How is natioanal wealth (money) created?

How is national wealth created, assuming it has neutral trade with other nations, and is not plundering other nations?

By this I mean how is the amount of capitol (real money whether electronic or hard copy) available to the citizens of a particular nation increased.
Now I know wealth can mean simple something of value. If Bill Gates has a major innovation in his products, he has increased his wealth, but only if someone can buy it. Gates' innovation has increased his personal wealth, but has it increased the nation’s wealth (spendable capitol)?
In the case of the USA, I believe the FED introduces new “money” into circulation through preferred borrowers, but no proof to this.

It can simply be manufactured (printed), but of course inflation will be a concern. Printing has to occur a relatively slow rate.
Does it matter if the new money being printed is represented by a new widget (which has international value) one of the citizens discovered/found/etc.?

In particular, I’m wondering why it is not true the Money Pie is a limited size, able to be divided only so many ways.
How true is the statement “Everyone can be a millionaire” (assuming hard work, etc, etc…)?

 

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http://en.wikipedia.org/wiki/Money_supply

If everybody owned a share of company x and for some irrational reason the stock price rose until it traded at one million a share then everyone would be millionaires.

Central banks try to keep some sort of relationship between the money supply and GDP.

 

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MONEY and WEALTH are two different things.

Wealth can be purchased with money and money can be obtained by liquidating (selling) wealth, but talking as though they are the same thing is confusing.

psikeyhackr

 

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No ...money is just a SYMBOL of wealth, it's not wealth unless the money has some value. And for money to have any value, it must SYMBOLIZE wealth.

Money is just a convienent way of carrying your wealth around in your pocket, but it ain't the wealth.

Baron Max

 

I won't disagree. No point in discussing the words about what we are discussing instead of discussing what we are discussing.

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nirakar: Here is what you gave me:

The supply of money can only increase if the money is first "printed" by the issuer of money, the independent Federal Reserve. The Federal Reserve "prints" coins and bills and electronic money. The Federal Reserve is subject to laws such as the Freedom of Information Act and the Privacy Act which cover Federal agencies but not private corporations; yet Congress gave the Federal Reserve the autonomy to carry out its responsibilities insulated from political pressure.

Each of the Federal Reserve's three parts – the Board of Governors, the regional Reserve banks and the Federal Open Market Committee – operates independently of the federal government to carry out the Federal Reserve's core responsibilities. Once a member of the Board of Governors is appointed, he or she can be as independent as a U.S. Supreme Court judge, though the term is shorter.

The "printing" is usually done with the Fed buying government debt. The government debt can be bought directly from the government or from public holdings (primarily banks). In the United States the decision on how much government debt the Federal Reserve should buy is decided by the Federal Open Market Committee (FOMC).

The process by which the M0 money supply is managed is known as open market operations.

The big chunk of the money supply, M1, M2, and M3, are types of deposit accounts. The first balance sheet item in a bank is usually deposits. If $1 end up as a deposit in a bank (bank liability), depending on what "reserve requirements" that deposit has, the whole sum or almost the whole sum can immediately be lent out. If the deposit has no reserve requirement the whole dollar can be lent out, and the borrower can buy an asset, and the seller of the asset can place the proceeds in another money supply constituent deposit. And the money supply is now $2 or close to $2. That money can then in theory continue to increase many times over.

The Federal Reserve decides the level of "reserves of depository institutions".
Monetary policy has effects on employment and output in the short run, but in the long run, it affects primarily prices.

The balance sheets:
This is what money supply growth may look like starting with 1 new dollar of deposits. The money is moving from left to right. The federal Reserve buys a government bond from Bank 1 for $1, Bank 1 lends the proceeds to Person 1, who buy an asset from Person 2, who deposit the proceeds at Bank 2, who loans it to Person 3, who buys an asset from Person 4, who deposit the proceeds in Bank 1, and the money supply is $2.

~ ~ ~ ~ ~ ~ ~~

Here are some questions:
How did Bank 1 get the government bonds it sells to the Fed? Didn’t they buy them at a discount rate?
If they bought them, what price did they pay for a $1 bond?
Comment: It seems to me that essentially they buy $1.00 bonds for, say, $.98. Isn’t this a gift to the banks?
Isn’t our government just giving money away to bankers?

~ ~ ~ ~

But where would the "money" come from.
If all of the shares were sold, where did the money come from to buy it? There is not that much money in circulation.

 

Every minute when there is a imbalance of buyers and sellers for a particular stock the specialist at the NYSE or the computer at Nasdaq will raise or lower the price of the stock. That is where the wealth comes from and goes to. In other words the wealth comes from nowhere.

Bill Gates made and lost fortunes as the value of Microsoft shares rose and fell with the tech bubble. The average net worth of stock holding Americans rose and fell with the tech bubble. It was vast sums of wealth created from nowhere and returned to nowhere and the Federal Reserve had no control over that.

 

Sorry, that dog won’t hunt.
You are looking at transactions as merely numbers on a ledger sheet. You fail to see the real transactions.
When the stock is bought, some person had to say, “Okay, I have this money sitting over here doing something (whether owning other stock, in a savings, etc). I’m going to take that money and buy Bill Gates' stock.” And so they do.
Or they will say, “I want the stock, but I don’t have any more money available. So I will borrow money (from someone who actually has money to lend) to buy it.” And so they do.
No one says, “well, I don’t have any money, but I am going to buy some of that stock.”
If they tell someone at NYSE “I want to buy some of that stock, but I don’t have any money”, what is your reason for saying the NYSE says “Yeah, no problem, buy all you want. You don’t need money. Money comes from nowhere anyway.”

