FED UP

In 1910 six men locked the door behind them as they entered an old clubhouse in Jekyll Island, Georgia. For nine long days, these men schemed in secret. It was so secret that no one would know about their meeting for twenty years. Their actions during those nine days would change America forever. The men were Nelson Aldrich, a senator from Rhode Island; A. Piatt Andrew, Secretary of the Treasury; Henry Davison, a partner at J.P. Morgan; Arthur Shelton, the secretary of the National Monetary Commission; Frank Vanderlip, president of the National City Bank; and Paul Warburg, an investment banker. Their ideas for America’s future were dangerous. They knew that their goals would not succeed if it was public knowledge, so they kept their plans undisclosed. Ultimately, they created an institution that steals power and money from American citizens. It still exists today, more dominant than ever–– a threat that needs to be ended.

In order to understand the full repercussions of these men’s decisions, it is important to understand a few concepts first. What is economics? What is money? What is banking? Where did they begin, and how have they evolved? After understanding their history, it will be easier to comprehend the impact.

Firstly, economics is the study of how people value resources. When a person makes a decision, he is inevitably gaining one thing and giving up on something else. For example, if you decide that you are going to have a cheeseburger for lunch, you are giving up the pizza that you may have had instead. Economics is the study of the decisions people make and why they make them.

Money is a huge part of economics. It functions as a commodity that shows what is valuable to people, but it has not always existed. We must understand the origins of money and banking before any other claims can be made. Before money, people traded goods with each other. Take, for example, a fisherman, a lumber jack, and a farmer who are trying to survive on an island. The fisherman spends his day catching fish and has no time to chop down wood for a fire. If he wants wood for his fire, he may trade some of his fish to the lumber jack for firewood. If the lumber jack is hungry, then he will also be willing to trade. However, if the lumber jack does not want fish but instead wants eggs from the farmer, a problem arises for the fisherman. In order to get lumber now, the fisherman must trade his fish to the farmer to get eggs and then trade the eggs with the lumber jack for wood. Furthermore, all of this is contingent on if the farmer wants fish. As you can imagine, trading becomes very complex. Robert Murphy, an author, economist, and professor, says, “Consider a merchant whose business required him to closely follow twenty different goods. In a world of pure barter—where each good traded directly against every other good—in principle he would have to keep track of 190 separate barter ‘prices’” (Murphy 9).

These circumstances led to the use of commodity money. Commodity money had a dual purpose. It was a good that was also used as money. For example, cigarettes have often been used as commodity money in prisons. They can be smoked, or they can be used as money and traded in select quantities. Commodity money was far more convenient than the previous barter system. All goods could be held to a standard. It was helpful for a number of reasons. “Moving from a state of barter to a monetary economy allows for economic decisions to be appraised in terms of a standard unit. With the use of money, business owners can engage in accounting, where they can easily calculate whether they had a profitable year” (Murphy 11). Essentially, it made the process of trading a whole lot easier. Other goods could be held to a standard, so people were not guessing the worth of each item.

Now commodity money could not be just any material. For example, grass would not make for good money because anyone can obtain it. Seashells would be difficult for people who live near an ocean. Abundant goods cannot be used as money because people could obtain it in other ways besides trading, which would defeat its purpose. Over time, certain materials became recognized as better mediums of exchange. They included livestock, tobacco, silver, and gold. These were great choices for commodity money because they were scarce.

A reliable source for commodity money was based on a number of factors. “Ease of transport, durability, divisibility, homogeneity, and convenient size and weight for the intended transactions” (Murphy 12). It was for these reasons that gold and silver became commonly used as money. However, just exchanging chunks of these precious metals could be problematic for a number of reasons. Firstly, every time a transaction was made, the gold or silver must be weighed and shaped into the correct amount. Secondly, the metal being exchanged would have to be tested to identify its purity. “The solution to this problem is to coin the raw hunks of metal into recognizable disks of a uniform size and purity” (Murphy 17). Hence, coins were made. Coins became trusted currency because they were stamped to show that the value was pure and worthy.

