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Federal Reserve Questions

Hello everyone!

I've been learning more about the role of the Federal Reserve, I watched tons of videos on YouTube and even read Rep. Ron Paul's "End the Fed" book. I was wondering if someone could take the time and answer some of these questions that I can't seem to get a solid answer for.

1) What caused bank runs and panics prior to the creation of the Federal Reserve? Did the Federal Reserve solve the problems of preventing future bank runs?

2) Was there fractional reserve banking when the US was on the gold standard, prior to the creation of the Federal Reserve? Can fractional reserve banking be sustainable or is full reserve banking the best option for a sound monetary policy?

3) If the Federal Reserve is really a private bank ran stockbrokers and private bankers aren't they aware of the inflation caused by their policies? Aren't they hurting their own agenda?

4) If our currency is considered fiat does that mean our 17 trillion dollar debt is fake and shouldn't exist?

5)What is the purpose of keeping track of the debt and deficits if our money is "worthless" anyway?

6)Should Americans be concerned about the estimated 100 trillion dollars it will cost for future entitlement programs such as Social Security & Medicare?

7)What if President Obama does an executive order or Congress passes a law requiring the Treasury Department to reset the national debt to zero? Will there be any negative consequences to the economy if that ever happened?

8)Could the Federal Reserve create an 17 trillion dollars worth of money out of thin air to "pay off" the debt?

I know it's a lot of questions, but I'm interested to know what everyone thinks.



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"1) What caused bank runs and

"1) What caused bank runs and panics prior to the creation of the Federal Reserve? Did the Federal Reserve solve the problems of preventing future bank runs?"

So prior to the Federal Reserve...well, prior to Lincoln allowing the US dollar to be fractioned, banks had their own currency. In the era of free banking, they issued their own currency. Of course, they fractioned this to ridiculous proportions, and mostly busted. Lioncoln's law brought some regulation back to the backs, setting strict limits as to how much they could fraction. These laws were mostly followed.

The federal reserve did not solve the issue of a future bank run, as observed by the panic of 1929. What the federal reserve did was give governmental influence over the money supply/monetary policy, as well as provide a lender-of-last-resort.

"Was there fractional reserve banking when the US was on the gold standard, prior to the creation of the Federal Reserve? Can fractional reserve banking be sustainable or is full reserve banking the best option for a sound monetary policy?"

The US only went off the gold standard in 1971. There was so-called fractional reserve banking long before then.

Full-reserve banking will work in the sense that it is incredibly incremental, severely punishes risk-taking, and would only work for a domestic sector that is an exportation empire. Moreover, there is little evidence to suggest that "free markets" ever gravitated towards full-reserve banking. Enhanced credit creation has caused the greatest economic expansion (from 1913 to 2008), EVER. Not even close. From 1800 to 1907..with the industrial revolution, huge advances in technology, the slaves being freed...the average American could buy about twice as much at the end of the 107 years. From 1913 until now, the average American can buy 4-5 times what he could.

"3) If the Federal Reserve is really a private bank ran stockbrokers and private bankers aren't they aware of the inflation caused by their policies? Aren't they hurting their own agenda?"

This is a difficult one to answer. In truth, I don't really think the federal reserve is "causing" inflation. Inflation is caused by debt creation much more than it is created by the creation of available reserves. If the federal reserve raises the short-term interest rate high enough, this will increase the costs of borrowing to the banks, which in turn will lower inflation. In practice, though, there is little correlation, especially now that reserve requirements are basically zero. Remember, the loanable funds model died in 1971. The US government no longer needs gold to issue reserves. Banks no longer need gold to fill requirements; they need US reserves...and the requirements are lower than ever.

"4) If our currency is considered fiat does that mean our 17 trillion dollar debt is fake and shouldn't exist?"

No. The reason the federal reserve issues debt, is to control the reserve rate and to provide an interest-bearing asset to the economy. If the treasury didn't issue any debt, then the 17 trillion (less what would be exported, so really about 13 or 14 trillion) would just sit on the reserves of banks. Because they would have a massive amount of reserves, the reserve requirements would become meaningless and interest rates would plunge to near-zero (as they are now, with the FR paying interest on excessive reserves setting a floor). Moreover, the banking system would lose 200-400 billion in interest payments per year.

