The Federal Reserve and Current Crisis of our Democracy

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Thu Apr-30-09 03:45 PM
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The Federal Reserve and Current Crisis of our Democracy

The Federal Reserve System originated in a highly secret meeting of seven of the wealthiest men in the world, taking place at Jekyll Island, off the coast of Georgia in 1910. The seven men included one of our nation�s most powerful U.S. Senators, Nelson Aldrich, and six bankers. An article written by one of its participants, Frank Vanderlip, 22 years after the passage of the Federal Reserve Act, documents the aura of secrecy that surrounded the creation of the Federal Reserve:

I do not feel it is any exaggeration to speak of our secret expedition to Jekyll Island as the occasion of the actual conception of what eventually became the Federal Reserve System� We were told to leave our last names behind us� We were instructed to come one at a time� where Senator Aldrich�s private rail car would be in readiness�

It was the names of all printed together that would have made our mysterious journey significant in Washington, in Wall Street, even in London. Discovery, we knew, simply must not happen, or else all our time and effort would be wasted. If it were to be exposed publicly that our particular group had got together and written a banking bill, that bill would have no chance whatever of passage in Congress.

The Federal Reserve as a system for favoring wealthy financial interests

Edward Griffin explains the purpose of the Federal Reserve in his book, �The Creature from Jekyll Island � A Second Look at the Federal Reserve�. He describes it as a cartel of private banks � meaning a group of banks joined together in order to maximize profits by reducing competition through the creation of a monopoly. That Cartel was legalized in 1913 with the enactment of the Federal Reserve Act of 1913. Since the creation of a powerful cartel would seem anti-democratic, the real purpose of the Federal Reserve System had to be disguised with a purported purpose. Griffin explains the concept like this:

To cover the fact that a central bank is merely a cartel which has been legalized, its proponents had to lay down a thick smoke screen of technical jargon focusing always on how it would supposedly benefit commerce, the public, and the nation; how it would lower interest rates, provide funding for needed industrial projects, and prevent panics in the economy. There was not the slightest glimmer that, underneath it all, was a master plan which was designed from top to bottom to serve private interests at the expense of the public.

William Greider, in his new book, �Come Home America � The Rise and Fall (And Redeeming Promise) of our Country�, elaborates on this subject by noting the anti-democratic nature of the Federal Reserve and how it has favored wealth and power at the expense of the great majority of Americans in recent decades, to bring us to our current financial crisis:

It was mainly the Federal Reserve � sheltered from public scrutiny and protected from political accountability � that engineered America�s great shift in fortunes� with its successful campaign to suppress price inflation. Then it proceeded to encourage or passively allow the scandalous financial behavior that followed � wealth being concentrated in the financial sector, the growing inequalities among Americans, deregulation and the creation of dominating megabanks, and recurrent frauds and financial bubbles followed repeatedly by government bailouts of banks and financial firms.

The Federal Reserve�s policy essentially tilted the normal economic balance hard in one direction, then held it there for a generation. It favored wealth over wage income, creditors over debtors, capital over labor, financial investors over producers� the few over the many. My indictment may sound extreme and unfamiliar since few in public life talk about the United States� central bank in terms of the deeper consequences its policy decisions have. Both the press and the politicians defer to the mystique of the Fed� This deference enhances the central bank�s power�

The Federal Reserve has abused its powers as a government institution. By favoring wealth and wealth holders over the broader interests of Americans year after year, the central bank�s policy decisions proved to be deeply unfair and antidemocratic, and also irresponsible�

The first major Federal Reserve Failure and its aftermath

Greider describes how the subservience of the Federal Reserve to the banking industry facilitated the Great Depression of the 1930s, following the Stock Market Crash of 1929:

The Federal Reserve�s first historic disgrace occurred after the crash of 1929 when the Fed failed to counter deflationary forces that contributed to what became known as the Great Depression� They resisted the political cries for prompt action. Lowering the interest rates, they feared, would undermine �sound money� and damage the balance sheets of major banks. For three grueling years, Fed officials hesitated as the American economy unwound� driving unemployment to a peak of 25 percent�.

