Topic: The Federal Reserve
The Money Matrix - How the FED Works (PART 6/15) A step-by-step explanation of how the Federal Reserve, America's Central Bank, can manipulate monetary policy.by Jake Towne, the Champion of the Constitution
(libertarian)
Monday, November 17, 2008
In this article, I hope to share, as simply as possible, enough details for you to understand how modern-day central banking tries to control the money supply, and even how the value of the paper money in your wallet or the electrons in your bank account fluctuates on a daily basis. First I will formally define fractional reserve banking and describe how it expands or contracts the money supply. Next I will share how the Federal Reserve controls monetary policy and supply with its three major tools – "printing" or "de-printing" money (technically referred to as "open market operations" by the FED), bank reserve requirement ratios, and the infamous "Fed-rate."
Fractional Reserve Banking is a banking system in which banks are supposed to maintain a quantity of reserves from their depositors. This quantity is a fixed fraction of the amount of new money the banks are then allowed to create. This newly created money is then loaned to the bank’s borrowers.
Fractional reserve banking has two major flaws. The first is that money creation is a fraudulent or even criminal act, which is a topic more suited for Part 7. (See Rothbard’s "The Case Against the Fed" below, pages 40-45.)
The second flaw is insolvency. This is commonly known as a "bank run" and is easy enough to understand. If the system’s depositors demand in excess of the reserve amount within a short enough time span, the entire system theoretically just runs out of printed cash and goes broke. To prevent this system crash, governments often resort to a massive physical printing of currency, resulting in massive devaluation of the currency and its eventual demise by hyperinflation. Hyperinflation in its terminal stages looks like Zimbabwe's, which is estimated at 89.7 sextillion percent.
Here is how fractional reserve banking works in the United States, using the current approximate 10% fractional reserve ratio requirement:
1) A depositor deposits $100 with a bank. (This depositor could be a citizen, or another bank, even a receiver of the FED’s open market operations which is described later.)
Total Reserves: $100, Total Loans: $0, Total Money Supply: $100
2) The bank holds $10 for its reserves and loans out the other $90 to other banks or citizens. If it is a citizen, this money is temporarily held outside the banking system until he/she decides to deposit the money into a bank.
Total Reserves: $10, Total Loans: $90, Total Money Supply: $100
3) Next, the second bank takes the $90 in deposits, holds $9 for its reserves, and loans out the other $81.
Total Reserves: $19, Total Loans: $171, Total Money Supply: $190
4) Step 3 repeats. The third bank takes the $81 as a deposit, holds $8.10 for its reserves, and then loans out $72.90.
Total Reserves: $27.10, Total Loans: $243.90, Total Money Supply: $271
5) Step 3 repeats again. The fourth bank takes the $72.90 as a deposit, holds $7.29 for its reserves, and then loans out $65.61.
Total Reserves: $34.39, Total Loans: $309.51, Total Money Supply: $343.90
6) And so on. The bulk of the money creation is done after 15 repeats, but what is eventually left after 40 or 50 repeats is pretty much:
Total Reserves: $100, Total Loans: $900, Total Money Supply: $1000
So you can see that within a very short period of time, banks transferring to other banks within the system can CREATE $900 from the initial $100 deposit. For many, this process is such NONSENSE that it is indeed hard to grasp, which is why I used the numbered steps and tallies.
Now I will describe how the FED controls our monetary policy in concert with the fractional reserve banking system. The FED uses three prime monetary mechanisms to accomplish this. These powers are Open Market Operations, Bank Reserve Requirement Ratios, and the Discount Rate. I will not discuss the FED's vocal propaganda pronouncements which have had some success at driving contemporary and future expectations in the past.
The Federal Reserve writes here on page 36 (my italics) "In theory, the Federal Reserve could conduct open market operations by purchasing or selling any type of asset. In practice, however, most assets cannot be traded readily enough to accommodate open market operations. For open market operations to work effectively, the Federal Reserve must be able to buy and sell quickly, at its own convenience, in whatever volume may be needed to keep the federal funds rate at the target level. These conditions require that the instrument it buys or sells be traded in a broad, highly active market that can accommodate the transactions without distortions or disruptions to the market itself."
Earlier this year and for decades prior, the vast amount (as in 90-95%), of the FED’s balance sheet rested in US Treasury securities traded in New York City. However, this changed with the Great Panic of 2007, and the FED is now exercising its' once-theoretical abilities. The Atlanta FED published this truncated graph, and now foreign securities, AIG, illiquid mortgage debt have replaced, then ballooned the FED’s balance sheet. Now Treasury securities account for only 32% of the FED’s balance sheet, which limits the effectiveness of this monetary weapon, per the FED’s own admission above.
Here’s how it works, step-by-step, when the FED buys Treasuries, although it is the same process for whatever asset they wish to purchase.
1) The FED’s Open Market Committee (FOMC) decides expand the nation’s money supply and purchases, for example, $10 billion in Treasury bonds.
Monetary Supply Expansion: $0
2) The FED writes a check on itself for $10 billion. [Where did it get the money? The answer is FROM NOWHERE!]
Monetary Supply Expansion: $10 billion
3) This $10 billion FED check then goes to one of the select government bond dealers (such as Secretary Paulson’s Goldman Sachs) in exchange for the $10 billion in Treasuries.