Sure Bill Gates made and lost millions.
Sure the STOCK net worth rose and fell.
No, wealth (read: money) did not come from nowhere.

Seems to me what you are describing is the margin buying that caused the crash of 1929.

 

For real wealth you need to think about inflation and other factors, but we are talking about money, right?

Imagine a company that had 20 million shares outstanding. Imagine that you and I each bought up half the shares at fifty dollars a share last week. So you own 10 million shares at fifty dollars that have a total value of five hundred million dollars and I also own five hundred million dollars worth of the company. Today the company puts out good news that may be real good news or may be meaningless spin. I decide to sell a million of my shares to capture some profit from the good news. Today I sell one million of my shares to various investers at one hundred dollars a share.

The last share sold was sold at one hundred dollars per share. Tonight Forbes' Fortune Five Hundred is trying to calculate your net worth to see where you fall on their list. What do they say your holding of ten million shares of the company is worth? If you go to a bank tommorow and want to borrow money to build yourself a super mansion and you offer your stock as collateral what will the bank say your stock is worth?

They are going to say they you own One billion dollars worth of stock in the company. But you only paid five hundred million dollars. Where did the second five hundred million dollars worth of value for your stock cme from?

If tomorrow bad news comes out and it turns out our company was a fraud and the share price drops to ten dollars a share where did our money go?

I think I heard that one of the crimes that Enron did was trade assets back and forth between various parts of enron while increasing the price of the asset with each trade. This gave Enron phony profits and phony net asset values. The difference between what Enron did and what millions of Americans who participated in the tech bubble did is that Enron controlled both the buyer and the seller and presumably knew that nothing had really happenned that increased the value of the assets who's paper valuations they were inflating where as in the tech bubble nobody controlled the buyers and the sellers and the buyers and perhaps the sellers had no idea that they were pushing the paper valuations of tech stocks into the realm of fantassy.

Things are worth whatever people will pay for them even if the people are fools.

 

Yes, real money, whether digital or hard copy.

I’m beginning to think you do not understand the question.

You have only explained how individuals increase their money supply. The money you “created” merely came from other individuals who had money to spend. The national money supply did not increase one dollar.

The money went nowhere, because there wasn’t any money, it didn’t exist, there was only potential value. The value was only there if someone actually bought it at the proposed value. The value of stock was not money, just poteential money. Since no new money came into circulation, none went away.

 

Hmm, so why do you suppose so many people committed suicide in the market crash of the 20's? And why do you think so many people were in soup lines if they still had all the same money they had before the crash?

No, we're talking real money, real value, even if you don't fully understand it! When MicroSoft stock drops, Bill Gates actually, really loses lots of money ...you can be sure of that.

Baron Max

 

Okay, Let’s play it your way.
Where did the money go?

Let’s say I have a valuable stamp collection,”worth” one million dollars.
If they are destroyed, is my estate value decreased by $1M? Absolutely! Am I sad? Absolutely!
Is there less money in circulation (whether digital or hard copy)? Of course not!

 

To other people for other goods and services that Mr Gates paid for ...wages, upkeep on his facilities, salesman, equipment stock, bills to Intel for the processors, etc., etc. Mr. Gates bought all that stuff thinking that his software, etc was going to sell for more than it did. He lost the gamble ....AND he lost that money!

The money is still in circulation, but Mr. Gates ain't got any of it! And worse, perhaps, it's spread out now over lots and lots of people, none of whom have the power or ability to do anything with it other than to buy food. But the people who work for Mr. Gates are now laid off, they have no money and so it works out evenly. See? Some rich, some poor ...it's a balancing act.

Your stamp collection analogy has no bearing on the issue because the stamps aren't treated as "money" ...i.e., I don't give a damn about your stamps, so there's one person who wouldn't give you one penny for the whole lot. That's the difference. One dollar equals one dollar, but one stamp doesn't equal anything unless someone wants to trade dollars for your stamps.

Baron Max

 

No. Now look, one day the stock is worth $10M, and it crashes and the next day it is worth $1M.
Nobody went out and spent $9M on janitors and supplies and parking lots, inventory and buildings overnight.
A stock certificate is the same as a valuable stamp. They are only worth what people will pay for them.
Of course stamps are treated as money every bit as much as stock certificates.

 

Oh, yes they did!!! And that's where you're just not getting it.

A family who owns a million dollar home and can make the payments each month have a value of a million dollars. But if they suddenly lose their jobs and can't make the payments, what do you think their value is then?? See? No actual money exchanged hands, yet that couple is now on the street and homeless when just a few days ago they were worth a million dollars! And guess what? ...someone else is now the owner of that million dollar home and HIS value just increased my a million dollars.

The concept of debt is often misunderstood, but believe me, there's money involved and, contrary to popular belief, it's REAL money, not just paper money!!

Your stamp analogy just doesn't hold up in the real world. I do understand how and why you're asking about it, but why not just stick to money? ...especially if you think it's the same thing! Why confuse the issue?

