Chapter 2: The Origin and Nature of the Fed
[note: all italicized words are quotes (or grammatically-altered quotes) from the text]
The Federal Reserve was created during the “Progressive Era – a time in which business in general became infatuated with the idea of forming cartels as a way of protecting profits and socializing losses. The largest banks were no exception.
Dr. Paul goes on to explain the problem with protecting profits and socializing losses. First, protecting profits is not a problem – it’s what private businesses do. The problem is that when the businesses (or banks) run into trouble, they want to socialize their losses, i.e., make the citizens absorb the loss, i.e., get “bailed out.” That kind of system eliminates risk. That kind of system is destined for failure – it will make a few people rich, and it will bankrupt the rest of the country. That kind of system is what was created in the Fed. The Fed provides for the flourishing of all sorts of financial demons.
The first demon is the fractional reserve banking practice. This means that when you put your money in a bank, they’re only required to keep a fraction of that money in the bank. The rest is loaned out/invested.
For example… (and for this example, we’ll imagine the bank is required to keep 10% of your deposit as fractional reserves…in reality, it varies from bank to bank)
Imagine you put $1,000 into your savings account. The bank will keep $100 there, and loan out the remaining $900 (of course, your account balance still shows $1,000). Then imagine I get a loan from that bank for $900. That’s your $900. Perhaps I don’t need the money quite yet, so I stick it in the bank. Now, from your $1,000, the bank has $1,900 on the ledger. That’s nice for them.
But it doesn’t stop there.
Because of the 10% fractional reserve requirements, the bank only has to keep $90 of my $900 (which is really yours) in-house. So they loan out $810 to Joe. Joe doesn’t need the money quite yet, either, so he sticks it in the bank. Now your $1,000 has turned into $1,710. Of course, it doesn’t stop there either. The bank only has to keep $81 of Joe‘s deposit (which is actually mine, which is actually yours). So they loan out the rest – $729. And on, and on, and on. Eventually, the bank can foreseeably have turned your $1,000 into $10,000!
The Fed would say this is a good thing – it allowed lots of people to get loans when there otherwise wouldn’t have been the money for it. But surely we know from recent experience (read: Fannie Mae and Freddie Mac) that copious loans aren’t always good (in fact, they’re rarely good). Yet, the Fed props this system up by encouraging banks to keep loaning – and by adding reserves to the balances of member banks in the hope of inspiring ever more lending!!!
But when your $1,000 turns into $10,000, no new wealth was created. It was essentially the printing of money without turning on the printing press. Now, provided every single one of those loans is paid back, then in the end, we can deduce that wealth was eventually created. But we know that loans aren’t always paid back. And in the current crisis, many many loans aren’t being paid back – which means that dollars are out there that shouldn’t be out there – they are supposed to be representing wealth, but that wealth doesn’t exist, and never will, so the result is the inflation of the currency. This problem is created because of the “easy money” (banks can lend out almost an endless supply, so they do), so investors and loan recipients take unreasonable risks, and end up creating a buying/selling craze (like the recent housing bubble). An even worse result is that once the banks teeter on the brink of failure, the government swoops in and bails them out (which the banks knew the government would do – which is why they played games with our money) – with your money. Our money.
The modern system of money and banking is not a free-market system. It is a system that is half socialized – propped up by government – and one that could never be sustained as it is in a clean market environment. And this is the core of the problem.
The second demon is the boom/bust economic cycle – which the Fed was actually intended to end.
Congressman Paul explains in great detail the creation of the Fed, but I’ll give the highlights.
The 1800s were filled with economic booms and busts, brought about by two attempts at a central bank (The First Bank of the United States, and The Second Bank of the United States). Both were closed. A gold standard was attempted, but with flaws, like the existence of a fractional reserve system (encouraging malinvestment) and regulations that banks depended on to dampen competition.
Big bankers started crying for a centralized bank in the early 1900s. Finally, with Congress’s approval, at a week-long secret meeting of two Rockefeller people; two Morgan people; a Kuhn, Loeb person; and one economist (essentially, a roomful of powerful bankers, being justified by an economist), the Federal Reserve was invented. Congress approved it in 1913, and that’s where we are now.
The goods and services you could buy for $1.00 in 1913 now cost nearly $21.00. Another way to look at this is from the perspective of the purchasing power of the dollar itself. It has fallen to less than $0.05 of its 1913 value. We might say that the government and its banking cartel have together stolen $0.95 of every dollar as they have pursued a relentlessly inflationary policy.
The creation of the Fed didn’t end the boom/bust cycles either. According to the National Bureau of Economic Research, the recessions of the 20th century are as follows:
1918-1919, 1920-1921, 1923-1924, 1926-1927, 1929-1933, 1937-1938, 1945, 1948-1949, 1953-1954, 1957-1958, 1960-1961, 1969-1970, 1973-1975, 1980, 1981-1982, 1990-1991, 2001, and 2007 (the current recession).