Also, the dollar would definitely lose value. Foreigners can no longer exchange dollars for what is considered one of the safest investments in the world: US government debt. In that case, it might benefit the US. The trade imbalance would probably be shifted practically overnight. The US could start importing financial wealth instead of relying on debt.

"5)What is the purpose of keeping track of the debt and deficits if our money is 'worthless' anyway?"

Not sure what you mean by this. Mostly, I would guess that it is because most people do not understand how the monetary system works. They still think in terms of the gold standard; in terms of defaults and borrowing and loanable funds. Keynesians, Modernists, Austrians...they all share this same belief.

6)Should Americans be concerned about the estimated 100 trillion dollars it will cost for future entitlement programs such as Social Security & Medicare?

So those estimates are wildly off.

I would say they may have to worry because some idiot politicians may come and ruin the system. Plus, belief in a lie can often make that lie truth...if people keep on repeating that we will go bankrupt, that is how the investment community will respond. Which is why at first gold and metals soared in response to QE; the market naively thought that QE would cause hyperinflation. Slowly, they are starting to realize it doesn't.

Fundamentally, the Federal Government can run whatever deficit it wants. If the deficit is too much, then it will lead to inflation as there won't be enough production to meet the demand. As long as the productive capacity of the country exists, the government should be able to run a deficit. If trillions are needed to fund SS and Medicare, than the government SHOULD be able to print those trillions..the presumption being that those trillions will be met with production that intends to CLAIM those trillions. Meaning, the elderly need money to buy goods...without the money, there are no goods. If the government provides the money, they can show that they have the money and goods will be provided to meet that money.

Of course, the complicated layer is how government deficits will influence private-sector debt creation, which could cause inflation.

"7)What if President Obama does an executive order or Congress passes a law requiring the Treasury Department to reset the national debt to zero? Will there be any negative consequences to the economy if that ever happened?"

Depends on what you mean. If the government just ripped up all the treasury bonds, yes, this would be a HUGE problem. As those treasury bonds represent the savings of the American people. Net financial savings would be zero (negative if you count the foreign deficit).

If Obama instead just issues money for the bonds, and then destroyed all the bonds, there would still be consequences. The private sector would lose an interest-bearing asset. Interest rates would plunge to zero, and IMO, would just give banks more incentive to speculate. Previously, they at least had to worry about making balance-of-payments...

"8)Could the Federal Reserve create an 17 trillion dollars worth of money out of thin air to 'pay off' the debt?"

Well, the treasury could. But that would have certain adverse consequences as outlined above.

Plan for eliminating the national debt in 10-20 years:

Overview: http://rolexian.wordpress.com/2010/09/12/my-plan-for-reducin...

Specific cuts; defense spending: http://rolexian.wordpress.com/2011/01/03/more-detailed-look-a

Cyril's picture

Answers

I'll have to re-read Dr. Paul's End the Fed to point out his insights wrt. your first two questions, even if partial, if I can find such and relevant, explaining better than I would.

Your other questions aren't too difficult to answer, AFAIC, though:

3) If the Federal Reserve is really a private bank ran stockbrokers and private bankers aren't they aware of the inflation caused by their policies? Aren't they hurting their own agenda?

It doesn't really matter whether the planners and plunderers come from the private vs. the public sector (academia, inclusive) - they have in all times shared the same common attributes:

contempt for economic fairness, just weights, justice, the true value of labor, fair competition, the markets, and mankind's individual incentives in general.

Therefore, they are actually illogical, irrational, against the forces of nature (economics included, specifically), and also have utter contempt for the unintended long term consequences of their plunder and unsound "principles". They live selfishly in their materialistic present, have no concerns whatsoever for peoples' future.

They think they are Supermen gifted with god-like powers over entire peoples and/or nations.

Power corrupts - always. And absolute power corrupts absolutely.

The power of "creating (fake) money" in a monopolistic, centralized fashion IS the most absolute power OF ALL.

See also, btw (in case you think the Federal Reserve Creature / Monster "is anything new"):

http://en.wikipedia.org/wiki/Gosbank#Foundation

Or, even:

http://en.wikipedia.org/wiki/Banque_de_France#History

I don't think that needs a drawing to elaborate further.

