12.23.2016 Doc of the Day

“The Federal Reserve Bank (or simply the Fed), is shrouded in a number of myths and mysteries.  These include its name, its ownership, its purported independence form external influences, and its presumed commitment to market stability, economic growth and public interest.

CC BY by KJGarbutt

The first MAJOR MYTH, accepted by most people in and outside of the United States, is that the Fed is owned by the Federal government, as implied by its name: the Federal Reserve Bank.  In reality, however, it is a private institution whose shareholders are commercial banks; it is the ‘bankers’ bank.’  Like other corporations, it is guided by and committed to the interests of its shareholders—pro forma supervision of the Congress notwithstanding.

The choice of the word ‘Federal’ in the name of the bank thus seems to be a deliberate misnomer—designed to create the impression that it is a public entity.  Indeed, misrepresentation of its ownership is not merely by implication or impression created by its name.  More importantly, it is also officially and explicitly stated on its Website: ‘The Federal Reserve System fulfills its public mission as an independent entity within government.  It is not owned by anyone and is not a private, profit-making institution.’

To unmask this blatant misrepresentation, the late Congressman Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s, described the Fed in the following words:

‘Some people think that the Federal Reserve Banks are United States Government institutions.  They are private monopolies which prey upon the people of these United States for the benefit of themselves and their foreign customers; foreign and domestic speculators and swindlers; and rich and predatory money lenders.’

The fact that the Fed is committed, first and foremost, to the interests of its shareholders, the commercial banks, explains why its monetary policies are increasingly catered to the benefits of the banking industry and, more generally, the financial oligarchy. Extensive deregulations that led to the 2008 financial crisis, the scandalous bank bailouts in response to the crisis, the continued showering of the “too-big-to-fail” financial institutions with interest-free money, the failure to impose effective restraints on these institutions after the crisis, the brutal neoliberal cuts in social safety net programs in order to pay for the gambling losses of high finance, and other similarly cruel austerity policies—can all be traced to the political and economic power of the financial oligarchy, exerted largely through monetary policies of the Fed.

It also explains why many of the earlier U.S. policymakers resisted entrusting the profit-driven private banks with the critical task of money supply and credit creation:

“The [private] Central Bank is an institution of the most deadly hostility existing against the principles and form of our constitution . . . . If the American people allow private banks to control the issuance of their currency . . ., the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered” (Thomas Jefferson, 3rd U.S. President).

In 1836, Andrew Jackson abolished the Bank of the United States, arguing that it exerted undue and unhealthy influence over the course of the national economy. From then until 1913, the United States did not allow the formation of a private central bank. During that period of nearly three quarters of a century, monetary policies were carried out, more or less, according to the U.S. Constitution: Only the “Congress shall have power . . . to coin money, regulate the value thereof” (Article 1, Section 8, U.S. Constitution). Not long before the establishment of the Federal Reserve Bank in 1913, President William Taft (1909-1913) pledged to veto any legislation that included the formation of a private central bank.

Soon after Woodrow Wilson replaced William Taft as president, however, the Federal Reserve Bank was founded (December 23, 1913), thereby centralizing the power of U.S. banks into a privately owned entity that controlled interest rate, money supply, credit creation, inflation, and (in roundabout ways) employment. It could also lend money to the government and earn interest, or a fee—money that the government could create free of charge. This ushered in the beginning of the gradual rise of national debt, as the government henceforth relied more on borrowing from banks than self-financing, as it had done prior to granting the power of money-creation to the private banking system. Three years after signing the Federal Reserve Act into law, however, Wilson is quoted as having stated:

“I am a most unhappy man.  I have unwittingly ruined my country.  A great industrial nation is controlled by its system of credit.  Our system of credit is concentrated.  The growth of the nation, therefore, and all our activities are in the hands of a few men.  We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world.  No longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men” [2].

While many independent thinkers and policy makers of times past thus viewed the unchecked power of private central banks as a vice not to be permitted to interfere with a nation’s monetary/economic policies, most economists and policy makers of today view the independence of central banks from the people and the elected bodies of government as a virtue!

