WEBVTT NOTE How the Fed Rules and Inflates 1 00:00:00.000 --> 00:00:04.000 How the Fed Rules and Inflates 2 00:00:04.000 --> 00:00:09.000 Having examined the nature of fractional reserve and of central banking, 3 00:00:09.000 --> 00:00:16.000 and having seen how the questionable blessings of central banking were fastened upon America, 4 00:00:16.000 --> 00:00:21.000 it is time to see precisely how the Fed, as presently constituted, 5 00:00:21.000 --> 00:00:28.000 carries out its systemic inflation and its control of the American monetary system, 6 00:00:28.000 --> 00:00:39.000 Pursuant to its essence as a post-Peel Act central bank, the Federal Reserve enjoys a monopoly of the issue of all banknotes. 7 00:00:39.000 --> 00:00:57.000 The U.S. Treasury, which issued paper money as greenbacks during the Civil War, continued to issue $1 silver certificates, redeemable in silver bullion or coin, at the Treasury until August 16, 1968. 8 00:00:57.000 --> 00:01:08.000 The Treasury has now abandoned any note issue, leaving all the country's paper notes or cash to be emitted by the Federal Reserve. 9 00:01:08.000 --> 00:01:20.000 Not only that, since the U.S. abandonment of the gold standard in 1933, Federal Reserve notes have been legal tender for all monetary debts, public or private. 10 00:01:20.000 --> 00:01:33.000 Federal Reserve notes the legal monopoly of cash or standard money now serves as the base of two inverted pyramids determining the supply of money in the country. 11 00:01:33.000 --> 00:01:40.000 More precisely, the assets of the Federal Reserve banks consist largely of two central items. 12 00:01:40.000 --> 00:01:46.000 One is the gold originally confiscated from the public and later amassed by the Fed. 13 00:01:46.000 --> 00:02:10.000 Interestingly enough, while Fed liabilities are no longer redeemable in gold, the Fed safeguards its gold by depositing it in the Treasury, which issues gold certificates guaranteed to be backed by no less than 100% in gold bullion buried in Fort Knox and other Treasury depositories. 14 00:02:10.000 --> 00:02:16.460 It is surely fitting that the only honest warehousing left in the monetary system is 15 00:02:16.460 --> 00:02:20.320 between two different agencies of the Federal Government. 16 00:02:20.320 --> 00:02:26.640 The Fed makes sure that its receipts at the Treasury are backed 100% in the Treasury vaults, 17 00:02:26.640 --> 00:02:33.080 whereas the Fed does not accord any of its creditors that high privilege. 18 00:02:33.080 --> 00:02:39.400 The other major asset possessed by the Fed is the total of U.S. government securities 19 00:02:39.400 --> 00:02:45.620 it has purchased and amassed over the decades. On the liabilities side there are also two 20 00:02:45.620 --> 00:02:51.740 major figures, demand deposits held by the commercial banks which constitute the reserves 21 00:02:51.740 --> 00:02:58.640 of those banks and Federal Reserve notes, cash emitted by the Fed. The Fed is in the 22 00:02:58.640 --> 00:03:05.520 rare and enviable position of having its liabilities in the form of Federal Reserve notes constitute 23 00:03:05.520 --> 00:03:12.880 with the legal tender of the country. In short, its liabilities, Federal Reserve notes, are 24 00:03:12.880 --> 00:03:19.520 standard money. Moreover, its other form of liability, demand deposits, are redeemable 25 00:03:19.520 --> 00:03:26.800 by deposit holders, that is, banks who constitute the depositors or customers of the Fed, in 26 00:03:26.800 --> 00:03:31.920 these notes, which, of course, the Fed can print at will. 27 00:03:31.920 --> 00:03:38.200 Unlike the days of the gold standard, it is impossible for the Federal Reserve to go bankrupt. 28 00:03:38.200 --> 00:03:44.840 It holds the legal monopoly of counterfeiting, of creating money out of thin air in the entire 29 00:03:44.840 --> 00:03:46.600 country. 30 00:03:46.600 --> 00:03:52.440 The American banking system now comprises two sets of inverted pyramids, the commercial 31 00:03:52.440 --> 00:03:58.840 banks pyramiding loans and deposits on top of the base of reserves which are mainly their 32 00:03:58.840 --> 00:04:01.840 demand deposits at the Federal Reserve. 