E Financial Bubbles (Part III)

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<<Read Part II: Financial Bubbles

One of the most important financial, but least understood, events of the 20th century was the creation of the Federal Reserve System.  In the late 19th century and the early 20th century a series of financial panics promulgated a convention of thought that a banker’s bank was required to avert such disasters in the future. On Jekyll Island, Georgia in 1913 the idea of a central bank was born.  [There is something ironically symbolic about the creation of this institution on an island by the name “Jekyll.”]

The Federal Reserve System (FED), created in 1913, functions as a central bank. It is a private organization with twelve regional Federal Reserve Banks located in major cities. The term “private” is a bit of a misnomer since the President appoints the Board of Governors of the FED and ostensibly, there is some degree of Congressional oversight. There are also thousands of private banks that are also members of the FED (meaning they own stock in their associated FED bank). The FED is not part of the government, however. 

The FED is supposed to mitigate the circumstances that led to the financial panics mentioned earlier. Unfortunately, 16 years after FED creation, a financial panic ensued that evolved into the Great Depression. The panic led President Roosevelt and Congress to take extraordinary measures in 1933 such as outlawing domestic gold ownership and domestic contracts denoted in gold.  These directives meant that existing paper notes were not exchangeable for gold. The inability to exchange paper notes for gold provided the catalyst for future inflation. Why? Because now Federal Reserve Notes (FRN) could be created without regard to the supply of wealth. Furthermore, FRN became legal tender, which meant they had to be accepted by the public for debts both public and private. At this point, the FRN no longer represented wealth since they were not exchangeable for wealth.  Though some notes were exchangeable for silver, this ceased in 1964. 

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