The Weiner Component #147 Part 2 – Money & the Federal Reserve

English: Paul Volcker, former head of the Fede...

English: Paul Volcker, former head of the Federal Reserve Board . (Photo credit: Wikipedia)

Unfortunately economics is not an exact science and different economists can hold different views about what should be done.   However there are basic principles that all economists adhere to and the overwhelming majority of economists do believe in the use of both Fiscal and Monetary Policy.  Many, if not most, Republicans do not believe in either of these processes.  Fiscal Policy has to do with Congress passing laws that enhance employment throughout the country.  This is extremely important at present because the overall unemployment rate is 5% and the country’s infrastructure is still well into the 20th Century; it desperately needs upgrading and modernizing.  Monetary Policy consists of the controls exercised by the Federal Reserve, essentially regulating the amount of currency in the National Cash Flow, its flow through the overall economy, and the use of money throughout the economy.  Many Republicans equally oppose this agency.

 

Basically one of the major difference between the Republicans and the Democrats is their positions upon these two uses of economics.  The Democrats believe in the overall principles of economics and using its tools while the Republicans do not.  They hold that an unfettered Free Market will make all the proper decisions within the society.  Their solution to recessions or depressions is to lower taxes for the rich, limit any kind of regulation and let the economy take off with this new financial investment.  This Supply Side Economics was first advocated by the Ronald Reagan Administration.  It didn’t work then and it isn’t going to work now.  Point of fact, it was this type of behavior that brought about the Bankers Depression of 1907, the Great Depression of 1929, and the Real Estate Crash of 2008.

 

But the Republicans seem to be oblivious to the past, particularly their own errors in the past; they are only interested in the near future and substantially ignore what has happened and their own mistakes, always proposing to do the same things again.  For example: not too long ago, Jeb Bush vowed to cut taxes for the very wealthy and for corporations when he became president.  He would reduce the top income tax bracket from 39.6% to 28% and corporate taxes from 35% down to 20%.  This would mean that those not in the upper 5 or so percent would be paying a higher percentage of their incomes in taxes.  His rationale, I assume, would be the application of Supply Side Economics which didn’t work earlier or ever.  The theory being that by lowering taxes for the rich the Federal Government would take in more tax revenue.  So much for reasonable thinking!

 

Of course Jeb Bush claims to have been a phenomenal success as the former governor of Florida.  He seems to have forgotten or ignores some of the disreputable things he did as governor.

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In 1964 Lynden B. Johnson, after finishing the late President John F. Kennedy’s term in office, won the Presidency on his own in 1964, running against Republican Conservative Barry Goldwater.  In his prior two years in office he had pushed through his “Great Society” legislation, extending, among other things, Civil Rights, the Voting Rights Act, Medicare, Medicaid, and his “War on Poverty,” that helped millions of Americans rise above the poverty level.

 

But Johnson also, it would seem, had an ego problem.  He saw himself as the most powerful man on earth.  He apparently decided that he would have the United States subdue North Viet Nam and make the country into a democratic democracy through the use of U.S. military power.  In 1964 he escalated involvement in Viet Nam, bringing military involvement from 16,000 advisors in non-combat roles in 1963 to 550,000 mostly military combatants by early 1968.  Unfortunately he was wrong; even with the use of American military might, he was unable to subdue the Viet Cong.

 

What Johnson attempted was what was generally referred to as a policy of “Guns and Butter.”   The Federal Government would continue its’ domestic policies within the country and at the same time fight and supply a major war.  It meant that the productivity and costs of what was going on within the United States would continue unabated while the additional costs, manpower, and productivity of a major military action would be added to this.  Johnson would supposedly finance this with a small temporary addition to everyone’s income tax.

 

The result of this great increase in productivity and manpower was the beginnings of an inflationary spiral that would continue to escalate gradually, for that and other reasons, and not be ended until the early 1980s with major disruptions throughout the U.S. economy.  In essence the competition between the non-war effort and the war effort for the production of goods and services would begin and continue the inflationary spiral.

