America in Denial: The Federal Reserve System

INTRODUCTION

“The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.”

Those are the words written at the top of the official website of the Federal Reserve . The funny thing is, on a Yahoo! search for “Federal Reserve” [1] (I know, who uses Yahoo! to do a search, right?), only a few spots down we find a very different description:

“Mr. Chairman, we have in this Country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal Reserve Banks, hereinafter called the Fed. The Fed has cheated the Government of these United States and the people of the United States out of enough money to pay the Nation’s debt. The depredations and iniquities of the Fed has cost enough money to pay the National debt several times over.

“This evil institution has impoverished and ruined the people of these United States, has bankrupted itself, and has practically bankrupted our Government. It has done this through the defects of the law under which it operates, through the maladministration of that law by the Fed and through the corrupt practices of the moneyed vultures who control it.” [2]

Spend five minutes on that page and you’ll find a few more historical quotes mirroring those sentiments along with accusations that the “the Fed” had a hand in The Great Depression and is the brain-child of European bankers who funded Trotsky and the Russian Revolution. All around are Amazon ads showing the covers of books like “The 9/11 Commission Report: Omissions and Distortions”, “End of America: Letter of Warning to a Young Patriot”, “The Assassinations”, and “America’s Secret Establishment: An Introduction to the Order of Skull and Bone”. Add to this the horribly-outdated web design and it’s not long before most of us shrug this off as a conspiracy-type, “nutjob” website and are sure that a few more scrolls will lead us to Bigfoot and Area 51.

But why do we react that way? Why are we so quick to roll our eyes, laugh, or get angry when presented with explanations of history that conflict with those taught in our high school textbooks? Do we just have that much confidence in our education? Do we really think that our professors, textbooks, and The History Channel are the infallible, omniscient sources from which all accurate information flows? Do we think the “official record” is always in harmony with reality? Does our government (or any other government for that matter) always give us the best and clearest picture of what’s really going on? Or is there some other reason we act the way we do? Is it possible we instinctively reject non-conforming historical relations because we are in denial?

Denial is “an unconscious mental maneuver that cancels out or obscures painful reality” [3] and is a common defense mechanism. It is used to deal with unpleasant situations over which we have little or no control. One example of denial, given by Sigmund Freud – the famous psychoanalyst who first postulated the concept – is that of King Boabdil. According to the account [4], King Boabdil was the last Moorish King and had just received news that his capitol city was about to fall. In an attempt to delay or erase that painful reality, the King burned the letter and beheaded the messenger.

Boabdil’s reaction didn’t change the fact that his kingdom was lost, but the reality of the situation was too much to bear at the time. Many of us have employed denial to deal with the stress of exams or writing a paper. Overwhelmed by the task before us, we further sabotage ourselves as we put off studying and instead go online to see who’s updated their Facebook status, knowing full-well that 9:00 a.m. isn’t getting any further away. Because of the stress of the reality that faces us, our mind refuses to confront it and we find some other activity to comfort ourselves.

We employ the same defense mechanism when it comes to our government. All of us know politicians mislead or make ambiguous statements to sway voters and keep their jobs – we have seen it happen before our eyes over and over again. I’m willing to bet that every one of us has fumed, even if just for a second, at the blatant lies those in office have tried to feed us. (Of course our candidate doesn’t do that, but we know the opposing party is full of tricks).

One of the clearest examples that we all will remember is President Bill Clinton’s White House Press Conference on January 26, 1998, where, amidst mounting pressures regarding an alleged affair with Monica Lewinsky, he emphatically proclaimed (adding to the drama by banging the pulpit and pointing directly at us):

“But I want to say one thing to the American people. I want you to listen to me. I’m going to say this again: I did not have sexual relations with that woman, Ms. Lewinsky…” [5]

However, a few months later on August 17, 1998, President Clinton explained that:

“Indeed, I did have a relationship with Ms. Lewinski that was not appropriate… I know that my public comments and my silence about this matter gave a false impression. I misled people…and I regret that.” [6]

While commentators argued over the legal difference between “inappropriate” and “sexual relations”, most of us had no doubt about the reality of the situation.

