I go over how the Federal Reserve Bank manipulates interest rates.
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Transcript
How the Federal Reserve Manipulates Interest Rates
The Federal Reserve bank was created on December 23rd, 1913, just 2 days before Christmas, through the Federal Reserve Act.
Since that time, the Federal Reserve has acted as the chief controlling body over the currency and monetary policy in the United States.
While many have heard that the Federal Reserve bank is a threat to our financial stability through its inflationary policies, few understand precisely how this threat manifests.
To understand how the Federal reserve manipulates interest rates through its currency controlling power, we must first understand the basics of the Federal Reserve’s operations.
The Federal Reserve is comprised of a seven-member board of directors headquartered in Washington D.C.
Each member has a 14-year term after being nominated by the U.S. President and confirmed by the U.S. Senate.
The appointments are staggered so that one member retires every two years.
The Federal Reserve board sits over 12 regional Federal Reserve banks, each working within a specific district of the United States.
These banks are in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Franscico.
The Federal Reserve Board, along with some presidents of these regional banks, manage the Federal Open Market Committee, or FOMC, which is the body responsible for setting monetary policy.
The FOMC consists of 12 members: the seven members of the Federal Reserve Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining 11 regional Federal Reserve Bank presidents, who participate on a rotating basis.
This group meets at least 8 times per year, approximately every six weeks, to make decisions.
At the root of the Federal Reserve’s operations is its holding of U.S. government securities.
These securities are debt instruments where the U.S. government pays interest to the Federal Reserve for purchasing them.
The securities vary by duration of loan and interest payment rate and come in a variety of instruments including Treasury Bonds, Treasury Notes, Treasury Bills, Treasury Inflation-Protected Securities, and Savings Bonds.
What’s important to note about this is that the Federal Reserve does not actually need anything substantive to purchase these treasuries.
The Federal Reserve can create currency digitally simply by crediting the reserve accounts of the banks that sell these securities.
The reserve accounts are held at the Federal Reserve itself.
In other words, the Federal Reserve creates currency out of thin air for member banks to then deal in U.S. government securities afterward.
Take a moment to think about that.
Imagine if you could just go to the store and say that you want to buy whatever you want, and you can just make up currency on the spot and take home anything because you scribbled on a piece of paper.
As you can imagine, this has some dangerous consequences, which we will get into later.
For now, let’s continue understanding how this process leads to the Federal Reserve manipulating interest rates.
The Federal Reserve, historically, controlled interest rates with its powers by setting a target for the “Federal Funds Rate.”
The Federal Funds Rate is the interest rate at which banks and credit unions lend reserve balances to other depository institutions overnight on an uncollateralized basis.
In layman’s terms, member banks must keep a certain amount of money at the Federal Reserve, and banks loan each other money daily to maintain those balances.
The interest rate on those loans affects the general lending rates downstream.
This lending is not the only part that affects currency and interest rates.
This Federal Funds Rate target is achieved through a bundle of tools used by the Federal Reserve.
The first of this, is Open Market Operations.
This is where the Federal Reserve buys or sells U.S. government securities on the open market.
This can add reserves to the banking system, lowering that Federal Funds interest rate, or lower reserves in sale, heightening the Federal Funds interest rate.
There is also the Discount Rate, the interest rate at which commercial banks can borrow from the Federal Reserve.
Lowering this rate can make borrowing from the Federal Reserve cheaper while increasing does the opposite.
Lastly, is the Reserve Requirement policy.
The reserve requirement policy is the amount of currency reserve that banks must hold against all deposits.
If you remember from my video on Fractional Reserve banking, banks do not have to keep all deposits on hand.
Banks can keep a fraction of that reserve and lend out a certain percentage of what is held.
For example, if someone deposited $100, the bank could lend out $90 of that $100 if there is a 10% reserve requirement.
If they loan $90 to someone, and that person then deposits the $90 into the bank, the bank then can lend out $81 of that money to someone new.
And so on.
As you can see, this gets tricky quickly as the bank ultimately has close to none of its book balances in their vault.
With the Federal Reserve, this policy applies to the 12 member banks, who have to maintain those minimums.
Which is why those banks may engage in loans or buying and selling, to meet those minimum deposit requirements.
The Federal Reserve also pays interest on excess reserves held by member banks, called the Interest on Excess Reserves.
