The Federal Reserve is the source for America’s Money!

What is the Federal Reserve?

The Federal Reserve Bank (FRB) is likely the most important entity in our country as it is our central bank. It has four tiers, was established in 1913 as a result of the Federal Reserve Act and has 12 regional banks. The United States is a country that was kind of late starting a central bank as countries go, and it was borne out of a stock market, 50% reversal in 1907. The Federal Reserve is also a lender of last resort meaning should something happen to a bank, they can conceivably print enough money to satisfy any claims. The dollar is not tied to anything, which makes unlimited printing possible, yet this is hardly a sustainable policy, and one that carries economic dangers for any country. The more important role of the FRB now is to set monetary policy for the country in a few key ways, which includes, as we have seen in recent years, operating under a zero-interest rate policy (ZIRP). The FRB also has expanded responsibilities, including those outlined under the 1946 Employment Act which calls for pursuit of maximum employment, and then in 1977 the Federal Reserve Reform Act was passed, and that instructed the FRB to use monetary policy to stave off inflation and promote job creation. The FRB is assigned several key tasks, and they are collectively the most important institution in our country.

The Federal Reserve Board (FRB)

After that fateful stock market reversal of 1907, in which people ran on banks demanding their money, the widespread panic from what was perceived to be, in the short-term anyway, market failure, is what was tantamount to creation of the FRB. Cash-in-hand was exactly what they were looking for. People wanted their money back from banks, so they went, en masse, looking for their funds. This panic precipitated creation of the reserve as banks struggled to individually satisfy customer withdrawals, with many falling short. It has often-times been said that necessity is the mother of invention; well the creation of the Federal Reserve is illustrious of that very notion.

Congruent with our nationalistic desire to check-and-balance all central authority, almost eschewing such, we were resistant to start a central bank. The 2 words taken together, central and bank, were the antithesis of what any person concerned with the government not getting too powerful wanted to even sew together. Alas, many countries had already created central banks by the time we created ours, the direct result of a crisis situation, no less.

Federal Reserve Board Structure

The FRB has 4 tiers, which are: the Board of Governors, the Federal Open Market Committee (FOMC), 12 regional banks, and then smaller member banks.

The Board of Governors is composed of 7 people, who are nominated by the President, and with Senate approval, they will take their seat on what many would argue is the most powerful board in our country. They collectively comprise the main governing body of the entire FRB system. The appointments to this very powerful board must establish fair representation of financial, agricultural and commercial interests of the country. They must also represent different geographic locations. This goes right back to our love of division-of-power and checks-and-balances.

The FOMC consists of 12 members, which include the 7 members of the Board of Governors, the president of the Federal Reserve Bank of New York, and the other 4 are Reserve Bank Presidents who serve, on a rotating basis, one-year terms. The Reserve Banks are in Philadelphia, Richmond, Chicago, Boston, Cleveland, Atlanta, St. Louis, Dallas, Minneapolis, Kansas City and San Francisco. The New York Federal Reserve Bank implements monetary policy, regulates and supervises financial institutions and serves to help maintain our nation’s payment systems. The New York FRB is the most influential of the 12 regional banks as it is the most active by volume, and has the largest asset base.

There are 8 regularly scheduled meetings each year of the FOMC. Economic and financial conditions of the entire country are reviewed at these meetings, and policy is slowly borne. The FOMC is charged with the task of running market operations. They will raise interest rates to help stave off inflation, and to slow the pace of our economy. Their function is very key, and their announcements, however forewarned, will rock markets around the world. Two weeks before each policy meeting, the FOMC releases the “Beige Book.” This is a survey of economic conditions across the country. It is largely used by the Fed when deciding on monetary policy.

Regional Banks of Federal Reserve

Each federal reserve bank funds its own operations. These funds are raised from interest on loans it issues and on securities it invests in. Expenses and dividends are a small fraction of the FRB revenue each year, and by law, the remainder gets transferred to the Federal Treasury. Those funds are used as interest on any outstanding Federal Reserve Notes.

Reserve banks serve banks, the U.S. Treasury, and even the public to a certain extent. It is called a “banker’s bank” as they store currency, coins, process checks and electronic payments. They also supervise other regional commercial banks.

Greece, the Art of Printing Money and the Dollar as a Fiat Currency

The 19th Century could loosely be characterized as a series of uncontrolled total economic panics. We saw in 2008 that the Fed will be the lender of last resort, and they bailed out several institutions to this end. This is representative of the Fed’s ability to print money, as needed, to ameliorate problems in the economy. The reason they can do this is our dollar is considered to be “fiat currency,” or that which a government decrees as their legal tender. Even valueless money can be used as money as a result of government decree.

Greece, however, is a fine example of this kind of policy run amuck. Eventually the preponderance of the woes in the Greek economy were pushed off onto the European Central Bank (ECB), and money was being printed to help Greece survive. In the middle of a crisis, it is quite hard to discern when to say when, and with policy in place that does not allow a central bank to directly finance a government directly, the ECB used bonds to get money into Greece. It also allowed banks in Greece to issue even more emergency loans to keep the country’s banks afloat.

It is situations like happened in Greece that led to the creation of the FRB, and also to establish rules on what banks have to hold in reserve. The panics of 1893, 1907 and finally the Great Depression led to the creation of Federal Deposit Insurance Corporation (FDIC). The Banking Act of 1935 made the FDIC a permanent agency of the government. It went from having to have reserves on hand to satisfy claims of $2500 in 1934 to $250,000 in 2008. FDIC underwrites bank deposits, offering some protection against failure for depositors. The S&L crisis in the early 1990s was the first real test of FDIC, and it served to be successful.

The FRB, Inflation and Employment

The FRB can intervene in the economy in a few ways. There is a rate that is charged to commercial banks and other depository institutions on loans they make from the FRB’s lending facility, and this is called the discount rate, which they control. They also have the reserve requirements, which mandate how much a bank needs to have in reserves, thereby controlling what it can lend out. The two afore mentioned tools are powerful, but where the Fed can really effect changes in the economy is through “open market operations.” They use “quantitative easing” to buy assets, for example buying government bonds in the open market as a means to adjust the federal funds rate to a certain target, which is the rate at which banks loan money to each other, and they also control the federal funds rate directly with increases and decreases, but since the 2008 crisis, the FRB had a zero-interest rate policy in place for years so as to stabilize the economy.

Recently there has been talk of negative interest rates as a potential policy tool as Fed Chair, Janet Yellen, came under fire for raising interest rates by 25 basis points, or 1/4 percent, in December. This will serve to tighten the economy, making money more expensive to borrow, and while other countries are attempting to ease policy to foster growth, critics felt the United States should be following suit rather than tightening. There is still legal murky water to sort through before the Fed could use negative interest rates to correct this recent action, but it also appears there is no particular restraint either. This would be a first for our country, but if the recent tightening proves to be antithetical, this might be the next corrective, and historical move by our FRB.

The FRB is not owned by anyone in particular, but is an independent governmental entity. It is also not a private, profit-making entity. It really is the backbone of our country in the financial sense, and serves to support and maintain our capitalistic infrastructure.