How the Federal Reserve Creates Money

[lozina]

Originally posted by: XZeroII
The federal reserve system was created by President Wilson. On his deathbed, he admitted that he completely ruined this country when he signed it into action (not in those exact words, but similar words).

Didn't it also receive a vote by Congress, during a Christmas recess? I remember reading something about that... I really despise this loophole in our congress- democrats/republicans alike taking advantage of certain recesses to pass things that would not normally pass given full attendence.

Only Congress has the right to coin money, so literally speaking, the Federal Reserve is unconstitutional. It didn't mention anything about Congress has the right to appoint a private party the right to coin money.

 

[robh23]

Originally posted by: Zephyr106
As Robh23 said, the "money multiplyer" is the source of the the amount of money "in use". I say in use because banks do not simply print more money as they loan it out, the amount of money printed by the government is strictly regulated by the Fed, otherwise there would be serious devaluation of the currency. We see this all the time in South American countries, haphazardly printing more money is one of the worst things you can do.

Consequently, with the limited money production rate, and the money multiplyer in effect, there is definately not enough currency to back up all outstanding loans- if everyone wanted to get their hands on their cash, they can't- there's not enough bills, so not only currency, but consequently loans are legal tender merely due to good faith in the government.

It's a complicated situation that I know far from enough on, and I am curious as to how other countries handle their finances.

Zephyr

no well run economy prints money, its just causes inflation and nothing else, its also an uncontrollable form of inflation as it componds, people expect it, put up prices, gov has to print even more next year, total spending in the economy is in excess of the value of goods at this years prices etc....

what the gov does is keep a small amount of inflation say 2.5% over the cycle, in excess of say 2.5% GDP growth (so about 5% per year total). this inflation wears their debt burden down in relation to the size of the economy each year, so if gdp is 2.5% and gov notes (< 5 years) are say 3.5%, then inflation wears the value of the bonds down, long term bonds would be say gdp + inflation or 5% and stand still against the economy.

its basically a free loan to the gov, but its also risk free, so no profit should be acrued by the lender.

secondly banks dont normally borrow from the fed, normally only when they run out of cash. the way the fed manges the economy is noise and action.

the noise is the fed funds rate, people get a guide to the future cost of cash from it, but apart from that its basically nothing.

the action is called open market operations. the fed has a huge cash pile, partly regulatory reserves from the banks in the country (which it doesnt pay interest on - i think) and partly its own money and partly borrowed money. it uses this muscle when it wants to squeeze or loosen the money supply. a tight money supply means demand for liquidity (cash/ loan) is higher than supply, so interest rates go up, the fed buys cash and sells federal bonds, notes and bills. it either borrows and sells them or sells from its vault, and visa versa. most economists discount the effective ness of the fed ding open market ops in normal situations.

 

[AmbitV]

Originally posted by: Dissipate

Originally posted by: vman

The Federal Reserve of course, and therefore the Federal Reserve deliberately causes inflation every single year. Why? Simple, to insure that the banking industry makes billions of dollars a year off of money that they create from nothing.

That line is just false. The federal reserve changes the money supply to either stimulate or slow down the economy. Inflation over the past decade has actually been quite modest, due mainly to efforts by the federal reserve to stabilize inflation. This focus on inflation was initiated by Fed Chairman Volcker and the cause has now been taken up by Greenspan. In fact the federal reserve raised rates in 2000 (i.e. lowered the money supply) after the economic figures were pointing to increased inflation. That put the brakes on the economy and sent us into the recession (along with 9/11 of course) that we're only now starting to come out of. If the federal reserve loved inflation so much they could have easily just let the bubble keep growing and would always leave interest rates low.

You are confusing short term inflation with long term inflation. Did you not read the quote I put in my original post? Short term inflation is caused by market forces, granted this is what the Fed staves off. But like Dr. Ball said, long term inflation is caused by only one thing, consistent increases in the money supply beyond the growth of the GDP.

The Fed enjoys keeping the economy "healthy" while it bleeds off a chunk of the economy every year right under our noses. Look at the hyper inflation of the '70s. During the '70s inflation was so bad that people started exploring alternative currencies. The Fed could not let that go on because use of alternative currencies would shatter the Feds grip on the economy. Therefore, the Fed keeps inflation "low" but steady so that it can continue to leech.

If the Fed kept up their current policies, then long term inflation would be minimal, no? Sure there has been crazy inflation in the past, like in the 70s as you point out, but that's why I said the current focus on minimizing inflation was only started after the 70s. The reason why monetary policy was so loose before 1980 and why inflation was so rampant is because economists at one point thought that inflation and unemployment were linked (the Phillips Curve). They thought that if they increased inflation, they could reduce unemployment. The stagflation of the 70s proved them wrong, and we learned our lesson, so to speak. Now we realize that a stable inflation rate is key to a healthy economy, and target low single digit inflation numbers that are in line with long term GDP growth.