Baron Max

 

I like this question. It is such an important question.

But your next sentence says that the beautiful question I thought you were asking Is not what you were asking. This is a complete change of direction. Money supply is not national wealth. You ask a technical question that I knew Wikipedia would answer better than I would, so I gave you the link. The change of direction makes me wonder if you think the expansion of the money supply increases the wealth.

In Bill Gates' case because he owns so much stock in one publicly traded company his wealth goes up and down wildly based on peoples changing beliefs about the beliefs that other people will soon have about the future profits of the Microsoft which is in turn based on beliefs about future sales and future costs for Microsoft.

Now where do you see the Fed's money supply policy figuring into Microsofts sales in a major way? If the Fed wildly increases the supply of money borrowers have more money to bid against other buyers for the limited supply of product and therefore inflation takes place. If Microsoft does not raise product prices in the inflated expanded money supply environment then they can sell more product but the dollars they receive for the product will be less valuable dollars so it would be as if Microsoft had dropped their prices in a non-inflated economic environment.

If Microsoft raises their prices to keep up with inflation they sell the same amount of product but would get more dollars for their product but these "more dollars" have the same purchasing power as Microsoft would have had with their old prices and the old uninflated dollars. Who cares about how many dollars you have you want purchasing power.

Now increases in the money supply may help borrowers and people who sell to borrowers at the expense of savers and people who sell to savers and decreases in the money supply may do the opposite. But it hurts my head a bit to think about this and this is not talked about probably because it is not a important effect and it hurts other peoples heads to think about it also, or perhaps I am wrong. Anyway I see no sign that you are interested in that possible side effect of money supply policy.

The ratio of money to widgets available for purchase does matter because changes in the ratio of money to widgets available to represent inflation or deflation. Inflation and deflation would not be bad if they were at fixed predictable stable rates. When inflation/deflation is unpredictable it screws up the lending process and make economic winners out of people who are competitive failures and makes economic losers out of people who are competitive winners and thereby destroys the marketplaces ability to reward efficiency and destroy the inefficient. Real wealth (not money) happens more when efficiency is increased.

Everybody can be a millionaire but what would that mean? For it too translate into material wealth rather than inflation their would have to be great increases in the efficiency at which essential products like housing are created. "Anyone can be a millionaire" is a similar but very different statement that holds everybody responsible for their own success or failure and thereby removes the excuses of those who fail to compete and relieves the successful of their guilt about the fate of those who could not compete.

I can't promise that the government does not give bonds to the Fed but that is not the way I think it works.


From another Wikipedia article:
An example of the creation of new money
The following steps describe one way that new money can be created. It is an example from the US.

1. The government prints a treasury bond. This is simply an IOU, a promise to pay the holder a specified sum of money on a particular date. In this example, let’s say the government issues $1,000,000 worth of bonds. Individual investors, pension funds, mutual funds, insurance agencies, banks, foreign government central banks, can all buy the bonds, effectively loaning money to the federal reserve. They do this to invest their money and receive interest in return.
2. The Federal Reserve prints a check, in the amount of $1,000,000 and makes it payable to the government. This check is the proceeds from the sale of the bonds.
3. The $1,000,000 is recorded as an asset by the Fed. (money owed to the central bank is called an "asset" by the bank) It is assumed the government, with its power to tax, will make good on its debt (this is why the people buying the bonds from the fed consider it a risk free investment). The government deposits the check in its own account.
4. The government hires employees and buys things with the $1,000,000, and it does so by writing government checks. These government checks are then deposited in commercial banks. For the sake of simplicity, assume it all goes into one commercial bank, which has a zero balance to begin with.
5. The commercial bank now claims $1,000,000 in new liabilities (the amount on deposit in a bank is called a "liability" by the bank, because the bank has to pay interest to it, amongst other things). In the US, the law allows the bank to loan out 90% of what it has on deposit. This loaning of money that it has on deposit is the precise point new money is created, because the depositor still has his money, and the person getting the loan now has money too.
6. $900,000 is loaned out on Friday for someone to buy a house. This loan is in the form of a check. The home buyer signs the check and gives it to the seller, who deposits it right back into the bank on Monday. Note however, in real life that money would only come from the bank temporarily, who then would issue its own bonds or use a company like Fannie Mae to issue its own bonds, so that again investors can actually lend the money while the bank is simply a middleman, called a "servicer".
7. The commercial bank now claims $900,000 in new liabilities. 10 percent of that money is put into a reserves, and 90% of that, or $810,000 is loaned out. As soon as the $810,000 is deposited back into the bank, the cycle repeats and repeats until there is no more money to lend.
8. The total amount lent out to borrowers is $9,000,000. Add that to the $1,000,000 that it still has on deposit and the total is $10,000,000. Commercial banks make profit by charging fees for transactions, and by charging a higher interest rate to those they lend to, than what they pay for the funds. If the commercial bank charges 6% interest on the $9,000,000 it will earn $540,000 per year. If the bank making the loan pays 1% interest to the person who put the money on deposit in the first place it will cost them $90,000 per year. With 90% of that money lent out, if the originally depositor wants their money back, the bank has to borrow that money from another bank (or maybe from another source), at rate of interest set by the government (the overnight rate, or the federal funds rate in the US). This is called "asset-liability bouncing", and is a delicate balancing act all banks must work on every day.

