Debunking Federal Reserve conspiracy theories

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PublicEye.org - The Website of Political Research Associates

Myth #1: The Federal Reserve Act of 1913 was crafted by Wall Street bankers and a few senators in a secret meeting.

On the Georgian resort hideaway of Jekyll Island (which has some excellent golf courses, by the way), there once met a coalition of Wall Street bankers and U.S. senators. This secret 1910 meeting had a sinister purpose, the conspiracy theorists say. The bankers wanted to establish a new central bank under the direct control of New York's financial elite. Such a plan would give the Wall Street bankers near total control of the financial system and allow them to manipulate it for their personal gain.

G. Edward Griffin lays out this conspiratorial version of history in his book The Creature from Jekyll Island. His amateurish take on history is highly suspect, however. Gerry Rough, in a series of well- researched essays on U.S. banking history, reveals many historical inaccuracies, inconsistencies, and even contradictions in Griffin's book and others of its genre. Instead of reproducing Rough's work here, I offer the reader a substantially more accurate view of the events leading up to the creation of the Federal Reserve System in 1913. To get a proper historical perspective, the story of begins just prior to the Civil War...
The National Banking Acts of 1863 & 1864

Prior to the Civil war there were thousands of banks in operation throughout the Union, all of them chartered, that is, licensed by the state governments. Banking regulations were virtually nonexistent. The federal government had no meaningful controls on banking practices, and state regulations were spotty and poorly enforced at best. Economic historians call the era leading up to the Civil War as the 'state banking era' or the 'free banking era.'

The problems with state banking were numerous, but three were conspicuous. First, the nation had no unified currency. State banks issued their own bank notes as currency, a system which at worst invited severe bouts of counterfeiting and at best introduced additional uncertainty in the task of determining the relative value of each bank note. Second, with no mitigating influence on the issuance of bank notes, the money supply and the price level were highly unstable, introducing and perhaps causing additional volatility in the business cycle. This was due in part to the fact that bank note issuance was frequently tied to the market value of the bank's bond portfolio which they were required to have by law. Third, frequent bank runs resulted in substantial depositor losses and severe crises of confidence in the payments system.5

The National Banking Acts of 1863 and 1864 were attempts to assert some degree of federal control over the banking system without the formation of another central bank. The Act had three primary purposes: (1) create a system of national banks, (2) to create a uniform national currency, and (3) to create an active secondary market for Treasury securities to help finance the Civil War (for the Union’s side).5

The first provision of the Acts was to allow for the incorporation of national banks. These banks were essentially the same as state banks, except national banks received their charter from the federal government and not a state government. This arrangement gave the federal government regulatory jurisdiction over the national banks it created, whereas it asserted no control over state-chartered banks. National banks had higher capital requirements and higher reserve requirements than their state bank counterparts. To improve liquidity and safety they were restricted from making real estate loans and could not lend to any single person an amount exceeding ten percent of the bank's capital. The National Banking Acts also created under the Treasury Department the office of Comptroller of the Currency. The duties of the office were to inspect the books of the national banks to insure compliance with the above regulations, to hold Treasury securities deposited there by national banks, and, via the Bureau of Engraving, to design and print all national banknotes.5

The second goal of the National Banking Acts was to create a uniform national currency. Rather than have several hundred, or several thousand, forms of currency circulating in the states, conducting transactions could be greatly simplified if there were a uniform currency. To achieve this all national banks were required to accept at par the bank notes of other national banks. This insured that national bank notes would not suffer from the same discounting problem with which state bank notes were afflicted. In addition, all national bank notes were printed by the Comptroller of the Currency on behalf of the national banks to guarantee standardization in appearance and quality. This reduced the possibility of counterfeiting, an understandable wartime concern.5

The third goal of the Acts was to help finance the Civil War. The volume of notes which a national bank issued was based on the market value of the U.S. Treasury securities the bank held. A national bank was required to keep on deposit with the Comptroller of the Currency a sizable volume of Treasury securities. In exchange the bank received bank notes worth 90 percent, and later 100 percent, of the market value of the deposited bonds. If the bank wished to extend additional loans to generate more profits, then the bank had to increase its holdings of Treasury bonds. This provision had its roots in the Michigan Act, and it was designed to create a more active secondary market for Treasury bonds and thus lower the cost of borrowing for the federal government.5

It was the hope of Secretary of the Treasury Chase that national banks would replace state banks, and that this would create the uniform currency he desired and ease the financing of the Civil War. By 1865 there were 1,500 national banks, about 800 of which had converted from state banking charters. The remainder were new banks. However, this still meant that state bank notes were dominating the currency because most of them were discounted. Accordingly, the public hoarded the national bank notes. To reduced the proliferation of state banking and the notes it generated, Congress imposed a ten percent tax on all outstanding state bank notes. There was no corresponding tax of national bank notes. Many state banks decided to convert to national bank charters because the tax made state banking unprofitable. By 1870 there were 1,638 national banks and only 325 state banks.5

While the tax eventually eliminated the circulation of state bank notes, it did not entirely kill state banking because state banks began to use checking accounts as a substitute for bank notes. Checking accounts became so popular that by 1890 the Comptroller of the Currency estimated that only ten percent of the nation's money supply was in the form of currency. Combined with lower capital and reserve requirements, as well as the ease with which states issued banking charters, state banks again became the dominant banking form by the late 1880’s. Consequently, the improvements to safety that the national banking system offered were mitigated somewhat by the return of state banking.5

There were two major defects remaining in the banking system in the post Civil War era despite the mild success of the National Banking Acts. The first was the inelastic currency problem. The amount of currency which a national bank could have circulating was based on the market value of the Treasury securities it had deposited with the Comptroller of the Currency, not the par value of the bonds. If prices in the Treasury bond market declined substantially, then the national banks had to reduce the amount of currency they had in circulation. This could be done be refusing new loans or, in a more draconian way, by calling-in loans already outstanding. In either case, the effect on the money supply is a restrictive one. Consequently, the size of the money supply was tied more closely to the performance of the bond market rather than needs of the economy.5

Another closely related defect was the liquidity problem. Small rural banks often kept deposits at larger urban banks. The liquidity needs of the rural banks were driven by the liquidity demands of its primary customer, the farmers. In the planting season the was a high demand for currency by farmers so they could make their purchases of farming implements, whereas in harvest season there was an increase in cash deposits as farmers sold their crops. Consequently, the rural banks would take deposits from the urban banks in the spring to meet farmers’ withdrawal demands and deposit the additional liquidity in the autumn. Larger urban banks could anticipate this seasonal demand and prepare for it most of the time. However, in 1873, 1884, 1893, and 1907 this reserve pyramid precipitated a financial crisis.5

When national banks experienced a drain on their reserves as rural banks made deposit withdrawals, new reserves had to be acquired in accordance with the federal law. A national bank could do this by selling bonds and stocks, by borrowing from a clearinghouse, or by calling-in a few loans. As long as only a few national banks at a time tried to do this, liquidity was easily supplied to the needy banks. However, an attempt en masse to sell bonds or stocks caused a market crash, which in turn forced national banks to call in loans to comply with Treasury regulations. Many businesses, farmers, or households who had these loans were unable to pay on demand and were forced into bankruptcy. The recessionary vortex became apparent. Frightened by the specter of losing their deposits, in each episode the public stormed any bank rumored, true or not, to be in financial straights. Anyone unable to withdraw their deposits before the bank’s till ran dry lost their savings or later received only pennies on the dollar. Private deposit insurance was scant and unreliable. Federal deposit insurance was non-existent.5

 

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The 1907 Banking Panic

The 1907 crisis, also called the Wall Street Panic, was especially severe. The Panic caused what was at that time the worst economic depression in the country’s history. It appears to have begun with a stock market crash brought about by a combination of a modest speculative bubble, the liquidity problem, and reserve pyramiding. Centered on New York City, the scale of the crisis reached a proportion so great that banks across the country nearly suspended all withdrawals -- a kind of self-imposed bank holiday. Several long-standing New York banks fell. The unemployment rate reached 20 percent at the peak of the crisis. Millions lost their deposits as thousands of banks collapsed. The crisis was terminated when J.P. Morgan, a man of sometimes suspicious business tactics and phenomenal wealth, personally made temporary loans to key New York banks and other financial institutions to help them weather the storm. He also made an appeal to the clergy of New York to employ their Sunday sermons to calm the public’s fears.

Morgan’s emergency injection of liquidity into the banking system undoubtedly prevented an already bad situation from getting still worse. Although private clearinghouses were able to supply adequate temporary liquidity for their members, only a small portion of banks were members of such organizations. What would happen if there were no J.P. Morgan around during the next financial crisis? Just how bad could things really get? There began to emerge both on Wall Street and in Washington a consensus for a kind of institutionalized J.P. Morgan, that is, a public institution that could provide emergency liquidity to the banking system to prevent such panics from starting. The final result of the Panic of 1907 would be the Federal Reserve Act of 1913.

The Federal Reserve Act of 1913

Following the near catastrophic financial disaster of 1907, the movement for banking reform picked up steam among Wall Street bankers, Republicans, and eastern Democrats. However, much of the country was still distrustful of bankers and of banking in general, especially after 1907. After two decades of minority status, Democrats regained control of Congress in 1910 and were able to block several Republican attempts at reform, even though they recognized the need for some kind of currency and banking changes. In 1912 Woodrow Wilson won the Democratic party’s nomination for President, and in his populist-friendly acceptance speech he warned against the "money trusts," and advised that "a concentration of the control of credit ... may at any time become infinitely dangerous to free enterprise."3

Also in 1910, Senator Nelson Aldrich, Frank Vanderlip of National City (today know as Citibank), Henry Davison of Morgan Bank, and Paul Warburg of the Kuhn, Loeb Investment House met secretly at Jeckyll Island, a resort island off the coast of Georgia, to discuss and formulate banking reform, including plans for a form of central banking. The meeting was held in secret because the participants knew that any plan they generated would be rejected automatically in the House of Representatives if it were associated with Wall Street. Because it was secret and because it involved Wall Street, the Jekyll Island affair has always been a favorite source of conspiracy theories. However, the movement toward significant banking and monetary reform was well-known.3 It is hardly surprising that given the real possibility of substantial reform, the banking industry would want some sort of input into the nature of the reforms. The Aldrich Plan which the secret meeting produced was even defeated in the House, so even if the Jekyll Island affair was a genuine conspiracy, it clearly failed.

