Tag Archives: Federal Reserve

House Votes Overwhelmingly to Audit the Fed!

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Good news for a change…

WASHINGTON, July 24 – Congressman Ron Paul today applauded the passage by the House of Representatives of H.R. 459, the Federal Reserve Transparency Act.  The bill, which calls for a full audit of the Federal Reserve System– including its lending facilities and critical monetary policy operations– passed overwhelmingly by a bipartisan vote of 327-98.

“I am very pleased that the House passed my Audit the Fed legislation today,” Congressman Paul stated.  “It has been a long, hard fight, but Congress finally is getting serious about exercising its oversight responsibility over the Federal Reserve.  Auditing the Fed is a common sense issue supported by the overwhelming majority of the American people.  The Fed’s trillions of dollars worth of asset purchases and its ongoing support of foreign central banks cannot be allowed to continue without Congressional oversight.  Today’s passage of H.R. 459 is a good first step towards full Fed transparency, and I hope that the Senate will consider the bill before the end of the year.”

Cheers!

Alan

Fractional Reserve Banking, Government, and Moral Hazard

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Last week my subcommittee held a hearing on fractional reserve banking and the moral hazard created by government (taxpayer) insured deposits.  Fractional reserve banking is the practice by which banks accept deposits but only keep a fraction of those deposits on hand at any time. In practice, nearly 100% of deposits are loaned out, yet depositors believe that they can withdraw the full amount of their deposit at any time. Loaned funds are then redeposited and reloaned up to the limit of the bank’s reserve requirements, compounding the effect.

As Murray Rothbard put it, “Fractional reserve banks … create money out of thin air.  Essentially they do it in the same way as counterfeiters. Counterfeiters, too, create money out of thin air by printing something masquerading as money or as a warehouse receipt for money. In this way, they fraudulently extract resources from the public, from the people who have genuinely earned their money. In the same way, fractional reserve banks counterfeit warehouse receipts for money, which then circulate as equivalent to money among the public. There is one exception to the equivalence: The law fails to treat the receipts as counterfeit.” *

While mainstream economists extol this “money multiplier” as a nearly miraculous process that results in a robust economy, low reserve requirements actually enable banks to create trillions of dollars of credit out of thin air, a process that distorts the structure of production and gives rise to the business cycle. Once the boom phase of the business cycle has run its course and the bust commences, some people will naturally look to hold cash. So they withdraw money from their bank accounts in order to hold physical currency. But bank deposits consist of a huge amount of credit pyramided on top of a small of amount of original cash deposits. Each dollar of cash that is withdrawn unwinds the multiplier, resulting in a contraction in credit. And if depositors en masse attempt to withdraw more funds than are available in reserves, the entire of house of cards comes crashing down. This is the very real threat facing some European banks today.

Since the amount of deposits always exceeds the amount of reserves, it is obvious that fractional reserve banks cannot possibly pay all of their depositors on demand as they promise – thus making these banks functionally insolvent. While the likelihood of all depositors pulling their money out at once is relatively rare, bank runs periodically do occur. The only reason banks are able to survive such occurrences is because of the government subsidy known as deposit insurance, which was intended to backstop the stability of the banking system and prevent bank runs. While deposit insurance arguably has succeeded in reducing the number and severity of bank runs, deposit insurance is still an explicit bailout guarantee. It thereby creates a moral hazard by encouraging bank deposits into fundamentally unsound financial institutions and contributes to instability in the financial system.

The solution to the problem of financial instability is to establish a truly free-market banking system. Banks should no longer have a government backstop of any sort in the event of failure. Banks, like every other business, should have to face the spectre of market regulation. Those banks which engage in sound business practices, keep adequate reserves on hand, and gain the confidence of their customers will survive, while others fall by the wayside.

Banking, like any other financial activity, is not without risk – and the government should not continue its vain and futile pursuit of trying to eliminate risk. Get government out of the way and allow the market to function. This will result in a more stable system that meets the needs of consumers, borrowers, and investors.

