Federal Reserve Moves to Restore Original Purpose

According to an Associated Press report ("Fed to buy massive amounts of short-term debt," Jeannine Aversa, AP Economics Writer, 10/07/08), the Federal Reserve has announced that it will purchase massive amounts of short-term loan paper. This is a startling reversal of the near-century long use of the Federal Reserve as lender of first resort to the government, and a long-overdue return to its primary function as lender of last resort to the private sector.

While described as "radical," there is nothing radical or even new in the proposal. Discounting of short-term (up to 90-day) commercial paper for qualified industrial, commercial, and agricultural purposes is one of the reasons the Federal Reserve was established in 1913. Existing accumulations of savings supplemented with the gold- and silver-backed currency was considered the primary money supply.

The Federal Reserve was to provide liquidity in the form of "pure credit" whenever the existing liquidity in the system was insufficient to meet the needs of commerce, industry, and agriculture. This would avoid the twin evils of inflation and deflation, and finance the formation of capital to reach "full production." Full production would result in full employment of all resources, not just labor, without the need for government intervention or subsidies. The Federal Reserve operated in this way until 1917, when politicians decided to finance America's entry into World War I primarily through borrowing rather than by raising taxes.

As we have proposed it, Capital Homesteading would improve certain features of this restoration of the Federal Reserve's original purpose:

• Cut the federal government off completely from the discount window by forbidding the Federal Reserve to deal in any kind of government securities, primary or secondary.

• Prohibit the Federal Reserve from extending credit for anything other than qualified industrial, commercial, and agricultural projects that generate income to repay the credit.

• Institute a 100% reserve requirement for commercial banks, reserves to be in the form of cash or government securities.

• Extend the term of the qualified paper discounted at the Federal Reserve from the current short-term to a maximum 20-year term.

• Most important, all credit extended by the Federal Reserve must only be done in ways that makes new owners out of people who have previously owned nothing.

By agreeing to restore their original function to provide short-term, asset-backed liquidity to the financial system, the Federal Reserve has taken a giant step in the direction of reestablishing an asset-backed currency, providing financing for America's economic growth and expansion, and assisting average citizens to exercise their natural right to acquire and possess private, income-generating property.

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