CAN THE FED PREVENT DEFLATION? DOES IT WANT TO? (must go to source to get all the links).

It has been a few weeks since I've written on the subject of deflation, and in the meantime Mish has had a couple of good articles (here and here) on deflation that have answered just about every question anyone could ask on the subject. But after mulling all this over, I've got another more fundamental question that I'm looking for an answer to: Does the Fed really want to prevent deflation?

As Mish points out, there is near complete confidence that the Fed can and will be able to stop deflation simply by "printing money." Under this inflationist view, the Fed is obliged to stop deflation simply because it is in the best interest of the system -- American consumers, businesses, and the government. As the thinking goes, all of these entities are in so much debt that they can simply never pay it all back. Therefore, not only the easy way out - but the only possible way out - is through continued inflation of the currency - the printing press solution. Bernanke shouted this intention loud and clear in his "It" speech that I discussed last time. As part of the new and improved, Clear-speak program at the Fed, Bernie didn't mash or mince words the way his predecessor Greenie did, and judging from what everyone seems to think, the message has gotten through. Mission accomplished, Ben! The threat of deflation has been dispelled and we've seen red hot inflation since 2003.

But deflationists argue that this inflation cannot continue forever, and the trend will ultimately reverse. At which point, try as it might, the Fed will be helpless to prevent or reverse deflation for a variety of reasons. What the two camps share in common is the underlying assumption that the Fed is terrified of deflation. But why should it be? Why does everyone think the Fed wants to prevent deflation in the first place? The common wisdom is that deflation would simply be too detrimental. But for whom?

A Brief History of the Fed Nearly everyone thinks that the Federal Reserve and the Federal Government are one and the same, but this is not the case. The Fed is a private, for-profit banking cartel and the government is, well, the government. The reason for the confusion is clear because it is, in fact, quite deliberate. The formation of the Fed in 1913 was and continues to be one of the greatest Statue of Liberty plays in American history. "The Federal Reserve is no more Federal than Federal Express" says Michael Ruppert in America From Freedom to Fascism. But separate as they may be, these two powerful institutions are joined in an unholy matrimony - a powerful marriage of convenience in which each party benefits tremendously.

Elected officials (i.e. the government) love to spend money and hate to raise taxes. If anything, they want to spend more money and levy fewer taxes. This is surely the path to reelection. Bankers love to make money with as little risk as possible. Voilà! An opportunity is seen, and a partnership is struck. The government hands over monetary responsibilities to the Fed, the Fed loans money back to the government at interest and each party is happy. The Fed reaps profits, the Government spends money thereby providing the people with pork and programs, and taxes are not raised a dime. It is a win, win, win situation, right? Right!

Except for the little matter of the Federal debt which grows and grows and grows. Oh, and also the small matter of inflation that eats away at the savings, buying power and quality of life of the American people. The buying power of the dollar has dwindled so far since the formation of the Fed in 1913 as to leave it practically worthless. So the question of whether we will have hyperinflation is the wrong question - we've already had hyperinflation! It takes a full dollar today to buy what a nickel would have bought in 1913, according to the Fed's own CPI calculator!

The Fed is not Stupid This level of inflation cannot continue indefinitely without dire consequences, and the Fed knows it. Anything us regular folks know about inflation, deflation, fiat money and the gold standard (not because we learned it in school, or heard it on the news but because we read it on the internet!) - the Fed certainly already knows, too. Like us, they too understand that every fiat currency throughout history has ended the same way - in a hyperinflationary blowout, and despite what Ben has said about the magic printing press, they want to avoid such an outcome with the Dollar. Such an end is not good for anyone, least of all them. The bank gets its power from the ability to issue dollars - it would do them no good to kill their golden goose.

In football, it's called the Statue of Liberty play. For those of you who don't know football, this is a trick play designed to fool the opposition. In it, the quarterback - the one who normally throws the ball - instead hands it off to a running back. The running back, who normally runs with the ball, instead motions to throw it. But just as he is getting ready to throw, another player sneaks around from behind, grabs the ball, and takes off running down the field! (The running back is left standing in a pose like the Statue of Liberty - thus the name of the play.)

