Saturday, December 4, 2010

The Federal Reserve

This three column series was first published in November in the Bucks County Courier Times, and on line in a three newspaper edition,

The Federal Reserve
Part I: A dagger to the heart of democracy.

Voter turnout in many congressional districts was far greater than in many years. It is the enduring myth of American democracy - the people speaking out in free and fair elections to make known and enforce their will on their elected representatives.

But it is a myth. Federal elections in the United States are no longer either free or fair, and the results will have little impact on the economic policies that will determine the future well being or, alternatively, misfortune of the American people.

For several decades, the reforms of the political parties, election and campaign finance laws meant to empower ordinary Americans (“open up” the political process) have had the opposite effect.

Vast sums of money now flow not through the political parties accountable to the American people, but instead through a maze of pseudo-political organizations, accountable to no public constituency, donors increasingly anonymous or untraceable, to select the candidates for federal office, buy their votes and keep them bought.

And no one spends more money in U.S. politics than the people who have it.

This is the reality of America almost never discussed, much less taught in American schools: there are only two classes of Americans, those who have money and those who do not, and they have always been at war. And those Americans who have no money – the great majority of the American people - are getting clobbered.

While it has always been the case that the great majority of Americans have no money, it has not always been the case that their economic circumstances were so dire, or their chances to move up to the ranks of the “moneyed” class were so limited.

To understand how this is so requires an understanding of what “money” is in the language of American politics and economics.

Money is not the bills in your wallet or purse, or the coins in your pocket or the balance in your checking or savings account, which is all the money most Americans have. Money in political and economic terms is accumulated wealth, the surplus beyond the costs of living that an individual or family can invest and bequeath.

This distinction has always been the one important divide that defines the two classes of Americans. And today, the money in America, accumulated wealth, is concentrated as never before in the hands of a few, managed by their agents in the finance industry and protected by the Federal Reserve.

The Federal Reserve was created in 1913 by act of Congress after a series of banking crisis from the 1800s through 1907 wiped out farms, businesses and banks and at one time left one in six Americans unemployed. At a time when 6 in 10 Americans lived on farms, the liquidation of those farms had the same effect as the current wave of foreclosures in the suburbs and cities – a lot of Americans lost their homes and moved down the ladder.

These were crisis of “liquidity” – there was not enough money in circulation or reserve to meet the needs of large portions of the economy. The legislation to address this ongoing problem was supported by an unlikely combination of the Wall Street barons and populists. The latter were ardent democrats.

The barons realized that the U.S. economy had grown so large that the capital formation required to support it meant taking risks that they could no longer cover if they failed. They wanted an agency to be available to cover their bets when they crapped out.

The populists – mostly from the predominantly agricultural south and west – realized that without available and affordable credit, the cycle that every farmer knows is a part of the inherent risk of agriculture would keep on wiping them out: in the bad years of crop failure, or the hopeful years when they acquired expensive debt to increase production, or years of overproduction, accompanied by depressed crop prices and predatory pricing from banks, grain storage facility and railroad operators.

Both preached the same solution: federal regulation of the supply of money and its cost. But the solution of President Wilson and the experts who had come to power in America in a wave of “progressive” thinking that sought to lessen the “corrupt” practices of elected American politicians, was to take the regulation out of the hands of politicians elected by and accountable to the people – the Congress and president - and give it to a newly created, autonomous and independent central bank, the Federal Reserve.

It was a dagger to the heart of democratic government in the United States.

The Federal Reserve
Part II: The rich get richer

The legislation that created the Federal Reserve is intentionally vague as to its purposes. But from the beginning, bankers and a few astute politicians understood the enormous power conferred in the authority to control the nation’s supply of money and its cost.

This control impacts on every decision made by the American people to loan, borrow, invest, buy or sell. It determines winners and losers.

The Federal Reserve creates money with a data entry, adding debt to the American people, and provides this money to the banks at low interest or no interest. These banks then loan it to their customers at higher interest rates. One of their biggest “customers” is the Federal government. What a racket!