Monetary Supply Expansion: $10 billion
4) Then the bond dealer deposits its $10 billion FED check at a commercial bank.
Monetary Supply Expansion: $10 billion
5) Go to the fractional reserve loop above. We just learned how this deposit will very quickly be "pyramided" and lead to $10 billion in deposits and $90 billion in loans within the banking system.
Monetary Supply Expansion: $100 billion
Now, the FED can very quickly CONTRACT the money supply in a similar fashion by SELLING its assets. The process typically takes several weeks. However, the key enabler to do this is that there must be a buyer outside of the FED so it is not quite as easy – Treasuries are (historically-speaking) a liquid market, but the AIG debt, for instance, is a lot harder to find a buyer for.
[And yes, the US government DOES pay interest on the Treasuries to the FED, which many harp on, since it can never be paid back since there are not enough dollars in the banking system to ever clear all of the debt owed. Others love to point out that the privately-held FED stock pays a guaranteed 6% annual dividend to the (undisclosed) owners. However, if these are compared to the raw power to create money with its open market operations and the power I will describe next, I want to point out that these are, monetarily-speaking, quite insignificant.]
Per the FED, the reserve requirement ratio is the ratio of "funds that a depository institution must hold in reserve against specified deposit liabilities." "Specified deposit liabilities" are traditionally limited to cash deposits from depositor, but the FED is technically free to redefine this as they wish. A simpler, but slightly less precise, definition is the fraction of deposits at a bank that it is supposed to hold in cash for withdrawals. I write "supposed to" since modern banks do not really have to do so. (Like the thieving medieval goldsmith, good work if you can get it!)
The Federal Reserve writes here on page 41 (my italics): "The Federal Reserve can adjust reserve requirements by changing required reserve ratios, the liabilities to which the ratios apply, or both. Changes in reserve requirements can have profound effects on the money stock and on the cost to banks of extending credit and are also costly to administer; therefore, reserve requirements are not adjusted frequently. Nonetheless, reserve requirements play a useful role in the conduct of open market operations by helping to ensure a predictable demand for Federal Reserve balances and thus enhancing the Federal Reserve’s control over the federal funds rate."
"Profound effects" is right! The reserve requirement ratio has been more or less at 10% since the 1990s, falling from 14% in the 1970s. Rothbard notes: "Ever since the Fed, after having expanded bank reserves in the 1930s, panicked at the inflationary potential and doubled the minimum reserve requirements to 20 percent in 1938, sending the economy into a tailspin of credit liquidation, the Fed has been very cautious about the degree of its changes in bank reserve requirements." (p. 144)
However, if the Federal Reserve Board of Governors have a joint bad hair day and decide tomorrow to halve the reserve requirement ratio to 5%, the nation’s money supply will almost DOUBLE in a matter of weeks. A $20,000 asset like a car or a small apartment would rapidly approach $40,000 in value. In fact, just about everything would see 100% inflation, but salaries’ purchasing power would be halved until the inflationary tidal wave rips them upwards. (The FED finds it far less painless to do this over a long period of time by utilizing open market operations. What I just described happened not in a few weeks, but from 1985 to 2008. Use this calculator for those years to track the worth of $1.)
With the weapons of "open market operations" and "reserve ratio requirements," the FED has close to absolute monetary control over the American dollar, aka the Federal Reserve Note. There is one last tool that is more or less a propaganda-type revolver, although without bullets recently. However, since it is what most Americans associated with the FED before the Great Panic of 2007, I will address it briefly.
The FED Discount Rate, or "Fed Rate," is the interest rate the FED charges to banks to borrow from the FED. However, borrowed reserves are not as satisfactory to the banks as reserves that are wholly theirs, as they now have to pay it back with interest.
Per the FED, the discount rate "is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility - the discount window. The Federal Reserve Banks offer three discount window programs to depository institutions: primary credit, secondary credit, and seasonal credit, each with its own interest rate. All discount window loans are fully secured."
However, the Federal Reserve also notes "the volume of discount window borrowing is relatively small." Besides being famous previously for dramatically shifting the stock market’s ebb and flow within minutes of its announcement, it is merely an ordinary wave in monetary policy compared with the other two powers. An open market operation could be construed as a double-overhead (surfer slang), and a sizeable shift in the reserve requirement ratio could be construed as a monster rogue at a certain magical place in California called Maverick’s. You can check the discount window volume by googling DISCBORR.
END THE FED! Protest to take place on Saturday, 11/22/08 Published: November 16, 2008 "Scenes are now to take place as will open the eyes of credulity and of insanity itself, to the dangers of a paper medium abandoned to the discretion of avarice and of swindlers." -Thomas Jefferson to Thomas Cooper, 1814
We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.
As always, unlike the NFL, the author grants full permission to allow any accounts of, rebroadcasts, retransmissions, repostings in part or full of this article to your blog or anywhere else in order to promote the Restoration of our Republic.
Veritas numquam perit. Veritas odit moras. Veritas vincit. Truth never perishes. Truth hates delay. Truth conquers.
"Whenever the legislators endeavor to take away and destroy the property of the people, or reduce them to slavery under an arbitrary power, they put themselves into a state of war with the people, who are thereupon absolved from further obedience, and are left to the common refuge which god hath provided for all men against force and violence." – John Locke
The "Great Slump" of 2008 (PART 1/2) Published: December 20, 2008 One of Lord John Maynard Keynes's essays "The Great Slump of 1930" is extremely relevant today as we look forward at the 2009 economy and future governmental antics. Let's take a look!
