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NOTE Money, Banking and the Federal Reserve

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The Federal Reserve System virtually controls the nation's monetary system, yet it is accountable

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to no one.

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It has no budget, it is subject to no audit, and no congressional committee knows of or

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can truly supervise its operations.

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These are the words of the late Professor Murray N. Rothbard, economist and academic

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vice president of the Ludwig von Mises Institute.

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The Institute is dedicated to the ideals of a free market and sound money.

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This program is dedicated to the memory of Murray N. Rothbard and his prolific work on

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on Money and Banking.

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For more than 20 years, the living standards of middle class Americans have steadily declined.

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Incomes have remained flat or fallen,

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and the opportunities and security we once took for granted have begun to fade.

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For most families, one income no longer pays the bills.

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It requires two or more incomes to afford a home, pay medical and child care expenses, and put children through school.

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Unless present trends change, young workers are unlikely to ever live as well as their parents.

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Good jobs with the future are harder to come by. Education doesn't count for what it once did.

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Taxes continue to rise while Social Security is going bankrupt.

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Private pensions are no longer reliable.

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Economic volatility and uncertainty are on the rise.

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Politicians espouse numerous theories about the cause of this country's economic woes.

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Seldom, however, do these officials look below the surface.

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The roots of our economic ills can be traced to central banking and our present monetary system.

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The Federal Reserve claims to manage our money. Instead, it makes our money worth less and

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less every day. It has generated continuous and worsening business cycles and lowered our

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living standards. It's really no different from a burglar in your house wanting to steal

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your money. That's what the Federal Reserve does. It depreciates your savings, it takes

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Money is supposed to serve as a reliable standard of economic value, not a source of instability.

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Until we restore sound money and take away the government's ability to debase it, we

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have little hope of restoring the freedom and prosperity that made America great.

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And we really have a choice of what we want in money.

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Do we want money that's going to be losing its value every year?

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Or do we want money that's going to be gaining in value?

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If you are happy with your money losing value, then you want the present system.

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If you want money to increase in value, then you want a gold standard.

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What is money?

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As the good that makes exchange possible, it's the foundation of every economic activity.

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In the earliest times, people traded goods and services directly. This form of exchange

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is known as barter.

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That is, if a fishing tribe desired to have maybe wheat, which they themselves did not

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produce, they would seek out other individuals that produced wheat. And then they would exchange

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there for fish.

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But barter had limitations in the marketplace.

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Well, actually people perceived pretty quickly problems with that direct exchange. If you

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If you wanted, for example, fish and you had wheat, but the people who had fish didn't desire the wheat, you were stuck, unless you went out and found some other good, possibly berries, that everyone in that society consumed.

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Then you would trade your wheat for the berries in full confidence that you could turn around and trade the berries for the fish or anything else that you desired.

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The most widely accepted goods in a society became valued for their use in indirect exchange.

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Money is simply another name for the most generally accepted medium of exchange.

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Throughout history, many goods have served as money.

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Feathers from the Ketzel bird were used for exchange by the Mayan Indians up to the 15th century in Central America.

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Tea leaves compressed into bricks were traded in East Asia through the 1800s.

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Wampum shells were money to North American Indians,

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while early American colonists traded beaver pelts which had a high value both at home and abroad.

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Metal coins first emerged in Greece and Asia Minor during the 7th century BC.

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Gold and silver were valued for their use and beauty in jewelry and the decorative arts.

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They were durable, easily divisible and limited in supply.

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These precious metals also had a high value to weight ratio, making them easily transportable.

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We might think back or we can think back to a time when iron was used as money.

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In 1536, less than 50 years after Christopher Columbus set foot on American soil, a Spanish

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mint in Mexico City struck the first coins made in the New World. These silver coins

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has eventually found their way into the British colonies.

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Great Britain's mercantilist policies deliberately tried to keep precious metals out of America,

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so the Spanish milled dollar became the unofficial currency.

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It was often divided into eight pieces for smaller transactions, hence the term pieces

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of eight, with one quarter of the coin being two bits.

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In 1792, Thomas Jefferson adopted the dollar as this country's official monetary unit.

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He looked around, he investigated to see what were the American people using his money,

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and that was the dollar. And so that's why that dollar became the standard of the United States.

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And we went on to a gold and silver standard and started minting gold coins with the American ego.

