Aboloshing the Federal Reserve

[AutoDas]

I have to admit, I don't know much about this issue. This seems to be a core issue to his campaign. Does anyone who has similar political beliefs as me can summarize what this is about? (I know I am against the gold standard and any other similar commodity-backed money)

[roguepatriot]

My 2 cents:

I didn't read every response thus far but the one thing I think worth mentioning regarding the current crisis is that the Fed completely lost control of the money / credit supply because of the wonderful world of structured finance and securitization. This allowed the money center banks to move all sorts of risky assets off balance sheet (ala Enron) - thereby making reserve requirements meaningless.

Secondly, whether one thinks the Fed should be abolished or not is really secondary IMO. What's really important is that we eliminate the debt-based (fiat) money system that we currently have and at the very least legalize COMPETING currencies (ie gold/silver backed currencies). Given the choice of holding Federal Reserve NOTES or a commodity-backed currency the people will quickly vote for the the backed currency. This is important because it limits the amount of money that can be created, thereby reducing the insidious inflation tax.

Lastly, I am of the opinion that the Fed serves no useful purpose to the We the People*, so there would be little lost in abolishing them. They tend to follow the bond market when setting the Fed FUnds rate anyway. Besides, history has proven time and again that central planning DOESN'T work and that prices should be set by the marketplace. To me, this includes the PRICE of MONEY.

*Note: The Fed does however serve a very useful purpose to the Banks in its lender of last resort role. This facilitates situations as we have now and have seen many times in history since 1913 where banks fail and the losses are socialized.

[Zippyjuan]

The biggest players (and the most messed up) in the housing crises were not the regular bank but investment banks like Bear Stearns. They do not have to worry about any banking regulations like reserve requirements and often take on greater risks. The major banks do handle mortgages but they were not exposed as heavily to the subprime segment. SInce they tend to keep more of their mortgages instead of reselling them to someone else, they made sure they signed up better quality mortgages and borrowers. The investment banks bought and sold the loans and looked only at the potential return (forgetting that higher returns mean higher risks) and repackaged them and bought and sold them to each other and other investors. The Bush administration is proposing to have investment banks covered by more of the regulations presently facing standard banks like making them keep a certain amount of reserves.

[gilliganscorner]

Hi Folks,

Let me explain the loan process of a bank. The mathematics will be simplified to illustrate the point. I will strip out banking terminology and accounting language as it only serves to obfuscate the issue.

1) You go into a bank for a mortgage of 300K. Let's say that the mortgage is fixed at 6% for 25 years, payable monthly. You will make no early pre-payments or double up your monthly payments. Very simple.

This means at the end of your mortgage (after 300 monthly payments = 25 years). According to this calculator here, this means that you will pay $1,919.00 a month. You will pay back the amount you borrowed (300K) + the interest (a whopping $275,826.00 - almost double the amount you borrowed.

2) The bank puts you through some preliminary hoops to see if they are going to make money off of you. I.e. you have a job, your credit is not maxed out, etc.

3) The bank creates 300K out of thin air. They do NOT take that money from their depositor's accounts to give to you. Because of the fractional reserve requirements, they only have to keep a very small amount of "money" in the vault to back that loan. I say "money" because that is easier for most of us to understand, rather than the term "capital instruments".

So if the Fed requires the bank have a reserve requirement of 10%, this means that they have to have $30,000.00 dollars of "money" in the vault. Here in Canada, the reserve requirements for our private chartered banks is 0%. That is not a typo. Our banks, in reality DO keep reserves, but there is no law that requires them to do so.

4) You pay the seller of the house. Be it the builder or the owner, they take that money and (a) pay for all the labour and materials used to build the house and keep a profit, or (b) the owner of the house takes that money and buys a yacht or another house or whatever. That new "money" you borrowed (the 300K) makes its way out into the economy. In otherwords, by you willing to shackle yourself to debt, you allowed the bank to add 300K to the money supply.

By a simple accounting trick, the bank records the loan in two columns in the ledger book. The mortgage goes in the asset column as it is an interest bearing financial instrument. It ALSO goes in the liability column as someone will deposit it into an account and start writing checks against that account. Thus, the books balance.

5) You work for 25 years to pay that back, paying your $1,919 a month.

6) Around year 13 of your 300K mortgage, you would have paid the principle back. You still have 12 years to go to pay the $275K in interest back. Question. Where did the money come from to pay back the interest? What created the $275K and added it to the money supply in order for you to obtain it by working to pay the bank?

Do you see at this point? The bank loan actually reduces the amount of money in circulation over its lifetime! It transfers wealth out of the economy and gives it to the bank for the bank's unearned work (their right to mint "checkbook money")! Normally, this system would collapse!

But our system hasn't collapsed. So what gives?

The answer is simple.