Board of Governors of the Federal Reserve System. "Purposes and Functions." 2005. Pages 27-50.
Martenson, Chris. While I do not agree with a lot of what Dr. Martenson says, this 4 minute and this 7 minute video are great visuals for understanding money creation.
Although I want to end their organization, I want to express my thanks to the members of the FED who have answered my emails over the past several months. The one that wasn't answered was errr... a little emotional, so I would have done the same in his shoes. It is a little weird how anxious they are to share everything and reply, although I have never received a reply (no matter how respectful I am) from my Congresswoman and Senators.
"We do not come as individuals... We come to speak for this broader class of businessmen... We beg no longer; we entreat no more; we petition no more. We defy them!... If they dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold."
- William Jennings Bryan, 1896 Democratic National Convention, Chicago, Illinois, excerpts from the famous "Cross of Gold" speech. This poison was far more cunning at achieving its political purpose for the bankers than even the best efforts from President-Elect Obama. Will Obama realize that gold is not a "cross"? That it is the only way to free the world from its Crown of Debt? Doubt it. The world must learn to free itself.
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The first fallacy in your explanation is that in your first example, the only way the fractional banking system could work in your example is if each SUCCESSIVE BORROWER SAVES all the money they borrowed. Why they would even do that, I have no idea because it costs them more in interest to borrow the money than they would earn in interest to save it. So your first example is COMPLETELY WRONG. If each borrower SPENT the money they borrowed which is the NORMAL use of the money, there is no PROGRESSION.
If I borrow $100 by charging it on my credit card, the store where I buy something will then have my $100 but they will use it (retire debt, use it for accounts payable, payroll, expansion, invest it in new inventory, whatever) so the money cannot be compounded. Your example is as fraudulent as the system you accuse of being fraudulent!
Secondly, your explanation of how the Fed BUYS securities is greatly OVERsimplified (which then makes it more greatly INACCURATE) as you seem to think that Goldman-Sachs, et. al are SELLING securities to the Fed. That's totally untrue. The US Treasury prints, issues, and sells ~ in public auctions that have first been approved by Congress if the debt ceiling needs to be increased ~ the treasury bills, bonds, and notes that it AUCTIONS off. Goldman-Sachs, et. al. can bid for these treasuries as much as anyone else can. When the Fed bids for them, it CREDITS the Treasury Department's account with an equivalent amount of spending power, and HOLDS the treasuries to redeem or sell at some time in the future. Much to your confusion, when Goldman-Sachs buys them, they are GIVING money to the Treasury Department which will be repaid in the future with interest. It is a short (or medium, or long) term loan. The Fed is NOT buying them from Goldman-Sachs, et. al, and to imply so is a bigger LIE than you claim the Fed is committing.
I tried to continue reading through this maze of confusion you imposed on us all in your article, but each step along the way just makes me realize how inept your understanding of this process is. In fact, you should really NOT try to explain something that you don't even understand yourself. It's like trying to translate a book from German to English when you don't understand German!
I would love to rip and shred the Rothbard stuff because he is such a beloved idol of Libertarians, but your articles always wear me out ~ both by their unrestrained LENGTH and their CONFUSED content.
Posted By: Jake, the champion of the constitution
Date: 2008-11-17 16:59:10
Dear MC,
Thanks for writing back. This should be fun, as you claim to know how the FED works better than the FED itself. On your replies, I would appreciate if you document your sources, you know better to believe that I will take you at your word, correct?
On your first point:
Of course the borrower doesn't save the money! They buy a house or a car or whatever. They have to pay back the principal at interest to the bank (or default) slowly over time. When the borrower pays out the money the bank gave it to another party, and this money makes it back to a bank, the money is pyramided again at 10% held at the bank and 90% loaned out.
I do not touch at all upon consumer credit cards at all since they have nothing to do with the crux of fractional reserve banking . They are just part of the loans on (some) bank's balance sheet. I may be incorrect, but I think the credit cards are typically funded by bonds - Visa or a bank (if its a bank credit card) creates a bond that pays interest for investors to buy, then pays for the credit card consumers debits out of that.
Please educate me if I am incorrect.
On your second point, you have a mixture of truth and false information in your replies, but you are wrong. If you can educate yourself on this you might change your view on central banking a bit. Hint: You can also email the FED and they will correct you.
You wrote: "The US Treasury prints, issues, and sells ~ in public auctions that have first been approved by Congress if the debt ceiling needs to be increased ~ the treasury bills, bonds, and notes that it AUCTIONS off. Goldman-Sachs, et. al. can bid for these treasuries as much as anyone else can."
True! But why doesn't the FED just buy from the Treasury directly? Because doing so would not serve to increase the money supply! (I am not sure that the FED can NEVER buy Treasuries directly, however, I will have to email the FED to find out.)