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Ten dollar gold coin.

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Jefferson in particular spoke eloquently of the dangers of paper money.

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During the war for independence, the Continental Congress printed vast sums of paper money out of thin air to finance the army.

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The diluted money supply naturally depreciated to almost nothing, leading to the phrase, not worth a continental.

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The people who held on to these notes, who tended to be patriotic Americans, concerned about,

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wanted America to be free of British control, lost everything, whereas the Tories, who

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wanted nothing to do with this American government money and immediately got rid of it, were

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benefited, and Pelletier Webster, the first American economist and others who looked

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at this, saw that this paper money unbacked by gold was extremely dangerous.

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As early as the 16th century in Europe, goldsmiths stored gold coins for their customers for a fee and issued receipts for the gold to the depositor.

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Thus began the use of paper as money.

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In other words, if you came in and deposited 10 ounces of gold for safekeeping, you got back receipts in the amount of 10 gold ounces.

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And those receipts entitled you to instantaneously redeem that gold.

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These receipts soon became widely accepted as a means of exchange since it was easier and safer to use the receipts for significant transactions.

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This was the origin of banknotes as money substitutes. These first bankers then took this process one step further.

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In effect, if the goldsmith had 1,000 ounces of gold and 1,000 ounces of legitimate receipts being held by the depositors of that gold,

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There was no longer a one-to-one ratio of paper to gold. Now there could be three or four pieces of paper in circulation for every unit of gold in the vault.

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These bankers were no longer simply storing or warehousing gold for a fee.

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They were artificially inflating the money supply and loaning out these phony receipts at interest.

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This system became known as fractional reserve banking and was later transported to the early American colonies.

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It formed the root of American commercial banking and ultimately the Federal Reserve System.

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This is a fraudulent system. It's not allowed in any other business.

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If you had a grain warehouse that had loaned out the grain it was supposed to have in storage,

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that's considered criminal, the guy would go to jail.

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The banks are the one industry that's allowed to get away with this and to profit from it.

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Alexander Hamilton became the first Treasury Secretary,

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and in 1791 set up the first Bank of the United States as America's central bank to expand the supply of paper money for the benefit of the government and the commercial banks.

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Alexander Hamilton believed in a strong central government and he saw a central bank as one of the means by which the government could be centralized and by which its power could be expressed.

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Thomas Jefferson opposed this view. He saw a central bank as an undemocratic tool of the northeastern banking establishment. It was dismantled after 20 years.

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Jefferson was an opponent of the strong central government and at all costs wanted to remove the central bank.

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In 1816, the federal government made another attempt to set up an inflationary central bank.

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But this second bank of the United States was denounced by President Andrew Jackson as a monster bank for benefiting a few at the expense of many.

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They inflated the money supply which brought about a boom initially, that is prosperity to the country, followed by a bust.

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Jackson succeeded in abolishing the second central bank in 1836, but by then, speculators

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had set up hundreds of new private banks with little or no gold to back the notes they issued.

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The nation's monetary system became more stable when the United States introduced a

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The gold standard was understood by the founding fathers, by Andrew Jackson and others, as

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being a money of the people. That is, it was a hard money, a money that could not be tampered

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with, that could not be inflated to permit government expenditures skyrocketing.

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But by 1862, Abraham Lincoln needed to fund his invasion of the South. So once again,

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the government began to print up paper money.

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Basically, the United States went off the gold standard in order to finance the Civil

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War. And you'll find in history that almost every large war, every major war, has involved

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Lincoln's notes became known as greenbacks, because they were printed in green ink rather

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than the usual black ink on the reverse side. These so-called fiat notes were deemed legal

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tender by the government, but they were not redeemable in gold.

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Lincoln, under cover of war, issued tremendous numbers of greenbacks. Gold was still circulating

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The government's power to print unbacked paper notes would later become the pillar of the Federal Reserve system.

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After the Civil War, the nation's monetary system became sounder when the US adopted a gold standard.

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We were back on the gold standard in 1879 and had probably the greatest period of growth

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and of prosperity ever in the country's history.

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For nearly 20 years, the total output of goods and services grew at an unprecedented rate

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of 4% per year.

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The reason being that with the sound money and without the ability to manipulate the

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In the midst of this prosperity, the big industrialists and financiers were plotting

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to expand their empires with the help of government.