The money comes from people who borrowed AFTER you. They borrowed the money via the same mechanism from their private banks, dumping their newly minted "money" into overall money supply.

7) To sustain the money supply, we need to attract new borrowers into the system as old loans are being paid off. Rate of money created = rate of money disappearing = stable money supply.

If the rate of money creation is higher than the money being destroyed, we are told it is economic "growth" and possibly inflation, which rewards producers/spenders, but hurts consumers.

If the rate of money creation is lower, we have the opposite effect. The money being retired, we are told we have a "recession" and possibly deflation, which rewards consumers, but hurts producers.

8) This is where the Fed (or any central bank) comes in. These central banks (or cartels of government agents and banking interests) look at a pool of economic data, have the power to artificially raise or lower interest rates. If they see the economy getting "hot" and inflation rising, they raise the interest rates.

This deters people from lining up for new loans. The money supply begins to contract. The economy slows down.

If the economy gets too slow, they lower interest rates, thus enticing people to line up at the loan window of the banks. New money is dumped into the economy. It heats up again.

In other words, the Fed is always looking for the sweet spot where banks can maximize its members profits of the backs of slaves (run as fast as you can on the old hamster wheel = keep up payments), but not kill them (i.e fall off the hamster wheel = bankruptcy). What's that old saying? "You can't beat a dead horse."

9) The bank, believe it or not, does NOT want to foreclose on your house. They hate that. Now they have a non-paper asset they have to pay taxes and maintenance on. They might have to sell it into a market where there is a glut of foreclosed homes on the market = lower prices. They hate that. They just want your payments.

10) That money you paid back to the bank does NOT stay in the bank. Banks record the interest as profit. From that profit, they pay their employees, taxes, shareholders, capital/operational costs, finance business growth, and of course, the obscene bonuses to the CxO's. Since shareholders are making a profit, they cheer the bank on! Employees are grateful for their jobs! Government relishes the tax revenue!

But all of these people who work at the banks/government/shareholders have loans they have to pay back too.

Since the money is backed by debt and issued by the bank, it's ultimate destination is always back to the bank.

11) You can see where this is all going right?

Because we have a money supply that demands new loans to be created to keep the money supply stable, this means that we MUST have infinite economic growth.

This is not sustainable. The economy is 100% driven from whatever we can fish out of the sea, farm off the land, or dig out of the earth. It can't go on forever. The planet will collapse into a smoking hole. I am not a big truther on global warming, but it would be insanity to ignore ALL arguments. The earth is flashing warning signs at us.

And we bicker without understanding the nature of the problem. Their can be no environmental sustainability unless the money supply issue is fixed. We need to have a non-debt based money where we can prosper in a zero-growth economy. This concept is usually pretty foreign to most people.

And as the earth declines, it will be the banking industry and their debt based money standing on our corpses, before they are killed too. All their power won't save them.

[luke-gr]

Zippyjuan, would you care to edit your numbers in your original post if you meant them to be something else. Gilliganscorner is stating that the banks inflate the money that they have on hand tenfold but your post indicates that this is not the case. I am slowly trying to wrap my head around this whole thing.....

[Banana]

luke-gr, the point is that only 90% of initial deposit is available for loaning out, keeping 10% in reserve. It's the multiplier effect that allows that 90% to be re-loaned (whether at same bank or at another bank) to a maximum of 10:1 for 10% reserve, so we end up with 9x more money that was created out of thin air.

[luke-gr]

Originally Posted by Banana

luke-gr, the point is that only 90% of initial deposit is available for loaning out, keeping 10% in reserve. It's the multiplier effect that allows that 90% to be re-loaned (whether at same bank or at another bank) to a maximum of 10:1 for 10% reserve, so we end up with 9x more money that was created out of thin air.

Banana, if Im reading this right, then the bank is not creating more money. It seems you are saying that the bank can only loan out 90% of it's deposits (so it does have the money to loan out). In GilligansCorner's post it seems the bank creates ten times the money that it really has.

Am I hopeless? I'll do some more reading.....

[Banana]

The key part is that what happens to that first loan.

When loan is spent.. let's say we spent it buying a car. The car dealer takes that money then deposit in his bank. That money becomes available for re-loaning, and bank borrows against it.

So... say reserve is 10%, and we start with $1,000 in Bank A.

Bank A has $1,000, so it loans out $900. This is used to buy a car.
Bank B gets a deposit of $900 from the car dealer who just sold the car. It then loans out $810 (90% of 900).
Bank C gets a deposit of $810 from the second loan (via a similar transaction to that car. It then loans out $729.
....

The total loans add up to $9,000, thanks to that initial deposit of $1,000.

Now, mind you, in real life, we don't always have the maximum multiplying effect if some of that loan money is consumed instead of deposited in a bank. Nonetheless, it enables the banks as whole to loan much more money than they have on hand.

