Economy

General category for discussing topics related to state of economy

Is Federal Reserve Private or Government owned?

Recently I had a few friends over and as we talked about the current state of economy and certain policies Feds use for boosting overall growth, an interesting question came up. What is Federal bank? Who owns the bank? Is it private and if so then why do President appoint the chairman?

Let’s understand the structure and working of the internal aspects such as board of governors, chairman’s role and responsibilities, government intervention and regulation, printing of money and distribution. Fed oversees the overall money flow and each bank in US is affiliated with the Fed in terms of lending the money when needed and paying interest on it. Fed system is headed by seven boards of governors from other seven federal banks and a chairman both appointed by the President of United States. The system is strange in regard that while President appoints the governors and chairman, he cannot fire them and nor can chairman fire any of the governors and nor can Congress fire any of them.  The Fed chair is actually not in complete and absolute control of the policies and decisions coming out of the fed committee. He merely persuades and influences others to vote on issues and topics that he thinks needs attention. Federal Reserve has close to 20,000 employees and around $2.3 billion worth of real estate and around $3.7 trillion dollars on their books.

One of the most important job of the chairman is to decide on how much money should circulate in the market. Too much money can cause inflation whereas too little can cause high unemployment. Delicate decisions have to be made depending on the current and future state of economy. Fed might infuse more money in the economy to increase growth and such a scenario is usually turns out positive if the net exports are higher and the net imports are down. This is a very top level assessment but there are many more complicated variables to be considered in an equally complex system.  Chairman cannot alone pull trigger on any decisions but he has to get a majority of votes from the appointed governors. It is interesting to note that only five of the governors can vote at a time and rarely there is a disagreement of more than three votes.

Feds have a strong grip on bank regulation and monetary decisions. Even congress cannot force Fed into any decisions by withholding funding. Since printing money is a job of Federal, its other way around when it comes to Congress. It is the fed who after their operating and administrative expense supplies Congress with the leftover money. So it is safe to say that Congress do not fund Fed but Fed funds Congress. The system is set up in this way due the constitutional decision to not let politics interfere with the monetary policies. For example, when a country is leading to an election any president would like to have low interest rate to boost the economy and help people with lending as well as encourages businesses to lend more and invest more. This might not be as beneficial to the future of the economy as lower interest rates can cause bubbles in in different areas such as housing. The current set up insulates the Federal Reserve to operate through independent & separate decisions from the volatile nature of government policies. Although Congress routinely tries to influences their own agenda in senate hearings.

Fed intervenes heavily during a financial crisis like the 2008 housing bubble crisis when Feds infused various banks with needed fund to stay afloat or by buying the largest insurance firm in the world AIG. When Fed has borrowing needs they swap Federal Reserve Notes for US bond from Treasury.

It is controversial to say Fed is not private yet not managed by government. It is even more controversial to say that the Fed is private. The reason being that government oversees and appoints the chair and governors and fed is answerable to Congress. But the governors are also the CEOs of other private banks which could cause motivation of pushing certain policies beneficial to those banks in particular. Even the shareholders of Fed are 100% private banks. So technically they are owned by these banks. These banker shareholders are paid their operating expenses in addition to the fixed 6% return for profit.  This also means that common people will have to pay for the interest in maintaining certain fixed reserve for every dollar that was lend to a bank. In my opinion this just adds an overhead and benefits those banks in particular. Maybe there is a need for reforms?

Here is the official explanation from the the federal reserve website.

Who owns the Federal Reserve?

The Federal Reserve System fulfills its public mission as an independent entity within government.  It is not “owned” by anyone and is not a private, profit-making institution.

As the nation’s central bank, the Federal Reserve derives its authority from the Congress of the United States. It is considered an independent central bank because its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government, it does not receive funding appropriated by the Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

However, the Federal Reserve is subject to oversight by the Congress, which often reviews the Federal Reserve’s activities and can alter its responsibilities by statute. Therefore, the Federal Reserve can be more accurately described as “independent within the government” rather than “independent of government.”

The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation’s central banking system, are organized similarly to private corporations–possibly leading to some confusion about “ownership.” For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year.

References: http://www.federalreserve.gov/faqs/about_14986.htm

Gold as reserve currency – Part 1

In the time of economic distress, Gold is often seemed as the last man standing. To help understand the role of gold we need to understand how is gold related to the fiat currencies and how it works now as compared to how it worked in the past.

It all started with IOUs being issued against the gold reserves. So in a classical sense the domestic gold supply is directly proportional to the country’s stock of gold. On the international trade front, the notes issued against the gold reserves would be constricted when a country experiences a deficit in trade in terms of gold due to the loss of gold while importing more than the exports.  This depresses the price levels and makes the exports more attractive to other countries while making the imports more expensive. This leads to an automatic correction of the country’s deficits.

What follows is sterilization under a gold standard where the exchange rates are fixed so there is no currency appreciation or depreciation. When a country has net surplus of gold in-flowing from deficit countries, the inflation of that country rises since people will have more gold to buy more imports. And over time since the imports will also increase due to the increased capacity of the nation’s citizens to buy more, the deficit will be corrected.  There will also be declines of export from deficit countries because of the higher prices. The deficit countries will also end up exporting instead of consuming part of their production to correct the deficit. Countries like US and France used the Sterilization in 1920s and 1930s with some success whilst stocking up piles of gold. Around early 1930s this model had detrimental effects on the global economy and was abandoned.

This classical gold model turned out badly in practice due to depletion of gold stocks in some countries while explosion in practice of hoarding gold.