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With the passage of the Interstate Commerce Act of 1887, the large railroads succeeded

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The ICC was put in place in order to protect the railroad owners from competition. It was not the case that it was going to protect consumers or shippers. In fact, consumers were hurt because ultimately, with higher railroad rates, they were forced to pay higher prices for the goods and services that were shipped across the country.

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By 1896, they were poised to do the same thing with the banks. Two camps emerged as leaders in this economic war. They were led by J.P. Morgan, the world's most powerful private banker, and John D. Rockefeller, the oil tycoon.

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Morgan and Rockefeller were great adversaries, but despite their business differences, they both favored a central bank.

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They wanted cheap credit and an inflated money supply to finance the expansion of their empires.

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Together, they led the campaign to sell the idea to the American public, which later led to the founding of the Federal Reserve.

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If the American people got wind of the fact that this bank was not in their interests,

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In fact, they understood that it was in the interest of the financial elites who would use it to inflate the money supply and in doing so, increase their own revenues, they would have been held to pay.

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Legislation would have never passed under those conditions. So it had to be sold to the American people as a way of making their currency more elastic.

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The bank reform campaign received a boost in 1907 when there was a run on some of New York's biggest banks thanks to their fractional reserves. Panic spread among depositors who got wind of the bank's insolvency and tried to withdraw their money.

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The Knickerbocker Trust failed and two other institutions went to the brink of bankruptcy

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despite a 35 million dollar bailout from J.P. Morgan. Wall Street swiftly adopted the fear

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of bank failures to sell the idea of a central bank or lender of last resort to the American

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public.

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And so the Federal Reserve was to be the lender of last resort in case any bank got into trouble,

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The question is, however, whether it is really desirable to have such a thing as a lender

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of last resort.

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The correct position appears to me that every single bank should be responsible for its own

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and Contractual Obligations, and if banks through imprudent policy then go bankrupt, this should

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not be considered a bad thing, but in fact considered to be a magnificent thing, because

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bankruptcies, the danger of bankruptcies is precisely what makes banks adhere to sound

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policies.

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But both runs and failures continued at an alarming rate.

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In 1908, the National Monetary Commission, headed by John D. Rockefeller Jr.'s father-in-law, Senator Nelson Aldrich, was set up to push for a central bank.

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In November of 1910, under the guise of a duck-hunting trip,

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6 men took a secret train ride to an exclusive private club on Jekyll Island, Georgia to write a central banking act.

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The classified gathering read like a who's who of American banking.

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There were two Rockefeller men, Aldrich and Frank Vanderlip of the National City Bank of New York.

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Two Morgan men, Henry P. Davidson from Morgan Bank and Charles D. Norton, president of Morgan's First National Bank of New York.

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in New York, Paul Warburg, a Kuhn-Lowe partner, and Assistant Treasury Secretary AP at Andrew, who is friendly to both camps.

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They spent a week at the luxurious club as Morgan's guests, crafting the proposals that would form the basis of the Federal Reserve System.

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It would be three years before their vision was realized.

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Just before Christmas 1913, the Federal Reserve Act was passed by Congress and signed by President Wilson.

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It established a Federal Reserve system to oversee monetary policy and regulate the commercial banks.

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It's no coincidence that the Federal Reserve system was established by the Wilson administration.

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This was the height of the Progressive Era, a time of tremendous government expansion of special interest deals in Washington.

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There are 12 regional reserve banks concentrated in the East and the Midwest.

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The Board of Governors of the Federal Reserve controls and coordinates their activities.

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The Board is made up of seven members appointed by the President.

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Even though there were 12 regional banks, Wall Street soon ran the show.

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As President of the New York Fed, Morgan protégé Benjamin Strong seized control of the Board's Open Market Committee operations.

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Strong would remain the dominant force at the Fed until his death in 1928.

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The Federal Open Market Committee, now based in Washington, directs the Fed's most important instrument of monetary policy,

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the purchase and sale of government securities on the open market.

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To increase the supply of money and credit, that is to inflate,

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the Fed buys government securities from a few hand-picked firms with newly created money.

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To tighten money and credit, the Fed sells securities. In this, it can act on its own discretion.

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Every government wants the ability to create new money. It's an alternative to raising taxes.

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Taxes, as we said, when they're raised, tend to evoke a lot of resistance among the public.

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It's much less painless to increase the money supply.

