Gold and Inflation Part 1: Understanding the Federal Reserve
By: Danny VanDerschelden
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As gold prospectors we love to be outdoors, away from it all, and all that jazz. But, lets be real. We ain’t looking for dirt clods, sticks, or other things of no value. To varying degrees we all like gold because its valuable. There are several reason why it is, but today I am just going to touch on one. Gold is valuable because it is a hedge against inflation.
Over the next several weeks I am going to publish a series of articles titled “Gold and Inflation.” I am going to boil a complicated economics subject down to where even “we here simple miners” can understand it (I kid, I kid). To start the series off we will go over what the Federal Reserve is.
When discussing the economy we are quick to point out how our money is used. We argue how we should spend our money, how the government should spend or tax our money, how banks should lend their money and how investors should invest theirs. The question of how money should be used to enhance the economy is important, but an even more important question we need to ask is, what is money and what should it be?
The Federal Reserve, “the Fed,” works as the U.S. government’s bank. When the government spends more than it receives in taxes it must borrow money. They borrow it by selling bonds to foreign countries and to the public (when you buy bonds you are loaning money to the government). Unfortunately, those two together can’t lend enough to fund our growing government. That is when the government turns to the Fed.
Like foreign countries and the public, the Fed buys bonds from the government, but with a twist. The money they buy the bonds with comes from nothing; it is simply printed or typed into existence. This type of currency on demand is known as fiat currency. That is the way the Fed causes inflation and the way they can control the value of the dollar, along with prices of goods and services. That is the main function of the Fed.
Another job the Fed has is lending money to banks. Normally, we are used to the banks lending money to us. The Fed is the bank’s bank. The Fed lends money to the banks and then they lend it to us and charge interest, thus making a profit. Right now, the fed lends money to banks at a rate of nearly 0%, in other words; for free. The banks then lend this free money to us, charge interest, and make a nice profit.
The Fed’s ability to simply create money and lend it has led to easy credit and the ease of credit has led to loans being made to the wrong people (sub-prime loans). The Fed creates money by lending to the government and banks. Banks also create money by lending to us. Banks use a reserve ratio. This means that they can lend a certain amount of money per dollar they actually have. The United States has a reserve ratio of 10%, meaning that if you deposit $100 into your bank, the bank can then lend $90. While they lend that money to someone else you still have $100 dollars, so the other $90 was created from nothing. These newly created dollars expand the money supply and cause inflation. So banks create money from nothing, lend it to us and charge us interest, and in the process they inflate the dollar which raises the cost of living and destroys our savings.
The Fed was created by the Federal Reserve Act on December 23rd 1913 on a day when most congressmen were gone on holiday. Within hours, the bill was rushed to Woodrow Wilson and signed into law. Wilson supported the Fed until he left office. That is when he said,
“I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated governments in the civilized world. No longer a government by free opinion, no longer a government by conviction and the vote of the majority, but a government by the opinion and duress of a small group of dominant men.” -Woodrow Wilson
Now The Fed is getting into the business of bailouts. In 2008, our government made a monstrous bank bailout costing nearly a trillion dollars. What few people know is that the Fed did their own bailout of the banks. This bailout did not cost nearly a trillion dollars, but instead cost several trillion dollars. This bailout was not created nor passed by our duly elected representatives unlike the original smaller one, but instead was created by the unelected board of governors of the Federal Reserve. In a hearing, senator Bernie Sanders asked chairman of the Fed, Ben Bernanke, “Who was given these trillions?” Bernanke refused to answer.