But even with this new money, another problem arose. Wealthy people would not want to store vast amounts of gold and silver within their homes because of the risk of theft. Banks were the solution. They were places that held and protected your money so that you were not constantly anxious about its safety. It is interesting to note the type of people who worked at these banks. “The goldsmith was a logical person to also act as banker, because his business already involved storing stockpiles of gold. It was easy enough for members of the community to deposit coins with the goldsmith in exchange for an official receipt indicating how much of the money commodity they (the depositors) had stored with him” (Murphy 19). Because handling gold was such a key part of banking, most bankers were goldsmiths. Banking was a simple process. When people had gold that they wanted to store in a bank, they would pay a fee to deposit it. The banks would hold the money in a safe and in return give the depositors a note. The note could be brought back to the bank and exchanged for the gold whenever it was needed. Soon, people realized that instead of going to the bank every time they wanted to withdraw their money, they could use the bank’s notes as money. Bank notes became a common form of money because they were backed by the gold in the safes.

At this point, the banks realized that there was a profit to be made. Bankers knew that the chance of everyone coming back for their money at once were rare. There was a lot of gold in the safes, and so bankers began to loan out some of the gold and charge interest. This is called fractional reserve banking. It is a banking system that creates money–– new money that is not tied to any standard. It is very complex and dangerous for an economy.

Take, for example, that there is $100 in a bank. Instead of charging a fee to the depositor to keep their money in the safe, the bank does not charge anything. They have a different way to make profit. Knowing that the depositor will not come back for all of their money at once, the bank only needs to keep 10% of the money within their safe. The rest of that money can be loaned with interest. So, if another person deposits $50 in the bank, the bank will only keep $5 and loan out the rest. This is essentially creating money because there is allegedly $150 in the bank, but also $135 being loaned out. So now, there is $285, and not all of it is backed by gold. This is when money starts to lose its value.

When depositors decide to make big withdrawals, banks have to close their doors because they do not have enough cash on hand. Then, banks crash. They do not have enough money to pay back all their depositors. As expected, this ruins the economy and causes chaos. Fractional reserve banking causes people’s money to become less valuable; it deteriorates money’s worth.

Furthermore, there is another consequence that fractional reserve banking has. It affects interest rates. When banks loan money to people, instead of people loaning their own money, the interests rates go down. Individuals will be careful with their money. They will not loan out their money unless they are certain they will get it back, and they will likely charge a higher interest rate when lending their money. People with less money are going to loan out their money with even higher interest rates. For example, someone supporting a large family, getting by paycheck to paycheck, will charge high interest on a loan. Their money is very important to them. People who are wealthier will have lower interest rates because their money is not as vital, and they do not need it back immediately. This is idea is echoed by Robert Murphy when he states:

An individual who has just enough resources to keep himself alive is unlikely to lend or invest his paltry means. The cost of lending, or investing, to him is likely to be very high… Once his wealth starts to expand the cost of lending, or investing, starts to diminish. Allocating some of his wealth toward lending or investments is going to undermine his well-being in the present to a lesser extent. (Murphy 23)

People whose money is scarce are generally more careful with their money and not as willing to lend, thus increasing the interest rates.

Contrarily, when banks loan, the interest rates fall. Money is not scarce for them, so the rate falls–– it falls lower than it should be. Why? It is because banks have an abundance of money and are not affected like individuals are. They can continue to loan money at a low interest rate with small consequences. When money might be tight, and interest rates high, fractional reserve banks still have a low interest rate. Interest rates are not as they should be when banks are loaning money in a fractional reserve system. These low interest rates are dangerous for an economy. The problem is an increase in the number of people who take loans; people take more risks. Low interest rates cause risk-taking. People who would have otherwise not taken a loan because the interest rates were too high will now take that chance. The increase of risk-takers includes people who may not be able to repay the debt. The excessive risk-taking makes an economy very unstable. With all of the loans, banks must raise their interest rates to ensure that they will get their money back. When the interest rates rise, people stop taking loans. Frank Shostak, an Austrian School economist, echoes this when he writes,

If banks continue to expand the credit out of ‘thin air,’ nonproductive activities will expand. Once the continuous generation of credit lifts the consumption of consumer goods above their production level, real savings decline. Consequently, the banks’ bad loans start to increase. In response, banks curtail their lending activities, leading to a decline in the money stock. (Remember, the money stock declines once loans generated out of “thin air” are repaid and not renewed.) The fall in the money stock undermines nonproductive activities, leading to an economic recession. (Nonproductive activities cannot stand on their own feet. To support themselves, they require thin air” credit.) (Shostak)

Essentially, lowering interest rates causes businesses that are not producing products that are in demand to remain in business, wasting money and creating a shaky economy. When the interest rates finally do rise, those businesses obviously die and leave the economy in a recession. The common denominator is the fractional reserve bank.

