Tens of millions of Americans want to abolish the world’s largest central bank

In early June of this year, Senator Mike Lay, Republican of Utah, submitted a bill that called for the abolition and dissolution of the Federal Reserve. A similar proposal was put before the House a few weeks earlier by Kentucky Republican Thomas Massey, a member of the House of Representatives. The main rationale for the proposals is that the deficit, government debt and inflation are the fault of the Fed and its policies. Many Americans share the opinion of the proposers. According to a 2018 Voltaire poll, one in seven Americans supports abolishing the Fed entirely. In 2010 over half believed that the Fed should be abolished or brought under the control of the politicians.

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The Bank of England, technically, was not the first but the second central bank founded in Europe – but in every other respect it was the model for all the banks that came after it, including the Fed. In 1660, after the death of Oliver Cromwell, who won the War of Parliament in the King, the monarchy was restored in England. But the new king Charles II no longer had unlimited powers to impose taxes. From now on his government had to operate within the framework of a budget established by the parliament, and the deficits began to pile up.

The rise of printed money

In 1694 the new king William II needed a large financial infusion to finance the wars in Europe. A loan in the amount of 1.2 million pounds was arranged by a group of rich people, and in return they received a charter to establish a company called the “Bank of England”, Company of the Bank of England. The bank accepted deposits from savers and issued them bank notes that guaranteed the payment of these deposits according to Due to their convenience and reliability, the bills became an extremely popular means of payment. Over time, legislation made the bills the legal tender in the country, with which debts could be paid and taxes paid.

In the 19th century, more and more royal houses in Europe adopted the model and banknotes printed as mentioned became the means of payment, i.e. the most popular money in Europe. From there they migrated to colonies across the ocean. In June 1775, the Congress of the Rebellious Colonies in America met, and authorized the printing of bills to finance the expenses of the war against the British. As the war dragged on, the amount of banknotes printed kept increasing, and at the same time, naturally, their value decreased. Benjamin Franklin sarcastically remarked “This money is a wonderful device… it not only covers the cost of recruiting, it also covers the cost of itself… by its continued depreciation”.

This inflationary experience undoubtedly contributed to the statement in the US Constitution that “no country (of the states of the Union) shall print notes or money or allow anything but gold or silver to be legal tender for the payment of debts”.

In 1792, Congress passed a law that made the dollar the legal tender in America, and also determined the amount of gold and silver that would be in each dollar. This was the way things were, with a temporary pause during the Civil War (1861-1865), until 1900. At that time, Congress enacted the “Gold Standard Act” which abolished the status of silver metal and made gold alone the standard unit of calculation in the economy. The law also stated that all bills in circulation would be convertible into gold, and on them was printed: “This bill confirms that the sum of (the amount of the bill) dollars in gold has been deposited in the US Treasury, to be paid to the bearer of this bill upon demand.”

To meet this conversion obligation, the government created gold reserves of $150 million. The law also limited the amount of banknotes that the Treasury could produce to two and a half times the amount of gold in reserves, meaning a 40% gold coverage for the banknotes in circulation. With the establishment of the Federal Reserve in 1913, the authority to produce the banknotes was transferred to it, but the limit on the quantity produced remained unchanged.

The gold standard that dominated the world at the end of the 19th century collapsed in Europe with the outbreak of World War I, but in the US it lasted for almost two more decades.

The gold is found outside the law

In the 1932 election amid a huge recession and an unprecedented economic and social depression, Franklin Roosevelt was elected president of the United States. A few days after the beginning of his term in April 1933, he signed Presidential Directive 6102. According to it, all holders of gold in America were required to “deliver it to the nearest Federal Reserve branch by 1 May 1934”. The penalty for not handing over the gold was set at 10 years in prison. Also, all links to gold and all conversion obligations of the Fed as stated in the bills were canceled. The Fed, by the way, paid for the confiscated gold its value in paper bills (dollars) at a price of $20.67 per ounce.

At the beginning of 1934, Congress made the provisions of the order into law, and later the dollar exchange rate against gold decreased to $35 per ounce, where it stood until 1971.

After the Second World War, the Bretton Woods agreements were signed that returned gold to the basis of the global monetary system and as such between central banks. But he did not return to his status as already converted to notes in circulation. In 1971, President Nixon canceled the Bretton Woods agreements, and the era of fiat money was born. Close to the cancellation of the agreements, Congress passed a law that canceled the obligation to cover (then of 25%) gold for the dollars in circulation.

Since the middle of the 17th century, new money has been created in the system mainly by providing credit, through the mechanism of fractional reserve banking. But as long as the basis of the system was an asset, gold, which was limited in quantity, the amount of money that could be produced was also automatically limited. But since 1971, when gold lost its monetary role, the interest rate set by the Fed became the main regulator determining the rate of money flow in the economy’s pipes, by controlling the level of demand for such credit.