 

During the time Jimmy Carter was President, from 1977 to 1981, the inflation rate had reached just under 14.8%, interest rates went up to 18%, and unemployment had risen to just under 10%.  Paul Volcker, as chairman of the Federal Reserve, attempted to stringently drop the interest rate.  He did this by raising it, making money too expensive to borrow.  A number of small businessmen complained strongly to President Carter that they were being forced into bankruptcy by this practice.  President Carter had Volcker back-off.  And the situation continued.

 

The next President, Ronald Reagan, allowed Volcker to carry out this policy.  There was a lot of ensuing misery throughout the United States.  President Reagan got on national television and told people that if there were no jobs in their area then they should go to where there were jobs.  He provided no other information.  Large numbers of individuals packed their cars and their families and took off, following rumors.  For a while there were all sorts of elderly vehicles going from city to city, their occupants looking for work.  Temporary agencies did well at this time.  It took around two years for the inflation rate to drop down to a low single digit, where it has remained since then.  The increase in homelessness that resulted from this is still with us.

 

What, in effect, happened was that the price of borrowing money became too expensive for many companies.  Higher interest rates brought about higher inflation, which in turn brought about a recession.  Multitudes of these smaller businesses that needed short term loans to keep operating could not afford the cost of these loans and went under increasing unemployment during President Ronald Reagan’s first two years in office.  A lesser demand for financial borrowing brought down the cost of loans significantly.    It would drop to a low single digit number, where it has generally stayed since that time.

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Shortly before withdrawing from the 2016 Republican Presidential race Rand Paul, one of the potentially Republican candidates, publically stated that he didn’t trust banks, particularly the biggest bank in the United States, the Federal Reserve.  He obviously considers them on the same basis as the commercial banks and the credit unions that deal directly with the public.  He doesn’t understand that the Federal Reserve is the banks’ bank and to a certain extent controls all the banks that deal directly with the public.  The FED controls all the money in the United States and generally how all the other banks do business.  Its purpose is to have the nation function at its highest level of efficiency and its major tool is the currency that the country uses.  This is Monetary Policy;

 

It’s obvious that Paul and the majority of the elected Republicans and probably some of the Democratic Congressmen could use and should be required to take at least a short course on Macroeconomics.  It would seem that being elected to public office does not require any specific knowledge.  Our Founding Fathers emphasized public education, believing that an educated person would elect the best possible people to public office.  It would seem that they were wrong; many people tend to vote more with their feelings than with their brains.

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The functions of the Federal Reserve can and have strongly affected the condition of the country.  If we briefly examine how the FED worked over the last forty years we get an image of this and also see some of the fallacies of their dealing with the welfare of the nation.  As we’ve seen Lynden Johnson’s enhanced police action in Viet Nam began an inflation spiral that eventually required drastic action to end it in the early 1980s.  Johnson underestimated the productive abilities of the United States to supply both “Guns & Butter” during his term as president in 1964 to 1968 and the result was a gradual growth of inflation for the American public over a sixteen or so year period to require drastic economic actions.

 

In 1979 then President Jimmy Carter appointed Paul Volcker to be Chairman of the Federal Reserve.  He would hold that office for eight years under Presidents Carter and Reagan.  Previously Volcker had been President of the Federal Reserve Bank of New York, one of the FED’s twelve regional banks.

 

We’ve considered his actions against the inflationary spiral.  Under his leadership the FED limited the growth of the National Cash Flow, limiting the money supply and increasing short term interest rates.  At the cost of a heavy recession in the early 1980s he was able to end a high two digit recession and bring about what turned out to be a prolonged period of economic growth.

 

Volcker was succeeded by Alan Greenspan, a conservative economist, who was appointed by President Ronald Reagan.  He chaired the FED from August 1987 to January 31, 2006 for four, four year terms, sixteen years.  Among other things he was criticized by Democrats for wanting to privatize Social Security.  The Republicans held him in awe.

 

President Reagan, who believed totally in Adam Smith’s late 18th Century concept of the Free Market, unfettered capitalism, chose a fellow conservative, economist Alan Greenspan, who shared his views on economics.  It was during this period that the banks were totally deregulated and given the freedom to act as they saw fit.  And it was during the Reagan administration that government regulation of industry was essentially done away with.   The banking institutions, whose deposits were insured by the Federal Government, were now free to act as they saw fit.  Their motivation being Adam Smith’s “invisible hand,” profit.

