Can someone explain the Fed?

[sjw]

I have two questions.

First, regarding this lowering of interest rates when the stock market goes down: Isn't that just a shell game? I mean, when you lower interest rates you're essentially just making it a worse idea to store money in the bank. There's really no other place to store it than the stock market, or in stuff that you buy. So this manipulation of rates is just a cynical game politicians play to favor or de-favor the stock market. They have no idea of knowing whether the money is better off in the bank or in investments, they just see people screaming about their 401K's or desire for cheap housing and to console those people they lower interest rates. Is this accurate? Or is there anything actually reasonable about what the Fed is doing?

My second question is about mechanics. I vaguely understand that the way the Fed lowers rates is by printing more money. Or maybe it's that when they lower rates that more money gets printed because people are more inclined to borrow from somewhere. In either case, more money is being printed. But what does that mean concretely? When they print a new dollar, what exact government agency owns that dollar and how do they benefit from this new dollar, and how is it transferred from the original owner to the new owner? How is this process any different from counterfeiting? I know that in effect it is counterfeiting, but I don't see how it isn't precisely counterfeiting.

Shayne

[Wolf DeVoon]

The ruling class gets nervous when the economy sputters and stalls. There is a community of interest among investment bankers, politicians, defense contractors, captains of industry, labor leaders -- all of whom might be hauled off to the guillotine any second, unless the broad middle class of folks who work for a living (the electorate) can afford incrementally better food, shelter, clothing, cars, drugs, cheap airfares and electronics (it used to be a smaller list). What's been happening over the past several decades is cheating our children and grandchildren to bribe and baffle today's "consumer of last resort."

I know that doesn't make a lot of sense. There can be no consumption without production, unless you borrow somebody else's production with paper money, credit cards, nothing-down no-doc home loans, etc. The national balance sheet has been bright red for a long time and getting worse every day.

The way the Federal Reserve creates money is buying US Treasury bills and/or accepting toxic junk from Wall Street as collateral for cash that doesn't have to be paid back anytime soon. The theory behind this is a dollar tomorrow is worth less than a dollar today -- so banks and brokers can pay back the govenment in cheaper dollars eventually someday maybe. In reality, no one expects any of these "discount swaps' to be paid back.

The Fed's balance sheet is a joke. Its 'assets' are increasingly worthless government debt, a claim on future production of real goods. Not toys. Not bombs and bullets. Real food, clothing and shelter that we've mortgaged to the ruling class of pashas and pawnbrokers. A free market wouldn't and couldn't stand for it, but a mixed economy of freedom and controls breeds progressively more bizarre Enron-like illusions.

W.

Over to you, Brant.

Edited January 22, 2008 by Wolf DeVoon

[merjet]

The Fed lowering interest rates is conducive to easing credit and hence credit expansion. Many financial companies, especially banks, profit by borrowing at one rate and lending at a higher rate. The difference is the interest rate spread. If the Fed lowers the rate at which banks can borrow and the rate at which they lend drops a lesser amount (usually the case), the spread rises and induces lending. They who borrow from the banks might use the money in various ways -- buy consumer goods, business purposes or even buy stocks.

A technical point -- the Fed doesn't print money, the Treasury does. Inflation does not require printing more currency. These days inflation is mainly by increasing the amount of debt in circulation.

Edited January 22, 2008 by Merlin Jetton

[Michael Stuart Kelly]

Shayne,

I would start here. This research was an eye opener for me.

You might want to start with the following video (47 minutes). It is light and nothing but an overview, but it is a very good overview and it explains why and how fractional reserves came about as a policy.

Money as Debt

Michael

[Brant Gaede]

The Fed is socialism having a death grip on our financial life-blood. Money monopoly maintained by legal tender laws. Because of its actions in the last two decades, since Volker left and Greenspan came in, the business cycle has been suppressed with understated inflation (we have much more inflation than the official numbers)--i.e., gross inflation of the money supply. Now the business cycle is finally reasserting itself in both crude and creative destruction. It's going to be especially rough the next year or two as the government fights the business cycle instead of letting it do what it has to do as quickly as possible. Collectively, Americans are now richer in things and poorer in capital than 20 years ago. Technology has a lot to do with this, but they should have even more and better things and more savings, but why save inflated inflating currency?

