A Dark Hole of Democracy: How
the Fed Prints Money Out of Thin Air
by William Greider, The Nation
www.alternet.org/, July 17, 2009
Speaker of the House Nancy Pelosi:
"We wake up one morning and AIG was
receiving $80 billion from the Fed. So of course we're saying,
'Where is this money coming from?"
The financial crisis has propelled the
Federal Reserve into an excruciating political dilemma. The Fed
is at the zenith of its influence, using its extraordinary powers
to rescue the economy. Yet the extreme irregularity of its behavior
is producing a legitimacy crisis for the central bank. The remote
technocrats at the Fed who decide money and credit policy for
the nation are deliberately opaque and little understood by most
Americans. For the first time in generations, they are now threatened
with popular rebellion.
During the past year, the Fed has flooded
the streets with money -- distributing trillions of dollars to
banks, financial markets and commercial interests -- in an attempt
to revive the credit system and get the economy growing again.
As a result, the awesome authority of this cloistered institution
is visible to many ordinary Americans for the first time. People
and politicians are shocked and confused, and also angered, by
what they see. They are beginning to ask some hard questions for
which Federal Reserve governors do not have satisfactory answers.
Where did the central bank get all the
money it is handing out? Basically, the Fed printed it, out of
thin air. That is what central banks do. Who told the Fed governors
they could do this? Nobody, really -- not Congress or the president.
The Federal Reserve Board, alone among government agencies, does
not submit its budgets to Congress for authorization and appropriation.
It raises its own money, sets its own priorities.
Representative Wright Patman, the Texas
populist who was a scourge of central bankers, once described
the Federal Reserve as "a pretty queer duck." Congress
created the Fed in 1913 with the presumption that it would be
"independent" from the rest of government, aloof from
regular politics and deliberately shielded from the hot breath
of voters or the grasping appetites of private interests -- with
one powerful exception: the bankers.
The Fed was designed as a unique hybrid
in which government would share its powers with the private banking
industry. Bankers collaborate closely on Fed policy. Banks are
the "shareholders" who ostensibly own the twelve regional
Federal Reserve banks. Bankers sit on the boards of directors,
proposing interest-rate changes for Fed governors in Washington
to decide. Bankers also have a special advisory council that meets
privately with governors to critique monetary policy and management
of the economy. Sometimes, the Fed pretends to be a private organization.
Other times, it admits to being part of the government.
The antiquated quality of this institution
is reflected in the map of the Fed's twelve regional banks. Five
of them are located in the Midwest (better known today as the
industrial Rust Belt). Missouri has two Federal Reserve banks
(St. Louis and Kansas City), while the entire West Coast has only
one (located in San Francisco, not Los Angeles or Seattle). Virginia
has one; Florida does not. Among its functions, the Federal Reserve
directly regulates the largest banks, but it also looks out for
their well-being -- providing regular liquidity loans for those
caught short and bailing out endangered banks it deems "too
big to fail." Critics look askance at these peculiar arrangements
and see "conspiracy." But it's not really secret. This
duck was created by an act of Congress. The Fed's favoritism toward
bankers is embedded in its DNA.
This awkward reality explains the dilemma
facing the Fed. It cannot stand too much visibility, nor can it
easily explain or justify its peculiar status. The Federal Reserve
is the black hole of our democracy -- the crucial contradiction
that keeps the people and their representatives from having any
voice in these most important public policies. That's why the
central bankers have always operated in secrecy, avoiding public
controversy and inevitable accusations of special deal-making.
The current crisis has blown the central bank's cover. Many in
Congress are alarmed, demanding greater transparency. More than
250 House members are seeking an independent audit of Fed accounts.
House Speaker Nancy Pelosi observed that the Fed seems to be poaching
on Congressional functions -- handing out public money without
the bother of public decision-making.
"Many of us wereif not surprised,
taken aback, when the Fed had $80 billion to invest in AIG just
out of the blue," Pelosi said. "All of a sudden, we
wake up one morning and AIG was receiving $80 billion from the
Fed. So of course we're saying, Where is this money coming from?