But with the onset of the Franklin Roosevelt Presidency beginning in 1933 things began to change markedly for the better. The steep slide in GDP was arrested in 1933. Job growth during FDR�s first (5.3%) and third (5.1%) terms still stand today as the largest recorded in U.S. history.

Greider describes how the Federal Reserve was reformed during FDR�s presidency:

In the aftermath of the destruction, the Federal Reserve was substantially reformed. Washington consolidated its control of monetary policy and the Fed adopted a more balanced understanding of the broader public interest it was supposed to serve�

The New Deal didn�t just fade away after FDR�s death. Instead, due to its stunning success, most of its components lasted for decades. Largely as a result of this, we experienced for the next three decades what Nobel Prize-winning economist Paul Krugman calls �the greatest sustained economic boom in U.S. history�.

As a result of the labor protection laws enacted during FDR�s presidency, the percent of non-agricultural U.S. workers who were members of labor unions rose from 10% to close to 30% during his presidency and remained at that level for many decades, until the anti-labor policies of the Reagan administration resulted in a precipitous decline in union membership. The labor protection laws and other New Deal innovations, such as Social Security and unemployment insurance, were instrumental in alleviating poverty in our country and producing a vibrant middle class.

Median family income is one of the best indicators of the economic health of a people. This chart shows median family income levels, beginning in 1947, when accurate statistics on this issue first became available. Family income rose steadily (in 2005 dollars) from $22,499 in 1947 to more than double that, $47,173 in 1980.

The disconnect between worker productivity and income

Thus it was that from the beginning of FDR�s presidency through the late 1970s, the American Middle Class was created and sustained, and it was generally accepted in our country that the benefits of economic growth should be widely shared. But beginning in the late 1970s, this began to change. Greider summarizes what happened:

For 25 years� financial wealth grew much faster than the real economy, where average wage incomes have long been stagnant or falling� Year after year, the financial system�s valuations and profits departed from the underlying economy upon which financial assets are presumably based� The financial system achieved its own lofty altitude� The Dow was a little below 800 in August 1982� 25 years later, the Dow was at 14,100� The Dow reached its peak in October 2007, just before the financial crisis struck�

In his book �Crunch � Why Do I Feel So Squeezed�, Jared Bernstein discusses the apparent paradox of how the financial situation of so many Americans in recent years could be so poor in the presence of such healthy �economic indicators�:

Over the course of this highly touted economic expansion, poverty is up, working families� real incomes are down�. By 2007, 44% said they lacked the money they needed �to make ends meet��

If you feel squeezed, chances are it�s because you are squeezed. Most of the indicators that matter most to us in our everyday lives� are coming in at stress inducing levels, but GDP� keeps on truckin�. Something�s wrong, something fundamental�

The name of the problem is economic inequality� It�s a sign that something important is broken: the set of economic mechanisms and forces that used to broadly and fairly distribute the benefits of growth� unions, minimum wages� full employment� quality jobs, safety nets, and social insurance�

How did it happen that income inequality has grown so much and the previous mechanisms for widely distributing the benefits of growth disappeared? Greider describes the process as beginning with Paul Volcker�s manipulations as Chairman of the Federal Reserve:

The recessionary policies of Fed Chairman Volcker

In 1979� Paul Volcker, the Fed chairman� threw out the usual rules and slammed on the brakes, sending interest rates soaring, shutting down credit, and abruptly stopping economic growth. This started a wrenching two-year recession in which unemployment peaked at 11 percent. It also doomed Carter�s reelection in 1980�.

Volcker�s tough intervention against the inflationary disorders effectively preempted the politicians, and he basically ignored their complaints� It had the full and fervent support of Wall Street as well as of many citizens� The true winners are people of vast accumulations of financial wealth� Virtually every financial asset� became more valuable as inflation declined� Investors began collecting bonuses�Debtors, on the other hand, experienced the opposite consequences. In August 1982, Volcker finally relented on his recessionary policy and abruptly reduced interest rates, signaling that the Fed would at last allow the economy to recover�

