PART II
What are we to do when Banks that loaned out customer’s money go belly up and people start running on banks, causing them to close? It’s really quite a shame that banks, acting illegally, loaned out people’s money and then got caught doing so. There must be some way that the Federal Government can help out here, and Keynes and other macro-economists had the answer.
In 1913, the Federal Reserve Bank was established. As I said, it was a hedge against bank runs and ultimately a way to control business cycles to prevent recessions. The major tools the Federal Reserve Bank (which is actually a system of 9 Fed banks controlled by a government-run board) uses are the printing and inflation of the money supply, raising or lowering the “discount window” which effects the prime interest rate, and setting the reserve requirements for banks (how much money they need to keep in their vaults physically and how much or what percent they can lend out). These tools control the supply of money, the principal means of exchange which is based on what people find valuable, not what government determine to be valuable.
Rather than allowing shady banks who loan out too much money to fall on their face when they misuse deposits entrusted to them, The federal Reserve acts as a safeguard, or a “lender of last resort”, and prints money when banks are insolvent. Setting up a Federal Reserve System is basically a signal to banks to loan their money out as much as they want, and they will get bailed out by the Fed. Rather than allowing banks to learn their lesson or better yet JAIL those who outright stole individual’s money by lending it out for personal gain and in exchange for a free checking account and (maybe) a free pen, we’ll bail them out with taxpayer’s money.
Wait, why do I say taxpayer’s money? If the Federal Government is printing the money, then it’s not really coming from me, right?
Actually, it does come form you! And this brings us to the first of the Feds tools used to control the money supply. The money most definitely comes out of your pocket and out of everyone’s pocket that has an American dollar in it. Every time the Fed prints money which is not backed by something of real value (we used to be backed by gold like the people on our island from part I. A few years after the Federal Reserve was enacted, an act of Congress took us off the gold standard, and said that paper money would no longer be redeemable in gold. This was economic suicide.), we see the phenomenon known as inflation, or, too much paper chasing too few goods.
This all simply goes back to Says Law. This states that in an economy, the amount of money you have in circulation and the number of goods in circulation determines the price in an economy, and it generally evens out. Let’s say there is 10 dollar bills representing representing 10 oz of gold, and there are 10 items in the economy. The price of each good will be about $1 dollar. For reasons of “macro” control over our tiny economy, let’s say the king of this market decides to print more money for whatever reason. He prints 10 more dollars. But there are only 10 oz of gold in the vaults. That means that there is extra paper chasing the goods in society now. That means according to Says Law that each good will be worth about $2. Then the king takes society off the gold standard completely, and raises the prices even higher by printing more and more paper money to fund his various tax initiatives, the building of roads, subsidizing farms, royal welfare programs, etc. This is the phenomenon of inflation.
Back to the Federal Reserve and its tax on you. If you have 100 dollars in the bank, that can buy you x amount of goods at pre-inflation levels. But when the Fed prints money, your buying power with those hundred dollars goes down. If inflation goes up by 5%, then you only have the buying power of 95$ pre-inflation dollars with your 100$. In a few more years and more government printing of money, inflation creeps to 10% and you can only buy 90$ worth of goods with your $100 dollars. See the problem? It’s a hidden tax and a method of control.
How so? When prices are steadily rising due to inflation, people notice. Look at the way we are all watching gas prices. What happens is that people are literally compelled to buy now before their money is worth less. Inflation is a was to discourage savings, because no one is going to sock their money away for tomorrow when tomorrow is going to be a more expensive day. No one saves in the market.
Keynes believed that savings was a bad thing, as it supposedly took money out of the economy that could be used to stimulate it. If people saved their money, business would slow down, and we would see various parts of the economy stall or even go out of business entirely. Through his macro-policies, he tried to get people to spend money as much as possible, as this in his mind helped to stimulate the economy. Well, he was partially right.
The printing of money and inflation it causes does in fact stimulate the economy, but it is a false stimulation. When people save and have excess wealth, they tend to invest it, and this investment process is used to lengthen the production process of various lenders, or make products better and cheaper. When no one is saving their money, there is less money to invest and additionally, those who invest tend to spend money on first order consumer goods (such as the final products or materials that directly bring the good about, such as building materials for cars, houses, labour, etc.) rather than spending it on higher order goods, as more people are buying first order consumer goods at the moment. This tends to make the final products that are in a high demand of cheaper quality and harder eventually to obtain, which raises the price.
So Keynes belief that he would stimulate the economy backfires. The situation where money is pumped into the economy, but prices are still rising and the economy remains in a recession is known as stagflation, and occurred in the 1970’s.
Other ways the Fed controls the money supply. It can lower what is known as the reserve requirements that banks have. That remember is the fraction of the money a bank must keep of the deposited money. Now it is about 5%. Why do that? The Federal Reserve will “loan” money to private banks by printing it when it sees fit to stimulate the economy. The banks receive these loans, and rather than tally them in their liability column (what they owe) they treat them as deposits or assets as well as liabilities. They loan out what the Federal Reserve Bank loaned to them (up to a certain fraction, I believe 90%, which is also federally mandated) to other banks, who similarly receive loans and treat them as assets, and on and on. A few million dollars rolls out into the economy exponentially until it grows into really large numbers. Keep in mind this money was printed and backed by nothing to begin with. So essentially the Federal Reserve is loaning out paper money and then banks are loaning that out as well, ad infinitum. As crazy as it sounds, this happens and surprisingly this is how the system is supposed to work.
The Federal Reserve pumps money into the economy like this and then concurrently will lower discount window (the third tool), or their interest rate. Normal banks follow the Feds interest rate closely. When Banks receive the money printed by the bank and when the prime rate of interest falls, they are much more inclined to loan out that money and the money of depositors to finance private and business loans. Normally, it can be hard to get a loan due to your risk assessment. But in a time of easy credit, just about anyone can get a loan, even those who might not be able to pay it back. The banks don’t mind because they are backed by the Federal Reserve, who has promised to be a lender of last resort. The result is easy credit and individuals who have a spend rather than save mentality. This was not a social consensus remember. This was a trend established by the Federal Reserve.
All three of these tools combined gives the Federal Reserve and the government real control over your money and even your value system. They can create an environment of spending by printing more money, lower the discount window, and lower the reserve requirement of banks. This encourages banks to loan and people to operate on credit. If they tighten the money supply, or raise the interest rate, reserve requirements and stop printing money, people will save.
By either tightening or loosening money and credit policy, the Federal Reserve basically decides how you are going to act. This is a Keynesian agenda at work here. You the human actor are too stupid to do anything independently, so the government will balance everything out and make sure we have continued and steady growth. (hint hint: This does not work, as seen by the Great Depression, 1970’s stagflation under Nixon, Housing Market crash, etc. All owed a major debt to Federal Reserve tampering)
These are all means to stimulate the economy, which really don’t work as I hinted at. When inflation surpasses the point of government-sponsored inflation, people’s wages cannot keep up with the inflation. That’s why you hear stories about Germany papering their walls with German Marks. They too inflated their money supply to stimulate a lagging economy, and the too suffered the consequences.
When things get bad enough, historically people flock to a value based money system. If a currency fails, people will still continue to trade and live. If not a barter system, usually a gold-based economy emerges. Historically when fiat money was introduced ion one form or another, there has always been some circulation of gold and silver in economies. Today, however, there is no such safeguard. We need to, right now, return to a gold standard or some value-based monetary system, before we wind up papering our wall with German Marks.
So much for Money and the Federal Reserve!
