A Plan for
Joseph George Caldwell
Updated
[This piece, posted at http://www.foundationwebsite.org/APlanForAmerica.htm , is an addendum to The Late Great United States essay, posted at http://www.foundationwebsite.org/TheLateGreatUnitedStates.htm .
© 2008 Joseph George Caldwell. All rights reserved. Posted at Internet web sites http://www.foundationwebsite.org and http://www.foundation.bw. May be copied or reposted for non-commercial use, with attribution.
The
As I stated in the introduction to this piece, it is my view
that the
So if nothing can be done to “save” the US in the long term,
the question remains whether there is anything that can be done to save it in
the short term, i.e., to continue it in some semblance of its current status as
a large-scale industrial society. Yes,
there is. Before doing so, however, it
would be necessary to determine whether this would be a good idea, i.e., to
determine in what way a short-term extension of this industrial society would
benefit the long term. To accomplish an
extension, the policies that have brought it to its present condition would
have to end, and some very fundamental changes made. If this were done, the
Recently the pastor of our church delivered a sermon in which he related the story of King Hezekiah. At the point at which the story begins, King Hezekiah is dying, and he calls for the prophet Isaiah to comfort him. Isaiah tells the king that he is indeed going to die, and that he should put his things in order. At this point, the very distraught Hezekiah implores the Lord to save his life. Upon hearing Hezekiah’s earnest plea, the Lord takes pity on him and grants him 15 years’ additional life.
The
Once Americans see that all that can be accomplished is a
brief extension of their industrial society (because oil is running out), they
may not be sufficiently motivated to work toward it. Also, simply because Americans have the
desire for their society to survive for one more generation before suffering
its demise is not at all sufficient. As
Jared Diamond pointed out, some societies die because although they understand
what is happening, but they do not know what to do about it. To accomplish an extension of life for the
A Major Collapse of the
What sort of “shock” would be sufficient to motivate the
My main reason for believing that a financial collapse is
imminent is that it appears that it is already beginning – large banks and
other large investment organizations such as Fannie Mae and Freddie Mac are
failing. The only reason why they are not collapsing in larger numbers at the
moment is that the
Most federal tax revenue (which is ordinarily used to pay
for bailouts) comes from taxes on the middle class. Middle-class taxpayers are “maxed out,” deep in debt with both parents of most families
working; the cost of living (housing, commuting, energy, food) is very high
(because of our inefficient oil-based system); many good jobs have been
exported and (real, adjusted for inflation) middle-class wages are stagnant or
declining; and there simply is not sufficient tax revenue available for a
massive bailout. The national debt is
already very high (so that interest is a major component of the national
budget), and pushing it higher may alarm foreign creditors (the value of
Various financial systems (of which money and banking
systems are major components) have been in operation in different parts of the
world for a long time. Depending on how
they are set up, they may operate for a long time. Unfortunately, our financial system is not
stable, and a major reason for the instability is the money and banking
system. It is designed to promote rapid
economic growth, and (in a “laissez-faire” free-market economy) it
exhibits a fair amount of random behavior, including wild “swings” (economic
expansions and contractions; “booms and busts”). It is designed to generate massive wealth for
the wealthy elite, primarily at the expense of the masses. Our financial system promotes the transfer of
wealth from the middle class to the wealthy in several ways: through private
ownership of banks, which accrues interest to private bankers; through the
mechanism of debt and compound interest, which continually transfers wealth
from the borrowers to the lenders; and through periodic economic contractions,
in which many of the middle class lose everything. (In addition to the financial system, other
features of
As discussed earlier, because our financial system is based
on debt-based money and compound interest, the total amount of money and debt
are, on average, over time, generally growing.
As long as the debt is small relative to the budget, things continue
pretty well. For various reasons (greed;
inadequate government regulation and financial prudence; external shocks; the
inherent random nature of a laissez-faire, free-market system; an
inadequate tax system that promotes national debt; limited ability of the
government to control the system), the amount of debt becomes unmanageable at
times, and the system collapses. The
larger the system grows, the larger are the collapses. The more interconnected the global system
becomes, the greater the likelihood that when a serious problem occurs, such as
bankruptcy of the
The last major depression was the Great Depression that
started with the collapse of the
For a number of reasons, the likelihood of a
[If you are not interested in technical details, skip the
next several pages, and proceed to the section headed, “A Program for
The Nature of the
As was discussed earlier, the
“Money” refers to anything that is generally accepted as
payment for goods and services and debts.
To be useful, money must be fungible (one unit is equivalent to
another), highly divisible and verifiable (authenticity and amount). The major types of money are commodity money
(e.g., gold, silver), representative money (certificates or tokens that may be
exchanged for a fixed quantity of a commodity), fiat money (money legislated by
the government) and credit money (IOUs, bonds, not payable immediately). Most of the world’s money and banking systems
today (including that of the
There is a lot of room for confusion in the term “money,” and the specific meaning is often implied by context. “Money” may refer just to currency (coins and notes), but it can just as well refer to debt instruments (bonds and other securities) and credit. When it is important to make the distinction, the form of the money (e.g., currency notes or bonds) will be specified.
The national debt is all
In the first case, no new M0 money (physical currency) is created, but M3 increases (since new government bonds are created). The existing currency that is received for the bonds (from the purchasers) is used to pay the government’s creditors. In the second case, new M0 money is created (in amount equal to the value of the bonds). (Note that M3 automatically increases, since M0 is a component of it). Moreover, the amount of money that may ultimately be created is much more than the amount of the bonds, since under the system of fractional-reserve banking, bonds deposited in the Federal Reserve constitute backing for loans made by commercial banks (M1 money). Each commercial-bank loan generates money (“checkbook money”). The total amount of the commercial loans must be backed by Federal Reserve deposits (bonds) equal to a certain fraction (the reserve ratio) of the loans.
Note that in either case, M3 increases by the amount of the deficit. In the first case, money is created by the government’s lending (it into the economy), whereas in the second case, money is created by the government’s spending. In the first case (selling bonds) the national debt increases; in the second case (monetization) it does not (the amount of the deficit is borne by everyone, whose currency is depreciated (the cost being proportional to their wealth holdings)).
