The Weiner Component Vol.2 #6 – The Federal Reserve: Part 1

English: Monthly changes in the currency compo...

English: Monthly changes in the currency component of the U.S. money supply as reported by the Federal Reserve at the St. Louis Fed’s F.R.E.D. website at: http://research.stlouisfed.org/fred2/data/CURRNS.txt The data was copy/pasted into an OpenOffice.org Calc spreadsheet, the monthly changes were calculated using a simple formula, then this image was generated from that data. (Photo credit: Wikipedia)

Every industrial nation or group of countries like the Euro-pact, which uses a common currency, has a Central Bank that largely controls that controls its Monetary Policy, the flow of currency within its borders. In Europe it’s called the Central Bank and in the United States it is called the Federal Reserve System or the Fed.

 

Initially when the United States was founded under the Constitution in 1789 the Secretary of the Treasury, Alexander Hamilton, suggested that a Bank of the United States be established; and it was in 1791. The bank served as a repository for federal funds and as the government’s fiscal agent.

 

The bank was privately owned, as money for it was subscribed by private citizens, but its prime function was to serve the new government. It was granted a twenty year charter by Congress and had branches in eight cities. Consequently in addition to acting for the government the bank also conducted general commercial business. Although it was well managed and profitable critics charged that it was favoring the mercantile class over agrarian interests. This brought about its temporary termination after its charter expired in 1811. In 1816 the Bank of the United States was reestablished because the country had faced financial problems during the War of 1812 and it received a new twenty year charter.

 

The Second Bank of the United States would exist until and through most of the second term of Andrew Jackson’s presidency. It’s President, Nickolas Biddle, attempted to force Jackson to sign a Congressional bill chartering another twenty year extension to the bank. President Jackson reacted to this by moved all new government income to a group of western banks, that became known as his “pet” banks, and spent the funds already deposited in the Bank of the United States before withdrawing funds from his “pet” banks to pay for the needs of the Federal Government. The Second Bank of the United States got a state charter and would eventually go bankrupt. The western “pet” banks went on a lending spree which inflated the sale of western land by hundreds of percent, resulting in a depression, when the bubble burst, that affected the entire United States during the tenure of the next President, Martin Van Buren. In any event the nation no longer had a Central Bank.

 

In 1913, during the Presidency of Woodrow Wilson, a new Central Bank was set up by Congress. It was called the Federal Reserve and was supposed to regulate the flow of currency within the nation in order to avoid the large and regular economic dips of recession and depression.

 

Its initial mission was to control Monetary Policy, the flow of money through the entire economy. Gradually Congress extended it purpose by new legislation. These gradual extensions were a broadening of Monetary Policy.

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Keep in mind that at this point in the history of the United States money or currency was specie; that is, it was gold or silver in the form of coins. Paper money did exist but it was a promissory note that could be exchanged at any bank, theoretically at any time, for gold and silver coins. However if this was done on a massive scale there would be a run on the bank and it would run out of money and go bankrupt. In order for business to properly occur more bank notes were printed than there was gold available.

 

Basically these metals, gold and silver, were purchased by the National Government and then minted into different denominations. The coins denoted the weight of the metal. A one ounce gold coin was a $20 gold piece. A one ounce silver coin was a silver dollar. Money, then, was exchanging value for value. The basic value of the metals was agreed upon international; so money as gold or silver could be used anywhere in the world.

 

In 1929, for various reasons, the Great Depression occurred. Under a Republican administration, that of President Herbert Hoover, the country, and, for that matter, the world, went economically downhill for the next decade. Each industrial nation had to work out its own deliverance from the Great Depression.

 

In 1932, the Democrat, Franklin D. Roosevelt was elected President of the United States. He introduced the “New Deal.” His basic program was the three R’s: relief, recovery, and reform. He attempted to offer employment to many of the unemployed, an end to the reasons for the depression, and reform by legislation or otherwise so it could never happen again.

 

Roosevelt was the longest serving President in the history of the nation. He served for four terms, through the Great Depression and most of World War II, dying in office during his fourth term.

 

Sometime during his first administration he had a bill passed by Congress that changed the use of money, first in the United States and then it was copied throughout the rest of the world. The Federal Government collected all the gold coins, with the exception of a small number that could be kept as souvenirs, issued paper silver certificates for one and five dollar bills and Federal Reserve Notes for any amount above that. The gold coins were melted down into bars of gold and stored in underground depositories like Fort Knox, situated around the country, with gold certificates issued for the gold, which the government kept on deposit to verify the value of the Federal Reserve Notes.

