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“The Federal Reserve is no more Federal than Federal Express”
– Dennis Kucinich, former Democratic Congressman from Ohio’s 10th District
“There is no institution in the United States that has such a high public standing and such a poor record of performance”
– Milton Friedman, Nobel Prize winning economist
The New York Times recently had a story about how large financial institutions on Wall Street (Goldman Sachs, JPMorgan Chase and Morgan Stanley to name just a few) have been extremely active – and engaging in questionable business practices – in the commodity markets. It appears that exemptions given by the Federal Reserve Bank of the United States (the Fed) in 2003, in conjunction with loosened regulations approved by Congress, allowed banks to invest (i.e. speculate) in the infrastructure used to store, transport and deliver commodities such as metals, oil, wheat, cotton, coffee, petroleum and electricity.
The Times’ story focuses on the actions of Goldman Sachs and its alleged manipulation of the aluminium market. Three years ago, Goldman Sachs bought Metro International Trade Services, an aluminium storage company. Since the purchase, average waiting times at the storage facility have increased by a factor of 10. And just what exactly is causing this increase in waiting times? Reportedly, Goldman Sachs moves 90% of its aluminium stock between its different warehouses every day. The results, according to current and former employees at Metro, are artificial bottlenecks which have led to an increase in holding costs.
How this benefits customers and final consumers is not immediately clear.
“It’s a totally artificial cost,” says Jorge Vazquez, an expert consultant on the aluminium industry. “It’s a drag on the economy. Everyone pays for it.”
The scheme is estimated to have cost the American consumer about $5 billion over the past three years. But what will most likely be of greater concern to regulators, and what might actually cause them to do something, is the increase in operating costs for the likes of MillerCoors, Coca-Cola, Boeing or any other company that uses large quantities of aluminum.
The fallout from the revelations in the New York Times is already being felt, with JP Morgan Chase announcing that they will no longer be trading physical commodities. Goldman Sachs, however, is standing firm, saying that “recent news reports have inaccurately accused Metro of deliberately creating aluminium shortages and incorrectly asserted that Metro moves aluminium from one warehouse to another in order to earn more rent fees.”
But Goldman Sachs needs to worry about overplaying its hand. Senator Elizabeth Warren (D – Massachusetts), a member of the Senate Banking Committee and a person not known for holding back on what she really thinks about America’s financial institutions, is extremely concerned about this matter, saying, “I share the concern of many of my colleagues about asset managers at huge Wall Street banks exercising control of key parts of America’s infrastructure.”
The Federal Reserve is reviewing the exemptions that it gave to banks to allow them to speculate in non-banking activities. In a statement, the Fed said that it “regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies.” But unfortunately, it appears that they have no immediate plans to require banks to sell the assets they acquired to do business in commodity markets.
For his part, Senator Sherrod Brown (D – Ohio), a member of the Senate Banking Committee and the Senate Committee on Finance, says, “Banks should be banks … they should make loans, not manipulate the markets to drive up prices for manufacturers and expose our entire financial system to undue risk.”
But a bigger question that can be asked is, “What exactly is the role of the Fed?” According to its own documents it has “supervisory and regulatory authority over a wide range of financial institutions and activities. It works with other federal and state supervisory authorities to ensure the safety and soundness of financial institutions, stability in the financial markets, and fair and equitable treatment of consumers in their financial transactions.”
Important stuff, to say the least. This raises another serious question. After all that we have learned as a result of the 2008 financial crisis, why would the Fed allow banks to make major investments in unrelated nonfinancial businesses (i.e. gamble) when it is clear that they barely understood the risks involved in their principle lines of business in the first place? I mean, why would the government allow such potentially reckless and irresponsible behaviour?
That’s easy. It’s because the Federal Reserve is a private bank and not part of the government. In fact, it is the third central bank that America has had in her 237 year history. Interested readers might want to look into what happened to the first two.
The Federal Reserve System is broken up into 12 regional districts, each with its own bank. The regional Federal Reserve Banks are private banks. Once more, they are not part of the government. To quote a story that appeared in Bloomberg News, “The New York Fed and other regional banks maintain they are separate institutions, owned by their member banks, and not subject to federal restrictions.”
And just what kind of people are running the Fed? Oddly enough, Jamie Dimon, Chairman of the Board and CEO of JP Morgan Chase – an institution that is no stranger to controversy and run ins with the law, and which has received at least $26 billion in taxpayer backed bailouts since 2008 – was until recently on the board of directors of the New York Federal Reserve Bank (the most powerful of the 12 regional banks).
To add insult to injury, Larry Summers is now being mentioned as a possible candidate to be the next chairman of the Fed. Here is a man whose tenure as president of Harvard University could best be summed up by “Chicks: you can’t live with them and you can’t live without them, am I right fellas?” This is a man who, as Secretary of the Treasury under President Clinton, was instrumental in undoing the main provisions of the Glass – Steagall Act, an act which had, for the most part (up until 1999), limited the types of risky activities that banks could get involved in. It has been credited with being the main reason America was able to go several decades without a major financial crisis or panic.
Nine short years after the repeal of Glass – Steagall, America would have its worst financial crisis since the Great Depression, bringing hardship and misery to millions of Americans.
Mr. Summers has also been an outspoken critic of regulating the currently unregulated global derivatives market, a market that is estimated to be worth $ 639 trillion. That is almost ten times the total value of the entire planet. If (more likely when) this market crashes, all of the King’s horses and all of the King’s men won’t be able to put Humpty Dumpty back together again.
Another even more curious oddity about the Fed is the fact that for every dollar that the Federal Reserve creates, one dollar of debt is created as well. The Federal Reserve “creates” money (i.e. puts money into circulation) by buying Federal (i.e. US Government) debt. And just how does the Federal Reserve have the money to buy all of this debt? Good question. It doesn’t. The Fed simply creates the money electronically out of thin air, with the cost of the debt purchased by the Federal Reserve merely being put on the Government’s books, since debt bought by the Federal Reserve counts against the country’s debt ceiling.
Since the recession of 2008, the Federal Reserve has pledged a minimum of $7.77 trillion (some reports put the figure at $16 trillion – more than the total value of the US economy) to rescue the financial industry, loaning at least $1.2 trillion to banks and financial companies affected by the crisis; a crisis, it is important to note, of Wall Street’s own making. Is it any wonder that with a private bank regulating other private banks the American economy is in the condition that it is?
The Federal Reserve is nothing more than a middleman between the US government and the US economy (and an ineffective middleman at that). If the US Treasury were to simply issue paper money – as it currently can do with coins – rather than let the Fed do it, the exponential rate at which the US is presently creating debt would most likely be slowed.
Why we allow this predatory private institution to continue to exist and threaten the well being of our society is truly bewildering.
Tom McNamara is an Assistant Professor at the ESC Rennes School of Business, France, and a former Visiting Lecturer at the French National Military Academy at Saint-Cyr Coëtquidan, France
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