Note that there is a profound difference in the role of
bonds held outside the Federal Reserve and bonds held by the Federal Reserve
(as backing for money). They appear
identical, but their function is very different. The “outside” bonds represent real
obligations to others; the bonds in the Federal Reserve are simply convenient
accounting fictions to reflect the value of issued money. In fact, most of the “interest” charged on
them (by the central bank, to the government) is simply returned to the
government (which pays the interest on all government bonds), since there is no
“consideration” involved. In many
countries the central bank is owned by the government, and so this debt is
literally owed to itself. In the
The process of redeeming bonds (which may be done if the government runs a surplus rather than a deficit) is the reverse of the process of issuing them. Bonds may be redeemed from the market (outside the Federal Reserve) in exchange for currency (Federal Reserve notes), or they may be redeemed from the Federal Reserve in exchange for currency. In both cases, the size of M3 decreases by the size of the debt repayment. In the first case, the M0 money supply remains the same (money is taken from taxpayers and given to bondholders). The bond is destroyed (and M3 decreases). In the second case, currency is paid to the Federal Reserve, and it “voids” the bonds by destroying both the bond and an equivalent amount of currency (i.e., M0 decreases, as does M3, which includes M0). In this case, the money supply may decrease in two ways: for certain from a destruction of currency (M0 money) equal to the value of the bonds, and potentially because there is less reserve against which commercial banks may create loans (M1 money that is not M0).
If there is no deficit, the government may still sell bonds (or other IOUs) and simply store the currency it receives in payment. In this case, the money supply available to the public shrinks. Also, if the government repays a bond held by the Federal Reserve but the Federal Reserve does not void the bond (destroy both the bond and an equivalent amount of currency), then the reserve still exists and commercial banks may make loans (create M1 money) against it.
Although there are two basic categories of money – physical currency (central bank money) and money created through loans (commercial bank money, or checkbook money), this distinction is conceptual. In reality, money is fungible, and checkbook money, although it starts simply as a bookkeeping entry, may be redeemed for physical currency (although not all at once, since it is backed up only fractionally).
When currency (Federal Reserve notes) is created, it starts out equal in amount to the corresponding bond, but over time the bonds accrue interest, while the currency does not. (Where the interest comes from will be discussed later.) The bonds on deposit in the Federal Reserve also generate interest, but, as mentioned, because there is no “consideration” for this loan, most of the interest (which was paid by the government) is returned to the government.
Although there are just two standard ways of handling deficits (selling bonds on the open market or “monetizing” the debt), there are several different ways in which bonds may be redeemed. In later discussion, it will be helpful to understand these ways, and so they will be summarized here. In the discussion that follows, it is important to remember that when a government bond is deposited by the government in the Federal Reserve, an equivalent amount of (central bank, M0) money is created, and when a government bond is voided (by the Federal Reserve), an equivalent amount of money is destroyed.
The ways in which bonds may be redeemed are: (1) use tax
revenues to redeem outstanding bonds held outside of the Federal Reserve; (2)
use tax revenues to redeem bonds at the Federal Reserve, and void them –
destroy the bond and destroy the currency associated with it; (3) place new
bonds with the Federal Reserve and use the issued currency (Federal Reserve
notes) to redeem outstanding bonds outside of the Federal Reserve; (4) redeem
bonds outside the Federal Reserve, but do not void them; and (5) print
money that is not backed by bonds in the Federal Reserve (US notes backed by
the credit of the US government), and redeem bonds (held outside the Federal
Reserve) with this money. In the first
case, the national debt is reduced and the size of the M3 money supply
decreases – the M0 money is transferred from taxpayers to the bondholders, and
the national debt is reduced (the bond is destroyed). In the second case, the amount of the bonds
at the Federal Reserve is reduced and the M3 money supply shrinks, at least by
the amount of the bonds redeemed, and potentially up to the
fractional-reserve-banking multiplier that allows commercial banks to make
loans (create money) many times the value of the reserves backing them (e.g.,
ten times as much). In the third and
fourth cases (which are equivalent) the national debt (bonds outside the
Federal Reserve) is reduced, but simply by replacing it by bonds held by the
Federal Reserve. The immediate effect is
to reduce M3, but in this case, the money supply may actually increase
since the new bond in the Federal Reserve may be used to back money created by
commercial banks (in an amount many times the size of the bonds). In the fifth case, the M3 money supply
remains the same and the national debt (bonds held outside the Federal Reserve)
decreases (it is converted from bonds (non-M0) to currency(M0)). This method of retiring debt is rarely
used. It would represent a significant
departure from a system in which the
In cases 1, 3, 4 and 5 the national debt is decreased, whereas in case 2 the national debt does not change.
It is reasonable to ask why the
As will be discussed, the ownership of the central bank is of little effect, if its role is restricted to storing of the reserves backing up the nation’s currency (and regulating banks and the money supply). What is of great effect is the ownership of the commercial banks.
Since the bonds held by the Federal Reserve as backing for
the nation’s currency do not generate interest, that “debt” is of no real
consequence, and it is therefore not considered a part of the national
debt. It is always a small fraction of
the total money supply. Under a system
of debt-based money it cannot be repaid, without destroying (collapsing)
the money supply. For the money supply
to exist in a debt-based money system, someone has to hold the debt
backing the money. The government bonds
that are of real significance are the bonds (or other securities) held outside
the Federal Reserve. These are real
obligations to nongovernmental entities, and they generate real (non-rebated)
interest. For the country to be in
control of its destiny, these bonds (true debt, national debt) should be small
or zero most of the time, created only to overcome financial crises (to
stimulate a depressed economy, per Keynesian economics). The crisis that the country faces at the present
time is that the national debt has exploded in recent years. Furthermore, much of it is held (currency and
bonds) by foreign countries, such as
What Matters Most Is How Interest Is Handled
Although the fact that the US central bank is privately owned does not matter much from the point of view of holding reserves backing the money supply (since the interest is rebated to the government), the fact that the commercial banks are privately owned matters a very great deal. If all banks were national (government-owned) banks, the government would collect all of the interest, and could use it (in lieu of taxes) to fund its operations. Under a system of privately owned commercial banks, private bankers collect all of the interest and become fabulously wealthy. The fabulous profits from banking operations are given to the bankers, rather than to the people. A key aspect of money and banking is how interest is handled.
