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The Federal Reserve – Lender and Buyer of Last Resort

Can the Federal Reserve save the U.S. economy from failure? Is this their mandate? When you research "lender of last resort (LLR)," which is what the Fed is supposed to be, you mostly find the source to be Walter Bagehot’s Lender of Last Resort Doctrine.  This doctrine came about from Bagehot's book, Lombard Street: A Description of the Money MarketHartley Withers, in 1915 wrote of the book; "It is a wonderful achievement, that a book dealing with the shifting quicksands of the money market should still, after more than forty years, be a classic of which no one who wishes to understand the subject can afford to be ignorant." This could be true even of today.

When it comes to Central Banks, lets face it; most of us in America are ignorant. Hopefully this article will clear things up a bit and help you make good decisions on your investments moving forward, or at a minimum explain to you why gold is still needed today, just as it was when gold was the standard and base of the monetary system when Bagehot wrote his Lombard Street book, before the Federal Reserve even existed.

Bagehot's main LLR thesis about the Bank of England (the Federal Reserve had not yet come into existence), was the following;

In ordinary times the Bank is only one of many lenders, whereas in a panic it is the sole lender, and we want, as far as we can, to bring back the unusual state of a time of panic to the common state of ordinary times.

In other words, the Bank of England, in times of panic, could step in and provide liquidity to calm any fears that may arise. Then the economy would revert back to business as usual. The LLR was always there if needed. This isn't such a bad thing, but even good things can be abused if the actions of some central characters are not controlled or reversed.

In the U.S., before they had a Central Bank, the LLR was primarily one man; J.P. Morgan and a few of his banking friends in New York, who together prevented the Panic of 1907 from getting worse as they shored up the banking system with their own money.

If you have read my book, Buy Gold and Silver Safely, or my articles over the years, all crises stem from a banking problem or issue. This will be how things unfold in the future as well. We got a good idea of how far out of control things became in the 2007/2008 Financial Crisis, but I'm getting ahead of myself.

Enter the Federal Reserve 

According to Michael D. Bordo, PhD Professor of Economics and Director of the Center for Monetary and Financial History at Rutgers University, and his article "The Lender of Last Resort: Alternative Views and Historical Experience" listed on the Federal Reserve Federal Reserve Board (FRB) website;

The Federal Reserve System was created in 19 14 to serve as a lender of last resort. The U.S. did not experience a banking panic until 1930, but as Friedman and Schwartz point out, during the ensuing three years, a succession of nationwide banking panics accounted for the destruction of one-third of the money stock and the permanent closing of 40 percent of the nation’s banks. Only with the establishment of federal deposit insurance in 1934 did the threat of banking panics recede.

But what Professor Bordo didn't say was the other reason for the Fed's success in stemming the banking panic; they confiscated gold and then devalued Federal Reserve Notes by 40%! The price of gold was $20 an ounce in 1933 and in 1934 when Roosevelt signed an Executive Order for citizens to turn in their gold for Federal Reserve Notes. The administration artificially moved the price of gold from $20 to $34 an ounce, a 70% increase. This meant that your $20 gold piece that you didn't turn into the government was now worth $34. But the $20 bill in your pocket that the bank gave back to you for your $20 gold coin a year earlier, could only buy you 41% of the gold you used to be able to buy.

How did the Lender of Last Resort do? They saved the system, right? But at who's expense? Those that held Federal Reserve Notes, of course. While the Fed, via the government confiscated the People's gold, the monetary system still used gold to trade from country to country to settle accounts. This continued until 1971 when multiple countries were asking for settlement in gold, rather than Federal Reserve Notes. 

In 1971 Nixon took us off the Gold Standard completely and told the world, take our dollars only as you aren't getting anymore of our gold. The other countries had no choice.

What did the price of gold do for the next 10 years after the Fed changed the game? It shot straight up.

gold prices 1971

Some of you may be asking, "Why is all of this knowledge of what the Federal Reserve does important to me? It's simply because they will always do what it takes to make whole the banks, at your expense. They do it under various guises like; "if we don't do this, then the system will collapse." But would it? Wouldn't another system take its place? Or do we all just rollover and die? Rome collapsed. Did Rome die? Germany collapsed. Did Germany die? Argentina collapsed in the late 80's. Did they die? 

Sure there will be some that are hurt, but whom? And for how long? There will always be individuals, companies, charities, community organizations that will band together to help those in need. That's what's so great about America. But if a bank failed? It would be replaced by a stronger bank that didn't take the same risk as the bank that failed. Banks that take on unnecessary risk don't need a handout, they need to fail. As a result of us bailing out the banks that made mistakes, we now have QE infinity and you can bet there will be more Fed action to come that are just going to make matters worse. We are simply digging a hole that we won't be able to climb out of. Meanwhile, Congress does what they do best; agreeing to raise the debt ceiling because all they have to do is ask the Fed for more money to pay for your expense either through higher taxes or eventual higher inflation that destroys your purchasing power.

These Guys Will Fix the System, Right?

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Dare I say, we resort to change our secret ingredient: Thin-Air?

Dare I say, our other last resorts didn't pan out so well.

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

Exactly Mark Twain

Most people wont' read a technical article through like I just wrote, but I am getting good feedback on it. It's all an "illusion," one of the words I am utilizing in the title of my next book.

I may use that cartoon! Thx...

Author of Buy Gold and Silver Safely
Next book: Illusions of Wealth - due out soon
Also writing book We the Serfs!