The Federal Reserve is America’s Central Bank
By John Lawrence
The Fed doesn’t actually “print” money in the sense of ink on paper hundred dollar bills. But what it can do is create money with a few keystrokes on a computer.
Money so created is called “fiat money” since it’s not backed by gold or anything else. The Fed currently prints the money to purchase $40 billion in mortgage backed securities and $45 billion in government bonds each month. The rationale for doing this is that it keeps interest rates low which is thought to be necessary to keep the economy humming.
Before the financial crisis of 2008-09, the Fed managed to keep interest rates low by adjusting the interest rate at which banks borrow overnight. But after the financial crisis, the Fed needed a more robust policy which is called Quantitative Easing or QE. This policy is mainly a giveaway to the big Wall Street banks to augment their reserves. The lack of sufficient reserves is thought to have been the problem that caused the financial crisis.
The Fed’s massive QE program was ostensibly designed to lower mortgage interest rates, stimulating the economy. And rates have indeed been lowered – for banks. But the form of QE the Fed has engaged in – creating money on a computer screen and trading it for assets on bank balance sheets – has not delivered money where it needs to go: into the pockets of consumers, who create the demand that drives the real economy.
Low interest rates will certainly stimulate the economy in the sense that they will encourage the sale of cars and houses, both of which are usually done by borrowing money at interest. So the Fed’s policies are all about generating economic activity by creating more debt for average Americans and this results in bigger profits for Wall Street.
The Fed’s QE policy means that the Fed buys government bonds and mortgage-backed securities from private investors – mainly the big Wall Street banks – and then credits the accounts of those banks with the cash. In return the Fed takes possession of the bond or security it has just bought which is just added to the Fed’s balance sheet.
Now if the Fed sells that bond back into the market or redeems it from the government, it would get the cash that it had created back and could just extinguish it by a few more keystrokes on the computer. At that point the money that had previously been created will have been destroyed and would be subtracted from the Fed’s balance sheet. So in that long run scenario the Fed would not have “printed” or created any money at all except on a temporaray basis.
The rub is that the Fed may never remove that money from its balance sheet. It certainly hasn’t done so thus far. The Fed has been buying bonds since early 2009. During that time its balance sheet has increased from $900 billion to over $4 trillion today.
A secondary effect of keeping interest rates low is that it lowers the Federal government’s interest payments on its gargantuan Federal debt.
That tends to neutralize the issue of government spending and deficits as a political issue. The Fed has also been buying the bonds being sold by the US government to finance its deficit. This is considered a Ponzi scheme by some writers as the Fed buys up government deficits and in effect disappears them making sure that bond redeemers always get paid. Bernie Madoff went to jail for doing the same thing except Bernie could not create money with a few keystrokes on a computer like the Fed can.
The negative side of low interest rates is that it hurts savers. Saving accounts produce hardly any interest so there is not much incentive to save. There is, therefore, an incentive to invest in the stock market which has risen dramatically and basically has become a bubble similar to the rapid increase in home values prior to the Great Recession of 2008. When that bubble burst, home values fell precipitously.
The same thing could happen to the stock market if the Fed eases off its policy of QE and interest rates rise. Then the stock market could deflate like a punctured balloon.
So what is the other negative aspect of the Fed’s QE policy? All that money the Fed is creating or printing, if you will, is pooling in the financial system mainly among rich investors. It is not going into the real economy or into the average person’s pocket. If that money were injected into the real economy, it could be used for rebuilding, repairing and building new infrastructure, for example, which would create jobs.
Instead the Fed’s idea of creating jobs is to keep interest rates low so that more cars and houses will be built and sold. The jobs created will be mainly for car salesmen and real estate salespersons as well as construction crews and assembly line workers.
Money pooling in the financial system and not entering the real economy has only an indirect effect on economic growth, and has the primary purpose of making rich people, especially bankers, richer. This is thought to be a good thing in that it shores up bank reserves which were drastically depleted due to the casino operations leading up to the Great Recession when the banks collapsed not essentially because they had little in the way of reserves but primarily because they had run up their gambling debts to excessive levels with nothing to back them up.
So what will the Fed do now? It may never be able to reduce its balance sheet by either redeeming government bonds or selling them into the market because that would raise interest rates and drive up the amount the Federal government would have to pay in interest on its debt. At that point paying interest on the debt might take up the entire or almost the entire Federal budget.
In addition raising interest rates would put a damper on economic activity in the form of discouraging people from purchasing cars, houses and other consumer items. Since consumption is 70% of GDP, this could lead to a recession. This would again place the big banks in jeopardy because, as economic activity diminishes, interest payments to the banks – a big part of their income – will go down, and this will add to the downward spiral which could produce Great Recession, Part 2.
Therefore, the government bonds and mortgage-backed securities that the Fed is taking on its balance sheet via their money printing operations may never be redeemed or sold and may have effectively disappeared into a black hole as the Fed’s balance sheet continues to increase. The Fed may be stuck printing money ad infinitum and subsidizing the banks at the expense of the average American in perpetuity.