In early cultures (e.g., Judaism, Christianity, Islam), charging of interest was generally forbidden, or debts had to be forgiven on a regular basis (e.g., every seven and fifty years in Judaism). This was done to prevent concentrations of wealth (that might rival the government or the church) and to prevent using wealth (rather than labor, earned income) to generate income and more wealth. Since private ownership of banking does not serve the people and enriches the bankers, it is of interest to examine why our banking system is set up this way. First, however, it is helpful to present a simple example that illustrates different ways that interest may be handled in a society. Consider the situation of a retired widow who owns a home that she wishes to dispose of, and a young couple who wish to acquire a home. The young couple are without savings, but they have income from work. We may consider three cases: (1) the widow sells the home to the young couple, giving them a 30-year loan for $100,000 at 5.3 percent interest (payments of $555.30 per month); (2) the couple borrows the same amount at the same terms from a private bank and purchases the house; and (3) the couple borrows the same amount at the same terms from a national bank (i.e., from the government) and purchases the house. To keep the example simple, let us suppose that the rate of inflation is zero, so that the value of things (such as the widow’s house) does not change over time. In case 1, at the end of 30 years, the widow has been repaid her $100,000 principal and an additional $100,000 in interest. She now has double the original value of her house – in effect, she now owns the equivalent of two houses. The second “equivalent house” was acquired by her holding the loan and receiving the interest on it. In case 2, the widow receives $100,000 for her home. If she doesn’t re-invest the money, at the end of 30 years she still owns one house. (If she reinvests the money, she will receive some income, but probably not as much as the bank’s mortgage interest rate.) The bank has collected the interest, and at the end of 30 years it now has $100,000, the equivalent of one house. In case 3, the widow receives $100,000 for her home and, as in case 2, if she doesn’t re-invest the money, at the end of 30 years she still owns one home. In this case, the government has collected the interest, and at the end of 30 years it now has $100,000, the equivalent of one house (or it may spend the interest any way it wishes, avoiding the need to levy $100,000 in taxes).
It is clear from this simple example that whoever lends the money receives the interest. If there is no bank at all, a private individual (the widow) makes the loan and retains the interest. If the bank makes the loan, it retains the interest. If the bank is privately owned, then the banker (private owner of the bank) retains the interest. If the bank is owned by the government, then the government retains the interest. This simple example shows that it is extremely important who owns the banks, since they acquire the interest.
The fundamental problem causing the national debt to be so large (as well as transferring massive wealth from the middle class to the wealthy) is the private ownership of the commercial banks, which create money every time a loan is made and retain all of the interest charged. If banks were nationalized, so that the interest on bank loans accrued to the government, there would be no public-debt crisis, we would not need an income tax, and the distribution of income and wealth would not be skewing as it is. Whether the central bank (the Federal Reserve) is privately owned or not is not the fundamental problem or issue. Of course, if all commercial banks were government-owned, it would be logically consistent for the central bank to be government-owned as well.
In the
In the
It might be argued, in the preceding example, that the widow is entitled to the interest because she owned the property and accepted the risk that the couple would destroy it before she was repaid. It might be argued that the bankers are entitled to the interest, because they accept the risk (which the widow no longer bears once the bank takes the title to her house and gives her the cash for it) and have to cover the cost of servicing (collecting) the debt. Or it might be reasoned, as was once done by the three Abrahamic religions (and Karl Marx) that interest (or rents, which are essentially the same thing) should not accrue to private individuals. (It is interesting to note that Judaism allowed charging of interest to non-Jews.) The issues here are whether unearned income (interest, rent) is moral and serves a useful social purpose. (The story of Jesus throwing the moneylenders out of the temple is worth keeping in mind.)
A key element of the situation is that the loan may be made only if the couple is trustworthy, i.e., has good “credit.” This credit is an essential ingredient of the transaction, and is of high value. In making the loan, the couple is giving the value of their good credit to whoever extends the loan – it is the assurance that they will pay. (The couple is also receiving the benefit of its good credit, in qualifying for the loan.) They may wish to give this value to the widow (who may in fact be a friend, or a relative, or their mother), or to the government (for the interest to benefit the public, of whom they are a part), but it is hard to understand why they would give it to anonymous bankers. This very scenario plays out in a large scale today, in the credit-card industry (and now debt crisis). When I was young, a person with good credit would arrange to purchase goods from a local merchant on his good name, sometimes receiving the goods right away (or after making a down payment) and other times after completing the payment (“layaway”). Today, a young person routinely forfeits the value of his good credit by letting a credit-card company pay the merchant, and then paying the credit card company an exorbitant rate of interest, such as 20 percent. He gives the full value of his credit to the credit-card company – and pays them for it!! (The merchant usually also pays a small fee to the credit-card company.) In the past, he could negotiate his good credit to receive the goods from the merchant without paying a penny in interest, and the merchant also did not have to pay anything to the credit-card company. He fully realized the value of his good name and credit, by not having to pay interest while he paid for the goods. Today, he gives the total value of this credit to the credit-card company (instead of to himself), and ends up deep in compound-interest debt – charged on his own credit! Why?
Why Aren’t
How did it happen that in the
“Agrarian and progressive interests, led by William Jennings Bryan, favored a central bank under public, rather than banker, control. But the vast majority of the nation's bankers, concerned about government intervention in the banking business, opposed a central bank structure directed by political appointees. The legislation that Congress ultimately adopted in 1913 reflected a hard-fought battle to balance these two competing views and created the hybrid public-private, centralized-decentralized structure that we have today.”
