# How does our economy work?

1. Nov 19, 2008

### jreelawg

Trying to figure out how our economy works gives me a headache.

1) The Treasury borrows money from the federal reserve right. Where does the federal reserve get the money?

2) Does the country pay interest to the federal reserve, and if so, how much and who gets the profit?

3) Why do we need to take a loan from essentially a "bank" in the name of the taxpayers and then loan it to financial institutions adding more interest. Couldn't the people with the money at the federal reserve, loan the institutions the money directly, cutting out the extra interest the taxpayers would get?

Is it something like me borrowing 5,000 dollars at 10%, and then loaning it out to you right away at 5%. So I pay more than I get back essentially meaning a give away to you under the disguise of a loan?

Last edited: Nov 19, 2008
2. Nov 19, 2008

### Phrak

The Federal Reserve Bank is a private corporation. It's traded on the New York stock exchange. By law they are the only entity allowed to issue unredeemable notes--Federal Reserve notes. (If we write our own notes (checks) we have to have something other than another check to back it up. It doesn't go into circulation never to return home for redemption.)

New money is generated (out of thin air) in an effort to maintain the rate of inflation at a nominal 4.25%. Lately, of course, interest rates have been forced way down in an initial effort to keep corporations solvent by the availabiliy of cheap loans after the March 2000 market bubble, and lately to reduce housing loan defaults--to keep lending institutions from sucking under like they did the last time, under the fledgling Federal Reseve.

The US government is funded by taxes, and the auctioning of treasury bills and bonds. New money is generated to pay the premium on these instruments as they come due and to pay other debts incured over the course of doing government business where revenues exceed income.

The system is set up such that the Federal Reseve acts as the banker to the US government and operates via instructions from the Treasury Department. By law, the Chairman of the Federal Resever Corporation is an official appointed by the government.

I don't mean to sound as if it all makes sense and is a wonderful way for the government to be financed. The Federal Reserve was concieved by a consortium of bankers in 1918(?) or so, of and for the enrichment of said bankers, who sold the idea to the voting public that a US government owned bank, distributed across the many states was to their interests, though it it is not a government institution, nor is distributively controlled. Obstensibly the chairman to the FRC is an appointed representative of we-the-people. (However, should Potus attempt to instruct the FRC chairman, I think he'd find out he was reaching outside the range of his powers.)

An excellent text on banking and the money market is "The Money Market: Myth, Reality, and Practice", Marcia Stigum.

The conception and origin of the Federal Reserve Banking Corporation is found in "The Creature from Jekyll Island", though I haven't read it.

Last edited: Nov 19, 2008
3. Nov 19, 2008

### jreelawg

So if the federal reserve is essentially a private U.S. bank, then aren't they part of the financial system themselves. Why is it considered that the 700 billion dollar bail out is injecting capital into the system. Isn't the money already in the system. Taking a loan to give someone else a loan isn't really adding capital is it?

I wonder if some of the same people who own tons of stock in the federal reserve don't also hold lots of stock in the financial institutions borrowing the money. In that case they would be loaning money to themselves while skimming huge profits off of the losses that the taxpayers suffer in playing middle men in the transfer of capitol from the big banks to the little ones?

4. Nov 19, 2008

### CRGreathouse

I don't think it's traded on the NYSE -- I can't find it there, at any rate. Regardless, while it is a private corporation in name, it is not in practice. It remits its net profit to the US government each year.

Edit: from the Fed's website:

5. Nov 19, 2008

### jreelawg

So the money comes from private sources, it is loaned to the treasury at a rate. The profit goes back to us, except the 6% per year which goes to the stockholders. So if we are not in debt, then there is less interest being paid, so therefore we make less profit. The more we are in debt, the more interest we have to pay, the more the profit of the federal reserve and so the more the 6% is. Is that right? Is the profit of the federal reserve stockholders proportional to the amount of national debt we have?

6. Nov 19, 2008

### AeroFunk

The federal reserve system is pretty much a government institution. Congress has immense control over it and the bank is not subject to competitive pressures(legal tender laws). The federal reserve prints money that is not backed up by any real commodity, unlike when we had the gold standard and each dollar represented a bit of gold.

When the fed prints money, this causes inflation. There are now more dollars competing for the same amount of real goods. This is what is meant by the "weakening" of the dollar. But there are consequences to inflation, the fed cannot monetize all of the 700 billion bailout because this would lead to hyper inflation, the value of a dollar would become so worthless that our economy would be reduced to a barter economy like in Weimar(sp?) Germany. Inflation works in the same way as a tax.

There are some economists who believe the federal reserve banking system is partly to blame for our current economic mess (The Austrian business cycle theory)

For a REALLY good book about money and central banks read "What has goverment done to our money" by Murray N. Rothbard http://mises.org/money.asp" [Broken]

Last edited by a moderator: May 3, 2017
7. Nov 20, 2008

### Phrak

Who lobbies the legislative bodies in concerns of banking interests?