And BTW Japan has a fractional reserve banking system, and they have had numerous bouts of deflation over the past decade.

It sounds like a lot of you are mad because somehow the bankers make a lot of money from all of this. But let's not forget that bankers provide a useful function - because borrowers and savers now have an intermediary they can trust, a lot of capital is directed towards socially beneficial projects that would not otherwise take place. Sure they may be monopolists, but this may be more a function of them being a natural monopoly rather than them employing anticompetitive practices. People trust banks with reputations - banks that have been around for a long time. Obviously if you have a whole mess of banks it'll be hard to tell which ones are trustworthy and which ones are not.

And what's so bad about a little inflation over the long run? Would you rather have a pure asset-backed money system? Show me one country with a different system that has a better track record of economic growth that the United States.

 

[Dissipate]

Originally posted by: vman

Originally posted by: Dissipate

Originally posted by: vman

The Federal Reserve of course, and therefore the Federal Reserve deliberately causes inflation every single year. Why? Simple, to insure that the banking industry makes billions of dollars a year off of money that they create from nothing.

That line is just false. The federal reserve changes the money supply to either stimulate or slow down the economy. Inflation over the past decade has actually been quite modest, due mainly to efforts by the federal reserve to stabilize inflation. This focus on inflation was initiated by Fed Chairman Volcker and the cause has now been taken up by Greenspan. In fact the federal reserve raised rates in 2000 (i.e. lowered the money supply) after the economic figures were pointing to increased inflation. That put the brakes on the economy and sent us into the recession (along with 9/11 of course) that we're only now starting to come out of. If the federal reserve loved inflation so much they could have easily just let the bubble keep growing and would always leave interest rates low.

You are confusing short term inflation with long term inflation. Did you not read the quote I put in my original post? Short term inflation is caused by market forces, granted this is what the Fed staves off. But like Dr. Ball said, long term inflation is caused by only one thing, consistent increases in the money supply beyond the growth of the GDP.

The Fed enjoys keeping the economy "healthy" while it bleeds off a chunk of the economy every year right under our noses. Look at the hyper inflation of the '70s. During the '70s inflation was so bad that people started exploring alternative currencies. The Fed could not let that go on because use of alternative currencies would shatter the Feds grip on the economy. Therefore, the Fed keeps inflation "low" but steady so that it can continue to leech.

If the Fed kept up their current policies, then long term inflation would be minimal, no? Sure there has been crazy inflation in the past, like in the 70s as you point out, but that's why I said the current focus on minimizing inflation was only started after the 70s. The reason why monetary policy was so loose before 1980 and why inflation was so rampant is because economists at one point thought that inflation and unemployment were linked (the Phillips Curve). They thought that if they increased inflation, they could reduce unemployment. The stagflation of the 70s proved them wrong, and we learned our lesson, so to speak. Now we realize that a stable inflation rate is key to a healthy economy, and target low single digit inflation numbers that are in line with long term GDP growth.

And BTW Japan has a fractional reserve banking system, and they have had numerous bouts of deflation over the past decade.

It sounds like a lot of you are mad because somehow the bankers make a lot of money from all of this. But let's not forget that bankers provide a useful function - because borrowers and savers now have an intermediary they can trust, a lot of capital is directed towards socially beneficial projects that would not otherwise take place. Sure they may be monopolists, but this may be more a function of them being a natural monopoly rather than them employing anticompetitive practices. People trust banks with reputations - banks that have been around for a long time. Obviously if you have a whole mess of banks it'll be hard to tell which ones are trustworthy and which ones are not.

And what's so bad about a little inflation over the long run? Would you rather have a pure asset-backed money system? Show me one country with a different system that has a better track record of economic growth that the United States.

How did we ever realize that inflation is key to a healthy economy? Dr. Ball does not mention this in his paper, he only says that ending inflation might cause a recession. I can't account for Japan's deflationary economy as I haven't studied it very much but I would chalk that up to their inability to control the economy. Look at the U.S. economy now. Deflation has arrived, even though the Fed has set the interest rates as low as they can possibly go. This won't last of course as the Fed has shown throughout history that it will cause inflation no matter what.

I am mad because the bankers have a monopoly on our common currency the U.S. dollar and that they profit hugely from this. You see currencies, while they do have unique properties are largely just like anything else in the economy. Any economist will tell you that unchecked monopolies are very bad. In the case of the U.S. dollar the Federal Reserve and its member banks have a complete monopoly on our currency. You might say that in many cases monopolies are necessary because there is too much cost to having competing companies. This is true of electric companies and other services in the economy. However, in these cases there is an INDEPENDENT entity that regulates and watches over these monopolies. This entity is not involved in the trade itself, it merely watches over. The vast majority of the time this entity is the government.