 

It was during the Reagan years that the mortgage crisis really began.  Prior to this time mortgages were split into a small number of pieces, each held by a separate individual, but now the concept of fractionalization of mortgages into a hundred or more pieces began.  The banks discovered that they could split mortgages into a hundred or more pieces, with a separate hedge fund owner for each piece.  Basically they sold the pieces to investors but maintained control of mortgages, charging fees for every service they performed.  In addition all the banks set up their own agency to keep control of all the property dealings throughout the United States.

 

Traditionally all the property dealings were recorded in the cities and counties where the property was located.  But this was too slow a process for the financial institutions.  They created their own single record keeping institution to keep tabs on all the mortgaging and refinancing throughout the fifty states.  This bank-owned company had so much to do that their error factor was phenomenally high.  Their records became an unfathomable mess.  In essence when it came to foreclosing on a property for nonpayment it was eventually discovered that no one owned enough of the property to foreclose.

 

Throughout the country people were encouraged to continually refinance their homes taking their ever-rising equity out of the properties that were continually going up in value.  Virtually everyone who wanted to could continually take money out of their homes which kept increasing in value.  The banks meanwhile making billions in fees while continually maintaining control of the properties.

 

What was happening from the 1980s on was that the National Cash Flow, the amount of money within the economy, was increasing exponentially.  There was a constant need for money, for all kinds of economic expansion and the banks, for a price, were supplying these funds.

 

Allan Greenspan, as Chairman of the Federal Reserve, essentially sat back and enjoyed this growing prosperity.  He basked in his treatment by Congress.  There was a need for an increase of money in the National Cash Flow on a rational level but Greenspan and his Board of Directors ignored this.  I imagine they felt that if something was going well, don’t change it.  But conditions weren’t really going well, the country was moving toward 2007 when it became obvious the Real Estate Market was headed for a crash.  This was met by denial at the banks.  Many of them raised the amount of money they would lend on a property to 125% of its appraised value.  The crash came in late 2008, toward the end of President George W. Bush’s last year in office.  By then Alan Greenspan had retired as Chairman of the Federal Reserve and been replaced by Ben Bernanke.

 

The easy money policies of the FED and the tax cuts during Greenspan’s chairmanship, which increased the National Debt, have been suggested as a leading cause of the sub-prime mortgage crisis.  Greenspan served for sixteen years.  He resigned on January 31, 2006.  Was he aware at that time of what the future held?  An interesting question, which will never be answered.

 

Ben Bernanke was appointed by George W. Bush on February 1, 2006 as Chairman of the Federal Reserve.  He started as a registered Republican and had been chairman of President Bush’s Council of Economic Advisers.  He was reappointed by President Barack Obama in 2010.  Under his guidance the country went through the Real Estate Crash in late 2008.  Working with President Obama and by the use of Creative Monetary Policy, the two were able to pull the country out of a disaster that could have been greater than the Great Depression of 1929.

 

In his 2015 book Bernanke asserted that it was only through the novel efforts of the FED, cooperating with other agencies of both the U.S. and of foreign governments that they were able to prevent an economic catastrophe far greater than the Great Depression.

 

It is interesting to note that the U.S. House of Representatives, from 2011 on, after the Republicans gained control of that body, not only did no pass any legislation to alleviate the economic crisis but they did push through bills that intensified the effects of the conditions of the sub-prime mortgage crisis by increasing unemployment.

 

Bernanke requested numerous times, both formerly and informedly, to Congress that it pass Fiscal Policy Bills, but was ignored to the point that the subject wasn’t even brought up in the House of Representatives.  This meant that any action to divert a major depression had to be taken by both the President and by the Federal Reserve.  President Obama bailed out the banks and the auto industry and, where possible, used his power of executive privilege.  For his part Bernanke after gradually lowering the interest rate the FED charged banks to 0 to encourage the banks to lend money; he came up with Creative Monetary Policy.  Meanwhile the FED continually added sums of money to the National Cash Flow.  They did this by having the FED in open market operations sell less bonds than they cashed out when they became due.