'Oh, we have it. And not only that, we have more.'" So who
needs Congress? Pelosi sounded guileless, but she knows very well
where the Fed gets its money. She was slyly tweaking the central
bankers on their vulnerability.
Fed chair Ben Bernanke responded with
the usual aloofness. An audit, he insisted, would amount to "a
takeover of monetary policy by the Congress." He did not
appear to recognize how arrogant that sounded. Congress created
the Fed, but it must not look too deeply into the Fed's private
business. The mystique intimidates many politicians. The Fed's
power depends crucially upon the people not knowing exactly what
Basically, what the central bank is trying
to do with its aggressive distribution of trillions is avoid repeating
the great mistake the Fed made after the 1929 stock market crash.
The central bankers responded hesitantly then and allowed the
money supply to collapse, which led to the ultimate catastrophe
of full-blown monetary deflation and created the Great Depression.
Bernanke has not yet won this struggle against falling prices
and production -- deflationary symptoms remain visible around
the world -- but he has not lost either. He might get more public
sympathy if Fed officials explained this dilemma in plain English.
Instead, they are shielding people from understanding the full
dimensions of our predicament.
President Obama inadvertently made the
political problem worse for the Fed in June, when he proposed
to make the central bank the supercop to guard against "systemic
risk" and decide the terms for regulating the largest commercial
banks and some heavyweight industrial corporations engaged in
finance. The House Financial Services Committee intends to draft
the legislation quickly, but many members want to learn more first.
Obama's proposal gives the central bank even greater power, including
broad power to pick winners and losers in the private economy
and behind closed doors. Yet Obama did not propose any changes
in the Fed's privileged status. Instead, he asked Fed governors
to consider the matter. But perhaps it is the Federal Reserve
that needs to be reformed.
A few months back, I ran into a retired
Fed official who had been a good source twenty years ago when
I was writing my book about the central bank,
Secrets of the Temple: How the Federal
Reserve Runs the Country
He is a Fed loyalist and did not leak
damaging secrets. But he helped me understand how the supposedly
nonpolitical Fed does its politics, behind the veil of disinterested
expertise. When we met recently, he said the central bank is already
making preparations to celebrate its approaching centennial. Some
of us, I responded, have a different idea for 2013.
"We think that would be a good time
to dismantle the temple," I playfully told my old friend.
"Democratize the Fed. Or tear it down. Create something new
in its place that's accountable to the public."
The Fed man did not react well to my teasing.
He got a stricken look. His voice tightened. Please, he pleaded,
do not go down that road. The Fed has made mistakes, he agreed,
but the country needs its central bank. His nervous reaction told
me this venerable institution is feeling insecure about its future.
Six reasons why granting the Fed even
more power is a really bad idea:
1. It would reward failure. Like the largest
banks that have been bailed out, the Fed was a co-author of the
destruction. During the past twenty-five years, it failed to protect
the country against reckless banking and finance adventures. It
also failed in its most basic function -- moderating the expansion
of credit to keep it in balance with economic growth. The Fed
instead allowed, even encouraged, the explosion of debt and inflation
of financial assets that have now collapsed. The central bank
was derelict in enforcing regulations and led cheers for dismantling
them. Above all, the Fed did not see this disaster coming, or
so it claims. It certainly did nothing to warn people.
2. Cumulatively, Fed policy was a central
force in destabilizing the US economy. Its extreme swings in monetary
policy, combined with utter disregard for timely regulatory enforcement,
steadily shifted economic rewards away from the real economy of
production, work and wages and toward the financial realm, where
profits and incomes were wildly inflated by false valuations.
Abandoning its role as neutral arbitrator, the Fed tilted in favor
of capital over labor. The institution was remolded to conform
with the right-wing market doctrine of chairman Alan Greenspan,
and it was blinded to reality by his ideology (see my Nation article
"The One-Eyed Chairman," September 19, 2005).