How do you distinguish between money and assets? In jail cigarettes are used as money. Are the cigarettes not money? The government changes reserve requirements to affect the velocity of money. When assets increase and decrease in value thereby effecting their use as collateral and effecting their owners liquidity and effecting their owners economic confidence and willingness to take risks, are asset valuations not as much or more of an impact on velocity as reserve requirements are?

There are three points to having a money supply policy. 1: to provide a trusted medium of exchange. 2: to have stable predictable inflation / deflation rates. 3: to create a method with which to try and smooth out business cycles.

What is money other than potential value? Money or stamp collection or deed to a property, they are all worth only what people say they are worth. If you go down to the car dealer and try to trade your stamp collection for a car the dealer can say yes if he wants to so your stamp collection is the same as money. The stamp collection is not as liquid as money so the car dealer will have to charge you extra for his having to hire a stamp appraiser but what does it matter whether you or the car dealer has to hire the stamp appraiser. You are making money and assets more separate in your mind than they really are.

 

"Money" as we know it is just a concept. It only has value as long as others buy into the concept that it has value. It has no intrinsic value and is not redeemable in anything tangible.

"When you or I write a check there must be sufficient funds in out account to cover the check,
but when the Federal Reserve writes a check there is no bank deposit on which that check is drawn.
When the Federal Reserve writes a check, it is creating money." -- Putting it simply, Boston Federal
Reserve Bank

"Neither paper currency nor deposits have value as commodities, intrinsically, a 'dollar' bill is just
a piece of paper. Deposits are merely book entries." -- Modern Money Mechanics Workbook,
Federal Reserve Bank of Chicago, 1975

"The Federal Reserve system pays the U.S. Treasury 020.60 per thousand notes --a little over
2 cents each-- without regard to the face value of the note. Federal Reserve Notes, incidently, are
the only type of currency now produced for circulation. They are printed exclusively by the
Treasury's Bureau of Engraving and Printing, and the $20.60 per thousand price reflects the Bureau's
full cost of production. Federal Reserve Notes are printed in 01, 02, 05, 10, 20, 50, and 100 dollar
denominations only; notes of 500, 1000, 5000, and 10,000 denominations were last printed in
1945." --Donald J. Winn, Assistant to the Board of Governors of the Federal Reserve system

"The few who understand the system, will either be so interested from it's profits or so dependant
on it's favors, that there will be no opposition from that class." -- Rothschild Brothers of London, 1863

"Give me control of a nation's money and I care not who makes it's laws" -- Mayer Amschel
Bauer Rothschild

http://www.apfn.org/apfn/reserve.htm

http://www.bankhonesty.com/

http://www.newswithviews.com/Veon/joan2.htm

http://www.fame.org/

 

Production within the members.

 

From: http://libertyunbound.com/archive/2004_10/woolsey-fed.html

Who Owns the Fed?

by Bill Woolsey

The Federal Reserve System prints $100 bills at a cost of 6¢. So who pockets the $99.94 profit?


It was in the late eighties. I was a new faculty member at The Citadel, teaching Money and Banking. A memo was in my box. There was a phone number and a note that someone had questions about the Federal Reserve.

Being dutiful (and not tenured), I returned the call. A man answered. I said that I was from The Citadel and understood that he had some questions about the Fed. An interrogation then began.

"Isn't it true," he demanded, "that the Federal Reserve pays the Treasury three cents for each dollar bill printed?" I replied that this was pretty much true.

He continued, "Isn't it true that the Federal Reserve lends this money to ordinary banks and charges 3% interest?" I noted that while the discount rate was currently at 3%, it has sometimes been higher or lower. I added that the Fed doesn't really lend out currency directly and that these Federal reserve advances aren't very important. He interrupted, "Is it true or not?" I said, "Pretty much so."

His next question was a bit different. He asked, "Isn't it true that the Federal Reserve is privately owned?" I agreed that it was, "kind of."

The rest came out in a bit of a rush. "So, isn't it true that, for every dollar printed, the Federal Reserve covers the three cent cost of printing the currency with the interest and so makes a one dollar profit for the owners. And that's how the international bankers get their money to rule the world."

I said that no, that wasn't true, but I had no quick and easy explanation. And my conspiracy theorist wasn't interested in anything other than a confirmation of the first three premises. His logical deduction of a one dollar profit and his alleged bankers' conspiracy weren't things he needed to have confirmed.

I had never heard anything like it. Now, don't get me wrong. I have been a libertarian since I was a teenager in the mid-'70s. The notion that the Federal Reserve, as an engine of inflation, was nefarious seemed natural. It was just this particular approach to the evils of the Fed that was new to me.

Soon after, a former student visited and asked me about Pat Robertson's discussion of the Federal Reserve in his book "The New World Order."1 As my student relayed the story, the Fed pays three cents for each dollar, lends it out at 3% interest and so on. Another student reported on a story about a Washington call girl. She claimed that all the politicians had credit cards. Where did they get the money? The Fed pays three cents per dollar bill and so on. A year later, at a local Libertarian Party meeting, a newcomer was distributing issues of The Spotlight, a publication of the anti-Semitic Liberty Lobby. Among the articles about the dual loyalists in the State department was one about the Fed. It pays three cents per dollar bill, lends it out at 3% interest, and so on. This time, however, it was the international Jewish bankers making all the profit.