Another infamous example is President George W. Bush’s “Mission Accomplished” [7] speech on May 1, 2003. After landing in a jet on the aircraft carrier U.S.S. Abraham Lincoln, President Bush announced:

“Operation Iraqi Freedom was carried out with a combination of precision and speed and boldness the enemy did not expect, and the world had not seen before…Major combat operations in Iraq have ended. In the battle of Iraq, the United States and our allies have prevailed…The nation thanks all the members of our coalition who joined in a noble cause. We thank the Armed Forces of the United Kingdom, Australia, and Poland, who shared in the hardships of war. We thank all the citizens of Iraq who welcomed our troops and joined the liberation of their own country… America is grateful for a job well done.” [8]

Despite having been “carried out”, Operation Iraqi Freedom continues nearly five years later with a vast majority of coalition and Iraqi casualties occurring after the speech [9]. As the war dragged on, the White House explained in various press conferences and interviews that the prominent “Mission Accomplished” banner and language used was meant to be understood in the context of the end of the 10-month tour of the U.S.S. Abraham Lincoln and its crew – the longest deployment in Navy history. White House spokeswoman Dana Perino frustratingly responded that the sign probably should have read: “mission accomplished for these sailors who are on this ship on their mission” [10]. Notwithstanding the many clarifications, “Mission Accomplished” continues to be a favorite of political satire. In June 2005, playing the part of Senior Military Analyst on The Daily Show, Stephen Colbert explained that “the most famous seeming miscue of this White House” was:

“…just more of your Western, linear, left-to-right, letters-in-consecutive order, syllable-based banner reading. The true message was there, you just had to read the letters in anagram form as it was intended: ‘C’mon I lied, so scampish.’” [11]

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We known these two examples are not anomalies, and we could all think of many more but despite all this we continue to put our trust in the words of our politicians and give credence to the official record. The Board of Governors of the Federal Reserve’s statement that they provide our country with “a safe, flexible, and stable monetary system” is very comforting, but is it the truth? And more important to our study here – if it’s not, do we really want to know? Maybe we would just rather take the official record at face value than find out that the system that runs our economy really is “the most corrupt institution in the world.” Maybe we would rather believe the lies than deal with the stress of reality. So is the Board of Governors’ statement an accurate assessment of the Federal Reserve system or do the naysayers have a point?

Let’s assess the claim.

WHAT IS A CENTRAL BANK?

In order to begin to assess the official story, then, we have to understand what a central bank is and what it does; and in order to understand central banks, we need to understand what a regular bank is and does. Banks are institutions where we keep our money, right? It doesn’t seem practical to store all that cash under your mattress, so you take it to a bank. You the customer deposit the money you earn into an account where you can later withdraw it again. But banks do not just hold money, they lend it as well. This is part of how a bank makes its money – by the interest it collects on mortgage loans, car loans, business loans, etc. But where does a bank get the money to make loans? Well, the bank loans out your money. This is how a bank can offer you interest on the money you deposit – the bank makes interest on your money (that it lends) and decides to share a little of the profit for the privilege of using your money and no doubt to entice more depositors. More deposits means bigger loans the bank can collect interest on.

But a problem occurs if there is a “run on the bank”. You may have heard of bank runs in the context of the Great Depression, where scared depositors would all rush to the bank to get their cash out with many coming home empty handed. Banks make the gamble that not enough people will want to withdraw enough money at the same time to cause any problems, so the bank decides not to let all that precious cash just sit there in its vaults and instead loans it out, collecting interest on every dollar. If enough people want to withdraw enough money out at once, though, the bank is mathematically unable to give some people their money back so it’s first come, first serve. This is because the bank no longer holds all of the deposited money, but has given it to others in the form of loans. When a run happens, a bank is either forced to close its doors (sorry everyone, our bad!) and go bankrupt, or get some more money from somewhere else to cover those withdrawals. This is where a central bank comes in.