You wote: "When the Fed bids for them, it CREDITS the Treasury Department's account with an equivalent amount of spending power, and HOLDS the treasuries to redeem or sell at some time in the future. Much to your confusion, when Goldman-Sachs buys them, they are GIVING money to the Treasury Department which will be repaid in the future with interest. It is a short (or medium, or long) term loan. The Fed is NOT buying them from Goldman-Sachs, et. al, and to imply so is a bigger LIE than you claim the Fed is committing. "
This is not true. The government already received the payment (in pre-existing physical or electronic Federal Reserve Notes) from the FED's primary dealers. (The federal government does not create any money, they just use it to fund their operations, and interest accrues on the bond for WHOEVER owns the bond.)
The primary dealers then sell to the FED. The FED pays for it with a check of Federal Reserve Notes that never existed before (the money is created just like I wrote above)
On the bond they sold to the FED, the primary dealers do NOT owe any money to the federal government - they already paid so they could receive the bond in the first place! They then do exactly what I describe above - they cash the FED's CHECK at a commercial bank. Perhaps they even made a PROFIT! (Silly thought!)
Please read (see the link in the article) the FED's "Principles and Functions" pages 36-41.
And also the following BEFORE you reply
Example of the FED selling gov't securities to its primary dealers http://www.newyorkfed.org/markets/statistics/deal.pdf
Definition of primary dealer http://www.newyorkfed.org/aboutthefed/fedpoint/fed02.html
List of primary FED dealer's http://www.newyorkfed.org/markets/pridealers_current.html
FED primary dealer list of requirements (and deregulation) http://www.newyorkfed.org/markets/pridealers_policies.html
If your way IS true, please do try to prove it if you wish and again I am not going to believe your word alone, so please documentyour sources!!
Again Carl, I had the same questions as you before I wrote this, perhaps unlike some of the other columnists here, I do very much appreciate your efforts to educate me, you are welcome to continue them.
Hi Jake, I don't understand why the Fed is buying foreign securities? Doesn't that send the Fed money overseas? What would be the purpose of that if we are spending like crazy here? and nice job on the article!
You seem to be really lost, even in your own examples. One principle you seem to miss is that for every DEPOSIT in one place, there is a WITHDRAWAL in another. Most often, just as you and I might live from paycheck to paycheck, any money we put INTO a bank we also spend before the month is up. That is why the banks are limited to a maximum 70% loan to deposit ratio. In addition, there is a RESERVE REQUIREMENT for banks to put aside a required % of all deposits.
When you take out your LOAN from Bank A to buy a house from a seller who does their banking with Bank B, there is no equivalence here. The seller with Bank B receives the money, but PAYS OFF the balance on their existing mortgage (which may be $60,000 on a $100,000 house, as an easy example) then deposits the balance in Bank B. Usually the recipient of this money then uses the balance to buy another home, or keeps it until they can. Of course, where do they live until then? What other debts do they have? So, the money is NOT available for NEW LOANS. New loans generally come from NEW DEPOSITS not from turning over old debts.
So, if the person SPENDS the money, then it is dispersed to those places where it is spent. Then, it is spent again and again by places where THAT money is spent. In order for a bank to make new loans with it, it must be money that REMAINS ON DEPOSIT. That's what causes defaults or even (technical) bankruptcies in banks when they exceed their loan-to-deposit ratios as deposits LEAVE the banks (are spent) and LOANS are not paid off or recalled.
You don't seem to understand, either, that the Treasury is GOVERNMENT and the Fed is a PRIVATE BANKING system. The Fed DOES buy T-bills from the Treasury. That's HOW it increases the money supply. If the Fed SELLS treasuries in the open market, that CONSTRICTS the money supply because buyers of the T-bills give the Fed cash and the Fed gives the buyer the T-bill which they then hold until it matures and receive interest while they hold it.
As I said, the Fed does NOT buy T-bills from Goldman-Sachs, et. al. I don't know HOW or WHERE you got that idea. They buy them directly from the Treasury, as does EVERYONE ELSE. That's how the Treasury "borrows" the money it needs. Those who advocate an elimination of the Fed usually say that the Treasury could just "create" (print, if you wish, although nearly ALL of it is just electronic money, not really "bills") and not have to pay INTEREST on the money it borrows (or, in that case, "creates"). Although everyone, except the Fed, pays with money they've acquired. The Fed merely "creates" money for the Treasury to spend. They say that it costs the Fed 4 cents for every dollar it creates just because of administrative costs. So, it is a VERY profitable transaction for the Fed.
You go ahead and write what you want, but you're really out there in LIMBO somewhere. I think you might even be confusing some of this BAILOUT procedure with Fed monetary policy. You'll never find ANYWHERE that Goldman-Sachs is selling Treasuries to the Fed. And, all this mumbo-jumbo about the Fed already having the money, and whatever else you're trying to say, is just gibberish to me. I'm not going to take the time to try and figure out what you're getting at, or why you're not getting there.
I wrote out this process very clearly in my articles on the Fed. Monetary policy involves the Fed in BUYING t-bills from the Treasury which INCREASES the money supply, and SELLING t-bills to the HIGH BIDDER, whomever that might be, when they DECREASE the money supply.
But, it sounds like you prefer to explain it some other way, so go ahead. It doesn't have MY name on your byline.
Posted By: Jake, the champion of the constitution
Date: 2008-11-18 02:44:11
Dear MC -
I think you missed my reply where I listed a few documents to read and prove that the Federal Reserve DOES buy Treasuries from its primary dealers which DOES include Goldman Sachs.
