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Why Federal Reserve Bank Which Is Neither Federal Nor Has Any Reserves Should Be Abolished


  Sat, 5:55 PM        
Why Federal Reserve Bank Which Is Neither Federal Nor Has Any Reserves Should Be Abolished

I have often identified Keynesian economists and the Federal Reserve as cargo cults. After the U.S. won World War II in the Pacific Theater, its forces left huge stockpiles of goods behind on remote South Pacific islands because it wasn't worth taking it all back to America. After the Americans left, some islanders, nostalgic for the seemingly endless fleet of ships loaded with technological goodies, started Cargo Cults that believed magical rituals and incantations would bring the ships of "free" wealth back. Some mimicked technology by painting radio dials on rocks and using the phantom radio to "call back" the "free wealth" ships.
The Keynesians are like deluded members of a Cargo Cult. They ignore the reality of debt, rising interest payments and the resulting debt-serfdom in their belief that money spent indiscriminately on friction, fraud, speculation and malinvestment will magically call back the fleet of rapid growth.
To the Keynesian, a Bridge to Nowhere is equally worthy of borrowed money as a high-tech factory. They are unable to distinguish between sterile sand and fertilizer, and unable to grasp the fact that ever-rising debt leaves America a nation of wealthy banks and increasingly impoverished debt-serfs.
The Keynsian Cargo Cult relies on an essentially magical belief that government give-aways will raise "aggregate demand," the "animal spirits" demand for more of everything, which will magically increase productivity, wealth, etc.
The Cargo Cult faithful do not understand diminishing returns: at some point, the interest on skyrocketing debt drains income and capital from potentially productive investments to pay for previous unproductive spending on fraud, friction and malinvestments. "Free money" creates moral hazard, which means that those who can borrow money for almost nothing and never have to pay it back act entirely differently from those paying market rates for money and backing their loan with real collateral that is at risk.
The Keynesian Cargo Cult is based on ever-expanding debt and fiscal moral hazard. The Federal Reserve Cargo Cult is based on ever-expanding debt and monetary moral hazard. The Fed loaned over $16 trillion to "too big to fail banks" at rates that are negative once inflation is accounted for, and it has essentially stolen hundreds of billions of dollars from savers and pension funds in order to subsidize the housing industry with artificially low-interest mortgages.
The Fed's plan to boost more consumer borrowing/spending via the "wealth effect" by elevating the stock market has failed. The "wealth effect" is classic Cargo Cult magic: if you make people feel richer by managing their perceptions, they will start acting richer, i.e. borrowing and spending more based on phantom assets.
Why is this perception-management a form of magic? Household incomes have declined. How can a debtor borrow and spend more if his income has declined? The "magic" only works if he can borrow money based on phantom collateral, and the rate of interest is so low that his impaired income enables him to leverage more debt--though any prudent banker would reject the debtor as a bad risk.
Borrowing money at near-zero rates with no collateral creates massive moral hazard. No skin in the game? Default is not just easy, it's rational: All Praise to the new subprim1 out of six FHA loans is now dilinguent
The Fed has gone to considerable trouble and expense to goose the stock market to multi-year highs. Yet the economy is still stagnant. If you have any doubts about this, please study this article and these charts: The lost decade of the middle class (Pew Trust) Real household income has declined:

Real household income by age bracket: only the 65+ group's income has increased.

Labor's share of the non-farm private-sector economy has fallen off a cliff:

Household debt has far outpaced wages: households are over-indebted and over-leveraged. Only the top 5% have reduced leverage. Remove their income and debt from the calculation and the "households are deleveraging" argument collapses.

The economy is 14 million jobs short of what's needed to support housing and spending:

The Fed's monetary policies of saving the "too big to fail banks" and stealing from savers to subsidize cheap mortgages and other debt has failed on multiple levels:The "wealth effect" it sought to create by manipulating the stock market ever higher has been limited to the top 5%, an easily predictable result (all you have to do is look at who owns most the nation's stocks and bonds--surprise, it's the top 5%).

