debunking the federal reserve myths

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Home Issues » Magazine » Books & Reports » Multimedia » About » Newsroom » Donate Connect » Site Guide » By: Edward Flaherty, Ph.D. Department of Economics College of Charleston, S.C. Facts: Yes, the Federal Reserve banks are privately owned, but they are controlled by the publically-appointed Board of Governors. The Federal Reserve banks merely execute the monetary policy choices made by the Board. In addition, nearly all the interest the Federal Reserve collects on government bonds is rebated to the Treasury each year, so the government does not pay any net interest to the Fed. Facts: No foreigners own any part of the Fed. Each Federal Reserve bank is owned exclusively by the participating commercial banks and S&Ls operating within the Federal Reserve bank's district. Individuals and non-bank firms, be they foreign or domestic, are not permitted by law to own any shares of a Federal Reserve bank. Moreover, monetary policy is controlled by the publically-appointed Board of Governors, not by the Federal Reserve banks. Fact: Independent accounting firms conduct full financial audits of the Federal Reserve banks and the Board of Governors every year. The Fed is also subject to certain types of audits from the Government Accounting Office. Facts: The Federal Reserve rebates its net earnings to the Treasury every year. Consequently, the interest the Treasury pays to the Fed is returned, so the money borrowed from the Fed has no net interest obligation for the Treasury. The government could print its own currency independent of the Fed, but there would be no effective safeguards against abuse of this power for political gain. Facts: The Federal Reserve banks have only a small share of the total national debt (about 7%). Therefore, only a small share of the interest on the debt goes to the Fed. Regardless, the Fed rebates that interest to the Treasury every year, so the debt held by the Fed carries no net interest obligation for the government. In addition, it is Congress, not the Federal Reserve, who is responsible for the federal budget and the national debt. Facts: Kennedy wrote E.O. 11,110 to phase out silver certificate currency, not to issue more of it. Records show Kennedy and the Federal Reserve were almost always in agreement on policy matters. He even signed legislation to give the Fed more authority to issue currency. Facts: McFadden was incorrect regarding the Fed costing the government money. However, Online Articles: Most Recent Articl More Articles Features from past The Public Eye Ma PRA Reports - Onl i Former Front Page Announcements Spotlight On Civil Liberties & Repress Economic Justice LGBTQ Equity Racial Justice Reproductive Justice Christian Right & Theocr Understanding the Right More Article Topics Explore Browse Topics | Site Gui d Bookstore | Magazine | Pu Activists Resources Political Research Associ About Us PRA News Watch short videos Donate! PublicEye.org - The Website of Political Research Associates http://www.publiceye.org/conspire/flaherty/Federal_Reserve.html 1 of 2 1/3/2011 10:15 AM

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This research report debunks the common myths about the Federal Reserve

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Page 1: Debunking the Federal Reserve Myths

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By: Edward Flaherty, Ph.D. Department of Economics College of Charleston, S.C.

Facts: Yes, the Federal Reserve banks are privately owned, but they are controlled by thepublically-appointed Board of Governors. The Federal Reserve banks merely execute themonetary policy choices made by the Board. In addition, nearly all the interest the FederalReserve collects on government bonds is rebated to the Treasury each year, so thegovernment does not pay any net interest to the Fed.

Facts: No foreigners own any part of the Fed. Each Federal Reserve bank is ownedexclusively by the participating commercial banks and S&Ls operating within the FederalReserve bank's district. Individuals and non-bank firms, be they foreign or domestic, are notpermitted by law to own any shares of a Federal Reserve bank. Moreover, monetary policy iscontrolled by the publically-appointed Board of Governors, not by the Federal Reservebanks.

Fact: Independent accounting firms conduct full financial audits of the Federal Reservebanks and the Board of Governors every year. The Fed is also subject to certain types ofaudits from the Government Accounting Office.

Facts: The Federal Reserve rebates its net earnings to the Treasury every year.Consequently, the interest the Treasury pays to the Fed is returned, so the money borrowedfrom the Fed has no net interest obligation for the Treasury. The government could print itsown currency independent of the Fed, but there would be no effective safeguards againstabuse of this power for political gain.