And herein lies ANOTHER MYTH that is created around the Fed: that it is an independent, purely technocratic or disinterested policy-making entity that is solely devoted to national interests, free of all external influences. Indeed, a section or chapter in every college or high school textbook on macroeconomics, money and banking or finance is devoted to the “advantages” of the “independence” of private central banks to determine the “proper” level of money supply, of inflation or of the volume of credit that an economy may need—always equating independence from elected authorities and citizens with independence in general. In reality, however, central bank independence means independence from the people and the elected bodies of government—not from the powerful financial interests.

“Independence has really come to mean a central bank that has been captured by Wall Street interests, very large banking interests.  It might be independent of the politicians, but it doesn’t mean it is a neutral arbiter.  During the Great Depression and coming out of it, the Fed took its cues from Congress.  Throughout the entire 1940s, the Federal Reserve as a practical matter was not independent. It took its marching orders from the White House and the Treasury—and it was the most successful decade in American economic history” [3].

Another MAJOR MYTH associated with the Fed is its purported commitment to national and/or public interest. This presumed mission is allegedly accomplished through monetary policies that would mitigate financial bubbles, adjust credit or money supply to commercial and manufacturing needs, and inject buying power into the economy through large scale investment in infrastructural projects, thereby fostering market stability and economic expansion.

Such was indeed the case in the immediate aftermath of the Great Depression and WW II when the Fed had to follow the guidelines of the Congress, the White House and the Treasury Department. As the regulatory framework of the New Deal economic policies restricted the role of commercial banks to financial intermediation between savers and investors, finance capital moved in tandem with industrial capital, as it essentially greased the wheels of industry, or production. Under those circumstances, where financial institutions served largely as conduits that aggregated and funneled national savings to productive investment, financial bubbles were rare, temporary and small.

Not so in the age of finance capital. Freed from the regulatory constraints of the immediate post-WW II period (which determined the types, quantities and spheres of its investments), the financial sector has effectively turned into a giant casino. Accordingly, the Fed has turned monetary policy (since the days of Alan Greenspan) into an instrument of further enriching the rich by creating and safeguarding asset-price bubbles. In other words, the Fed’s monetary policy has effectively turned into a means of redistribution from the bottom up.

This is no speculation or conspiracy theory: redistributive effects of the Fed policies in favor of the financial oligarchy are backed by undeniable facts and figures. For example, a recent study by the Pew Research Center of income/wealth distribution (published on December 9, 2015) shows that the systematic and escalating socio-economic polarization has led to a sharp decline in the number of middle-income Americans.

The study reveals that, for the first time, middle-income households no longer constitute the majority of American house-holds: “Once in the clear majority, adults in middle-income households in 2015 were matched in number by those in lower- and upper-income households combined.” Specifically, while adults in middle-income households constituted 60.1 percent of total adult population in 1971, they now constitute only 49.9 percent.

According to the Pew report, the share of the national income accruing to middle-income households declined from 62 percent in 1970 to 43 percent in 2014. Over the same period of time, the share of income going to upper-income households rose from 29 percent to 49 percent.

A number of critics have argued that, using its proxies at the heads of the Fed and the Treasury, the financial oligarchy used the financial crisis of 2008 as a shock therapy to transfer trillions of taxpayer dollars to its deep pockets, thereby further aggravating the already lopsided distribution of resources. The Pew study unambiguously confirms this expropriation of national resource by the financial elites. It shows that the pace of the rising inequality has accelerated in the aftermath of the 2008 market implosion, as asset re-inflation since then has gone almost exclusively to oligarchic financial interests.

Proxies of the financial oligarchy at the helm of economic policy making no longer seem to be averse to the destabilizing bubbles they help create. They seem to believe (or hope) that the likely disturbances from the bursting of one bubble could be offset by creating another bubble! Thus, after dot-com bubble, came the housing bubble; after that, energy-price and emerging markets bubble, after that, the junk bond market bubble, and so on. By the same token as the Fed re-inflates one bubble after another, it also systematically redistributes wealth and income from the bottom up.

This is an extremely ominous trend because, aside from issues of social justice and economic insecurity for the masses of the people, the policy of creating and protecting asset bubbles on a regular basis is also unsustainable in the long run. No matter how long or how much they may expand financial bubbles—like taxes and rents under feudalism—are ultimately limited by the amount of real values produced in an economy.