33 00:04:01.840 --> 00:04:07.800 The Federal Reserve itself determines its own liabilities very simply by buying or selling 34 00:04:07.800 --> 00:04:14.760 assets which in turn increases or decreases bank reserves by the same amount. 35 00:04:14.760 --> 00:04:20.720 At the base of the Fed pyramid and therefore of the bank system's creation of money in 36 00:04:20.720 --> 00:04:26.400 the sense of deposits is the Fed's power to print legal tender money. 37 00:04:26.400 --> 00:04:35.280 But the Fed tries its best not to print cash, but rather to print or create demand deposits, 38 00:04:35.280 --> 00:04:41.800 checking deposits out of thin air, since its demand deposits constitute the reserves on 39 00:04:41.800 --> 00:04:48.160 top of which the commercial banks can pyramid a multiple creation of bank deposits or checkbook 40 00:04:48.160 --> 00:04:49.160 money. 41 00:04:49.160 --> 00:04:52.360 Let's see how this process typically works. 42 00:04:52.360 --> 00:04:58.080 Suppose that the money multiplier, the multiple that commercial banks can pyramid on top of 43 00:04:58.080 --> 00:05:04.840 reserves is 10 to 1. That multiple is the inverse of the Fed's legally imposed minimum 44 00:05:04.840 --> 00:05:11.360 reserve requirement on different types of banks, a minimum which now approximates 10%. 45 00:05:11.360 --> 00:05:18.560 Almost always if banks can expand 10 to 1 on top of their reserves, they will do so 46 00:05:18.560 --> 00:05:48.560 The counterfeiter, after all, will strongly tend to counterfeit as much as he can legally get away with. Suppose that the Fed decides it wishes to expand the nation's total supply by $10 billion. If the money multiplier is 10, then the Fed will choose to purchase 1 billion of assets, generally U.S. government securities, on the open market. 47 00:05:48.560 --> 00:05:54.100 and below demonstrates this process, which occurs in two steps. 48 00:05:54.100 --> 00:05:59.280 In the first step, the Fed directs its open market agent in New York City to purchase 49 00:05:59.280 --> 00:06:03.240 one billion dollars of U.S. government bonds. 50 00:06:03.240 --> 00:06:10.360 To purchase those securities, the Fed writes out a check for a billion dollars on itself, 51 00:06:10.360 --> 00:06:12.700 the Federal Reserve Bank of New York. 52 00:06:12.700 --> 00:06:19.620 It then transfers that check to a government bond dealer, say Goldman Sachs, in exchange 53 00:06:19.620 --> 00:06:26.620 for $1 billion worth of U.S. government bonds. Goldman Sachs goes to its commercial bank, 54 00:06:26.620 --> 00:06:33.500 say Chase Manhattan, deposits the check on the Fed, and in exchange increases its demand 55 00:06:33.500 --> 00:06:41.740 deposits at the Chase by $1 billion. Where did the Fed get the money to pay for the bonds? 56 00:06:41.740 --> 00:06:48.260 It created the money out of thin air by simply writing out a check on itself. Neat trick 57 00:06:48.260 --> 00:06:54.460 if you can get away with it. Chase Manhattan, delighted to get a check on the Fed, rushes 58 00:06:54.460 --> 00:07:00.520 down to the Fed's New York branch and deposits it in its account, increasing its reserves 59 00:07:00.520 --> 00:07:07.320 by one billion dollars. Figure 10 shows what has happened at the end of this step one. 60 00:07:07.320 --> 00:07:16.160 Number 10, Fed buys $1 billion bond, immediate result, commercial banks, T-account, assets 61 00:07:16.160 --> 00:07:25.020 on the left, deposits at Fed reserves plus $1 billion, equity plus liabilities, demand 62 00:07:25.020 --> 00:07:33.480 deposits to Goldman Sachs plus $1 billion, the Federal Reserve assets, U.S. government 63 00:07:33.480 --> 00:07:44.200 Securities, plus $1 billion, Equity plus Liabilities, Demand Deposits to Banks, Chase, plus $1 billion. 64 00:07:44.200 --> 00:07:50.760 The nation's total money supply at any one time is the total standard money Federal Reserve 65 00:07:50.760 --> 00:07:54.960 notes plus deposits in the hands of the public. 