Federal Reserve News

This book may seem to be about the Federal Reserve System, and indeed the Fed will be the focus of 75-80% of it. However, before we can focus on the Fed, we must first agree on what prosperity is. Lacking a coherent sense of what prosperity is, we can't even begin to identify what is good or bad about a form of money or of the banking system in which it exists.

Prosperity is nothing more and nothing less than having a growing supply of goods and services that benefits all of us due to having a relatively level money supply. To some, this may seem clear and obvious. To others, it may seem ludicrous. To still others, it may seem irrelevant. There is no doubt that most economists pay no attention to it, and even on those rare occasions where they do pay attention to it, they dismiss or reject it more often than they embrace it.

So let me state for the record the most simple, basic, self-evident fact that has been so consistently ignored throughout my lifetime by all civilizations on this planet. In a truly free market, the supply of goods and services rises over time, and the supply of money remains relatively stable and constant over time. Thus the value of market-trusted money in a truly free market increases on average over time, prices come down on average over time, and in this way prosperity is shared with the poorest of people. In such an economy all a poor laborer has to do to get ahead in life is to scrimp and save. He doesn't even need to earn interest in a bank savings account. Merely the act of putting money away for a rainy day makes him wealthier, and in such a society everyone prospers.

Further, in a free society whenever money loses value it is a certain and clear signal that its value, and therefore the prosperity of the society as a whole, is being siphoned off by some group of individuals. Except when that money is commodity-based (such as gold or silver) and that commodity is being increased through honest production, such siphoning off of prosperity is fraudulent. It can even be legal fraud (as is the case with the Federal Reserve System), but it is still nonetheless fraud.

Of course, if a commodity-based money supply increases too quickly via honest production, then the usefulness of that money supply as money becomes less because the value to society of the money is being watered down. In such instances, so long as the free market has alternative commodities which can be used as a basis for money available to it, natural market forces will automatically shift society toward the newly preferred form of money. So if the overall supply of silver, for instance, is increased by record amounts of mining that doesn't get eaten up by industrial production, society can prefer gold-based money and thereby avoid the problems associated with an inflating silver supply.

Unfortunately, we do not live in a free society; our markets are so far from being free that it's laughable; and our supply of money isn't even close to being constant or stable. It is the failure of our society to insist upon a stable money supply, combined with its insistence on market regulation, which makes the poor seem to be poorer while the rich get richer. In fact, looking at the whole picture this way, it becomes clear that the rich get richer by the draining of wealth from the poor via money supply manipulations. The poor's share of a free society's benefits is being siphoned away, and most of them don't even understand how it's happening. All they know is that they find it harder and harder to make ends meet. The same can be said for the middle class, who are generally even less aware than the poor of what is happening to them, simply because the crisis doesn't seem as dramatic to them. Historically, only the so-called Austrian economists have expressed sentiments compatible with this principle regarding the widening gap between economic classes.

The Austrian school's leading master, Ludwig von Mises wrote, "If the money relation remains unchanged, neither an inflationary (expansionist) nor a deflationary (contractionist) pressure on trade, business, production, consumption, and employment can emerge." (Mises, Human Action: A Treatise on Economics, 3rd edition published by Henry Regnery Company by arrangement with Yale University Press, 1966, p. 430)

Murray Rothbard, another Austrian economist and a student of Mises wrote, "An increased supply of goods produced will raise the demand for money and also therefore lower the overall level of prices." (Rothbard, The Mystery of Banking, Richardson & Snyder, New York, 1983, p. 59)

The Austrians did and do not claim that there had to be a particular quantity of money. To the contrary, they argue that any quantity will do. They are quite content to let the market determine what that level should be. To be fair, they rarely discussed directly the importance of having a relatively constant quantity of money. No economist does, and more's the pity, because particularly in what another Autstrian economist, Hans Sennholz called, "The Age of Inflation," it is easy to forget this most basic of facts: that a money supply must be relatively constant in order to spread prosperity to all, including the poorest of people.

