Questioning Assumptions about The Federal Reserve (Part IV)

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Beginning of Series: Beginning

Time to Rethink Fed Assumptions?


Imprecise language can work when we agree on the true meaning. We still refer to sunrise and sunset, even though we nearly all know it does not work that way. But do we understand the operation of the Fed so well that we can convey an accurate meaning with inaccurate phraseology?

Imprecise language sometimes becomes a substitute for clear thinking. I suggest using more precision for those just using sloppy language. For the rest who make these misleading statements, I suggest checking the following assumptions:

  1. The Fed sets interest rates
  2. The Fed Funds Rate acts as a base for all market rates
  3. The Fed “pumps” money into the economy

The Fed sets interest rates

Although many people say the Fed “sets” interest rates, what assumptions support that statement? How does the Fed unilaterally hike interest rates?

Only exchanges of current dollars for commitments of future dollars determine the amount of interest. Interest rates (or, more precisely, fractional interest rates) reflect the accumulation of interest as a percentage of current dollars in increments of time (usually yearly). In other words, interest and interest rates consist of dependent variables—dependent on the number of current dollars and the number of future dollars.

How can the Fed, or anyone for that matter, unilaterally control a dependent variable that requires two independent variables?

No one can “set” interest rates unilaterally.

How, then, can the Fed “set” or “hike” interest rates?

The Fed Funds Rate acts as a base for all market rates

How can interest rates, established in a closed market, provide a base for all other market rates?

We must consider the Fed Funds market as a closed market: only members of the Federal Reserve System can trade reserve dollars in this market. To qualify as a base rate, transactions must occur in an open market (open to private entities) for the exchange of money dollars.

The Fed “pumps” money into the economy

The expansion of the money supply amounts to a very complex topic. I will touch on just a couple of the effects of monetary expansion that benefit billionaires—investment markets and supplier trades.

How can the Fed add money to the economy when only banks (and some foreign accounts) can own dollars held in reserve accounts?

We should examine the assumption that the Fed has ever created, or does now create, money.

(Remember: I use the term money to refer to dollars created by or distributed by banks only.)


Test your assumptions by engaging in this thought experiment:

If the Fed sold 100% of its assets, thereby eliminating reserve balances, in this zero reserve requirement environment, what effect would that have on the money supply?

☐ The quantity of money would shrink.
☐ The quantity of money would expand.
☐ The quantity of money would not change.
☐ Other.

Carefully examine your assumptions about The Federal Reserve and the rest of the banking system. A high probability exists that some, if not all, of those assumptions contain significant flaws.

Final in Series: Summary

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