Facts: The Federal Reserve banks have only a small share of the total national debt (about7%). Therefore, only a small share of the interest on the debt goes to the Fed. Regardless, theFed rebates that interest to the Treasury every year, so the debt held by the Fed carries nonet interest obligation for the government. In addition, it is Congress, not the FederalReserve, who is responsible for the federal budget and the national debt.

Facts: Kennedy wrote E.O. 11,110 to phase out silver certificate currency, not to issue moreof it. Records show Kennedy and the Federal Reserve were almost always in agreement onpolicy matters. He even signed legislation to give the Fed more authority to issue currency.

Facts: McFadden was incorrect regarding the Fed costing the government money. However,

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Page 2: Debunking the Federal Reserve Myths

later economic analysis agrees with him that Federal Reserve policy blunders had asubstantial role in causing the Depression. However, his implication that this was donedeliberately has no basis in fact. Moreover, for a dozen years prior to his rant, McFadden hadbeen the chairman of the House subcommittee that oversaw the Federal Reserve. Why didn'the do anything to reform or abolish the Fed while he had the chance?

Facts: The banking system is indeed able to create money with a mere computer keystroke.However, a bank's ability to create money is tied directly to the amount of reservescustomers have deposited there. A bank must pay a competitive interest rate on thosedeposits to keep them from leaving to other banks. This interest expense alone is asubstantial portion of a bank's operating costs and is de facto proof a bank cannot costlesslycreate money.

Fact: The term 'lawful money' does not refer to gold or silver coin, but to types of moneywhich the government would permit banks to use when tabulating their reserves. These typesof money included, but were not limited to, gold and silver coin.

BY: Edward Flaherty, Ph.D. Department of Economics College of Charleston, S.C.

Myth #1: The Federal Reserve Act of 1913 was crafted by Wall Street bankers and afew senators in a secret meeting. Myth #2: The Federal Reserve Act never actually passed Congress. The Senate votedon the bill without a quorum, so the Act is null and void. Myth# 3: The Federal Reserve Act and paper money are unconstitutional. Myth# 4: The Federal Reserve is a privately owned bank. Myth #5: The Federal Reserve is owned and controlled by foreigners. Myth #6: The Federal Reserve has never been audited. Myth #7: The Federal Reserve charges interest on the currency we use. Myth #8: If it were not for the Federal Reserve charging the government interest, thebudget would be balanced and we would have no national debt. Myth #9: President Kennedy was assassinated because he tried to usurp the FederalReserve's power. Executive Order 11,110 proves it. Myth #10. The Legendary Tirade of Louis T. McFadden

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Myth #1: The Federal Reserve Act of 1913 was crafted by Wall Streetbankers and a few senators in a secret meeting.

On the Georgian resort hideaway of Jekyll Island (which has some excellent golfcourses, by the way), there once met a coalition of Wall Street bankers and U.S.senators. This secret 1910 meeting had a sinister purpose, the conspiracytheorists say. The bankers wanted to establish a new central bank under thedirect control of New York's financial elite. Such a plan would give the WallStreet bankers near total control of the financial system and allow them tomanipulate it for their personal gain.

G. Edward Griffin lays out this conspiratorial version of history in his book TheCreature from Jekyll Island. His amateurish take on history is highly suspect,however. Gerry Rough, in a series of well- researched essays on U.S. bankinghistory, reveals many historical inaccuracies, inconsistencies, and evencontradictions in Griffin's book and others of its genre. Instead of reproducingRough's work here, I offer the reader a substantially more accurate view of theevents leading up to the creation of the Federal Reserve System in 1913. To geta proper historical perspective, the story of begins just prior to the Civil War...

The National Banking Acts of 1863 & 1864

Prior to the Civil war there were thousands of banks in operation throughout theUnion, all of them chartered, that is, licensed by the state governments. Bankingregulations were virtually nonexistent. The federal government had nomeaningful controls on banking practices, and state regulations were spotty andpoorly enforced at best. Economic historians call the era leading up to the CivilWar as the 'state banking era' or the 'free banking era.'

