Wednesday, January 26, 2011

Fiscal responsibility, our financial future, and the Federal Reserve

I think it's long gone time that something drastic was done to rein in the Federal Reserve before it destroys America.

Think I'm exaggerating? Think again.

First, let's be clear about the background to the enormous Government debt that we've built up. A recent article called this country 'America The Broke'.

... for the first time, our national debt has surpassed $14 trillion - a dubious and shameful record.

Even more astonishing, the past two presidents, one from each major political party, are responsible for half of that monstrous sum. As an Associated Press story noted,

about half of today’s national debt was run up in the past six years. It soared from $7.6 trillion in January 2005 as President George W. Bush began his second term to $10.6 trillion the day President Obama was inaugurated and to $14.02 trillion now.

In this era of hyper-partisanship, it is comforting to know that there is one thing both parties have agreed upon - spending the nation into insolvency.

It is clear that $14 trillion is an amount so astronomical as to be literally incomprehensible - beyond the ken of our formidable, if recently evolved, homo sapiens mind.

Unfortunately, that does not stop us from racking up such sums. Doubtless, the two phenomena are somehow related.

So deduct ... $45,300 from your salary. That is what the national debt amounts to for every man, woman, and child in America. For a family of four with two small children and both parents working, that’s an additional $181,200 in family debt.

Few such families reckon this additional burden when they allocate their already-stretched resources. Yet reckon it they should, for national governments - despite our legal fictions to the contrary - are not autonomous entities. The money they spend and promise has in the end but one fount - the wallets and purses of individuals and families.

The government’s debt is our debt, and when our creditors at last demand their due, that heretofore unseen $45,300 per person in debt will suddenly surge to the surface and sweep all before it in a terrible deluge. Not one person in America will be unaffected. The rich will become less rich; the middle class will become, for all intents and purposes, poor; and the poor will see any hope they may have had of economic advancement disappear.

There's more at the link.

Now, realize that it's the Federal Reserve which has provided these enormous sums to the Government, allowing it to spend us into bankruptcy. Rep. Ron Paul is derided by many as an impossibly unrealistic libertarian (and, to a certain extent, I agree with his critics, particularly concerning his support for the gold standard and opinions on various social issues). Nevertheless, he's right to point out that the Federal Reserve is at the root of our money woes.

Since the creation of the Federal Reserve, middle and working-class Americans have been victimized by a boom-and-bust monetary policy. In addition, most Americans have suffered a steadily eroding purchasing power because of the Federal Reserve's inflationary policies. This represents a real, if hidden, tax imposed on the American people.

From the Great Depression, to the stagflation of the seventies, to the burst of the dotcom bubble last year, every economic downturn suffered by the country over the last 80 years can be traced to Federal Reserve policy. The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial "boom" followed by a recession or depression when the Fed-created bubble bursts.

. . .

Though the Federal Reserve policy harms the average American, it benefits those in a position to take advantage of the cycles in monetary policy. The main beneficiaries are those who receive access to artificially inflated money and/or credit before the inflationary effects of the policy impact the entire economy. Federal Reserve policies also benefit big spending politicians who use the inflated currency created by the Fed to hide the true costs of the welfare-warfare state.

. . .

Abolishing the Federal Reserve will allow Congress to reassert its constitutional authority over monetary policy. The United States Constitution grants to Congress the authority to coin money and regulate the value of the currency. The Constitution does not give Congress the authority to delegate control over monetary policy to a central bank. Furthermore, the Constitution certainly does not empower the federal government to erode the American standard of living via an inflationary monetary policy.

Again, there's more at the link. Rep. Paul has previously introduced legislation to abolish the Federal Reserve. It hasn't got anywhere . . . yet. I suspect that, as more and more people realize the damage the Federal Reserve is doing to this country, his proposal will draw increasing support.

The self-serving machinations of the Federal Reserve are becoming clear to an increasing number of commentators. For example, CNBC pointed out in December last year that its own policies might drive the Federal Reserve into insolvency - technically, at least.

... the Fed's newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to "recapitalize" the Fed - economist-speak for what others might call a bail-out.

That would be a strange role reversal given the Fed's efforts to ease monetary policy by buying the Treasury's debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk.

Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke - at least on paper.

. . .

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss.

The Federal Reserve clearly wasn't happy to have this pointed out. Within weeks, they removed any possibility of insolvency, technical or actual. They did so, not by changing their flawed policies, but by changing their accounting standards. They could get away with that because they're independent - no-one can tell them what to do or how to do it.

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability.

. . .

"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note.

Isn't it wonderful? A stroke of the pen, and you're out of financial danger! If only we could all do that! But . . . guess what? In the real world, things don't work that way. We can't eliminate our financial liabilities with the stroke of a pen. In reality, neither can the Federal Reserve.

One commentator has already pointed out that the Federal Reserve's size, policies and influence have become illogical, counter-intuitive, and completely out of balance.

The Fed’s rationale for buying a stunning $75 billion per month of Treasury notes and bonds (almost the entire issuance) has been its fear that the economy was slowing and its hope that Fed bond purchases would lower Treasury and corporate bond yields in a stimulative manner. Neither part of this logic is working. Bond yields have risen sharply, while recent economic data - from rising auto sales to falling jobless claims to ADP’s report yesterday that its customers added record jobs in December - is contradicting the Fed’s thesis of an economic slowdown. The Fed’s December 14 minutes still fretted about deflation even as this week’s two ISM surveys confirmed the surge in prices that is being recorded in global commodity markets.

Under the Fed’s have-it-both-ways logic - buy more bonds if growth is slow (in order to speed it up) and buy more bonds if growth is fast (on the view that bond buying is working) - the Fed’s massive new program will quickly take on a life of its own. Just as Fannie Mae and Freddie Mac became instruments of Congress’s social policy, Fed bond purchases will become one of the Executive branch’s favorite growth policies - "costless" stimulus through a huge expansion of the Fed’s turf, with minimal Congressional oversight.

A growing worry: this Fed program, like almost all other Washington power grabs, may never die. The Fed has now established the precedent that it has the power and, under its reading of its full employment mandate, the responsibility to buy long-term assets to boost the economy. The Federal Reserve System (including the regional banks) already has 22,000 employees. Its assets will soon top $3 trillion if it continues with QE2. That’s way too big for safety. Despite having little in the way of equity capital, the Fed is leveraging itself up using overnight deposits from commercial banks to buy very long-term Treasury, MBS and agency bonds. This is creating what must be history’s biggest, most leveraged maturity mismatch.

Even if the Fed stops buying bonds at its January 26 meeting, as it should, it may take years or even decades for the Fed’s existing multi-trillion dollar bond portfolio to mature and burn off. The Fed’s large bond holdings distort prices, expose the Fed (and the taxpayer) to interest rate risk, and create a conflict of interest for the Fed in setting interest rates (since rate hikes will hammer the Fed’s bond portfolio.)

The Fed is already worrying that a decision by the Fed to not buy bonds risks higher bond yields, a recipe for the Fed to buy all kinds of bonds. ... Following this logic, the Fed will be inundated with political requests that it buy other assets like muni bonds or infrastructure bonds in order to keep their yields from rising. Every rising bond yield can be blamed on inadequate Fed purchases.

Again, there's more at the link. It's worth reading the whole article.

You may ask why more mainstream economists aren't picking up on these criticisms, and publishing their own views. The answer seems relatively simple . . . the Federal Reserve has allegedly 'bought the economics profession'.

The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.

This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.

Once more, there's more at the link.

Finally, to sum up the problems with the Federal Reserve, here's Rep. Ron Paul discussing its lack of transparency.

Makes you think, doesn't it?

I suggest you write to your Congressional representative and your Senators, asking why the Federal Reserve is permitted to get away with such malfeasance in office. Personally, I think it's high time it was abolished altogether. After all, things could hardly be worse without it!

Politicians and bureaucrats! Grrr!



Chip said...

There's also pretty good evidence that the Fed was manipulated by Goldman Sachs. They have made huge sums off of every downturn.

FrankC said...

Forgive the question (I'm a rightpondian so leftpondian finance is somewhat obscure to me) but isn't the Federal Reserve a private bank? Just as Bank of America is private, but sounds good? Cf. Bank of England.