It's not completely that simple. Introduction of new money into the ecomony has long and short term effects. In the short run, prices remain stable, if the process doesn't continue for too long. But when the tape is turned down, or time mounts, inflation ensues. I'm not an economist, and causal nature of this process illudes me--I haven't studies this stuff in years. But you're certainly right that the effect over time is to devalue the currency.

Edit: If I recall the causal trail correctly, new currency initially causes increased spending as is less precious. Increased spending increases sales. Increased sales drives down the need for businesses to increase profits with higher prices. Businesses don't increase prices. The price of goods remains stable.

This causal string accurately describes the state of afairs in the early 2000's. And in these late 2000's has come home to roost.

Last edited: Nov 20, 2008
8. Nov 20, 2008

### Phrak

I think you may have me there, CR. I can't find any reference to public trade, so it's probably so. And it actually makes far more sense it would be set-up under restricted trade.

Many NPO's are immensly profitable. The FRB is no exception. How poor would you, your lawyers and your dog be with monopoly control of the bank account of the United States government; your client having revenues of 0.4 trillion dollars a year? More flush than many countries, I'd imagine.

You should recongnize the family names of some of these, not so poor fellas: Rockefeller, Morgan, Vanderbilt, Ford, Carnegie, Armour, Du Pont--and others.

OK. You have the public face. Now find the private face.

Last edited: Nov 20, 2008
9. Nov 20, 2008

### Phrak

jreelawg. I should have said so from the beginning. It's not your economy, and it's not mine. I'm refering to your opening statatement about our economy.

Last edited: Nov 20, 2008
10. Nov 20, 2008

### AeroFunk

Phrak, the federal bank is not really a private entity, the stockholders are member banks who must be stockholders. It's like calling the post office a private business. The details of the feds responsibilities are subject to congressional oversight. However, it is separated from the legislative and executive branches as much as possible to try and remove political pressure from its operation decisions as much as possible (unsuccessfully IMO).

Central Banks are often nominally owned by private
individuals or, as in the United States, jointly by private
banks; but they are always directed by government appointed
officials, and serve as arms of the government.
-Murray Rothbard in "What has government done to our money"

11. Nov 21, 2008

### Phrak

I'm sure the line gets fuzzy. But it's not a government agency. I thought this was more widely understood. It might be best described as a privatey held company where the US government is part owner.

Most water and power utilites are not agencies of local governments, but monopolies, and as such are more tightly regulated, varying with local laws and political clout.

This might help. I googled "Ownership of the Federal Reserve Bank".
http://land.netonecom.net/tlp/ref/federal_reserve.shtml" [Broken]

Last edited by a moderator: May 3, 2017
12. Nov 21, 2008

### AeroFunk

While I agree its a fuzzy line, it is far from generally being considered a private entity, it is much more public then private, at least that is what I've been taught. I don't really have much more to say other then what I've already posted. The Fed isn't regulated, like energy, but a fully nationalized government system. I would define ownership as being able to run and make decisions regarding its operation and policies, the fed's policies and operations are driven by politics and not to max profit (unlike a regulated industry, which tries to max profit in the parameters allowed by the regulators). Realize that it is not 'common knowledge' that the fed is in the private sector.

13. Nov 21, 2008

### Phrak

AeroFunk. No problem. We mostly disagree on a label anyway, rather than the operation.

Parasitic relationships, such as the FRB was originally envisioned, eventually evolve to some semblance of sybiosis or perish.

If miffs me that I can't respond properly to jreelawg's questions. At one time I read, or heard the full transactional relationship between the Treasury and the FRB, the movement of money (initiated by bill auctions?), but I seem not to have the source material.

Last edited: Nov 21, 2008
14. Nov 21, 2008

### Phrak

Federal reserve agency:
http://www.the7thfire.com/Politics%20and%20History/Federal-Reserve.html" [Broken]

It gets a bit weird, and hysterical, but somewhat imformative.

(btw, what is the federal reserve reverving?)

Last edited by a moderator: May 3, 2017
15. Nov 21, 2008

### jreelawg

So as I think I understand it, most of the Assets of the federal reserve are based on the ability for the country to pay taxes. (hence the phrase "loaning us our own money with interest") Right now we are "injecting capitol into the system", but that doesn't make sense because our GDP is falling. It seams that we will only devaluate the dollar. More money in circulation less GDP, etc.

So there is no extra money added, there is no additional assets added to be invested. So, the only difference between giving the financial institutions 700 billion and not, is who invests it? Capital will be transfered from the taxpayers to the hands of the financial institutions assuming they will manage it better than the public. But what about the investors over seas who are getting the part of the transfer? Is that capital transfered out of the system to another nation, or large private entity.
If we didn't "inject capital", or rather "transfer the capitol", more money would be in the hands of consumers, and less in the hands of profiteers, which would eventually correct itself right?

Last edited: Nov 21, 2008
16. Nov 22, 2008

### Phrak

The assets of an entity are what that entity owns---what it posesses. In the case of the FRB these consist of currency, the stock value of the corporation itself, and some gold. The majority of it is currency.