The Aldrich Plan called for a system of fifteen regional central banks, called National Reserve Associations, whose actions would be coordinated by a national board of commercial bankers. The Reserve Association would make emergency loans to member banks, create money to provide an elastic currency that could be exchanged equally for demand deposits, and would act as a fiscal agent for the federal government. Although it was defeated, the Aldrich Plan served as an outline for the bill that eventually was adopted. 5

The problem with the Aldrich Plan was that the regional banks would be controlled individually and nationally by bankers, a prospect that did not sit well with the populist Democratic party or with Wilson. As the debate began to take shape in the spring of 1913, Congressman Arsene Pujo provided good evidence that the nation’s credit markets were under the tight control of a handful of banks – the "money trusts" against which Wilson warned.1 Wilson and the Democrats wanted a reform measure which would decentralize control away from the money trusts.

The legislation that eventually emerged was the Federal Reserve Act, also known at the time as the Currency Bill, or the Owen-Glass Act. The bill called for a system of eight to twelve mostly autonomous regional Reserve Banks that would be owned by the banks in their region and whose actions would be coordinated by a Federal Reserve Board appointed by the President. The Board’s members originally included the Secretary of the Treasury, the Comptroller of the Currency, and other officials appointed by the President to represent public interests. The proposed Federal Reserve System would therefore be privately owned, but publicly controlled. Wilson signed the bill on December 23, 1913 and the Federal Reserve System was born.6

Conspiracy theorists have long viewed the Federal Reserve Act as a means of giving control of the banking system to the money trusts, when in reality the intent and effect was to wrestle control away from them. History clearly demonstrates that in the decades prior to the Federal Reserve Act the decisions of a few large New York banks had, at times, enormous repercussions for banks throughout the country and the economy in general. Following the return to central banking, at least some measure of control was removed from them and placed with the Federal Reserve.

 

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Myth #2: The Federal Reserve Act never actually passed Congress. The Senate voted on the bill without a quorum, so the Act is null and void.

The silliest of the Federal Reserve conspiracy theories is that the Federal Reserve Act of December 23, 1913 passed illegally. The constitution stipulates that both the House and the Senate must have at least half their members present, a quorum, to vote on any bill. According to this myth, the Senate voted on the Federal Reserve Act (known as the Currency Bill at the time) deviously in a late night session when most of its members had gone home or had left town for the holiday. This was done to impose the will of a pro-banker minority on the objecting majority. Since no quorum was present, the Federal Reserve Act is not valid.

This idea is better described as folklore than a full-blown conspiracy theory because I've never been able to find it in print, only on occasion on Usenet or in e-mail from readers. Gary Kah, author of En Route to Global Occupation, came close when he wrote that the bill's supporters waited until its opponents were out of town and it was passed under "suspicious circumstances" (Kah, p. 13-14). Nevertheless, the myth has no basis in fact. The House passed the bill 298-60 on the evening of Dec. 22, 1913.3 The Senate began debate the following day at 10am, and passed it 43-25 at 2:30pm.4

What of the missing Senators? Since there were 48 states in 1913, forty eight votes plus the tie-breaking vote of vice-President Thomas Marshall would have been sufficient to approve the bill even if all absent votes had been cast against the bill. However, many of the missing Senators had their positions recorded in the Congressional Record.1 Of the 27 votes not cast, there were 11 'yeas' (in favor of the bill) and 12 'nays.'1 Even if the absentee Senators had been there, the Currency Bill would have passed easily.

President Wilson signed the Currency Bill into law in an "enthusiastic" public ceremony on Dec. 23, 1913.4

 

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Myth #3: The Federal Reserve Act and paper money are unconstitutional. Gold and silver coins are the only constitutional forms of money.

Those who hold that the constitution should be interpreted very strictly believe the Federal Reserve System and paper money are unconstitutional. Sharing the interpretive philosophy of Thomas Jefferson, they argue that Congress has only those powers which the constitution specifically enumerates. If the power is not explicitly granted, then the federal government simply does not have it. Therefore, the Federal Reserve is unconstitutional because Congress does not have the specific power to create a central bank. In addition, the federal government's power to create money -- lawful money -- is limited only to minting gold or silver coins; paper currency is forbidden.
The Constitutional Basis for Central Banking

First, the constitution grants the Congress the right to coin money and to regulate its value. It is not clear from the constitution or the Federalist Papers what the authors meant by the term 'value.' Traditionally, it has meant the weight and metallic content of the coin. No one challenges this interpretation. On the other hand, the only relevant meaning of 'value' in the context of money is its value in trade, also known as its purchasing power. This a government cannot regulate merely by an act of Congress. The government's only tool for regulating this latter value is altering the money supply.

Second, Congress has the right to regulate interstate commerce. Banking and other financial services clearly involves interstate commerce as the courts have come to define it.

Finally, and perhaps most importantly, Congress has the right to make any law that is 'necessary and proper' for the execution of its enumerated powers (Art. I, Sec. 8, Cl. 18). A law creating a Bureau of the Mint, for example, is necessary and proper for the Congress to exercise its right to coin money. A similar argument may justify a central bank. It facilitates the expansion and contraction of the money supply and it serves as means to regulate the banking industry.

Is this a reasonable use of the necessary and proper clause? I do not know, but a test of its meaning came early. The history of central banking in the United States does not begin with the Federal Reserve. The Bank of the United States received its charter in 1791 from the U.S. Congress and Washington signed it. Secretary of State Alexander Hamilton designed the Bank's charter by modeling it after the Bank of England, the British central bank. Secretary of State Thomas Jefferson believed the Bank was unconstitutional because it was an unauthorized extension of federal power. Congress, Jefferson argued, possessed only delegated powers that were specifically enumerated in the constitution. The only possible source of authority to charter the Bank, Jefferson believed, was in the necessary and proper clause. However, he cautioned that if the clause could be interpreted so broadly in this case, then there was no real limit to what Congress could do.2

Hamilton conceded that the constitution was silent on banking. He asserted, however, that Congress clearly had the power to tax, to borrow money, and to regulate interstate and foreign commerce. Would it be reasonable for Congress to charter a corporation to assist in carrying out these powers? He argued that the necessary and proper clause gave Congress implied powers -- the power to enact any law that is necessary to execute its specific powers. A “necessary” law in this context Hamilton did not take to mean one that was absolutely indispensable. Instead, he argued that it meant a law that was “needful, requisite, incidental, useful, or conducive to” the primary Congressional power which it supported. Then Hamilton offered a proposed rule of discretion: “Does the proposed measure abridge a pre-existing right of any State or of any individual?” (Dunne, 19). If not, then it probably is constitutionally proper on these grounds. Hamilton’s arguments carried the day and convinced Washington.

The Supreme Court had its say on the matter in McCulloch v. Maryland (1819). It voted 9-0 to uphold the Second Bank of the United States as constitutional. The Court argued with the doctrine of implied powers, stating that to be ‘necessary and proper’ the Bank needed only to be useful in helping the government meet its responsibilities in maintaining the public credit and regulating the money supply. Chief Justice Marshall wrote, “After the most deliberate consideration, it is the unanimous and decided opinion of this court that the act to incorporate the Bank of the United States is a law made in pursuance of the Constitution, and is part of the supreme law of the land” (Hixson, 117). The Court affirmed this opinion in the 1824 case Osborn v. Bank of the United States (Ibid, 14).

Therefore, the historical legal precedent exists for Congress' power to create a central bank. It formed the Federal Reserve system in 1913 to perform many of the same functions as its predecessors. As before, the courts have agreed that a central bank, and the Federal Reserve in particular, is constitutional.
The Constitutional Basis for Paper Money

Even if the Federal Reserve is a constitutionally proper institution, what of paper money? The federal government has issued many forms and denominations of paper currency since 1812. It first made paper a legal tender in 1862. Does not the constitution require the Congress to coin money, not to print it? Is this not what the authors of the constitution intended? Perhaps, but it's not an air-tight issue. S.P. Breckenridge wrote in Legal Tender of the significant disagreements the delegates to the constitutional convention had over the issue, and even over the interpretation of the wording that they eventually adopted.

Prior to the constitutional convention in the summer of 1787, the States exercised their sovereign powers over monetary matters. Most States had issued their own forms of paper money, typically called ‘bills of credit’ at the time, and had declared some foreign coins as a legal tender. By ‘legal tender’ we mean a form of money which a government specifies may be used to settle debts and to pay taxes due to it. During the Revolutionary War many States issued paper money to excess. The Congress of the Articles of Confederation had also relied heavily on using paper money to fund its war expenditures. The States had also declared various forms of paper currency, including the Congress’ emissions, a legal tender. Severe price inflation was the necessary result of this over-indulgence in paper, and by the time the constitutional convention convened paper money had many enemies.

The primary foes of paper money were commercial and banking interests. When a lender agrees to fund a loan, he charges a rate of interest which, among other factors, includes a premium for any expected loss in the purchasing power of the principal during the life of the loan. If the price level is expected to rise, say, five percent then the lender will insist on an interest of at least that amount. If in actuality the price level increases eight percent, then the lender stands to lose as much as three percent of his principal. If a government has the power to issue paper money, then the potential abuse of this power increases the probability of an unexpected inflation. Commercial concerns also were generally against allowing paper, and for similar reasons. The sour inflationary experience of the previous decades made the business climate less stable than it might otherwise be with a constitutionally guaranteed gold or silver monetary standard. In addition, such a standard would protect the integrity of commercial contracts that specified fixed payments in specie. These interests at the convention therefore had two objectives: To forbid both the States and the federal government from issuing bills of credit -- the common term for paper money at the time -- and to base the monetary system on gold or silver.

Paper money was not without its partisans, however. Agricultural interests and debtors were fond of paper money, as well as Ben Franklin, and for many of the same reasons. The losses a lender is likely to suffer at the hands of a paper-induced inflation are exactly offset by the gains of the borrower. The debtor would then be able to repay a fixed debt in less valuable currency. Farmers also generally favored paper money because it tended to create an economic climate of rising commodity prices relative to other goods, thereby increasing their real income. Their monetary goal at the convention was to give the government the right to issue bills of credit or, at the very least, not to deny it the power.