The Fed's Cargo Cult faith held that this largesse to the banks and the wealthy would magically trickle down to the bottom 95%. It didn't, as anyone who actually lives in the real world could have predicted.
My neighbor buying a Porsche and a bunch of stuff made in China does not generate income for me unless I assemble Porsches or stuff in China or I own shares in Porsche and WalMart. Since Americans don't assemble things in Germany and China, and 95% don't own enough shares in any company to generate meaningful income, the Fed's policies failed miserably. The Fed's Cargo Cult "trickle down" magic was the equivalent of waving dead chickens and dancing the humba-humba around the campfire at midnight.
Having failed to create a useful "wealth effect" by goosing stocks, the Fed is trying once again to goose housing. Hey, it worked from 2002 to 2007: make money cheap and easy to borrow, accept phantom assets as collateral, lower down payments to near-zero, and housing prices soar, creating a bubblicious amount of equity that can be borrowed and blown.
In other words, the only mechanism the Fed has to spark a widespread "wealth effect" is to re-inflate housing. It has been trying to do so mightily for years, by stealing hundreds of billions from savers to subsidize low-interest mortgages and by buying $1 trillion of impaired mortgages off the banks, clearing their balance sheets and theoretically enabling them to originate more mortgages.
Lower rates were supposed to spark a re-financing boom that would free up billions of dollars as monthly mortgage payments dropped, but oops, very few homeowners are creditworthy now that having a pulse and the ability to lie are no longer sufficient to get a mortgage.
The Fed can funnel trillions to banks, but it can't force them to lend money to un-creditworthy borrowers putting up phantom collateral.
So the Fed is back to the game of goosing phantom assets higher with perception management. The Fed is hoping to generate a "virtuous cycle" in which higher home prices lead to millions of homeowners rising above water and having equity, which will make them feel wealthier (the wealth effect) and more energized ("animal spirits") to borrow and spend.
In a centrally managed economy and market, housing prices are manipulated higher by lowering rates, lowering credit standards, guaranteeing marginal borrowers can buy homes with 3% down payments and so on. The Federal government basically took over the mortgage market in 2009, and government-backed mortgages still account for over 95% of all mortgages. The mortgage market has been completely socialized as a means of subsidizing housing.
Note the Cargo Cult magic of the "wealth effect" has it backwards: income doesn't rise as a result of productive investments and higher productivity that's passed on to workers, it rises because phantom assets are inflated to justify workers taking on more debt to boost their spending.
How has the Fed's Master Plan been working so far? Hmm, not much bang for all those bucks.

The Fed Cargo Cult wants to paint dials on rocks and re-set the S-curve that guides all speculative bubbles and busts. This time we'll force people to buy houses for inflated prices and force lenders to make risky loans to credit-impaired buyers with our magic mind control! The housing industry and its Fed backers were ecstatic with recent increases in the Case-Shiller index of housing prices. I've marked up the chart to reveal the underlying dynamics of this underwhelming reflation.

The entire Fed Cargo Cult depends on the "magic" of manipulating internal psychological states: 1. Boosting expectations of inflation so people will be encouraged to spend what money they have now. 2. Creating the perception that housing is recovering, as opposed to the truth that housing is only rising due to stupendous incentives created by subsidies paid by others and the banks' stealth campaign to lower supply by holding millions of defaulted homes off the market. 3. By stimulating demand and artificially reducing supply, the Fed and the banks hope to create phantom collateral (home equity) that can support another enormous wave of new borrowing and spending.
What nobody dares mention is the Cargo Cult is funneling trillions of dollars into unproductive malinvestments. Housing is a form of consumption; it is not a productive investment. It is subject to diminishing returns: all the trillions dumped into subsidizing housing have yielded a pathetically meager increase in phantom assets.

The Cargo Cult of the Federal Reserve has failed, and it should be abolished as the ultimate destroyer of wealth via its policies of manipulation, malinvestment and moral hazard.

Why the fed must be abolished.

The Fed should be abolished . It a private cartel of bankers
permitted by congress in 1913 to create
money out of nothing. It is thee cause of all our economic difficulties

• It is incapable of accomplishing its stated objectives.

• It is a cartel operating against the public interest.

• It is the supreme instrument of usury.

• It generates our most unfair tax.

• It encourages war.

• It destabilizes the economy.

• It is an instrument of totalitarianism.

details of all 7 upon request

It is is not abolished the fourth collapse of the three previous Central banks of the United is imminent and unavoidable.

Historians seeking to justify governmental control of the monetary system have claimed the booms and busts that occurred during the Civil War through the 1920's were the result of free and competitive banking. But these destructive cycles were the direct result of the creation and then extinguishing of fiat money through a system of federally chartered banks, dominated by a handful of firm on Wall Street which constituted a half-way house to central banking. None of these banks were truly free of state control nor were they competitive in the traditional sense of the word. They were in fact subsidized by the government and had many monopolistic privileges. From the perspective of bankers on Wall Street however there was a great deal more to be desired. For one thing, America
still did not have a "lender of last resort:. That is banker language for a full blown central bank with the power to create unlimited amounts of money which can be rushed to the aid of any individual bank that is under siege by its depositors wanting their money back. Having a lender of last resort is the only way a bank can create money out of nothing and still be protected from a potential "run" by its customers. In other words , it is the means by which the public is forced to pay a hidden tax of inflation to cover the shortfall of
fractional-reserve-banking. That is why the so-called virtue of a lender of last resort is taught with great reverence today in virtually all academic institutions offering degrees in banking and finance. It is the means by which the system perpetuates itself The banks could now inflate more radically and more in unison than before the war but, when they pushed too far and too fast their bank generated booms still collapsed into recessions. While this could be highly profitable to the banks, it was also precarious. (more about this on pages 432 and433 of The Creature From Jekyll Island (5th edition
September 2010)