This means banks may choose to keep more deposits if the interest rate offered is favorable.
A higher rate encourages banks to keep more reserves at the Federal Reserve whereas a lower rate encourages lending toward the wider public instead.
This is a complex set of actions that come together to produce the monetary policy and interests rates we see in the wider economy.
We’ve already discussed that the Federal Reserve can just print digital currency out of thin air, and that banks can lend out what they don’t have on-hand.
What is even more concerning is that, since March 26th 2020, the Federal Reserve bank dropped the reserve requirement to 0%, and has continued to maintain that at 0% into 2024.
So now, banks are largely not obligated to keep any material reserves on-hand.
This means that the Federal Reserve can’t directly control the Federal Funds rate with a minimum reserve requirement.
Instead, the Federal Reserve has mostly used interest rates on reserve balances and open market operations as the means to manipulate interest rates.
Now, the U.S. banking system is riddled with malinvestment through the Federal Reserve’s policy.
The Federal Reserve has given itself near unlimited purchasing power with the Federal Government acting as an enabler through the Federal Deposit Insurance Corporation, backing accounts up to $250,000 per depositor.
As the Federal Reserve acts as a central planner, we don’t get the necessary free market signals that enable people to make better decisions.
Instead, we get the government giving banks free reign to enrich themselves in ways that, if we were to do as individuals, would count as currency counterfeiting and lead to our arrest.
Subsidizing banks and giving them the power to create currency out of nothing drops the value of our dollars and makes us poorer as inflation rises.
If we want to avoid a total economic collapse, we need to have a free market in money and banking and end the Federal Reserve’s blank check writing ability.
Sources
How the Fed Enables Money Creation
https://mises.org/mises-wire/how-fed-enables-money-creation
Money, Banking, and the Federal Reserve: the Complete Transcript
https://mises.org/mises-daily/money-banking-and-federal-reserve-complete-transcript
Does the Central Bank Determine Interest Rates?
https://mises.org/mises-wire/does-central-bank-determine-interest-rates
How the Federal Reserve Implements Monetary Policy
https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm
Federal Funds Rate: What It Is, How It's Determined, and Why It's Important
https://www.investopedia.com/terms/f/federalfundsrate.asp
Reserve Requirements 0%
https://www.federalreserve.gov/monetarypolicy/reservereq.htm
When banks hold excess reserves at the Fed, they earn interest at the IORB rate, making it more attractive for them to keep funds with the Fed rather than lending them out at a lower rate.
https://www.federalreserve.gov/monetarypolicy/reserve-balances.htm#:~:text=They%20are%20not%20updated%20on,balances%20(November%205%2C%202008)
With a 0% reserve requirement, the Federal Funds rate is primarily influenced by the Federal Reserve through managing the "interest on reserve balances" (IORB), essentially the rate banks earn on funds they hold at the Fed, which indirectly controls how much banks are willing to lend to each other overnight, thus affecting the federal funds rate; essentially, the Fed uses this rate to incentivize banks to lend at a desired level, even without a formal reserve requirement to enforce it.
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(The fact that many vendors accept the FED's "legal tender" in exchange for natural "LAWFUL money", means people can still spend their nonredeemable FED notes on the market and "buy" a form of money with intrinsic value.)
Though all value is subjective.
It's all a game held together with bullets and missiles and threats of nuclear annihilation. And they intimidate anyone innovating a new and better solution with "legal" action.
The non-federal depleted reserve is (we are expected to believe) the only "legal" option, as the non-promissory notes say "legal tender for all debts", even though it's not LAWFUL money at all. FED notes were always suppose to be exchangeable for a LAWFUL money... meaning the FED notes themselves are not LAWFUL money.
The contract used to read:
Once FED notes became unredeemable for LAWFUL money, FED notes are worthless, except by legal intimidation, bullets and the full strength of the US military forces.
Yup!
And then there was Bitcoin Cash.
Anyone with a computer could create money. It is costly and risky though as it should be. Eventually there is an end to printing and new money supply ends
Catch behind-the-scenes posts and help choose my next video topic at:
Patreon: https://www.patreon.com/thepholosopher
If you want a freer future, you must act with principles. To understand those principles, you need a clear, cohesive framework. That framework is The Definitive Guide to Libertarian Voluntaryism. Pick up a copy today and be the change you want to see:
https://amzn.to/42Bk6nY
(affiliate)