 

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Charles Pinckney of South Carolina produced a draft of a constitution that had two interesting features for our purposes. From Art. VII. Sec. 1 of his draft we read “The legislature of the United States shall have power … (4) To coin money … (5) To regulate the value of foreign coin … (8) To borrow money and emit bills on the credit of the United States …” Also we find in Article XII: “No state shall coin money.” We further read in Article XIII: “No state, without the consent of the legislature of the United States, shall emit bills of credit, or make anything but specie a tender in payment of debts.” We can glean some indication of the Founders’ intent concerning paper money from the debate on the matter in Madison’s notes on the convention. What follows below is an excerpt of those notes on this debate:

MR. GOUVERNEUR MORRIS [PA.] moved to strike out “and emit bills on the credit of the United States.” If the United States had credit such bills would be unnecessary; if they had not, unjust and useless.

MR. BUTLER [S.C.] seconds the motion.

The fundamental theory on which the Founders created the U.S. constitution is of a government of limited powers. The federal government would have only those powers specifically enumerated and those reasonably necessary to enact them. If a power is not expressly given to it, then it is denied. What Robert Morris of Pennsylvania seeks to do with the above motion is to deny the federal government the specific right to issue paper money. The discussion continued:

MR. MADISON [Va.] Will it not be sufficient to prohibit making them a tender? This will remove the temptation to emit them with unjust views; and promissory notes in that shape may in some emergencies be best.

MR. GOUVERNEUR MORRIS: Striking out the words will still leave room for the notes of a responsible minister, which will do all the good without the mischief. The moneyed interests will oppose the plan of government if paper emissions be not prohibited.

MR. GORHAM [Mass.] had doubts on the subject. Congress, he thought, would not have the power unless it was expressed. Though he had a mortal hatred to paper money, yet, as he could not foresee all emergencies, he was unwilling to tie the hands of the legislature. He observed the late war could not have been carried on had such a prohibition existed.

Gorham’s thoughts on this are key to interpreting how the Founders would eventually resolve this issue. The Revolutionary War was financed to a great extent on paper money the Continental Congress and later the Congress of the Articles of Confederation had issued. The Congress had no taxing authority of its own and the newly independent States were unwilling to contribute any significant funds of their own for the war effort. The Congress, with limited credit, was therefore left to emitting paper money. Although its over-issuance was largely responsible for the severe inflation of the time, it was also clear to the Founders and to later historians the States could not have funded their effort in any other way. The personal financial losses many of the delegates suffered at the hands of the paper money did much to alienate them from the medium, but it did not erase from their memory the acknowledgment of its financial contribution to their independence. Gorham, like others at the convention, disliked paper, but were hesitant in denying forever the government’s ability to use it. Madison’s notes continued:

MR. MERCER [Md.] was a friend to paper money, though in the present state and temper of America he should neither propose nor approve of such a measure. He was consequently opposed to a prohibition of it altogether. It will stamp suspicion on the government to deny it discretion on this point. It was impolitic also to excite the opposition of all those who were friends to paper money. The people of property would be sure to be on the side of the plan, and it was impolitic to purchase their further attachment with the loss of the opposite class of citizens.

MR. ELLSWORTH [Conn.] thought this a favorable moment to shut and bar the door against paper money. The mischiefs of the various experiments which been made were now fresh in the public mind, and had excited the disgust of all the respectable part of America. By withholding the power from the new government, more friends of influence would be gained to it than by almost anything else. Paper money can in no case be necessary. Give the government credit, and other resources will offer. The power may do harm, never good.

MR. RANDOLPH [Va.], notwithstanding his antipathy to paper money, could not agree to strike out the words, as he could not foresee all the occasions that might arise.

Here in a microcosm is the debate on whether to deny the federal government the right to issue paper money. Mercer and Ellsworth clearly represented the agricultural and commercial interests, respectively, and their positions are understandable within this context. Randolph, however, took the middle ground, wondering whether it was wise to tie the hands of future legislatures.

Eventually, the convention voted 9-2 to strike the clause, thereby denying the federal government the specific power to emit bills of credit. The relevant sections of the constitution eventually approved read: Art. I. Sec. 8.: “The Congress … shall have power … (2) to borrow money on the credit of the United States … (5) To coin money, regulate the value thereof, and of foreign coin, and fix the standard weight and measures.” Art. II. Sec 10.: “No state shall coin money nor emit bills of credit nor make anything but gold and silver coin a legal tender in payment of debts …”

These clauses have several implications relevant to the question of whether today’s paper money is constitutional. Among the lesser effects for our purposes is that it removed from the States their previous sovereign power to coin money or to emit paper money. It also restricted what they could declare a legal tender. The question, though, is whether the Congress may legally issue paper money. Some argue that it was the Founders’ intent to bar the door to paper money permanently and the vote to strike the bills of credit clause from Pinckney’s draft is evidence of this intent. This may be a hasty interpretation, however.

Although several members of the convention wanted to deny paper money to the federal government and believed the act of striking the 'bills of credit' clause accomplished the task, not all delegates shared either this intent or this interpretation. Several members, as shown above, were either friends of paper money or did not want to tie the hands of the Congress for all time. The interpretation of their action varies widely. Mason believed that if the power was not expressly given, it was denied. As far as he was concerned, the Congress could not authorize paper money. Morris, though, believed it to be permissible for a ‘responsible minister.’ Madison, who cast the deciding vote in the Virginia delegation to strike the clause, still viewed it as legal provided the notes were safe and proper. Madison wrote, “Nothing very definite can be inferred from this record” as to the views of the convention on this matter. As President, Madison approved of a $36 million non-legal tender paper money issue to help finance the War of 1812. His actions seem to have spoken louder than his words. Luther Martin, a delegate from Maryland, explained his views to the Maryland legislature and stated:

Against this motion we urged that it would be improper to deprive the Congress of that power; that it would be a novelty unprecedented to establish a government which should not have such authority; that it would be impossible to look forward into futurity so far as to decide that events might not happen that should render the exercise of such a power absolutely necessary; and that we doubted whether if a war should take place it would be possible for this country to defend itself without resort to paper credit, in which case there would be a necessity of becoming a prey to our enemies or violating the constitution of our government; and that, considering that our government would be principally in the hands of the wealthy, there could be little reason to fear an abuse of the power by an unnecessary or injurous exercise of it.

It is clear the intent of the Founders was to prohibit the States from issuing paper money. It is not clear whether the same intent applied to the Congress. Wrote Breckenridge, “the clause granting to Congress the power to emit bills was stricken out, and no prohibition was laid. Silence as to that was maintained; and all that can be said as to the interpretation of that silence is that, although there was a strong and well-nigh universal dread of paper issues, there was a stronger dread of too narrowly limiting the powers of the new legislature; and that there was neither a very definite nor a unanimous opinion as to the effect of striking out the clause, or as to the extent of the power granted (p.84).” It appears the Founders, whether intentionally or not, left the paper money issue to be settled by future generations.

 

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Recent Federal Court Rulings on the Federal Reserve and Paper Money

Below are some recent court rulings on the issues of the Federal Reserve and paper money.

U.S. v. Rickman, 638 F.2d 182, C.A.Kan. 1980:

Federal Reserve Notes in which the defendant, charged with failure to file federal income tax returns, was paid were lawful money within the meaning of the United States Constitution. 26 USCA §7203; USCA Const. Art. 1, §8, cl. 5.

U.S. v. Wangrund, 533 F.2d 495; C.A.Cal. 1976

The statute establishing Federal Reserve Notes as legal tender for all debts, public and private, including taxes, is within the constitutional authority of Congress; thus the defendant could not overturn his conviction on two counts of wilful failure to make an income tax return on the theory that he did not receive money since checks he received as compensation for his services could be cashed only for Federal Reserve Notes which were not redeemable in specie. 26 USCA §61, §7203; USCA Const. art. 1, §8; Coinage Act of 1965, §102; 31 USCA §392.

Nixon v. Individual Head of St. Joseph Mortgage Company, 615 F.Supp. 890, affirmed 787 F.2d 596. D.C.Ind. 1985.

Federal Reserve notes are legal tender.

Ginter v. Southern, 611 F.2d 1226, certiorari denied 100 S.Ct 2946, 446 US 967, 64 L.E.d.2d 827. C.A.Ark. 1979.

Tax protestor's claims concerning the constitutionality of the Federal Reserve System, Internal Revenue Code and establishment of tax court were so frivolous as not to require discussion and detail. USCA Const. Amends. 5, 13; 28 USCA §1346; 26 USCA §6532, 26 USCA §7422.

U.S. v. Schmitz, 542 F.2d 782 certiorari denied 97 S.Ct. 1134, 429 US 1105, 51 L.Ed.2d 556. C.A.Cal. 1976.

Federal Reserve Notes constitute legal tender and are taxable dollars. USCA Const. Art. 1, §10.

Milam v. U.S., 524 F.2d 629. C.A.Cal. 1974.

The statute which delegates to the Federal Reserve System the power to issue circulating notes for money borrowed and the power to define the quality and force of those notes as currency is valid ... Although golden eagles, double eagles, and silver dollars were lovely to look at and delightful to hold, the holder of a $50 Federal Reserve Bank Note, although entitled to redeem his note, was not entitled to do so in precious metal. Federal Reserve Act, §16, 12 USCA §411; Coinage Act of 1965, §102, 31 USCA §392.

Moreover, the paper money issue is an irrelevant one. If we replace each all paper that has "one dollar" printed on it with a coin that has "one dollar" stamped on it, what will we gain? We willl have achieved compliance with the literal words of the constitution at the expense of a convenient and popular form of money.
Gold and Silver Coin

It is also sometimes argued that the constitution permits the minting only of gold or silver coins. This is a misinterpretation, as a federal court makes clear in U.S. v. Rifen, 577 F.2d 1111. C.A.Mo. 1978:

The United States Constitution prohibits states from declaring legal tender anything other than gold or silver but does not limit Congress' power to declare what shall be legal tender for all debts ... Federal Reserve Notes are taxable dollars. Coinage Act of 1965, §102, 31 USCA §392; USCA Const. Art. 1, §10.