The bills to abolish the Fed do not discuss this critical question of the interest rate setting mechanism. Will it be the president, as some of Trump’s advisers suggest? Will it be the free market, in a mechanism whose nature is unclear, as perhaps the libertarian Senator Leigh would probably prefer? This central question in an economy with uncontrollable inflation on the one hand and severe recession on the other has no answer in the bills. And for good reason.

The last companion

The Federal Reserve has several key roles in the economy. The first is the determination of interbank interest rates. In this way, it indirectly affects the price of money in the entire economy. Since 2008, the Fed also began to purchase US government bonds and thus directly affect the quantity and price of money in the economy. In its second role, the Fed is the “lender of last resort” to the banking system.

Until the middle of the 17th century, organizations that engaged in providing credit mainly lent their own money, i.e. the owner’s equity. But since the 18th century, and even more so since the beginning of the fiat era, the bank’s equity constitutes an extremely small part of its credit portfolio. All the rest are funds belonging to depositors in these institutions. Since the bank’s obligations to depositors are mostly short-term, i.e. to be paid according to their demand, but the loan portfolio, the bank’s assets, is usually longer-term, a slight panic in which the depositors “run on the bank” and demand their money immediately, is enough for the bank to collapse, This is regardless of the nature of his assets.

Such a panic spread on Wall Street in 1907 and almost resulted in a total systemic collapse within two weeks. It was this event that led in 1913 to the establishment of the Federal Reserve as a lender of last resort, i.e. a body with almost infinite means that would prevent a panic from breaking out in the first place.

The effectiveness, as well as the need, was demonstrated by the Fed in the banking crisis in 2022. While its vigorous intervention prevented a relatively local crisis from becoming a huge conflagration. The structure, human nature, and history leave no room for doubt. A financial system built on fractional reserve banking but without a “lender of last resort” will always and surely experience repeated crises and huge collapses. They will be accompanied by massive write-offs of depositors’ money.

The danger of canceling the Fed

“Abolish the Federal Reserve” is therefore a light Twitter slogan, and perhaps sounds good in election speeches, which have become more of a stand-up show than a platform for discussing ideas anyway. But in practice without a practical and clear alternative system, it is a real life threat to the entire huge, complicated, complex and delicate financial system, as it was built and developed to be in the past half century.

The Fed is not without serious mistakes. The first of which is his interest rate policy since 2001. This has caused structural instability, repeated financial bubbles, a huge debt bubble, a completely broken real estate market, consuming inflation, and a dangerous concentration of wealth. But truth be told: no less than the Fed in general, and Ben Bernanke and Alan Greenspan in particular wanted to flood the economy with cheap money – the politicians wanted, asked, pressured, and tempted him to do so. Now that the Fed is trapped in the trap it created for itself and for us, the politicians are once again coming up with “miracle solutions” that are completely disconnected from reality.

The swelling government deficit and the federal government’s debt that has passed the $34 trillion line, cited as the main reason for the bills to abolish the Fed, are indeed problematic. But, at the same time, the very same political currents are the ones promising to cut taxes, cuts that according to the estimate of the Congressional Budget Office will increase the deficit and the debt by an additional 4.6 trillion in the coming decade. What further complicates the matter is the simple fact that everyone conveniently ignores: the main reason for the deficit is not the government’s current expenses but its statutory expenses – which no one dares to talk about and which only Congress, not the administration, can change.

In numbers, civilian government spending in the 2024 budget is barely 13.5% of the budget. Another 12.7% is the defense budget. All the other 74% of the budget are expenses stipulated by law such as for Medicare and National Insurance, as well as about 900 billion dollars in interest expenses. These expenses are not under the control of the government or the Fed, and they will only increase as the population ages.

Simply put, the deficit and debt will not stop in the coming decades without increasing taxation in general, and those who fund the National Insurance and Medicare in particular. This is in addition to a reform that will cut these payments. But of course there is no politician who wants to be elected who will propose such reforms. Pointing the finger of blame at the Federal Reserve and its much easier policy.

Abolishing the Federal Reserve or dramatically cutting its powers, primarily the setting of interest rates, and transferring them to politicians will not solve the problems of inflation, the budget or the debt. On the contrary, it will only exacerbate them. America’s real problem, which no one dares to tell the crowd, is that while capitalistic slogans are in their throats, they have built a world built on the fantasy of a debt that is not repayable but only rollable.

It is this debt that has made it possible for America in general, and the top 10% in particular, to live at a standard of living that they cannot afford, to disperse social guarantees without lasting sustainability, and to maintain a deficit taxation system that greatly benefits the very richest, who are of course also the biggest donors to politicians.

Scattering empty promises about cutting taxes, abolishing the Fed and constantly lowering interest rates may buy the politicians another term or two, but it will also make America’s encounter with the approaching economic doomsday, which nothing short of a technological miracle will be able to prevent.