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The Creature From Jekyll Island Book Review

“The truth will set you free, but first it will piss you off”

- Gloria Steinem

Introduction on the creation of the Federal Reserve

The Federal Reserve System is the central banking system of the United States, created on December 23, 1913, with the enactment of the Federal Reserve Act. The three key objectives for the Federal Reserve re: maximizing employment, stabilizing prices, and moderating long term interest rates. Further duties expanded over the years also include supervising and regulating banks, maintaining the stability of the financial system, providing financial services to depository institutions, and provide numerous economic publications. (Wikipedia)

The meeting that led to the creation of the Federal Reserve was conceived under ultimate secrecy, on Jekyll Island, Georgia, in order to establish a banking cartel to protect its members and somehow convince the general public that it was in its best interest to support its creation as an agency of the United States government. Based on chronicles provided, it was known that those who participated to the 1913 meeting included: Nelson W. Aldrich, Chairman of the National Monetary Commission and business associate of J.P. Morgan. Abraham Piatt Andrew, Assisstant Secretary of the United States Treasury, Frank A. Vanderlip, president of the National City Bank of New York, Paul M. Warburg, representative of the Rothschild banking dynasty in England and France, Head of the Warburg banking consortium in Germany and Netherlands, and many more.

Motivations of a cartel

A cartel is a group of independent market participants who collude with each other to improve their profits and dominate the market, often an alliance of rivals, and is considered an anti-competitive behavior. It is hard to believe how the Federal Reserve can even be classified as a cartel, but its original founders were clear on their intentions. Based on Nelson W. Aldrich’s recount of the meeting written in his own book, The Federal Reserve System, ITs Origin and Growth:

Together, these members represented about 1/4 of the total wealth of the world at the time. They were mainly driven to cooperate with each other in order to battle their common enemy - competition. Since the 1900s the number of non-national banks of small to medium sizes have continued to grow and prosper within the geographic area, creating a steady trend of diversification that would spread revenues amongst its players. By 1910, around 71% non-national banks held 57% of the deposits, and were by law also allowed to issue their own currency in the form of bank notes. Banks could create loans in excess of actual deposits, but were still limited to the supply of gold that they held. Funding for American corporations were largely growing on their own through the provision of their own capital, allowing them to become increasingly independent of banks for funding. At the same time, the federal government was also regularly increasing their stockpile of gold and reducing the national debt, further pushing against the power that banks were known to hold. This would have been a major cause of concern for the large players of the market since their market share would be steadily decreasing, their sources on income were thinning, and their importance were reducing. These problems were compounded by the fact that banks were allowed to loan out even more than they received, by a factor of 10-1, while the actual cash held in the banks were 3%. This means that the more debt being repaid, the less ‘assets’ they had available to make loans on, and the lower the amount collected from interest as profit. Thus the practice of ‘loaning up’, i.e. pushing down their reserve ratios as much as possible. The representatives needed a way to control and reverse the trend of diversification from the growing number of non-national banks, and find a way to expand their limits to issuing capital.

The solution, was to make the money supply disconnected from gold and be made plentiful - more elastic. If all banks could be forced to issue loans at the same reserve ratio, no matter the credit history of the bank nor the risk of the loan itself, then there would be no drainage between banks. The entire banking industry might have collapsed under such a system, but not individual banks - all banks would walk an equally small distance from the edge. The goal of the group assembled on Jekyll Island was thus:

  • to pool the reserves of the nation’s banks into one large reserve so that all would follow the same reserve ratio

  • had this led to the eventual collapse of the whole banking system, how to shift losses from owners of the banks to the taxpayers

  • convince Congress that the scheme was a measure to protect the public

Convincing the public to become advocators of inflation

The first decision made towards public acceptance of this form of organisation, was to name the cartel a possibly neutral name that would elude the scrutiny of the public, such as a central bank. It was “not a bank, but a cooperative union of all the banks of the country for definite purposes” (Aldrich) and it will “make all incorporated banks together joint owners of a central dominating power” (A. Barton Hepburn). Aldrich also made it clear by his comment: “Before the passage of this Act, the New York bankers could only dominate the reserves of New York. Now we are able to dominate the bank reserves of the entire country”.

Warburg was previously known to hold a very specific point of view, where he complained that the American monetary system was crippled by its dependency on gold and government bonds, both of which were in limited supply. He spent many years trying to convince the public and government to adopt his policies and wrote numerous publications on how such a system would operate. It was his idea to phrase the organisation in such a way that would always highlight how it would benefit the public, economy and business environments through lower interest rates, additional funding for projects, and how it would prevent panics in the economy.

Interestingly enough, the most widely known and accepted reason for the establishment of this banking cartel is from the panic of 1907, as written in textbooks: “with its alarming epidemic of bank failures: the country was fed up once and for all with the anarchy of unstable private banking.” But since its inception, countless examples of banking failures were recorded in history, including the crashes of 1921, the Great Depression in 1929-1939, the Great Recession 1953-69, and the Black Monday in 1987. It is in these episodes that one has to question the ability for an organization as such, to stabilize the economy, with the presence of experts and officials having revised the charter countless times and for them to learn from history, to have to come to a contradictory conclusion that those were never the true objectives. The goal of the Federal Reserve is not to kill the goose that lays all its eggs, but if a conflict of interest ever arises between the public and the needs of the cartel, the public will be sacrificed. What does this imply? That in the event of a systematic failure of the banks, the taxpayers are required to pick up the cost of bailing gout the banks in the form of invisible taxation - inflation.