Fractional reserve banks negatively impact an economy by encouraging risk taking in the wrong areas. However, people realized that factional reserve banking can benefit the government. That is why in 1913, instead of ending fractional reserve banking, wealthy politicians voted to create a national fractional reserve bank that could create money and supposedly keep the economy steady. It could save banks that were going to crash.

In the 1800’s, America’s currency was dependable. The citizens had gold to back their money in case of an economic crisis. This created a problem for fractional reserve banks. Money had to be held to a gold standard; it could not be created freely. That is why,

FDR would issue an... executive order on April 5, 1933, which required all citizens to turn in virtually all holdings of gold coin, bullion, and certificates in exchange for Federal Reserve notes, under penalty of a $10,000 fine and up to ten years in prison. Although US citizens couldn’t buy gold, foreigners still traded in the world market... The Roosevelt administration in 1934 officially devalued the currency some 41 percent by locking in a new definition of the dollar that implied a gold price of $35 per troy ounce. However, this redemption privilege was only offered to foreign central banks; American citizens were still barred from holding gold, and even from writing contracts using the international price of gold as a benchmark. (Murphy 33)

This was the first step of many to creating an overwhelmingly powerful Federal Reserve. With gold being taken away from the American public and banks, money could not truly be held to a standard, even though the gold standard was allegedly still in use.

The next step was Nixon’s actions to suspend the gold standard. In order to have sufficient money to spend during the Vietnam War, Nixon abolished the gold standard to create enough money to fix America’s financial problems.

Eventually the weight (of the war) became too much to bear, and President Richard Nixon formally suspended the dollar’s convertibility on August 15, 1971. Along with other interventions in the economy (such as wage and price controls), this official closing of the gold window has been dubbed the “Nixon shock.” Although Nixon assured the public that the gold suspension would be temporary, and that his policy would stabilize the dollar, neither promise would be fulfilled. From this point forward, the US—and hence the rest of the world— would operate on a purely fiat monetary system. (Murphy 41)

Nixon took the remnants of the gold standard away. This was a dangerous decision that gave new levels of power to the government and the Federal Reserve.

How are the Federal Reserve and the government connected? Well, the government needs funding, and the Federal Reserve needs power. The government’s revenue comes from taxes and inflation. When taxes are not enough, inflation must do the heavy lifting. No politician will win a campaign promising to raise taxes, so the Federal Reserve (as will be addressed later) does the dirty business of collecting the money through their own form of taxes: inflation. Noticeable examples of the tax of inflation are often seen during wars. Murphy writes:

To say that World War I would have been “unaffordable” on the classical gold standard really just means that the citizens of the countries involved wouldn’t have tolerated the huge increases in explicit taxation and/or regular debt issue to pay for the conflict. Instead, to finance such unprecedented expenditures, their governments had to resort to the hidden tax of inflation, where the transfer of purchasing power from their peoples would be cloaked in rising prices that could be blamed on speculators, trade unions, profiteers, and other villains, rather than the government’s profligacy (Murphy 41)

The Federal Reserve funds the governments to do things that otherwise would not have been possible. “The US government relied on Federal Reserve monetary inflation to help finance the Vietnam War and the so-called War on Poverty” (Murphy 42). As you can imagine, this is dangerous for several reasons.

Understanding the true purpose of the Federal Reserve explains why it should not exist today. Consequently, it is no coincidence that the Federal Reserve is essentially undercover. Most Americans lack any understanding of the Federal Reserve or its origins. The Federal Reserve is not static; it has increased in power, becoming more and more unchecked and uncontrolled. The institution of the Federal Reserve will argue that they are working for the people’s good with the power that they have. This simply is not true. Daniel Lacalle, an author and economist, writes, “Interventionist governments never reduce consumer prices because they benefit from inflation, dissolving their political spending commitments in a constantly depreciated currency” (Lacalle). The government prioritizes itself over the people in every circumstance. In order for them maintain power, the government needs to keep taking money from its citizens. The moment their monetary wealth is held to a standard, they are prevented from their unlimited funding, and they do not have such immense power. With an unchecked banking system that creates money, the government can grow to dangerous levels of power. Although they are supposed to be separate, the Federal Reserve and government work together. To some, the Federal Reserve has arguably become the fourth and most powerful branch of government.

