Janet Yellen and the Fed Work Their Slow, Methodical Magic

Since the creation of the United States, the third most important law we have ever passed, after the Constitution itself and the Northwest Ordinance, is the creation of the Federal Reserve System, affectionately known as the “Fed.” 

Our Fed is the central bank of the United States.  It was created in 1913 by President Woodrow Wilson.  It is divided into twelve districts (Boston, New York, Philadelphia, Richmond, Atlanta, Minneapolis, St. Louis, Cleveland, Dallas, Kansas City, San Francisco, and Chicago), each with its own bank.  The Fed sets the nation’s monetary policy, supervises and regulates banks, and helps to maintain the stability of our financial system.   

            You need only look at the difference between the financial stability of our country, and those without an independent central bank to see the value of the Fed. The steady, modest and intelligent work of the Fed is conducted by the 7 man governing board.  The Fed’s Chair (arguably one of the most powerful humans on the planet) is appointed to a 4 year term.  He or she (now Janet Yellen) is appointed by the President and approved by the Senate.  The members of the seven man board each serve a 14 year term.  These long and staggered terms make them impervious to political manipulation or expediency.  They are spectacularly independent of political perversion and work for only one thing, a strong American economy.

            Now the Fed is raising its interest rates for the first time since 2008, to a rock bottom 0.25-0.5%.  Please note that both of these are less than 1%.  This does not necessarily raise your interest rates.  It raises the rate the Fed charges member banks on money the banks borrow from the Fed.  The banks may or may not change your rate.

            Banks see the raising of interest as a double edged sword.  Remember, interest rates are the cost of “buying” money.  When you borrow money you pay for that money with the interest rate.  But—and this is frequently forgotten—interest is also what you are “paid” when you put money in a saving account.   

            Higher interest rates work for the saver, and regulate the borrower.  Lately, the money being paid on savings have been pathetically low.  This has made spending rather than saving more attractive which has added a modest, plodding growth to a recessionary economy. 

            Ordinarily the Fed is much more interested in preventing inflation than curing recession.  Why?  For the same reason doctors are more interested in making you suffer out an ordinary cold than curing pneumonia.  One is much more dangerous than the other.  A recession can be cured by putting people to work and growing the economy—all good things.  Rampant inflation can only be cured by constricting the economy, putting the hurt on people by decreasing both wages and production.  One need only look at the inflation mad economies like Greece to see what that looks like. 

            The Fed can purchase U. S. Treasury securities, but only from open market operations.  It is prohibited by law from purchasing these directly from the government.  The Fed buys its securities from you, me, banks, corporations, or foreign governments.  In doing so it creates a reserve of cash in the banks, which banks can use (or not!) for the purpose of lending.  It is when banks lend money that revenue is generated. 

            It is in loaning you money that a bank “creates” wealth.  And, yes, when you pay off your loan that same wealth is annihilated.

            The Fed is part of the genius and success of this country.

            Learn! And keep the faith.