***

Is there a solution to the ravages wrought to the economies/societies of the core capitalist countries by the accumulation needs of parasitic finance capital—largely fostered or facilitated by the privately-owned central banks of these countries?

Yes, there is indeed a solution. The solution is ultimately political. It requires different politics and/or policies: politics of serving the interests of the overwhelming majority of the people, instead of a cabal of financial oligarchs.

The fact that profit-driven commercial banks and other financial intermediaries are major sources of financial instability is hardly disputed. It is equally well-known that, due to their economic and political influence, powerful financial interests easily subvert government regulations, thereby periodically reproducing financial instability and economic turbulence. By contrast, public-sector banks can better reassure depositors of the security of their savings, as well as help direct those savings toward socially-beneficial credit allocation and productive investment.

Therefore, ending the recurring crises of financial markets requires placing the destabilizing financial intermediaries under public ownership and democratic control. It is only logical that the public, not private, authority should manage people’s money and their savings, or economic surplus. As the late German Economist Rudolf Hilferding argued long time ago, the system of centralizing people’s savings and placing them at the disposal of profit-driven private banks is a perverse kind of socialism, that is, socialism in favor of the few:

‘In this sense a fully developed credit system is the antithesis of capitalism, and represents organization and control as opposed to anarchy.  It has its source in socialism, but has been adapted to capitalist society; it is a fraudulent kind of socialism, modified to suit the needs of capitalism.  It socializes other people’s money for use by the few.’

There are compelling reasons not only for higher degrees of reliability but also higher levels of efficacy of public-sector banking and credit system when compared with private banking—both on conceptual and empirical grounds. Nineteenth century neighborhood savings banks, Credit Unions, and Savings and Loan associations in the United States, Jusen companies in Japan, Trustee Savings banks in the UK, and the Commonwealth Bank of Australia all served the housing and other credit needs of their communities well. Perhaps a most interesting and instructive example is the case of the Bank of North Dakota, which continues to be owned by the state for nearly a century—widely credited for the state’s budget surplus and its robust economy in the midst of the harrowing economic woes in many other states.

The idea of bringing the banking industry, national savings and credit allocation under public control or supervision is not necessarily socialistic or ideological. In the same manner that many infrastructural facilities such as public roads, school systems and health facilities are provided and operated as essential public services, so can the supply of credit and financial services be provided on a basic public utility model for both day-to-day business transactions and long-term industrial projects.

Provision of financial services and/or credit facilities after the model of public utilities would allow for lower financial costs to both producers and consumers.  Today, between 35 percent and 40 percent of all consumer spending is appropriated by the financial sector: bankers, insurance companies, non-bank lenders/financiers, bondholders, and the like.  By freeing consumers and producers from what can properly be called the financial overhead, or rent, similar to land rent under feudalism, the public option credit and/or banking system can revive many stagnant economies that are depressed under the crushing burden of never-ending debt-servicing obligations.”  Ismael Hossein-Zadeh, “Who Owns the Federal Reserve Bank, & Why Is It Shrouded in Myths & Mystery?”

“By the 1890s, the leading Wall Street bankers were becoming increasingly disgruntled with their own creation, the National Banking System.  In the first place, while the banking system was partially centralized under their leadership, it was not centralized enough.  Above all, there was no revered Central Bank to bail out the commercial banks when they got into trouble, to serve as a ‘lender of last resort.’  The big bankers couched their complaint in terms of ‘inelasticity,’ ‘The money supply,’ they grumbled, wasn’t ‘elastic’ enough.  In plain English, it couldn’t be increased fast enough to suit the banks.