[Zippyjuan]

Originally Posted by Banana

The key part is that what happens to that first loan.

When loan is spent.. let's say we spent it buying a car. The car dealer takes that money then deposit in his bank. That money becomes available for re-loaning, and bank borrows against it.

So... say reserve is 10%, and we start with $1,000 in Bank A.

Bank A has $1,000, so it loans out $900. This is used to buy a car.
Bank B gets a deposit of $900 from the car dealer who just sold the car. It then loans out $810 (90% of 900).
Bank C gets a deposit of $810 from the second loan (via a similar transaction to that car. It then loans out $729.
....

The total loans add up to $9,000, thanks to that initial deposit of $1,000.

Now, mind you, in real life, we don't always have the maximum multiplying effect if some of that loan money is consumed instead of deposited in a bank. Nonetheless, it enables the banks as whole to loan much more money than they have on hand.

Each of the loans is made from a deposit. Not from "thin air" which is a phrase commonly thrown out. Banana gives a good description of the maximum that can happen to the supply of money based on loans and reserve requirements. But the bank does not just have the original deposit- but all the following depostits as well. In the first three steps of the examples, a total of $2710 was deposited and $2439 loaned out. The loan is money going out. It is true that this increases the supply of money availible in the economy. But the money does not only flow in that direction. The borrower still has to pay back the loan from their future earnings (with interest) which takes money back out of the system. The borrower is trading future spending for present spending. And loans are not necessarily bad for the economy. They encourage economic activity and create jobs. It makes it easier for new businesses to get started or established businesses to expand.

If the borrowers are continuing to borrow more and more money at faster rates than they repay their loans, then the supply of money increases. People are spending more than they earn. If they repay their loans faster than they increase their credit, then the supply of money does not increase but goes down. One reason that the economy is slowing right now is that due to the housing lending crisis, banks and other institutions are less willing to lend money than they were a few years ago when they were throwing money everywhere they could.

Consumer spending is down now- people had been spending as much as they made if not more. Now they are finally spending less which means fewer sales for businesses which will probably cut back. That may not be that great for business, but it will put the consumer in a better position in the future than if they continued to spend too much. If I am spending money to pay back my loan, I am not spending it on goods and services in the economy.

[Zippyjuan]

Another question is of course where did the money come from for the deposit? The depositor (let's say it is me) earned that money through economic activity and certainly could have spent it in the economy on somebody else's economic activity- either goods or services. By not spending that money, it is no longer in the economy and not productive. So it gets deposited in a bank. The bank wouild like to make money on that deposit (it is costing the bank money to keep it- in interest paid and the costs of the physical location of the money as well as somebody to accept and keep an eye on the deposit). So they loan it out- at a charge in the form of a higher interest rate than they were paying to keep the money- who can then spend the money that I was not going to spend. But they can't spend all of it- the bank is required to keep a certain portion of the money on hand to meet potential withdrawl demands. If the reserve requirement is 10%, then they can only spend 90% of what I could have spent.

This means that there is actually LESS money circulating with the bank in place than without one since there would have been a greater likelyhood of me spending the money instead of stuffing it under a rock somewhere and getting nothing out of my labor. The bank offers me a reward for not spending my money (more money to spend later instead of the same amount to spend now).

Now if the person who borrowed my money decides to deposit that money in the bank too, again it is not circulating and being spent on goods and services. Money only has true value when it is used to exchange for goods and services. So his deposit is not contributing to the economy or having any effect on increasing prices and neither is mine. "Too much money chasing too few goods" is what economists often use as a basic definition of inflation. If the money is in a bank, it is not chasing any goods. Money not being spent means less demand for goods and services which could potentially lead to less, not more, inflation.

If the second person decides to spend the money he borrowed, then the money goes into the economy (but again he has less ability to spend money than I did since he could only borrow part of my money), then the bank is not getting any new deposit to loan out from. They still have only my original deposit. The intermediate loans and redeposits do not matter- they do not effect the money supply if they are not spent. Nothing has actually left the bank. The money gets taken out of the bank but put back in in that case. If they do deposit the money, then it is available for someone else to borrow- but again, the next person gets a smaller slice of my original money. They have less money to spend than either of the first two people. The bank's reserves are growing, but the money being spent in the economy is actually shrinking. A smaller and smaller portion of the money I could have spent is now available to chase the goods and services in the economy. The bank is really taking money out of the economy- not creating it.

If the multiple borrowers and depositors do eventually decide to spend the money they borrowed and redeposited, then there is more money in the system. Temporarily. The bank can no longer make any new loans since the deposits are no longer there (aside from the reserve requirements). The loans have to be repaid eventually (with interest) and that will take money back out of the system in the future. The borrowing trades future spending for current spending.

It is only when the money is spent that it can add to the number of dollars chasing goods- and at that point, it is no longer in the bank and available to be loaned out again.