Part three in the on-going saga of posting a paper no one wants to read.

PART THREE: THE FEDERAL RESERVE SYSTEM – THE MAGICAL MONEY MAKING MACHINE

“The world is governed by very different personages from what is imagined by

those who are not behind the scenes.” – Benjamin Disraeli, English Statesman 1844.

In the preceding pages, a quick sojourn through time has shown the many seemingly innocuous and worthless items that have been used as money. We have also taken a brief jaunt alongside the continued attempts to build a centralized banking regime in America and the subsequent fall of each. In this section, that basic framework becomes the context with which the merits of the Federal Reserve System are called into question. The question was posed in the opening paragraphs of whether or not there should be an all-mighty arbiter that controls the creation and flow of money. That is precisely what the Federal Reserve is.

Llewellyn Rockwell, Dean of the Ludwig von Mises Institute, has a less flattering view: “It’s no different from a burglar in your home wanting to steal your money – that’s what the Federal Reserve does. It depreciates your savings, it takes away your economic security and it ought to be treated as an institution that does that rather than something of alleged benefit.”

What is the alleged benefit of the Federal Reserve system? In October of 1929, speculators who borrowed heavily on margin to buy stocks saw the market lose one third of its value. Bank loans totaling more than $7 billion were left outstanding. Stocks bought on margin use that purchased stock as consideration (collateral) for the loan. The dip in stock values prompted the lending banks to call in those margin loans. As speculators defaulted on loans, bank failures spiraled out of control and the Great Depression began. The primary alleged benefit of the Federal Reserve system is that it safeguards against a depression by being a lender of last resort. In case any bank got into trouble, they didn’t have to worry – they could get the money from Washington. The legitimacy of such an argument is thinly veiled as the artificial fluctuation of interest rates by the Fed result in an initial inflation of the money supply and thus abundant credit, the boom, and the eventual contraction of that credit that creates the bust of the so-called business cycle.

Hans Hoppe, Economics Professor at the University of Nevada Las Vegas, questions whether or not it is even desirable to have such a thing as a lender of last resort. “The correct position appears to me,” he says, “that every single bank should be responsible for the its own debts and contractual obligations. And if banks, through imprudent policy, then go bankrupt, this should be considered a magnificent thing because the danger of bankruptcies is precisely what makes banks adhere to sound policies” (MBFR). Let us examine how the Federal Reserve system operates.

The previous sections explained the concept of fractional reserve banking. Initially, all Federal Reserve notes were backed by 40% gold. That is to say for every Federal Reserve Dollar in circulation, forty cents of that were represented in their reserves by actual gold. The other sixty cents were pure faith. The Federal Reserve is not a government institution, but rather a privately owned enterprise that prints money and loans it to its customer, the U.S. Government, at interest. Seven presidentially appointed board members oversee the Fed and its twelve regional reserve banks located in San Francisco, Kansas City, Atlanta, Boston, Minneapolis, Chicago, Philadelphia, Richmond, Dallas, St. Louis, Cleveland, and New York. The creation and distribution of “money” follows this course: The U.S. Government sells securities in the form of bonds to the Federal Reserve which then makes a loan for a specified sum – let us say $10 billion for this illustration. Now that money comes bearing interest which must be repaid, but it does not go to the government to disperse as it sees fit. The $10 billion is given to a Federal Reserve member bank and used as the basis for loans to various subsidiary banks that in turn use the money as loans to its customers. As current regulations stand, the requirement for this banking system is 10% of total liabilities as the “required reserve”; anything beyond is categorized as “excessive reserve” and used as the basis for new loans. Thus, the initial $10 billion can be used to create another $9 billion in non-existent money. One would think that would mean that any loans would come directly out of that $10 billion, but that is not the case. The newly created $9 billion is added to the initial principle, inflating that $10 billion to $19 billion. (Zeitgeist: Addendum) The process continues in every bank that money encounters. Consider the chart below for clarification.