A Google search on the Federal Reserve and ownership will generate several hundred thousand hits, many of which allege that the private owners of the Fed are making huge profits from the issue of currency. There are quite a few links to sites that specifically debunk the conspiracy theory. Some links are to Federal Reserve sites that describe the system's ownership structure.

The conventional wisdom among libertarian economists is that central banking is the modern means by which governments continue their traditional policy of debasement — using inflation as a means of public finance. The government prints money and spends it. The result is price inflation, which is often blamed on the greed of businessmen who actually set the prices. Could economists be wrong? So I did some research.

The conspiracy theorists have a point regarding the ownership of the Federal Reserve. The Federal Reserve system is made up of twelve Federal Reserve banks. According to the Atlanta Federal Reserve bank, "They were to be quasi-private bankers' banks, owned by the member banks, which would buy all the stock of the Reserve Banks and receive dividends for it."

Any Principles of Economics or Money and Banking text describes the situation, usually in similarly ambiguous terms. Baumol and Blinder state, "Technically, each Federal Reserve bank is a corporation; its stockholders are its member banks."3 Mishkin explains, "Each of the Federal Reserve banks is a quasi-public (part private, part government) institution owned by the private commercial banks in the district that are members of the Federal Reserve system."4

The courts have taken notice of the Fed's peculiar status. In the 1982 case, Lewis v. United States (see "The Lewis Decision"), the Ninth Circuit Federal Court of Appeals opined, "Federal reserve banks are not federal instrumentalities for purposes of a Federal Torts Claims Act, but are independent, privately owned and locally controlled corporations." On the other hand, the opinion notes, "The Reserve Banks have properly been held to be federal instrumentalities for some purposes."5

Apparently, there is something unusual about the status of these Federal Reserve banks. Some libertarian economists describe claims about the "private" nature of the Fed with an attitude of "if only." In the context of a proposal to privatize the Federal Reserve banks, Richard Timberlake explains that "The member commercial banks already 'own' the twelve Fed banks," but adds that, "they have no property rights."6 Murray Rothbard notes that "[c]entral banks are often nominally owned by private individuals or, as in the United States, jointly by private banks, but they are always directed by government-appointed officials, and serve as arms of the government."7

According to the Federal Reserve Act, a Federal Reserve bank is a special type of corporation chartered by the Federal government.8 Shortly after the act was passed, the United States was divided into twelve districts and a Federal Reserve bank was organized in each district.9 National banks (private commercial banks chartered by the Federal government) were forced to join the Federal Reserve system. State chartered banks could join if they chose, though most did not.10 Any newly chartered national bank must still join the system and existing or new state chartered banks can still choose to join.

One requirement of membership was for a bank to purchase stock in its district Federal Reserve bank. The amount purchased was fixed by the Act. Each member bank must purchase stock equal to 3% of its capital.11

Take a bank's total assets — vault cash, loans, investments, building, and equipment. Then subtract its liabilities — checking accounts, savings accounts, bonds. The difference is the bank's capital, which, in banking lingo, is another term for net worth. Multiply by 3% and that is the dollar value of the Federal Reserve stock a bank must hold.

The par value of the Federal Reserve stock was fixed by the Act at $100 per share.12 As a bank's net worth changes and deviates from the 3% requirement, its Federal Reserve bank issues it new shares or buys back excess shares — always at the $100 par value. If any bank joins the system, its district Federal Reserve bank issues new shares. If any member bank fails, its district Federal Reserve bank pays off the shares.

The Federal Reserve Act contained a provision for selling shares to the general public or even to the U.S. Treasury if necessary to meet a minimum capitalization for each district bank. These provisions weren't needed, and so all shares are held by member banks.13

All member banks are U.S. chartered banks — chartered by the federal government as national banks, or by one of the states. However, the stockholders of the various banks can be U.S. citizens or foreigners.

So, private investors, including foreigners, own the member banks which in turn seem to own Federal Reserve banks. That is the element of truth in the conspiracy theory.

The member banks' "ownership" of the Fed is consistently described as "quasi," technical, or nominal. The key reason is that owning stock in a Federal Reserve bank does not provide the usual benefits of stock ownership.

One of the key benefits of the corporate form of business relative to partnerships is that the owners can sell part or all of their interest in a business by selling some or all of their shares. But Federal Reserve banks aren't like ordinary corporations. Aside from the transactions with their Federal Reserve banks to maintain the 3% ratio to capital, the member banks cannot buy additional shares or sell off their shares. They cannot pledge the shares as collateral for loans.14

Most investors purchase stock to earn capital gains, in the hope that it will increase in value. There is no market for Federal Reserve stock — its price remains at the par value of $100. It is impossible for the shareholders of Federal Reserve banks to earn capital gains or suffer capital losses on their stock.

Of course, stockholders in ordinary corporations can also hope for dividends. As the owners of the business, all profits belong to them. In most corporations, the board of directors decides if and when to pay dividends on common stock. But the Federal Reserve banks are different. The Federal Reserve Act fixes dividends at 6% per year.15 That is $6 per year per $100 share. Any additional earnings go to the U.S. Treasury.