* Murray N. Rothbard, The Mystery of Banking, 2nd ed. (Auburn, Alabama: Ludwig von Mises Institute, 2008), p. 98.

Failed Fed Policies Prolong the Agony

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The Federal Reserve’s interest rate price-setting board, the FOMC, met last week.  They will continue to set the federal funds rate at well below 1%, and plan to keep it low until the end of 2014.  That’s a year and half longer than they planned when they met just last month.  Chairman Bernanke says they are keeping interest rates so low for so long because the economic outlook warrants it.

The fallacies in their reasoning would be amusing if they weren’t so dangerous.  The Fed wants to keep the price of money at essentially zero – in other words “free” – to boost the economy.  But the boost they are attempting won’t get here for another three years.  That’s not a recovery.  And we’ve already tried this tactic.  That’s how we got into this mess in the first place: with interest rates artificially low for a very long time.  Free money doesn’t stimulate growth, as Japan’s two lost decades clearly show.  Artificially low interest rates only serve to punish saving, distort market signals, and cause further malinvestment.  They also do nothing to address the only real solution to our economic woes: liquidation of the bad debt that hangs around the neck of the world’s economy, preventing recovery.  Artificially low interest rates merely ensure that we remain a debt-financed consumer economy guaranteed to end up with a weaker economy and higher prices.

What baffles me even more is that two decades after the collapse of Soviet planning and decades more since the U.S. and economists purportedly rejected the idea of price setting, we find nothing wrong with the Fed setting the price of money.  We all agree it is a bad idea to have a board saying the price of wheat should be $250 a ton today, or carpenters wages should be $25 an hour until the end of 2014.  But we are perfectly comfortable with having a board set the price of one half of every transaction in our economy.  And our markets are supposedly free.

The Fed policies of low interest rates, Operation Twist, and rounds of quantitative easing are all attempts to keep the economy alive artificially. But the 12 FOMC participants cannot manage the economy any better than the bureaucrats of the Soviet Union.  The policies haven’t worked. They won’t work. Real economic recovery cannot come until we liquidate the bad debt, until we eradicate the poor decisions we made over the last decade, and start with a sound foundation. It is time we acknowledge the truth of the Fed’s activities: they are merely using fancy words for price setting.

Treasury Secretary Andrew Mellon was correct in the 1920s when he said “liquidate everything.”  That’s what we did in the severe depression of 1920-21, and we recovered so quickly it is never even talked about.  We didn’t take his advice after the 1929 crash, and ended up with the Great Depression.  We are committing the same mistakes, destined to live in this Great Recession for a decade or more—it has already been four years, the Fed says it will be at least three more!  It’s time we start rethinking what the Fed’s policies are really doing to our economy, because obviously, by their own admission, they haven’t helped.

Ron Paul

Ron Paul – The Fed Twists, The Market Shouts

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Last week the Federal Reserve began the second incarnation of “Operation Twist”, an attempt to drive down interest rates by purchasing long-term Treasury debt and selling short-term debt. This is just the latest instance of the central bank desperately flailing around doing something merely for the sake of doing something. Fed officials still do not understand– or admit– that the Fed itself caused the financial crisis by driving interest rates too low and relentlessly expanding the money supply. Thus, this latest action will just exacerbate the problem.

Markets, however, understand that the Fed has failed and has no clue what it is doing. This is why markets went into a tailspin after the Fed’s new strategy was announced. Stock, bonds, and commodities dropped in price while the financial press wondered whether this worldwide sell-off meant that the entire system was collapsing. Not since 2008 had there been such a dramatic drop across so many different sectors of the market.

Because of continued rising inflation and the Federal Reserve’s suppression of interest rates, investing in traditional safe havens such as savings accounts, mutual funds, and Treasury bonds has become unprofitable. Lots of money is moving through the system seeking a return on investments or at least some measure of safety, as increasingly desperate investors move their funds around in search of long-term profits and stability. Until the Fed stops its monetary intervention and allows interest rates to be set by the free market, investors will move their money in a volatile manner. They will invest in commodities and stocks while prices swing upwards, but will flee to bonds and cash at the first sign of a downturn.