DOES IT?

4) If our currency is considered fiat does that mean our 17 trillion dollar debt is fake and shouldn't exist?

The issue is a big proportion of that debt already comes from the sweat, and even blood, already spent by others who (already, just as well) know they will never been paid back anywhere close to what they're owed - the Chinese, most notably, but certainly not exclusively.

History has shown that in such cases, the value owed that can't be paid back is sometimes converted into resentment, revengeful plunder the other way round... For years or decades... See this wars serie in Europe for instance : 1870 - 1914 - 1939 - I'll let you do your own homework out of these mere year numbers...

5)What is the purpose of keeping track of the debt and deficits if our money is "worthless" anyway?

See (4) - i.e., try to convince the USA's creditors that they need to get along with the idea that "you" - it's only rhetorical, it's actually the USA - don't even care any longer keeping track of your past and present wrong deeds...

6)Should Americans be concerned about the estimated 100 trillion dollars it will cost for future entitlement programs such as Social Security & Medicare?

Americans don't need to be concerned about the estimated 100, etc ... instead they need to accept the idea that IT'S GONE. IT'S OVER. THE MUSIC IS STOPPING ALREADY.

The American people IS SCREWED for AT LEAST this current generation (of my own 40s), and likely for my kids' generation, too - before the USA eventually "comes clean" to the face of the world.

What you alluded to... Make no mistake... At this point, IT WOULD NEVER BE HONORED, IF ONLY PARTIALLY, IN ANY OTHER WAY THAN THRU MORE PLUNDER against whoever else after the Chinese... That is, unlikely to happen after it's soon exposed that the emperor has no clothes... Then, brace!

7)What if President Obama does an executive order or Congress passes a law requiring the Treasury Department to reset the national debt to zero? Will there be any negative consequences to the economy if that ever happened?

See (4) and (5)

8)Could the Federal Reserve create an 17 trillion dollars worth of money out of thin air to "pay off" the debt?

That's what they are already doing.

See (4) and (5) again, for a longer term perspective of that sort of kicking the can down the road.

'HTH,

"Cyril" pronounced "see real". I code stuff.

http://Laissez-Faire.Me/Liberty

"To study and not think is a waste. To think and not study is dangerous." -- Confucius

Not an expert, but some thoughts

I have read Ron Paul's book and Creature from Jekkyl Island. But no expert. Just a couple thoughts:

1) What caused bank runs and panics prior to the creation of the Federal Reserve? Did the Federal Reserve solve the problems of preventing future bank runs? --- The biggest crashes, including the Great Depression, were after the Federal Reserve Act. And, a bit of semantics, the Federal Reserve was already created before the "Act" was passed in Congress. The Federal Reserve Act was basically a public/private partnership commissioning the FED to take care of the money supply.

3) If the Federal Reserve is really a private bank ran stockbrokers and private bankers aren't they aware of the inflation caused by their policies? Aren't they hurting their own agenda? --- The stakeholders of the FED get the money first, inflation happens after the devaluation and the initial purchase of capital. They are ahead of the curve. Inflation is the way wealth is moved from the middle class to the wealthy.

4) If our currency is considered fiat does that mean our 17 trillion dollar debt is fake and shouldn't exist? ---- That's a bit of an Apples to Oranges fallacy. Fiat just means it isn't backed. The debt is the supply of money based on government bonds borrowed from the FED. So, in the sense that our agreement with them means we are paying the interest on the money supply, then the interest is very real.

6)Should Americans be concerned about the estimated 100 trillion dollars it will cost for future entitlement programs such as Social Security & Medicare? --- Of course, but they aren't and won't be. Just as college students aren't afraid of taking FED backed student loans.

7)What if President Obama does an executive order or Congress passes a law requiring the Treasury Department to reset the national debt to zero? Will there be any negative consequences to the economy if that ever happened? --- It is not up to the Treasury, first of all. It is up to the FED. The Treasury can only deal with money coming in. As I understand it, all money collected by the IRS in Box 13 of a W2 goes to the FED for the interest payment to the FED for our money supply (based on the Grace Commission). If the debt to the FED was negated, then probably the dollar would completely collapse and the owners of the FED would own most of the capital in the nation.