Specifically, the Wall Street banks found the money supply sufficiently “elastic” when they generated inflationary booms by means of credit expansion. The central reserve city banks could pyramid notes and deposits on top of gold, and thereby generate multiple inverse pyramids of monetary expansion on top of their own expansion of credit. That was fine. The problem came when, late in the inflationary booms, the banking system ran into trouble, and people started calling on the banks to redeem their notes and deposits in specie. At that point, since all of the banks were inherently insolvent, they, led by the Wall Street banks, were forced to contract their loans rapidly in order to stay in business, thereby causing a financial crisis and a system-wide contraction of the supply of money and credit. The banks were not interested in the contention that this sudden bust was a payback for, a wiping out of the excesses of, the inflationary boom that they had generated. They wanted to be able to keep expanding credit during recession as well as booms. Hence their call for a remedy to monetary “inelasticity” during recessions. And that remedy, of course, was the grand old nostrum that nationalists and bankers had been pushing for since the beginning of the Republic: a Central Bank.

Inelasticity was scarcely the only reason for the discontent of the Wall Street bankers with the status quo. Wall Street was also increasingly losing its dominance over the banking system. Originally, the Wall Street bankers thought that the state banks would be eliminated completely because of the prohibition on their issue of notes; instead, the state banks recouped by shifting to the issue of demand deposits and pyramiding on top of national bank issues. But far worse: the state banks and other private banks began to outcompete the national banks for financial business. Thus, while national banks were totally dominant immediately after the Civil War, by 1896 state banks, savings banks, and private banks comprised a full 54 percent of all bank resources. The relative growth of the state banks at the expense of the nationals was the result of National Bank Act regulations: for example, the high capital requirements for national banks, and the fact that national banks were prohibited from having a savings department, or from extending mortgage credit on real estate. Moreover, by the turn of the twentieth century, state banks had become dominant in the growing trust business.

Not only that: even within the national banking structure, New York was losing its predominance vis-à-vis banks in other cities. At the outset, New York City was the only central reserve city in the nation. In 1887, however, Congress amended the National Banking Act to allow cities with a population over 200,000 to become central reserve cities, and Chicago and St. Louis immediately qualified. These cities were indeed growing much faster than New York. As a result, Chicago and St. Louis, which had 16 percent of total Chicago, St. Louis, and New York bank deposits in 1880 were able to double their proportion of the three cities’ deposits to 33 percent by 1910.15

In short, it was time for the Wall Street bankers to revive the idea of a Central Bank, and to impose full centralization with themselves in control: a lender of last resort that would place the prestige and resources of the federal government on the line in behalf of fractional-reserve banking. It was time to bring to America the post-Peel Act Central Bank.

The first task, however, was to beat down the Populist insurrection, which, with the charismatic pietist William Jennings Bryan at its head, was considered a grave danger by the Wall Street bankers. For two reasons: one, the Populists were much more frankly inflationist than the bankers; and two and more importantly, they distrusted Wall Street and wanted an inflation which would sidestep the banks and be outside banker control. Their particular proposal was an inflation brought about by monetizing silver, stressing the more abundant silver rather than the scarcer metal gold as the key means of inflating the money supply.

Bryan and his populists had taken control of the Democratic Party, previously a hard-money party, at its 1896 national convention, and thereby transformed American politics. Led by the most powerful investment banker, Wall Street’s J. P. Morgan & Company, all the nation’s financial groups worked together to defeat the Bryanite menace, aiding McKinley to defeat Bryan in 1896, and then cemented the victory in McKinley’s reelection in 1900. In that way, they were able to secure the Gold Standard Act of 1900, ending the silver threat once and for all. It was then time to move on to the next task: a Central Bank for the United States.”  Murray Rothbard, “Origins of the Federal Reserve: Wall Street Discontent”

“The Federal Reserve Act of December 23, 1913 was part and parcel of the wave of Progressive legislation, on local, state, and federal levels of government, that began about 1900.  Progressivism was a bipartisan movement which, in the course of the first two decades of the twentieth century, transformed the American economy and society from one of roughly laissez-faire to one of centralized statism.

Until the 1960s, historians had established the myth that Progressivism was a virtual uprising of workers and farmers who, guided by a new generation of altruistic experts and intellectuals, surmounted fierce big business opposition in order to curb, regulate, and control what had been a system of accelerating monopoly in the late nineteenth century.  A generation of research and scholarship, however, has now exploded that myth for all parts of the American polity, and it has become all too clear that the truth is the reverse of this well-worn fable.

