BF2S Forums Is the Federal Reserve system bad and contributing to economic woes?

Buckles wrote:

Globally recognised for being environmentally and eco-friendly. Pours billions every year into preventing climate change and invests nearly as much in youth development.

So not all financial institutions are evil and satanic.

First of all, "evil and satanic" makes those of us who dislike the idea of so much money and power gathered in one place look like morons. I would refrain from using such terms. Second, charity proves nothing. Having extra-rich corporations and banks on the one hand, and millions of people on minimum wage on the other does not change with the former dripping some money to the poor for advertisement. If ever a true effort were made to change things it would have to make sure that there be no such economic gaps in the first place. Charity is a farce, a deceiving ad.

Sorry for the late reply, would have replied sooner but I've been busy.

Yes I believe our current economic situation is a result of the Federal Reserve, and many other events. In fact it's first failure has so far been it's greatest failure, and that would be the Great Depression. With the introduction of credit, and lower interest rates, many people borrowed money and invested it in the stock marketin mass, creating a bubble in the 20's. The Dow Jones more than tripled in less than 10 years. That had never happened before. Then in 1929 it popped, and the Fed lowered interest rates again, in which the stock market started to recover (artificially mind you) and again started to collapse in 1930. The inflated money supply also began to contract, leading to price deflation which subsequently lead to wage deflation, which made debt service harder to pay back (debt service is based in nominal terms) and lead to mass unemployment.



Here is The Great Depression as examined by Austrian economist Murray Rothbard.

The Keynesians and Monetarists always point out the evil of deflation but fail to see that it was a corrective act by the market. Too much inflation lead to deflation to squeeze out the excessive inflation. They will also argue that the Fed didn't lower interest rates enough, such as Ben Bernanke and Milton Friedman. Something that would have been a recession ended up turning into the most painful economic experience the United States has suffered in modern times, thanks to Fed. It looks to be rivaled in the near future though, with the route we are going.

Now that was just one example. Let us look at the past 10 years. Fearing a recession at the end of the 90's steaming into 2000, Alan Greenspan then Chairman of the Fed began lowering interest rates, which lead to an increased flow of credit that in turn was invested in a frenzy of tech stocks, and lead to the Tech Bubble which then popped. Alan Greenspan then lowered interest rates much more aggressively to 1.25% to soften the blow of the bursting of the Tech Bubble and recession, which lead to the housing bubble, which is still collapsing and has a long ways to go.

With so much cheap credit flooding the market, it was basically being dumped at people's door steps by banks and creditors during the housing boom. "You've been preapproved for this! You've been preapproved for that!" "Bad credit, no credit, no job (in some cases), no problem." "Now you too can own a new home!" (Fannie Mae commercial geared towards minorities). And Banks were more than happy about the boom. They took huge bets on sub prime backed derivatives like CDS's (credit default swaps) and CDO's (collateralized debt obligations).

So this excess credit found its way into the housing market, and people being people bought into it collectively, and banks greatly encouraged it. But now it has come to burn them. Major banks around the world have lost hundreds of billions so far. Citigroup for example has lost over $30 billion in sub prime backed derivatives. Banks are scared to lend, and are trying very hard to gain capitol and keep it, as it is being eaten away by derivatives. This has lead to a contraction of credit, which will spread to regular mortgages and commercial loans, as well as credit cards.

With so much money being printed as a result of lowered interest rates, as seen by M3's rate of growth, inflation has been causing everything to increase in price, especially commodities. Just look at the price of gold for example. Because of this, investors, namely hedge funds, have been pouring into commodities. With oil making new highs daily, people wonder if there is a commodities bubble. I'd have to say probably, but not in all commodities.



But the biggest and most dangerous bubble is currently in the bond market. Inflation is almost always a result of an increase in the money supply, and deflation a contraction in the money supply. So looking at the rate of money supply growth, inflation is much higher (16%) than what the government says it is, and the CPI is currently at 4%. Well who in the world would buy US bond that only yield 4-5%? Central banks are, and they are willing to take losses but only at some point. Even Bill Gross, King Bond, has advised people not to buy US bonds, something PIMCO has been in business in for decades.