8)Could the Federal Reserve create an 17 trillion dollars worth of money out of thin air to "pay off" the debt? --- Most of that debt is owed to the FED already. They have already created and loaned to us at least 15 trillion, why would they do it again? They would only be diluting and making the dollar even less valuable.

"In the beginning of a change the patriot is a scarce man, and brave, and hated and scorned. When his cause succeeds, the timid join him, for then it costs nothing to be a patriot."--Mark Twain

Hope this helps...

1) What caused bank runs and panics prior to the creation of the Federal Reserve?

Money creation. There were two central banks prior to the Fed which engaged in the same money creation as the Fed does now. And even in the periods where there was no central bank, there were laws in place which (in various ways) allowed private banks to create money on a far larger scale than they otherwise could have, in a free market.

Did the Federal Reserve solve the problems of preventing future bank runs?

No, considering that the worst rash of bank runs in American history occurred in the early 30s (Fed was created in 1913). That said, bank runs are only a symptom of the problem, not the problem itself. Bank runs occur when banks have created too much money. The problem is the money creation, which the Fed enables.

Was there fractional reserve banking when the US was on the gold standard, prior to the creation of the Federal Reserve?

Yes, there has always been FRB.

Can fractional reserve banking be sustainable or is full reserve banking the best option for a sound monetary policy?

FRB in a free market is fine. The problem is government intervention in the banking industry which shields banks from the risks of creating too much money. This includes the Fed (as lender of last resort to banks that get into trouble), FDIC (which makes depositors indifferent to risk and therefore allows banks to take more risk), et al.

If the Federal Reserve is really a private bank ran stockbrokers and private bankers

It's misleading to call it a private bank. The Federal Reserve System is a cartel of private banks supported by the government.

aren't they aware of the inflation caused by their policies? Aren't they hurting their own agenda?

For various technical reasons that I won;t get into right now (ask me for details if you want), banks make more money if they can all create money at approximately the same rate. The purpose of the Fed is to coordinate the inflation among banks so they all inflate at the same rate -- and to insulate them from the consequences of their risk-taking, as by bailouts, etc. So, no, this system is extremely profitable for them. They don;t care about the costs to society.

If our currency is considered fiat does that mean our 17 trillion dollar debt is fake and shouldn't exist?

I'm not sure what you mean by "fake." It exists in the sense that millions of people own it and expect to be paid capital and interest, and failure to make those payments would have serious consequences. Should it exist? No, the government should not be allowed to borrow money IMO. But it does.

What is the purpose of keeping track of the debt and deficits if our money is "worthless" anyway?

The dollar is not worthless. Saying that it will eventually become worthless as a result of inflation and saying it is already worthless are entirely different claims.

Should Americans be concerned about the estimated 100 trillion dollars it will cost for future entitlement programs such as Social Security & Medicare?

Of course. to meet those obligations, the government will have to either tax the hell out of us or (more likely) print like crazy, which will cause a massive decline in the value of the currency and all kinds of real economic problems.

What if President Obama does an executive order or Congress passes a law requiring the Treasury Department to reset the national debt to zero? Will there be any negative consequences to the economy if that ever happened?

Most of the banks would collapse. Pension funds and a great many private retirement accounts would take a massive hit. It's the same as if Walmart defaults on its bonds -- the holders of those bonds eat it.

Could the Federal Reserve create an 17 trillion dollars worth of money out of thin air to "pay off" the debt?

Certainly, but then the currency would completely collapse.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Good questions. You've been studying and thinking.

Some of these questions could fill a post by themselves. I don't have all the answers and space does not allow for all the history or back ground, but here is some quick answers to start the discussion. I'm sure others will comment and flesh out the details and debate the nuances.

Lets take this one Question at a time.

Question #3 Does inflation hurt the Bankers?

No. For several reasons.

1.) Inflation takes time to manifest. New money benefits those who have it first before the inflation kicks in. Who gets the money first? The bankers who create it. They buy assets with cheap dollars that they create out of nothing. The value of those assets rise as inflation affects the currency. They buy low and sell high.