 

In essence money being worth its weight in gold became a myth. The gold certificates were never on display or otherwise available. There was never any record kept of actual gold being added or subtracted from the gold supply in the depositories. Money became paper, a token of no real value; everything else was a fiction.

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Early on in World War II the countries that were to become allies of the United States shipped their gold supplies to the U.S. I don’t believe the gold was ever returned to those nations. They spent the gold on buying supplies with which to fight the war. After the gold was spent the United States used a system called “lend lease” to supply its allies with the necessary food and war materials. Those goods were never really paid for monetarily. But World War II ended the last hangovers of the Great Depression. The United States and later the rest of the world emerged in different levels of economic fitness in 1945. All actual money had become paper tokens that were used to exchange goods and services for goods and services. The basic world currency, upon which all the other national currencies were based, after the war was the American dollar. It is still that today.

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The Federal Reserve came into being because of the depression or panic of 1907 and other extreme downturns in the economy. Attempts had been made during the late 19th and early 20th Centuries, by the moneyed class, mainly bankers, to control the economy mainly for reasons of profit. These, in turn, particularly when they failed, had exacerbated economic shifts within the economy, usually in a downward direction.

 

The Panic of 1907 and 1908 was also known as the 1907 Bankers Panic or Knickerbocker Crisis. Its causes took place initially over a three week period when the New York Stock Exchange fell almost 50% from its peak the previous year. It lasted for slightly over a year.

 

Monetary panics occurred during this time of economic recession and there were numerous runs on banks and trust companies. It spread throughout the nation with many state and local banks and businesses going bankrupt. The primary cause of the run was a retraction of market liquidity by a number of New York City banks and a loss of confidence among depositors, exacerbated by unregulated side bets of bank funds by banking executives.

 

The panic was begun in 1907 by a failed attempt to corner the market on stock of the United Copper Company. When this failed, banks that had lent money to the cornering scheme suffered runs that later spread to affiliated banks and trusts, leading a week later to the downfall of the Knickerbocker Trust Company, New York City’s third largest trust. The collapse spread throughout the city trusts as regional banks withdrew reserves from New York City banks. Panic extended across the nation as vast numbers of people withdrew their deposits from regional banks.

 

To simply state what happened was that the object was for a group of investors to gain control of the stock shares of United Copper Company. The group concerned controlled numerous banks and trust companies. They believed that a large number of shares had been borrowed and sold short. (To sell short is to sell a stock at a higher price before one owns it, then when the price drops buy the stock at a lower price, and eventually pocket the profit.)

 

The group believed that a majority of the stock was held by the Heinze family and that a significant number had been borrowed and sold short on the belief that the price would drop considerably. Their aggressive purchasing would drive up the price of the stock. The short sellers would be forced to come to them in order to purchase stocks that they had already sold and they could charge whatever they wished.

 

United Copper rose in one day from $39 to $52 a share. It then went up to nearly $60 a share, but the short sellers were able to able to find United Copper from other sources. The group has misread the Market and the stock price began to collapse. It closed at $30 and then dropped to $10 a share. The manipulators and the banks they represented were ruined. As news of the collapse spread depositors rushed to pull their money out of these banks. The run on banks spread throughout the city. A week later many regional stock exchanges throughout the nation were closing or limiting trading.

 

The hero of the crisis was J.P. Morgan. He coordinated the heads of the banks and trust companies and was able to keep the total economy of the United States from collapsing. The Panic of 2007 was from May 2007 to June 2008, 13 months. While it started and was centered in New York City the entire nation was involved. There was bank panic, runs on banks and trusts with crowds of depositors withdrawing all their funds, and falling stock prices that resulted in massive economic disruption. Production fell 11% in the nation, imports went down by 26%, and unemployment rose to 8% from under 3% two years earlier. Even immigration dropped to 750,000. It had been 1.2 million two years earlier. J. P. Morgan lost about $21 million straightening the situation out.

 

The frequency of economic crises and the severity of the 1907 panic led to a national debate on reform of the system. In May 1908 Congress passed the Aldrich-Vreeland Act that established a National Monetary Commission to investigate the panic and propose legislation to regulate banking.

 

It was discovered that the major difference between European and American banking systems was the existence of a Central Bank which controlled Monetary Policy. They could easily move money to where it was needed. The European nations all had one, the United States did not. The European states were able to extend the supply of currency during periods of low cash reserves. The United States had a great problem doing this.