If executed properly, this is a masterful play of deception. The defense is in a state of complete disarray, having no idea what is going on. Is the other team passing? No - running! No, passing! No! Running! What the hell is going on?! By this time the play is over and the offensive team has scored a huge gain, capitalizing on the opposition's confusion. Wikipedia's definition of it adds: "The phrase has also come to represent any bit of desperate trickery or misdirection outside of sports…" Though it adds that the play is rarely used in professional leagues, but more often in pee-wee or high school football because "...a professional player is less likely to be tricked..."

Unfortunately, it has become all too easy to trick the average American when it comes to the subject of money. Just watching the first few minutes of Fiat Empire gives you a taste of how woefully unsophisticated Americans are when it comes to the subject our money. Because of this woeful unsophistication, the Fed can talk relentlessly about the war against inflation, yet all the while be the primary culprit behind inflation. Ron Paul, who serves on the Congressional Banking Committee, has said many times that some members who sit on the committee with him still believe the dollar is backed by gold! It is not. But this demonstrates just how effective the Statue of Liberty play that the Fed has been running since its creation truly is. The Fed was born of deception in 1913 and yet most people still to this day solemnly take what it says at face value.In a PBS interview in 2000, the late Milton Friedman was very clear about where the blame lies for the first great depression:

We had repeated recessions over hundreds of years, but what converted [this one] into a major depression was bad monetary policy. The Federal Reserve system had been established to prevent what actually happened. It was set up to avoid a situation in which you would have to close down banks, in which you would have a banking crisis. And yet, under the Federal Reserve system, you had the worst banking crisis in the history of the United States. There's no other example I can think of, of a government measure which produced so clearly the opposite of the results that were intended.

And what happened is that [the Federal Reserve] followed policies which led to a decline in the quantity of money by a third. For every $100 in paper money, in deposits, in cash, in currency, in existence in 1929, by the time you got to 1933 there was only about $65, $66 left. And that extraordinary collapse in the banking system, with about a third of the banks failing from beginning to end, with millions of people having their savings essentially washed out, that decline was utterly unnecessary. At all times, the Federal Reserve had the power and the knowledge to have stopped that. And there were people at the time who were all the time urging them to do that.

So it was, in my opinion, clearly a mistake of policy that led to the Great Depression. (all emphasis mine)

Mistake? Really? For whom? 75% of the banks that failed were not part of the Federal Reserve System. Those banking failures went a long way towards eliminated the Fed's competition. The American people were devastated, but the Fed and the Government came out of the Great Depression stronger than ever. Gold was outlawed, confiscated from the American people and once it was safely in the hands of the government, the official price was raised. The greatest power couple in world history consolidated their gains. Today's common wisdom is that the Fed didn't know what it was doing back in the 30's and ineptly caused deflation and the Depression. But now - thank God -- we know so much more and that will never happen again! Lest you have any doubt, Bernanke spelled it out for us loud and clear in his tribute to Milton Friedman on his 90th birthday. "Regarding the Great Depression," Bernanke said, addressing Friedman. "You're right, we (the Federal Reserve) did it. We're very sorry. But thanks to you, we won't do it again."

Great job, Ben! A command performance, complete with an admission of guilt, a show of contrition and a loud proclamation that it won't happen again. You may as well have used a megaphone. And followed up, no less with a rousing encore in the form of the now infamous printing press speech just two weeks later.

But after all we know about the Fed, you're telling me that we're supposed to take this dog and pony show at face value? Ha! As the old saying goes, fool me once, shame on you...

Thought Exercise: Now Pretend You're the Bank Take a look at this quote, which can be found all over the internet:

If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.

This quote is attributed to Thomas Jefferson, though it is most certainly apocryphal. However I use it because it is instructive in many ways. First, don't believe anything just because you read it, even if you've read it many times. You can find this quote on a hundred web pages attributed to Jefferson. Second, even though Jefferson didn't say it, there is still wisdom in whoever did: "First by inflation, and then by deflation..." As I already pointed out, we've already had the inflation. Most everyone is in debt up to his eyeballs, and the dollar has been inflated to within 5% of its life. There's not much more room to go before it is completely dead. These are hard times for many individuals, corporations, and the government itself. Ben even told the government so recently -- that this is the "calm before the financial storm." (more on that next time)

But pretend for a moment that YOU are the bank, and all these entities owe YOU the money. When you look at the problem from this point of view, something quite amazing happens. Why, there is no problem at all! Those poor consumers, businesses and the Federal government have all gone and gotten themselves into debt, haven't they? Well now they are just going to have to pay it all back. End of story. What is the problem now?