It is said that William Jennings Bryan, who had fought hard
against a private banking system for years, was “tricked” into agreeing to
support the Federal Reserve Act of 1913, and was utterly dismayed when he
realized what he had done. The bill was
passed by Congress on
In any event, the bankers got virtually everything they wanted – the banking system is private in everything but the name of the central bank. The essential role of the bank is to store the reserves (government bonds) backing up the currency, and to regulate the private banks and the money supply (e.g., by setting the fractional reserve ratio). In the beginning, the Federal Reserve even kept the interest on these bonds, but, as I mentioned earlier, this ridiculous set-up was eventually modified so that the interest is “rebated” to the government (29 billion dollars in 2006). The crucial aspect of the system is that commercial banks create money whenever they create a loan, and all of the interest from the loan accrues to them. The bankers get it all. The interest, which could be used to reduce or obviate the need for taxes if the banks were publicly owned, goes to the wealthy elite (the owners of the commercial banks), not to the government and the people.
The Constitution is not clear about the role of the central
bank and the matter of who issues money (although it does state that only the
government may “coin” it, and the Preamble states that the government is to
promote the general welfare). Thomas
Jefferson was in favor of a public banking system and Alexander Hamilton was in
favor of a private one. Eventually,
The financial crisis represented by massive US national debt
could be resolved by our government, through prudent fiscal measures (such as
elimination of free trade, replacement of the income tax by a value-added tax,
reduction in government spending, nationalization of all banking and moneylending, and prohibiting the charging of interest (per
the original tenets of Judaism and Christianity, and of Islam today), but it is
unwilling to do any of these things (since they would retard economic growth
and generation of wealth for the wealthy elite). When the coming financial collapse occurs, it
will be willing to do these things. (It
is interesting to note that the solutions involve a return to the traditional
morality of yesteryear. One might easily
conjecture that religious “fundamentalists” will play a role in the
“redemption” of the
Who Owns the Federal Reserve?
There is a lot of confusion about the ownership of the
“Some people think that the
Federal Reserve Banks are United States Government institutions. They are
private monopolies which prey upon the people of these
– The Honorable Louis McFadden, Chairman of the House Banking and Currency Committee in the 1930s
The Federal Reserve (or Fed) has assumed sweeping new powers in the last year. In an unprecedented move in March 2008, the New York Fed advanced the funds for JPMorgan Chase Bank to buy investment bank Bear Stearns for pennies on the dollar. The deal was particularly controversial because Jamie Dimon, CEO of JPMorgan, sits on the board of the New York Fed and participated in the secret weekend negotiations. In September 2008, the Federal Reserve did something even more unprecedented, when it bought the world’s largest insurance company. The Fed announced on September 16 that it was giving an $85 billion loan to American International Group (AIG) for a nearly 80% stake in the mega-insurer. The Associated Press called it a “government takeover,” but this was no ordinary nationalization. Unlike the U.S. Treasury, which took over Fannie Mae and Freddie Mac the week before, the Fed is not a government-owned agency. Also unprecedented was the way the deal was funded. The Associated Press reported:
“The Treasury Department, for the first time in its history, said it would begin selling bonds for the Federal Reserve in an effort to help the central bank deal with its unprecedented borrowing needs.”
This is extraordinary. Why is the Treasury issuing
“The Treasury is setting up a temporary financing program at the Fed’s request. The program will auction Treasury bills to raise cash for the Fed’s use. The initiative aims to help the Fed manage its balance sheet following its efforts to enhance its liquidity facilities over the previous few quarters.”
Normally, the Fed swaps green pieces of paper called Federal
Reserve Notes for pink pieces of paper called
“The Term Securities Lending
Facility is a 28-day facility that will offer Treasury general collateral to
the Federal Reserve Bank of
“To switch debt that is less liquid for
In its latest power play, on
“The U.S. Federal Reserve gained a key tactical tool from the $700 billion financial rescue package signed into law on Friday that will help it channel funds into parched credit markets. Tucked into the 451-page bill is a provision that lets the Fed pay interest on the reserves banks are required to hold at the central bank.”
If the Fed’s money comes ultimately from the taxpayers, that means we the taxpayers are paying interest to the banks on the banks’ own reserves – reserves maintained for their own private profit. These increasingly controversial encroachments on the public purse warrant a closer look at the central banking scheme itself. Who owns the Federal Reserve, who actually controls it, where does it get its money, and whose interests is it serving?
Not Private and Not for Profit?
The Fed’s website insists that it is not a private corporation, is not operated for profit, and is not funded by Congress. But is that true? The Federal Reserve was set up in 1913 as a “lender of last resort” to backstop bank runs, following a particularly bad bank panic in 1907. The Fed’s mandate was then and continues to be to keep the private banking system intact; and that means keeping intact the system’s most valuable asset, a monopoly on creating the national money supply. Except for coins, every dollar in circulation is now created privately as a debt to the Federal Reserve or the banking system it heads. The Fed’s website attempts to gloss over its role as chief defender and protector of this private banking club, but let’s take a closer look. The website states:
So let’s review:
1. The Fed is privately owned.
Its shareholders are private banks. In fact, 100% of its shareholders are private banks. None of its stock is owned by the government.
2. The fact that the Fed does not get “appropriations” from Congress basically means that it gets its money from Congress without congressional approval, by engaging in “open market operations.”
Here is how it works: When the government is short of funds, the Treasury issues bonds and delivers them to bond dealers, which auction them off. When the Fed wants to “expand the money supply” (create money), it steps in and buys bonds from these dealers with newly-issued dollars acquired by the Fed for the cost of writing them into an account on a computer screen. These maneuvers are called “open market operations” because the Fed buys the bonds on the “open market” from the bond dealers. The bonds then become the “reserves” that the banking establishment uses to back its loans. In another bit of sleight of hand known as “fractional reserve” lending, the same reserves are lent many times over, further expanding the money supply, generating interest for the banks with each loan. It was this money-creating process that prompted Wright Patman, Chairman of the House Banking and Currency Committee in the 1960s, to call the Federal Reserve “a total money-making machine.” He wrote:
“When the Federal Reserve writes a check for a government bond it does exactly what any bank does, it creates money, it created money purely and simply by writing a check.”
