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WORLD | BUSINESS

Federal Reserve: Mortal Agony on Day of Jubilee

Valentin KATASONOV | 23.12.2013 | 00:00 Comments: 1
 

The Federal Reserve Act was enacted December 23, 1913, a hundred years ago the bill was signed into law by President Woodrow Wilson. Since then the Federal Reserve System has become a factor determining the US economy and politics. 

Federal Reserve System illegitimate

Many Americans believe that a bunch of international bankers got hold of power as the Federal Reserve System (FRS) came into being. President and Congress became servants of FRS main shareholders. The privately owned Federal Reserve Corporation belonging to a group of bankers became the only real power in America which then started to vie for world dominance. Numerous publications are devoted to the subject. 

The book Secrets of the Federal Reserve by Eustace Mullins was the first to see light in late 1940s to be followed by The Federal Reserve Conspiracy by Antony Sutton, The Syndicate: The Story of the Coming World Government by Nicholas Hagger, The Unseen Hand by A. Ralph Epperson and The Gods of Money by William Engdahl. There is a recent bestseller by US former Representative Ron Paul called End the Fed. The power of Federal Reserve in the XX century instilled a false feeling of its infinity just like the dollar it issued. These illusions get gradually evaporated as events unfold in the early days of XXI century… Ron Paul enumerates many cases when the Federal Reserve System has been in direct violation of the Federal Reserve Act. The most egregious one is granting by the Federal Reserve System incredibly huge credits for the total sum of $16 trillion to the largest banks of America and Europe during the recent financial crisis. I’m not talking about the fact that the very establishment of the Federal Reserve System was a blatant violation of American Constitution which puts it plainly that only Congress is authorized to issue currency, not some group of private owners. 

«Escape from the dollar» scenario

The Federal Reserve System has preserved its influence during the entire century because the US dollar produced by its printing press has been in demand in the country as well as beyond its borders. All US foreign policy efforts at the beginning of the XX - early XXI centuries were focused on the promotion of the commodity produced by the Federal Reserve printing press. That’s what led to unleashing two world wars and a lot of local conflicts. It was not a big thing to keep the Federal Reserve System production in demand after WWII when the world was getting the largest share of purchased goods from the United States giving dollars in return. The US was the largest shareholder of the International Monetary Fund and the World Bank which promoted the process of «dollarization». That is what the Marshall plan was about launching multiple US foreign aid programs. 

Thanks to the Kissinger’s Middle East policy backed up by US military might, Washington managed to introduce the basics of oil-dollar standards in 1973-1975. The world started to sell the «black gold» for dollars only. The world financial markets started to thrive in the second half of the XX century and «financial instruments» were predominantly sold for US dollars too. 

The demand for dollar started to fall down in the recent years. The competition with other currencies has been started. The euro, the yuan and the currencies outside the world reserve list challenged the greenback. Trying to get rid of the dependence on the dollar, the leaders of other countries ever so often make statements which are perceived by the Federal Reserve System’s owners as calls for the boycott of oil-dollar standard. In his time Saddam Hussein refused to sell the «black gold» for dollars and even switched to euro payments. Washington responded promptly; the revolt resulted in the Saddam Hussein’s overthrow and the following execution. Sometime later the same fate happened to be in store for Muammar Qaddafi who had planned to leave the dollar for golden dinar. The Washington’s plans flopped when it came to Iran. The US sanctions have been imposed since a long time ago (1979). But the country happened to be a hard nut to crack. Iran has totally refused to use the US dollar for foreign transactions (it should be noted that all transactions go through the US banking system and are controlled by the Federal Reserve System). This is a dangerous precedent, an example which other states may follow. The cautious steps to gradually get away from the dollar have been started to be taken by China. Beijing has concluded a string of agreements with other countries to use national currencies for foreign trade. For instance, an agreement is in force between Beijing and Tokyo which envisions the use of the yuan and the yen for China-Japan trade transactions keeping all other currencies aside, including the US dollar. These events could be characterized as gradual emancipation from the US dollar, the process which at any given moment may become a flight from the United States currency. In this case, the Federal Reserve System may not die as yet, but it will become nothing more than just an ordinary central bank with operations limited by the domestic economic developments only. 