2.) If the currency does not inflate it will collapse. Money (as federal reserve notes) is debt. Every dollar of debt is a new dollar created to circulate. So the money circulating reflects all the principle of the loans but no money is created to pay the interest. If all the debt was paid there would be no currency. If we don't keep expanding the economy through inflation there would be no ability to pay interest. It is a Ponzi scheme.

3.) That is a fools paradise, a rat trapped in a treadmill, unsustainable. Don't they know that they are screwing themselves too?
Being greedy doesn't mean most of the "staff" who make it possible are smart. They get commissions in federal reserve notes, but the banks get the assets.
When it does collapse the bankers who are actually just a few families and individual people (who also put their pants on one leg at a time) will foreclose on all the debt and own all the assets. Your house, your car, your business, your property. All your pledged collateral. Not so dumb

Wealth is created by labor and creativity. Wealth is never destroyed. It is only transferred. When the currency collapses the wealth of assets are taken by the bankers when they call the loans.

The Bankers Association actually planned and colluded to create many of the "Panics" just to seize the assets through foreclosure both before and after the creation of the fed. That is how they pushed through the Aldrich commission which created the Fed. The seizure of the gold under FDR at $20/oz which was revalued at $35 once it was in the Fed's vaults. The Great depression where so many families lost the farm but created modern agri-business when the lands were taken and the banks called in the mortgages.

Banks create inflationary bubbles to inspire people to create wealth so they can seize it through foreclosure and concentrate it into the corporations they own and control. The stocks of the inflated 1920's stock market. Who took control of all those companies and land? The corporations continued and grew more concentrated. too big to fail. Modernly, the 1980's Commercial real estate bubble that resulted in the RTC, the dot com bubble, the Housing bubble that concentrated and bailed out the banks and insurance companies owned by the banks.

Question #2.B - Fractional reserve banking sustainable?

Maybe. I have been pondering that question.

I think the real answer depends on the basis of the currency.

Free Markets will eventually sort out many of the problems, but if the currency is unsound the free market is distorted.

The real question is NOT - "What would work best in a libertarian utopia?"

The question is how to transition from the mess we have now to a workable system over the next 100 years.

Question #2.A - Fractional reserve and the gold standard

Yes, Fractional Reserve banking existed even before there was a USA. And the US was not always or only been on a gold standard before the Fed.

For most of its history the US used gold AND silver. Mostly silver. The original definition of the US dollar was a specific weight of silver (the Spanish doubloon or "pieces of eight") We have used silver, gold, government issue fiat money not based on debt, and private bank issued money backed by silver and/or gold.

Today we use private bank notes which are based on debt. Every dollar in circulation is either created by the Fed giving Federal reserve notes to the Government for a bond with an interest obligation, or the Fed loaning money to other banks, or a bank issuing a loan to business or a individual. Please research Money as Debt.

There is a lot of debate over whether we should use Gold, Silver, Gold and Silver, or a debt free government issued fiat currency in a return to a constitutional sound currency. I don't pretend to have the answer but here are some of my observations which may inspire some more posts:

Two times that Gold only standards were instituted resulted in currency contractions and concentrations of wealth to the bankers who held most of the physical gold.

The dollar is defined as silver, and gold was often used as a more concentrated "species" to reflect a ratio of value of silver to gold.

Gold is useful for international currency exchange, but silver makes for a more plentiful and flexible currency.

Non-debt fiat money? Well we had the continental and the greenback. The continental failed catastrophically because it was over issued. The green back fared better.

Question #1

Bank runs and panics are not necessarily the same things. Bank runs were typically caused when people were concerned that a specific bank did not have enough "species" (gold or silver coinage) to cover their bank notes which was passed as currency. Panics were credit contractions where continuing credit was refused and existing loans called (often orchestrated to seize the assets of borrowers)which also caused contraction in the money supply.

No, the Fed did not solve the problem. Today we all know and accept that our banks do not have enough "assets" to cover your deposits. (In fact your deposit is not an asset - it is a loan to the bank which the bank can default on and comes behind the other banks, and even derivatives obligations in a bank bankruptcy) But bank runs do occur when people are afraid that a bank will fail and default on their loan from you. There have also been more credit contractions and panics in the 100 years since the Fed was chartered than the 100 years before.