A flight from the dollar will turn into a flight to safety, in which case central banks will start dumping the dollar en mass sometime in the future if we don't raise interest rates (at least 10%) to save the dollar. We are in the same mess back when Paul Volcker had to come in and raise interest rates to 20% and save the dollar from runaway inflation. Although I don't think we can "save" the dollar from losing value. It will continue to lose value, however, it won't be worthless (hyperinflation) if we raise interest rates incredibly high. That will put us into a very deep recession though, possibly another great depression.

But all actions seem to indicate the Fed is willing to sacrifice the dollar in order to save the banking sector from a systematic collapse in the US and possibly worldwide, the result of hundreds of trillions of derivatives waiting to implode ($560 trillion last I checked). The Federal Reserve and Secretary of Treasury have been talking about a strong dollar policy for years, yet the dollar has been losing value. It's all talk, a ploy to fool the masses into believing they are in control and hawking on inflation, yet the Fed's policies are a result of our inflationary recession.

The Fed has been trying to create enough liquidity to inject in insolvent banks, and trying to inflate home prices as they deflate in price. It has not worked, and home prices continue to fall. The worst is not over, it has only begun. I suggest you read John Walter William's article about his predictions of hyperinflation coming soon.

And here is one thing that is interesting, surrounding the "bailout" of Bear Stearns.

Web of Debt wrote:

“According to the NYSE there are only 240 million shares of Bear outstanding . . . [Yet] 188 million traded on Mar. 14 alone? Doesn’t this strike you as being odd? . . . What percentage of the firm was owned by insiders that categorically did not sell their shares? . . . Bear Stearns employees held 30 % of the company’s stock . . . 30 % of 240 million is 72 million. If you subtract 72 from 240 you end up with approximately 170 million. Don’t you think it’s a stretch to believe that 186+ million real shares traded on Friday Mar. 14? Or do you believe that rank-and-file Bear employees, worried about their jobs, were pitching their stocks on the Friday before the company collapsed knowing their company was toast? But that would be insider trading – wouldn’t it? No bloody wonder the SEC does not want to probe J.P. Morgan’s ‘rescue’ of Bear Stearns . . .”8

Read the full article here. The Fed has been doing some very unsavory things.



And this is why we should be on a gold standard.

Is done.

While the Fed screwed up in terms of the Great Depression, it is incorrect to put most of the blame on the Fed.

While the Fed contributed to the stock-market collapse, the real cause for the GD was under consumption and overproduction, a large problem with a modern society with great wealth disparage. The companies were making too much goods without paying their workers enough that they can buy the goods, as a result the companies stopped making money.

Now this was unseen until the stock-market crash in 1929 because economists at the time looked at the stock-market as the sole economic indicator. And with the SM inflated to due on-margin investing the economists thought nothing of the decreasing employment rate, consumption and corporate profits. And since the investors didn't realize how bad things were, they continued buying stocks on margin and pouring their incomes into the SM.

We need to return to the gold standard and do away with the central bank yesterday.

I agree with CaptainSpaulding about the fed and inflation stuff. This is what is bad about the fed, they can just print money about the thin air, and they constantly keep doing this. The US paper money today is worth nothing, bury it and it's worth nothing. Who remembers way back when you could hand in paper money to the banks and get gold in return? Why can't we do that today anymore? The fed's so entirely useless, just protects banks. I don't understand why bank's need this sort of protection though, they've essentially robbed the middle class of every dollar, who's suppose to protect your everyday citizens from this garbage?

The Fed may have been implemented to create stability, but the Fed and the people who support it use every event cause by it to further reinforce their need for the Fed, and give them more powers. The Fed makes assets bubbles with too much liquidity, plain and simple. It's historically proven.

About the constitutionality of the Fed.

Article 1, Section 8 of the Constitution enumerates the powers of the government. It reads in part:

    The Congress shall have Power . . .

        * To borrow Money on the credit of the United States;

        * To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes;

        * To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;

        * To provide for the Punishment of counterfeiting the Securities and current Coin of the United States; . . .

        * To declare War, grant Letters of Marque and Reprisal, and make Rules concerning Captures on Land and Water;

        * To raise and support Armies, but no Appropriation of Money to that Use shall be for a longer Term than two Years; . . . --And

        * To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof.