3. The Fed cannot possibly examine "systemic
risk" objectively because it helped to create the very structural
flaws that led to breakdown. The Fed served as midwife to Citigroup,
the failed conglomerate now on government life support. Greenspan
unilaterally authorized this new financial/banking combine in
the 1990s -- even before Congress had repealed the Glass-Steagall
Act, which prohibited such mergers. Now the Fed keeps Citigroup
alive with a $300 billion loan guarantee. The central bank, in
other words, is deeply invested in protecting the banking behemoths
that it promoted, if only to cover its own mistakes.
4. The Fed can't be trusted to defend
the public in its private deal-making with bank executives. The
numerous revelations of collusion have shocked the public, and
more scandals are certain if Congress conducts a thorough investigation.
When Treasury Secretary Timothy Geithner was president of the
New York Fed, he supervised the demise of Bear Stearns with a
sweet deal for JPMorgan Chase, which took over the failed brokerage
-- $30 billion to cover any losses. Geithner was negotiating with
Morgan Chase CEO and New York Fed board member Jamie Dimon. Goldman
Sachs CEO Lloyd Blankfein got similar solicitude when the Fed
bailed out insurance giant AIG, a Goldman counterparty: a side-door
payout of $13 billion. The new president at the New York Fed,
William Dudley, is another Goldman man.
5. Instead of disowning the notorious
policy of "too big to fail," the Fed will be bound to
embrace the doctrine more explicitly as "systemic risk"
regulator. A new superclass of forty or fifty financial giants
will emerge as the born-again "money trust" that citizens
railed against 100 years ago. But this time, it will be armed
with a permanent line of credit from Washington. The Fed, having
restored and consolidated the battered Wall Street club, will
doubtless also shield a few of the largest industrial-financial
corporations, like General Electric (whose CEO also sits on the
New York Fed board). Whatever officials may claim, financial-market
investors will understand that these mammoth institutions are
insured against failure. Everyone else gets to experience capitalism
in the raw.
6. This road leads to the corporate state
-- a fusion of private and public power, a privileged club that
dominates everything else from the top down. This will likely
foster even greater concentration of financial power, since any
large company left out of the protected class will want to join
by growing larger and acquiring the banking elements needed to
qualify. Most enterprises in banking and commerce will compete
with the big boys at greater disadvantage, vulnerable to predatory
power plays the Fed has implicitly blessed.
Whatever good intentions the central bank
enunciates, it will be deeply conflicted in its actions, always
pulled in opposite directions. If the Fed tries to curb the growth
of the megabanks or prohibit their reckless practices, it will
be accused of damaging profitability and thus threatening the
stability of the system. If it allows overconfident bankers to
wander again into dangerous territory, it will be blamed for creating
the mess and stuck with cleaning it up. Obama's reform might prevail
in the short run. The biggest banks, after all, will be lobbying
alongside him in favor of the Fed, and Congress may not have the
backbone to resist. The Fed, however, is sure to remain in the
cross hairs. Too many different interests will be damaged -- thousands
of smaller banks, all the companies left out of the club, organized
labor, consumers and other sectors, not to mention libertarian
conservatives like Texas Representative Ron Paul. They will recognize
that the "money trust" once again has its boot on their
neck, and that this time the government arranged it.
The obstacles to democratizing the Fed
are obviously formidable. Tampering with the temple is politically
taboo. But this crisis has demonstrated that the present arrangement
no longer works for the public interest. The society of 1913 no
longer exists, nor does the New Deal economic order that carried
us to twentieth-century prosperity. The country thus has a rare
opportunity to reconstitute the Federal Reserve as a normal government
agency, shorn of the bankers' preferential trappings and the fallacious
claim to "independent" status as well as the claustrophobic
demand for secrecy.