Central banks are also referred to as “lenders of last resort”. This is because of the situation explained above. If a bank faces the problem of having too many withdrawals than it has cash in its vaults to honor, then, as a last resort, a central bank can lend money to that bank to keep it from collapsing [12]. Of course this is not the only function of a central bank, but it is one of its most important purposes. Among other things, the Federal Reserve System acts as the lender of last resort for the nation’s banks.

So the Federal Reserve is a central bank and the official record can be trusted in this case, right? Well yes, but what about the part about providing the nation with a safe, flexible, and stable monetary and financial system? Don’t you want to know where the Federal Reserve gets that money it lends to banks? Good question.

THE MANDRAKE MECHANISM

The Federal Reserve gets money to member banks by “monetizing debt”, a characteristic ability of all central banks. Monetizing debt is banker language for creating money out of the need to borrow and is accomplished by the Federal Reserve through what G. Edward Griffin calls “The Mandrake Mechanism” [13]. The Mandrake Mechanism works like this:

The United States adds ink to a piece of paper and calls it a Treasury note or bond. These are promises to pay a given sum at a given interest on a given date. The paper is then given to the Federal Reserve where it is classified as a “securities asset”. These government bonds are also available to you and me and some of you may even have received these as gifts from grandma and grandpa. They are purchased at a certain lower price and can be cashed for a certain higher price years down the road when they “mature”. It’s one way the government funds itself – by borrowing your money today and promising to pay it back with a little interest tomorrow. When the government deals with the Federal Reserve, however, it’s for much, much greater sums of money.

This Treasury note or bond is considered an asset by the Federal Reserve because the assumption is the U.S. government can tax its citizens when it needs to in order to pay the debt. The Fed can now use this “asset” to take on a liability and adds ink to a paper, calling it a Federal Reserve Check. On this check will be inked the same number that was inked on the piece of paper called a Treasury note or bond (symbolizing a specific amount of money). The government will then endorse the Federal Reserve Check and deposit it into its account at one of the Federal Reserve banks [14].

From its account at the Federal Reserve bank, the United States will issue more inked pieces of paper in smaller amounts called government checks that it uses to pay its bills. When these checks are deposited into the bank accounts of those being paid by the Federal government, they become commercial bank deposits. As long as these “assets” remain in bank accounts, commercial banks (Bank of America, Trustco, WaMu – oops, nevermind, KeyBank, etc.) consider these to be bank “reserves”.

This is where we come back to our discussion of how banks work. Banks hold your money as well as lend it to make a profit. So the more money a bank has in deposits, the more loans it can make and the more interest it can collect. In addition to lending money that doesn’t belong to them, under the Federal Reserve system banks are also allowed to practice what is called “fractional reserve banking” which is a nearly magical process by which banks can increase their profits many times over.

Under this system, commercial banks are only required to hold $1 in reserve for every $9 they lend [15]. That 10% ($1 for every $10) is called their reserve-ratio. With a 10% reserve-ratio, for every $1 million in deposits a bank has $900,000 in “excess reserves” burning a hole in its pocket. So instead of letting it sit there, banks put that $900,000 to good use by making car loans, home loans, business loans, etc and collecting interest on them. But it doesn’t end there. As Griffin explains:

“The process now repeats but with slightly smaller numbers each time around. What was a “loan” on Friday comes back into the bank as a “deposit” on Monday. The deposit then is reclassified as a “reserve” and ninety percent of that becomes an “excess” reserve which, once again, is available for a new “loan.” Thus, the $1 million of first wave fiat money gives birth to $900,000 in the second wave, and that gives birth to $810,000 in the third wave ($900,000 less 10% reserve). It takes about twenty-eight times through the revolving door of deposits becoming loans becoming deposits becoming more loans until the process plays itself out to the maximum effect…”

Although banks are not usually able to see this process unfold to the 28th time [16], it is theoretically possible and, in any case, banks under the Federal Reserve system enjoy the benefits of not only collecting the interest on money loaned from your account, but are given the ability to collect interest on money that didn’t even previously exist.