--Brant

[tjohnson]

The term 'inflation' is tricky. It is often characterized as an increase in the costs of goods and services but it's "really" due to too much money in circulation, IMO. When there is more money in the economy than is justified then the money becomes less valuable and it appears as if things cost more. When the fed lowers interest rates there is more borrowing which infuses money into the economy, perhaps too much. The interest rate should be decided by the marketplace and the fed should control the money supply according to real measures of it's size. They don't do this because people with access to the money don't care about inflation because they will always have enough money.

[studiodekadent]

The term 'inflation' is tricky. It is often characterized as an increase in the costs of goods and services but it's "really" due to too much money in circulation, IMO. When there is more money in the economy than is justified then the money becomes less valuable and it appears as if things cost more. When the fed lowers interest rates there is more borrowing which infuses money into the economy, perhaps too much. The interest rate should be decided by the marketplace and the fed should control the money supply according to real measures of it's size. They don't do this because people with access to the money don't care about inflation because they will always have enough money.

Of course the interest rate should be market priced. However, governments want to promote the "dream of home ownership" and hence do everything to encourage people to buy homes and hence take out loans. The fed then takes this as a sign of people with a lot of money, expands credit, making homes (and other loans, like business loans) look cheap. People buy. But people aren't saving enough to make the loans (i.e. the loans outstrip the supply), but the price is artificially kept low.

People then are employed to build skyscrapers because businesses are expanding. They spend their wages on consumption goods. But resources are stretched between skyscraper construction and making consumption goods. Inflation sets in. The fed gets scared and clamps down on the lending.

Thus begins the credit crunch.

Interest rates shoot up. Since the Skyscrapers (and other long term investments) wont pay up for a while the interest hike makes the investments more expensive than they initially were. So the investors sell off. Stock market crashes.

New investments aren't completed. Workers building new buildings are laid off. Recession begins.

[Michael Stuart Kelly]

Andrew,

The Fed does not expand or restrict credit. It merely raises or lowers the rate on funds it loans to banks. (Incidentally, the Fed orders physical money to be printed by the mint, just like we order a poster from a printing office. Each dollar costs it a fraction of a cent.)

The Fed is a private company with private owners (all banks), but it is a bit mixed because it enjoys some government monopoly privileges in exchange for the government being able to appoint the chairman. Its constitutional purpose is to manipulate the money market in any manner it can to ensure a stable money supply for the country.

It is all more complicated than that, but these are the essentials.

The government does not expand or restrict credit. Banks do.

Michael

[merjet]

[The Fed] does not expand or restrict credit. It merely raises or lowers the rate on funds it loans to banks.

That's only one rate -- the discount rate -- the Fed can do to manipulate credit. More powerful and often used is changing the Fed funds rate -- which is the loan rate that banks charge each other.

There's more. The Fed can buy (expands money supply) or sell (shrinks money supply) U.S. Treasuries. The Fed can change reserve requirements (rarely done).

Its constitutional purpose is to manipulate the money market in any manner it can to ensure a stable money supply for the country.

Incorrect. From a Fed document: "The Federal Reserve sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates" (my bold).

[Michael Stuart Kelly]

Merlin,

You are correct. Buying treasury bills is the way it's done.

For those still confused, a treasury bill is a hifalutin IOU. The US government prints all of those it wants to.

But stable prices also apply to the money market. I.e., stable money supply. That was my logical connection. Still, you are right about the wording.

Michael

[syrakusos]

MSK: Each dollar costs it a fraction of a cent.

What is your point? I mean, that statement sits without context. I know what you think you mean. You think that a "dollar" cannot be woth a "dollar" unless it is made from a "dollar's" worth of gold or silver or something. You are mistaken. You can read a summary I wrote for RoR by clicking here.

(Incidentally, the Fed orders physical money to be printed by the mint, just like we order a poster from a printing office. Each dollar costs it a fraction of a cent.)