66 00:07:54.960 --> 00:08:01.960 Note that the immediate result of the Fed's purchase of a $1 billion government bond in 67 00:08:01.960 --> 00:08:08.960 in the open market is to increase the nation's total money supplied by one billion dollars. 68 00:08:09.360 --> 00:08:15.020 But this is only the first immediate step because we live under a system of fractional 69 00:08:15.020 --> 00:08:22.160 reserve banking. Other consequences quickly ensue. There are now one billion dollars more 70 00:08:22.160 --> 00:08:28.480 in reserves in the banking system and as a result the banking system expands its money 71 00:08:28.480 --> 00:08:35.480 The expansion beginning with Chase and quickly spreading out to other banks in the financial system. 72 00:08:35.480 --> 00:08:51.480 In a brief period of time, about a couple of weeks, the entire banking system will have expanded credit and the money supply another $9 billion, up to an increased money stock of $10 billion. 73 00:08:51.480 --> 00:09:04.480 Hence the leveraged or multiple effect of changes in bank reserves and of the Fed's purchases or sales of assets which determine those reserves. 74 00:09:04.480 --> 00:09:13.480 Figure 11, then, shows the consequences of the Fed purchase of $1 billion of government bonds after a few weeks. 75 00:09:13.480 --> 00:09:40.480 figure 11, Fed buys a $1 billion bond, result after a few weeks, commercial banks, T account, assets on left, loans and securities, up $9 billion, deposits at Fed reserves, up $1 billion, equity and liabilities, demand deposits up $10 billion, 76 00:09:40.480 --> 00:09:53.480 The Federal Reserve, assets, U.S. government securities, up one billion, equity plus liabilities, demand deposits to banks, up one billion. 77 00:09:53.480 --> 00:09:59.480 Note that the Federal Reserve balance sheet after a few weeks is unchanged in the aggregate, 78 00:09:59.480 --> 00:10:07.480 even though the specific banks owning the bank deposits will change as individual banks expand credit 79 00:10:07.480 --> 00:10:12.480 and reserves shift to other banks who then join in the common expansion. 80 00:10:12.480 --> 00:10:17.480 The change in totals has taken place among the commercial banks 81 00:10:17.480 --> 00:10:23.480 who have pyramided credits and deposits on top of their initial burst of reserves 82 00:10:23.480 --> 00:10:28.480 to increase the nation's total money supply by $10 billion. 83 00:10:28.480 --> 00:10:35.480 It should be easy to see why the Fed pays for its assets with a check on itself 84 00:10:35.480 --> 00:10:39.240 rather than by printing Federal Reserve notes. 85 00:10:39.240 --> 00:10:44.320 Only by using checks can it expand the money supply by tenfold. 86 00:10:44.320 --> 00:10:48.840 It is the Fed's demand deposits that serve as the base of the 87 00:10:48.840 --> 00:10:54.240 pyramiding by the commercial banks. The power to print money, on the other hand, 88 00:10:54.240 --> 00:10:58.080 is the essential base in which the Fed pledges 89 00:10:58.080 --> 00:11:02.400 to redeem its deposits. The Fed only issues paper money, 90 00:11:02.400 --> 00:11:08.160 Federal Reserve notes if the public demands cash for its bank accounts and the commercial 91 00:11:08.160 --> 00:11:12.800 banks then have to go to the Fed to draw down their deposits. 92 00:11:12.800 --> 00:11:18.800 The Fed wants people to use checks rather than cash as far as possible so that it can 93 00:11:18.800 --> 00:11:24.440 generate bank credit inflation at a pace that it can control. 