The Wall Street banks, it should be pointed out, make money every time the Fed purchases a government bond or mortgage backed security from them. Since the Fed is prohibited by law from buying government bonds from the government directly, Wall Street banks effectively act as middle men and they do so for a price, a price the Fed gladly pays, and for no risk on the part of the banks.
As the Fed continues to subsidize the big banks with money pooling at the upper end of the income spectrum, inequality increases in American society. The Fed policy of QE is a policy designed to increase inequality as the price to be paid to keep the economy rolling. The price of increased economic activity and rising GDP is the further indebtedness of the American people as they buy cars, houses and other consumer items with borrowed money.
The Fed, which is not publicly owned, functions to improve the financial prospects of the Wall Street banks which are its real owners. (They actually own most of the stock in the Federal Reserve.) Is it any wonder then that the Fed’s policies primarily serve the interests of its owners – the big Wall Street banks? A truly public central bank, one owned by the people of the US, could have the same function of increasing the money supply as needed, but it might do so by using the fiat money so created to more directly benefit the American people.
Germany tried “abnormal” money printing in the early 1920s after WW 1 and the result was hyperinflation, collapse of the German economy, and the rise of Hitler. The same might happen in the US if hyperinflation were to start taking place while the Fed is stuck in handing out money to the big banks in order to keep them afloat.
To fight hyperinflation the Fed would have to raise interest rates and this might bring the US economy to a grinding halt. The policy of reducing the amount of QE on a monthly basis is called “tapering.” This doesn’t mean that the Fed is selling off the government bonds or mortgage backed securities on its balance sheet, just buying less of them than they had previously. The Fed will still be adding billions to its balance sheet every month. Inflation is the only thing that will force the Fed to reduce its balance sheet. Otherwise, it could disappear government deficits and bank owned mortgage backed securities into its black hole indefinitely.
If the Fed starts to taper, the big boys at the Big Banks might take this as a signal to short the stock market, and this might cause the stock market bubble to burst as stock values are driven down. The average non sophisticated 401k investor would probably panic and sell on the dip losing the value of his or her retirement savings as the Wall Street guys make a killing.
When the market reaches its lowest ebb, the Big Guys will start buying again driving the market back up. After the market rallies sufficiently, the average guy will work up the courage to get back in with his 401k, having lost a ton of money selling on the dip and buying on the rally, just the opposite of what sophisticated investors do.
Concomitantly, the Fed will probably reintroduce its policy of QE in order to stabilize the economy, and it might have to admit that this policy will continue indefinitely or even ad infinitum. The denouement is that the rich will have gotten richer while the middle class will have been reduced to penury, just the same tendency as happened after the recession of 2008.
This debt-based, Wall Street centric, unstable economy known as US capitalism could be changed by replacing the privately owned Federal Reserve with a publicly owned central bank that created and extinguished fiat money. This would more directly benefit the American people, and serve the needs of the real economy rather than being an effort to stabilize and profit Wall Street banks. Rather than providing jobs indirectly only if more debt for the American people is created, a public central bank could inject money as needed directly into the real economy creating jobs in the process and building wealth for the average American while reducing inequality.
Check out this book with much more on the topic – Gold Wars: Battle for the Global Economy –
I wish we could rely on an economics that escapes finance. Interest rates, stock exchanges, money supply… all the institutions that control those sectors are intertwined and ideologically friendly to each other (even if their members would eat each others livers, if given the chance). They have their own languages, they don’t have to drive cars, food comes to them and they don’t have to give a damn about the necessities of life.
Their accumulation of money frees them from suffering to pay the mortgage, the insurance, the property tax, the tuition of their kids. Optional goods and services like booze, dope, the latest electronic miracles… all the stupid shit that compensates for loss of self-respect and lovelessness… are now necessities to the poor and middle class. We end up losing our own stability to the newest chrome and plastic box that blinks red or green. All of it is a financial design to suck money upward and out of reach of more and more people.
A public bank? How does a public bank escape that economy so ruled by finance? I’m stupid on the subject. It’s an honest question I’m asking.
Bob, a public bank would not be involved in the derivatives shananigans that the Wall Street banks are involved in. 2. It would be able to inject money into the economy directly instead of giving it to Wall Street banks to loan out. Hence, no debt would be created in the process. Instead only jobs would be created. 3. It could help people under the threat of foreclosure by refinancing their mortgages to reflect current market values and by writing down their mortgages. 4. It could directly subsidize students or create student loans at low interest rates. Basically, instead of engaging in high finance that benefitted primarily big Wall Street banks, it would benefit and subsidize the American people.
For an example of how this works see Ellen Brown’s book, “Web of Debt”. Abraham Lincoln financed the transcontinental railroad and the Land Grant colleges this way so it has already been used in the US in the past. He saved the US government a lot of money that it would have paid in interest if he had borrowed the money.
