bank #1 creates significantly more paper money than bank #2, then bank #2 will end up holding a large amount of bank #1’s paper money. Eventually it will wish to redeem this for real gold or silver, thus bankrupting bank #1.
The problem then, as bankers saw it, was to design a system where all competing banks could expand their money supplies in unison. As long as bank #1 has claims against bank #2 that are equal to the claims that bank #2 has against bank #1, then the claims simply cancel each other out. That way, with equal amounts of outstanding debt, in principle all the bankers could enjoy spending an endless source of new and additional paper money, without having to redeem much of anything.
As critics and conspiracy theorists tell it, many attempts at banking cartels were implemented, where supposedly competing bankers conspired with one another to print equal amounts of paper money. These cartels were ultimately in vain, because of the ever-present counter-incentive to break the cartel, print less paper money than the competing bank, and end up with the ability to withdraw real gold or silver from the competitors vault, possibly bankrupting them in the process.
The only way to orchestrate the expansion and contraction of credit and money on a large scale is to make it a matter of law. Private citizens must be forced to accept a single type of paper money in payment of debt or contract, and paper money must be irredeemable for anything of real value. When paper money has been completely separated from any commodity, it is known as "fiat money" (money by decree). Central governments in all industrialized nations have now achieved just such a situation, in partnership with the large commercial banks. Skeptics point out that government leaders would also have a strong incentive to bring about pure fiat money, because it would enable those leaders to spend additional revenue without having to raise taxes directly.
Proponents of the Austrian school of economics conclude that manipulation of the money and credit supply is the cause of the boom-bust business cycle. Some even go so far as to claim that major wars would be impossible without central banking, because citizens are unlikely to support such costly endeavors when they are made to pay for them up front.
New money is created by the issuance of new debt, and injected into the banking system from a single central location, thus ensuring precisely the symmetrical, uniform expansion of the money supply long desired by the bankers. Critics, skeptics and conspiracy theorists argue that the monopolistic power to create new money costlessly, “out of thin air”, is in fact the power to transfer real wealth away from consumers, and place it squarely in the hands of those with the money monopoly, i.e. the central government itself, the large commercial banks, and government contractors.
Money-creation primer
The creation of new money “out of thin air” works like this:
- The government prints up a piece of paper called a treasury bond. This is simply an IOU, a promise to pay the holder a specified sum of money on a particular date. In this example, let’s say the government issues $1,000,000 worth of bonds. Individual investors, pension funds, mutual funds, insurance agencies, banks, foreign government central banks, can all buy the bonds, effectively loaning money to the federal reserve. They do this to invest their money.
- The Federal Reserve prints up a piece of paper called a check, in the amount of $1,000,000 and makes it payable to the government. This check is the proceeds from the sale of the bonds.
- The Fed and the government trade pieces of paper. The Fed now claims $1,000,000 in new assets (money owed to a bank is called an "asset"), and it is assumed the government, with its power to tax, will make good on its debt (this is why the people buying the bonds from the fed consider it a risk free investment. The government deposits the check in its own account.
- The government hires employees and buys things with the $1,000,000, and it does so by writing government checks. These government checks are then deposited in commercial banks. For the sake of simplicity, assume it all goes into one commercial bank, which has a zero balance to begin with.
- The commercial bank now claims $1,000,000 in new liabilities (the amount on deposit in a bank is called a "liability", because the bank has to pay interest to it, amongst other things). Now, the law allows the bank to loan out 90% of what it has on deposit. This loaning of money that it has on deposit is the precise point new money is created, because the depositor still has his money, and the person getting the loan now has money too.
- $900,000 is loaned out on Friday for someone to buy a house. This loan is in the form of a check. The home buyer signs the check and gives it to the seller, who deposits it right back into the bank on Monday. Note however, in real life that money would only come from the bank temporarily, who then would issue its own bonds or use a company like Fannie May to issue its own bonds, so that again investors can actually lend the money while the bank is simply a middleman, called a "servicer".
- The commercial bank now claims $900,000 in new liabilities. 10 percent of that money is put into a reserves, and 90% of that, or $810,000 is loaned out. As soon as the $810,000 is deposited back into the bank, you guessed it, the cycle repeats and repeats until there is no more money to lend.
- The total amount lent out to borrowers is $9,000,000. Add that to the $1,000,000 that it still has on deposit and the total is $10,000,000 of new money. 6% interest on $9,000,000 is $540,000 per year. Recall the bank began the example with a zero balance. The bank making the loan however, usually can't collect the 6 percent interest without paying for example 1% of interest to the person who put the money on deposit in the first place. And, with 90% of that money lent out, if the originally depositor wants their money back, the bank has to borrow that money from another bank (or maybe from another source), at rate of interest set by the government (the overnight rate). This is called Asset-Liability bouncing, and is a delicate balancing act all banks must work on every day.
Further reading
- Greider, William (1987). Secrets of the Temple. Simon & Schuster. ISBN 0671675567; a book intended for lay readers explaining the structures, functions, and history of the Federal Reserve.
- Epstein, Lita & Martin, Preston (2003). The Complete Idiot's Guide to the Federal Reserve. Alpha Books. ISBN 0028643232.
- Meyer, Lawrence H (2004). A Term at the Fed : An Insider's View. HarperBusiness. ISBN 0060542705.
- Rothbard, Murray N. (1994). The Case Against the Fed. Ludwig Von Mises Institute. ISBN 094546617X.
See also
- Discount Window
- Federal Reserve Banks
- Money supply
- Open Market Operations
External links
- Board of Governors of the Federal Reserve System
- Federal Reserve Bank of Chicago
- Federal Reserve Routing Directory
- Gross Federal Debt History Fact Sheet
- Articles
- Federal Reserve Bank of Minneapolis - The Region - Paul Warburg's Crusade to Establish a Central Bank in the United States (May 1989)
- Opposition to the Fed
- Congress should stand up to the Fed by Ralph Nader
- Billions for bankers, debt for the people By Sheldon Emry
- Secrets of the Federal Reserve by Eustace Mullins (Makes arguments about the New World Order owning stock in the Fed, when it is banks that actually own the stock as mentioned above)
- Creature from Jekyll Island (Chapter 10) by G. E. Griffin
- Who Owns the Fed? Liberty article by Bill Woolsey.
- What Has Government Done to Our Money? by Murray N. Rothbard
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