As the Bank, you're power comes from 1) your monopoly on the issuance of legal tender, 2) your ability to create it out of thin air and 3) your willingness to loan it out and charge interest on it. In fact, deflation wouldn't be such a bad thing at all, since it increases the value the currency you have a monopoly on creating. During deflation it is best to have a mountain of cash and a positive cash flow to ride it out. The only problem is if folks start defaulting on you. But that has already been taken care of with the Bankruptcy Reform Act of 2005. That law was written by the credit card companies, i.e. the banks, i.e Federal Reserve members, to keep working people on a treadmill of perpetual debt.

This reminds me of the stories of economic colonialism John Perkins told in his book, Confessions of an Economic Hit Man. First the World Bank would go to some natural-resource-rich third world country and offer it a fat loan to "develop" its resources. The loan would be bigger than necessary, and certainly more than the country could ever afford to pay back - but the bank would say, "with your new refinery/mine/port/whatever, you'll have enough revenue to pay it back." When the country eventually did default, the IMF would sweep in with "fiscal austerity measures" for the people and the government. All the revenue from the new development would be siphoned to the banks in order to pay off the huge loan. Tsk tsk.

Sound familiar? Anyone who bought a house in the last five years knows that mortgage bankers rarely advocated financial prudence when buying a house, but instead pushed the idea to "buy as much house as you can (or can't) afford!" And now with prices coming down, many of those buyers are stuck right where those third world countries got stuck. Looks like a fiscal austerity plan is coming down the pike for many consumers so they can stay on the financial treadmill while the productive fruits their life - their labor - are siphoned off by the bank. Because the banks still know that as much money as they make trading and manipulating paper and financial "products," there is still only one true source of wealth, and that is human labor.

No, the Fed is not stupid. Not stupid at all. There will always be booms and busts, and the best way to position oneself is to take advantage of both sides of the trade. Or as one responder to my last article put it so eloquently:

I am fascinated by the common perception that the Federal Reserve is a proven non-stop inflation machine. Inherently, the Federal Reserve uses inflation and deflation to whipsaw the average bystander out of their savings. I don't see how one economic machination is more favored over the other when the goal is to ensure that the public's savings ends up in the accounts of the shareholders of the Federal Reserve System.

Inflation steals from lenders in favor of borrowers, because they can pay a loan back with less valuable money. Deflation reverses the advantage.

Government that issues debt, especially debt it has no intention to really repay, has a vested interest in ongoing inflation, as long as it does not get so high as to cause a political revolt.

Our Federal Reserve, a private corporation whose shareholders are exclusively financial institutions and not the government, has a policy of deliberate inflation, with a stated "target" of 2%.

The only way to kill the monstrous theft that inflation causes is to do away with fiat money.

Please allow me to add that fractional reserve banking allows private corporations to extend the fiat money inflation by also creating money out of thin air.

In the case of the US Dollar, this is made far worse where other nations peg their currency to the dollar. When, for example, a Panamanian bank extends a local loan, the local money it creates out of thin air is just as much part of the US money supply as any $20 bill we print up for a few cents. The reason is that money is fungible and once the Panamanian borrower gets his money, because of the dollar peg, it is has the same economic effect as if the bank had created dollars instead.

The flip side of money creation by fractional reserve bank loans is the equal amount of leverage on the contraction of the money supply when loans are reduced, either through policy or lack of demand.

The two policies of fiat money and fractional reserve banking guarantee a business cycle of expansion, boom and bust. Learn it, love it, live it, because too many people either want it that way, benefit from it, or just consider it to be the natural state of affairs.

You appear as an astute poster on the subject.

One question that still fascinates me was posed by Aaron Russo (freedomtofascism.com)

http://video.google.com/videoplay?docid=-4312730277175242198&q=

and that question is why does the government pay interest to the 'Federal' Reserve (indeed no more 'federal' that Fedex). The 'Fed' does not even print money so much anymore than they just create it as digits on a computer. Simply put, the 'Fed' has the power to sit at a computer and write 1000000000 into a data field and presto they created a billion dollars. So the question he asks is why can't our government do the same and forgo the interest payments?

Of course we can get distracted and start arguing well, we really don't want our government 'printing' or creating money. That's not the point unless we seek to return to dollars backed by gold or silver. But that's getting off the point. The point is it's all about interest.