If an ordinary corporation is liquidated, any remaining assets belong to the stockholders. But that isn't the situation with the Federal Reserve banks. If the Federal Reserve is liquidated, the member banks get back their $100 per share and pending dividends and anything left over goes to the U.S. Treasury.16

Stockholders generally vote for their corporation's board of directors, and that is true of the stockholders of the Federal Reserve banks. But there are some very unusual voting rules. Usually, stockholders vote their shares, so that the largest stockholders get the most votes. Each member bank, however, gets just one vote regardless of the number of shares it owns in its Federal Reserve bank.17

Each Federal Reserve bank has nine board members. They are divided into three groups. There are three Class A directors, three Class B directors, and three Class C directors.

The Class A directors can be involved in the banking industry and usually are. The member banks are divided into three groups — large, medium, and small banks. While this is measured by their stockholdings, stock holding is proportional to net worth, which is closely associated with total bank size. The large banks elect one Class A director, the medium-sized banks elect another, and the small banks elect the third.19

Class B directors are elected in much the same way, except that none of them can be bank employees or stockholders. Each member bank gets one vote and the large, medium, and small banks elect one director each.

Class C directors cannot be involved in the banking industry either, but they aren't chosen by the stockholders. They are instead appointed by the Board of Governors in Washington D.C.20

To sum up, the stockholders of each Federal Reserve Bank elect two-thirds of its board of directors. They don't vote by shares, but rather each bank gets one vote. Bank size does influence voting, however, with large, medium, and small banks getting two directors each — one banker and one nonbanker.

For most corporations, the board of directors selected by the stockholders is free to choose top management. While the board of directors of each Federal Reserve bank chooses its president, that decision is subject to approval by the Board of Governors in Washington, D.C.21

There are seven members of the Board of Governors and they are appointed by the president of the United States with the advice and consent of the U.S. Senate. They are appointed for 14-year terms. The chairman is appointed by the president with approval by the Senate for a four-year term.22 The current chairman is Alan Greenspan.

The Board of Governors is clearly a federal government agency. Its members have substantial independence from the president and Congress because of their long terms — less than federal judges, but more than those serving on most federal regulatory commissions.

The Board of Governors dominates the twelve Federal Reserve banks. Not only does it appoint one-third of their boards of directors, it has an effective veto power over the selection of the twelve Federal Reserve bank presidents.

The Federal Reserve Act authorized the board of directors of each Federal Reserve bank to set its own discount rate in consultation with the Board of Governors. This was the interest rate at which Federal Reserve banks made loans (called advances) to member banks.23 While some of those supporting the Federal Reserve Act thought that there would be different discount rates across the United States depending on local conditions, the consultation process with the board of governors resulted in the twelve boards of directors setting a uniform discount rate.24 During the Great Depression, the Banking Act of 1933 changed consultation to a requirement that Federal Reserve banks obtain Board of Governors approval for their discount rates.25 There continued to be a single discount rate for the Federal Reserve system, though it was routinely approved by each Federal Reserve Bank's board of directors.

In 2003, the Fed changed its lending policy. Today, any financially sound bank (member or not) can obtain loans from its district Federal Reserve bank at the primary credit rate. It is set at 1% above the Federal Funds rate.26 Since the Federal Funds rate is the interest rate at which banks borrow from and lend to other banks for overnight loans, there is little motivation to borrow from the Fed. Financially troubled banks can obtain loans at the secondary credit rate. That rate is set at .5% above the Federal Funds rate and entails added supervision.27 Given this new policy, the "power" of the board of directors of a Federal Reserve bank to set the discount rate has become a dead letter.

While the Federal Reserve Act implies that lending at the discount rate would be the key element of monetary policy, that approach was long ago superseded by open market operations. Open market operations are the purchase or sale of government bonds by the Federal Reserve.

The Federal Reserve Open Market Committee directs open market operations. It is made up of the seven members of the Board of Governors and five Federal Reserve Bank presidents. The president of the New York Federal Reserve always serves and the other four slots rotate among the other eleven Federal Reserve bank presidents.28

The committee sets a target for the Federal Funds rate.29 The open market trading desk at the New York Federal Reserve buys or sells government bonds. Generally, they purchase them at either a faster or slower rate so that surpluses or shortages of funds in the market cause private traders to agree to interest rates on overnight loans close to the target.

When the Federal Reserve Open Market Committee sets its target for the Federal Funds rate, it is also determining the primary and secondary credit rates for loans by the Federal Reserve banks. Today, monetary policy is controlled entirely by the Open Market Committee.

The politicians appoint the Board of Governors, which makes up seven of the twelve members of the committee. That same Board of Governors appoints one-third of the boards of directors, which select the Federal Reserve bank Presidents that make up the remaining five-twelfths of the committee. And the Board of Governors has an effective veto over the selection of Federal Reserve bank presidents.

Because of the 14-year terms for the members of the Board of Governors, today's monetary policy mostly depends on the appointments made by politicians in the past. Short of rewriting the Federal Reserve Act, appointments by today's politicians will only gradually effect future monetary policy. That is why the Federal Reserve System is described as an independent agency within the federal government.