This point is made further in Nixon v. Phillipoff, 615 F.Supp. 890, affirmed 787 F.2d 596. D.C.Ind. 1985:

The provision of the Constitution [USCA Const Art. 1, §8, cl. 5] which gives Congress the right to coin money, and regulate the value thereof, gives Congress exclusive ability to determine what will be legal tender throughout the country ... The provision of the Constitution [USCA Const. Art. 1, §10, cl. 1] which mandates that no state shall make anything but gold or silver coin tender in payment of debts acts only to remove from states inherent soverign power to declare currency, thus leaving Congress as the sole declarant of what constitutes legal tender; the provision does not require states to accept only gold and silver as tender ... Federal Reserve Notes are legal tender for any debt or public charge ... Using or accepting Federal Reserve Notes as payment for state court filing fees was completely proper under the Constitution. USCA Const. Art. 1, §8, cl. 5; 31 USCA §5103.

The court made the point again somewhat humourously in Foret v. Wilson, 725 F.2d 400. C.A.La. 1984:

Gold and silver coin do not constitute the only legal tender by the United States; thus, the appellant, who bid $2.80 in silver dimes on a foreclosed property requiring a minimum bid of $80,000 under Louisiana law, was not entitled to the deed to the property.

Are Gold and Silver Practical Metals for Coins?

We could replace all our paper money with coins containing the appropriate amount of a precious metal. Gone would be the $1 Federal Reserve Note, and in its place a coin with $1 stamped on it. Apparently, this would make the paper money opponents happy. Or would it? As it turns out, the amount of gold that would need to be in a $1 coin would be so tiny it would barely be there at all.

In the summer of 1999, the price of gold is about $250/oz. Therefore, a $1 coin would need 1/250ths ounce of gold in it; that is to say, it would contain 0.4% gold and 99.6% base metals. A quarter-dollar would have 0.1% gold and 99.9% base metals. A $20 coin would have 8.0% gold and 92% base metals. If any more gold than that were included, then it would pay to melt the coins and sell the gold, and then we'd be without a physical medium of exchange.

Silver has the same problem. The price of silver is about $5/oz., so we could mint a $5 coin containing 100% silver. A $1 coin would have 20% silver. A quarter would have about 5% silver and 95% base metals. Could anyone honestly tell the difference between the quarter we have now and one with 5% silver?

Myth #4: The Federal Reserve is a privately owned bank out to make a profit at the taxpayers' expense.

This myth claims that the 12 Federal Reserve banks are privately owned and therefore want to earn a profit just like any other company. Of course, the Fed holds the reigns of monetary policy, so naturally they will use it for the benefit of their owners and not the economy at large. And finally, since the Fed owns lots of government bonds, much of the Fed's profits come at the taxpayers' expense through the interest paid to the Fed on those bonds. Like many of the other Federal Reserve myths, this one has a small degree of truth to it, but also has a fair amount of misinterpretation and it leaves out a number of crucial details.

Organization of the Federal Reserve System

The Federal Reserve System is sometimes described as a quasi-government agency because it contains elements of both the private sector and of government control. The System has three organization levels: member banks, Federal Reserve Banks, and the Board of Governors. Let's examine each briefly.

Member banks are at the bottom of the organization chart. These are commercial banks and S&Ls who have joined the Federal Reserve System (FRS). By law, all nationally chartered banks must join, and any state chartered bank has the option to join (12 USCA §282). By joining the FRS a member bank is becoming a shareholder -- an owner -- in its regional Federal Reserve Bank. For example, suppose you and I open a new nationally chartered bank in Charlotte, North Carolina. According to the district map, we see that Charlotte is in the Richmond Federal Reserve district, so our new bank will have to become a member of the Richmond Federal Reserve Bank. So, the claim that the "Fed is privately owned" is correct -- each Federal Reserve Bank is owned by private for-profit commercial banks and S&Ls.

Why are member banks -- the owners -- at the bottom of the organization chart? They are at the bottom because unlike the shareholders of a typical corporation such as IBM, member banks have very little power over how their regional Federal Reserve Bank is run. And they have no control at all over monetary policy. Shareholders of IBM elect the company's board of directors who in turn choose the firm's CEO, so they have a collective say on the company's operations. Member banks also get to select 6 of the 9 directors of their regional Federal Reserve Bank, but these directors control only the Bank's daily operations, not monetary policy which is the most important function of the Federal Reserve System (12 USCA §301 and 12 USCA §302).

At the middle level in the organization chart are the 12 regional Federal Reserve Banks. They have a variety of powers and duties, some of which are:

Buy and sell government bonds in the secondary markets (open market operations)
Lend reserves to member banks
Offer check-clearing services to member and non-member banks
Issue Federal Reserve Notes and collect worn-out ones for destruction
Enforce reserve requirements and other regulations of the member banks
Monitor banking and economic activity within their respective district

In terms of monetary policy, the most important power is the first one -- open market operations. Buying government bonds in the secondary markets increases the amount of reserves in the banking system, puts downward pressure on interest rates, and tends to expand the money supply. Selling government bonds does the opposite. This is the monetary policy function that is most often associated with the Fed (What is monetary policy?). However, a Federal Reserve Bank can only employ open market operations with the explicit approval of the Board of Governors (12 USCA §355).

Finally, at the top of the structure chart is the Board of Governors. The Board is a 7-member panel who is appointed by the President of the United States and confirmed by the Senate (12 USCA §241). The Board's current Chair is Alan Greenspan. Among its responsibilities:

Determine open market policies
Set the required reserve ratio for member banks
Set the Discount Rate
Deciding how much new currency to print
Monitor the health of the U.S. economy
Report to Congress periodically on the state of the U.S. economy

It's single most important duty is deciding its open market policy, that is, whether it should order the Federal Reserve Banks to buy or sell government bonds, and if so, how much. This decision is made in conjunction with the Federal Open Market Committee. The FOMC is a 12-member panel can consists of all the Board members, the president of the New York Federal Reserve Bank, and 4 presidents from the other Federal Reserve Banks on a rotating basis. The presidents are appointed by each Bank's board of directors, pending approval from the Board of Governors (12 USCA §341).

Thus, all the key monetary policy decisions -- the ones that affect interest rates -- are made by a government agency whose members are selected by the President of the United States. The Fed may be privately owned, but it is controlled by the government.

The Fed and Taxpayers

The second part of this myth is that the Fed is a drain on the Treasury, and therefore a drain on taxpayers. This is untrue. The Federal Reserve Banks are entirely self-financing institutions; they do not receive any tax dollars allocated to them from the federal budget. Let's take a look at the table below to see exactly where they get their money and how they spend it:

1999 Combined Statements of Income of the Federal Reserve Banks (in millions)

Interest income Interest on U.S. government securities $28,216 Interest on foreign securities 225 Interest on loans to depository institutions 11 Other income 688 ------- Total operating income 29,140

Operating expenses Salaries and benefits 1,446 Occupancy expense 189 Assessments by Board of Governors 699 Equipment expense 242 Other 302 ------- Total operating expenses 2,878

Net Income Prior to Distribution $26,262

Distribution of Net Income Dividends paid to member banks 374 Transferred to surplus 479 Payments to U.S. Treasury 25,409 ------- Total distribution 26,262

Source: 86th Annual Report of the Board of Governors, p.335.

We can see from the top of the table that the Fed's primary source of income is interest from government bonds. This money is paid to the Fed by the U.S. Treasury. Is this not de facto evidence the Fed is leaching off the taxpayers? No, it is not. The Treasury is obligated to pay interest to whomever owns those bonds. If the Fed did not own them, then the interest would have been paid to someone else. In fact, from the Treasury's perspective, it is a good thing the Fed holds those bonds. At the bottom of the table, we see the Fed makes a substantial annual payment to the Treasury. The higher the Fed's net income is, the larger the payment to the Treasury. In other words, the Treasury gets back a significant amount of the interest paid to the Fed. Thus, government bonds held by the Fed are essentially interest-free loans to the government.
Conclusion

The regional Federal Reserve Banks are private owned, but they are controlled by the Board of Governors -- a federal agency whose members are appointed by the President and confirmed by the Senate. The Board sets monetary policy and the Federal Reserve Banks execute it. In addition, the Fed does not use any taxpayer money to fund its operations. While the Fed does collect interest on government bonds, the Treasury would have had to make such payment even if they Fed did not hold any bonds. Moreover, the Fed rebates a significant share of its net income to the Treasury each year, revenues the government would not have at all if the Fed owned no government bonds.

 

[Dusty Bake Activate]

Myth #5. The Federal Reserve is owned and controlled by foreigners.

Introduction

The Federal Reserve System is the primary regulatory agency governing the U.S. banking industry. It has singular importance in setting monetary policy and many economists believe it has substantial influence on the course of the business cycle. Yet, could it be that the most important economic institution in the United States is actually owned by foreigners? Gary Kah (1991) and Eustace Mullins (1983) authored separate books alleging that a secretive international banking elite owns and controls the Fed. Furthermore, his shadowy group uses its power to manipulate financial markets and to control the U.S. economy.

The focus of both books is the Federal Reserve Bank of New York. What we typically call the ‘Fed’ is actually a two level system: 12 regional Federal Reserve Banks (the New York Fed is one of them) and the Board of Governors that runs them (Alan Greenspan is the Board’s chair). Gary Kah claimed foreigners directly own the New York Fed, the largest and most important of the dozen regional institutions. Through it the international collaborators control the entire Federal Reserve System and reap its gigantic profits. Eustace Mullins agreed on the importance of the New York Fed, but instead claimed it is owned indirectly by foreigners – through a European banking club he termed the “London Connection” which controls the Fed’s policies from abroad.

Are any of allegations true? In this article I focus on whether foreigners own the Federal Reserve Bank of New York either directly or indirectly, whether it controls the enitre of the Federal Reserve System, and whether foreigners receive the Fed’s large annual profits.
Who Owns the New York Federal Reserve?

Each of the twelve Federal Reserve Banks is organized as a corporation in much the same way as many other firms. According to Kah, foreigners own a controlling interest in the shares of the New York Fed. He claimed that “Swiss and Saudi Arabian contacts” identified the top eight shareholders as

Rothschild Banks of London and Berlin
Lazard Brothers Banks of Paris
Israel Moses Seif Banks of Italy
Warburg Bank of Hamburg and Amsterdam
Lehman Brothers of New York
Kuhn, Loeb Bank of New York
Chase Manhatten Bank, and
Goldman, Sachs of New York (Kah, p. 13).