Banks can also obtain funds from the Federal Reserve through the “discount window” [17], which are low-interest loans (that will be deposited and loaned again to consumers at a higher rate of interest). The Federal Reserve creates this money in much the same way as when dealing with the United States, only this loan is given directly to member banks and uses a bank’s reserves as backing for the loans.

If you’re a little confused at this point, don’t feel bad. The whole process defies good sense or any of the limits of legal business most of us are used to. If you need to, go back and re-read this section or, for a more detailed explanation of our economic system under the Federal Reserve, borrow a copy of The Creature from Jekyll Island: A Second Look at the Federal Reserve.

THE CONSEQUENCES

The result to all this banking magic is an injection of currency into the economy up to ten times the amount of the original amount “loaned” by the Federal Reserve. Even more significant, is that there is no real value backing this money other than the United States’ ability to confiscate the value from its citizens through taxation if need be.

More dollars in the system might sound like a good thing, but only until we begin to understand its implications. When such a large amount of Federal Reserve Notes (ie, dollars) comes into our system to mix with existing dollars, the result is a decline in the worth of all dollars. This is called “inflation”. It’s very much like adding more water to the Kool-Aid – sure there’s more Kool-Aid, but the potency keeps going down with every cup of water you add. In the end, prices must adjust to keep in step with the value of the dollar and since each dollar is now worth less, this means prices must go up to compensate. One effect of inflation is that the $10,000 you’ve saved under your mattress can buy you less and less over time with each injection of dollars the Fed pumps into the system through the Mandrake Mechanism. During the Revolutionary War, the United States was printing the “Continental” (a form of currency, like dollars) to try and finance the war. So many notes were printed and the currency was devalued so greatly that George Washington wrote: “A wagon-load of money will scarcely purchase a wagon-load of provisions.”[18] Inflation is part of the reason why nickel movies and 25-cent sodas are only memories.

Another consequence of this system is a cycle of economic booms and busts. The Mandrake Mechanism is the source of nearly every dollar in existence today.[19] Because the Federal Reserve creates money out of debt, when that debt is paid that money ceases to exist. Among other mechanisms, by raising interest rates at the discount window, the Federal Reserve can discourage banks from borrowing from the central bank, causing less money to be pumped into the system. As loans are repaid and less new loans created, less dollars are suddenly available to go around and the economy contracts. The more loans that are repaid without new money being created, the less money circulates in the economy and the more severe the effects. If the Federal Reserve were not to create any more money and all loans were repaid, there would not be a single dollar left in existence.[20] Therefore, under the Federal Reserve system the United States and its citizens are obligated to remain perpetually in debt.

Perhaps most troubling of all these issues is the ability politicians have to raise taxes without asking. When the United States receives a “loan” from the Federal Reserve and inflation dilutes the value of our existing money, the effects are the same as if we paid the amount of the loan in direct taxes. After all, being able to buy less with your money is the same as having less money, right? All this is in addition to the direct Income and other taxes we pay every year. But because raising taxes directly can be so unpopular, the government has enlisted the Federal Reserve to do its dirty work for them, collecting funds from the American public through the hidden tax called inflation.

CONCLUSION

“The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.”

This statement is not at all unlike the attempts by “Slick Willy” or “Dubya” to sooth and comfort the American public through misleading statements or blatant lies and is simply not true. Yes, the Federal Reserve is the central bank of the United States; yes, under the Federal Reserve System, money is flexible in that it can be created out of thin air and its value manipulated; but a monetary and financial system under central banking and the Federal Reserve is anything but safe and stable. At all times, our entire economic system hangs by a thread and we and our country are perpetually in debt. With the general consensus being what it is, and most economic experts never challenging this system, it seems we would rather make it easier on ourselves and believe the official record than deal with the stress of reality.

