The Occupiers, the Tea Party Both Have a Point About the Fed

December 12, 2011

For release Dec. 14 and thereafter (554 words)

On Monday Dec. 5, Charles Evans, president and CEO of the Federal Reserve Bank of Chicago, was the keynote speaker at the annual Indiana Economic Outlook sponsored by the Center for Business and Economic Research at Ball State University at the Horizon Convention Center in Muncie. Rumor had it that “Occupy Muncie” activists would stage a demonstration at the event.

Delaware County sheriff deputies were on hand but no protestors showed up. Perhaps the rain and cold weather dampened their spirits. But we can ask what complaint would the protestors have lodged against the Federal Reserve President?

The answer might be in a recent Bloomberg report indicating that banks earned $13 billion in additional income from access to almost $8 trillion in “secret” loans from the Fed. A question about the report emerged at the forum, and subsequent communications from the Federal Reserve have questioned the Bloomberg study.

Some simple principles of modern money and banking sheds light on both of these stories.

Our economy uses “fiat money.” That means the Federal Reserve will not redeem the $20 Federal Reserve note you hold in your wallet for silver or gold. They will give you another newly printed $20 bill (or two $10 bills).

So what backs the dollar? Nothing but the public’s faith in the dollar. Dollars are worth something because people accept them as a means of payment. If the general public ever stops accepting these “fiat” dollars they become worthless. And talk all you want about gold and silver being “real money,” try using a silver bar to pay for your next restaurant meal.

The Federal Reserve Bank is the custodian of the value of the American dollar; it must make dollars sufficiently scarce to ensure the dollar maintains a modicum of stable value. This is central to its mission. But another foundational purpose of the Federal Reserve is to be the “lender of last resort” to member banks. That means if banks risk running  short of money to redeem their customers’ deposits  the Fed will create new money by fiat — or, more parochially, out of thin air. This power is vested in the Fed to ensure that the economy is not beset by widespread bank panics and economic depression.  

The Bloomberg report is not news — or more precisely it hasn’t been news for 100 years. In 2008, banks were struggling and the Fed knew it. It did what it was supposed to do according to its 1913 mission: It loaned reserves to banks at low rates. That banks use these loans for profit is hardly surprising.  

It is easy to call critics of the Fed in either Occupy Wall Street or the Tea Party ignorant “know-nothings” who fail to comprehend how the system operates. That’s a mistake. One can imagine a scenario where the Fed overdoes it, issues too much money and confidence in the dollar declines resulting in a devastating inflationary spiral. Banks get “special favors” from the Fed; they are also subject to “special regulation” by the Fed.

All of this should be part of our knowledge base. If you don’t like it, that’s fine. Place the blame on the early 20th-century progressives who gave us a Federal Reserve System — and start thinking about a gold standard.

Cecil Bohanon, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, teaches economics at Ball State University. Contact him at editor@inpolicy.org.



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