Now, questions should arise. How does this scheme work? How does the Federal Reserve actually create new money and give it to the government? The government budget is the money that they receive from taxes. However, when they spend more than they take in, they decide to issue treasury bonds; they sell treasury bonds to American citizens. As they continue to do this, interest rates will inevitably rise as people become uncertain if the government will be able to pay their debt. This is when the Federal Reserve steps in. They buy the treasury bonds from American citizens at any price, keeping the interest rates low. They create money. So, instead of the government paying back their debt with interest to the people, the Federal Reserve swallows the debt and gives free money to the government.

This is where monetary inflation kicks in, where the citizens pay this secret tax to the government. Monetary inflation is the increase in the money supply of a country. The Federal Reserve is responsible for the monetary inflation in America. Monetary inflation creates another form of inflation, asset inflation. Asset inflation is directly related to low interest rates. For example, a stock or bond rising above their actual value would be asset inflation. Asset inflations leads to consumer good inflation. Consumer good inflation is an increase in the price of goods. For example, the food at your favorite restaurant costs more than it did last week. All types of inflation come from money not being tied to a standard, which the Federal Reserve promotes. Brian Wesbury, an American Economist, states, “What causes inflation is an increase in the supply of money and credit. This is often brought on, directly or indirectly, by government policies—especially when the Federal Reserve decides to print new money to fuel government deficits” (Wesbury).

This is problematic because money ultimately loses its spending power as monetary inflation leads to asset inflation which leads to consumer good inflation. Interestingly enough, this cycle affects the poor more than the rich. This is known as the Cantillon effect–– the effect on an economy when new money is created. (Walter). The citizens hurt more than the government. Inflation’s sting is felt after the new money has already been spent; the first to spend that money is the government. It is created and spent (monetary inflation), but the damaging effects become noticeable when the prices rise for the citizens (consumer good inflation). Ultimately, it is only after the created money is spent that the money loses its value. So, when American citizens get the money, inflation hits them far harder than those who get to spend the money first.

The government likes to say that a 2% inflation rate is “normal” or “good.” This is simply not true. Inflation is never necessary. It does not happen if money is not being created out of nothing. If there were no fractional reserve banks, money could not be created out of thin air. If the paper money was tied a standard such as being backed by gold, inflation would be absent. The government would not claim that a 2% inflation rate is necessary. Ultimately, it is not fair to American citizens to have to pay this hidden tax to the government.

Another note to make is that the Federal Reserve today is nothing like it was when it was created. The Federal Reserve becomes more powerful with every economic crisis. One of the monumental moments of this growth was the global financial crisis of 2009. The Federal Reserve lowered the interest rates to almost nothing. This increased a huge amount of buying and selling, setting America up for high inflation. When the buyers were not able to pay off their debt, everything crashed. The Federal Reserve stepped in and saved major banks from going under–– banks that should have been put out of business. They created new money, high inflation, and greater power for their institution.

Not only does the Federal Reserve gain from these crises, but they create them.  Since the government grows from economic failure, it is only necessary they continue to happen. Bob Murphy contrasts the effects of a free market compared to a regulated market and the problems that arise when it is regulated:

During those crises, governments largely remained aloof, and that’s why the economy recovered. In contrast, it wasn't until government and central bank officials became serious about helping with “countercyclical” policies in the 1930s that an initial crash blossomed into a Depression that wouldn't go away. (Murphy 53)

America’s economy could recover from depressions if the Federal Reserve would not intervene. It is their intervention that keeps crises ongoing. For the sake of power, the government regulates and creates long-lasting problems for America.

How does the Federal Reserve create an economic crisis? It all comes back to their regulation of interest rates. Interest rates decided by free markets are far steadier and more accurate than ones regulated by the Fed. Instead of letting the economy dictate how high the interest rate should be, the Federal Reserve attempts to set them itself. They regulate interest rates depending on what they believe the future of spending and buying will be, and they are almost always wrong. So, when interest rates inevitably have to go up, everything goes downhill. The Federal Reserve create problems that would not exist if the interest rates were not controlled. That is why the head of the Federal Reserve, Jerome Powell, can be considered even more powerful than the president. He dictates the rate of inflation by regulating what the interest rates should be. In a sense, he is in control of America’s money. This is a dangerous level of power for one person to have.

