Saturday, July 28, 2007

On the issues: Monetary Policy

Okay, I'll admit it's not the sexiest topic to discuss, but I think it's important to provide some insight into what exactly is America's monetary policy and the impacts our current policy has (hint - it ain't great).

Definitions -
U.S. Dollar: a good question is what is the value of a dollar, or what does legal tender really mean? So, how much is that dollar bill in your pocket worth? As much as I am obsessed with getting as many of those little green pieces of paper as I can, I honestly couldn't have told you much about this whole topic despite having college level courses in economics... that is until I started researching Ron Paul and his "crazy" ideas. I knew, from my schooling, that we ended the Gold Standard like 100 years ago or something and that was meant to allow us to control the amount of currency in circulation to prevent things like the depression. Sound about right?

So here's the first problem - if we aren't on the Gold Standard, what gives our money value? The shortest answer is, nothing. In the 1970's, Nixon finally severed all ties between the gold in our reserves and the dollar. Prior to this, the dollar could have theoretically been exchanged at any time for a fixed fraction of an ounce of gold. So, what was the gold value replaced with? Nothing but a faith in the American government. Or rather, how many goods and services people were willing to give you in exchange for that dollar bill. It frankly isn't worth the paper it is printed on as, if you went to the Fed with a dollar bill to exchange it for something of value... all they'd be able to do is give you... a different dollar bill.

The second problem is that it's a fiat currency. I'm not making fun of the money, I'm just saying that the government has created the money (fiat essentially means "by decree"), in this case out of nothing, as a form of legal tender. What's legal tender again? It's money that can legally be used in the repayment of debt. I hate to point out the obvious, but it's also the only way you or I can pay our income taxes. As funny as it sounds, the Federal Reserve System (we'll get to that in a second) and the personal income tax were both created in the same year - 1913. Coincidence??

Problem 3. Who makes the money? Well, some people would say, the U.S. Mint or the Bureau of Engraving and Printing. They'd be technically accurate as the BEP prints the bill, and the mint makes the coins and since the bill is technically worth nothing anyway, the Mint or the BEP must have created it right? Well, no. They only create the money that the Federal Reserve "essentially" tells it to. So, let's talk a minute about how the Federal Reserve creates money (out of thin air.)

Federal Reserve System: AKA the Fed, is designed to control the value of the dollar and other "national goals" such as encouraging economic growth or controlling inflation by managing the amount of currency in circulation and by determining the interest rate the Federal Banks charge other banks that borrow money from the Fed. The Federal Reserve was created in a kinda shady way back in 1913. As you'll see, it is neither Federal nor is it much of a Reserve. Some say it's about as Federal as Federal Express. It's not exactly true, but it's pretty darn close.

So who's the Fed? The Fed is essentially a private or independent entity created and overseen by (to some degree) congress. It is, in essence, the Banker's Bank, made up of 12 regional Federal Banks overseen by a board of governors appointed by the President and confirmed by congress. I guess I should point out that the list of candidates for these positions is suspect and from what I've found is essentially created by the Banks themselves... but regardless, the banks have to do what the board of governors says. However, these Banks are "owned" by shareholders, and while we don't know really any specifics (boy they sure do love their secrecy...), the shareholders are other private banks. In fact, banks that are member banks must purchase/own stock equivalent to 6% of their "capital and surplus". That may seem like a lot, but the Fed allows them to really only keep 3% of their assets with the Fed... the other 3% is "callable" by the Fed at any time... hmmm. Wait. It gets better. The revenue from the fed is then used to pay the shareholders 6% dividends each year. That's 6% of their 6%, not 6% of their 3% that they actually have in the Fed. Nice racket if you can get it, right? Just wait till we find out where the Fed gets the vast majority of it's revenue!

Okay, so that's not too bad, right? Why is the fed really evil? Well, it comes down to it's manipulation of the amount of currency in circulation (using what they call Open Market Operations) and fractional reserves.