Many of the conspiracy theories claim that the private owners of the Fed are making large profits from the issue of currency — Federal Reserve notes. The twelve Federal Reserve banks are responsible for issuing Federal Reserve notes, but they don't print currency themselves. They pay the Bureau of Printing and Engraving, a division of the U.S. Treasury, for the service. Estimates for the amount the Fed pays for printing each note vary from 2 cents to 6 cents. In 2003, about 8 billion notes were printed. The Fed purchased currency with a face value of $143 billion30 and then paid the U.S. Treasury $508 million.31 That amounts to about 6 cents per note and .3 cents per dollar printed.

It is like having copies made at Kinko's, and even more like the cost of printing checks. The printing cost doesn't have much to do with the amount the checks will be worth when they are written and spent.

While paying less than one cent per dollar issued sounds profitable, the Federal Reserve Banks do not treat this as profit. The Fed accounts for Federal Reserve notes as a liability — a debt of a Federal Reserve bank.32

When the Fed was formed, the United States was on a gold standard and the Fed was obligated to pay off Federal Reserve notes on demand with lawful U.S. money — mostly gold coins and gold certificates. While the Fed no longer pays off Federal Reserve notes with anything, it continues to account for them as liabilities.

After the Fed has currency printed and before it is issued, it is just paper — like a blank check. When the currency is issued to banks or ends up in the hands of other firms or households, it becomes a liability for the Fed. When the currency is deposited by a bank back into the Fed, it is again meaningless paper — like a cancelled check. Unlike a used check, however, the Fed can issue out currency again.

While the Fed accounts for Federal Reserve notes as liabilities, the U.S. government guarantees them as well. If a Federal Reserve bank were to fail, then the U.S. government would pay off the outstanding currency. To protect the U.S. government from losses, it requires that Federal Reserve banks set aside U.S. government bonds or gold certificates as collateral.33 When the United States left the gold standard, there was no longer any possibility of the Fed defaulting on Federal Reserve notes, so the secondary U.S. government guarantee became meaningless. Still, the Federal Reserve banks pledge collateral for Federal Reserve notes.

The Federal Reserve doesn't directly lend currency to banks. When a bank gets an "advance" from the Fed, the Fed just makes an entry into its computer and credits the bank's deposit account. So rather than paying less than one cent per dollar for the money they lend to banks, the Fed actually pays nothing.

Of course, banks can withdraw currency from their deposit accounts at the Federal Reserve banks whenever they want. And they do so regularly, to cover currency withdrawals by their depositors and to stock ATM machines. The Federal Reserve banks have currency printed up as needed to cover withdrawals by the banks. And while the total stock of currency is usually expanding, a substantial portion of the Fed's printing cost is for new currency to replace worn currency that has been withdrawn from circulation and shredded. In 2003, the Fed increased the stock of Federal Reserve notes by $42 billion and replaced $101 billion of worn currency.

Suppose the Fed lent money to a bank, charging 2.25% annual interest (the primary credit rate in August 2004).35 The bank might withdraw the funds and the Fed would be obligated to issue it currency which would cost .3 cents per dollar (or 6 cents per note). When the bank repaid the loan (probably the next day), the Fed would earn a tiny fraction of a cent per dollar. The returned Federal Reserve note, however, wouldn't be revenue. And the Fed could issue it out (perhaps by lending) again and again until it wears out.

Total outstanding loans by the Fed to the banks was $245 million in July 2004.36 At 2.25% interest, that would earn the Fed an income of about $5.5 million per year. But since the total amount of Federal Reserve notes is approximately $700 billion,37 it is apparent that Fed lending to banks does not play a significant role in the creation of currency.

Conspiracy theorists, like Thomas Schauf38 and Eustace Mullins,39 complain that the private owners of the Federal Reserve are profiting from the national debt. Since the Federal Reserve creates money out of thin air through open market operations — purchasing government bonds — they are at least looking in the right direction.

As of July 2004, the Fed held government bonds worth $693 billion.40 Contrary to the claims by some conspiracy theorists that the entire national debt is associated with the issue of currency, the Fed's holdings are about 9% of the $7.5 trillion gross national debt.41 After subtracting securities held by various federal government trust funds, the Fed's holdings are about 15% of the remaining $4.5 trillion net national debt.42

When Fed bond holdings are added to the small amount of its lending to banks, the $11 billion gold reserve, $40 billion in holdings of foreign exchange, along with repurchase agreements, Federal Reserve bank premises, and the like, the Fed's assets cover its liabilities — Federal Reserve notes issued, the $25 billion that banks have deposited at the Fed, the government's $4 billion deposited in the Fed, and various other small items.43

Since government bonds make up the bulk of the Fed's assets, the interest from those bonds provides most of its revenue. In 2003, the Federal Reserve's total income was $24 billion, of which $22 billion came from holdings of government securities.44 While that is a substantial amount of money, the total interest expense for the U.S. government was $153 billion45 and total government spending was $2.157 trillion.46 The Federal Reserve's earnings on bonds were a bit over 14% of the government's interest expense and 1% of total government spending.

Some conspiracy theorists have claimed that personal income tax funds are earmarked to pay interest to the Fed, and if no such interest was paid, there would be no need for the income tax. Fed interest earnings amount to a bit over 2% of the $987 billion in personal income collections in 2003.47 Total interest payments by the government are about 15% of income tax revenues.

The chief problem with the theory that the private owners are making huge profits from the Fed is that the Fed transfers large amounts of money back to the U.S. Treasury each year. In 2003, the amount transferred was $22 billion.48 Since that is exactly how much interest the Fed earned from U.S. securities, the net cost of the Federal Reserve to the U.S. taxpayers was zero.