Denial, however, is never a productive defense mechanism. We refuse to accept reality and excuse it away as not important, refuse to think about it, or re-characterize it into some new half-truth that is less threatening to us. The problem is that despite our coping, the reality of the situation does not change. In this case, the very real problem of our economic system confronts us and only fundamental, and most likely painful, changes can save us. That problems do exist is painfully obvious, given the unfolding of events over the past year, and the futile attempts of our two-tongued politicians to patch up an unsustainable system will not get us far for much longer. However badly we may not want to take the necessary steps that will lead us to real economic safety and stability, if we continue to live in denial and ignore the reality of our situation the time will eventually come where we will have no choice but to experience the pain that has been accumulating since the adoption of this system.

__________________________________________________________

SOURCES

[1] Board of Governors of the Federal Reserve System, http://www.federalreserve.gov.

[2] Federal-reserve.net – Is Neither Federal Nor A Reserve, It Stole Our Currency In 1913, http://www.federal-reserve.net, quoted from Congressional Record, June 1932 at 12595-12603. (For you Googlers, you have to go to pg. 2 of a search to find this).

[3] Michael A. Milburn & Sheree D. Conrad, The Politics of Denial, 1 (1996).

[4] Id. at 13.

[5] White House Press Conference, January 26, 1998. (Watching the statement on video again helps us remember how convincing Mr. Clinton intended to be. One example is found at http://www.youtube.com/watch?v=KiIP_KDQmXs).

[6] Addressing the Nation, http://www.pbs.org/newshour/lewinsky_address/address.html. (full video here – http://www.youtube.com/watch?v=zFKtgTsKDIg).

[7] Whitehouse.gov indexes the speech as “President Bush Announces Major Combat Operations in Iraq Have Ended”. Note: With the change of administration, this reference may no longer be accurate.

[8] George W. Bush, President Bush Announces major Combat Operations in Iraq Have Ended, May 1, 2003, http://www.whitehouse.gov/news/releases/2003/05/20030501-15.html. (A full video recording of the speech is also found there). Note: With the change of administration, this reference may no longer be accurate.

[9] Survey numbers vary widely, but all agree with this assessment. Iraqi Health Ministry casualty survey, http://content.nejm.org/cgi/content/full/NEJMsa0707782/DC1. Lancet survey, http://web.mit.edu/CIS/pdf/Human_Cost_of_War.pdf. Opinion Research Business survey, http://www.opinion.co.uk/Newsroom_details.aspx?NewsId=88.

[10] Press Briefing by Dana Perino, April 30,2008, 12:40pm EDT, http://www.whitehouse.gov/news/releases/2008/04/20080430-5.html. Note: With the change of administration, this reference may no longer be accurate.

[11] Semantics, June 27, 2005, http://www.thedailyshow.com/video/index.jhtml?videoId=124201&title=semantics. (For maximum context and amusement, view the entire clip).

[12] For more on how the FDIC is not a true insurer of bank deposits, please G. Edward Griffin, The Creature from Jekyll Island: A Second Look at the Federal Reserve 33-38, 49-66 (4th ed. 2002).

[13] Id. at 185. (Here Griffin explains that he named this mechanism after “Mandrake the Magician”, apparently a comic strip character of the 1940’s. Mandrake would create things out of nothing and have them disappear likewise. My explanation is taken directly from Griffin’s book. For a more detailed explanation, please see 185-207).

[14] There are 12 Federal Reserve banks, each in a different U.S. city, and named after that city. They are the Federal Reserve Banks of: Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

[15] See Griffin, supra at 194, footnote 1. (“This 10% figure (ten-to-one ration) is based on averages. The Federal Reserve requires a minimum reserve of 10% on deposits over $47.6 million but only 3% on deposits from $7 million up to that amount and no reserves whatsoever below that amount. Reserves consist of vault cash and deposits at the Federal Reserve”).

[16] Id. at 199.

[17] For more detail on the discount window, see Id. at 478-480.

[18] Id. at 312.

[19] Id. at 388.

[20] Id.