3. The Fed generates profits for its shareholders.
The interest on bonds acquired with its newly-issued Federal Reserve Notes pays the Fed’s operating expenses plus a guaranteed 6% return to its banker shareholders. A mere 6% a year may not be considered a profit in the world of Wall Street high finance, but most businesses that manage to cover all their expenses and give their shareholders a guaranteed 6% return are considered “for profit” corporations.
In addition to this guaranteed 6%, the banks will now be
getting interest from the taxpayers on their “reserves.” The basic reserve
requirement set by the Federal Reserve is 10%. The website of the Federal
Reserve Bank of
The banks earn these returns from the taxpayers for the privilege of having the banks’ interests protected by an all-powerful independent private central bank, even when those interests may be opposed to the taxpayers’ -- for example, when the banks use their special status as private money creators to fund speculative derivative schemes that threaten to collapse the U.S. economy. Among other special benefits, banks and other financial institutions (but not other corporations) can borrow at the low Fed funds rate of about 2%. They can then turn around and put this money into 30-year Treasury bonds at 4.5%, earning an immediate 2.5% from the taxpayers, just by virtue of their position as favored banks. A long list of banks (but not other corporations) is also now protected from the short selling that can crash the price of other stocks.
Time to Change the Statute?
According to the Fed’s website, the control Congress has over the Federal Reserve is limited to this:
“[T]he Federal Reserve is subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute.”
As we know from watching the business news, “oversight” basically means that Congress gets to see the results when it’s over. The Fed periodically reports to Congress, but the Fed doesn’t ask; it tells. The only real leverage Congress has over the Fed is that it “can alter its responsibilities by statute.” It is time for Congress to exercise that leverage and make the Federal Reserve a truly federal agency, acting by and for the people through their elected representatives. If the Fed can demand AIG’s stock in return for an $85 billion loan to the mega-insurer, we can demand the Fed’s stock in return for the trillion-or-so dollars we’ll be advancing to bail out the private banking system from its follies.
If the Fed were actually a federal agency, the government
could issue
Addendum: Who Owns the Banks That Own the Fed?
Beyond merely stating that all the shareholders of the Fed
are its member banks, I’ve been asked to elaborate on who actually owns those
banks. Are they owned by powerful
foreign banking families as has been alleged?
According to a discursive article by Dr. Edward Flaherty, condensed
below, the answer is no – not to any provable extent. But that does not mean that the Fed and the
“. . . Each of the twelve Federal Reserve Banks is organized into a corporation whose shares are sold to the commercial banks and thrifts operating within the Bank’s district. Shareholders elect six of the nine the board of directors for their regional Federal Reserve Bank as well as its president. . . .
“The SEC requires the name of any individual or organization
that owns more than 5 percent of the outstanding shares of a publicly traded
firm be made public. If foreigners own any shares of [eight
banks claimed by Eustace Mullins to control the New York Federal Reserve], then
their portions are not greater than 5 percent at this time. With no
significant holdings of the major
“. . . The law stipulates a small portion of Federal Reserve stock may be available for sale to the public. . . . However, under the terms of the Federal Reserve Act, public stock was only to be sold in the event the sale of stock to member banks did not raise the minimum of $4 million of initial capital for each Federal Reserve Bank when they were organized in 1913 (12 USCA Sec. 281). Each Bank was able to raise the necessary amount through member stock sales, and no public stock was ever sold to the non-bank public. In other words, no Federal Reserve stock has ever been sold to foreigners; it has only been sold to banks which are members of the Federal Reserve System.
“. . . [E]ach commercial bank receives one vote regardless
of its size, unlike most corporate voting structures in which the number of
votes is tied to the number of shares a person holds. The New York Federal Reserve district
contains over 1,000 member banks, so it is highly unlikely that even the
largest and most powerful banks would be able to coerce so many smaller ones to
vote in a particular manner. To control the vote of a majority of member banks
would mean acquiring a controlling interest in about 500 member banks of the
[End of Hodgson article.]
Some Final Remarks on Banking
Monetary policy includes establishing what type of money and banking system is used (e.g., gold-backed or fiat currency) and actions such as setting the fractional reserve requirement (fraction of a private bank’s loans that must have deposits at the central bank) and the discount rate (interest rate charged to banks that borrow from the Federal Reserve). The goal of monetary policy is to regulate the money supply to promote economic growth. One of the objectives is to keep inflation (of prices and of the money supply) at a moderate level. A very high inflation rate is undesirable because it destroys the value of savings and makes it difficult for businesses to do long-range planning. A negative inflation rate (deflation) is considered undesirable because investors stop investing (so that economic growth slows) and bankers lose the ability to control the money supply by adjusting interest rates. (Investors stop investing under deflation because it is prudent to save money; cash money is worth more in the future, not less (as is the case with inflation). And all political leaders want growth.)
A key aspect of a central bank is to regulate the money supply to avoid booms and busts. This is done, as mentioned, through the structure of the money and banking system and the tools of monetary policy. Canadian economist Robert Mundell hypothesized that it is not possible to have all three of the following at the same time: (1) a fixed exchange rate; (2) free capital movement; and (3) an independent monetary policy. (This situation is referred to as the “impossible trinity,” the “inconsistent trinity,” or the “triangle of impossibility.” Mundell also did much work in the theory of optimal currency areas. An optimal currency area is a geographical region in which it maximizes economic efficiency to have the entire region share a single currency. Economic efficiency, of course, is a primary rationale behind globalization – and the resultant destruction of societies and of the biosphere.)