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Another device the Fed uses to control the amount of money in circulation is setting the

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discount rate.

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This is the interest rate charged to member banks when they borrow short term from the

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is a so-called discount window.

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If the Fed lowers the discount rate for its loans,

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commercial banks will likely borrow more from the Fed.

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This increases the amount of funds banks have to lend.

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Bank credit thus becomes cheaper,

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as reflected in lower interest rates on bank loans and credit cards.

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The increase in funds available for banks to lend

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also increases the amount of money in the economy.

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The Fed can also manipulate the nation's money supply

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Money Supply by raising or lowering the reserve requirement. Banks are required to set aside

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a percentage of their deposits as reserves to meet depositors' demands. When the Fed

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was established in 1913, it cut reserve requirements in half over the next four years, doubling

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the money supply by the end of World War I. But the Fed's real power lies in its monopoly

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to Create Money. Although the U.S. was still on the gold standard in 1913, it was quickly

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eroded as the Fed continued to expand the money supply. The first step was backing Federal

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Reserve notes by only 40% in gold, allowing the money supply to be increased two and a

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half times. The inflationary effect of fractional reserve banking was also heightened by the

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The Central Bank.

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The commercial banks are permitted to create checkbook money on top of Federal Reserve

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notes.

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That is to say, the commercial banks are only obliged by law to hold reserves in the form

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of Federal Reserve notes of 10% to back all demand deposits that they have.

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90% of the demand deposits are backed by nothing.

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The Federal Reserve system adds another inflationary layer to an already unstable banking system.

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For example, if the central bank has $100 worth of gold reserves in its vaults, and

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a 10% reserve requirement, it can print up $1,000 of new notes and deposits, which become

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the reserves of the commercial banks.

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The commercial banks take this $1000 and if they're required to hold 10% again in reserve,

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they can multiply the $1000 into $10,000 through fractional reserve loans.

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So an inverted pyramid is created with $100 worth of gold or real money at the bottom

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and $10,000 of inflated paper money at the top.

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As this $10,000 in new paper money circulates in the economy, it drives prices up, therefore

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reducing the buying power of ordinary citizens.

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When they spend that money, the people who get the new money first and are able to buy

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products with it benefit, and the people who get it at the end lose because when they go

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to spend it, prices have already gone up and so they're able to buy less.

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And so there's a transfer of wealth and of power from some segments of the economy to

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others because of the actions of the central bank.

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And basically those who benefit are the government itself, big banks and government contractors

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and anybody who's closely associated with the federal government.

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By making enormous amounts of credit easily available, the Fed can also drive down interest

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It sets in motion an unsustainable investment boom that carries with it the seeds of its own destruction.

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It's this business cycle that is ultimately responsible for economic disasters such as the Great Depression.

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Soon after the Federal Reserve was established, the U.S. entered World War I.

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Once again, the government temporarily abandoned the gold standard to print more money to finance the war effort.

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The US government borrowed heavily and the national debt ballooned from 1 billion to 27 billion dollars.

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A sharp spike of inflation followed. This set off a cycle of rapid expansion and contraction in the economy.

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To dampen the overheated economy, the Fed halted its inflation, causing interest rates to nearly double over the next 18 months.

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By 1921 the market began to recover. New technology helped to increase productivity. Markets developed

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for new cars and appliances. The 1920s were a period of extraordinary growth, but behind

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the scenes much of this growth was distorted by a Fed generated inflationary credit expansion.

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This was the roaring 20s. This was a period of increasing affluence. That hid the inflation from American economists.

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The Fed-generated bubble burst in the Wall Street crash of October 1929.

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Speculators who had borrowed money to buy shares when bank credit was readily available saw the stock market lose one-third of its value.

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Bank loans totaling $7 billion were outstanding.

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As the speculators defaulted on their loans, bank failures spiraled and the Great Depression set in.

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Depositors lost their bank accounts, both their savings deposits and checking deposits.

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They saw them disappear into thin air.

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In 1932, Franklin D. Roosevelt was elected president and quickly implemented a New Deal policy of spending us to prosperity.

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Even though we needed lower taxes and lower spending, his administration would seek unprecedented amounts of money to finance its big government programs.

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In his inaugural speech on March 4, 1933, Roosevelt vowed to put an end to poverty and the unemployment lines and get people back to work.

