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During the war for Independence, The continental congress printed vast sums of paper money to finance the war. The deluded money supply naturally depreciated to almost nothing, leading to the phrase, "not worth a continental". The people who held on to the paper money, generally attempting to show patriotism and the support for indepence from the British Empire, lost everything.
The Gold Standard was introduced in 1834, the Dollar was worth approximately 1/20th of an ounce of gold. The gold standard was understood by the founding fathers as being a "money of the people", it was "hard money", money that could not be tampered with., that could not be inflated to permit government expenditures skyrocketing.
By 1862, Abraham Lincoln needed to fund his invasion of the South, so once again, the goverment began printing paper money abandoning the gold standard to finance the civil war. Most major wars throughout history cause the abandonment of the gold standard due to its limitations placed on goverments in need of financing.
Lincoln's notes were called "greenbacks" as they were printed in green ink, rather than the usual black ink on the reverse side, hence green "back". These so-called "fiat notes" were deemed legal tender by the government but they were not redeemable in gold.
The government's power to print unbacked paper notes would later become the pillar of the Federal Reserve system.
After the Civil War the nation's monetary system became sounder when the US adopted a gold standard in 1879. This led to the greatest period of growth and prosperity in quite possibly the nation's history. For nearly 20 years, the total output of goods and services grew at an unprecedented rate of 4% per year. With a sound money and without the ability to manipulate the interest rate Americans saved and invested which then led to more capital goods and higher labor productivity in the United States.
In the midst of this prosperity the big industrialists and financiers were plotting to expand their empires with the help of government. With the passage of the interstate commerce act of 1887, the larger railroads succeeded in blocking their smaller competitors through regulation. Essentially, the ICC was put into place to protect the railroad owners from competition, it was not to protect consumers or shippers in fact consumers were ultimately hurt by this act as they were forced to pay higher prices for the goods and services that were shipped across the country.
By 1896, they were poised to do the same thing with the banks. Two camps emerged as leaders in this economic war. They were led by J.P. Morgan, the world's most powerful private banker, and John D. Rockefeller, the oil tycoon. They were great adversaries however they both favored a central bank. They wanted cheap credit as well as an inflated money supply in order to finance the expansion of their empires. Together, they led the campaign to sell the idea to the American public which later led to the founding of the federal reserve.
If the American people were to catch wind of the fact that this central bank was not in their interest, if they understood that it was only in the interest of the financial elites who would use it to inflate the money supply and in doing so increase their own revenues, there would have been hell to pay. Legislation would have never been passed with the truth therefore it had to be sold to the American people as a way to make their currency more elastic.
The bank reform campaign received a boost in 1907 when there was a run on some of New York's biggest banks thanks to their fractional reserves. Panic spread among depositors who got wind of the bank's insolvency and tried to withdraw their money. Wall Street quickly adopted the fear of bank failures to sell the idea of a central bank or lender of last resort to the American public. And so the federal reserve would be used to bail out banks.
In 1908 bank failures continued at an alarming rate. The national monetary commission headed by John D. Rockefeller's father-in-law Senator Nelson Aldrich was established to push for a central bank.
In November of 1910 under the guise of a duck hunting trip, six men took a secret train ride to an exclusive private club on Jekyll Island Georgia to write a central banking act. The classified gathering read like a who's who of American banking. There were two Rockefeller men, Aldrich, and Frank Vanderlipt of the national city Bank of New York, and two morgan men. Also attending were Paul warborg accume lobe partner, and assistant Treasury Secretary A.P. Andrew who was friendly to both camps. The proposals for the federal reserve were drafted over one week, it would be three years before their vision was realized. Just before Christmas 1913 the federal reserve act was passed by Congress and signed by President Wilson. He established a federal reserve system to oversee monetary policy and regulate the commercial banks.
There are 12 reserve banks concentrated in the East and Midwest. The Board of Governors of the federal reserve controls and coordinates their activities. The board is made up of seven members appointed by the president. Even though there were 12 regional banks, Wall Street soon ran the show. As president of the New York Fed, morgan protégé Benjamin Strong seized control of the board's open market committee operations. Strong would remain the dominant force at the Fed until his death in 1928.
The Federal open market committee now based in Washington directs the Fed's most important instrument of monetary policy, the purchase and sale of government securities on the open market. To increase the supply of money and credit, that is to inflate, the Fed buys government securities from a few hand-picked firms with newly created money. To tighten money and credit the Fed sells securities, in this it can act on its own discretion.
Every government wants the ability to create new money, it's an alternative to raising taxes, taxes evoke a lot of resistance among the public. It's much less painless to increase the money supply, the negative effects do not occur until the future at which time the increasing prices can be blamed on other factors such as the weather or speculators.
Another device the Fed uses to control the amount of money in circulation is setting the discount rate. This is the interest rate charged to member banks when they borrow short term from the so-called discount window. If the Fed lowers its discount rate for its loans, commercial banks will likely borrow more from the Fed this increases the amount of funds banks have to lend. Bank credit thus becomes cheaper as reflected in cheaper interest rates on bank loans and credit cards. The increase in funds available for banks to lend also increases the amount of money in the economy.
The Fed can also manipulate the nation's money supply by raising or lowering the reserve requirement. Banks are required to set aside a percentage of their deposits as reserves to meet depositors demands, when the Fed was established in 1913, it cut reserve requirements in half over the next four years doubling the money supply by the end of World War I.
But the feds of real power lies in its monopoly to create money. Although the US was still on the gold standard in 1913, it was quickly eroded as the Fed continue to expand the money supply. The first step was backing federal reserve notes by only 40% in gold allowing the money supply to increase 2 1/2 times. The inflationary effect of fractional reserve banking was also heightened by the central bank. Commercial banks are only required by law to hold reserves, in the form of federal reserve notes, of 10% to back all demand deposits that they have, therefore at 90% of the demand deposits are backed by nothing.
The federal reserve adds another inflationary layer to an already unstable banking system. For example if the central bank has $100 worth of gold reserves in its vault and a 10% reserve requirement it can print up $1000 worth of new notes and deposits, which become the reserves of the commercial banks. The commercial banks take this $1000, and if they are required to only hold 10% reserve they can multiply the $1000 into $10,000 through fractional reserve loans. So, an inverted pyramid is formed with $100 of gold creating $10,000 of paper money. As this $10,000 of new paper money circulates throughout the economy it drives prices up therefore reducing the buying power of ordinary citizens. The people that get the new money first are able to buy products with it benefit, and the people who get it at the end lose because when they go to spend it prices have already risen. There is a transfer of wealth and power from some segments of the economy to others because of the actions of the central bank. Those who benefit is the government, big banks, government contractors, and anybody who is closely associated with the federal government.
By making enormous amounts of credit available, the Fed can also drive down interest rates, sending out the wrong signal to investors. It sets in motion an unsustainable investment boom that carries with it the seeds of its own distruction. It's this business cycle that is ultimately responsible for economic disasters such as the Great Depression.
Money, Banking, and the Federal Reserve.
Ever wonder what the Fed IS and how is was established? Or, why interest rates play such a significant role in our economy? Those answers and much more are revealed in this 40 minute documentary.
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Section I - Stock Market Overview
Section II - Buying and Selling Stock
Sections III & IV - Fundamental and Technical Analysis
Section V - Diversification
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