armstrongeconomics.com / by Martin Armstrong / January 10, 2014
The Federal Reserve began as a simple private sector clearing house/insurance fund, which is why the banks were the owners. Yes, the Fed was given the power to create money that was to be ELASTIC. They would create money during a bank panic to satisfy demand and then shrink it when depositors return to the banks. This was actually a good idea insofar as it could create cash when people were in a panic and that prevented the banks from closing and having to dump assets at pennies on the dollar such as mortgages, This was a fantastic idea to stabilize the economy in a panic. If people knew they would always get their cash, then there was no reason to panic.
The flaw in banking that makes it unstable and prone to panics is simple. For you see, the banking system was based upon borrowing from the public on demand paying short-term rates and lending long-term such as in mortgages and business loans. The entire model ASSUMED the yield-curve of long-term rates higher than short-term was standard. But in a panic, the yield-curve flips and becomes inverted were short-term rates rise above long-term.
The design of the Fed was correct, brilliant, and not some wild conspiracy. What happens is people, not knowing the history, always judge things but the current terms. In 1913, the Fed “stimulated” by purchasing corporate paper NOT GOVERNMENT. The entire thing was a private sector solution that worked. Now enters government. World War I starts and they need to issue debt so they INSTRUCTED the Fed to buy government bonds not corporate paper. Fine if this was temporary for the war. But the way government screws things up consistently, they never put anything back. The killed the real stimulus quality of the Fed that was its ability to restrain unemployment by supporting companies in time of need.
Add to this the idea that INFLATION = the rise in the QUANTITY of money, and suddenly the Fed is now seen as the inflation fighter and its job is now to sterilize the reckless spending of Congress. It was like Congress can go get anyone pregnant without any responsibility for the consequences.