Ep. 161 The Huge Problem the Fed Caused When It, Ahem, Solved the Last Problem

20 October 2018     |     Tom Woods     |     12

During and after the financial crisis the Fed increased the monetary base to an unprecedented extent. Everyone hailed it for its wisdom. but that alleged solution is now a major problem hanging over the economy. What if anything can the Fed do now?

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Book Mentioned

How Privatized Banking Really Works – Integrating Austrian Economics with the Infinite Banking Concept, by Bob Murphy and Carlos Lara

Bob’s Latest Book

Contra Krugman: Smashing the Errors of America’s Most Famous Keynesian

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  • https://2vnews.com 2VNews

    Next financial crisis (coming soon) is going to be a good chance to end the Fed. They are pretty much out of ammo and hopefully people will them for what they are: gamblers with your money, lives, savings, investments, loans and expenses.

  • Craig

    Most people (eg. Ron Paul, etc.) completely misunderstand the nature of “legal tender” laws in the US. Altho such laws exist in Napoleonic code countries, in most Common Law countries (an exception is Australia) there is no (and can’t be any) law “forcing” people to use any particular money in commerce. That is, there is NO law that requires people to use FRNs and specifies a punishment if they don’t. You can freely use any money you want right now without any legal change needed.

    According to the Common Law “Legal Tender” is simply a traditionally defined technical legal term: the medium whose tender extinguishes a debt. The government can not change that meaning. All the government can do is to specify what is that medium. But if there is no debt (as in most retail commerce) then legal tender is a moot issue.

    In the US (Canada, England, etc.), Legal Tender laws do not mandate any behavior. They just specify that if you owe a debt then the tender of payment in a privileged medium (FRNs) constitutes payment for legal purposes. That is, once FRNs are tendered for payment of a debt it can no longer be collected in the courts. The effect is that if you were to refuse such a tendered payment (which you a perfectly free to do) you lose the legal ability to collect the debt.

    The US government CANNOT (legally) force people to use FRNs in commerce. The way the government has suppressed the use of alternate media of exchange is NOT by legal tender laws but by (bizarrely twisted!) use of the counterfeiting laws (eg. Liberty Dollar) and the money transmitter licensing laws (eg. e-gold).

    • martinbrock

      A legal tender law involves debts the state orders you to pay, not the currency you use in commerce. You can use Bitcoin or another medium of exchange in commerce, or you can barter, but you still owe sales, income, payroll and other taxes. The U.S. government can and routinely does force people to FRNs to pay these taxes, and it also forces people to pay other debts in FRNs when non-payment becomes an issue in court.

      Taxes are the principal pressure compelling subjects of the United State to use FRNs. If you’re paying half of every marginal dollar in taxes, you either accept FRNs in trade, or you exchange half the currency you accept for FRNs to pay the taxes plus the costs of the exchange. Either way, you generate demand for FRNs, and with network effects, this pressure practically guarantees that FRNs are the primary medium of exchange for U.S. subjects.

      • Craig

        Quite right.

        But the point was that libertarians such as Ron Paul are spreading ignorant nonsense when they claim that US legal tender laws make the use of other currencies illegal.

        As you point out, the legal tender status of the FRN tends to promote its use indirectly in various ways. But it does not compel it or even make the use of private alternatives impractical.

        For example, legal tender did not prevent e-gold from going into massive circulation. What killed e-gold was something else altogether: outrageous application of the money transfer licensing laws. Legal tender had nothing to do with it and can’t be used to suppress the use of other alternative currencies either.

        • martinbrock

          I’ve never heard Ron Paul say that legal tender laws make other currencies illegal, but the need to pay so much of my income in taxes, as well as the need to treat other exchange media as an asset subject to capital gains taxes and the like, does make using another currency, as my primary currency, impractical. I don’t know about the money transfer licensing laws.

  • NoMoreFed

    I really enjoyed this discussion. What are the consequences if, as Bob said, the Fed becomes insolvent? Is it just inflationary? When the Fed bought all of those mortgage-backed securities, you have to imagine that many of them (in the midst of the housing bust) were non-performing. The Fed bailed out the banks by paying the original value of those securities. Assuming some of those mortgage securities went into default, how can the Fed sell these off its balance sheet?

    • martinbrock

      Yes. In a free banking system with a silver standard, the value of a bank’s assets (like its liens on mortgaged houses) are measured relative to the value of silver. The bank’s notes promise so much silver, because it assumes its mortgaged houses are worth so much silver when it writes the mortgages. If the houses turn out to be worth less silver (and it cannot collect the silver from debtors anyway), the bank cannot keep the promises on its notes, so it’s insolvent.

      The Fed doesn’t have this problem. If the notes it issues promise more dollars than the market value of the bonds it exchanged for the notes, people holding the notes just have less valuable notes.

      People holding notes in the free banking scenario, when a bank is insolvent, also have less valuable notes (worth less than the silver promised), but these people can drive the bank into bankruptcy and demand the value of the bank’s liquidated assets. No one can drive the Fed into bankruptcy.

    • Danan

      The Fed technically can’t get insolvent. That’s not really possible when you can create money into existence.

  • Bob_Robert

    I wonder why Bob didn’t tell you you sounded like you were talking through a tin can and string.

  • ProfessorBernardoDeLaPaz

    Bob, Bob, Tom’s feelings!
    “A big ball of nothing!” was a cry for help. He was reaching out!
    And from you? No response.
    Not so much as a “Not so big…”

  • martinbrock

    The Fed absorbs bank reserves deposited at the Fed by selling the bonds on its balance sheet back to the banks it bought them from at prices attractive enough to persuade the banks to accept the interest income from the bonds, compared with the interest the Fed pays on reserves, given the bonds’ default risk. Reserves deposited at the Fed are around $2 trillion, up from around $0 in 2010.


    The Fed holds Treasuries and mortgage backed securities (MBS). The value of its MBS is slightly less than the value of reserves.


    If banks simply swap reserves for the MBS, the inflationary pressure is zero. The banks don’t “lend out” these reserves. The reserves only signify loans that banks have already made but for which the Fed is bearing the default risk.

    • Intersnooze

      Interesting points, thanks.