SAN FRANCISCO

Is the Federal Reserve still the Federal Reserve...???

This seems like an odd  question.  Books like "The Creature from Jekyll Island" or the "Secrets of the Temple" leave the impression that the Federal Reserve System, established with the Federal Reserve Act of 1913, is in its basic operation still the same Federal Reserve System we have today.  Nothing could be further from the truth.

A serious economic depression, brought on by the collapse of a number of large money center banks in 1907, finally prompted the U.S. Congress to hold hearings about the creation of a banking system which would create a national currency and which was supervised by an arm of the U.S. Congress.  Banks were chartered by state governments to issue a "redeemable" currency.  This currency was created against "Real Bills" which banks would acquire from businesses involved in the production of consumer items. Proper banking procedures required that no currency in excess to the value of un-matured "Real Bills" held was kept in circulation.  Instead, proper banking procedures were frequently violated, and idle currency was used to speculate in real estate.  This "borrowing short" and "lending long" invariably led to reoccurring economic recessions and bank failures.

With the 1913 Federal Reserve Act, the U.S. Congress created a reserve system to protect against bankruns and to franchise a national currency. The final legislation awarded the franchise to create the "redeemable" Federal Reserve Note to each of twelve separate regional reserve associations which collectively was called the "Federal Reserve System".  The regional Federal Reserve Banks were authorized to create "redeemable" Federal Reserve Notes against the value of Bills of Exchange and gold held by their member banks. Only "Real Bills" and gold were eligible to be monetized under the Federal Reserve Act of 1913.  "Anticipation Bills", aka government bonds, were specifically prohibited from monetization.  The U.S. Congress created and selected a "Board of Directors of the Federal Reserve System" to oversee the operation of the twelve regional Federal Reserve Banks and to report to Congress.

When in the early 1920 an economic downturn occurred, the New York Federal Reserve Bank under its Governor Benjamin Strong decided to acquire government bonds and to conduct Federal Open Market Operations. By reselling government bonds for currency, the Federal Reserve Bank of New York in essence monetized government bonds, aka "Anticipation Bills", was expressly prohibited under the provisions of the 1913 Federal Reserve Actl.

The New York Fed continued the rogue acts of monetizing government debt for a number of years without any effective opposition from the "Board of Directors of the Federal Reserve System" or the U.S. Congress.  The monetization of government debt during the 1920s caused the Florida real estate bubble to develop which burst in 1925. It also caused the spiralling upwards of equity valuations, which ended with the stock market collapse in 1929.  As the 1930s began, fewer and fewer banks were willing or able to redeem Federal Reserve Notes for gold.

Instead of proscecuting the violators of the original Federal Reserve Act, the U.S. Congress in 1934 amended Section 14 of the Federal Reserve Act of 1913, thereby ex-post-facto legalizing the rogue acts of the New York Fed in which it was engaged during most of the 1920s.  In 1933,  President Roosevelt declared a bank holiday and by executive order nationalized the gold holdings of American citizens. The prohibition of holding gold caused the market for "Bills of Exchange" to collapse. This destroyed the independent "commercial banking" system which created the "redeemable" Federal Reserve Note under the "Real Bills Doctrine" of Adam Smith, based on the gold standard.  

In 1935, the U.S. Congress passed a Banking Act which materially modified the provisions of the original Federal Reserve Act of 1913 to turn it from an independent, private reserve banking system into an independent U.S. Government agency central bank with a dependent banking system based on the original twelve Federal Reserve regions.  The 1935 Banking Act abolished the "Board of Directors of the Federal Reserve System" as an oversight body, and in its stead created a "Board of Governors of the Federal Reserve System" with authority to set the "prime" interest rate.  The Board of Governors was a fusion of the interests of the federal politicians vying for reelection with the interests of the big money center banks which wanted influence over currency creation and control over currency distribution and circulation.

The 1935 Banking Act ushered in the "Federal Reserve central banking system" we have today. It bases its currency creation on monetizing federal debt through the conduct of Federal Open Market Operations, and by funneling currency into local economies through earmarks and loans through the branch banking system of the member banks of the post-1935 Federal Reserve.  Credit authorization for loans are obtained from the Federal Reserve Agent at each of the regional Federal Reserve banks in relation to the submission of Treasury Bills as evidence of loan payments collected on previous loans extended.

A Federal Reserve Note, established with the 1913 Federal Reserve Act, was a currency with a "positive" value, because it was redeemable in gold.  The 1935 Banking Act turned this Federal Reserve Note into an irredeemable currency with a "negative" value, because it only represented government debt. The use of the present "irredeemable" Fedral Reserve Note amounts to circulating debt.

Monetizing debt by central banks can continue for twentyfive to thirty years, before the compound interest grows larger than the original debt. When that point is reached, it spells the demise of the system.  Evenso, Federal Reserve Notes were no longer redeemable for American citizens after 1933, foreigners could still redeem Federal Reserve Notes for another thirtyeight years.  The system which emerged with the Banking Act of 1935 was knowns as a managed gold standard or as an international bullion standard. When after the Vietnam War the drain of gold through foreign redemption of U.S. Dollars became alarming, President Nixon defaulted on the Bretton Woods Agreement of 1944. In 1971, he suspended redemption of U.S. Dollar as was required by the Agreement.  We are now forty years into a worldwide "irredeemable" currency regime anchored on the "irredeemable" U.S. Dollar denominated Federal Reserve Note.

The value of the Federal Reserve Note today is evidenced by its ubiquity. It enjoys this ubiquity by virtue of being the world''s reserve currency. It is the world's reserve currency, because Saudi Arabia as the marginal cost oil producer, quotes crude oil only in USD/FRN currency.  Every country in the world required to have U.S. Dollars on hand with which to pay their "oil bills".  However, the creation of huge amounts of Federal Reserve Notes under TARP legislation and under QE1 and QE2 policy may very well upruptly destroy the value of the Federal Reserve Note as a reserve currency. Should this happen, it will plunge the United States into a financial catastrophy.

How was it possible to change the non-inflationary Federal Reserve "independent commercial banking system", organized under the original  Federal Reserve Act of 1913, to which the separate states had given their full approval, into a highly inflationary Federal Reserve "central banking system" in whose creation the separate states had no say, whatsoever.

It was made possible by the ratification of two constitutional, "unconstitutional" amendments.  The 16th and 17th Amendments to the U.S. Constitution were ratified in 1913, a few month prior to the passage of the original Federal Reserve Act in December of 1913.  The 16th Amendment obligates the U.S. taxpayer to service the debt created by federal politicians, while the 17th Amendment excludes the input of the separate states which could voice an objection in the U.S. Senate.

It might be wise to reexamine the usefullness of the 16th and 17th Amendments in light of the present financial situation.

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