The problems with state banking were numerous, but three were conspicuous. First, the nation had no unified currency. State banks issued their own banknotes as currency, a system which at worst invited severe bouts of counterfeitingand at best introduced additional uncertainty in the task of determining therelative value of each bank note. Second, with no mitigating influence on the

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issuance of bank notes, the money supply and the price level were highlyunstable, introducing and perhaps causing additional volatility in the businesscycle. This was due in part to the fact that bank note issuance was frequentlytied to the market value of the bank's bond portfolio which they were required tohave by law. Third, frequent bank runs resulted in substantial depositor lossesand severe crises of confidence in the payments system.5

The National Banking Acts of 1863 and 1864 were attempts to assert somedegree of federal control over the banking system without the formation ofanother central bank. The Act had three primary purposes: (1) create a systemof national banks, (2) to create a uniform national currency, and (3) to create anactive secondary market for Treasury securities to help finance the Civil War(for the Union’s side).5

The first provision of the Acts was to allow for the incorporation of nationalbanks. These banks were essentially the same as state banks, except nationalbanks received their charter from the federal government and not a stategovernment. This arrangement gave the federal government regulatoryjurisdiction over the national banks it created, whereas it asserted no controlover state-chartered banks. National banks had higher capital requirements andhigher reserve requirements than their state bank counterparts. To improveliquidity and safety they were restricted from making real estate loans and couldnot lend to any single person an amount exceeding ten percent of the bank'scapital. The National Banking Acts also created under the Treasury Departmentthe office of Comptroller of the Currency. The duties of the office were toinspect the books of the national banks to insure compliance with the aboveregulations, to hold Treasury securities deposited there by national banks, and,via the Bureau of Engraving, to design and print all national banknotes.5

The second goal of the National Banking Acts was to create a uniform nationalcurrency. Rather than have several hundred, or several thousand, forms ofcurrency circulating in the states, conducting transactions could be greatlysimplified if there were a uniform currency. To achieve this all national bankswere required to accept at par the bank notes of other national banks. Thisinsured that national bank notes would not suffer from the same discountingproblem with which state bank notes were afflicted. In addition, all nationalbank notes were printed by the Comptroller of the Currency on behalf of thenational banks to guarantee standardization in appearance and quality. Thisreduced the possibility of counterfeiting, an understandable wartime concern.5

The third goal of the Acts was to help finance the Civil War. The volume ofnotes which a national bank issued was based on the market value of the U.S.Treasury securities the bank held. A national bank was required to keep ondeposit with the Comptroller of the Currency a sizable volume of Treasurysecurities. In exchange the bank received bank notes worth 90 percent, andlater 100 percent, of the market value of the deposited bonds. If the bankwished to extend additional loans to generate more profits, then the bank had toincrease its holdings of Treasury bonds. This provision had its roots in theMichigan Act, and it was designed to create a more active secondary market forTreasury bonds and thus lower the cost of borrowing for the federalgovernment.5

It was the hope of Secretary of the Treasury Chase that national banks wouldreplace state banks, and that this would create the uniform currency he desiredand ease the financing of the Civil War. By 1865 there were 1,500 national

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banks, about 800 of which had converted from state banking charters. Theremainder were new banks. However, this still meant that state bank notes weredominating the currency because most of them were discounted. Accordingly,the public hoarded the national bank notes. To reduced the proliferation of statebanking and the notes it generated, Congress imposed a ten percent tax on alloutstanding state bank notes. There was no corresponding tax of national banknotes. Many state banks decided to convert to national bank charters becausethe tax made state banking unprofitable. By 1870 there were 1,638 nationalbanks and only 325 state banks.5

While the tax eventually eliminated the circulation of state bank notes, it did notentirely kill state banking because state banks began to use checking accounts asa substitute for bank notes. Checking accounts became so popular that by 1890the Comptroller of the Currency estimated that only ten percent of the nation'smoney supply was in the form of currency. Combined with lower capital andreserve requirements, as well as the ease with which states issued bankingcharters, state banks again became the dominant banking form by the late1880’s. Consequently, the improvements to safety that the national bankingsystem offered were mitigated somewhat by the return of state banking.5

There were two major defects remaining in the banking system in the post CivilWar era despite the mild success of the National Banking Acts. The first wasthe inelastic currency problem. The amount of currency which a national bankcould have circulating was based on the market value of the Treasury securitiesit had deposited with the Comptroller of the Currency, not the par value of thebonds. If prices in the Treasury bond market declined substantially, then thenational banks had to reduce the amount of currency they had in circulation. This could be done be refusing new loans or, in a more draconian way, bycalling-in loans already outstanding. In either case, the effect on the moneysupply is a restrictive one. Consequently, the size of the money supply was tiedmore closely to the performance of the bond market rather than needs of theeconomy.5