«The Federal Reserve System out of business» scenario

Some years ago nobody could imagine a scenario which would envision the Federal Reserve System going bankrupt. But the FRS’s plight has started to rapidly deteriorate since 2010 due to the implementation of quantitative easing policy. Announcing the formal goal of restoring the national economy and boosting employment after the financial crisis, the Federal Reserve System goes on increasing the production of its printing press. The mechanism is as simple as it could be: the Federal Reserve System exchanges its paper production for different kinds of securities offered by American banks ($85 billion a month during the last year). The papers include US treasury bonds or mortgage securities. The last ones are nothing more but waste paper which the financiers call «toxic assets» using their professional jargon. The market price is extremely low (on and off it is fluctuating somewhere around zero), but the Federal Reserve System acquires them at face value or almost at nominal cost. The FRS can sell «toxic assets» only operating in the red. The accumulation of such «assets» will create a bubble to be blown out of proportions. There are real estate and exchange bubbles, now a new type of bubble will emerge. It’s not about mortgage papers only; treasury bonds may also cause problems. Today the Federal Reserve System pays a high price for treasury bonds but tomorrow their market price may plummet. So the FRS will operate in the red by selling them. Any commercial organization will use its own capital as a stand-by reserve to cover the losses. The same goes for the Federal Reserve System. But in this case it’s just a token capital accounting for only 3-4 percent of the current FRS assets. By the way, it must meet capital adequacy minimum requirements (the requirements are defined and the procedure stipulated by the special documents of the Committee on Banking Supervision of the Bank for International Settlements). At present the Federal Reserve System is far from complying with the requirements. Strictly speaking it should declare bankruptcy today. Experts know it well but the discussions never leave the narrow circle of savvies talking shop. Nobody among experts can come up with anything like a meaningful plan to rescue the Federal Reserve System from imminent bankruptcy. 

«Government Bankruptcy» scenario

The Federal Reserve System has acted as the savior of the US government. The FRS granted loans to the Treasury by buying out debt bonds. Of course, it was not the only entity to save the government. Many other US organizations have acquired the treasury bonds – commercial and investment banks, investment funds, insurance companies, pension funds. The other countries central banks and finance ministries had accounted for the acquisition of half of treasury bonds till recently. Today China, Japan, India, Saudi Arabia and some other countries with huge gold and foreign currency reserves are the leading creditors of US government. China and others are gradually losing the lust for adding «green paper» to their international reserves. In the fall of 2013 a Deputy Governor of the Bank of China made a sensational statement saying it was no longer in China’s favor to accumulate foreign-exchange reserves. 

The Federal Reserve System has become the main money lender (donor) of US Treasury. At the third round of quantitative easing "QE3" the Federal Reserve System has started to buy out the lion’s share of the papers used by the government to cover the budget holes (to pay for the budget deficit). A vicious circle starts: the Federal Reserve gives the Treasury the «green paper»; in return the Treasury gives the Federal Reserve the bonds. It’s resembles a monetary perpetuum mobile. This «close» mechanism deprives the American and world economy of needed currency, it works for itself only. The lack of «green paper» will be exponentially compensated by other currencies and their surrogates. 

Besides, there is one more trap in store for the United States government and the Federal Reserve System. The American government has to use the budget to pay off its debt. The interest rates currently set by the Federal Reserve System are about zero. The treasury bonds interest rates (oriented on the Federal Reserve System’s rates) are extremely low too. About 7 percent of budget money is spent on paying off government debts. It’s acceptable. But let’s imagine that the interest rates start to grow (sooner or later they will inevitably rise). The percentage of budget spent on paying off the debt (interest payments) will increase too. Experts believe it is possible that 50 percent of the entire budget will be spent to cover interest rates. In this case the financial perpetuum mobile will stop because it will hit a natural obstacle like the tax revenues filling the US state budget. Then the one and only client of the Federal Reserve System – the American government - will go bankrupt. After that the Federal Reserve System itself is to give up the ghost. 

There are other scenarios to be offered for consideration, all of them related to the Federal Reserve System, the dollar and the United States – the three pillars of integrated financial and political system. All of them are unfavorable for the Federal Reserve System’s owners. By and large, the very same situation was faced in the first half of the XX century by the owners of the Bank of England when the US dollar began to rival the all-powerful pound sterling. The last chance to preserve «the place under the sun» for the Bank of England’s owners was to unleash a large-scale war. I’m afraid that is exactly what the current Federal Reserve System’s owners have in mind.

 
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Valentin KATASONOV

D.Sc. (Economics), Economist and the chairman of the S.F. Sharapov Russian Economic Society


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