Fractional reserve banking allows the creation of check book money out of nothing, the banks could then derive profit from this money not by spending it, but by lending it to others and collecting interest. This is shown on the bank’s books as Assets. When a borrower cannot repay their loans, the bank must write off their loan as a loss. However, since the money was initially created out of nothing, little of what is tangible is lost, leaving only the previously recorded liabilities on the books. The only way to re-balance the books is to once again draw on the capital invested by the bank’s stockholders or to deduct it from the bank’s profits. When this happens, the bank becomes insolvent, and is kicked out of the game. This was, and had been the primary mechanism that limited the amount of which banks could loan out, and to maintain their loan-to-balance ratio in check. Players of the game were cautious, and bank failures were small and infrequent.

With the existence of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Federal Deposit Loan Corporation, the clever maneuver is presented to the public in the form of loan guarantees to the largest corporations even in case of default. The banks become released from the system that had protected it from failure in the first place, and are encouraged to issue as many questionable loans as possible. A single loan to a third world country enables banks to net a sizeable profit, often with the thought of the lower the expectation of repayment the better, since the federal government will “protect the public” through various mechanisms to ensure that the banks still receive interest. These loans are often allowed to be rolled-over with the establishment of even newer and bigger loans, effectively borrowing twice from the banks to pay for the interest from both the first loan and the second loan, at ever increasing rates. Instead of writing off the loan, the bank would do anything to keep the borrower, just enough to continue paying interest, and thus generate a greater profit to the bank than a more conservative loan. These types of rescheduled loans means a lower interest rates, but with a longer repayment period, achieving the aim of the game: the loan remains an asset, and interest payment continues. This system becomes a primary mechanism which aligns bank interests to make large, unsound loans, towards the objective of perpetual interest.

According to Banking Safety Digest, problem loans are in fact a big part of business: “At last year’s profitability levels, the banking industry could, in theory, 'buy out’ the entirety of their own Latin American loans within two years.” Once Congress is convinced to guarantee the loan in full, the government becomes a co-signer to the loan, and the inevitable losses are lifted from the ledger of the bank and placed onto the backs of the American taxpayers.

Why the system is flawed

The Federal Deposit Insurance Corporation FDIC is one of two agencies that provide deposit insurance to depositors in U.S depository institutions, the other being the National Credit Union Administration, which regulates and insures credit unions. It was enacted during the Great Depression, initially with up to $2,500 insured for each ownership category, which was increased over the years, to account for inflation, to up to $250,000 per category. Although it seems to be just the right type of protection depositors need, the amount held by the FDIC will never be enough to cover its potential liability for the entire banking system. The absolute amount insured is increasing, however it omits a critical component from the story - its relative size compared to the absolute amount of all bank deposits, which is decreasing at a faster rate. This means that the FDIC holds about $0.70 for every $100 (1994). The financial exposure of the FDIC is about 99.3% larger than the safety net which it is supposed to catch. At the time, a hypothetical failure of just two large banks could have completely wiped out the entire fund!

The FDIC is legislated to provide capital in order to avoid the moral hazard problem, which is when the policy holder has little incentive to avoid or prevent that which is being insured against. Depositors are told that their money is protected, as each bank is required to pay a common, specified percentage of its total deposits no matter how risky the loans or the previous records of the banks are, to guarantee at least a partial recovery of funds in the event of an insolvency. However, we can clearly see that the moral hazard problem is built into the system, since banks could make risky loans whilst still only putting the same percentage towards the insurance. They are encouraged to do so, to keep up with their competitors, and to get their ‘fair share’ of the fund’s protection. Even if a rescue of this kind was successful in preventing insolvency, funds that FDIC have transferred to distressed banks would flood into its accounts, diluting all money in the account, and finally causes prices to rise as a whole.

During the failure of Continental Illinois, the nation’s seventh largest bank in the early 1980s, a 100% guaranteed bail-out package was issued, where the FDIC took $4.5 billion in bad loans and paid Continental $3.5 billion for them by nationalizing the bank. The unlimited liquidity support offered by the end of the whole spectacle in 1984, had surmounted to a sum of $8 billion, while 43 other smaller banks failed without protection.

FDIC director Irvine Sprague admitted, "Small banks pay proportionately far more for their insurance and have far less chance of a Continental-style bailout.” Some careful commentators recounted the absurd fact that: although Continental Illinois had failed, it was “obviously the safest bank in the country to have your money in” during the time. A failed bank was even safer than one that had not failed! This creates a lasting impact in the industry as small players become wiped out of competition, and the pattern for consolidation and nationalization of failing banks has been set as the precedent for future cases as a way to transform the public into the ultimate price payers. The aim of the game, from the very beginning, was Bailout.

Further enquiries into the book

The creature from Jekyll Island was published in 1994, a feat accomplished through continuous efforts of extensive research over the span of decades. It details the creation of the Federal Reserve System, what the system achieves, and why it should be abolished. To allow the average reader to understand the mechanisms of the economics in the book, several sections have been devoted to the description of the history of monetary systems and policy in the United States, what money is and where does the value of money come from, as well as the role politics play in the dynamics of ensuring the scheme never fails.

It is a provocative yet fundamental piece of literature in the field of economics, and contains statements that go against conventional views of the bank and the Federal Reserve. No matter what level of economic knowledge one has, it is helpful to read this book critically, and to discern for yourself what is the truth that there is to believe in. It is widely known that the United States Government is among the largest advertiser in the country, which means a lot of information that comes from the government and bureaus can be part of an extensive ‘public education’ campaign. To the surprise of many, the Federal Reserve was not the country’s first attempt to a central banking system. In fact, it had been attempted 3 times previously. So why had they failed, and what does that imply about the government’s efforts? Read the book to find out!

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