I would appreciate it if you could show some evidence in addition to your usual reply. (Weblinks are definitely preferred, and half of my article is quoted directly from the FED, what are your FED sources?) I did read at least a few of your FED articles (of course I didnt agree with some to most of the content :), but which one specifically addresses this?
Try to teach a little! I will change anything that I wrote if you can prove it is incorrect. View this as a challenge from the perspective of your past job as an economic professor!
I have no interest at all in doing your work for you. I spent 4 years in undergraduate school and 2 years in graduate school studying Economics, and 18 years teaching it in a university. I taught over 4,000 students, and have spoken on economic, banking, and social issues to business groups on more than 8 occasions. I have no confusion or misunderstanding about this system. Because you have read some internet article, or even misunderstood some web posting at the Fed, doesn't change the reality of the process. I am as disinterested in PROVING my points as I was when the FBI asked me if I would take a polygraph test after a bank robbery occurred at the branch office where I was the Branch Manager. I told them "no", I wasn't interested in having to PROVE the veracity of what I told them. If they wanted to press charges against me for something they thought I did or something I told them that they could prove was incorrect, then go ahead and arrest me or accuse me of something. They didn't, I didn't, and I felt good that I made my point.
You go ahead with your articles. I have no doubt that the people on this website will gobble up anything that eventually bashes the Fed anyway, even an article that is as hobbled together and cryptically true as yours. You're looking to make a point that the Fed is CORRUPT, FRAUDULENT, and UNCONSTITUTIONAL so you're going to tell the tale that leads you down that road. That doesn't bother me at all. You can tell us all that MILK will give us the heebee jeebees and I'm NOT going to believe that, either. I have much different information that confirms a different conclusion.
I wish YOU could stand before a roomful of students who have a textbook for guidance and who are studying economics to try to ramble on with these assertions of yours. You totally miss the method or purpose ~ or are selectively LOOKING for ~ involvement with what you call "primary brokers". Either these are miniscule transactions in the whole process, or you confuse the purchase of securities HANDLED by brokers with purchases that are ~ nonetheless ~ still directly from the Treasury.
If you have a real estate broker take care of some of the paperwork and connect buyers and sellers ~ the loan and money and MORTGAGE are still the domain of the BANK. You seem to misunderstand some peripheral involvement by brokers, confusing that with the actual ownership ~ and purchase ~ of the Treasuries themselves.
Why don't you just go ahead and make whatever point it is you're trying to make. I'm sure I'll heckle and point out any injustices you do to the concepts or goals of the system ~ even though that group of GOVERNMENT HATERS on this website will believe whatever fits their preferences and will hoot and hollar in support of anyone who waives a banner of what they label as LIBERTY.
Freedom for the INDIVIDUAL ~ duress, insecurity, and insurrection for SOCIETY; that's the mantra that I've deduced from LIBERTARIANS!
Just to give you one more piece of the puzzle that you seem to be struggling with, let me make this point:
If Goldman-Sachs is SELLING Treasuries to the Federal Reserve, where is Goldman-Sachs getting them to sell? And, if (as I hope you recognize) Goldman-Sachs is getting them from the US Treasury, WHY WOULDN'T THE FED BUY THEM DIRECTLY FROM THE TREASURY? Do you think Goldman-Sachs would be selling them without a markup?
The Treasury doesn't sell these like hamburgers at McDonalds, they have ANNOUNCED AUCTIONS that anyone can participate in, although they are sold in minimums of $1 million so that limits some of the participants. In fact, even those denominations are a minority now.
Posted By: Jake, the champion of the constitution
Date: 2008-11-18 15:04:22
Dear MC -
You are right about the announced auctions from the US gov't! That's in the Functions and Purpose document. The NY market is just a liquid market for the dealers and whoever else owns Treasuries to sell them.
A professor for 18 years that doesn't want to prove one simple fact to me. If that's who you want to be, I have no problem with it.
Or could it possibly be that no matter how much you write back in reply, no matter how long you studied and taught economics, you are dead wrong?
You just go ahead and write what you want to write. We'll see if it adds up. I've already told you that you're wrong about Goldman-Sachs and I thought I gave you some rather obvious points to ask yourself. I gave you several examples. I spent some time trying to steer you in the right direction. But, I don't have to prove one simple fact to anyone. Facts prove themselves.
Posted By: Jake, the champion of the constitution
Date: 2008-11-19 07:12:35
Dear Gene -
I'm not sure I am the best person to answer this, but here's my best shot.
"I don't understand why the Fed is buying foreign securities?"
The reason the FED would buy foreign securities is that they decided for some reason to supply dollar funding to that country. "Why" is the tough part, so here's my very humble opinion.. My view is that all government fiat currencies are actually the same - intrinsically worthless paper or electrons, sure in April 1.6 Euro = $1, and in October 1.2 Euro = $1, so to some extent the FED also has to defend all other currencies. Sure the Icelander krona is meeting the hyperinflation demon, but what happens if a major currency bites the dirt - say the Euro or Yen or Dollar. What will immediately happen is that everyone will probably jump ship to the next sinking fiat lifeboat but also immediately start questioning ALL fiat currencies. And ALL governments, especially the US do NOT want that to happen. It is what keeps them racing with the lemming dollar to the cliff, and to some extent the FED time to time racing with the lemming Brazilian reale, etc.
"Doesn't that send the Fed money overseas?"