94 00:11:24.440 --> 00:11:30.560 If the Fed purchases any asset therefore it will increase the nation's money supply immediately 95 00:11:30.560 --> 00:11:36.360 by that amount, and in a few weeks by whatever multiple of that amount the banks are allowed 96 00:11:36.360 --> 00:11:44.360 to pyramid on top of their new reserves. If it sells any asset, again generally U.S. government 97 00:11:44.360 --> 00:11:52.040 bonds, the sale will have the symmetrically reverse effect. At first the nation's money 98 00:11:52.040 --> 00:11:58.760 supply will decrease by the precise amount of the sale of bonds, and in a few weeks it 99 00:11:58.760 --> 00:12:06.360 will decline by a multiple, say 10 times, that amount. Thus, the major control instrument 100 00:12:06.360 --> 00:12:15.360 that the Fed exercises over banks is open market operations, purchases or sale of assets, 101 00:12:15.360 --> 00:12:22.040 generally U.S. government bonds. Another powerful control instrument is the changing of legal 102 00:12:22.040 --> 00:12:27.880 reserve minima. If the banks have to keep no less than 10 percent of their deposits 103 00:12:27.880 --> 00:12:35.240 in the form of reserves and then the Fed suddenly lowers that ratio to 5%, the nation's money 104 00:12:35.240 --> 00:12:42.240 supply that is of bank deposits will suddenly and very rapidly double. 105 00:12:42.240 --> 00:12:48.120 And vice versa, if the minimum ratio were suddenly raised to 20%, the nation's money 106 00:12:48.120 --> 00:12:51.440 supply will be quickly cut in half. 107 00:12:51.440 --> 00:12:57.280 Ever since the Fed, after having expanded bank reserves in the 1930s, panicked at the 108 00:12:57.280 --> 00:13:27.280 Inflationary Potential and doubled the minimum reserve requirements to 20% in 1938, sending the economy into a tailspin of credit liquidation, the Fed has been very cautious about the degree of its changes in bank reserve requirements. The Fed ever since that period has changed bank reserve requirements fairly often, but in very small steps, by fractions of 1%. 109 00:13:27.280 --> 00:13:42.280 It should come as no surprise that the trend of the Fed's change has been downward, ever lowering bank reserve requirements and thereby increasing the multiples of bank credit inflation. 110 00:13:42.280 --> 00:13:58.280 Thus, before 1980, the average minimum reserve requirement was about 14 percent, and then it was lowered to 10 percent, and less, and the Fed now has the power to lower it to zero if it so wishes. 111 00:13:58.280 --> 00:14:06.280 Thus, the Fed has the well-nigh absolute power to determine the money supply if it so wishes. 112 00:14:06.280 --> 00:14:16.280 Traditionally, money and banking textbooks list three forms of Fed control over the reserves and, hence, the credit of the commercial banks. 113 00:14:16.280 --> 00:14:26.280 In addition to reserve requirements and open market operations, there is the Fed's discount rate, interest rate charged on its loans to the banks. 114 00:14:26.280 --> 00:14:33.440 Banks. Always a far more symbolic than substantive importance, this control instrument has become 115 00:14:33.440 --> 00:14:39.760 trivial, now that banks almost never borrow from the Fed. Instead, they borrow reserves 116 00:14:39.760 --> 00:14:43.640 from each other in the overnight federal funds market. 117 00:14:43.640 --> 00:14:50.080 Over the years, the thrust of its operations has been consistently inflationary, for not 118 00:14:50.080 --> 00:14:56.120 only has the trend of its reserve requirements on the banks been getting ever lower, but 119 00:14:56.120 --> 00:15:01.560 But the amount of its amassed U.S. government bonds has consistently increased over the 120 00:15:01.560 --> 00:15:08.560 years, thereby imparting a continuing inflationary impetus to the economic system. 121 00:15:08.560 --> 00:15:14.360 Thus, the Federal Reserve, beginning with zero government bonds, had acquired about 122 00:15:14.360 --> 00:15:23.840 $400 million worth by 1921 and $2.4 billion by 1934. 123 00:15:23.840 --> 00:15:30.600 By the end of 1981, the Federal Reserve had amassed no less than $140 billion of U.S. 124 00:15:30.600 --> 00:15:32.600 government securities. 125 00:15:32.600 --> 00:15:39.280 By the middle of 1992, the total had reached $280 billion. 126 00:15:39.280 --> 00:15:46.360 There is no clearer portrayal of the inflationary impetus that the Federal Reserve has consistently 127 00:15:46.360 --> 00:15:49.560 be given and continues to give to our economy.