 

The final report of the National Monetary Commission was on January 11, 1911. For nearly two years Congress debated the proposal. On December 23, 1913 Congress passed the Federal Reserve Act. President Woodrow Wilson signed the bill immediately and the legislation was enacted on the same day, December 23, 1913, creating the Federal Reserve System as the Central Bank within the United States.

 

 

English: Flag of the United States Federal Res...

English: Flag of the United States Federal Reserve Bank (Photo credit: Wikipedia)

The Weiner Component Vol 2 #1 Part 2 The Introduction

Deviations from the long term growth trend US ...

Deviations from the long term growth trend US 1954–2005 (Photo credit: Wikipedia)

Business Cycle

Business Cycle (Photo credit: Wikipedia)

To avoid the vicissitudes of the business cycle and the inequality of the distribution of the National Income, the Gross Domestic Product, we need a new economic model or we have to make intensive changes in our present system.  If we stay essentially with our present model then the government has through a tax and redistribution system to balance incomes. A realistic minimum standard of living has to be set.  Those earning more than this level will have to be taxed on a realistic graduated level.  Those earning less would receive transfer payments from the government to bring their standard of living up to the minimum level which has to allow for a decent standard of living.  With this system, which more or less exists today in many European nations, we can keep the profit system and have all its so-called advantages.  But would this end the vicissitudes of the Business Cycle?

 

The amount of productivity today per working unit/person is constantly increasing.  One individual working continually provides for more and more people.  In order to keep constantly producing goods and services this productivity must be continually used up so more is always needed.  Consumption now becomes as important as production if the economy is to continually grow.  Therefore the consumer whether or not he/she is employed is needed as much as the producer.  This system can only flourish through government taxes and a redistribution of the National Income.  The producers can earn assorted amounts of surplus income which they can spend, save or invest while the unemployed or underemployed population can receive government transfer payments which will allow them to properly consume the necessary goods and services to both keep production going and have a decent standard of living.

 

Of course if we can create a new economic model which would allow for a fair distribution of goods and services without using the profit system then we would be far better off.  But this would probably require a complete change in our overall thinking and value systems.  We would also have to deal with the issues of what to produce and how to produce it without the motivating force of the profit system. 

   

Is it possible?  We would have to separate production of goods and services from money and find another reason to labor other than individual profit.

 

There is a disparity between the use of money as income, a means of exchange, and storage for labor and profits.  The distribution and expenditure of money determines where we are on the Business Cycle.  This, in turn, can throw the economy into recession or depression and cause a breakdown in the production of goods and services and partial or massive unemployment.  The extent of the distribution of money can cause a partial or full cessation in the distribution of goods and services.  They are two separate entities that are tied together in an unwholesome relationship.  If they were separated the economy would be far better off.  The problem, of course, is how to separate them.

 

Generally speaking, the overall public reaction to all of this is to return to the thinking of the late Nineteenth Century: the “safety” of the profit system. This, I believe, President Donald J. Trump will attempt to do; and this, seems to be today, the basic Republican value for economic growth.

 

     MONEY: ITS HISTORY AND USE:  The two entities which keep any economy functioning are self-interest and money.  Self-interest would affect every working individual from owner, entrepreneur, to physical laborer who wants the greatest return he/she can get from their endeavors.  Money is the grease that operates the economy: it is wages, salaries, profits, rents, interest, and dividends.  The spending of money determines demand, production, and also the phases of the Business Cycle.

 

The entrepreneur, factory or store owner will charge the greatest amount they can legitimately and pay his employees the least amount they can get away with.  Thus prices will be as high as possible while money paid to worker will be as low as it can be.  The producer will maximize production to increase profits; the workers will not be able to purchase all the goods and services produced because of low wages and over-production will eventually result.  This will lead to recession, unemployment, business failures, and depression.  Self-interest, which is the major motivating force of the economy, also tends to eventually cause the economy to malfunction into depression.

 

What is the problem?  It is the process of the distribution of money throughout the economy.  Whenever the distribution breaks down the economy goes into recession and depression.  It ceases to operate for the benefit of its members.

 

The use and distribution of money becomes the problem.  What then is money?