He also described these groups as the bank’s “Class A shareholders” (p. 14). This is curious because Federal Reserve stock is not classified in this manner. It can be either “member stock” or “public stock,” but there are no such things as ‘Class A’ shares. However, the directors of a Federal Reserve Bank are separated into classes A, B, and C depending on how they are appointed (12 USCA §302). This may have been the source of Kah’s confusion.

Eustace Mullins compiled a very different list. He reported that the top 8 stockholders of the New York Fed were

Citibank
Chase Manhatten Bank
Morgan Guaranty Trust
Chemical Bank
Manufacturers Hanover Trust
Bankers Trust Company
National Bank of North America, and
Bank of New York.

According to Mullins these institutions in 1983 owned a combined 63% of the New York Fed’s stock. These American banks, in turn, were owned by European financial institutions. Since the commercial banks in the New York Fed's district elect its board of directors, the London Connection is able to use their American agents to pick the Bank's directors and ultimately control the whole Federal Reserve System. He explained,

... The most powerful men in the United States were themselves answerable to another power, a foreign power, and a power which had been steadfastly seeking to extend its control over the young republic since its very inception. The power was the financial power of England, centered in the London Branch of the House of Rothschild. The fact was that in 1910, the United States was for all practical purposes being ruled from England, and so it is today (Mullins, p. 47-48).

He remarked further that the day the Federal Reserve Act was passed in 1913, “the Constitution ceased to be the governing covenant of the American people, and our liberties were handed over to a small group of international bankers” (p. 29).

Clearly, there is a discrepancy between the two lists. According to Kah, foreigners own shares of the New York Fed directly, but Mullins stated they owned and controlled the Fed indirectly through ownership of American banks. So who is right? Mullins cited the Federal Reserve Bulletin for his information on share ownership, but that publication has never reported the shareholder list of any Federal Reserve Bank. Kah’s source is equally elusive – unnamed Swiss and Saudi Arabian contacts. Despite the difficulty in verifying their sources, it may be possible that both men are correct. The two authors published their lists eight years apart. Since Mullins’ was the earlier of the two, it may be possible that sometime between 1983 and 1991 foreigners acquired a substantial amount of stock in the New York Fed. Of course, it is also possible that they're both wrong.

To clarify this mystery, let’s first look at the Federal Reserve Act of 1913. The law requires that all nationally chartered commercial banks and S&Ls buy stock in their regional Federal Reserve Bank, thereby becoming “member banks” (12 USCA §282). State chartered banks may also join voluntarily. The amount of stock a given bank must purchase is proportional to the bank’s size, so we would expect that the largest shareholders to be the biggest commercial banks operating in the district. This agrees with Mullins since all of the banks on his list were the largest banks in the New York region in 1983.

Gary Kah’s list of alleged shareholders is more suspect. The law does not permit the stock of a Federal Reserve Bank to be traded publicly like the stock of a typical corporation (12 USCA §286). The original Federal Reserve Act called for each regional Bank to sell stock to raise at least $4 million to begin operations (12 USCA §281). The stock was to be sold only to banks, not to the public. Only in the event that sales to member banks did not raise the necessary $4 million would the regional Fed Banks be permitted to sell shares to the public. However, all Banks raised the requisite amount of capital. No stock in any Federal Reserve Bank has ever been sold to the public, to foreigners, or to any non-bank U.S. firm (Woodward, 1996). Foreign interests comprise half of the alleged owners on Kah’s list. Moreover, three of the hypothesized American owners are not even banks: Goldman-Sachs, Lehman Brothers, and Kuhn-Loeb are all investment banks, not commercial banks, and so are ineligible to own any shares of a Federal Reserve Bank. The law prohibits the general public, non-bank firms, and foreigners from owning anything more than a trivial amount of stock in any Federal Reserve Bank (12 USCA §283). The only institution on Kah's list that could possibly own shares of the New York Fed is Chase Manhatten. All the others named on the list are incorrect. Kah's list is mostly bunk.

Fortunately, we can take a more direct approach to the question of ownership of the New York Fed and the other Federal Reserve Banks. The New York Fed reports that its eight largest member banks on June 30, 1997 were:

Chase Manhatten Bank
Citibank
Morgan Guaranty Trust Company
Fleet Bank
Bankers Trust
Bank of New York
Marine Midland Bank, and
Summit Bank.3

All of the major shareholders seen here and all of the banks on the complete list are either nationally- or state-charted banks. All of them are American-owned. Kah’s claim that foreigners directly own the N.Y. Fed is completely wrong. This list is consistent, however, with Mullins in that all the owners are domestic banks functioning within the N.Y. Federal Reserve district. The discrepancies are likely due to mergers or other significant changes in the size of district banks since the publication of Mullins’ list. To obtain a list of member banks of other Federal Reserve banks, click here.

 

[Dusty Bake Activate]

Global Domination Through the Back Door?

Although foreigners do not own the New York Federal Reserve Bank directly, perhaps, Mullins argued, they own and control it indirectly via ownership of domestic banks. Since the money-center banks of New York own the largest portion of stock in the New York Fed, they hand-pick its board of directors and president. This would give them, and hence the London Connection, control over Fed operations and U.S. monetary policy.

The Securities and Exchange Commission requires that firms whose stock is traded publicly report their major stockholders each year. The reports identify all institutional shareholders (primarily, firms owning stock in other companies), all company officials who own shares in their firm, and any individual or institution owning more than 5% of the firm’s stock. These reports show that only one of the N.Y. Fed’s current largest shareholders, Citicorp, has any major foreign stockholders. As of January 1996, Price Alwaleed Bin Talad of Saudi Arabia owned 8.9% of Citicorp stock.2 None of the member banks on the above list have any significant portion of shares held by any foreign individual or institution. Mullins' claim that foreigners own the N.Y. Federal Reserve indirectly is also wrong.

Moreover, the ownership rights of Federal Reserve Bank stock are different than the common stock of typical corporations. Usually, the number of votes a shareholder has is proportional to the number of shares he owns. However, ownership of Federal Reserve Bank stock entitles the shareholder to one vote when voting for its regional Federal Reserve Bank officials regardless of how many total shares the member bank may own. A group of international conspirators would need to purchase a controlling interest in a majority of the banks operating in the N.Y. district to guarantee the election of their desired minions to the N.Y. Fed’s board of directors. Buying that much stock in so many U.S. banks would require an outlay of hundreds of billions of dollars. Surely there must be a cheaper path to global domination.

Mullins’ premise here is that the member banks control the policies of the N.Y. Fed. In the next section I detail why this is wrong, but an historical example also illustrates the fault of this assumption. Galbraith (1990) recounts that in the spring of 1929 the New York Stock Exchange was booming. Prices there had been rising considerably, extending the bull market that began in 1924. The Federal Reserve Board decided to take steps to arrest the speculative bubble that appeared to be forming: It raised the cost banks had to pay to borrow from the Federal Reserve and it increased speculators’ margin requirements. Charles Mitchell, then the head of National City Bank (now Citicorp, one of the largest shareholders of the N.Y. Fed at the time), was so irritated by this decision that in a bank statement he wrote, “We feel that we have an obligation which is paramount to any Federal Reserve warning, or anything else, to avert any dangerous crisis in the money market” (Galbraith, p. 57). National City Bank promised to increase lending to offset any restrictive policies of the Federal Reserve. Wrote Galbraith, “The effect was more than satisfactory: the market took off again. In the three summer months, the increase in prices outran all of the quite impressive increase that had occurred during the entire previous year” (Ibid). If the Fed and its policies were really under the control of its major stockholders, then why did the Federal Reserve Board clearly defy the intent of its single largest shareholder?
Does the New York Fed Call the Shots?

Mullins and Kah both argue that by controlling the New York Federal Reserve Bank, the international banking elite command the entire Federal Reserve System and thus direct U.S. monetary policy for their own profit. “For all practical purposes,” Kah writes, “the Federal Reserve Bank of New York is the Federal Reserve” (Kah, p.13; emphasis his). This is the linchpin of their conspiracy theory because it provides the mechanism by which the international bankers can execute their plans. A brief look at how the Fed’s powers are actually distributed shows that this key assumption in the conspiracy theory is wrong.

The Federal Reserve System is controlled not by the New York Federal Reserve Bank, but by the Board of Governors (the Board) and the Federal Open Market Committee (FOMC). The Board is a seven-member panel appointed by the President and approved by the Senate. It determines the interest rate for loans to commercial banks and thrifts, selects the required reserve ratio which determines how much of customer deposits a bank must keep on hand (a factor that significantly affects a bank’s ability create new credit), and also decides how much new currency Federal Reserve Banks may issue each year (12 USCA §248). The FOMC consists of the members of the Board, the president of the New York Fed, and four presidents from other regional Federal Reserve Banks. It formulates open market policy which determines how much in government bonds the Fed Banks may buy or sell – the major tool of monetary policy (12 USCA §263).

The key point is that a Federal Reserve Bank cannot change its discount rate or required reserve ratio, issue additional currency, or purchase government bonds without the explicit approval of either the Board or the FOMC. The New York Federal Reserve Bank, through its direct and permanent representation on the FOMC, has more say on monetary policy than any other Federal Reserve Bank, but it still only has one vote of twelve on the FOMC and no say at all in setting the discount rate or the required reserve ratio. If it wanted monetary policy to go in one direction, while the Board and the rest of the FOMC wanted policy to go another, then the New York Fed would be out-voted. The powers over U.S. monetary policy rest firmly with the publicly-appointed Board of Governors and the Federal Open Market Committee, not with the New York Federal Reserve Bank or a group of international conspirators.

Mullins also made a great to-do about the Federal Advisory Council. This is a panel of twelve representatives appointed by the board of directors of each Fed Bank. The Council meets at least four times each year with the members of the Board to give them their advice and to discuss general economic conditions (12 USCA §261). Many of the members have been bankers, a point not at all missed by Mullins. He speculates that this Council of bankers is able to force its will on the Board of Governors:

The claim that the “advice” of the council members is not binding on the Governors or that it carries no weight is to claim that four times a year, twelve of the most influential bankers in the United States take time from their work to travel to Washington to meet with the Federal Reserve Board merely to drink coffee and exchange pleasantries (Mullins, p. 45).