Yet the Fed operates apart from the elected government of the people and is accountable to no one. Unlike the central banks of most developed nations, no one from the elected government of the United States has a voice in its deliberations or a vote among its governors.

The Fed raises its own revenue and neither its budget nor its multi-billion dollar transactions are reviewed by the Congress or audited by any other agency of the elected federal government.

The Fed operates in great secrecy. Minutes of many important meetings are released only years after the fact. For some of the most important, no minutes of any kind are kept!

And its public pronouncements are made in the deliberately obfuscating language of the pseudo-science of modern economics that most Americans do not speak or understand

I say pseudo-science because, pretend as modern economic experts will that their profession is a science, the hallmark of science is the ability to predict according to fixed laws, and the Fed consistently fails this test, doing damage control after the economy crashes.

But while the Fed may be accountable to no one, it nevertheless has a constituency.

This was made brutally clear by former Fed Chairman Paul Volcker, when in the midst of the crushing recession brought on by the Fed’s anti-inflation campaign of the early Reagan presidency, a group of state legislators from some of the most distressed farm states came to plead for relief.

Volcker heard them out and turned them down saying, “Look. Your constituents are unhappy, mine aren’t.”

Critics often charge that the Fed is owned by the banks and point to the fact that local banks are all shareholders in the regional Federal Reserve Banks. This ownership of shares is not about control, it is about cover.

The power in the Fed is held by the seven governors in Washington appointed by the president to fourteen year terms. And the five other governors selected on a rotating basis from among the presidents of the fifteen regional reserve banks, while sometimes willing to pull in different directions, do not have the votes, and in fact are excluded from voting on crucial matters.

But, when the Fed is sometimes attacked by critics in the Congress of one party or the other, the governors can rally the “shareholder” banks and local bankers to apply pressure – and campaign cash – directly to the complaining member of Congress.

Nevertheless, the characterization of the Fed as “owned” by the banks is apt, and it works to protect the accumulated wealth which they represent. The Fed’s never ceasing fight against inflation is but one example.

Americans are taught that inflation is a bad thing. This is always true for accumulated wealth. It is not always true for those hoping to acquire wealth.
Home ownership, until recently one of the few opportunities of the vast majority of Americans to acquire wealth is an example.

If you buy a home with a thirty year fixed mortgage and there is any significant inflation, over time that fixed monthly payment of say $1,000 becomes worth progressively less each month in constant dollars, and you may be making that $1,000 payment with only $800 worth of dollars – for years. Conversely, if you are the lender, with inflation your monthly $1,000 income from the loan becomes worth only $800.

So the Fed can use its power as it did in the 1980s to restrict the money supply or drive up interest rates, which protects the value and income earning potential of existing wealth, but restricts the ability to prosper for the vast majority of Americans who have no accumulated wealth to invest.

Sometimes the contractions induced by the Fed are severe, and millions lose their jobs or homes, as businesses throughout the real economy cut back or fold in manufacturing, mining, agriculture, retail and virtually every sector of the real economy.

The Fed defends these hurtful decisions in the impenetrable language of their pseudo-science, but the message is always the same: “Don’t blame us. This disaster for millions is the result of ‘market forces’ over which we have no control.”

It is a complete sophistry. Human beings, the governors of the Fed and each with a vote make the call, and in fact unleash those forces. And they have historically sided with accumulated wealth, which is the past.

The Fed is like the dead hand of the past laying on the future of most Americans, snuffing out hope and opportunity as it insures that the rich get richer.

The Federal Reserve
Part III – Reverse the flow

It was the era of “trickle down” economics. Congress and the administration “devised tax credits, refunds and abatements to benefit private corporations, and they enacted four major reductions in income tax rates, skewed to benefit the upper income brackets.”

Inflation was defeated and the stock market roared. But there were signs of trouble.