A money-and-banking system can continue indefinitely in a “steady-state” (no growth, stable) economy if the government issues all money, and if something is done to prevent the accumulation of interest (e.g., it accrues only to the government, and the government then spends it or destroys it; or it is paid for by taxes; or if it is periodically forgiven). (The reason why the accumulation of interest cannot be allowed in the long run in a steady-state economy is that interest represents “new” money. (Recall that in making a loan, the bank creates the principal but not the interest. The interest must be created by means of additional loans.) Either it may be charged only by the government and spent by the government, or it cannot be charged (by others) or it must be forgiven (or paid for by taxes), or it must remain as a permanent debt (e.g., the national debt).) If all loans were made by the government, then all interest payments would accrue to the government. All interest would accrue to the government, not to private banks or individuals. It would not be necessary to tax income to pay interest on the national debt – the government’s interest income would be quite sufficient to cover this, as well as other budget items. The government could forgive any amount of debt. The government could spend the interest earned on any programs it wished. If properly managed, there would be no need for any taxes at all – all government expenses could be covered by interest earned.
A key feature of the Federal Reserve System is that private bankers keep the interest on loans, but the taxpayer pays the interest on the national debt (which includes the money created to pay the interest). This is typical of our governmental system, which serves the wealthy – the costs are borne by the public (“socialized”), and the benefits are given to the wealthy (“privatized”). This is done mainly via the income tax. (The income tax and the Federal Reserve were established at the same time, in 1913. The government wants the interest on the debt to be paid by taxes on earned income, not by taxes on interest (unearned income).) It is not practical to tax interest earnings on bonds at a high rate, or else there would be little reason for buying the bonds – that is one reason why capital gain taxes are low. Furthermore, the government cannot tax bonds owned by foreigners.
The government has to pay the interest on the debt that it
creates (bonds), but the private bankers get to keep the interest on the loans
that they make (using money that the government authorizes them to
create). If the government owned the
banks and collected all of the interest on loans made using the nation’s money,
the government would have vastly more financial resources at its disposal. The amount of interest from commercial loans
exceeds the income from taxes. If the
government owned the banks there would be no need for income taxes. There would be little need for a national
debt if the government made all loans and collected all interest from them
(since the government would have so much greater financial resources). Fannie Mae and Freddie Mac would never have
been privatized and looted, and there would be no mortgage crisis today. Their destruction and the massive losses
associated with it were caused by the “privateers” who looted it, and the
The Coming Collapse
The National Debt (Debt-Based Money, Compound Interest, the
Income Tax System)
The
A major problem facing the
The national-debt problem is that (1) the national debt is high, the government owes the interest on the bonds to private entities, and they have no intention of forgiving the debt; (2) most of the interest on the national debt is paid for by taxes on the labor income (earned income) of the middle class, and the interest on the national debt is growing much faster than the labor-income-tax revenue. (Monetization of budget deficits is not a good solution since it inflates the money supply.) This is the fundamental problem – the government uses income taxes to pay the interest on the national debt, the debt is growing faster than the income tax revenues, and there does not appear to be any way of fixing this – with our current financial system (money and banking system, tax system).
Eventually, with the interest on the national debt growing
faster than the tax revenue available to pay it, a point is reached where it is
no longer possible for the government to pay the interest on the national debt
with income taxes. Adding the interest
to the debt is not a long-term solution.
If the government monetizes the debt, the
point will be reached where inflation reduces the value of
Keynesian Economics
A common response of the government is to try to “spend” its way out of financial crises, by increasing the money supply and thereby stimulating the economy. This is the basis of “Keynesian economics” (deficit spending by the government when the economy turns bad). It is the reason why the government has encouraged banks and credit-card companies to create massive credit-card debt. It is the reason why the government encouraged granting of mortgages to people without sufficient credit. All of this debt is money. Unfortunately, all of the money is debt. Under compound interest at high rates, many credit-card holders are mired in debt, and can never recover. Many people who could not afford to purchase homes were induced to do so by adjustable-rate mortgages (ARMs) that have little or no interest for several years. They could not quality for a standard mortgage, and when the interest rate of the ARM rises after a few years (an increase in the monthly payment of up to 60 percent), they cannot pay. That is the reason for the current mortgage crisis, in which millions of home mortgages are going into default and the homes lost to foreclosure. The next major crisis may well be a credit-card crisis – people will start defaulting on credit cards en masse.
Using deficit spending to stimulate the economy has worked
in the past, when the
Financial Derivatives
In addition to debt-based money, another major problem in today’s financial system is the massive amount of financial derivatives. Derivatives are nothing more than bets on the outcome of a future specified event, such as the price of a commodity or bond, or the value of a foreign currency, or whether a firm fails. They are so-called because their price (value) is “derived,” or based, on the value of something else (e.g., a commodity or some other financial instrument). The simplest derivatives are bets (options; “puts” and “calls”) on the price of a commodity (e.g., cotton, copper, frozen pork bellies, soybean meal) at a future date. Trading in derivatives is considered little more than gambling, because the value of the derivative is not directly tied to a real (existing in the present) tangible asset, such as a share in a company or a bond earning a fixed rate of interest. (Buying and selling stocks and bonds is little more than gambling, too, but people are “used to” it and it is euphemistically called “investing.”) It is because they are considered essentially a form of gambling that derivatives are not closely regulated, as are stocks and bonds. Some years ago there was a move to make trading in derivatives illegal, but financiers argued that they were a useful tool in “risk management,” and therefore of value to the legitimate economy.
Like many things, derivatives started out as seemingly harmless but useful devices to control risk. The farmer wanted to be assured of a good price for his crop, and so he sold it in advance. He did not own the crop when he sold it, but it was his intention to raise it. The buyer of the crop future was buying nothing more than a good intention, but there was a basis for his confidence. The problem arose that if the farmer could sell something that did not exist, other people could, too. Selling something that you don’t own is called a “short sale.” Very quickly, the number of short sales in commodities exploded – the total amount of a commodity being sold (e.g., coffee futures) vastly exceeded the annual crop. Very few of the commodities traders – the farmer and the person who wanted his crop – were sincere. All of the others simply had different ideas about what the future value of the crop would be, and wanted to make money on their opinion. All that the gamblers had to do was make sure that their contracts were “closed” by the end of the growing season, so that they did not have to actually deliver or receive the product.