Russo ask why do we pay personal income taxes on our labor. Not excise taxes, not corporate taxes but personal 1040 taxes. Does it go for schools? No. Does it go for roads? No. Does it go for the military? No. (Corporate taxes pay for the military). Does it go for social security? No. (That's FICA tax). Does it go for Medicare? No.

Where do our 1040 taxes go?

Answer by Russo: to pay the 'Fed' for the interest on the debt that our government takes out, debt exchanged for money that was created out of thin air.

Was the debt taken out by our government taken for our benefit? No.

Then who benefits?

Answer: it's a secret of the 'Fed's. The individuals behind the 'Fed' curtain can create money out of thin air and reap an interest on it at a rate that they decide for themselves.

The 'Fed' controls the whole show.

Who might these mysterious individuals be? The American public does not know but we have a strong suspicion that Rockefeller is connected to them, Soros is likely connected to a connected 'Fed' shareholder beneficiary. (Money from nothing to buy and wield power)

I think it's safe to infer that the beneficial shareholders of the 'Federal' Reserve form the ruling class of the USA and are cliqued to the ruling class of the New World Order.

Russo goes on to encourage by noting that we the American people still have the 'power' to get rid of the 'Fed'. We still have the power if our voting system is not yet controlled to the point that it is ineffective for us.

And would it be a bad thing to get rid of the 'Fed'? I can't think of why we need it. Our government can create money the same as they and it would eliminate mounting interest payments and begin the process of paying down the debt. Our government could hold committees of academic scholars and business leaders to formulate monetary policy. We need not hand it over to a private corporation 'Fed' who will charge whatever interest they decide to create money from nothing.

One of the provisions of SARBOX is that companies must certify their financial statements. Another has the effect of requiring full and complete disclosure of unrelated entities, which was the way Enron created assets out of thin air with shell companies domesticated in tax-haven countries.

There is a very urgent SARBOX issue with respect to every commercial bank that owns any shares in the US Federal Reserve: what value to you put on the shares for purposes of reporting them as an asset? How do you 'mark to market' a share that is not traded on the open market? You cannot. Until you can, these numbers are only a guess, and I would suggest a fraudulent one.

Why is this important? Before we can cure the curse of fiat money, we must regain control of it. How would the federal government repurchase all the shares in the Federal Reserve Corporation? What is the value, in terms of US Dollars, of a corporation that has the legal monopoly on creation of US Dollars? Well, dollars cannot buy it!

Of course, this would be a gigantic political battle, if some conservative candidate for high office would care to bring it up. But you can guarantee that there would be a very long line of learned experts the MSM would parade in front of the cameras and onto talking head shows that would assure us that the Federal Reserve should be protected, not dismantled.

There are a very large number of powerful people who make lots of money from the money system we presently have. The biggest beneficiary of all is the federal government because the fiat scheme coupled with built-in inflation means they can have all the money they can get away with and never have to pay off the debt.

We are all enslaved by this system. Want to escape? Anyone who expatriates (leaves the US and gives up their citizenship), must continue to file and pay US taxes for an additional 10 years. Not only that, but the law allows them to be prohibited from ever returning.

Slavery is servitude when you cannot escape your master. The TIAs (Tax Information Agreements) the US has with many other countries insures that if you have assets in any of those countries and the IRS thinks you owe them, they can and will seize the money. Come near to them, and they will seize you too!

These issues are all part of the same power-grabbing conversion of our liberty-based Constitution to the one we have now.

Thanks for your thoughts. It's refreshing to see a poster that understands the issues. But we need a Fredrich Hayek to explain it to the average Joe.

I'm curious why you think our government would want or need to buy out the 'Fed'. I haven't read all the details of the original Federal Reserve Act law but I don't recall it saying that a rescission of that law would necessitate a buyout of the 'Fed'.

I agree that our federal government has a good deal and that they can pass on interests costs to the taxpayer. Russo basically concludes (and mostly correctly IMO) that the 1040 taxes are to pay the 'Fed' bills. But they would also have a good deal if they just printed or created the money themselves under a Department of Treasury Monetary Service. The 1040 income taxes would continue on for the purpose of paying the remaining 'Fed' debt. After a generation or two those taxes would no longer be necessary.