Yes, you betcha!
"What would be the purpose of that if we are spending like crazy here?"
IMVHO, to keep any stray lemmings from falling away from the pack.
Face facts thought. The FED is our REX. They can do whatever pleases them.
JIM LEHRER: What is the proper relationship, what should be the proper relationship between a chairman of the Fed and a president of the United States?
ALAN GREENSPAN: Well, first of all, the Federal Reserve is an independent agency, and that means, basically, that there is no other agency of government which can overrule actions that we take. So long as that is in place and there is no evidence that the administration or the Congress or anybody else is requesting that we do things other than what we think is the appropriate thing, then what the relationships are don't, frankly, matter. And I've had very good relationships with presidents.
JIM LEHRER: But you don't feel any responsibility for keeping interest rates low?
ALAN GREENSPAN: Well, let me tell you. We had no choice. I mean, we're the vaunted Federal Reserve.
Posted By: Jake, the champion of the constitution
Date: 2008-11-19 07:27:57
Dear MC -
Geez dude. One more time to try to take those forks stuck in your eyes out. I am not writing "what I want", I am writing what I believe to be true. Prove me wrong, and your blither blather doesn't work on me, we've been over that in the comment fields in other articles.
The FED buys its Treasury OMO's from its primary dealers, not from the Treasury direct as you allege. I explained why they do this in my article (to manipulate the money supply) and the specifics in my first reply, but let me puke up the evidence again and add something new.
Please read (see the link in the article) the FED's "Principles and Functions" pages 36-41.
Example of the FED selling gov't securities to its primary dealers http://www.newyorkfed.org/markets/statistics/deal.pdf
Definition of primary dealer http://www.newyorkfed.org/aboutthefed/fedpoint/fed02.html
List of primary FED dealer's http://www.newyorkfed.org/markets/pridealers_current.html
FED primary dealer list of requirements (and deregulation) http://www.newyorkfed.org/markets/pridealers_policies.html
and a new one for you to grow on. Straight from the FED at http://www.newyorkfed.org/markets/omo/omo2007.pdf
from page 34:
"1. The Federal Open Market Committee authorizes and directs the Federal Reserve Bank of New York, to the extent necessary to carry out the most recent domestic policy directive adopted at a meeting of the Committee:
(a) To buy or sell U.S. Government securities, including securities of the Federal Financing Bank, and securities that are direct obligations of, or fully guaranteed as to principal and interest by, any agency of the United States in the open market, from or tosecurities dealers and foreign and international accounts maintained at the Federal Reserve Bank of New York, on a cash, regular, or deferred delivery basis, for the System Open Market Account at market prices, and, for such Account, to exchange maturing U.S. Government and Federal agency securities with the Treasury or the individual agencies or to allow them to mature without replacement;
Thank you for writing so clearly on this profoundly important topic. Thank you further for being quite patient with this rude and misled MC person. As a mathematician I find your logic very clear and obvious. But there are many many people out there, like MC here, who do not have a mind for logic and fact, and so rely on some kind of zealous market-religion faith instead. I find my patience wears very thin with those types, and I respect the patience you have shown MC. It's important that, however lost these people are, we continue to try to teach them. There are so many of them. And they vote!
One important point I want to make is that this is not so much a libertarian issue as it is a question of right and wrong or freedom and slavery. I find myself leaning a bit conservative and statist, yet ever since I learned about this it has become the single most important political issue to me. This is far from an anti-government view, since the Fed is not even a government body. It has private stockholders!
Posted By: Jake, the champion of the constitution
Date: 2008-11-20 09:31:19
Dear PhilRatio -
Thanks a lot for your interest. If I can take politely take one issue against what you wrote, its your use of the term libertarian, or liberty. (not to be confused with the Libertarian PARTY that ran a Vegas bookie for VP)
Being a libertarian to me IS being for justice and freedom for all individuals. The more I study, the more I find that freedom and liberty is like a giant key. Economic liberty issues like the FED, personal liberty issues like freedom of speech are all part of a single whole. You can't unlock the door without the whole key. Statism is the denial of individuality.
Conservativism means many things to many people, what does it mean to you?
Posted By: Jake, the champion of the constitution
Date: 2008-11-20 09:48:28
Dear MC -
Just to apply the coup de grace to your unfounded, unproven claim, also read Modern Money Mechanics from the Federal Reserve Bank of Chicago.
"the Federal Reserve offsets undesired changes in reserves through open market operations, that is, by buying and selling U.S. government securities in the market."
"One way the central bank can initiate such an expansion is through purchases of securities in the open market. Payment for the securities adds to bank reserves. Such purchases (and sales) are called "open market operations."
Wow, they are called OPEN MARKET operations since the FED buys them on the OPEN MARKET!! aka NOT at Treasury auctions from the Treasury.
That's a very well made video. Truly freedom is in my view the central American value. The question that tends to drive me in a statist direction is that of how we guarantee our freedoms, especially for the less super-human among us. As the video dipicts, your freedom must end where my rights begin, but I'm not just going to state that ideal and trust you to uphold it. We need strong deterrents. And further, when we achieve a level of sophistication that allows us to recognize a new form of murder, slavery, or theft, we need to act to protect each other from that as well.