Article I, Section 10, provides that "No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

Gold Eagle wrote:

The Revolutionary War era Articles of Confederation contained a clause authorizing the Continental Congress to coin money and emit bills of credit (paper money), which they did with a notorious lack of success. On August 16, 1787, during the Constitutional Convention convened to replace the Articles of Confederation, the same clause was presented to the convention by the drafting committee. The paper money proposal hit a raw nerve. Opposition was vehement. It was even suggested that the federal government should be affirmatively prohibited from issuing paper money. According to James Madison's Records of the Federal Convention (See pp 308, 309 and 310), the language authorizing the Congress to emit bills of credit was removed, but a suggestion that an affirmative prohibition be added was not taken up as an amendment. Madison's final footnote read:

Link.

Do you know why the founding fathers wanted a gold standard? They believed in liberty and the free markets, and the markets set the price of gold (it has always been stable and consistent for over 5,000 years as a monetary metal, all fiat currencies always end in ruin eventually). Having a central bank (which is a private bank with government authority) was a severe consolidation of power, in which case many of the founding fathers feared.

peirro wrote:

Some facts on the current head of the central bank:
-Ranked as the32nd best economist in the world
-John Bates Clark Medalist (the "Field's Medal" for economists)
-Highest SAT score in his state and educated at Harvard and MIT
-Head of the economics department of Princeton
-Specialized in the study of The Great Depression

So if anybody here is as qualified to bash the Federal Reserve as he is to defend it I'd like to know…unfortunately he probably won't be able to respond as he's busy saving the economy of the greatest nation on earth

What exactly are you saying? That unless anyone here has impressive scores and awards like he does, their argument against the Fed has no weight? If that is so, are you just as accomplished as Ben Bernanke to defend the Fed for him? You're not telling me anything new pierro. He obviously isn't stupid and is a very studied hard working man, but I happen to believe he belongs to a school of thought that has a flawed understanding of economics (I adhere to Austrian economics if you didn't notice).

But he has made a few bonehead statements. He said the subprime debacle was "contained". That could not be further from the truth. He also said a weaker dollar would not result in higher prices here domestically. A weaker dollar purchases less, simple as that, whether you are buying something here or over seas. And he also said derivatives were safe, and well managed.

Ben Bernanke wrote:

I think, generally speaking, they are very valuable. They provide methods by which risks can be shared, sliced and diced and given to those most willing to bear it. They add, I believe, to the flexibility of the financial system in many different ways.

And, with respect to their safety, derivatives, for the most part, are traded among very sophisticated financial institutions and individuals who have considerable incentive to understand them and to use them properly.

Actually that is just plain false. Derivatives are so huge and spread amongst so many counter parties, that many people, even many educated economists, find them hard to understand. So did he sleep during economics, or was he being dishonest? Or maybe his computer models suggested otherwise? You decide.

pierro wrote:

Your right about the Great Depression (the Fed admits they made a mistake)…but I think your grouping is a little misleading. Your taking the mainstream left and (somewhat) mainstream right and grouping them together... the fact that economists on both ends of the spectrum (except the fringe right Austrian school of economics) agree that the fed should have cut interest rates more is worth mentioning

I believe I grouped them correctly. The mainstream view is that the Fed didn't lower interest rates enough, while the Austrians believe they lowered them too much. In fact, they also believe the market should set interest rates, and that would require a gold standard.

But I do have sympathy for Ben Bernanke in a sense. Yes I think Alan Greenspan propped the economy up for political reasons, and now Ben Bernanke is inheriting the mess. However, I believe his theory of creating enough liquidity so painful deflation doesn't kick in to save the economy (or at least save it from a depression) will not work. Yes, you can defeat deflation through inflation if you create enough of it, but you will create massive amounts of inflation in the process. If we are to see another "Great Depression", inflating your way out of it would certainly result in hyperinflation.

My 16% figure came from M3, because as I explained earlier, inflation is usually the result of increase money supply (the more you print, the more you dilute), and deflation is usually the result of contraction in the money supply. So M3 gives a more accurate picture of inflation than the CPI. But if we were to disregard M3, I still wouldn't quote the CPI.

The CPI has been disputed by a number of people who feel it understates inflation. Bill Gross, Peter Schiff, Axel Merk, John Walter Williams, are just a few off the top of my head. The main complaint is the methodologies implemented over the years that have helped understate inflation, such as hedonistic quality adjustments, not taking into account food and energy prices (headline inflation, it only reports "core"), substitution based index (if people can't buy steak they will buy hamburger so no inflation), and calculations of housing costs via owners' equivalent rent. You can find a detailed article about it by John Walter Williams here.