The concept works the same for any firm that does international business. The firm does not wish to incur a loss because of currency fluctuations, and so it sells its products or buys its raw materials (e.g., oil) in advance. This is a perfectly rational way of minimizing risk, allowing it to concentrate on its area of expertise (making its products) without having to worry that an adverse move in foreign currencies could bankrupt it.
Some argue that trading in derivative is so risky, and little more than gambling, that it should not be allowed, or tightly regulated, or taxed. But where do you draw the line? Should only farmers and agribusinesses needing crops be allowed to trade crop futures? Should only exporters and importers be allowed to deal in currency futures? Should only wholesale oil merchants be allowed to deal in oil futures? The argument of some is that commerce is facilitated by an active, liquid market in futures, and that this serves business well. Furthermore, because of the high risk (fortunes may be made or lost in minutes), it was assumed that only the very wealthy would play the derivatives game, and only they would get hurt. The current financial crisis, which stems mainly from derivatives, shows how very wrong this assumption was.
Since it was not practical to deny some people the ability to trade in options and not others, the government allowed trading in futures to the public. It regulated the commodities exchanges lightly, but allowed purchases of futures contracts to be made with very little margin (e.g., three percent). Since there is a fair volatility in commodities prices many months ahead of delivery, much money can be made – or lost – in a few days, or even hours or minutes, in the commodity futures markets. Whereas a trader in stocks or bonds has to put up most of the money and wait for a long time to see the result of his deal (e.g., several years – the “long term”), the commodities trader can be in an out of the market in a very short time. Futures trading hence became very popular as a legitimate form of gambling.
Once the government allowed the short selling that is fundamental to trading in commodities futures (i.e., selling something you don’t own, and that doesn’t even exist in the present), it was an easy step to allowing people to trade in anything. The derivatives markets expanded from commodities futures to puts (shorts) and calls (longs) on stocks, and then to contracts on anything, such as the value of a stock-market index. A popular form of derivative is a “credit default swap,” which is a bet on the future value of a bond. In order to make money in the derivatives market, it is necessary to determine an appropriate present price for the value of a stochastic process at some time in the future. This is a problem in statistics. The problem may be solved in “closed form” (i.e., with the answer given by a mathematical formula) for simple cases (e.g., the “Black-Scholes” model), but for complex situations it is necessary to use numerical methods to determine the price. The problem involves what is called “stochastic calculus,” and the solution of partial differential equations. Since numerical methods are involved, it is not possible to show anyone the “formula” for the price, as may be done, for example, in the present value of an annuity, or a monthly mortgage payment. The field of pricing of derivatives is arcane.
Derivatives are typically risky. They are deliberately so in order to produce a high return (per the Fundamental Theorem of Finance, which declares that higher returns must be associated with higher risks). In fact, the higher the risk, the higher the return. The perfect situation for a seller of derivatives is to insure an event that is catastrophic but has a very low chance of happening. The risk is tremendous, and the derivative seller reaps large premiums in the knowledge that it is very unlikely that he will ever have to cover the loss. This is the very kind of event that today’s derivative traders sought, and the very kind of derivatives they sold. For quite a while, the sellers of derivatives were making incredible profits, because the rare events that they insured against never occurred. The problem was, however, that the losses being insured were so large that the sellers could not possibly cover them if they occurred, particularly if many of them occurred at the same time. But they eventually did occur; and at the same time.
In today’s derivative market, many derivatives are insurance against catastrophic loss. Derivative sellers have made fortunes by insuring catastrophic events that are considered unlikely to occur. One party pays a small premium to insure against a potential future event that is very unlikely to occur, but if it does, the loss would be massive. A real problem with derivatives stems from the fact that, like life and hazard insurers, the derivative insurers insure vastly more than they possess, so they are bound to go bankrupt if many of their insured losses materialize at the same time (which is what happened in the current financial crisis involving mortgage-backed securities). With life insurance and hazard insurance, there is a sound statistical basis for the insurance. Not everyone is going to die at once, and not all buildings are going to catch fire at once, and the amount of “reserves” needed to cover expected losses in any given year with an extremely high probability can be determined with a high degree of confidence. Derivatives are not based on underlying natural and independent stochastic processes, however, and it is quite possible for all of the losses to occur at once (as in the case of the current financial crisis, in which a massive number of risky mortgages (to “subprime” borrowers) went bad at the same time because the only way the “subprime” lenders could pay was if the price of housing kept going up, and it failed to do so).
The original concept in allowing derivatives to be legal was that they would be traded mainly to control risk (e.g., buying and selling of commodities futures; hedging against international currency fluctuations) and traded by the rich. The problem that has arisen is that trading in derivatives became very popular, to the point where the potential loss associated with all derivatives is so monumental that if it occurs, the “loser” cannot possibly pay up (i.e., it exceeds the gross domestic product of all countries in the world by many times). If these instruments were in fact traded only by the rich, this would not matter – the losing party would simply be wiped out financially. What has happened, however, is that, lured by the large returns (e.g., 40 percent per annum) all sorts of people and institutions started buying them, including banks and pension plans and individuals. The major dealers in derivatives are “hedge” funds (a derivative is a “hedge” against something), but their instruments have been purchased by the general public. At this point, if the derivative “balloon” were to burst, financial ruin would be faced by all investors, not just the rich.
The current government bailouts of the financial industry are an attempt to prevent this total collapse, which can occur when just a few of the derivative “bets” go bad (because they are so large and interrelated). The government is using taxpayer money to prevent a large number of the insured losses (e.g., credit default swaps) from happening, in an attempt to avoid a total collapse of the derivatives market. The problem is that the derivatives market is extremely large. The total amount of insured risk is vastly more than the global gross domestic product, and so government bailouts can work only if a relatively few of the “big bets” go bad. If many of the losses insured by derivatives go bad, the government cannot possibly cover them all, and the derivative market collapses.