The Federal Reserve had won its great battle against inflation � it fell substantially during the 1982 recession � but the Fed continued its war� By its estimate, inflation was still too high � bouncing around 4 to 5 percent� The Federal Reserve suppressed inflation by targeting the wages of working people. It prevented their incomes from rising even though, in a healthy economy, wages would normally rise consistently. Nobody in authority ever acknowledged this strategy� By holding back the natural energies of the economic recovery, this monetary policy kept� the unemployment rate higher� at around 6 percent. That made it very difficult for industrial workers� to demand higher wages�. But the conservative Federal Reserve regarded rising wages as an inflationary threat and worked deliberately to prevent it. Throughout the 1980s and most of the 1990s, the Fed protected its victory over inflation by keeping its foot on the brake and tapping it occasionally to make sure the economy did not get too healthy. That is, the federal government � represented by the central bank � ensured that the broad ranks of working people would not share in the �good times��

Financial deregulation under Chairman Greenspan

The new Fed chairman (Alan Greenspan, 1987-2006) set out to liberate finance from government. His most audacious initiative was � to legalize the new all-purpose megabank that would concentrate financial power in a handful of very large institutions. Greenspan preempted Congress on this issue by unilaterally approving what was still prohibited by law�. Hard lessons learned during the crisis of the 1930s were discarded as obsolete. Democrats and Republicans collaborated in repealing or gutting prudential safeguards enacted in the New Deal� For three decades, Wall Street bankers had lobbied to reunite commercial banking with investment banking� The two realms had been separated after the stock market crash of 1929 because fraudulent self-dealing by Wall Street�s major banks fed the stock market mania that led to the crash. Preaching financial modernization, Greenspan restored the system that had failed some seventy years before. These banking conglomerates were equipped with trapdoors and accounting gimmicks that allowed the bankers to hide the debts and troubled assets. The financial gimmicks blew up in the sub-prime mortgage crisis of 2008�

The Fed first denied there was a housing bubble, then tried to restore order� until the bubble popped � and revealed the mess in Wall Street� The financial industry was earning inflated profits� and many firms borrowed heavily� marketing millions of dubious mortgages� The �debt industry� became increasingly unstable and self-indulgent as it prospered, but the Fed stood by it� When the accumulated excess led to crisis and failure, the central bank rushed to rescue the endangered Wall Street firms�

Our current financial crisis

So it is that the Federal Reserve helped us to arrive at our current financial crisis through a long process of subservience to wealth and power. Greider describes the current status of the Federal Reserve and its relationship to our current financial crisis:

The modern Federal Reserve once again faces the prospect of historic disgrace� Its inherent democratic contradictions are becoming visible to all. The US government protects certain large interests from the costs of their own recklessness, but prescribes the perils of market competition for everyone else. The illegitimacy of the present system is reflected in the recent bailouts of major financial houses in what amounts to American-style socialism for selected interests � the largest and wealthiest enterprises in finance. The losses incurred by these Wall Street firms were effectively socialized by the bailouts, meaning that the costs were dumped on society and the taxpayers. The Fed relieved the banks of their rotten assets and transferred them to the balance sheet of an unwitting public. The Federal Reserve, having aided in creating the oversized megabanks and having declined to regulate their behavior rigorously� when these institutions are endangered, the Federal Reserve rescues them because, well, they are indeed �too big to fail.� � or so we are told.

This arrangement is not only unjust and hypocritical, it also actively encourages the kind of reckless behavior the central bank is supposed to prevent. The potential for collusion at the public�s expense is enormous� Since the public is not allowed to know all the terms we cannot judge whether the Fed defended the public interest or simply gave the bankers whatever they said they needed� There�s no need to bother taxpayers with the messy details of what happens behind closed doors�

The plan is yet another massive, ineffective gift to banks and Wall Street. Taxpayers, of course, will take the hit� The banks don't want to take their share of those losses because doing so will wipe them out. So they, and Geithner, are doing everything they can to pawn the losses off on the taxpayer�. In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

The Federal Reserve in the context of American democracy

The Federal Reserve is anti-democratic by its very nature because it has been given extraordinary powers to manipulate the financial status of our nation, and yet, being an unelected and �independent� body, it is not limited in its actions by accountability to the American public. Yet the anti-democratic machinations of the Federal Reserve are but one manifestation of numerous anti-democratic forces working on the life of our nation today.