Families “were working longer hours for the same wages and borrowing more heavily to keep up… the struggling labor movement was decimated; unions lost nearly 30 percent of their membership.”

It reads like recent history, but is in fact a description of the 1920s, when the term trickle down was coined, the decade before the First Great Depression.

Then as now, the Fed failed.

Prior to each failure, money was flowing up in the U.S. to its richest citizens. With the New Deal, FDR and his newly appointed Fed Chairman, a Republican banker from Utah, reversed the flow and the nation began to recover.

They understood that the spending of the rich few cannot sustain a great economy. The sale of thousands of $500 a pair sneakers and $300,000 cars cannot generate the same volume and velocity of money moving through the economy – economic activity - as the sale of millions of less expensive shoes or cars.

That flow of money to the many was the foundation of the remarkable prosperity of post World War II America . It lasted until Ronald Reagan, with the support of a Democratic Congress and the Fed combined to shut it down.

Reagan and Congress revived regressive tax cuts for the wealthy and trickle down economics, allowed the combinations that led to “too-big-to-fail” banks and legalized usurious interest rates on consumer credit.

The Fed crushed inflation with interest rates that devastated the real economy but protected accumulated wealth, and bailed out Wall Street when their bubble of bad loans to the third world burst.

Historically, when the Fed thinks the wealthy will not be unduly burdened and decides to expand the economy or overcome an economic contraction, one of its tools is to “flood the street with money;” that is, to pump a lot of cash into the system where it is loaned, used, circulated and exchanged in the many millions of transactions that add up to a recovery.

With the crash of 2008, the Congress and the Fed did indeed “flood the street.” But the money never got past Wall Street to your street. This was intentional.

As the Fed pumped trillions into the banks and finance companies, it risked massive inflation in the U.S. (remember that inflation destroys accumulated wealth). The remedy to this threat was to simultaneously keep interest rates low. But much of the rest of the world’s major and developing economies have higher interest rates.

The money that flows through the world’s financial system has a property similar to liquid, and like water money seeks its own level. And the level money seeks is the highest interest and rate of return

So the money of America has been flowing in a massive flight of capital into the rest of the world, protecting accumulated wealth while beggaring the future of most Americans.

The Ford Motor Company is about to open its newest and most modern plant – in China, where the government is raising wages and pumping billions into infrastructure; while across America workers are forced to accept wages cuts to keep their jobs and infrastructure begins to resemble the third world.

What to do? Reverse the flow.

Interest rates in the U.S. must rise from their historic lows to attract capital and investment in the U.S. Funds must flow massively into jobs creating, taxpayer creating, revenue creating U.S. infrastructure. The first stimulus was unfocused and insufficient. The president’s proposal for a $50 billion transportation infrastructure initiative is inadequate.

A fair share of the accumulated wealth of America must be made to flow down into many more hands. Income, capital gains and inheritance must be taxed at higher rates. The argument that this will choke investment is a patent fraud. That wealth has been protected from meaningful taxation for decades, but do you see a new washing machine or tractor plant going up nearby?

The out-of-control U.S. military must be disciplined. Wars and by some reports as many as a thousand U.S. military bases in 152 foreign nations are a huge flow of dollars and tax revenue out of the U.S.

Federal taxes on gasoline must be increased. There will be an immediate reduction in the import of foreign oil and the massive out-flow of dollars to buy it. But exempt, subsidize and invest in all mass transit systems (including school bus fleets), and rebate the mostly suburban, auto dependent middle class.

But above all, the Federal Reserve must be brought inside the American democracy and Constitution and made part of the Treasury Department, its accounts audited, so that the elected government of the United States may assume the authority and responsibility for the decisions about money that determine the future well being of every American man, woman and child.

This is what must be done, but will not soon be done. The new Congress will be as bought as the current Congress; because there is one other flow that must be halted - the tidal wave of lobbying and campaign cash that buys and sells U.S. federal elections for America ’s established, accumulated wealth.

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