Between 1900 and 1910 seventy percent of American Corporate growth was funded internally, making industry increasingly independent of the banks. What the bankers wanted-- and what many businessmen wanted also -- was a more "flexible" or "elastic" money supply that would allow them to create enough of it at any point in time so as to be able to drive interest rates downward at will. That would make loans to businessmen so attractive they would have little choice but to return to the bankers' stable.

One more problem facing Wall Street was the fact that the biggest investment houses, such as Morgan & Company and Kuhn Loeb & Company, although they remained as competitors, were by this time so large they ceased doing serious battle against each other. The concept of trusts and cartels had dawned in America and, to those who already had made it to the top. joint ventures, market sharing, price fixing, and mergers were far more profitable than free-enterprise competition as Ron Chernow explains on pages 433 and 434

This trend was not unique to the banking industry, Ron Paul and Lewis Lehrman provide the historical perspective on pages 434 and 435. The challenge no longer was how to overcome one's adversaries, but how to keep new ones from entering the field. When John D, used his enormous profits from Standard Oil to take control the Chase national bank, and his brother, William, bought th national City Bank of new York, Wall Street, had ye tone more gladiator in the financial arena. Morgan found that he had no choice except to allow Rockefellers into the club but, now that they were in, they all agreed
that the influx of competitors had to be stopped. And that was to be the hidden purpose of federal legislation and government control which Gabirel Kolko explains on page 435. Writing in the year 1919 , from the perspective of an inside view of Wall Street at that time, John Moody completes the picture on pages 435 to 437

And the event of the Aldrich-Vreeland Act of 1908 as well as the creation of a national Monetary Commission to study the problems of the American banking industry and make recommendations to Congress finally brings us to he Jekyll Island plan for convincing Congress and the public that the establishment of a banking cartel was ,somehow, a measure to protect the public.

The Jekyll Island strategists laid down the following plan of action.

1. Do not call it a cartel or even a central bank

2. Make it look like a government agency

3. Establish regional branches to create the appearance of
decentralization, not dominated by Wall Street banks

4. begin with a conservative structure including many sound
banking principles knowing that the provisions can be quietly altered or
removed in subsequent years

5. Use the anger caused by recent panics and bank failures to
create popular demand for monetary reform

6. Offer the Jekyll Island Plan as though it were in
response to that need

7. Employ university professors to give the plan the
appearance of academic approval

8 Speak out against the plan to convince the public that
Wall Street banker do not want it.

The American public would never have accepted the Federal reserve System if they had known it was half cartel and half central bank. Even though the concept of government protectionism was rapidly gaining acceptance in business and academic circles, of cartels, trusts, and restraints of free competition was still quite alien to the average voter. And within the halls of Congress, any forthright proposal for either a cartel or a central bank would have been soundly defeated. This is further described on page 439 through 449.

Banking in the period immediately prior to the passage of the Federal Reserve Act was subject to a myriad of controls regulations, subsidies and privileges at both the federal and state levels. Popular history portrays this period as one of unbridled competition and free banking. It was in fact, a half-way house to central banking. Wall Street, however, wanted a "lender of last resort to create unlimited amounts of fiat money for their
use in the event they were exposed to bank runs or currency drains. They also wanted to force all banks to follow the same inadequate reserve policies so that more cautious ones would not draw down the reserves of the others..

The first draft of the Federal Reserve Act was called the Aldrich Bill and was co-sponsored by Congressman Vreeland, but it was not the work of either of these politicians. It was the brainchild of banker Paul Warburg and was eventually written by bankers frank Vanderlip and Benjamin Strong. Aldrich's name attached to a banking bill was bad strategy because he was known as a Wall Street Senator. His bill was not politically acceptable and was never released from committee. The groundwork had been done, however, and the time had arrived to change labels and political parties. The measure would now undergo minor cosmetic surgery and reappear under the sponsorship of a politician whose name would be associated in the public mind with anti-Wall Street sentiments

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.