Zero? The conventional view among economists is that the Fed makes money for the government. How? One way to look at it is that if the Fed didn't own these government bonds, then someone else would. Those investors would not transfer their earnings back to the Treasury. By having the Federal Reserve own a portion of the national debt, the U.S. government saved $22 billion in interest expense in 2003.

Conspiracy theorists like Schauf have proposed that the government replace Federal Reserve notes with "greenbacks" — U.S. Treasury notes that bear no interest.49 They claim that this would free the government from paying interest on part (or even all) of the national debt.

If the government replaced Federal Reserve notes with that sort of currency and retired interest-bearing debt, then the government would not have paid the Federal Reserve $22 billion in interest. But neither would the Fed have transferred the $22 billion back to the Treasury. An exact match doesn't occur every year. In 2002, the Fed earned $25 billion on government bonds and transferred back only $24 billion.50

Still, that didn't create an additional $1 billion "profit" for the member banks that "own" the Federal Reserve. The member banks make six cents on each dollar they are forced to have invested in the Federal Reserve system. In 2003, the total dividends to the member banks were $518 million.51 That amounts to .02% of U.S. government spending. It amounts to about .5% of the $100 billion in total commercial bank earnings.52

The rough equivalence between the interest the Fed earns from the government and the amount it transfers to the U.S. Treasury causes most economists to see these financing issues as a shell game. Since nearly all the interest paid on debt sold to the Fed is transferred back to the U.S. Treasury, there isn't really any interest paid. The government uses the Fed to partly finance its deficit by creating money and spending it. The end result is no different than if the U.S. Treasury just printed up "greenbacks" and spent them. The process is just a bit more "efficient" than the ancient practice of melting down silver coins and mixing in lead. Most economists would argue that the Fed created $36 billion for the government in 2003.53 That is the change in the monetary base (currency and reserves) less the expenses of operating the Federal Reserve system.

Do shady international bankers control the Federal Reserve? Perhaps, but not because they "own" the Federal Reserve system. The politicians have control, in the same sense that they control the federal judiciary. Government appointees make up the majority of the Open Market Committee and those same appointees have an effective veto in selecting the Federal Reserve presidents who make up the remainder of the body. Further, they appoint one-third of each Federal Reserve bank's board of directors, which in turn choose those presidents.

However, if one begins with an understanding that the Fed is fundamentally a political operation, then it is unusual in that bankers have an extra avenue of influence. Like everyone else, they can vote, lobby, and make campaign contributions and so influence the politicians. Unlike everyone else, they can own shares of stock in member banks that "own" the Federal Reserve banks and so influence directors, Federal Reserve bank presidents, and the Open Market Committee.

Do shady international bankers make large profits from the Federal Reserve? It depends on what is meant by "large." Since there is little or no risk in stock whose value remains at par, and the interest rate earned by the Fed on its government securities portfolio is closer to 3% than the 6% dividend, perhaps a substantial cut in payments to the member banks is in order. If the dividend rate were reduced to reflect the current return on the Fed's portfolio, the taxpayers could save as much as $250 million a year in financing the national debt.

However, this potential gain depends on the low levels of interest rates for the last few years. Since 1960, the rate on Treasury bills has been greater than 6% almost 40% of the time. It was consistently above 6% from the fall of 1977 to the summer of 1986. When the T-bill rate peaked at 15% in March of 1980, the Fed was earning substantially more on its security portfolio than the dividend rate it was paying the member banks.54

Further, from a libertarian perspective, there are any number of ways in which regulations associated with the Federal Reserve system impose unjustified costs on banks. Reserve requirements force banks to tie up more funds than they believe necessary in vault cash and Federal Reserve deposits. The banks earn less interest and the Fed and the U.S. Treasury collect roughly what the banks lose. More importantly, by taking away the right of banks to issue redeemable, dollar-denominated banknotes, the Fed's compulsory monopoly on currency issue reduces bank earnings by tens of billions of dollars. How a competitive banking system would distribute those funds between bank stockholders and customers is difficult to predict, but there is a cost to having the government finance its budget deficits by issuing currency.

Who owns the Fed? The owners of a business typically have ultimate authority over operations and serve as residual claimant. Stockholders elect directors, who appoint top management. Stockholders receive the profits — excess revenues after all other claims on funds are paid.

For the Fed, final authority is in the hands of the politicians. They appoint the Board of Governors, who dominate the Federal Reserve banks. Further, any earnings of the Federal Reserve banks beyond expenses, including the 6% dividend to the member banks, goes to the U.S. Treasury. Since the U.S. government has final authority and serves as residual claimant, the most reasonable view is that the Federal Reserve system is government-owned.

The conspiracy theorists' claim that private owners of the Fed are making bundles of money is false. The conventional view among economists (including libertarian ones) that the Fed is a government operation that partially finances fiscal deficits by money creation is fundamentally correct. The live question among libertarians is how to get the government out of the banking system — perhaps by truly privatizing the Fed's operations — in a way that prevents inflation and macroeconomic instability.

 

nirakar:
Thanks for the very informative posts. A lot of information which I am still absorbing. I appreciate your time and effort.
Thanks