It has been forgotten
by many that before 1913, there was no central
bank in the United States to bail out troubled
commercial and associated financial institutions
or to keep inflation in check by trading
employment for price stability. Few want inflation
but fewer still would trade their jobs for price
stability.
For the first 137 years of its
history, the US did not have a central bank. The
nation then was plagued with recurring business
cycles of boom and bust. For the past 94 years the
Federal Reserve, the
US
central bank, has assumed the role of monetary
guardian for the nation, yet recurring business
cycles of boom and bust have continued, often with
the accommodating participation of the Fed.
Central banking has failed in its fundamental
functions of stabilizing financial markets with
monetary policy, succeeding neither in preventing
inflation nor sustaining growth nor achieving full
employment.
Since the Fed was founded in
1913, US inflation has registered 1,923%, meaning
prices have gone up 20 times on average despite a
sharp rise in productivity.
For the 18
years (August 11, 1987 to January 31, 2006) of his
tenure as chairman of the Fed, Alan Greenspan
repeatedly bought off the collapse of one debt
bubble with a bigger debt bubble. During that
time, inflation was under 2% in only two years,
1998 and 2002, both times not caused by Fed
policy. Paul Volcker, who served as Fed chairman
from August 1979 to August 1987, had to raise both
the fed funds rate and the discount to 20% to
fight hyperinflation of 18% in 1980 back down to
3.66% in 1987, the year Greenspan took over the
Fed just before the October 1987 crash, when
inflation rose to 4.53%.
Under Greenspan's
market accommodating monetary policy, US inflation
reached 4.42% in 1988, 5.36% in 1989 and 6.29% in
1990. The inflation rate was moderated to 1.55% by
the 1997 Asian financial crisis, when Asian
exporting economies devalued their currencies to
lower their export prices, but Greenspan allowed
US inflation rate to rise back to 3.76% by 2000.
The fed funds rate hit a low of 1.75% in 2001 when
inflation hit 3.76%; it hit 1% when inflation was
3.52% in 2004; and it hit 2.5% when inflation rose
to 4.69% in 2005.
For those years, US real
interest rate was mostly negative after inflation.
Factoring in the falling exchange value of the
dollar, the Fed was in effect paying US
transnational corporate borrowers to invest in
non-dollar markets, and paying US financial
institution to profit from dollar carry trade, ie
borrowing dollars at negative rates to speculate
in assets denominated in other currencies with
high yields.
In recent years, the US has
been allowing the dollar to fall in exchange value
to moderate the adverse effect of high
indebtedness and using depressed wages, both
domestic and foreign, to moderate US inflationary
pressure. This trend is not sustainable because
other governments will intervene in the foreign
exchange market to keep their own currencies from
appreciating against the dollar to remain
competitive in global trade. The net result will
be a moderating of drastic changes in the exchange
rate regime but not a halt of dollar depreciation.
What has happened is a global devaluation
of all currencies with the dollar as the lead
sinking anchor in terms of purchasing power. The
sharp rise of prices for assets and commodities
around the world has been caused by the sinking of
the purchasing power of all currencies. This is a
trend that will end in hyperinflation while the
exchange rate regime remains operational,
particularly if central banks continue to follow a
coordinated policy of holding up inflated asset
and commodities prices globally with loose
monetary policies, ie releasing more liquidity
every time markets face imminent corrections.
Politics of central banking The
circumstances that created the political climate
in the United States for the adoption of a central
bank came ironically from internecine war on Wall
Street that spread economic devastation across the
nation during the recession of 1907-08, the direct
result of one dominant money trust trying to
cannibalize its competition.
In 1906, the
powerful Rockefeller interests in Amalgamated
Copper executed a plan to destroy the Heinze
combination, which owned Union Copper Co. By
manipulating the stock market, the Rockefeller
faction drove down Heinze stock in Union Copper
from US$60 to $10. The rumor was then spread that
not only Heinze Copper but also the Heinze banks
were folding under Rockefeller pressure. J P
Morgan joined the Rockefeller enclave to announce
that he thought the Knickerbocker Trust Co would
be the first Heinze bank to fail. Panicked
depositors stormed the teller cages of
Knickerbocker to withdraw their money. Within a
few days the bank was forced to close its doors.
Similar fear spread to other Heinze banks and then
to the whole banking world. The crash of 1907 was
on.