Many derivatives are bets involving very rare events. The loss that is being hedged against has a very low chance of occurrence, but if it does, the loss is very large. The risk is great, and the return is, also. The problem that has arisen is that, in the face of a general decline in the financial markets, many holders of derivatives face debts that they cannot possibly pay. Furthermore, now that so many institutions have invested in derivatives, that if the derivative system is allowed to “go bust,” the entire financial world will “go bust” along with it.
The financial event that threatens the derivative system at the present time is the mortgage crisis. Financial houses (e.g., Fannie Mae, Freddie Mac) created “mortgage backed securities” that included a massive number of unqualified (“subprime”) home purchasers. Homes were sold to totally unqualified people (“NINJA” loans – no income, no job, no assets), with inadequate checking of applications (“liar loans”). Homes were sold at “teaser” mortgage rates (adjustable-rate mortgages) that charged little or no interest at the beginning (e.g., for the first five years). When, after a few years, the interest charges began, the home purchasers could not pay and they defaulted in such large numbers that the whole market of mortgage-backed securities collapsed. World governments are injecting massive amounts of money into financial institutions in the attempt to avoid a collapse of the derivative “bubble,” but the total amount of value involved is now so massive relative to their tax revenues that it is very likely that a catastrophic collapse will not be avoided, and the global financial system will fail.
One large derivative scheme (“hedge fund”) – Long Term
Capital Management (LTCM) – collapsed some time ago. This happens when the people who sell
derivatives “misjudge” the risk (either its level, or the independence of the
events involved), in which case their elegant pricing formulas (e.g., Black-Scholes) fail to work.
In the particular instance of LTCM, the sellers of the derivatives did
not count on
(The story of Fannie Mae and Freddie Mac is incredible. Fannie Mae was once owned by the government,
and it was “privatized” – but with the government still backing it up. Freddie Mac was created to generate
“competition” for Fannie Mae. The chief
executive officers of Fannie Mae and Freddie Mac were paid about twenty million
dollars a year. They engaged in risky
behavior because of “moral hazard” – they knew that they could not fail,
because the government guaranteed their mortgages. And now, after bankrupting the
Here follows an excerpt from Ellen Hodgson Brown’s article, “It’s the Derivatives, Stupid!”, posted at her website at http://www.webofdebt.com/articles/its_the_derivatives.php .
The Anatomy of a Bubble
Until recently, most people had never even heard of
derivatives; but in terms of money traded, these investments represent the
biggest financial market in the world.
Derivatives are financial instruments that have no intrinsic value but
derive their value from something else.
Basically, they are just bets.
You can “hedge your bet” that something you own will go up by placing a
side bet that it will go down. “Hedge
funds” hedge bets in the derivatives market.
Bets can be placed on anything, from the price of tea in
“The point everyone misses,” wrote economist Robert Chapman a decade ago, “is that buying derivatives is not investing. It is gambling, insurance and high stakes bookmaking. Derivatives create nothing.” They not only create nothing, but they serve to enrich non-producers at the expense of the people who do create real goods and services. In congressional hearings in the early 1990s, derivatives trading was challenged as being an illegal form of gambling. But the practice was legitimized by Fed Chairman Alan Greenspan, who not only lent legal and regulatory support to the trade but actively promoted derivatives as a way to improve “risk management.” Partly, this was to boost the flagging profits of the banks; and at the larger banks and dealers, it worked. But the cost was an increase in risk to the financial system as a whole.
Since then, derivative trades have grown exponentially, until now they are larger than the entire global economy. The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars. How is that figure even possible? The gross domestic product of all the countries in the world is only about 60 trillion dollars. The answer is that gamblers can bet as much as they want. They can bet money they don’t have, and that is where the huge increase in risk comes in.
Credit default swaps (CDS) are the most widely traded form of credit derivative. CDS are bets between two parties on whether or not a company will default on its bonds. In a typical default swap, the “protection buyer” gets a large payoff from the “protection seller” if the company defaults within a certain period of time, while the “protection seller” collects periodic payments from the “protection buyer” for assuming the risk of default. CDS thus resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes. In one blogger’s example, a hedge fund could sit back and collect $320,000 a year in premiums just for selling “protection” on a risky BBB junk bond. The premiums are “free” money – free until the bond actually goes into default, when the hedge fund could be on the hook for $100 million in claims.
And there’s the catch: what if the hedge fund doesn’t have the $100 million? The fund’s corporate shell or limited partnership is put into bankruptcy; but both parties are claiming the derivative as an asset on their books, which they now have to write down. Players who have “hedged their bets” by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets.
The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme. The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives “weapons of financial mass destruction.” It is also why the banking system cannot let a major derivatives player go down, and it is the banking system that calls the shots. The Federal Reserve is literally owned by a conglomerate of banks; and Hank Paulson, who heads the U.S. Treasury, entered that position through the revolving door of investment bank Goldman Sachs, where he was formerly CEO.
The Best Game in Town
In an article on FinancialSense.com on September 9, Daniel Amerman maintains that the government’s takeover of Fannie Mae and Freddie Mac was not actually a bailout of the mortgage giants. It was a bailout of the financial derivatives industry, which was faced with a $1.4 trillion “event of default” that could have bankrupted Wall Street and much of the rest of the financial world. To explain the enormous risk involved, Amerman posits a scenario in which the mortgage giants are not bailed out by the government. When they default on the $5 trillion in bonds and mortgage-backed securities they own or guarantee, settlements are immediately triggered on $1.4 trillion in credit default swaps entered into by major financial firms, which have promised to make good on Fannie/Freddie defaulted bonds in return for very lucrative fee income and multi-million dollar bonuses. The value of the vulnerable bonds plummets by 70%, causing $1 trillion (70% of $1.4 trillion) to be due to the “protection buyers.” This is more money, however, than the already-strapped financial institutions have to spare. The CDS sellers are highly leveraged themselves, which means they depend on huge day-to-day lines of credit just to stay afloat. When their creditors see the trillion dollar hit coming, they pull their financing, leaving the strapped institutions with massive portfolios of illi