Thursday, July 11, 2013

The Federal Reserve Yet Again

If we keep raising the issue of the Federal Reserve, it’s because other people keep insisting on two things that we know are incorrect.  One, the federal government is the sole legal money creator in the United States.  Two, central banks were invented to finance government.

The basic problem is that the Federal Reserve System, the central bank of the United States, is being egregiously misused.  First, of course, it was never intended to finance government.  The power of the federal government to create money (“emit bills of credit”) was specifically removed from the enumerated powers of Congress under Article I, Section 8, and prohibited to the individual states under Article I, Section 10.

The framers had a very bad experience with the Continental Currency, and did not want a repeat.  Giving politicians the power to emit bills of credit (“create money”) virtually at will is a recipe for disaster, as we have seen with the rapid growth of the U.S. national debt since the New Deal.

The Federal Reserve was primarily intended “to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”  That is a direct quote from the preamble to the original 1913 Act . . . that has been carefully edited out.

The idea was to shift from an inelastic (i.e., fixed in amount) reserve currency backed with government debt (the United States Notes or “Greenbacks” of 1862-1971, the National Bank Notes of 1863-1913, and the Treasury Notes of 1890), to an elastic (i.e., varies directly with the present value of existing and future marketable goods and services in the economy) reserve currency backed with the present value of private sector hard assets.

The only reason that the Federal Reserve was permitted to deal in government securities of any kind, primary or secondary, was to retire the debt-backed reserve currency and replace it with an asset-backed reserve currency.  The program to retire the National Bank Notes terminated in 1938, so there is no longer any legal justification for the Federal Reserve to buy or sell government securities, either by discounting or rediscounting, or engaging in open market operations.


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