 

To understand what it is and its use(s) we need to have knowledge of how money was used both historically and at present.  Presumably, at first, man begins with barter: goods and services were directly exchanged for goods and services.  At some later point in time these were exchanged for their exact value, generally, in precious metals.  Rather than continue using scales to weigh the metal one group of traders, probably the Phoenicians, began stamping the weight on the metal piece.  This became the initial use of money.  The idea was then picked up by other groups or nations and coins came into being: an exact weight of a precious metal with the country or ruler or some symbol stamped on the metal to guarantee its value.  What happens here is that a good is exchanged for its exact value in the metal: equal value for equal value.  This allowed for free trade throughout the Mediterranean several thousand years ago.

 

Money, as it existed at this time, was labor or a good whose value was exchanged for its equivalent in gold, silver, or cooper coins.  Similar worth was exchanged for similar worth.

 

As time proceeded the coins became more ornate.  Rulers images were stamped on the coins, various designs were used.  Different denominations appeared, allowing coins to be minted in different sizes and weights; and also in different metals.  And thus was value exchanged for value, money for goods and services.

 

Of course, into this economic system occasionally various enterprising individuals and/or governments began a process of “watering” some of the coins minted; that is, mixing base metal with the gold or silver, thereby hoping to get more goods and services for less gold or silver.  This process would be done on a large scale by such individuals as the Roman Emperor, Nero; who tended to need more money than he could collect in taxes.  The result was to cheapen the value of the specie bringing about inflation which also resulted in a lowering of overall wages and other disruptive problems to the economy.

 

However, this economic system worked and continued to work successfully as long as conditions in the society(ies) were stable; that is, there is no rapid infusion of massive amounts of gold or if large amounts of money don’t have to be transferred over distant areas.

 

The discovery of the New World by Christopher Columbus brought into Europe, in the Sixteenth Century, massive amounts of gold over a fairly short period of time.  The Americas were systematically looted.  The gold passing through Spain and went on to the Netherlands, which was ruled by the same person as Spain, and then into rapid circulation throughout Europe.  This caused, what has been referred to as, “The Gold Revolution” which decreased significantly and continually the value of gold in its relationship to goods and services, and brought about unbelievable economic hardships to the wage earning working classes of Europe.  Wages remained essentially fixed while the value of the money dropped continually in a never ending cycle of inflation; thus bringing about a tremendous drop in standards of living.  It took about a century for a new reasonable balance between the value of gold in relation to the cost of goods and services to come about.   

 

Another problem which could upset the economies was large scale trade over great distances and/or between different nations. There was great danger from bands of thieves on land or pirates when shipping gold over bodies of water.  A safe way had to be found to ship gold. 

 

During the late Middle Ages different cities, city-states, provinces, and countries became known for producing certain products.  These were desired throughout Europe.  Also some of the Italian city-states, after gaining control of the Mediterranean Sea, gained a monopoly of trade with the East for spices and other products.  (It was the search for a new route to the East that brought about Columbus’ expedition.)  This and other factors brought about a need for the safe transfer of specie over long distances.  In addition the breakdown of Feudalism and the rise of Kings brought about a necessity for the availability of large amounts of money for the payment of armies and other large scale projects.

 

To offset these economic needs there arose in various cities: first in the Germanies and then in the Italian city-states merchant families who eventually traded in money as a commodity.  These became the merchant bankers of the Hanseatic League and the Italian city-states.  They set up branches of their banks in different countries which allowed for immediate transfers of gold; and they became in many cases the new nobility: the merchant princes.  Of the Medici family of Italy two of the women became queens in France and one of the Medici became a pope.  Cosimo, the founder of the family had been a money lender whose symbol of trade was three brass balls.

 

From the Italian Renaissance on (Fourteenth Century) banking was fully developed with the banking families, in many instances, ruling the Italian city-states.  The goods of the East came to Europe by way of the eastern Mediterranean, through the Italian city-states, and on to the general population of the continent.  The fleets of ships plying that sea were controlled by the merchants of the city-states; who also controlled banking and, among other enterprises, made high interest loans to the emerging kings.

 

It was the potential profits from the trade that caused the new nations like Spain, Portugal, England, and France to explore, searching for a new route to the East.  This was the justification for sailing west to get to Asia and thus discovering the Americas.  Prince Henry of Portugal began sending expeditions south, exploring Africa trying to find a river crossing Africa west to east.  Eventually one of the expeditions rounded that continent and was able to bring back to Europe a cargo of spices worth many times the value of the ship and cost of the expedition.  Portugal controlled that trade for about fifty years. 

 

With the new routes and the emergence of pirates in the eastern Mediterranean, Italy lost control of that body of water and the trade and profits moved to the new emerging nations.  Incidentally the Renaissance now became the Northern Renaissance and banking and trade moved to these countries.

