A Century of Money Mischief

On precisely the same weekend in November as the Republican victory parties in and around Washington, the Fed celebrated its centennial far away from its DC home at Jekyll Island, Georgia. One hundred years ago, seven US Congressmen and bankers gathered together in secret at this highly remote location to lay the political foundations for what would become, in 1913, the Federal Reserve Act. The ostensible purpose of creating the Federal Reserve was to provide for greater financial stability in the wake of the US banking panic of 1907. So how has the Fed fared in this role?

Well the Fed has come a long way in its first hundred years, to be sure. Let’s consider for a moment this summary of the first eighty of those, by quoting G. Edward Griffin, historian and author of The Creature from Jekyll Island:

Since it was created in 1913 the Federal Reserve System has presided over the crashes of 1921 and 1929, the Great Depression of 1929-39, recessions in the years 1953, 1957, 1969, 1975 and 1981, and a stock market Black Monday in 1987. We all know that corporate debt is soaring, personal debt is greater than ever before, both business and personal bankruptcies are at an all-time high, banks and savings and loan associations have failed in greater numbers than ever before in our history, interest on the national debt now consumes half of all of our tax dollars, heavy industry has all but been replaced by overseas competition, we’re facing an international trade deficit for the first time in our history, 75% of downtown Los Angeles and other metropolitan areas are now owned by foreigners and over half of the nation now officially is in a state of recession.

That is the report card for the Federal Reserve after eighty years of stabilizing our economy. I don’t even think it’s controversial to say that it has failed to meet its stated objectives. The only controversial part is, why has it failed?

Why indeed? There are, of course, two possibilities: Either the Fed is incompetent or, alternatively, it has a set of objectives other than those explicitly mentioned in the Federal Reserve Act. Rather than speculate on which of these two is correct here, let’s quote Mr. Griffin again, this time regarding his understanding of the bail-out practice known as “Too Big to Fail”:

Every time one of the big banks gets into trouble, not the small banks remember, they’re the competition, the big banks get into trouble and they are bailed out at taxpayers’ expense. Always in the name of protecting the people… The bank goes to Congress and says “you know, you’d better do something about this because if we have to write that loan off our books we may be bankrupt, we could fold. And look at all of the depositors, good Americans, who have their accounts with us who would lose their deposit. Maybe the FDIC won’t be able to cover; we could have a crisis on our hands. If our bank fails maybe the other banks will fail too and we’ll have a national recession. Look how the people will suffer.” So Congress dutifully steps forward–remember it’s a partner in this–and votes the funds to guarantee the loans or in some way to pass the payments on directly or indirectly in some very ingenious methods to the taxpayer.

And let’s not forget that the Federal Reserve has not done a particularly good job at protecting the purchasing power of the dollar through the years. Once again we quote Mr. Griffin:

[W]e’ve had a known inflation of 1,000% since the Federal Reserve System was created. Another way of phrasing that is that a dollar in 1913 buys about nine cents worth of goods. That’s how much money has been taken from us, taxed from us, through this hidden process.

I say 1,000% inflation that is known because it’s much more than that. Have you ever wondered, as I used to, why don’t we have more inflation than we have had? I knew they were creating this money like crazy, why only this inflation? And then I found out. Have you ever heard the expression that we’re “exporting our inflation.” Every once in a while you find that phrase in the financial section of the newspaper. It used to drive me crazy–how can you export inflation? It’s one of those phrases that people use and I’m not sure most of the people who use the phrases know what they mean. Like the other day I read that the Federal Reserve System bought dollars today to bolster up the dollar. How can you buy dollars? What do you buy it with? They buy it with other currencies, the Federal Reserve holds a lot of different currencies, yens and marks and that kind of thing so they just swap currencies around.

This expression of exporting inflation–what does that mean? It means 70% of the American currency that has been created by our Federal Reserve System is no longer in America, it’s overseas. Other nations use American dollars as their unofficial money supply. Especially those countries which have no realistic money of their own.  These countries that undergo inflation rates of 5,000 and 10,000% a year, you can’t work with money like that. Women have to take wheelbarrows full of paper money to the grocery store to buy a bottle of milk. You can’t carry on any serious economic transaction with money like that and they don’t, they use American dollars.

All the banks in those systems have dual types of money. American dollars are the mainstay of economic transactions in most of those countries. That’s where a lot of our money went. We have been spared the inflationary impact of all that money because had it stayed here, it would’ve bid against the existing money here and would have diluted our pot even more and we would’ve known what the inflation should’ve been.

What happens when the day comes when for whatever reason these countries can no longer, or no longer wish to, use American dollars? What are they going to do with those dollars? They’ll send them back. They’ll buy something with them while they can. It’ll be a big rush. It’ll be our refrigerators, our automobiles, our real estate, our high-rise buildings, our corporate stock, our politicians, whatever’s for sale. All of this money will come in and then we’ll find out in a very short period of time what the true inflation rate really should have been all of these years.

Those words were spoken by Mr. Griffin some twenty years ago. They are even more relevant today, following the Fed’s disastrous, serial bubble blowing activities of the past two decades, the colossal buildup of global economic imbalances, the exponential growth of the money supply and the federal debt, the monumental moral hazard of bank bailouts and most recently, the beginning of the next round of Fed balance sheet expansion known as QE2.

For those skeptical of Mr. Griffin’s view presented above, that the structure of the Federal Reserve System was designed primarily to protect the large banks rather than to safeguard the purchasing power of the dollar, please consider the Federal Open Market Committee (FOMC) voting structure: Whereas each member of the Board of Governors in Washington and the President of the New York Fed always have a vote, only four of the regional presidents may also vote at any one time, on a rotation basis. This implies that, even in the event that all four voting regional presidents dissent from a vote, the Board of Governors in DC and the NY Fed President will nevertheless carry a 2:1 majority! In other words, the power resides clearly at the political center, not the periphery. And historically, dissenting votes have come overwhelmingly from the periphery.

Well, we’re quite certain the Fed enjoyed its party on Jekyll Island. But as the champagne was popping and a jeroboam was smashed against the hull, the QE2 was leaving the dock. There is no reason to believe that this particular Fed policy voyage will be any less calamitous than those that have come before. Have a check around now for life vests and boats, they may be in short supply before long.


John Butler,
for The Daily Reckoning

[Editor’s Note: The above essay is excerpted from The Amphora Report, which is dedicated to providing the defensive investor with practical ideas for protecting wealth and maintaining liquidity in a world in which currencies are no longer reliable stores of value.]