Bill Gross wrote:

Let me reacquaint you with the debate about the authenticity of U.S. inflation calculations by presenting two ten-year graphs – one showing the ups and downs of year-over-year price changes for 24 representative foreign countries, and the other, the same time period for the U.S. An observer's immediate take is that there are glaring differences, first in terms of trend and second in the actual mean or average of the 2 calculations. These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%. The most recent 12 months produces that same 7% number for the world but a closer 4% in the U.S.

This, dear reader, looks a mite suspicious. Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity "miracle" may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% – 4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized "one price fits all" commodity driven global economy? I suspect not. Somebody's been foolin', perhaps foolin' themselves – I don't know. This isn't a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it. I'm just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference.

Full article here. Even Fed officials admit of it.



Shadowstats.com alternate measure of the CPI uses it as if it were calculated back in 1980, before the new methodologies were implemented. What didn't we get back then that we had to later implement such methodologies? And is it just a coincidence inflation has been reported low because of it? Even if you don't believe my extraordinary claim of 16% inflation, or around that area, you can't possibly believe the CPI to be true and accurate, can you?

And it doesn't end there. By understating inflation, they also overstate GDP growth. How can you find out if your home appreciated in real terms (or depreciated for that matter) if you don't know the true rate of inflation? If your home goes up in value by 5% every year, and the rate of inflation is at 5%, in real terms it hasn't done anything. If your home goes up in value by 10% every year, and the rate of inflation is at 5%, then your home has gone up by 5% in real terms, and visa versa.

So no, the economy has not been growing but is in fact contracting (you might want to read this as well), yet M3 has been surging, and is at the highest ever recorded in its series. Is it no wonder the Fed stopped publishing M3 back in 06 before Ben Bernanke started lowering interest rates? By the way, banks have been scared to lend to each other, and that means less money creation by them through fractional reserve lending, yet M3 is growing obviously from the rate cuts (you can't lower interest rates without printing money).

About the commodities bubble. The same people who say there is a bubble in commodities are the same people who said there was never a housing bubble. Maybe they wised up a bit, or maybe they are still hurt for being so awfully wrong. Jim Rogers thinks commodities are in the greatest bull market of all time (its more that the dollar is extremely bearish), but this could easily turn into a bubble since people are flocking to commodities to hedge against inflation.

I've read a lot of evidence supporting that there could be a bubble in base metals by Frank Veneroso (video, PDF). As for oil, it has skipped a number of corrections (although it did fall quite a bit today, but bounced back up). From the charts I've seen, I wouldn't expect oil to fall below $100 dollars a barrel (sorry folks, those days are over), and I especially don't think it would make a large correction until it reaches over $150-160 a barrel. But even if it makes a strong correction like that, oil will resume its upward trend.

pierro wrote:

The reason for today's minor slowdown has nothing to do with the federal reserve…it was because the banks felt free (using regulatory loop holes) to use this "cheap credit" Greenspan brought in…in increasingly reckless ways (knowing they were too important to the economy and would have to be bailed out)…if they're going to be protected by the government they should play by the governments rules e.g. regulate, but that's not the federal reserve's business

It has absolutely everything to do with the Federal Reserve and government. The Fed was the catalyst to it all with the ridiculous low interest rates. That would have never happened had interest rates been much higher (where would the credit have come from? The ECB?). Washington had also harped on lenders to lend to minorities more, saying they were being racist by denying them mortgages (in some cases yes they were). Even Alan Greenspan said so. The result was lending to anyone, no matter what (bad credit, no credit, no job).

Not to mention the Credit Rating Cartel. These agencies clearly were never qualified to give ratings, not to mention being payed to give the subprime backed mortgages AAA ratings when they were not worth it and too risky. Big Government wins again.

And despite the "bailout" of Bear Stearns (usually you are left standing when you get bailed out, not pillaged) and warning by Henry Paulson that they would not get bailed out if they continued to get in risky situations, credit derivatives jumped from $516 trillion at about the time of Bear Stearn's failure, to about $560 trillion now. Mind you that Citigroup has lost $30 billion alone from credit derivatives. Yet no matter, these people will be bailed out.

Anyways, I'm done for tonight. I'll get back to the gold standard in detail hopefully tomorrow.

edit: typos

Last edited by Phrozenbot (2008-07-14 08:32:02)