The Federal Reserve Bank: The Lender of First and Last Resort

Ben Bernanke (lower-right), Chairman of the Fe...

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Many wonder what function the Federal Reserve Bank fills.  It facilitates financial transactions between the Treasury Department (under the executive branch of the government) and itself, effectively controlling the money supply (M1).  “But where does the money come from,” we always ask ourselves. The money comes from nowhere specifically.  That is, money is either printed or, through the fractional reserve process, is simply entered as fictitious value into the computerized ledgers of the Fed’s balance sheet.  This is done via open market transactions, whereby the Treasury sells government securities to the Federal Reserve in exchange for fiat dollars.

Now, most important to understand is that those government securities have no real value, i.e. gold or goods, backing them. They are printed just like the fiat dollars they are exchanged for.  The only thing making our dollars legal tender is government declaration.  In fact, a publication entitled Modern Money Mechanics (p. 3), published by the Federal Reserve Bank of Chicago states, “Intrinsically, a dollar bill is just a piece of paper, deposits merely book entries.”  The Federal Reserve itself, then, states that dollars are nothing more than “fiat,” or fake money with no value except that which is determined by its scarcity, or supply.

The next step in the process is where things get a bit dicey.  The Fed takes the money printed to purchase the securities, and through the process of fractional-reserve banking, creates 9 additional dollars from each original dollar.  The money printed for the securities is spent by the government, while the “reserves” are redirected to the Discount Window and loaned to banks around the nation.  Those banks loan that money to businesses, smaller banks and credit unions, which loan the money to us.  There is much left out, but that is the down and dirty explanation of the federal reserve and where our money comes from.  For a more complete explanation of fractional reserve banking, there are many books on the subject.  One is G. Edward Griffin’s The Creature from Jekyll Island.  However, the following video concerning the origins of the Fed and their practices should suffice for the immediate observer.

Now that we know where money comes from, we must ask ourselves how this process affects our daily lives. The answer is so subtle that many do not see it.  I failed to see it as an undergraduate with over 60 hours of economics coursework.  However, I will wait and discuss such matters in my next post.  So for now, if you’ve been one of the many sitting in an economics class (whether high school or college), bewildered by questions so subtle concerning the origins of money itself, and equally bewildered at your teacher’s inability to provide definitive answers to your questions, I implore you to take a look at the video above and articles below for yourself.

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