Not exactly correct, Michael, or as some Objectivists might say, "wrong." The Mint strikes coins. There are four Mints: the main Mint in Philadelphia and three branch Mints -- San Francisco, Denver and West Point. Paper money -- and other documents -- come from the Bureau of Engraving and Printing. They used to print postage stamps, but that has since been contracted out, though they still accept responsibility for it. Also, note that the Fort Worth printing plant is also a contract facility. You can see their work if you look at your paper money and find an FW in the lower right on the face.

You can tell which Federal Reserve Bank the money was printed for by the Alphabet Letter in the Serial Number.

A = Boston

B = New York

C = Philadelphia

D = Cleveland

E = Charlotte

F = Atlanta

G = Chicago

H = St. Louis

I = Minneapolis

J = Kansas City

K = Dallas

L = San Francisco

Also, there is some internal coding in numbers on the notes that correspond to the letters A=1,...,L=12

On older notes, the letter was in a seal. New designs now have different details.

Personally, being an Objectivist, I keep about $20 in New York ones in the section on "Money" in The Ayn Rand Lexicon, just in case, I need some pocket money on my way out the door. I also accumulated a complete set A through L in nearly uncirculated condition just by watching my ones over the course of a year. If you have any preferences for Secretaries of the Treasury or Treasusers, you can collect signatures.

The first woman to serve as Treasurer of the United States was Georgia Neese Clark Gray, actress, bank president and Democratic Party stalwart. Following her every Treasurer of the United State has been a woman. Nellie Tayloe Ross was both the first woman to serve as a state governor and the first woman to serve as director of the U.S. Mint (1933-1953). During Nellie Tayloe Ross’s tenure the gold depository at Fort Knox was built. “She was born when U.S. Grant was President, and passed away when Jimmy Carter was in the White House... from the horse and buggy to men on the moon.” After Ross, there were ten more Directors of the Mint; five of them were women.

To learn more about the Federal Reserve, go their website: www.federalreserve.gov

You can also find a fairly objective overview on Wikipedia (Click here.)

Remeber: the US Dollar is directly convertible into gold via authorized agents of the US Mint at the current market price for gold. The US Mint strikes and sells an array of gold (and silver) coins.

Edited January 23, 2008 by Michael E. Marotta

[Michael Stuart Kelly]

MSK: Each dollar costs it a fraction of a cent.

What is your point? I mean, that statement sits without context. I know what you think you mean.

Michael,

I am afraid you are mistaken. You don't know what I mean.

After learning what I have learned, I see that I need to learn a lot more before adopting the gold-standard argument. I could ape Rand's argument (or the Austrian school one), but that is all it would be doing: aping. I still have a lot of studying to do and the more I learn about all this, while looking out at reality and seeing what works and doesn't, the more complex it becomes in my head. I am beginning to think that money is as complicated or as simple as its users and changes according to how it is used.

I want you to take a deep breath and let it out slowly. Now relax. Now try to imagine you are an Objectivist, libertarian or layman who knows nothing of the inner workings of how our money comes about. Can you try to see through their eyes?

They think the Fed is a government agency that prints money.

My statement was meant to dispel that notion. It was meant to emphasize that the Fed is a mixed economy business. That the Fed gives value to the dollar, not the government.

Nothing more.

Michael

[studiodekadent]

Andrew,

The Fed does not expand or restrict credit. It merely raises or lowers the rate on funds it loans to banks.

Which more or less equates to lowering the price of interest, and (hence) expanding credit. Although yes, the actual direct credit expansion is done by the banks, the Fed starts the chain reaction.

[Michael Stuart Kelly]

Andrew,

Your extension to the thought is how I understand it.

Michael

[syrakusos]

... You don't know what I mean. After learning what I have learned, I see that I need to learn a lot more before adopting the gold-standard argument. ... I am beginning to think that money is as complicated or as simple as its users and changes according to how it is used.

I highly recommend the works of E. C. Riegel. I wrote about his ideas here. The books were recommended to me by Spencer Heath MacCallum, himself an innovative thinker.