I'm going to outline one simple example of theft which I believe government should legislate against: Payday Loans. They set up a small shop in the middle of a ghetto and offer very short term loans (a week or two) and charge anywhere from 3% to 9% interest on the loan, which can amount to compound annual interest rates approaching 1000% for repeat customers. Clearly, such repeat customers are willing, but are being deceived. I classify this as the worst kind of theft because it prays on those who have the least. Recognizing it as theft, I support legislation against this practice - perhaps a limit on APR, or even, on the extreme end, requiring that the customer pass a test of mathematical competence before entering into the loan, which motivates potential creditors to provide education. In either case, Payday Loan shops would vanish.
I understand that this view seems too invasive to most libertarians. But I think it is intellectual elitism to give no thought to the victimization of the intellectually disadvantaged. They are being robbed every day by these outfits: [link edited for length]
As a nation with the power to stop this theft, we have a moral obligation to do so. This leads to a large and complex legal system, but it also protects the innocent, and I believe the cost is justified.
You also asked what conservative means to me. Indeed, what is liberal or conservative depends on who you ask. I personally feel the liberal/conservative divide is largely arbitrary, but it seems polite to try to self-identify a bit, based on the sum of such random categorizations I've heard out there. I call myself very moderately conservative, mainly because of my stand on social issues as a Christian.
Posted By: Jake, the champion of the constitution
Date: 2008-11-20 12:02:02
Dear PhilRatio -
The reason I asked about the conservative thing is that when I started writing here as a bright-eyed newbie, I wrote an article since I didnt even know what they were. My article's not too great, but I really liked the responses. Its right here.
http://www.nolanchart.com/article2716.html
I am no expert on the PayDay loans stuff, but any intent to defraud should and can be covered by anti-fraud laws. I think I know what you mean - let's "protect the idiots" type stuff. I dont think anyone is an idiot, but having a fraud-proof process is fine by me. Worth a thought or two later, I suppose, but I am a bit focused on the FEDdy FED FED this week.
So, when people say that the Fed "prints" money, is it safe to conclude that it does not actually print physical dollar bills? What is confusing me is how the money "created" by the Fed ever becomes physical dollar bills. If the Fed "writes a check on itself" for T-Bills, no physical money is created. I would think that the entry of massive amounts of new money in the system without a corresponding increase in paper bills would lead to a shortage of paper bills. How is this handled?
Posted By: Jake, the champion of the constitution
Date: 2008-12-10 17:56:09
Dear Nog Dog–
First “Printing money” is often used just as a figurative term by economists and laymen both to refer to money creation. Most money creation, as described above, consists of what I personally have taken to calling “fiat electrons,” (which for some reason really cracks me up).
"How is this [shortage of bills] handled?" Pretty much there is no shortage of bills ideally as all of the parties involved keep their money electronic. Its the little peons like you, I, (and perhaps later Ching the Chinese, Mitsui the Japanese and Sheik Abu Dhabi) who are pesky about this cash thing.
That's the short answer. But unfortunately for you that was just a warm up!
Cash is basically a pain in the butt for the FED, and if you’ve read how many planes we sent to Iraq with $100 bills for the “reconstruction” its frankly speaking, shocking. The below is coming from the Fed’s P&F document I attached above on pages 85-89 (numbered on the pages) starting with “Currency and Coin”
There are 12 issuers of FED notes, one from each Reserve Bank. The notes are printed by the Treasury (fun facts: using Swiss presses and costing 7-9 cents per note). All of the coin is issued and minted directly by the Treasury – (in my other writings you would discover a fondness for nickels, which have maintained their same mass and metal composition since 1866, 75% copper and 25% nickel if my memory is intact, except for a brief period in WWII when silver was used. That will change in 2009 as Congress authorized steel nickels and pennies, which are close to worthless, just like Euro coins)
So the Treasury prints and holds the notes in their vaults BUT it does not become currency until the FED needs it and it leaves the vault. There was some court case on this I think. So in other words, its just paper, not currency, until the FED needs it. Cool, huh?
A major task for the FED is to run this cash and coin around the country taking in excess cash from them and supplying their banks. I like to watch M1 growth rates and right now it’s at 20% - record setting levels since this translates into a lot more currency flooding the system – Americans (or is it foreigners?) want the paper cash.
Its worth noting that the banking system would prefer for everything to be completely 100% electronic, and they are at the point where the cash is basically just an annoyance. For each pesky $1 bill in your pocket, the system loses $9 of created money, and its no longer controlled by them. Checks are still a major pain in the ass for them. They weaned private citizens to debit and credit cards, but businesses still do a ton of checkwriting. All checks are destroyed by the Reserve Banks.
It’s a little known fact the Reserve Banks destroy incredible amounts of cash every week (dumpsters upon dumpsters) that will not function properly in vending machines. Due to the heavy metals in the inks, this is NOT very environmentally friendly.
Sorry for the long-winded response. Hope I answered your question somewhere in there. If you read this, I would appreciate it if you joted a note saying it helped, didn’t help, "Jake you are a complete windbag", etc.
Jake
PS Do you know that starting in 2009 the government will have “legal” access to all of your credit card statements? It was stuck into one of the very first bailouts that I reported on. So, the end of privacy is upon us. Even cash will eventually lose its anonymity, which is a feature most people never stop to think about.