Progressives in the early twentieth century,
drawn from the growing ranks of managerial professionals, believed
"good government" required technocratic experts who
would be shielded from the unruly populace and especially from
radical voices of organized labor, populism, socialism and other
upstart movements. The pretensions of "scientific" decision-making
by remote governing elites -- both the mysterious wisdom of central
bankers and the inventive wizardry of financial titans -- failed
spectacularly in our current catastrophe. The Fed was never independent
in any real sense. Its power depended on taking care of its one
true constituency in banking and finance.
A reconstituted central bank might keep
the famous name and presidentially appointed governors, confirmed
by Congress, but it would forfeit the mystique and submit to the
usual standards of transparency and public scrutiny. The institution
would be directed to concentrate on the Fed's one great purpose
-- making monetary policy and controlling credit expansion to
produce balanced economic growth and stable money. Most regulatory
functions would be located elsewhere, in a new enforcement agency
that would oversee regulated commercial banks as well as the "shadow
banking" of hedge funds, private equity firms and others.
The Fed would thus be relieved of its
conflicted objectives. Bank examiners would be free of the insider
pressures that inevitably emanate from the Fed's cozy relations
with major banks. All of the private-public ambiguities concocted
in 1913 would be swept away, including bank ownership of the twelve
Federal Reserve banks, which could be reorganized as branch offices
with a focus on regional economies.
Altering the central bank would also give
Congress an opening to reclaim its primacy in this most important
matter. That sounds farfetched to modern sensibilities, and traditionalists
will scream that it is a recipe for inflationary disaster. But
this is what the Constitution prescribes: "The Congress shall
have the power to coin money [and] regulate the value thereof."
It does not grant the president or the treasury secretary this
power. Nor does it envision a secretive central bank that interacts
murkily with the executive branch.
Given Congress's weakened condition and
its weak grasp of the complexities of monetary policy, these changes
cannot take place overnight. But the gradual realignment of power
can start with Congress and an internal reorganization aimed at
building its expertise and educating members on how to develop
a critical perspective. Congress has already created models for
how to do this. The Congressional Budget Office is a respected
authority on fiscal policy, reliably nonpartisan. Congress needs
to create something similar for monetary policy.
Instead of consigning monetary policy
to backwater subcommittees, each chamber should create a major
new committee to supervise money and credit, limited in size to
members willing to concentrate on becoming responsible stewards
for the long run. The monetary committees, working in tandem with
the Fed's board of governors, would occasionally recommend (and
sometimes command) new policy directions at the federal agency
and also review its spending.
Setting monetary policy is a very different
process from enacting laws. The Fed operates through a continuum
of decisions and rolling adjustments spread over months, even
years. Congress would have to learn how to respond to deeper economic
conditions that may not become clear until after the next election.
The education could help the institution mature.
Congress also needs a "council of
public elders" -- a rotating board of outside advisers drawn
from diverse interests and empowered to speak their minds in public.
They could second-guess the makers of monetary policy but also
Congress. These might include retired pols, labor leaders, academics
and state governors -- preferably people whose thinking is no
longer defined by party politics or personal ambitions. The public
could nominate representatives too. No financial wizards need
A revived Congress armed with this kind
of experience would be better equipped to enact substantive law
rather than simply turning problems over to regulatory agencies
with hollow laws that are merely hortatory suggestions. Reordering
the financial system and the economy will require hard rules --
classic laws of "Thou shalt" and "Thou shalt not"
that command different behavior from certain private interests
and prohibit what has proved reckless and destructive. If "too
big to fail" is the problem, don't leave it to private negotiations
between banks and the Federal Reserve. Restore anti-monopoly laws
and make big banks get smaller. If the financial system's risky
innovations are too complicated for bank examiners to understand,
then those innovations should probably be illegal.
Many in Congress will be afraid to take
on the temple and reluctant to violate the taboo surrounding the
Fed. It will probably require popular rebellion to make this happen,
and that requires citizens who see through the temple's secrets.
But the present crisis has not only exposed the Fed's worst failures
and structural flaws; it has also introduced citizens to the vast
potential of monetary policy to serve the common good. If Ben
Bernanke can create trillions of dollars at will and spread them
around the financial system, could government do the same thing
to finance important public projects the people want and need?