DEPOSIT MONEY CREATION / LOAN CYCLE

$10,000,000,000 1 $10,000,000,000

$9,000,000,000 2 $19,000,000,000.0

$8,100,000,000 3 $27,100,000,000.0

$7,290,000,000 4 $34,390,000,000

$6,561,000,000 5 $40,951,000,000

$5,904,900,000 6 $46,856,000,000

$5,314,410,000 7 $52,170,000,000

$4,782,969,000 8 $56,953,000,000

$4,304,672,100 9 $61,258,000,000

$3,874,204,890 10 $64,744,784,320

The table illustrates how money creation works within a fractional reserve framework. Each subsequent loan only requires a 10% reserve, and the resultant new money is piled on top of every other loan. By the tenth revolution of the loan cycle, a potential for creating nearly $65 billion exists with only about $4 billion in reserve to satisfy a demand for withdrawal. Couple that with the fact only 40% of that original $10 billion was backed by gold, it then becomes glaringly apparent that $65 billion in claims exist against $1.5 billion in equity. “Interestingly,” says Murray Rothbard ,”while Fed liabilities are no longer redeemable in gold, the Fed safeguards its gold by depositing it in the treasury, which issues gold certificates redeemable in nothing but 100% gold bouillon from treasury stocks deep within Fort Knox” (The Case Against the Fed, p.141)

In testimony before the House Committee on Banking and Currency on April 27, 1936, chairman of the New Economic Group Allen B. Brown made the following critique of the Federal Reserve. “The banks manufacture, without borrowing it, the monetary credit which they loan to the Government. For every dollar they themselves contribute to the loaning process, they manufacture 10 credit dollars, and call them their own, although they base the credit dollars on human sweat and labor and productive genius that is not

their own” (Martin).

It is imperative to note that this type of lending practice is what created the housing bubble and the financial crisis that plagued Wall Street in the tail end of 2008. The “easy money” practices of the Federal Reserve system and the irresponsible lending by government backed brokers Fannie Mae and Freddie Mac are a classic example of what happens when a bank or lender holds a forty-to-one debt to asset ratio and when reserves are over-extended in risky, high interest loans. The banks pursue a debt-based investment strategy; their investments are no longer financed by equity but out of debt; the money created as a loan and dealt out to the customer as a liability is treated instead as an asset and used as the basis for creating even more money. Does this seem like a rational expansion of the money supply? Or is it a pyramid scheme? What are the implications of acknowledging that the banking system loans money that is actually does not have?

Take, for example, the very interesting 1969 case of First National Bank of Montgomery vs. Jerome Daly. Mr. Daly was the holder of property with a mortgage claimed on it by the bank in question. Mr. Daly had fallen behind in payments and the bank foreclosed on his house and sold it from under him at auction. Mr. Daly argued that the contract with the bank required both parties to each put up a legitimate form of property. This is called consideration in legal terms. Mr. Daly’s consideration would be either a down payment as a portion of the loan or the property itself. The lawful consideration on the part of the bank would be the money they loaned to Mr. Daly, but as demonstrated in the preceding pages, that money was not real property of the bank, nor did it exist in real equity, The judge’s memorandum states that, “the money and credit first came into existence when they created it. Mr. Morgan (president of First National Bank of Montgomery) admitted that no United States Law or Statute existed which gave him the right to do this. A lawful consideration must exist and be tendered to support the note. The Jury found that there was no consideration and I agree. Only God can create something of value out of nothing.” The foreclosure was not only denied by that ruling, but the entire claim to the land or any lien on it declared null and void. (http://www.constitutionalconcepts.org/creditriver.htm)

Two years later, then president Richard M. Nixon eradicated the convertibility of the U.S. dollar into gold. In an address to the nation Nixon stated that he “directed secretary Connelly to suspend temporarily (time would show this to be permanent) the convertibility of the dollar into gold or other Reserve assets except in amounts and conditions determined to be in the interest of monetary stability and the best interest of the United States.” Bollocks!