 

There were two major problems facing the nation at this time.  One was the need for more currency available throughout the economy.  It was first believed that the banks would start again financing mortgages and refinancing homes; but that didn’t happen.  Suddenly the banks were very restrictive in the way they used their funds.  It seemed almost as though the banks got burned by mortgages and didn’t want to deal with them again.  Suddenly the banks had become very stingy with their funds.

 

The second problem dealt with the millions of fractionalized mortgages.  Initially the different banks generated papers from their computers and foreclosed upon multitudes of properties that they didn’t own.  These were homes that they administered for the assorted Hedge Funds.  Initially the courts assumed that the banks would not do anything dishonest.  If fact a number of attorney’s were disbarred for stating that the banks were dishonest.  Eventually the truth came out and the different banking houses paid heavy fines and stopped their foreclosures.  Every major banking house was included in this process and eventually, taken together, the banks paid well over a trillion dollars in fines.

 

The problem was that it was almost, if not totally impossible, to put together 50.1% of many of these mortgages.  Basically no one owned the mortgages for a large percentage of these properties.  In many cases the property values had dropped far below the current debt value of the homes and the former owners had walked away from their properties leaving them vacant.  It was a major disaster that left to itself would take well over one or two decades to straighten out.

 

The major question here was: Who owned what?  These conditions virtually destroyed the housing industry.  Builders could not borrow the funds to build new homes.  And a good percentage of the older homes were so tied up that they couldn’t be sold or bought.  The effect of this was to reduce employment to every industry that was effected by new and older homes and properties.

 

What Chairman Ben Bernanke came up with was his creative Monetary Policy.  Every month for a period of well over two years, ending in 2015 the Federal Reserve spent 85 billion dollars a month.  Forty-five billion was spent on the fractionalized mortgage paper and forty billion dollars was added to the National Cash Flow.  In 2015 the expenditures were reduced 10 billion dollars a month, five billion in mortgages and five billion to the National Cash Flow.

 

By the time Bernanke’s tenure in office had ended as of February of 2014 and Janet Yellen had become the new Chairperson in charge of the Federal Reserve.  It was she who gradually ended the bond buying.  It should also be noted that the Housing Crisis is essentially over.  There is new construction and older homes are selling.  AS of February 2016 all the employment that goes along with this is now in place.  The unemployment level in the United States is down to 4.9%.  Its lowest level since the Real Estate Crash of 2008.

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This blog began with the concept that economics is not an exact science.  Using hinder sight it is easy to pick out the major trends of the last few decades but living through that period and being able to make specific recommendations as to what was needed is not always that easy.  Alan Greenspan was the FED chairman for 16 years, and according to his theories he did what was necessary to keep the country functioning properly.  But he missed the greatest problem during that period and allowed the banks endlessly and with no restrictions, to add money to the economy, bringing about a crisis that could easily have been worse than the Great Depression of 1929.

 

Ben Bernanke was the right economist at the right time to be chairman of the Federal Reserve; but despite the fact that the Republican led House of Representatives absolutely refused to go cooperate with him, he and President Obama were able to mitigate, what has been called, The Great Recession and avoid a Greater Depression than that of 1929.

 

On February 3, 2014 Ben Bernanke completed his second term of four years as Chairman of the Federal Reserve.  The new chairperson was Janet L. Yellen.  She was appointed on that same date and had served as Vice Chair from 2010 to 2014.  Prior to that she was CEO of the Federal Reserve Band of San Francisco and had been Chair of the White House Council of Economic Advisers under President Bill Clinton.  Also she was the first Democrat appointed to that office.  Ms. Yellen is credited with the ability to connect economic theory to everyday life, actually to connect abstract theory to concrete living.

 

Yellen was the one who reduced the $85 billion that was added to the economy monthly by $10 billion, $5 billion from mortgage paper and $5 billion from being added to the National Cash Flow, until 0 was reached in each account.  At that point Ms. Yellen made conditional statements that these accounts could be reopened if the need arose.

