Magazine article The New American

Creating Wealth: The Federal Reserve's Ability to Create Money out of Thin Air and to Manipulate the Value of the Dollar Gives If Ultimate Control over the Purse Strings of Every American Household

Magazine article The New American

Creating Wealth: The Federal Reserve's Ability to Create Money out of Thin Air and to Manipulate the Value of the Dollar Gives If Ultimate Control over the Purse Strings of Every American Household

Article excerpt

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When the Federal Reserve announced on March 19 its latest offensive against the financial crisis--to purchase more than $1 trillion in government debt ranging from mortgage-backed securities to long-term Treasury bonds--Wall Street, the financial media, and the political classes had a conniption. Even the most diehard defenders of Fed Chairman Ben Bernanke and his monetary policies were aghast: surely this latest move would unleash long-latent inflationary forces that would cripple any prospects for a robust recovery. Even the New York Times made note of the danger, worrying that "the Fed was taking risks that could dilute the value of the dollar and set the stage for future inflation." The Times pointed as evidence to the sharp rise in gold prices and a drop in the dollar's value against both the yen and the euro that followed the Fed's announcement.

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The Federal Reserve has been in the news a lot lately, for this most recent action as well as many other headline-grabbing efforts to "get the economy moving again," as the talking heads are fond of saying. Unfortunately very few, even among the economic and business commentators in the news, truly understand how the Federal Reserve works. Were it otherwise, it would be more widely recognized that what Bernanke is doing is nothing new, except perhaps in degree. By using the Federal Reserve, with its monopoly on the issuance of currency, to manipulate the money supply, he is merely doing what central bankers like the Federal Reserve Chairman have always done--and the results will be the same that they have always been in the past.

Sordid History of Central Banks

The Federal Reserve, despite its misleading name, is in fact a type of bank known in the rest of the world as a central bank. Explained Liaquat Ahamed, a former employee of the World Bank turned financial historian: "Boiled down to its essentials, a central bank is a bank that has been granted a monopoly over the issuance of currency. This power gives it the ability to regulate the price of credit--interest rates--and hence to determine how much money flows through the economy." Central banks, in other words, are the ultimate trusts; they, and they alone, are authorized to issue a nation's money supply, giving them complete ascendancy over world finances.

Although central banks date all the way back to the late 17th century (the Riksbank of Sweden was the first), central banking in its modern form arose from the ashes of the First World War. Prior to the war, most of the world's largest economies had central banks, but although they exerted great power over world finance, they did not enjoy complete monopolies over money supplies. Nor, for that matter, were they free to create quantities of money without limit, for the world of the 19th century was a world tied to the gold standard (and, among poorer nations like Mexico and China, the silver standard). That is, money issued by banks, central or otherwise, needed to be backed by guarantees of redemption in "specie," the economists' term for precious metals.

Soon after the outbreak of World War I, European central banks, recognizing that they did not have enough gold reserves to finance an international war, suspended specie redemption so that they could begin to create money without regard for the limits of the gold standard. This was, properly speaking, the inauguration of the modern age of central banking.

"Endless money forms the sinews of war," the Roman statesman Cicero observed in the Philippics, and so it proved true throughout history. The governments of Europe, no longer bound by the limits of their gold reserves, issued vast amounts of unbacked paper money through their respective central banks to finance the war effort. The United States, which acquired a central bank of its own in 1913 with the creation of the Federal Reserve, was similarly able to fund its involvement in the war, including the enormous expense of transporting hundreds of thousands of men and armaments across the Atlantic Ocean. …

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