The Long Run Blog

Critical Thinking on Money, Finance, and Economics

The Fed – Tool of the New World Order or Jewish Conspiracy? Part I

How about ‘none of the above?’  Of course, there are many people who would pick both, and add a few choice words as well.  It is true enough that the founding fathers were very suspicious of central banks, and worked hard to prevent the United States from having one.  These days, though, a country without a central bank is like a hockey team without a goalie – it’s not against the rules, but it would lead to some wild action.

The Fed is a favorite target of conspiracy theorists of all stripes, most of whom seem to believe that currency must be backed by gold or have no value.  The fact that the Fed is independent of Congressional oversight (not entirely true) or the President – once he appoints the Governors – certainly adds to mistrust.  Alan Greenspan, chairman of the Fed from 1987 until 2006, also exacerbated the problem with his famous lack of clarity and air of ivory-tower wizardry.  Ordinarily I’d add a couple of links to conspiracy theory websites, but I don’t want to dignify them… oh, okay, just one. This is a youtube video: http://www.youtube.com/watch?v=sTqDFss24Hw

The Fed has at least three major functions, one of which is really boring and never talked about, one of which is usually overlooked, and one is the source of all the moaning and complaining.

The boring:  The Fed is responsible for all check clearing for the entire banking system.  They also clear transactions in US Government securities and perform a whole bunch of other mechanical, boring, and absolutely necessary banking functions.

The never talked about – though more important recently: The Fed’s number one highest priority is to safeguard the stability of the US Banking system.  They do this by auditing banks, setting reserve requirements, monitoring the overall health of banking institutions, and when necessary providing a virtually unlimited flow of cheap funds into the system.

The source of all the moaning: The Fed monitors and adjusts the supply of money in the banking system, and using this tool attempts to keep inflation under control while maximizing employment.  This is what makes the conspiracy nuts get their knickers in a twist. 

The basic theory – and the only one necessary if you’re what is known as a monterarist, is that inflation is a monetary phenomenon.  Print more money than necessary, you’ll have too much money chasing too few goods, and prices will rise.  Print less than needed, and demand will fall, and so will prices.  The Fed manipulates the supply of money through the Fed Funds rate, which is the rate that banks charge each other for overnight loans on their reserve balances – held at the Fed.  Every day, the Fed tries to figure out how much is needed to make sure all the banks have the right reserve level, and adds or subtracts funds to make everything balance.  If the Fed wants the rate to rise, they subtract money from the system and the banks accordingly charge each other more.  If the Fed wants the rate to fall they add a little, and down comes the rate.  The key thing is that the banking system takes its cue from the signals put out by the Fed as to where it wants the rate to be – and these days they announce the target rate so everyone knows what it is.  The higher the target rate, the tighter the policy.  Tight policy (in theory) chokes off demand and kills inflation, at the risk of killing off economic growth.  Loose policy sparks demand, encouraging economic growth, but risks causing inflation.

This manipulation of the economy by an unelected group – some would call it a cabal – is the source of an awful lot of resentment and the root cause of the paranoid thinking that leads to conspiracy theories.  I’ll stop here and continue later in another post – I think we all need to sit back and digest a little.

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August 21, 2008 - Posted by | Education, Markets, Theory | , , ,

6 Comments »

  1. Nice article.

    Quick blog comment: I can’t see who the author is when I’m looking at the article. To find out the author, I need to go to the front page. This is annoying since I come directly to the article through an RSS reader.

    In this case though, I could tell it was Jon.

    Comment by jonnyeh | August 21, 2008 | Reply

  2. You’re right. I think it’s the theme we’ve chosen for the blog – maybe we should switch to a different one. I’ll talk to Brett.

    Comment by Jon Blumenfeld | August 21, 2008 | Reply

  3. [...] to the crazy world of finance and it does a great job of it. Jon’s descriptions about how the federal reserve actually works is what got me good and hooked into this blog. His departure has not gone [...]

    Pingback by On the topic of other skeptic/science blogs. « Northwest Skeptics | October 8, 2008 | Reply

  4. Hi, I wonder if you could comment on Griffin’s Jekyll Island book. It smacks of that conspiracy theory genre and I really don’t want to waste my time reading it but I know nothing of the subject and would like to read something rational and well researched regarding the Fed Thanks, Bill

    Comment by upkerry11 | December 31, 2012 | Reply

    • While I haven’t read Griffin’s book, I’m pretty sure its pure crap judging by his other works, like “A World Without Cancer”. Go to the Fed’s website- there is a 75 page ebook there that explains the Fed and how it works. Or go to wikipedia. I’m sure their article describes it. It is not some mysterious conspiracy, but it does have certain flaws.

      Comment by Brett | January 1, 2013 | Reply

      • Even after reading thier spiel (which I did prior to writing you) i *still* don’t get where they actually get their money. They say from Treasury bonds…. um, I’m no financial genius but don’t we, the public/taxpayers buy these? so the fed is playing around with my money ultimately? Didn’t Bernanke just refuse flat out on TV during a hearing recently tell Congress he was NOT going to tell them how some moey was spent? What cojones! This is accoutability? And why are they, by law, getting a guaranteed six percent return? (see their own website). Nice work if you can get it.

        Comment by upkerry11 | January 1, 2013


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