Boat loads of currency have been dumped into the system since 2000. When you see the prime lending rate low, that means that they're still at it. It's a activity called "open market operations," and yes, it's devaluating the dollar. They knew this would happen, but took this option anyway in order to keep the economy producing. I'm sure the hope is to let the ecomomy down gently rather than crashing it as happened in the 30's.

In the late 20s and during the 1930's the US government took the opposite tactic to cool-off the over-inflated market and let the free market decide what businesses were viable. Capitol gains taxes were raised. Stock market frenzy had driven stock pices to irrational levels not reflected in their dividends. This strategy was called liquidation. The general concensus among ecomonists, was that the way to return the ecomony to stability was the via the school of hard knocks. ( I must sound like a economist myself, guarenteed to put one to sleep. Sorry about that.)

The bottom line is that we are in for an inflationary cycle, high rates of inflation, housing forclosures, lending institution failures, and a stock market that shouldn't recover, in terms of 2000 dollars, for several decades. Most of this has become old news. If you can think of anything else the occured in the thirties you can probably add that to the list. Maybe Obama will have a "new deal" of his own.

Sucks hu?

It doesn't take long for the majority of wealth to get locked up in the hands of a few. So millions of people who didn't know bit from byte invested in blue-sky stocks in the hell-bent endevor break into wealth---they too want to be one of the few. The emergent technology of PCs and the intenet and communications (once again) provided this oportunity. Some made it, some bet wrong. In any case a lot of money was invested in efforts that failed to break even. (Commerce and communications have been responsible for the last three recessions, this one included, if I recall correctly.)

Why should more money in circulation reduce the GDP? I don't see the cause and effect trail, if there is one. Can you explain?

We are going to pay for this either way. The federal reserve and the government don't work. They don't generate value. We do. The mint can print all the money they like. It has no value. Labor has value. Everything else is bookkeeping.

Last edited: Nov 22, 2008
17. Nov 22, 2008

### BWV

The gov is attempting to recapitalize the banks because without the availability of credit, business activity will grind to a halt and a vicious cycle of deflation where failing businesses sell assets, lay off employees which in turn creates falling prices and weak demand which causes more businesses to fail, laying off more employees, etc. Putting the money in the banking system will cause it to get lent out. The decisions on extending credit are far too complex for the government or anyone other than the banks to decide - they are the only institutions that have the knowledge to do this. These operations are being funded by investors who are liquidating their holdings of risky assets and purchasing treasury securities. We are borrowing from future tax revenues because if we do nothing the ensuing recession will destroy them anyway. The mistake of the 1930s was thinking that the private sector and the government could both tighten their belts at the same time. The systemic risk is that everyone cannot stop spending, sell assets and pay off debt at once, there has to be buyers on the other side. This is the role the Fed is playing - and successfully in many ways. They have for example been issuing 30 day Treasury bills at 1% or less and buying commercial paper yielding 2 or 3 times that and earning the spread. GDP is falling because there is a lag between the current slowdown and the impact of the stimulus

18. Nov 22, 2008

### jreelawg

I didn't didn't mean to imply that more money in the system reduces GDP, I just meant to state the fact that our GDP is going down in this current case, and the federal reserve is adding currency to the system when at the same time the value of the system happens to be falling in value, and the combination of the two seams like a bad recipe.

I have a small savings that I was planning on living off of, but now Paulson is slicing up the value of my savings in the hopes I will be able to get a job instead to earn new money. How can people who are retired cope with that? They will see their money worth much less, and they won't be able to work it off.

It seams contradictory, why don't we inject capitol into the system when the economy is booming, and the federal reserve has plenty of capitol?

Last edited: Nov 22, 2008
19. Nov 22, 2008

### Phrak

Yeah, it is. The 20's depression was the deepest because it was mis-managed. This time, they choose the exact opposite cure. I hope it's better than the do-nothing strategy.

If you move your parts of your savings out of dollars, you want assets that are easily liquified, have a low rate of exchange, are secure, and are not already inflated.

You have to think greed. We don't inject capitol and we don't decide when--the bankers do. If you are a banker what maximizes your wealth?

Before the poop hit the fan, the strategy was to maintain the prime lending rate at 4.25%. We, as banker, want high interest rates. But too high, and we strangle the economy. A nice heathy economy keeps us rich.

I'm repeating myself, but huge amounts of new currency were injected into the economy to keep corporations solvent by making available low interest rate loans. But there is a side effect. It also makes housing loans cheaper. To cure the stock market trouble, they aggrivated a housing bubble, as a side effect.

Now we see lending institutions failing from assuming too much bad debt (home loan defauts). What do we, as FRB bankers, do? We don't want a domino effect taking out productive industry. We, as bankers, thrive on a $healthy ecomony$. We pump in more money to keep housing from crashing to the deck and to prevent more lending institution failures. We pump in more money to keep businesses from laying off employees. We want the employees working so they won't default.

Last edited: Nov 22, 2008
20. Nov 22, 2008

### AeroFunk

The "do nothing" strategy of Hoover is a myth, he enacted a huge tariff and intervened in the economy a lot, see these http://econlog.econlib.org/archives/2008/11/hoover_sings_hi.html" [Broken]

Last edited by a moderator: May 3, 2017