The uncertainty caused by the Fed does help some people – professional traders on Wall Street for example. Increased volatility and huge price swings mean more opportunities for profit, as sophisticated electronic trading programs can buy and sell huge positions within a fraction of a second of a major market movement. But small businessmen are misled by the artificially low interest rates into making unwise investments, and those whose jobs vanish when the Federal Reserve’s latest bubble pops suffer. Without the knowledge or ability to move with the markets or diversify overseas, average Americans see their savings stagnate or depreciate– along with their hopes and dreams for a better tomorrow.

The only way to return to a sound economy is for the Federal Reserve to cease and desist its monetary manipulation and allow interest rates to be determined by markets, just as the price of goods, services, and labor should be determined by markets. Everything the Fed is doing by pumping money into the economy benefits only the insolvent, too-big-to-fail banks. Low interest rates encourage consumers to take on more debt, meaning more profits for the banks issuing those loans. Purchasing mortgage-backed securities, as the Fed has done, keeps housing prices inflated, helping the banks who have non-performing mortgages on their books. However, it hurts consumers who continue to be priced out of the housing market. In order to maintain a decent standard of living for the American people and to restore the vibrancy of the U.S. economy, it is time to end the Fed.

Ron Paul

The Fed Undermines Foreign Policy

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By: Dr. Ron Paul, U.S. Congressman

Last week I was both surprised and pleased when the Supreme Court upheld lower court decisions requiring the Federal Reserve Bank to comply with requests for information made by Bloomberg under the Freedom of Information Act (“FOIA”). Bloomberg simply wanted to know who received loans from the Fed’s discount window in the aftermath of the 2008 financial market crisis, and how much each entity received.  Surely this is basic information that should be available to every American taxpayer.  But the Fed fought tooth and nail all the way to the Supreme Court to preserve their privileged secrecy.  However, transparency and openness won the day.  There are some 29,000 pages to decipher, but a few points stand out initially.

The Fed lent huge sums of our money to foreign banks.  This in itself was not surprising, but the actual amount is staggering!  In one week at the height of the crisis, about 70% of the money doled out went to foreign banks.  We were told that bailing out banks was going to stave off a massive depression.  Depression for whom?  We now know that the Fed’s bailout had nothing to do with helping the American people, who have gotten their depression anyway with continued job losses and foreclosures.  But now we learn that a good deal of the money did not even help American banks!

In light of recent world events, perhaps the most staggering revelation is that quite a bit of money went to the Arab Banking Corp., in which the Libyan Central Bank owned about a third of its stock.  This occurred while Libya, a declared state sponsor of terrorism, was under strict economic sanctions!  How erratic the US must appear when we shower a dictator alternately with dollars and bombs!  Also, we must consider the possibility that those loans are inadvertently financing weapons Gaddaffi is using against his own people and western militaries.   This would not be the first time the covert activities of the Fed have undermined not only our economy and the value of the dollar, but our foreign policy as well.

Of course I can’t say I’m surprised by the poor quality of the data provided by the Fed.  The category of each loan made, whether from the “Primary Discount Window”, the “Secondary Discount Window,” or “Other Extensions of Credit,” is redacted.  Thus, we don’t know with certainty how much discount window lending was provided to foreign banks and how much was merely “other extensions of credit”.  Also, some of the numbers simply do not seem to add up.  We are of course still wading through the massive document dump, but it does seem as though several billions of dollars are unaccounted for.

As the world economy continues to falter in spite of – or rather because of – cheap money doled out by the Federal Reserve, its ability to deceive financial markets and American taxpayers is coming to an end.  People are beginning to realize that when the fed in effect doubles the worldwide supply of US dollars in a relatively short time, it has the effect of stealing half your money through reduced purchasing power.  Rapid inflation will continue as trillions in new money and credit recently created by the Fed flood into the commodity markets.

It is becoming more and more obvious that the Fed operates for the benefit of a few privileged banks, banks that never suffer for bad decisions they make.  Quite the opposite – as we have seen since October 2008, under our current monetary system politically-connected banks are paid to make bad decisions.