When the economy begins to crash due to the regulations, the Federal Reserve gives money to the government to “fix” the economy. Citizens consequently become reliant on the government to sustain them. As their money becomes increasingly worth less, their only other option is to hope the government will bail them out. With every new crisis, the government and the Federal Reserve receive more and more power. Morgan Reynolds, a well-known economist, explains this well,

As the demand for loanable funds rises, especially during a (healthy) recovery, interest rates rise to equilibrate between the demand for investible/loanable funds and the funds saved (true abstaining from present consumption) and offered for loan... The machinations of the Fed and its printing presses of “high-powered” money create false “savings” offered for loan through the banking system and artificially depress interest rates from the natural or market rates, regardless of the stage of the business cycle. That misleads entrepreneurs and results in the whole host of misallocations and avoidable suffering we call the boom-bust cycle.  On monetary policy, as Mises wrote, ‘All governments are firmly committed to the policy of low interest rates, credit expansion, and inflation.’ We might add: today, tomorrow, and all the time! (Reynolds)

The Federal Reserve's actions to regulate the free market upsets the normal boom-bust cycle (or business cycle). While claiming to save the economy, they are hurting it.

The Federal Reserve is legally doing something illegal: stealing. So, what can we do about the Federal Reserve? Isn’t it too powerful to be stopped? Is there any hope left? Well, it can be stopped. However, the chances of that happening are slim. Since both parties need the Federal Reserve to fund them, it is unlikely that things will ever change. However, with the present administration, the chance of the Fed being restricted is better than ever. Ron Paul, a well-known politician, is strongly opposed to Federal Reserve. His presence within the current administration may lead to reforms of the Federal Reserve. Nevertheless, even with people like him, the likelihood of the Federal Reserve’s complete abolishment is slim.

But, if those with political authority miraculously decide to rule the Federal Reserve as unconstitutional, we must abide by standards. We must hold the government accountable. A monetary system must be made and never compromised no matter the circumstances. The government cannot be allowed to take money whenever it wants or needs it. Fractional Reserve banking must be abandoned. This kind of banking creates money and causes inflation. All money must be backed by something else. This is not only economical, but also ethical. When the government must decide how they want to spend their limited amount of money, they will not waste it on the unimportant. A gold standard holds the government accountable for their actions.

One might argue that banks will lose all profit if they do not loan out money with interest, but there is a simple solution to this problem. It may sound extreme to those who have become accustomed to free checking and savings, but it is the far more ethical choice. Instead of banks profiting through inflation while not charging their clients, a price should be given to clients who want to put their money in the bank. After all, what is more inconvenient: paying a fair price for something you need or getting it for free while being charged a hidden fee that you have no control over? It is dangerous to have no control over what you pay, and that freedom should not be sacrificed at the expense of something free. Banks will make a profit if they set a price for their clients to pay; people do not want to store all of their cash in their house. Banks should profit from that by setting a reasonable price instead of not charging them at all.

Finally, we must understand that there will be economic pain if the Federal Reserve is abolished. The economy will suffer because of all of the bad decisions that have been made over time. However, the economy will also be much more stable and less susceptible to recessions and depressions. Americans can solve problems themselves; the government is not an all-powerful being that can save its citizens. It is proven that people do better at solving depressions and recessions than a government that creates money and regulates everything.

The Federal Reserve is a monster that has disguised itself well. However, with a comprehensive knowledge about its functionality it becomes clearer why it is unconstitutional, uncontrolled, and a threat to our democracy. The Fed is a thief, creating unnecessary problems for Americans as well as claiming to solve them by creating bigger ones. It only exists to fund the government and keep those in power wealthy and powerful.

In 1910, six men created a plan that would change America forever–– an idea that would take away economic freedom from the public and make it easy for the government to control. They knew it was wrong, and that is why it was a secret. The creation of the Federal Reserve left a scarring impact on America then, now, and it will continue to become worse as it grows.

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