Millions of depositors were sold out
penniless, their savings wiped out by bank
failures and homeowners rendered homeless by bank
foreclosure of their mortgages. The destitute, the
hungry and the homeless were let to fend for
themselves as best they could, which was not very
well. Money still in circulation was hoarded by
those who happened to still have some, so before
long a viable medium of exchange became
practically non-existent in a dire liquidity
crisis. The 1907 depression was much more severe
for the average family than the one in 1930.
Many otherwise healthy businesses began
printing private IOUs and exchanging them for raw
materials as well as giving them to their
remaining workers for wages. These "tokens" were
passed around as a temporary medium of exchange to
keep the economy functioning minimally. At this
critical juncture, J P Morgan offered to salvage
the last operating Heinze bank (Trust Co of
America) on condition of a fire sale of the
valuable Tennessee Coal and Iron Co in Birmingham
to add to the monopolistic US Steel Co, which he
had earlier purchased from Andrew Carnegie.
This arrangement violated then existing
anti-trust laws, but in the prevailing climate of
depression crisis the proposed transaction was
quickly approved by a thankful Washington. Morgan
was also intrigued by the paper IOUs that various
business houses were being allowed to circulate as
temporary media of exchange. Using the argument of
the need to create order out of monetary chaos,
the same argument that Rockefeller used to build
the Standard Oil Trust, Morgan persuaded Congress
to let him put out $200 million in such "tokens"
issued by one of the Morgan financial entities,
claiming this flow of Morgan "certificates" would
revive the stalled economy. The nominal GDP fell
from $34 billion in 1907 to $30 billion in 1908
and did not recover to $34 billion until 1911,
even with an average annual inflation rate of over
7%.
Getting rich from making money
As these new forms of Morgan "money" began
circulating, the public regained its "confidence"
and hoarded money began to circulate again as well
in anticipation of inflation. Morgan circulated
$200 million in "certificates" created out of
nothing more than his "corporate credit" with
formal government approval. This is the equivalent
of $100 billion in today's money. It was a superb
device to get fabulously rich by literally making
money.
Eight decades later, GE Capital,
the finance unit of the world’s largest
conglomerate that incidentally also manufactures
hard goods, did the same thing in the 1990s with
commercial paper and derivatives to create
hundreds of billions in profits. Soon, every
corporation and financial entities followed suit
and the commercial paper market became a critical
component of the financial system. This was the
market that seized in August 2007, starting the
current credit crisis.
"The commercial
paper market, in terms of the asset-backed
commercial paper market, is basically history,"
said William H Gross, chief investment officer of
the bond management firm Pacific Investment
Management Company, known as Pimco.
The
commercial paper market historically was best
known as an alternative market funding source for
non-financial corporations at times when bank
loans were seen as too expensive or possibly not
available due to tight monetary policy. Finance
companies, especially those affiliated with major
auto companies and well-known consumer-credit
lenders, have also issued paper tied to
non-financial industrial entities. In the
mid-1990s, non-financial corporate issues were
still nearly 30% of total paper outstanding. This
share began to drop precipitously just before the
recession of 2001 and has stabilized but not
recovered. By March 2006, the non-financial
segment constituted a mere 7.8% of the total, the
lowest in the 37-year history of the data.
Financial companies have also altered
their approach to the market. Some paper is still
backed by companies' general financial resources,
but other commercial paper is backed by specific
loans, including automobile and credit card debt
and home mortgages. Most ominously, commercial
paper is used to finance securitized credit
instruments that move debt liabilities off the
balance sheets of the borrowers.
Some
conspiracy theorists assert that the seeds for the
Federal Reserve system had been sown with the
Morgan certificates. On the surface, J P Morgan
seemed to have saved the economy - like first
throwing a child into the river and then being
lionized for saving him with a rope that only he
was allowed to own, as some of his critics said.
On the other hand, Woodrow Wilson wrote: "All this
trouble [the 1907 depression] could be averted if
we appointed a committee of six or seven
public-spirited men like J P Morgan to handle the
affairs of our country." Both Morgan and Wilson
were elite internationalists.
The House of
Morgan then held the power of deciding which banks
should survive and which ones should fail and, by
extension, deciding which sector of the economy
should prosper and which should shrink. The same
power today belongs to the Fed, whose policies
have favored the financial sector at the expense
of the industrial sector. At least the House of
Morgan then used private money for its predatory
schemes of controlling the money supply for its
own narrow benefit. The Fed now uses public money
to bail out the private banks that own the central
bank in the name of preventing market failure.
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