I want to believe, but I can’t help noticing the conditionals “would” and “could” in what you’re saying about the different behaviors of public and for-profit banks. What’s to keep the public bank from exploiting depositors and failing to live up to promises just as the giants in the commercial and financial investment world?
Well, we have one model in this country, the Public Bank of North Dakota, and dozens of models of public banks in other countries. I have not investigated enough to know if there have been problems with fraud among all these banks, and I don’t know what safeguards are in place to prevent ethical lapses. However, where most of the fraud comes in is when for profit banks have the possibility of making a lot of money by cutting ethical corners.
John,
Research confirms that the US banking system has become systemically risky with its gigantic casino holdings of derivatives of +-$300 trillion today… supported by a”peewee” FDIC Insurance Fund of $25 billion and US Commercial Bank Deposits of less than $10 billion (Source: Occ.gov; H.8 Statement, Zero Hedge) and an ongoing very poorly regulated banking system. When the next inevitable financial collapse of all collapses comes, resort to the FDIC Insurance Fund and US Bank Deposits will be like trying to stop a flood with a teaspoon.
Our stupendous speculative banking culture of “making money on money” schemes brings colossal risks for the economy and depositors. Most of the interest and profits go to fat-cat CEOs, management and shareholders — including profits of $21 trillion to $32 trillion sucked away and stored in offshore tax havens where little or no taxes are paid (Source: 2012 Report by the Tax Justice Network).
This is all made worse by a starkly regressive system of compound interest by which 35% to 40% of everything we buy goes to interest today (Source: Professor Margrit Kennedy’s book “Occupy Money,” 2012). As she shows, the ratio of ‘interest winners’ as opposed to ‘interest losers and those breaking even’ is 1 to 9. Only 10% are net lenders while 10% break even and 80% are net borrowers. This of course compounds the huge income & wealth inequality gap in America. Compound interest is a regressive tax born by the middle and poor classes and paid to the rich. This effective transfer of wealth to Wall street and top 1% is proceeding exponentially while US incomes for 80% of the population are stagnanting if not shrinking in real terms. As one expert commented, when money is created as a private banking credit, more money is owed back than created. This leads over time to increasingly less money being recycled into the economy. Such a banking model, besides being unsustainable, primarily benefits the financial services industry.
As you highlight John, in a public banking system bank profits and interest belong to the community. The Western parasitic global banking system “extracts” monies away from the community to maximize profits globally … while the public banking system “reinvests” interest and profits in the local community, thereby also creating more jobs (the same way worker-cooperatives do). The public bank in North Dakota is a proven example of this dynamic.
The cost savings can be significant. A government owned public bank keeps the interest and reinvests it locally. This can be done at a lower interest cost and a sensibly prudent CEO and management remuneration level. Taxpayers are in effect the shareholders. The primary goal of a public bank is to sustain, support the local economy for the long term rather than feed off it for maximum short-term private gain for worldwide shareholders, as is the practice of global banks.
As to the question what will hold public banks back from eventually becoming parasitic abusers and exploiters of the public’s monies in the mold of the big private, some call, ‘usury’ banks, I can only quote an expert’s recent remark:
“Publically-owned banks operate in the public interest by law. That means they must support the real wealth-producing economy. Bank profits generated from the credit of the public are returned to the public.”
Thanks, Frank, for your insightful and fact filled comment. With the Wall Street banking system we have now, profits made from the local economy go into private pockets all over the world. With a public bank like the Public Bank of North Dakota, the profits are reinvested locally. They never leave the state.
I’m convinced.
So when the Justice Department sues Citbank/Bank of America/et al for illegal dealings in the secondary mortgage market (circa 2009) Citigroup is simply giving the government back money that the government (FRB) gave it at 0% interest? Hmmm? Good cop bad cop kind of thing looks like.
And as Matt Taibbi points out in his book, “Divide,” not one banker has gone to jail although many black people are in jail simply for standing on the street corner or having a microscopic amount of weed on them. And the fines that have been given the banks represent a minuscule part of their profits, a mere slap on the wrist. It turns out that Holder is a wimp who used to work at the law firm of Covington & Burling in Washington, D.C, one of the major law firms representing the interests of the big Wall Street banks. During the S & L crisis in the 80s many bankers were put in jail. That was then. This is now.
A sociology professor back in my junior college days had probably the best analogy for the punishment banksters and other white-collar criminals face when busted…
Blue collar crime: You walk into a 7-Eleven, pour yourself a Slurpee, and hold up the cashier at gunpoint, emptying the register. You get caught, you go to jail, you’re sentenced to pay many times what you stole in restitution.
White collar crime (if it were the same situation): You walk into a 7-Eleven, pour yourself a Slurpee, and hold up the cashier at gunpoint, emptying the register. You get caught, and as punishment you have to give back what’s left of the Slurpee.
Best read I’ve seen on this topic in a while. Thanks, John!
Correction of Typing Error : $25 billion and $10 billion should each be $trillion.
Excellent article,