Now lets take a look at the Federal Reserve and its member banks. Clearly the Federal Reserve and its member banks have a virtually 100% monopoly on our common currency. I posted an article awhile back about a private currency that competes with the U.S. dollar but its circulation is miniscule. Now, since the Fed has a monopoly on our common currency economics tells us that there must be another independent entity to regulate and watch over this monopoly. In the case of the Federal Reserve what entity is this? The answer is there is none. The Federal Reserve was set up to be completely outside any influence whatsoever! No other entity regulates it or watches what it is doing. In fact the Federal Reserve has not had an independent audit since the '50s during the Eisenhower administration. Yes the Fed has "audits" but these "audits" are kept secret and is done by a branch that is within the Federal Reserve itself. This does not quality as the necessary watchdog agency.

Now we have to ask the question, well if the Federal Reserve and its member banks have a monopoly on our currency do they profit from this monopoly and is this profit exorbitant? The answer is HELL YES. The Fed and its member banks clearly abuse its monopoly to the tune of billions. There is no competition, no watchdog agency.

The U.S. is the wealthiest nation in the world in spite of the banking cartel instituted here. However, that does not mean that what this cartel is doing is any less wrong. Also, fractional reserve banking was borne in Europe and spread to the U.S. Therefore you cannot accurately compare the U.S. to any other country because all western nations have fractional reserve banking. There may be some countries that do not but they suffer from numerous other problems not related to banking. Its not something you can compare due to the fact that fractional reserve banking is a disease that has spread so far and wide it has infected all major economies.

Edit: Yes banks provide necessary functions in the economy, but these banks must function at full reserves and they must also not be a cartel. For instance there must be banks allowed to issue competing currencies and be independent of the Federal Reserve.

 

[robh23]

look.

this is why inflation is necessary.

in the modern western ecomomic paradigm. young peeps borrow to buy a house etc. old peeps lend their pension money. as the ecomomy gets more productive manufactured and similar goods come down in price year on year. if there was no inlfation, then as prices came down wages would as well, offset by gdp growth. as wages come down people afford less, because they are paying off loans growing at at least gdp growth, this reduces disposable imcome so some people lose their jobs, and shops and so on slash price to compete, and deflation goes into a spiral. it wreaks the economy.

if there is inflation, it hurts you when you have no equity, once you have a house the value of the house should rise by inflation and gdp plus a few % points on average over your lifetime, also when you are old and lend to young peeps you will benefit from inflation.

 

[Dissipate]

Originally posted by: robh23
look.

this is why inflation is necessary.

in the modern western ecomomic paradigm. young peeps borrow to buy a house etc. old peeps lend their pension money. as the ecomomy gets more productive manufactured and similar goods come down in price year on year. if there was no inlfation, then as prices came down wages would as well, offset by gdp growth. as wages come down people afford less, because they are paying off loans growing at at least gdp growth, this reduces disposable imcome so some people lose their jobs, and shops and so on slash price to compete, and deflation goes into a spiral. it wreaks the economy.

if there is inflation, it hurts you when you have no equity, once you have a house the value of the house should rise by inflation and gdp plus a few % points on average over your lifetime, also when you are old and lend to young peeps you will benefit from inflation.

Uh, I think you are confused. I am not advocating deflation. I am advocating 0 inflation. Please read the thread.

 

[ElFenix]

you really shouldn't be getting your panties in a twist over nominal inflation. in real terms we've gone through deflation for the past century

 

[Dissipate]

Originally posted by: ElFenix
you really shouldn't be getting your panties in a twist over nominal inflation. in real terms we've gone through deflation for the past century

I know that. That is because technology has improved worker productivity big time. I am not getting my panties in a twist over inflation in and of itself. However, a side effect of inflation is extraction of wealth from the economy. Its a devious tax.

Think of it this way. If you are a professional counterfeiter and you go around spending your bogus bills everywhere you are extracting wealth from the economy and at the same time causing inflation. This is exactly what the government does every year, except for some reason no one has the gall to simply call it counterfeiting. Its hidden by all these complex sounding economic terms. The government makes the process somewhat complex so that the common man won't figure it out for a long time.