Fractional Reserve Banking: One of the Fed's responsibilities is setting Reserve Requirements for other banks. Let's see what this means with a practical example: If a fictitious bank named "Local Bank and Trust" had checking and savings and various other accounts with a combined balance of $1,000,000, the bank is only required to keep a fraction of that - normally around 10% - in reserve. They should then be able to lend 90% of that, right? Well, Yes and No. See, through the magic of fractional reserve banking, the amount of money that will eventually get loaned back out is actually more like $10,000,000. See, the original $900,000 that is lent out is then spent, right? When it's spent, it goes into someone else's bank account and shows as a deposit. The bank that accepted the deposit can then lend that money out at 90% of what was deposited... etc. When you total it all up, the banks are lending way, way, way more money than they have in assets.

Open Market Operations: When the Fed decides that it needs to increase the supply of currency in circulation, it "buys" government bonds and securities. When it decides to decrease the supply, it "sells" government bonds (it rarely ever does this). "Buying" these securities and increasing the money supply by a little bit of new money is one thing, you also get to factor in the magic of Fractional Reserve Banking to multiple that new money by about 10 times.

Anyway, how does the Fed get the money to "buy" these bonds? That's easy, they just make it up out of thin air. Well, the money isn't backed by anything so that makes sense. But wait. It gets better. Because this new money is actually backed by government bonds, these are actually liabilities that the government (ie, the American Taxpayer) have to pay back to the Fed at interest. So all the money that the Fed makes out of thin air, they then get paid back at interest... So, how much money are we talking about? From the current balance sheet of the Fed, it looks like they are holding a little under 800 billion dollars worth. And who benefits? The commercial banks that own stock in the banks. Who suffers? The people who have to pay the government to pay the interest on the money that the Fed created out of thin air!

So what's the solution? Some advocate removing the fed's backed paper money and replacing it with U.S. Notes that are actually owned by the government instead of the fed. That's viable to an extent, but because it's still just paper money, the government is apt (especially in times of war), to increase the money supply, thus devaluing the currency. How apt is it? Well, pretty much every (if not absolutely every) fiat currency ever created has eventually gone the way of the dodo.

Ron Paul's suggestion is that we migrate slowly away from the fed by first legalizing competition for the Fed's notes. What that means is that you allow hard money, gold and silver backed currencies for example, can be bought and sold without having to pay sales taxes or pay capital gains taxes. This will force the Fed to restrict the money supply using it's various means such as requiring higher reserves and stop creating more debt at interest for the American taxpayers to pay back. We can get rid of the Fed... it'll take time. There's no doubt that there are hard times ahead regardless... but doing something positive for the economy now, before inflation and the business cycle of booms and busts caused by the Fed's activities completely wipes out the middle class of this country, is essential. The only candidate to even understand these concepts let alone talk about them in public? Ron Paul.

Tuesday, July 17, 2007

"We love Americans. We hate Bush"

Sorry for being away for a bit. My wife and I were traveling around Europe and into Russia so blogging was the furthest thing from my mind. But a funny thing happened as we came into contact with dozens of people from all walks of life, all different countries and with as varied political leanings as you could find... we found that one thing united them all - every single one of them hated Bush. We would ask our Russian and Estonian guides about if they had any antagonism towards Americans - and without fail they would say "No, we love Americans. We just hate Bush." Whether it's the Brits, the Germans or any place in between, they all are frustrated with the man in charge.

And I found myself agreeing with them. It's not because I like their politics - Europe's socialistic tendencies frighten me... some of whom pay income taxes as high as 50%, and yet they still have to pay VAT and various other nickel and dime type rip-offs. What connected me to them was that we all agreed that he's walking around like we're the big man on campus... and I ALWAYS hated that guy. I certainly don't want to be that guy. What surprised me even more was how influential the US is to these people. They are essentially being forced into a US government led war, not just in Iraq but the middle east as a whole. They are being told they are either with us or they are against us. Their countries are being held hostage by leaders who dare not defy the will of Bush. Despite that, for some odd reason American culture, American people and American freedoms are still held in high regard. How long that can last when we continue to elect people who feel that the US has a moral obligation to police the world and launch preemptive wars (without declaring them) against other sovereign nations? Tell me, how can we not take our duty as voting American citizens seriously and finally elect someone who treats others the way we'd like to be treated?