A point Mullins neglects entirely is that the Council has no voting power in Board meetings, and thus has no direct input into monetary policy. In support of his hypothesis Mullins offers no evidence, not even an anecdote. Moreover, his Council theory is inconsistent with his general thesis that the London Connection runs the Federal Reserve System via their imagined control of the N.Y. Fed. If this were true, then why would they also need the Council?
Who Gets the Fed’s Profits?

Gary Kah and Thomas Schauf (1992) also maintain that the huge profits of the Federal Reserve System are diverted to its foreign owners through the dividends paid to its stockholders. Kah reports “Each year billions of dollars are ‘earned’ by Class A stockholders of the Federal Reserve” (Kah, p. 20). Schauf further laments by asking, “When are the profits of the Fed going to start flowing into the Treasury so that average Americans are no longer burdened with excessive, unnecessary taxes?”

The Federal Reserve System certainly makes large profits. According to the Board’s 1999 Annual Report, the System had net income totaling $26.2 billion, which would qualify it as one of the most profitable companies in the world if the System were a typical corporation. How were these profits distributed? $342 million, or 1.4% of the profits, were paid to member banks as dividends. Another $479 million, or 1.8%, was retained by the 12 Reserve Banks. The balance of $25.4 billion -- or 96.9% of the profits -- was paid to the Treasury. Obviously, Schauf's statement that the member banks are getting "billions" in dividends every year is absurd. In addition, the Fed has been rebating its profits to the Treasury since 1947.
Conclusion

The allegation that an international banking cartel controls the Federal Reserve is wrong. Contrary to Kah’s claim, foreigners do not own any stock in the New York Federal Reserve Bank. Neither do they currently own any significant shares of the domestic banks that actually do own shares in the N.Y. Fed. Moreover, the central assumption that control of the New York Federal Reserve is the same as control of the whole System is badly mistaken. Also, the profits of the Federal Reserve System, again contrary to the conspiracy theorists, are funneled almost entirely back to the federal government, not to an international banking elite. If the U.S. central bank is in the grip of an international conspiracy, then Mullins, Kah, et al have certainly not uncovered it.

 

[Orbital-Fetus]

why does my government need to borrow money from a non Federal entity and charge me interest on it?

 

[Dusty Bake Activate]

Myth #6: The Federal Reserve has never been audited.

An often repeated Federal Reserve conspiracy theory is that the Fed has never been audited. "Every year Congress introduces legislation to audit the FED," wrote Thomas Schauf, "and every year it is defeated."7 Why? Conspiracy theorists such as Schauf, Gary Kah (1991), and Pat Robertson (1994) say the reason is that the Fed is involved in an international plot to subvert U.S. sovereignty and create a one-world government. Naturally, the Fed will not permit Congress to audit its activities, lest it discover this treasonous plan and shut it down.

How much truth is there to this claim? Has the Fed ever been audited by Congress or anyone else? The Fed controls U.S. monetary policy and can act with a great deal of independence from Congress and the executive branch. Clearly, such awesome power requires some sort of regular public oversight at the very least to insure that the Fed is doing its job efficiently and effectively, and to detect any abuses of power or fraud. This essay explores the claim that the Fed has never been audited and finds that it is completely false.
A Brief History of Federal Reserve Audits

Since its inception in 1913 the Federal Reserve System has been subjected to a variety of financial and performance audits by Congress, the executive branch, and private accounting firms, although responsibility for this task has shifted from time to time. From 1913 to 1921 the Board of Governors, then known as the Federal Reserve Board which sets monetary policy and regulates the activities of the Federal Reserve Banks, was audited annually by the U.S. Treasury Department. In 1921 Congress created the Government Accounting Office (GAO) and assigned it to audit the Board until 1933. In the Banking Act of 1933, Congress voted specifically to remove the Board from the GAO's jurisdiction. From 1933 to 1952 audit teams from the twelve Federal Reserve Banks performed the annual examination of the BOG's books. From 1952 to 1978, the Board, under authorization from Congress, decided to employ nationally recognize accounting firms to conduct the audits of itself to insure independent oversight. This provided an external evaluation of the adequacy and effectiveness of the examination procedures.1

In 1978 Congress passed the Federal Banking Agency Audit Act (31 USCA §714). It placed the Federal Reserve System back under the auditing authority of the GAO. The Act significantly increased the access of the GAO to the Federal Reserve Banks, the Board, and the Federal Open Market Committee (the FOMC). Since then, the GAO has conducted over 100 financial audits and performance audits of the three Federal Reserve bodies.3
Scope of GAO Audits

Some of the more important GAO performance audits of the Fed have been in the areas of bank supervision, payment systems activities, and government securities activities. In the first area, the GAO examined how well the Fed was enforcing its regulatory powers over its member banks. In 1992 it drew attention to the Fed's sluggish compliance with regulatory reforms mandated by the Foreign Bank Supervision Act of 1991. In examining the Fed's payment system activities, the GAO made the Fed aware of how its pricing policies for such services as check-clearing affected private suppliers of check-clearing services, and also suggested ways to speed up the process of check collections. Security markets for government debt is a crucial market, and GAO performance audits of the Fed have lead to more openness in the primary dealer system, particularly concerning the disclosure of price information. The GAO is also involved in several ongoing performance audits of the Fed such as analysis of risks and benefits of interstate banking, regulation of derivatives, and the budget of the Federal Reserve system.2
Audits By Private Accounting Firms

Financial audits of the Fed are also conducted regularly. Each Reserve Bank is audited every year by independent General Auditors who report directly to the Board of Governors. These examinations involve financial statement audits and reviews on the effectiveness of financial controls. Each Reserve Bank also has its own internal audit mechanisms. The Board contracts each year with an outside accounting firm to evaluate the audit program's effectiveness. Price Waterhouse conducted an audit of the Board's 1994, 1995, 1996, 1997, and 1998 financial statements and filed this report in the Board's 1996 Annual Report (nearly identical ones appear in other Annual Reports):

We have audited the accompanying balance sheets of the Board of Governors of the Federal Reserve System (the Board) as of December 31, 1995 and 1994, and the related statements of revenues and expenses for the years then ended. These financial statements are the responsibility of the Board's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted accounting standards and Government Accounting Standards issued by the Comptroller General of the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estmates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of the Board as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.

As discussed in Notes 1 and 3 to the financial statements, the Board implemented Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits, effective January 1, 1994. In accordance with Government Accounting Standards, we have also issued a report dated March 25, 1996 on our consideration of the Board's internal control structure and a report dated March 25, 1996 on its compliance with laws and regulations.4

The Board has also contracted with Coopers & Lybrand to conduct annual financial audits of the Board and the individual Federal Reserve Banks.

Exemptions to the Scope of GAO Audits

The Government Accounting Office does not have complete access to all aspects of the Federal Reserve System. The law excludes the following areas from GAO inspections (31 USCA §714):

(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;

(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, open market operations;

(3) transactions made under the direction of the Federal Open Market Committee; or

(4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to items.

In 1993 Wayne D. Angell, then a member of the Board of Governors, submitted testimony before a House subcommittee on the reasons for the restrictions on GAO access. He commented,

By excluding these areas, the Act attempts to balance the need for public accountability of the Federal Reserve through GAO audits against the need to insulate the central bank's monetary policy functions from short-term political pressures and to ensure that foreign central banks and governmental entities can transact business in the U.S. financial markets through the Federal Reserve on a confidential basis.2

In reference to a bill that would lift the constraints placed on the GAO's audit authority over the Federal Reserve, Angell stated,

The benefits, if any, of broadening the GAO's authority into the areas of monetary policy and transactions with foreign official entities would be small. With regard to purely financial audits, the Federal Reserve Act already requires that the Board conduct an annual financial examination of each Reserve Bank...The process of conducting financial audits is reviewed by a public accounting firm to confirm that the methods and techniques being employed are effective and that the program follows generally accepted auditing standards...Further, a private accounting firm audits the Board's balance sheet...Finally, and more broadly, the Congress has, in effect, mandated its own review of monetary policy by requiring semiannual reports to Congress on monetary policy under the Full Employment and Balanced Growth Act of 1978...In addition, there is a vast and continuously updated body of literature and expert evaluation of U.S. monetary policy. In this environment, the contribution that a GAO audit would make to the active public discussion of the conduct of monetary policy is not likely to outweigh the disadvantages of expanding GAO audit authority in this area.2

For more on GAO restrictions, you can search the Government Printing Office website for GAO report T-GGD-94-44, entitled "Federal Reserve System Audits: Restrictions on GAO's Access."

The Budget of the Federal Reserve and Other Oversight

The budget of the Federal Reserve system is determined by each Bank and the Board of Governors. Stephen L. Neal, the Chair of the House Subcommittee on Domestic Monetary Policy in 1991, stated that "Congress plays no direct role in setting or authorizing the Fed's budget. Control of its own budget is an essential component of the independence the Fed must enjoy."1 Additional oversight of the Federal Reserve System derives from the ability of Congress to expand or to contract the Fed's powers. On numerous occasions Congress has seen fit to change the Fed's structure, alter its mission, and grant it new or different powers. In 1935 Congress changed the composition of the Board of Governors to give it more independence, and it allowed the Board to determine the discount rate for all Federal Reserve Banks rather than allow each Bank to set its own rate. In1978 Congress mandated the Fed's new goal to be full employment and price stability. In 1980 Congress granted the Fed new regulatory powers over non-member banks.

Many other government reports on the audits of the Federal Reserve system are available on-line through the Government Printing Office website. Three interesting GAO reports on Federal Reserve finances and performance are:

Federal Reserve Banks: Innaccurate Reporting of Currency at the Los Angeles Branch, (9/30/96, GAO report AMID-96-146).

Federal Reserve Banks: Internal Control, Accounting, and Auditing Issues, (2/9/96, GAO report AMID-96-5).

Federal Reserve System: Current and Future Challenges Require Systemwide Attention, (6/17/96, GGD-96-128).