Very helpful. So, let's say a local bank has loaned out a bunch of money. More customers come in and withdraw physical cash than that bank has in its vaults. The bank has sufficient "fiat electrons," but insufficient physical notes. Meanwhile, the Fed has access to large numbers of bills that the Treasury has put in the vault but have not yet come to represent actual dollars. How does the paper in the vault work its way to the bank? Does the Fed send trucks with cash to banks to replenish supplies? I can't imagine that this is not an issue with the Fed destroying mountains of cash daily (as you mention). New paper bills need to find their way into the system.
Also, is it correct, then, to assume that the Treasury does not directly distribute or spend any paper bills so that paper bills do not have their entry point into the system through the Treasury but ONLY through the Fed?
I need to clarify this because it seems absolutely inconceivable to me that a private company is able to create and distribute money with no checks whatsoever. It is even more inconceivable if, as you state, we have no way to know who the Fed's shareholders are. And why would it even need shareholders? It creates money out of thin air, so presumably it is not relying on capital put in by shareholders. If you know of any writing that discusses this, please let me know. I have not read all of your articles in this series yet.
Posted By: Jake, the champion of the constitution
Date: 2008-12-11 02:44:43
Dear Nog Dog,
Thanks for your continued interest.
"How does the paper in the vault work its way to the bank? Does the Fed send trucks with cash to banks to replenish supplies?"
Yes. Like I mentioned before, the FED prefers to keep things electronic.
What's very interesting is what happened to me on my last trip to the US last month. I had taken out thousands of paper cash out via ATM in July, but when I tried the same in November, I hit a $1000 daily limit. I thought "What the??" and I grumbled to myself something like "now they are going to give me nickels" and I marched inside to the teller and she gave me the rest of the cash (and all the nickels) she had.
I mentioned this to a friend who goes to a credit union, and they mentioned the same thing - they had no clue, but need just over a grand to get some supplies. Had to cajole the teller into giving him an extra $200 of his own money. I would be curious to see if others have the same experience or not. Easy to check right? Take out $1100 or however much you have by ATM and then deposit it right away again just to prove you can. If this is widespread and has been blacked out, its time to get your money out ASAP. FDIC is useless during a meltdown, as I explained in my banking closure articles.
"Also, is it correct, then, to assume that the Treasury does not directly distribute or spend any paper bills so that paper bills do not have their entry point into the system through the Treasury but ONLY through the Fed?"
I believe the answer is yes.
The bills are printed by Treasury, issued by the FED, and distributed by the Reserve Banks to the rest of the system.
Coins are minted/issued by Treasury, purchased at face value by the FED, and distributed by the Reserve Banks to the rest of the system.
"inconceivable" was my first reaction too. I think its the normal reaction of anyone facing the truth for the first time.
Besides reading parts 1-5 and 10 of my series as fairly quick summaries - I wouldnt have written them if I found them all in one place already, as a primer, I recommend Rothbards "What Has the Government Done with our Money" (see link in pt 1 its about 45 pages) and then the link above "The Case Against the Fed" which is longer to discuss your topic.
Thanks for the read, the rest of the series is already planned out, but its still just in my mind. Interest like yours will help get the rest of the articles finished.
Posted By: James born on the 4th of July
Date: 2009-04-24 12:45:30
I read through all the posts, Jake. I really have to laugh because I know the labarynth that people are dealing with. That\'s why God invented the simplicity of gold, except that he left the challenge of liquidity to us.
Gold has never been a problem in monetary systems of the past. Only the logistics of gold have been a problem, based on a lack of liquidity. More specifically, for the sake of your audience, transposrting gold from A-B and being able to buy very low priced items was a challenge. The fixed peg really created a complication on the basis that gold is a finite resoruce and under the rules of a pegged system, entering more currency into circulation means needing more gold as they are joined at the hip. Unrealistic, completely, although I can\'t dispute the store qualities.
Gold money has never been deflationary. It\'s poor liquidy based on the underlying distribution system was to blame based on the "need for more gold". The problem was the fixed peg ...... not the gold ! This is why the peg had to be removed so that gold could float with free market fundamentals. The challenge that remained at that time was "how to split the gold" in an economical and user friendly way. That solution would have to wait for the information age.
Today, you, I or any participant on this forum can buy a single toothpick from a merchat on the other side of the globe, they can do so in an instant and they can do so using a debt free store of value on the basis of allocated gold reserves that support the digital weighted currency.
There is no financial crisis in terms of design. There is simply a marketing challenge. Instant liquidity has married debt free store of value. We are all invited to the "great wedding".
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Fractional Reserve Banking is a banking system in which banks are supposed to maintain a quantity of reserves from their depositors. This quantity is a fixed fraction of the amount of new money the banks are then allowed to create. This newly created money is then loaned to the bank’s borrowers. 
The Federal Reserve 
Per the FED
However, if the Federal Reserve Board of Governors have a joint bad hair day and decide tomorrow to halve the reserve requirement ratio to 5%, the nation’s money supply will almost DOUBLE in a matter of weeks. A $20,000 asset like a car or a small apartment would rapidly approach $40,000 in value. In fact, just about everything would see 100% inflation, but salaries’ purchasing power would be halved until the inflationary tidal wave rips them upwards. (The FED finds it far less painless to do this over a long period of time by utilizing open market operations. What I just described happened not in a few weeks, but from 1985 to 2008. Use 
Per the FED
We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.