In contrast, what actually happened was that business became increasingly competitive during the late nineteenth century, and that various big-business interests, led by the powerful financial house of J.P. Morgan and Company, tried desperately to establish successful cartels on the free market.  The first wave of such cartels was in the first large-scale business—railroads.  In every case, the attempt to increase profits, by cutting sales with a quota system and thereby to raise prices or rates, collapsed quickly from internal competition within the cartel and from external competition by new competitors eager to undercut the cartel.  During the 1890s, in the new field of large-scale industrial corporations, big-business interests tried to establish high prices and reduced production via mergers, and again, in every case, the merger collapsed from the winds of new competition.

In both these cartel attempts, J.P. Morgan and Company had taken the lead, and in both sets of cases 17 the market, hampered though it was by high protective tariff walls, managed to nullify these attempts at voluntary cartelization. It then became clear to these big-business interests that the only way to establish a cartelized economy, an economy that would insure their continued economic dominance and high profits, would be to use the powers of government to establish and maintain cartels by coercion, in other words, to transform the economy from roughly laissez-faire to centralized and coordinated statism. But how could the American people, steeped in a long tradition of fierce opposition to government-imposed monopoly, go along with this program? How could the public’s consent to the New Order be engineered? Fortunately for the cartelists, a solution to this vexing problem lay at hand.

CC BY by ToGa Wanderings
CC BY by ToGa Wanderings

Monopoly could be put over in the name of opposition to monopoly! In that way, using the rhetoric beloved by Americans, the form of the political economy could be maintained, while the content could be totally reversed. Monopoly had always been defined, in the popular parlance and among economists, as “grants of exclusive privilege” by the government. It was now simply redefined as “big business” or business competitive practices, such as price-cutting, so that regula – tory commissions, from the Interstate Commerce Commission (ICC) to the Federal Trade Commission (FTC) to state insurance commissions were lobbied for and staffed with big-business men from the regulated industry, all done in the name of curbing “big-business monopoly” on the free market. In that way, the regulatory commissions could subsidize, restrict, and cartelize in the name of “opposing monopoly,” as well as promoting the general welfare and national security. Once again, it was railroad monopoly that paved the way. For this intellectual shell game, the cartelists needed the support of the nation’s intellectuals, the class of professional opinion-molders in society. The Morgans needed a smokescreen of ideology, setting forth the rationale and the apologetics for the New Order. Again, fortunately for them, the intellectuals were ready and eager for the new alliance. The enormous growth of intellectuals, academics, social scientists, technocrats, engineers, social workers, physicians, and occupa – tional “guilds” of all types in the late nineteenth century led most of these groups to organize for a far greater share of the pie than they could possibly achieve on the free market. These intellectuals needed the State to license, restrict, and cartelize their occupati ons, so as to raise the incomes for the fortunate people already in these fields. In return for their serving as apologists for the new statism, the State was prepared to offer not only cartelized occupations, but also ever-increasing and cushier jobs in the bureaucracy to plan and propagandize for the newly statized society. And the intellectuals were ready for it, having learned in graduate schools in Germany the glories of statism and organicist socialism, of a harmonious “middle way” between dog-eat-dog laissez-faire on the one hand and proletarian Marxism on the other. Instead, big government, staffed by intellectuals and technocrats, steered by big business and aided by unions organizing a subservient labor force, would impose a cooperative commonwealth for the alleged benefit of all.

The previous big push for statism in America had occurred during the Civil War, when the virtual one-party Congress after secession of the South emboldened the Republicans to enact their cherished statist program under cover of the war. The alliance of big business and big government with the Republican party drove through an income tax, heavy excise taxes on such sinful products as tobacco and alcohol, high protective tariffs and huge land grants and other subsidies to trans – continental railroads. The overbuilding of railroads led directly to Morgan’s failed attempts at railroad pools, and finally to the creation, promoted by Morgan and Morgan-controlled railroads, of the Interstate Commerce Commission in 1887. The result of that was the long secular decline of the railroads beginning before 1900. The income tax was annulled by Supreme Court action, but was reinstated during the Progressive period.