Conclusion

It is obvious that the Federal Reserve System is and has always been audited. It is difficult to imagine how Kah, Schauf, and other conspiracy theorists could not have come across this evidence in the course of their research. Perhaps they are merely poor researchers. Or maybe they are reluctant to acknowledge facts which contradict their basic thesis. Either way, their credibility among skeptical readers takes a sharp hit by making such obvious factual errors.

For more on how the Federal Reserve system is audited, see the New York Federal Reserve's FedPoints.

 

[Dusty Bake Activate]

Myth #7: The Federal Reserve charges interest on the currency we use.

In my experience this particular myth has alarmed more people than any other. The Federal Reserve is a bank, no? Banks do not lend money for free, right? Our currency comes into circulation only when the government borrows currency from the Fed -- at interest -- and then spends it into the economy, right?. This means we, as citizens, pay interest on the very currency that we use. Conspiracy theorists believe this is part of the alleged "New World Order" plot to bankrupt the United States.

What is the truth here? Does the government really pay interest on our paper money, Federal Reserve Notes? Thomas Schauf of FED-UP, Inc. circulates an information letter in which he writes:

Why pay interest on our currency? A typical incorrect answer is - the FED profits are returned to the U.S. Treasury. The truth is, the FED is a private bank in business for profit. We pay roughly $300 billion in interest on our artificial debt and by special agreement, the U.S. Treasury receives $20 billion in return. Taxpayers lose $280 billion to the FED banking system per year ... Your local library has these dollar figures. The numbers don't lie.5

Schauf also argues that the Federal Reserve system is part of an international banking conspiracy, and that President Kennedy might have been assassinated because he allegedly attempted to curb the power of the Federal Reserve (See Myth #9). This currency interest issue is also raised by other conspiracy theorists. Television evangelist Pat Robertson in his book The New World Order and Jacques Jaikaran in Debt Virus make identical claims.

How accurate are these claims? Some of Schauf's statement is correct. The Treasury Department prints Federal Reserve Notes and then sells them to the Federal Reserve system for an average cost of about 4 cents per bill (see FedPoint #1). However, the Fed must present as collateral for the currency an amount of Treasury securities that is equivalent in value to the currency purchased. The Federal Reserve collects interest on all the Treasury securities it owns, including the ones held as collateral. This is as far into the realm of fact as Schauf's statement can take his reader.

What Schauf doesn't say is that nearly all the Federal Reserve's net earnings are repaid to the Treasury. This is done per an agreement between the Board of Governors and the Treasury. Schauf even says this "typical" answer is incorrect. The table below indicates otherwise.

1999 Combined Statements of Income of the Federal Reserve Banks (in millions)

Interest income Interest on U.S. government securities $28,216 Interest on foreign securities 225 Interest on loans to depository institutions 11 Other income 688 ------- Total operating income 29,140

Operating expenses Salaries and benefits 1,446 Occupancy expense 189 Assessments by Board of Governors 699 Equipment expense 242 Other 302 ------- Total operating expenses 2,878

Net Income Prior to Distribution $26,262

Distribution of Net Income Dividends paid to member banks 374 Transferred to surplus 479 Payments to U.S. Treasury 25,409 ------- Total distribution 26,262

Source: 86th Annual Report of the Board of Governors, p.335.

We can see from the table that the Fed's chief source of income is interest on government bonds. However, we can also see that 97% of the Fed's net income goes back to the Treasury.

Shauf is barking up the wrong tree when he complains that the Fed's portfolio of government bonds is costly to the Treasury. The Treasury would have to pay interest on those bonds regardless of who owns them. At least when the Fed owns a bond, the Treasury is going to get back a substantial portion of the interest. From the Treasury's point of view, the more bonds the Fed owns, the better.

Moreover, it is unclear how Schauf believes the Fed drains $280 billion from taxpayers every year. The Fed is entirely self-financed as the data above shows; it receives no outlay from Congress. Perhaps he thinks the Fed receives all the interest payments on the national debt, which in 1999 summed $353 billion.6 That's not true, either. The Fed owns only about 8.7% of the total national debt, so the vast bulk of the interest payments are going elsewhere.

Schauf believes the Treasury ought to issue its own currency in the form of United States Notes, a form of currency issued on a few occasions in the past (there are still some in circulation, although the total amount is limited by law). A 1953 series A note is shown below.

<<SNIP>>

Current paper money has the inscription "Federal Reserve Note" across the top, whereas the bill above has "United States Note."

Schauf and the Coalition argue this would be an "interest-free" form of currency. However, there is no functional difference between U.S. Notes and the Federal Reserve notes we now use. Neither impose a net interest burden on the Treasury. The key difference between the two currencies is who controls the issuance. The publicly-appointed Board of Governors now controls the emissions of Federal Reserve Notes and can make monetary policy decisions largely independent of political pressure. The issuance of U.S. Notes, on the other hand, would be controlled by the Treasury Department, an arm of the executive branch and a purely political entity. Monetary policy, in this economist's view, ought to be based on the needs of the economy, not on the needs of current incumbent political party.

Like many others, this Federal Reserve myth is also incorrect. Schauf and the Coalition err in the argument by ignoring entirely the funds rebated from the Fed to the Treasury each year. This key detail essentially means that the bonds held by the Federal Reserve are interest-free loans to the federal government -- the equivalent of printing money. Federal Reserve Notes do not cost the Treasury any net interest. Indeed, Mr. Schauf, the numbers do not lie.

 

[Dusty Bake Activate]

Myth #8: If it were not for the Federal Reserve charging the government interest, the budget would be balanced and we would have no national debt.

A popular misconception about the Federal Reserve is that it has something to do with the national debt. The argument is that because the government must pay interest on the money it has borrowed over the years, today's budget deficit is higher than what it would otherwise be. If only the Fed wouldn't charge interest on the debt, the government would not have a deficit.

Several things make this argument wrong. First, the Federal Reserve holds very little of the national debt. Of the $5.7 trillion in government bonds currently outstanding, the Fed holds only about 8.7%. 2 This means that the bulk of the interest payments go not to the Federal Reserve, but to the other bondholders.

Second, nearly all the interest paid to the Federal Reserve is rebated to the Treasury. This means that the bonds held by the Fed carry no net interest obligation for the Treasury. For example, in 1999 the Fed collected $28.2 billion in interest on its portfolio of government bonds, but it rebated $25.4 billion to the Treasury.1

Third, to say that the budget deficit would be smaller but for the interest payments is an exersize in absurd logic. One could just as easily say that the deficit is caused by defense spending, Medicare, or any other combination of programs with spending that sums to the amount of the budget deficit. One could also blame Congress for not raising enough taxes to cover their spending plans or for spending too much in the first place.

Finally, placing blame for the national debt at the door of the Federal Reserve demonstrates an ignorance of how our government works. The national debt has but one cause: Congress. The debt is the sum of all the budget deficits and budget surpluses the federal government has ever had. It is Congress, not the Federal Reserve, that determines federal spending and tax rates. Therefore, it is Congress, not the Federal Reserve, who is responsible for it.

Myth #9: President Kennedy was assassinated because he tried to usurp the Federal Reserve's power. Executive Order 11,110 proves it.

Presidential Executive Order 11,110 is quite infamous among conspiracy buffs. Jim Marrs, author of Crossfire: The Plot that Killed Kennedy, writes that the order instructs the Treasury secretary to issue about $4.2 billion in silver certificates as a form of currency in place of Federal Reserve Notes.1 Written by John F. Kennedy, Marrs also speculates this order was part of a larger plan by Kennedy to reduce the influence of the Federal Reserve by giving the Treasury more power to issue currency. The order wassigned June 4, 1963. A few months later, of course, Kennedy was killed, and conspiracy theorists hypothesize a link between the murder and E.O. 11,110. They argue that the Federal Reserve was somehow involved in the assassination to protect its power over monetary policy.

The executive order modifies a pre-existing order issued by Harry Truman in 1951. E.O. 10,289 states "The Secretary of the Treasury is hereby designated and empowered to perform the following-described functions of the President without the approval, ratification, or other action of the President..." The order then lists tasks (a) through (h) which the Treasurer can now do without bothering the President. None of the powers assigned to the Treasury in E.O. 10,289 relate to money or to monetary policy. Kennedy's E.O. 11,110 then instructs that

SECTION 1. Executive Order No. 10289 of September 9, 1951, as amended, is hereby further amended (a) By adding at the end of paragraph 1 thereof the following subparagraph (j):

'(j) The authority vested in the President by paragraph (b) of section 43 of the Act of May 12, 1933, as amended (31 U.S.C. 821(b)), to issue silver certificates against any silver bullion, silver, or standard silver dollars in the Treasury not then held for redemption of an outstanding silver certificates, to prescribe the denominations of such silver certificates, and to coin standard silver dollars and subsidiary silver currency for their redemption,' and (b) By revoking subparagraphs (b) and (c) of paragraph 2 thereof.

SECTION 2. The amendments made by this Order shall not affect any act done, or any right accruing or accrued or any suit or proceeding had or commenced in any civil or criminal cause prior to the date of this Order but all such liabilities shall continue anymay be enforced as if said amendments had not been made.

John F. Kennedy, THE WHITE HOUSE, June 4, 1963.