Perhaps the most serious underlying problem with our country today is its subservience to those with wealth, power, and political connections. That attitude is fostered in a number of ways. It is aggressively encouraged by corporate America through their news media, and by the elected officials who receive their blessings and money � including almost all of the Republican Party and much of the Democratic Party. And it is fostered by the revolving doors and very close ties between our nation�s elites � in government, the Federal Reserve, Wall Street, and much of the rest of corporate America.

This attitude has radically anti-democratic consequences, in that it sets up a vicious cycle, whereby our government helps to increase the wealth and power of those who already have the most of it, and in return the wealthy and the powerful help their friends stay in office, so that they can continue to dole out more favors to them.

No politician, and few other people, would acknowledge that it should work that way. That would sound �elitist� and be contrary to our Declaration of Independence, which says that we are all �created equal� and have inalienable rights to life, liberty and the pursuit of happiness. But nevertheless, our culture and system of government is permeated with the idea of subservience to the powerful.

Emblematic of this problem was President Obama�s recent statement, in response to being asked how he intends to handle the worst crimes ever committed by a presidential administration (Bush/Cheney) in US history, that we should �look forward, not backward� and not be concerned about �vengeance�. Since only crimes committed in the past can be prosecuted, the most obvious translation of that statement is that the president thinks we no longer have need for a criminal justice system � or rather, not with respect to a particular class of Americans, who should be allowed to commit crimes with impunity.

I�m not saying that I think he really believes that. More likely, his statement represents bowing to what he perceives as the political pressure that would accompany a decision to prosecute high ranking members of a previous presidential administration. Nevertheless, it represents the current political reality in our country � at least as perceived and encouraged by those in power.

A light at the end of the tunnel?

The anti-democratic attitudes noted above are primarily held and encouraged by our nation�s elites. For much of the history of our country they have been highly successful in transmitting those attitudes to large segments of the American public. But if and when the American people wise up and recognize how they have been played for fools all these years, the game will begin to unravel. And there are many signs today that the American people are indeed waking up to reality.

First there is the rapid demise of the Republican Party, manifested in the elections of 2006 and 2008. Those elections show that most Americans now recognize the deeply anti-democratic nature and hypocrisy of the Republican Party. But the demise of the Republican Party alone, even if complete, will not provide a far-reaching or permanent solution to our problems. As long as conservative Democrats like Arlen Specter, Joe Lieberman, Ben Nelson and Evan Bayh abound, progressive changes will occur only with great difficulty.

Another encouraging sign is a February Gallup poll which shows that Americans favor by almost a 2 to 1 margin either an independent panel or criminal investigations of the Bush administration for their use of torture. This finding is truly remarkable in view of the efforts of our corporate news media and a popular president to discourage investigation or prosecution of those crimes. Just imagine how much more enthusiastic the American public would be about this issue if our nation�s elites didn�t try to discourage it.

Another promising sign is a series of polls that showed a huge increase in the percentage of Americans who get �most of your national and international news� through the Internet � from a paltry 13% in 2001 to 40% in 2008. Those same polls showed that in 2008 the percentage of people under 30 who get most of their national and international news through the Internet was 59%, equal to those who noted television as their primary source (respondents were given more than one choice). The Internet is a much more active medium than television, and it is much easier to receive news via television than to obtain it via the Internet. The substantial switch from television to the Internet by so many millions of Americans must signal a rapidly growing awareness of the severe class bias of our corporate news media, as well as a willingness to put effort into becoming better informed.

And finally, Americans have become thoroughly alienated from the corporate elite who so affect their standard of living, as demonstrated by a 2007 Harris poll asking which industries Americans regarded as �generally honest and trustworthy�: Oil companies 3%; health insurance companies 7%; telephone companies 10%; pharmaceutical companies 11%; electric and gas utilities 15%. With numbers like that, and with more and more Americans turning to alternate news sources, it shouldn�t be too long before they begin to connect the dots and begin to hold their elected representatives more accountable for their actions.

The ultimate question

Greider summarizes what it will take to restore the promise of our democracy:

What the country needs is a third front in the political power struggle, a counterforce to both government and the private sector. This new source of countervailing power can come only from the people themselves�

Can people really handle their responsibilities as citizens? Or must our �betters�, who claim to know what is best for us, forever lead us around like children? We need to cut through their fog and condescension. We must reclaim our power as citizens