So the question remains 'Why do we permit our federal government to pay interest to a private company calling itself the 'Fed' when our feds can do the same that the 'Fed' is doing?'. It really is an intriguing question and I think you hit on it with your 'servitude' 'slavery' notions. They basically want everyone in debt and loving it. As Russo's film says we are going to love driving that red Corvette while we are in debt up to our eyeballs.

So a thought experiment would be this: Assume the American people wise up and cause passage of a law to overturn the Federal Reserve Act of 1913. Despite the implausibility of that happening quickly or soon, assume that if it were to happen, what then?

All of a sudden a huge cash stream of interest on new debt would be foreclosed on and the 'Fed' beneficiaries would have an adjustment shock.

But here is a thought question, how would similar international central banks react to the US dollar in such a situation? Assuming again that they are all tied together in our 'global village', they would suddenly view the American worker as no longer a cash cow for future revenue projections. Because it is the American worker that is paying the bill in those 1040 returns and such workers would only continue to pay on the existing debt, not new debt. (Already I am making it too wordy to keep an attention span.) But the conclusion would be that other financial banks would change their currency base from US dollar to something else as they are attempting to do now because of inflation and other concerns. In other words the dollar would collapse? Maybe yes or maybe no. It depends on the resultant psychology of financial markets.

Excellent comments.

Although I wasn't there at the time, the theory is that Roosevelt declared the US was defacto bankrupt when in 1933 he forced all US citizens to sell their all their gold in exchange for Federal Reserve Notes. This was a vast liquidation of national wealth in exchange for paper money. It makes the UN Oil for Food scandal look like kids stuff.

The Federal Reserve Corporation is a stock company owned by National Banks with shares owned in proportion to their capital. I read a Federal Reserve statement that stated the corporation gives the profit it makes on the interest it charges back to the Government after taking out what it costs to run the Fed. Needless to say, they have very high costs. I have not seen any recent numbers as to how much their "donation" amounts to.

I don't want the US Government to assume the same role as the Federal Reserve. We have descended even further into tyranny through its functions. When this country was founded, money was private property. If I had a gold coin, it belonged to me. Today, all money that is not in the form of currency, actually exists in a sub-account of the Federal Reserve. Federal Reserve Notes are owned by the Federal Reserve. But we do not only not own the FRNs in our own wallet, with the recent emergency rule banning the melting of pennies, we do not own our own coinage. It is now illegal to buy pennies and do with them as you please.

Of course, the real crime is that government has so debased the currency that the last 'bullion' coin, the penny, now has more value in metal than it has as a coin.

These are not trivial concerns. They have everyday implications. If government owns the money, it has the right to tell us what usage, and purchases, are legal and what are not. They have, for example, forbidden credit card companies from processing charges relating to internet gambling, but not for example, for buying state powerball tickets.

The next step is far worse: just as felons are "debilitated" from being able to legally possess a firearm, will we come to the point where some criminals, such as drug dealers, and other unpopulars will be "debilitated" from legally possessing US currency?

So, money itself, something that government used to have to get from the citizen in taxes, now the citizen has to get it from government. And with the passage of the 16th Amendment, every dollar a person has in his wallet, no matter how he came to have it, is potentially a taxable event! It is only exempt from taxation when government decides to make it so, and of necessity every citizen is now in the position of having to prove the tax status of every penny he has.

If he fails to pay the tax and buys something with the funds, he is not only guilty of tax evasion, but of money laundering.

Thus money itself has become one of the many ways that government can keep control over citizens and insure itself an income stream from taxation. That is why I do not want the Fed to just be purchased and replaced by the US Treasury. I want the whole monster slain and for us to return to the Constitution in Exile.

and that question is why does the government pay interest to the 'Federal' Reserve

Because the government pays interest to holders of Treasury securities.

Then who benefits?

Answer: it's a secret of the 'Fed's. The individuals behind the 'Fed' curtain can create money out of thin air and reap an interest on it at a rate that they decide for themselves.

LOL! Except for overnight money (Fed Funds), the Fed does not "decide" interest rates.

Who might these mysterious individuals be?

I heard they're Joooooooos.

Our government can create money the same as they and it would eliminate mounting interest payments and begin the process of paying down the debt.

The Fed returns it's "profits" to the Treasury each year.

If Aaron Russo doesn't know this, he's dumber than someone who'd post his B.S. on FR.

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