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The Depression got worse, thanks to increased central planning. FDR only succeeded in making the monetary system even less sound.

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Just after taking office, the president declared a four-day nationwide bank holiday,

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absolving the bankrupt fractional reserve banks of any need to repay their depositors.

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But before the banks reopened, the Roosevelt administration had to come up with a scheme that would lead people to believe that new deposits would be safe.

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It created the Federal Deposit Insurance Corporation to lull the public into a sense of security.

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In reality, the Federal Deposit Insurance Corporation holds just half of one percent of all the deposits it insures.

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By the mid-1930s, control of the Fed by the New York bankers was drawing to a close.

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The Morgan era ended when President Roosevelt, who was no friend of the Morgans, appointed

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Mariner Eccles as its governor. Eccles, a Republican from Utah, moved the activities

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of the Open Market Committee to Washington. President Roosevelt was on hand for the dedication

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of a new three and a half million dollar building to house the Fed.

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I dedicate this building today to progress, to progress toward the ideal of an America

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1933 also marked the beginning of the end for the gold standard. There was no end to Roosevelt's appetite for spending on such New Deal programs as the gigantic $13 billion Tennessee Valley Authority, which flooded vast areas of production.

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and productive farmland to provide government-subsidized electricity.

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The Works Progress Administration, which spent $11 billion on make-work jobs and pork-barrel public works.

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But the U.S. currency was tied to gold, which limited the amount of money the Fed could print to pay for these costly projects.

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So the government scrapped the gold standard for American citizens in 1933.

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And then Roosevelt confiscated the people's gold.

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As in World War I, the warring parties in the Second World War abandoned the gold standard

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to finance the war with central bank generated inflation. After the war, there was an attempt

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to use the prestige of the gold standard to establish a global inflationary system.

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The world's financial leaders met at Bretton Woods in New Hampshire under the direction

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Under the famous economist John Maynard Keynes, their idea was to set up a new international

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monetary system that would have both gold and inflation.

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Under this system, the U.S. dollar would be redeemable in gold, but only for foreign official

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institutions, central banks and foreign governments, at the rate of $35 per ounce.

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All other currencies would have fixed exchange rates with the U.S. dollar, and they would

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The New York Times editorialist Henry Hazlitt was one of the first to realize that this semi-gold standard would not succeed.

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Even from the very beginning it was doomed to failure and this very outstanding journalist at that time, Henry Hazlitt, predicted it wouldn't work.

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Because he says the temptation will always be that the government will print more money

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because they will accept these dollars and they won't demand the gold and won't hold the government in check.

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And he was absolutely right.

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During the 1960s, the U.S. government was trying to meet the cost of massive social welfare programs at home

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and the Vietnam War abroad.

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By printing more money, President Lyndon Johnson believed,

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The U.S. government could accomplish its goals without raising taxes, which may have caused a taxpayer revolt.

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In other words, it could have both guns and butter.

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We will make sure that every dollar is spent with a thrift and with a common sense

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which recognizes how hard the taxpayer worked in order to earn it.

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But the more money the U.S. printed, the more it eroded the value of the dollar.

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Nervous foreigners began redeeming their dollars in gold as they were entitled to do under the Bretton Woods Agreement.

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After paying out billions in gold, the U.S. was left with $36 billion worth of outstanding debt to foreign creditors and gold reserves worth just $18 billion.

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Rather than stop the inflation, in 1971, President Richard Nixon refused to redeem any more dollars.

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I have directed Secretary Connolly to suspend temporarily the convertibility of the dollar in the gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interest of the United States.

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It was the death knell for the Bretton Woods semi-gold standard, and a triumph for the Federal Reserve.

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The dollar would no longer have even the illusion of a fixed value against other currencies.

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It would float against them, causing even more dislocation in foreign trade and massive uncertainties for businessmen.

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Worse, the final check on dollar creation disappeared, creating endless possibilities for inflation.

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It's running at more than 300% since 1971, thanks to the Fed's power to create money out of thin air

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I don't think that that's something that enhances the efficiency of our economy. I believe that the best money is a market-determined money, such as we had under the gold standard. In order to get back to a market-determined money, the Fed has to be abolished.

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There is not now, nor has there ever been, any direct control over the Fed by the President or Congress.

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The meetings of the Federal Reserve Board are held in secret, and nobody knows exactly what goes on.

