Here’s how the ‘Fed’ works

Understanding money is puzzling. Holding American dollars made me rich for two days of my life. After communism ended in Romania, my wife and I had finished a teaching workshop in that nation. On our last day in the capital of Bucharest, I converted $50 American money into Romanian “lea.” Their money had the consistency of tissue paper, and it was forbidden to take it out of the country.

Now the problem was how could we spend that amount of money in a day? We could not no matter how much we tried. We hailed a taxi to drive us to the then top restaurant in town — Pizza Hut. We had as much as we wanted with drinks, dinners and salads. When we were finished, the same taxi driver was waiting to drive us to our hotel. We gave him the remaining “lea” as a tip. He said he could not take it as it was too much, but we insisted.

In August 2001, after completing a mission in the central Asian nation of Uzbekistan, we decided to spend a day in Samarkand near the Afghan border, After another high class meal of pizza, I gave a $100 bill to our local contact who said “it would be safer” if he converted the money to local currency. When he returned, he was carrying two large brown shopping bags of Uzbek money.

The point of these two anecdotes is that the value of money is determined by where and when you use it and the type of currency you have,

I do not know how to trade currencies internationally. If I did, I would not be concerned about school budgets. However, it is necessary to add some comments about the Federal Reserve System in response to viewpoints presented in the Feb. 4 Ledger-Transcript.

1. The Federal Reserve was legally created in 1913, and was designed to be independent of the government, i.e., the Congress and the president. The general belief is that politicians should not control America’s central banking mechanism.

2. The purpose of the “Fed” is to control inflation, which is more harmful to society than unemployment since inflation affects everyone while unemployment does not.

3. The creation of money by the Fed’ s purchasing of Treasury bonds, despite its opponents view, has not caused inflation. Increasing the money supply by hundreds of billions of dollars has not caused inflation to rise more than 1 to 1.5 percent a year for several years.

4. Quotations from Henry Ford, Lenin, John Keyes, and Mayer Rothschild, used to support the view that controlling the money supply is more important than political power is just plain wrong. If that were so, then the most important German leader in the 1930s would have been Dr. Hjalmar Schacht, head of the Reichsbank, and not Adolf Hitler.

5. Deflation, declining prices is the greatest economic danger a nation faces since it leads to depression, vastly different than recession. It is the difference between a high temperature and malaria. Deflation leads to a massive decline in production, GNP, and consumption with a traumatic increase in unemployment to over 25 percent of workforce. Every central banker in the industrialized world fears deflation.

6. Some people today propose returning to the gold standard, i.e., basing the value of money on gold. There are enormous drawbacks to that simplistic proposal. It means that the nation with the most gold has the most economic power. That might not be the United States. National sovereignty would be affected and the power of the rich increased even more. A careful reading of the full text of William Jennings Bryan’s speech to the Democratic Convention in 1896 shows how old-fashioned the gold standard would be.

7. Gold fluctuates widely in value and is no guarantee of financial stability. Economic cycles of boom and bust existed under the gold standard and were widespread in the 19th century.

8. Bills in your wallet are currency and not technically money. They represent money. There is more money in the money supply than there is currency, i.e., paper bills.

9. Money is actually created by the loaning of money. If you take a mortgage for $200,000 from a bank, the bank creates money by that loan. A reserve requirement of 20 percent means that the bank only needed to have $40,000 of its own to loan you the other $160,000. Thus, money is created out of thin air (see John Kenneth’s Galbrith’s book on money to see how this works). Banks loan money they don’t have, and the Federal Reserve System regulates this.

Surprisingly, this system works for the most part. The year is 2014 and at no time in human history has the world’s population been so well-fed, educated, possessed so many consumer goods, lived longer, and had access to so much technology.

The value of a dollar should also be based on the amount of time it takes through work to purchase an item: food, energy, and housing. Throughout history, most working hours were devoted to producing food and/or that was the largest expense people had. That is not the case today.

Despite its critics, I do not know of any way to replace the Federal Reserve System that would not create economic chaos.

Rick Sirvint lives in Rindge

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