March 28, 2008

Federal Reserve System

Stupid Question ™
March 28, 2002
By John Ruch
© 2002

Q: My co-worker says the Federal Reserve Bank is really a private cartel that lends the US money, with our taxes paying the interest. True, or conspiracy theory?
—Dara Naraghi

A: Your co-worker left out the most important part—it’s all a Jewish plot.

This inane conspiracy theory has traveled the classic path: from genuine political concerns, to distorted paranoia, to mainstream trickle-up.

The Federal Reserve System is a central-bank system which consists of 12 regional reserve banks (plus 25 additional branches) and the overseeing Federal Reserve Board in Washington.

All nationally chartered banks are required to own stock in their regional reserve bank, and to keep some specified percentage of their deposits in a reserve bank account.

The Fed regulates the economy by controlling the price and supply of money. Its main methods are raising or lowering the required-deposit amount for member banks, and setting the interest rate at which banks get short-term loans from the reserve banks or each other.

The Fed also circulates currency, regulates banking and provides various industry services.

It is certainly a government agency, with the board appointed by the president and confirmed by Congress.

The Fed began in 1914. Like America’s previous two short-lived central banks (established after the Revolution and the War of 1812), it was controversial from the start.

The main concern was its autonomy: it sets its own budget, funds itself, operates largely in secret and single-handedly creates monetary policy. (It wasn’t even subject to Congressional audit until 1978.) It’s technocratic, not democratic.

Other complaints: it doesn’t work as well as a free market; it participates in an industry it regulates; it benefits banks instead of borrowers. And it gets lumped together with other controversies, such as the gold standard and the national debt.

But even the original debate was colored by unfounded bigotry and paranoia about foreigners and/or Jews controlling the system.

The private-cartel claim relies on the fact that private banks hold stock in the regional reserve banks and also appoint six of the nine board members for each reserve bank. Obviously, private bankers have influence. But they clearly don’t have political control of the banks or the system. Furthermore, member banks aren’t like corporate stockholders; their shares don’t buy them control or voting rights.

Much is also made of the fact that the system was planned by private bankers and was originally intended to be completely private. But this is no conspiracy; giant private banks had long provided Fed-like services—except in a more sloppy and selfish fashion that often caused bank failures.

Probably feeding the paranoia was a 1912 scandal in which it was revealed that a group of large banks secretly controlled more than 130 other corporations—a true private cartel.

I don’t understand the government-loan claim. The Fed does serve as the government’s bank, and it makes most of its money on Treasury bond interest. But it gives all of its profit to the US Treasury ($25.4 billion in 1999), which thus gets nearly every cent back.

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