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If you watch the business report every night, commentators are constantly speculating about what the Fed might do.

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All eyes were on Washington today as the Federal Reserve met to decide the future direction of interest rates.

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Most economists expect the Fed to leave monetary policy unchanged.

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It has spawned a whole industry of Fed watchers who try to second-guess the Fed.

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The Federal Reserve has been surrounded by secrecy ever since its planning, its installation and its operations to the present day.

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And the reason is because they can't tell the truth.

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A recent attempt to open the Fed to public scrutiny came in 1993. The head of the House

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Banking Committee, Representative Henry Gonzalez of Texas, called for an independent audit

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of the Fed's operations. He wanted the proceedings of the Open Market Committee videotaped, with

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detailed minutes released within a week instead of vague summaries issued several weeks later.

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Gonzalez also proposed that the President choose the 12 heads of the Fed's regional banks instead of powerful bankers.

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Predictably, Fed Chairman Alan Greenspan resisted the changes.

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What was surprising was President Bill Clinton's position.

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He declared the reforms would, quote, run the risk of undermining market confidence in the Fed.

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After the Mexican government inflated and devalued the peso in 1995, the Mexican economy went into a tailspin.

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Alan Greenspan lobbied Congress and the Clinton administration for a $52 billion bailout.

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As it turned out, the Fed's member banks held as much as $26 billion in Mexican debt.

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With no choice in the matter, American taxpayers and savers paid the bill.

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The congressmen themselves, from my experience, they're pretty naïve and they don't understand it.

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The few that have to, like the chairman of the banking committee, is aware of this and goes along with it.

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And they continue to perpetuate this myth that the Federal Reserve brings about stability

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and they do good things for economic growth even though they're the culprits.

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They're the ones who have caused all the problems.

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They're the ones who caused the recession, the unemployment, and the downsizing of big business

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It is clear that the United States could not rely on Alan Greenspan or any other Fed Chairman to fight the chronic inflation that has wrecked our savings, distorted our economy, redistributed income and wealth, and brought us devastation.

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Inflating Booms and Busts

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Despite the established view, Greenspan, the Fed and big commercial bankers are not the inflation fighters they pretend to be.

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The Fed and its allied banks are not part of the solution to inflation and the business cycle.

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They are the problem itself.

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To limit chronic inflation and boom-bust business cycles, the currency must be backed 100% by gold.

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That would remove the Fed's ability to print money, which amounts to no more than legalized counterfeiting.

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Instead, there would be a monetary system where gold serves to anchor the dollar, rather than the fiat reserves created by the Fed.

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If we were to establish a real gold standard, the average American family would benefit tremendously.

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First of all, there'd be more jobs, better jobs, more secure jobs, more business opportunities,

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No more business cycle, no more recessions and depressions. People's savings would be secure.

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You wouldn't have to worry if you put away money for your old age, that its value would be stolen by the central bank and by the central government as they are today.

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Under a 100% gold standard, there would be no place for fractional reserve banking.

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For checking accounts and other demand deposits, the banks would keep reserves on hand to meet depositors' claims.

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Banks would receive a fee from their customers for keeping their gold.

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In loan banking, investors would hand over their money for a fixed period of time to earn interest.

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Once the gold standard is in place, individual bank depositors would always have access to their money,

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and investors would be kept informed of their balance sheet.

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And, at a national level, a tight rein would be kept on government spending.

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You have relatively priced stability. You have a stable purchasing power for the money. You eliminate the business cycle. You have reasonable interest rates rather than gyrating interest rates.

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And you get rid of the political manipulation of interest rates and the political manipulation of the money supply.

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And this then preserves wealth and builds wealth and allows for economic growth.

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It's as simple as this. Sound money means economic prosperity and limited government.

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Unsound money means inflation, recessions and depressions, and big government.

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What sort of system do we want for our families?

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Don't we want prosperity and security that we can hand on to future generations?

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Transition to a gold standard will not be easy.

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But as Murray Rothbard put it, the alternative is much worse.

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Since 1980, the Fed has enjoyed the absolute power to do literally anything it wants, to buy not only U.S. government securities, but any asset whatever, to buy as many assets and to inflate credit as much as it pleases.

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There are no restraints on the Federal Reserve. The Fed is master of all it controls.

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The Theory of Money and Credit

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The Theory of Money and Credit