The most interventionary of the Civil War actions was in the vital field of money and banking. The approach toward hard-money and free banking that had been achieved during the 1840s and 1850s was swept away by two pernicious inflationist measures of the wartime Republican administration. One was fiat money greenbacks, which depreciated by half by the middle of the Civil War. These were finally replaced by the gold standard after urgent pressure by hard- money Democrats, but not until 1879, fourteen full years after the end of the war. A second, and more lasting, intervention was the National Banking Acts of 1863, 1864, and 1865, which destroyed the issue of bank notes by state-chartered (or “state”) banks by a prohibitory tax, and then monopolized the issue of bank notes in the hands of a few large federally chartered “national banks,” mainly centered on Wall Street. In a typical cartelization, national banks were compelled by law to accept each other’s notes and demand deposits at par, negating the process by which the free market had previously been discounting the notes and deposits of shaky and inflationary banks.

In this way, the Wall Street-federal government establishment was able to control the banking system, and inflate the supply of notes and deposits in a coordinated manner. But there were still problems. The national banking system provided only a halfway house between free banking and government central banking, and by the end of t he nineteenth century, the Wall Street banks were becoming increasingly unhappy with the status quo. The centralization was only limited, and, above all, there was no governmental central bank to coordinate inflation, and to act as a lender of last resort, bailing out banks in trouble. As soon as bank credit generated booms, then they got into trouble; bank-created booms turned into recessions, with banks forced to contract their loans and assets and to deflate in order to save themselves. Not only that, but after the initial shock of the National Banking Acts, state banks had grown rapidly by pyramiding their loans and demand deposits on top of national bank notes. These state banks, free of the high legal capital requirements that kept entry restricted in national banking, flourished during the 1880s and 1890s and provided stiff competition for the national banks themselves.

Furthermore, St. Louis and Chicago, after the 1880s, provided increasingly severe competition to Wall Street. Thus, St. Louis and C hicago bank deposits, which had been only 16 percent of the St. Louis, Chicago, and New York City total in 1880, rose to 33 percent of that total by 1912. All in all, bank cle arings outside of New York City, which were 24 percent of the national total in 1882, had risen to 43 percent by 1913. The complaints of the big banks were summed up in one word: “inelasticity.” The national banking system, they charged, did not provide for the proper “elasticity” of the money supply; that is, the banks were not able to expand money and credit as much as they wished, particularly in times of recession. In short, the national banking system did not provide sufficient room for inflationary expansions of credit by the nation’s banks.

1 By the turn of the century the political economy of the United States was dominated by two generally clashing financial aggregations: the previously dominant Morgan group, which began in investment banking and then expanded into commercial banking, railroads, and mergers of manufacturing firms; and the Rockefeller forces, which began in oil refining and then moved into commercial banking, finally forming an alliance with the Kuhn, Loeb Company in investment banking and the Harriman interests in railroads.

2 Although these two financial blocs usually clashed with each other, they were as one on the need for a central bank. Even though the eventual major role in forming and dominating the Federal Reserve System was taken by the Morgans, the Rockefeller and Kuhn, Loeb forces were equally enthusiastic in pushing, and collaborating on, what they all considered to be an essential monetary reform.

The presidential election of 1896 was a great national referendum on the gold standard. The Democratic party had been captured, at its 1896 convention, by the populist, ultra-inflationist anti-gold forces, headed by William Jennings Bryan. The older Democrats, who had been fiercely devoted to hard-money and the gold standard, either stayed home on election day or voted, for the first time in their lives, for the hated Republicans. …

1 On the National Banking System background and on the increasing unhappiness of the big banks, see Murray N. Rothbard (1984, pp. 89–94), Ron Paul and Lewis Lehrman (1982), and Gabriel Kolko (1983, pp. 139–46).

2 Indeed, much of the political history of the United States from the late nineteenth century until World War II may be interpreted by the closeness of each administration to one of these sometimes cooperating, more often conflicting, financial groupings: Cleveland (Morgan), McKinley (Rockefeller), Theodore Roosevelt (Morgan), Taft (Rockefeller), Wilson (Morgan), Harding (Rockefeller), Coolidge (Morgan), Hoover (Morgan), or Franklin Roosevelt (Harriman–Kuhn–Loeb–Rockefeller).” Murray Rothbard, “The Origins of the Federal Reserve