In recent times, politicians have played on the idea of, "the rich getting richer and the poor getting poorer," but to my knowledge only one (Ron Paul, R-TX) has correctly identified why this process happens. Paul wrote, "The moral of the story is that spending is always a tax. The inflation tax, though hidden, only makes things worse. Taxing, borrowing, and inflating to satisfy wealth transfers from the middle class to the rich in an effort to pay for profligate government spending, can never make a nation wealthier. But it certainly can make it poorer." (Paul, "The Inflation Tax", lewrockwell.com, July 16, 2006)

Economists are generally much more concerned with what happens under an unstable money supply, which has led many, including the so-called Chicago school of economics led by the late Milton Friedman, to conclude that the ideal relationship between money on the one hand, and goods and services on the other hand, is where prices are kept stable. And how does the Chicago school propose to keep prices stable? They propose increasing the money supply at a rate that matches the growth of goods and services. Such an "equilibrium" is, in fact, impossible to maintain via regulation, but  that never stopped the Friedmanites from pursuing it. Nor did it stop them from adopting their flawed assumption.

Do you see the flaw in their assumption? It should be as plain as the nose on your face. If the supply of money increases in lock-step with the overall supply of goods and services, then the benefits of living in a free economy can never work their way down to the poorest members of society! Instead, as the money supply steadily rises, the poor will find themselves constantly behind the eight ball, struggling to stay afloat. Why? Because they're already poor! They're starting from point zero, and unless they become superb producers (rare among the poorest of people), they will remain at point zero. When the cost of living rises at the same rate as the standard of living, the only way to move ahead is to produce wealth at a rate that is greater than average among people...hardly a likely skill for a poor person!

Hopefully, you are now beginning to gain a glimmer of understanding as to why the money supply is so important. Those who invest in stocks, bonds, futures, commodities, etc. certainly think it's important. That's why the most successful investors of all kinds pay close attention to the money supply.

"Today, money supply figures pervade the financial press. Every Friday, investors breathlessly watch for the latest money figures, and Wall Street often reacts at the opening on the following Monday. If the money supply has gone up sharply, interest rates may or may not move upward. The press is filled with ominous forecasts of Federal Reserve actions, or of regulations of banks and other financial institutions."

Sounds like it was written earlier this year, doesn't it? Actually, the above paragraph was written 25 years ago and published in Rothbard's The Mystery of Banking. In fact, it was the opening paragraph of the book.

Since that book was written, it's been quite a roller-coaster ride. The 1980's roared until Black Monday on October 19, 1987, the day of the second worst stock market crash in history (second only to the 1929 crash which preceded the Great Depression). It sent the country into a funk into the early 1990s. In the mid-1990's the markets went through another dizzying round of craziness, only to conclude with the telecom crash of 2000. The turn of the millenium saw the craziness of the real estate industry as housing prices went out of sight. Now, it appears that's turning around as well, and with the sub-prime mortgage crisis there is considerable consternation regarding the aftermath. The hopes for the real estate market as a whole are currently dimmed as this book is being written.

Booms and busts have been with us for generations, so what's been going on lately is nothing new. However, it is clear that most people (including most economists) continue to be ignorant of why they happen with such frequency and what causes the devastation they leave in their wake. It is not a coincidence that the Federal Reserve Board of Governors have engaged in roughly 3-4 dozen rounds of economic stimuluses during the past 15-20 years. Once one realizes what the connection is between the Federal Reserve System and the boom/bust cycle, it becomes much more evident why the dizzying ride continues unabated.

This online book is being written by collaborators and contributors from all over America. It is a work in progress, so don't expect to see all of the answers you are looking for just yet. We're hoping to fill out the volume of this book pretty quickly, so check back over time if your particular question isn't answered just yet. Or just use the forums on this website and ask your question there.

This book tries to present a complete overview of money and banking, including considerable historical references that led among other things to the creation of the Federal Reserve System. However, the focal point of this book will be the sections that actually describe and discuss how the Fed works. In particular, it will focus upon how the Fed creates money out of thin air using bank deposits and reserves of all the banks in the United States as the basis for its activities. This activity has tremendous consequences for the entire American economy, and given the importance of the American economy to the world economy as a whole, it also has direct influence there as well.

We will also focus on how these money-creation activities appear to stimulate economic growth, while in actuality the appearance is deceiving and short-lived, thus leading to the boom/bust phenomenon.