To understand exactly what Kennedy's order was trying to do, we must understand the purpose of the legislation which gave the order its underlying authority. The Agricultural Adjustment Act of 1933 (ch. 25, 48 Stat 51) to which Kennedy refers permits the President to issue silver certificates in various denominations (mostly $1, $2, $5, and $10) and in any total volume so long as the Treasury has enough silver on hand to redeem the certificates for a specific quantity and fineness of silver and that the total volume of such currency does not exceed $3 billion. The Silver Purchase Act of 1934 (ch. 674,48 Stat 1178) also grants this power to the Treasury Secretary subject to similar limitations. Nowhere in the text of the order is a quantity of money mentioned, so it is unclear how Marrs arrived at his $4.2 billion figure. Moreover, the President could not have authorized such a large issue because it would have exceeded the statutory limit.2

As economic activity grew in the fifties and sixties, the public demand for low denomination currency grew, increasing the Treasury's need for silver to back additional certificate issues and to mint new coins (dimes, quarters, half-dollars). However, during the late fifties the price of silver began to rise and reached the point that the market value of the silver contained in the coins and backing the certificates was greater than the face value of the money itself.2

To conserve the Treasury's silver needs, the Silver Purchase Act and related measures were repealed by Congress in 1963 with Public Law 88-36. Following the repeal, only the President could authorize new silver certificate issues, and no longer the Treasury Secretary. The law, signed by Kennedy himself, also permits the Federal Reserve to issue small denomination bills to replace the outgoing silver certificates (prior to the act, the Fed could only issue Federal Reserve Notes in larger denominations). The Treasury's shrinking silver stock could then be used to mint coins only and not have to back currency. The repeal left only the President with the authority to issue silver certificates, however it did permit him to delegate this authority. E.O. 11,110 does this by transferring the authority from the President to the Treasury Secretary.2

E.O. 11,110 did not create authority to issue new silver certificates, it only affected who could give the order. The purpose of the order was to facilitate the reduction of certificates in circulation, not to increase them. In October 1964 the Treasury ceased issuing them entirely. The Coinage Act of 1965 (PL 89-81) ended the practice of using silver in most U.S. coins, and in 1968 Congress ended the redeemability of silver certificates (PL 90-29). E.O. 11,110 was never reversed by President Johnson and remained on the books until 1987 when there was a general cleaning-up of executive orders (E.O. 12,608, 9/9/87). However, by this time the remaining legislative authority behind E.O. 11,110 had been repealed by Congress with PL 97-258 in 1982.2

In summary, E.O. 11,110 did not create new authority to issue additional silver certificates. In fact, its intention was to ease the process for their removal so that small denomination Federal Reserve Notes could replace them in accordance with a law Kennedy himself signed. If Kennedy had really sought to reduce Federal Reserve power, then why did he sign a bill that gave the Fed still more power?

Marrs also makes some other factual errors in his conspiracy tale that suggest he is not very familiar with the Federal Reserve or the financial system. He writes that a source of tension between the Federal Reserve and the Kennedy Administration was the Treasury's desire to allow banks to underwrite state and local government bonds, thereby weakening the "dominant" Federal Reserve banks. However, such a move, which was later permitted by Congress, would not have affected the Federal Reserve system because it had never been involved in underwriting bond issues. Marrs also claims that Kennedy signed a bill that changed the backing of small denomination currency from silver to gold to "add strength to the weakened U.S. currency." This is completely false. U.S. currency has not been on the gold standard since 1934, and silver certificates, as their name suggests, had never been redeemable in anything but silver. In addition, U.S. currency was not "weak" during Kennedy's time: There had not been any significant inflation since the late forties, and the exchange rate value of the dollar was fixed according to the Bretton Woods agreement.

In the introduction to his book, Marrs advises the reader not to trust his book. This appears to be good advice.

 

[Dusty Bake Activate]

Myth #10. The Legendary Tirade of Louis T. McFadden

Louis T. McFadden was a member of the House of Representatives in the twenties and thirties and is one of the heroes of the Federal Reserve conspiracy theorists. A Republican from Canton, Pennsylvania, he was the chair of the House Banking and Currency Committee during the twenties, but was merely a Committee member by 1932. He used his position in Congress occasionally to crusade against the Federal Reserve, a stance Gary Kah implies may have cost McFadden his life.

On June 10, 1932 the House was debating a bill which would would expand the types of securities the Federal Reserve could trade when conducting monetary policy. McFadden used this opportunity to launch a twenty-five minute tirade against the Federal Reserve, and in so doing became a legendary champion amongst conspiracy theorists. However, just because a claim appears in the Congressional Record does not necessarily mean it is true. McFadden began...

Mr. Chairman, we have in this country one of the most corrupt institutions the world has ever known. I refer to the Federal Reserve Board and the Federal reserve banks. The Federal Reserve Board, a Government board, has cheated the Government of the United States out of enough money to pay the national debt. The depredations and the iniquities of the Federal Reserve Board and the Federal reserve banks acting together have cost this country enough money to pay the national debt several times over. This evil institution has impoverished and ruined the people of the United States; has bankrupted itself, and has practically bankrupted our Government. It has done this through defects of the law under which it operates, through the maladministration of that law by the Federal Reserve Board and through the corrupt practices of the moneyed vultures who control it.1

Once the hyperbole and histrionics are deducted, there is little remaining of substance in the above quotation. McFadden makes the claim that the Federal Reserve had cost the federal government enough money to "pay the national debt several times over." Is he correct?

Disbursements of Federal Reserve Net Income, 1914-1931 (in millions)

Total Revenues $970.7 Net Expenses 363.3 ------- Net Income 607.4

Distribution of Net Income: Paid as dividends 102.0 Payments to Treasury 147.1 Retained by Fed 358.3

Source: Annual Report, 1995, Board of Governors, p. 358.

In this table we see that from 1914 to 1931 the Federal Reserve system collectively earned profits totaling $607 million. About $102 million was distributed to member banks as dividends, and about $147 million was paid to the Treasury as a "franchise tax." The Federal Reserve banks kept the remaining $359 million. The national debt in 1932 was $19.5 billion, so even if the Federal Reserve had been paying all its profits to the government during this time, it would have been enough to pay only 3 percent of the national debt -- a far cry from McFadden's "several times over."4 Moreover, the Federal Reserve's total revenues for the period were $971 million, so if the entirety of the System's revenues had gone straight to the Treasury, it still would not have been sufficient to make McFadden's claim even remotely accurate.

McFadden then covered a wide variety of topics related to the Federal Reserve Board. He accused it of assisting Trotsky's efforts during the Russian Revolution, of being controlled by international bankers, of debasing the currency, and of many other fascinating transgressions. He also invoked the testimony of Father Charles E. Coughlin, the Catholic priest who would later become famous for his radio broadcasts in support of Hitler's National Socialist agenda.

We can study the accuracy of these claims, as well. The first one is new to me, and I have not the slightest idea whether it is true, although given that McFadden had trouble with a claim which could be easily verified, it seems wise to invoke skepticism on his more fantastic accusations. Generally, this accusation is consistent with the "Protocols of the Learned Elders of Zion," originally published in 1903 in czarist Russia. It is supposed to be an "internal" document proving the alleged international Jewish conspiracy, but it is now known to have been a hoax.2 Henry Ford popularized translations of it into English in the 1920s and this may have been McFadden's source. The second claim is false, as I show in my article, Do Foreigners Own the Fed? The claim that the Fed debased the currency is also false. To "debase" a currency means to reduce its purchasing power, which happens when the general level of prices rises over time. This is usually caused by excessive growth of the money supply, yet in 1932 the price level was lower than it was in 1914, indicating that the opposite of a debasement had occurred.

McFadden also made some important and accurate arguments. During his speech on the House floor, he stated,

From the Atlantic to the Pacific our country has been ravaged and laid waste by the evil practices of the Federal Reserve Board and the Federal reserve banks and the interests which control them ... This is an era of economic misery and for the conditions that caused that misery, the Federal Reserve Board and the Federal Reserve banks are fully liable.1

What did McFadden mean by "economic misery?" They year he spoke, 1932, was the very worst time of the Great Depression. The unemployment rate was approaching 25 percent of the labor force, which to this day stands as record for the U.S. economy. Homelessness, deprivation, and starvation, usually reserved for the ultra-poor in this country, were now stalking millions of former members of the middle class. "Economic misery" was an understatement.

Most economic historians would agree with McFadden that the policies of the Fed during this period were the primary cause of the Depression. A mild recession in the summer of 1929 turned into a banking panic after the stock market crash in October of that year. Banks, which owned stocks and made loans to customers for the purpose of acquiring stocks, suddenly found a large portion of their assets nearly worthless as a result of the crash. Many of them began to fail, taking with them the deposits of millions of families (at the time there was no deposit insurance).

This sort of thing had happened many times before, but the Federal Reserve was created in 1913 in part to mitigate its effects as the banking system's "lender of last resort." In the midst of the first severe wave of bank failures in 1930, the Fed was deadlocked on what to do, eventually deciding to do nothing. Several more waves of bank failures followed and the Depression was well underway. Thus, the crisis can reasonably be blamed on the erroneous policies of the Federal Reserve Board (The classic book, A Monetary History of the United States by Milton Friedman and Anna Schwartz, provides a detailed accounting of the Fed's internal policy debates during this critical time).

In my view, however, McFadden goes too far in terming the Fed's policies as "evil" or its consequences deliberate. As Friedman and Schwartz showed, the Fed essentially made an honest error in judgment. There is absolutely no evidence that the Federal Reserve intended to create the Great Depression. Such a motive would have made no sense from the Fed's point of view. The Depression created a highly unstable economic and political environment. Why would it have intentionally created the sort of conditions that would have seriously endangered its own existence?

Finally, after McFadden's twenty-five minutes of ranting had expired, Senator Benjamin Strong of Kansas commented on the oratory he had just heard:

There is a disease that afflicts mankind which is very vicious. It warps the judgment, it narrows the vision, it even causes men to see red, to make mountains out of mole hills. This disease has sometimes been referred to as B.A. Ladies may refer to it as "tummy" ache, but out in the wide-open spaces men call it the "belly" ache, and I know of no man of my acquaintance that has this disease in so violent a form as the gentleman from Pennsylvania, Mr. McFadden.

I have not the time to refer to the many charges he makes against the Federal Reserve system, but I call attention to the fact that for 12 years he has been the chairman of the Banking and Currency Committee of this House and did not see fit during that time to remedy any of the evils of which he now complains. It seems to me entirely out of place to wait until he is retired as chairman of that great committee and then assault all of the institutions of which it has control.1

Strong's statement suggested that McFadden's rant was little more than political bluster. If McFadden had really been the anti-Fed crusader some people today make him out to have been, then why did he not do anything about the Fed when he had the chance? More likely, he was making political points with his constituents by placing blame for the Great Depression at the door of the Federal Reserve. While this may have been justifiable, he went too far by implying the Fed intended to wreck the economy.

 

[thekingsmen]

Too bad the debunking is so off the grid. It supports Govt documents written by Wall Street lawyers and goes off the deep end with claiming every person who disagrees with the FED is a nutjob CTS.

 

[Orbital-Fetus]

Lincoln and Kennedy are the only two presidents who tried to get rid of the Fed...
both publicly assassinated.