 

Money, during this period, remained as it had always been: equal in value to the goods and services for which it was exchanged.  Spain’s looting of the gold from the New World and having it pass directly into the European economy brought about a 90 year period of inflation in the Sixteenth Century but did not change the concept of value for value.  Actually by making gold more plentiful and less expensive it allowed for a more rapid economic growth.

 

With the coming of the wonders of the Industrial Revolution (the development of machines going from wood to metal, transportation: put a steam engine on wheels and you have a train, advances in medicine: ever increasing abilities to fight the assorted diseases, phenomenal population growth, advances in metallurgy, gas and electric engines, etc., etc.) the nations of the planet underwent massive changes: national populations went from the low millions to the high millions approaching and exceeding in one or two cases a billion people.

 

As we moved into the Twentieth Century (in addition to the major wars which wiped out millions) with the tremendous growth of business, of  the needs for ever increasing goods and services there were not enough precious metals to allow for an exchange of goods and services based upon value for value.  For this and other reasons in 1929 we have the Great Depression.

 

Paper money when it was first used consisted of silver and gold certificates which supposedly could be exchanged for actual specie at any time at one’s bank.  (However, if everyone were to do it at the same time there would be a run on the banks and they might well become bankrupt because there was never enough metal to satisfy everyone’s needs.)  In point of fact the Industrial nations eventually got off the direct gold standard by collecting and storing the gold bullion and printing paper money supposedly based upon the value of this stored bullion.  Silver coins would maintain a certain amount of precious metal for a while.  Later in the Twentieth Century virtually all nations will go off the gold standard basing the value of the money on the prestige of the particular country. The remaining silver coins became copper sandwiches.  By the beginning of the Twenty-first Century money is, in all cases, devoid of any precious metal or anything else of real value except the credit of the nation issuing it.

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Since 2008, when the United States went through what is generally called today The Great Recession the country has been recovering from what could have easily been The Greatest Depression in its history.  This economic condition had been building rapidly since the presidency of Ronald Reagan in the 1980s, when all government restrictions on trade, many of which were developed by the Roosevelt administration during the Great Depression, had been done away with by the Reagan administration.  The banking industry in the country had a free hand to do whatever they wanted.  And what they wanted was to increase their profits astronomically.

 

The banking industry convinced a large percentage of homeowners to turn their homes into bank accounts by a process of continually taking equity funds out of their homes.  They did this by constantly refinancing their properties.  In the process of doing this the paper value of the homes continually increased.  Presumably people were spending what they believed was their never ending increases.

 

This became rampart from the Reagan administration on.  By 2007 the oncoming crash was apparent but the banking industry was in denial.  At that point mortgage refinancing was raised to 125% of the appraised value of the home.  In 2008 the crash came and the Housing Industry collapsed.  Many of the banking houses were overextended and also at the point of collapse or bankruptcy. 

 

Since the basic financial structure of the entire economy or nation is based upon the banking structure and their functioning the Bush administration in 2008 lent large amounts to the banks.  This, however, was not enough money and the incoming Obama administration had to make more massive loans to the banking houses in order to save them.  The Obama administration also set conditions about massive remunerations to executives which the Bush people had not done.

All of this was in 2008 and 2009.  The trillions of dollars the Federal Government spent at this time saved the country from going into a more massive depression than that of 1929.  In fact we would still be coming out of it if the government had not jumped in. 

 

What emerged instead has been called The Great Recession.  In 2009 the unemployment rate had risen to 7.6%.  By 2010 it had reached 9.8%.  Thereafter it began to fall, reaching 4.6% by November of 2016.

 

In this process millions of people were underwater in their homes, suddenly owing more on the house than it was worth.  The banks, with aid from the government, largely recovered, with some being taken over by other banking houses.  Even with virtually no regulation some of the banking actions were illegal.  No one went to jail.  Instead the banks paid fines, which taken together were in the billions of dollars. The banks eventually repaid their government loans and executive pay rose to new heights.

 

We are still in a recession, with unemployment at the tail end of December 2016 at 4.5%.  For recovery, on the business model to occur, the range of people not working would have to reach 2.5%.  Is that a future possibility with President Donald Trump?  Probably not.  Since the Republican image of creating jobs has nothing to do with current levels of economic understanding.  They believe that jobs are created by doing away with government regulation.  It would seem that by their way of thinking as pollution increases and so do jobs.