Daring as it sounds, the answer is, Yes, we can.
The central bank's most mysterious power
-- to create money with a few computer keystrokes -- is dauntingly
complicated, and the mechanics are not widely understood. But
the essential thing to understand is that this power relies on
democratic consent -- the people's trust, their willingness to
accept the currency and use it in exchange. This is not entirely
voluntary, since the government also requires people to pay their
taxes in dollars, not euros or yen. But citizens conferred the
power on government through their elected representatives. Newly
created money is often called the "pure credit" of the
nation. In principle, it exists for the benefit of all.
In this emergency, Bernanke essentially
used the Fed's money-creation power in a way that resembles the
"greenbacks" Abraham Lincoln printed to fight the Civil
War. Lincoln was faced with rising costs and shrinking revenues
(because the Confederate states had left the Union). The president
authorized issuance of a novel national currency -- the "greenback"
-- that had no backing in gold reserves and therefore outraged
orthodox thinking. But the greenbacks worked. The expanded money
supply helped pay for war mobilization and kept the economy booming.
In a sense, Lincoln won the war by relying on the "full faith
and credit" of the people, much as Bernanke is printing money
freely to fight off financial collapse and deflation.
If Congress chooses to take charge of
its constitutional duty, it could similarly use greenback currency
created by the Federal Reserve as a legitimate channel for financing
important public projects -- like sorely needed improvements to
the nation's infrastructure. Obviously, this has to be done carefully
and responsibly, limited to normal expansion of the money supply
and used only for projects that truly benefit the entire nation
(lest it lead to inflation). But here is an example of how it
President Obama has announced the goal
of building a high-speed rail system. Ours is the only advanced
industrial society that doesn't have one (ride the modern trains
in France or Japan to see what our society is missing). Trouble
is, Obama has only budgeted a pittance ($8 billion) for this project.
Spain, by comparison, has committed more than $100 billion to
its fifteen-year railroad-building project. Given the vast shortcomings
in US infrastructure, the country will never catch up with the
backlog through the regular financing of taxing and borrowing.
Instead, Congress should create a stand-alone
development fund for long-term capital investment projects (this
would require the long-sought reform of the federal budget, which
makes no distinction between current operating spending and long-term
investment). The Fed would continue to create money only as needed
by the economy; but instead of injecting this money into the banking
system, a portion of it would go directly to the capital investment
fund, earmarked by Congress for specific projects of great urgency.
The idea of direct financing for infrastructure has been proposed
periodically for many years by groups from right and left. Transportation
Secretary Ray LaHood co-sponsored legislation along these lines
a decade ago when he was a Republican Congressman from Illinois.
This approach speaks to the contradiction
House Speaker Pelosi pointed out when she asked why the Fed has
limitless money to spend however it sees fit. Instead of borrowing
the money to pay for the new rail system, the government financing
would draw on the public's money-creation process -- just as Lincoln
did and Bernanke is now doing.
The bankers would howl, for good reason.
They profit enormously from the present system and share in the
money-creation process. When the Fed injects more reserves into
the banking system, it automatically multiplies the banks' capacity
to create money by increasing their lending (and banks, in turn,
collect interest on their new loans). The direct-financing approach
would not halt the banking industry's role in allocating new credit,
since the newly created money would still wind up in the banks
as deposits. But the government would now decide how to allocate
new credit to preferred public projects rather than let private
banks make all the decisions for us.
The reform of monetary policy, in other
words, has promising possibilities for revitalizing democracy.
Congress is a human institution and therefore fallible. Mistakes
will be made, for sure. But we might ask ourselves, If Congress
were empowered to manage monetary policy, could it do any worse
than those experts who brought us to ruin?
William Greider is the author of, most
recently, "Come Home, America: The Rise and Fall (and Redeeming
Promise) of Our Country (Rodale Books, 2009)."
William Greider page