 

Presumably she had agreed with Bernanke that the time was right for these changes.  The mortgage crisis was essentially resolved, the amount of currency flowing through the economy was adequate, and inflation was low, by the beginning of 2016 it had dropped to slightly below 1%.  The issue of what to do next seems to have been raising the prime lending rate, which had been at 0% for a number of years since 2008.

 

Janet Yellen had been cautiously putting this off and then toward the end of 2015 the FED raised the discount rate ¼ of 1%.  The discount rate is what the Federal Reserve charges banks for monies borrowed from it.  This establishes the base for what banks charge the public and pay the public for money that the public deposits in them.  The banks translated this increase into a 2 to 3% increase in the interest they would charge on many long term loans.

 

There is an interesting note of irony here.  The monies that the banks lend out and from which they essentially make their profits is all the deposits made by the general public, many of whom have their pay checks automatically deposited into their accounts.  This was the basis of the monies loaned out prior to the 2008 Real Estate Crash which was also insured by the FDIC (Federal Deposit Insurance Corporation).  If these banks has gone under then the Federal Government would have been responsible for replacing all these funds up to ½ a million dollars per account.

 

Prior to the FED raising the discount rate the banks paid most of their depositors 1/10th of 1% interest for their deposits.  The overall interest that the general public received on their bank deposit accounts was under $10.00 a year, too small an amount upon which to even pay income taxes.  That translates into 1 cent in interest for every 10 dollars held by the bank for one year.

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Janet Yellen, the new Chairperson of the Federal Reserve, now has to bring the country back to prosperity, which would be full employment; but there currently are multi-forces pushing the country in different directions at the same time.  All this seems to begin with the international drop in oil prices from over $100 dollars a barrel of oil to what is currently under $30 a barrel.  What has happened with oil is that there are new methods of searching for it and the amount discovered has greatly increased the available supply.  (There are other economic costs.  Fracking tends to increase the possibilities of earthquakes by destabilizing the soil.)

 

This drop in oil prices has economically hurt many of the countries which depend upon their oil revenue to maintain their levels of prosperity.  Some examples would be Venezuela, Mexico, Brazil, Algeria Ecuador, and Egypt.  As the price of oil goes down so do their overall standards of living.  And many of these nations in order to make up the difference pump more oil, which, in turn, lowers the price per barrel even further.  While the lower price of oil noticeably lowers the inflation within many nations it also upsets the balance of trade between nations.

 

Another problem is that the dollar, despite nearly 19 trillion dollars of National Debt is currently considered the strongest currency in the world today.  Within the last few years it has slowly increased in value against all other currencies.  This means that American exports are increasing in price in other countries while their exports become less expensive in the U. S.  This, in turn, hurts American exports, which decrease, and causes the balance of trade to tilt in the direction of the other countries trading with the U.S.

 

Apparently the Japanese Government is now selling bonds within its country with a negative interest rate.  This means that for every $100 borrowed the borrower pays back less than the original amount when the debt becomes due.  China is apparently thinking along those lines with its Central Bank’s discount rate.  They want to bring their overall productivity back up to 8%.  For most countries 2 to 4% is considered a positive growth rate.

 

Within the last few months the Stock Market has gone down well over 100 points, with each point being one dollar in value.  That is the extent that many stocks have decreased in value.  Usually that indicates an oncoming major recession or depression.  What is causing the current drop?

 

Yet gradual economic growth is still occurring in the United States.  Real Estate construction is slowly still improving.  Inflation is very low.  Ultimately the United States uses 22% of the world’s productivity.  The inflation rate is in February of 2016 is 7/10ths of 1%.

 

The basic question is: What should the FED do?  Raise the discount rate another ¼ of 1%?  Leave things as they are?  What?  It would seem to be a major dilemma.  I would currently hate to have to make the decision.

 

On Wednesday, February 10, 2016, Janet L. Yellen, the Chair of the Federal Reserve Board gave her semi-annual report to the standing House Financial Services Committee on the economic condition of the nation and what the actions of the FED will or will not be.