Why the Fed is Committed to Inflation

"I spent my entire life studying for this moment!!"

Some will recall the speech that then NY Fed Governor, Ben Bernanke, gave in late 2002 honoring, Milton Friedman, in which he famously apologized to the great monetarist for what he saw as the Federal Reserve’s failure to prevent the Great Depression:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

Unfortunately, Bernanke got it backwards. If he was going to apologize for anything, it should have been for the Fed’s central role in enabling the conditions for, and then prolonging the duration of the Great Depression.

But of course, the Federal Reserve was never really created in order to prevent depressions, only to manage them in such a way so that its most powerful member banks could continue to profit, no matter which way the wind was blowing. More specifically, the Federal Reserve was created with the primary objective of protecting an established money trust of elite banking institutions, chief of which were the House of Morgan, National City Bank, the Rockefeller controlled Chase National Bank, and Kuhn, Loeb & Co., which had strong ties to the Rothschilds in England.

The Money Trust is seen here, exacting a toll from the average investor

In point of fact, after the passage of the 1913 Federal Reserve Act, Paul Warburg, widely recognized as the “father” of the Federal Reserve System (Warburg was very close to the Rothschilds and was brought to the United States in part because of his intricate knowledge and understanding of the type of central banking practiced in Germany and England, on which the new American system was to be closely modeled), began a long process of lobbying the smaller banks around the country to join the new Federal Reserve System. You see, membership was, and still is for state banks, optional. At the time, however, there was great hesitancy on the part of less well-connected and influential banks to join the new system for fear that they would eventually be bullied around and even swallowed up by the larger banks. So, how did Warburg eventually convince them to join? Easy, by promising them the prospect of profits the likes of which they could scarcely imagine or even believe…

The gist of Warburg’s sell to the smaller banks rested on the reality that, functioning in a free market, these banks were constrained in how much credit they could create through fractional reserve lending due to the ever-present potential for a bank run. The number of loans that they could pyramid on top of their existing deposit base – i.e. the amount of money that they could create out of thin air – was limited. Joining the Federal Reserve System however, would not only provide a central backstop and “lender of last resort” for these banks, but more importantly, it would unify all the pools of money that existed in dispersed, regional waterholes into one giant sea of capital. This is the origin of what is now known as the federal funds or inter-bank lending market, but which, at the time, was referred to as the market for bankers’ acceptances. It is this unified pool of money that all participating banks can access in order to meet their short-term liquidity needs, and it is here where the Federal Reserve Bank of New York conducts its open market operations (OMO), swimming about like a Great White shark amongst a sea of blue fish.

Paul Warburg

Its unlimited access to credit, which it itself creates out of thin air, allows the Fed to manipulate the key federal funds rate from which all subsequent rates and prices in the economy are ultimately determined. Therefore, just as the shark cannot exist outside the water, the Federal Reserve would be powerless if it didn’t have a big enough ocean of money within which to swim and from where it’s monetary manipulations could be sufficiently amplified. The more banks that participate, the more powerful the Fed becomes and the more influence its open market operations have on overall prices. This is why participation in the Federal Reserve System is necessary in order for the system to function. If the banks believed that it was not in their interest to participate, then the entire system would fall apart, since the Fed would have no money market in which to swim.

We must understand therefore, that it is in the interest of the financial industry to have a Federal Reserve. In fact, the Federal Reserve is directly responsible for the profitability and size of this industry, so we must immediately dispense with the silly notion that the Federal Reserve is a regulator; it is no more a regulator of wall street than OPEC is of the Gulf states. Its role is that of a front company. It is a legal cartel created by and for the benefit of its member banks, with one extra and very important benefit. It has the explicit backing of the United States government, making it legally impossible for any other bank or syndicate of banks to challenge it without legislative reform.

So, what has been the outcome of all this collusion? Well, one outcome was the boom of the 1920′s, brought about by a tremendous lending euphoria that simply could not have existed without the deterioration of credit standards and reserve requirements. In fact, mandated reserve requirements themselves only became necessary with the creation of the Federal Reserve, since before, banks had to determine for themselves what the proper amount of capital they needed on hand was. This amount varied from bank to bank, but was almost always much higher than that mandated by the Federal Reserve System, since the later had a new and much larger pool of capital from which to fund short-term liquidity needs (as well as the godly power to issue new federal reserve notes and call them money). The dream of financial alchemy had finally been achieved.

This is why the “too big to fail” debate is a mute point. To ask the Fed, along with congress, to help regulate the financial system so that no institution would be too big to fail is a contradiction in terms. The only reason why any single company in any economy can be too big to fail is because it has a direct lifeline to the Central Bank, and thus to an unlimited supply of money. If there were no Federal Reserve, then there would be no ability to fund a bailout, and if there were no such implicit guarantee to protect a company from failure, then no bank on earth would every lend out 20, 30 or even 100 times (as was seen during the most recent credit boom promoted by the Greenspan Fed) their deposit base. Such a move would be tantamount to suicide.

It was the inordinate and unprecedented expansion of credit, the deterioration of lending standards and the subsequent inflation in asset prices (seen most notably in the Florida land boom and in the stock market) that was ultimately responsible for the great depression. It was not the subsequent “reluctance” on the part of the Federal Reserve to lower interest rates in the economy by issuing more fiat liabilities through open market operations (i.e. printing money out of thin air) that was to blame. If anything, the Federal Reserve, along with the Hoover and Roosevelt administrations, crowded out private capital formation by issuing more debt and printing more money, making it more difficult for prices to adjust after the boom. This created a climate of excessive uncertainty and pessimism for the entrepreneur and businessman who is ultimately responsible for any recovery.

Picture of a Breadline from the Great Depression

So, come to think of it, maybe Ben Bernanke didn’t get it backwards when he apologized to Milton Friedman after all. Maybe what the Fed Chairman really meant to say was that the Fed failed in its primary objective: to save as many banks as possible. Maybe the real failure, in Bernanke’s eyes, was all the bank holidays, bankruptcies and bank runs. Maybe the “Great Depression” to Ben Bernanke, actually meant the 4,000 or so banks that went belly up in the three years between the Crash of 1929 and the election of FDR. Maybe it was JP Morgan’s inability to save the Knickerbocker Trust Company during the Panic of 1907 or the failure of New York’s Bank of the United States two years after Black Tuesday that nagged at the former NY Fed Governor the most.

Whatever his motivations, any doubts we may have had about Bernanke and his willingness to walk the walk when it came to fighting deflation the best way he knows how – by printing ungodly amounts of money – have now been laid to rest. Benjamin S. Bernanke, and his accomplices on the Federal Reserve Board have already committed the dollar to the currency dustbin of history. The inflation has already been baked into the cake. To reverse policies now would be tantamount to laying off half of the nation’s workforce within the matter of a year. Allowing prices to adjust would lead to the failure of not only the entire banking system, which has grown like a malignant tumor on the back of every honest wage earner in America, but a significant chunk of whatever real economy we have left. So discombobulated have the traffic signals become in our marketplace, that the Federal Reserve has little choice left but to keep its foot on the pedal, and drive us all right over the cliff.