 

[robh23]

disspipate im not an ecomomist.

basically we need inflation to control the ecomomy using fiscal measures, that is;

use the cost of loans to control the money supply and therefore supply of money and demand of goods in the economy; its called demand side economics, or something like that.


it works in two ways first you have some inflation that people expect and price into their prices and wage negotiations etc.

second you have the government who try and control the juggernaught through small variations in the fed rate, and through open market operations with which they effectively alter the money supply.

now if you want to aviod deflation, its easier to do that with a system that operates from a target of 2.5% inflation than one that trys to get zero. and if you look back 10 years to the monetarist period inflation was well over 6% on average.

if you have zero inflation then the gov only has about 2.5% of gdp growth to operate in in terms of cutting interest rates relative to the value of money/ the economy. at the end of the day the gov cant offer money to the person who borrows it, if gdp growth is 2.5% and the fed rate is 1% they are effectively giving 1.5% to borrowers - including themselves when it comes to the national debt. so the lowest you can go is 0.01% fed funds rate. so if they need fiscal stimulus to support demand, they cut interest rates, this helps keep companies from price slashing and absolute terms deflation. its a well known fact that demand side fiscal economics doesnt have an answer from a deflationary environment. i think they think the gov has to borrow and spend its way back to an inflationary environment - some sort of keynianism i think. think budget deficit, big $$$.

now i imagine what i said was a bit incoherent, so if you want to find out more then you will have to ask on an ecomics board as i really dont know any more than that.

 

[Dissipate]

robh23:

You are right. There needs to be a control of the money supply, the money supply has to grow with the economy otherwise deflation occurs. What I am saying is that inflation is not needed to avert deflation. If the money supply is increased only the amount the economy increases then theoretically you will have 0 inflation and everything will be fine. The government never does this though, they use inflation as a tax just like Germany did to pay for WWII. Only the government does it on a much smaller scale and throws up all kinds of economics B.S. as a smokescreen.

This is well documented in books such as The Creature From Jekyll Island: A Second Look at the Federal Reserve

 

[robh23]

look dopey;

if you have more assets than debt then some inflation is good, it wears down the principle of your loan faster.

if there were no inflation government debt wouldnt go down relative to tax inome over time quite as fast - and we are taking very small amount of difference here, as it would only really apply to short term notes, and you would have to pay for the taxes directly. of course differing sets of people would be affected. upfront taxes hurt the middle classes more, the "tax" you are bleeting about hurts investors more, now given that most of the effect on this is treasury bills of less than 2 years in duration, and that most of them are used for non-investment purposes, but banks, hedge funds and insurance companies, it mainly hurts people with investments in business via the stock market. having said that these people are much more advantaged by having a level of inflation that affords easy enough control of the economy, and the paradigm is a 2-3% inflation target band, and all modern central banks have a similar policy.

end of my participation in this discussion. you will understand when you are older.

 

[ElFenix]

Originally posted by: Dissipate

Originally posted by: ElFenix
you really shouldn't be getting your panties in a twist over nominal inflation. in real terms we've gone through deflation for the past century

I know that. That is because technology has improved worker productivity big time. I am not getting my panties in a twist over inflation in and of itself. However, a side effect of inflation is extraction of wealth from the economy. Its a devious tax.

Think of it this way. If you are a professional counterfeiter and you go around spending your bogus bills everywhere you are extracting wealth from the economy and at the same time causing inflation. This is exactly what the government does every year, except for some reason no one has the gall to simply call it counterfeiting. Its hidden by all these complex sounding economic terms. The government makes the process somewhat complex so that the common man won't figure it out for a long time.

yeah, and every other gov't on the planet does the exact same thing. most do it worse than ours. unfortunately its impossible to figure out exactly how much the economy is growing at in real terms beforehand, pretty hard to do it in real time, and its too late afterward. a little too much liquidity is probably better than not enough

 

[Dissipate]

Originally posted by: robh23
look dopey;

if you have more assets than debt then some inflation is good, it wears down the principle of your loan faster.

if there were no inflation government debt wouldnt go down relative to tax inome over time quite as fast - and we are taking very small amount of difference here, as it would only really apply to short term notes, and you would have to pay for the taxes directly. of course differing sets of people would be affected. upfront taxes hurt the middle classes more, the "tax" you are bleeting about hurts investors more, now given that most of the effect on this is treasury bills of less than 2 years in duration, and that most of them are used for non-investment purposes, but banks, hedge funds and insurance companies, it mainly hurts people with investments in business via the stock market. having said that these people are much more advantaged by having a level of inflation that affords easy enough control of the economy, and the paradigm is a 2-3% inflation target band, and all modern central banks have a similar policy.

end of my participation in this discussion. you will understand when you are older.

Look man. I have tried REAL hard to make sense of your gibberish. If you could capitalize your sentences, make clearer statements and learn how to use periods then I might be able to make sense of your "enlightening" comments. I'm not the god of grammar but dude your writings are abysmal. I am quite surprised someone as yourself would have the gall to call me dopey.

Thank you for exiting the discussion.