Another closely related defect was the liquidity problem. Small rural banks oftenkept deposits at larger urban banks. The liquidity needs of the rural banks weredriven by the liquidity demands of its primary customer, the farmers. In theplanting season the was a high demand for currency by farmers so they couldmake their purchases of farming implements, whereas in harvest season therewas an increase in cash deposits as farmers sold their crops. Consequently, therural banks would take deposits from the urban banks in the spring to meetfarmers’ withdrawal demands and deposit the additional liquidity in the autumn. Larger urban banks could anticipate this seasonal demand and prepare for itmost of the time. However, in 1873, 1884, 1893, and 1907 this reserve pyramidprecipitated a financial crisis.5

When national banks experienced a drain on their reserves as rural banks madedeposit withdrawals, new reserves had to be acquired in accordance with thefederal law. A national bank could do this by selling bonds and stocks, byborrowing from a clearinghouse, or by calling-in a few loans. As long as only afew national banks at a time tried to do this, liquidity was easily supplied to theneedy banks. However, an attempt en masse to sell bonds or stocks caused amarket crash, which in turn forced national banks to call in loans to comply withTreasury regulations. Many businesses, farmers, or households who had theseloans were unable to pay on demand and were forced into bankruptcy. Therecessionary vortex became apparent. Frightened by the specter of losing their

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deposits, in each episode the public stormed any bank rumored, true or not, to bein financial straights. Anyone unable to withdraw their deposits before thebank’s till ran dry lost their savings or later received only pennies on the dollar. Private deposit insurance was scant and unreliable. Federal deposit insurancewas non-existent.5

The 1907 Banking Panic

The 1907 crisis, also called the Wall Street Panic, was especially severe. ThePanic caused what was at that time the worst economic depression in thecountry’s history. It appears to have begun with a stock market crash broughtabout by a combination of a modest speculative bubble, the liquidity problem,and reserve pyramiding. Centered on New York City, the scale of the crisisreached a proportion so great that banks across the country nearly suspended allwithdrawals -- a kind of self-imposed bank holiday. Several long-standing NewYork banks fell. The unemployment rate reached 20 percent at the peak of thecrisis. Millions lost their deposits as thousands of banks collapsed. The crisiswas terminated when J.P. Morgan, a man of sometimes suspicious businesstactics and phenomenal wealth, personally made temporary loans to key NewYork banks and other financial institutions to help them weather the storm. Healso made an appeal to the clergy of New York to employ their Sunday sermonsto calm the public’s fears.

Morgan’s emergency injection of liquidity into the banking system undoubtedlyprevented an already bad situation from getting still worse. Although privateclearinghouses were able to supply adequate temporary liquidity for theirmembers, only a small portion of banks were members of such organizations. What would happen if there were no J.P. Morgan around during the nextfinancial crisis? Just how bad could things really get? There began to emergeboth on Wall Street and in Washington a consensus for a kind of institutionalizedJ.P. Morgan, that is, a public institution that could provide emergency liquidityto the banking system to prevent such panics from starting. The final result ofthe Panic of 1907 would be the Federal Reserve Act of 1913.

The Federal Reserve Act of 1913

Following the near catastrophic financial disaster of 1907, the movement forbanking reform picked up steam among Wall Street bankers, Republicans, andeastern Democrats. However, much of the country was still distrustful ofbankers and of banking in general, especially after 1907. After two decades ofminority status, Democrats regained control of Congress in 1910 and were ableto block several Republican attempts at reform, even though they recognized theneed for some kind of currency and banking changes. In 1912 Woodrow Wilsonwon the Democratic party’s nomination for President, and in his populist-friendly acceptance speech he warned against the "money trusts," and advisedthat "a concentration of the control of credit ... may at any time becomeinfinitely dangerous to free enterprise."3

Also in 1910, Senator Nelson Aldrich, Frank Vanderlip of National City (todayknow as Citibank), Henry Davison of Morgan Bank, and Paul Warburg of theKuhn, Loeb Investment House met secretly at Jeckyll Island, a resort island offthe coast of Georgia, to discuss and formulate banking reform, including plansfor a form of central banking. The meeting was held in secret because theparticipants knew that any plan they generated would be rejected automaticallyin the House of Representatives if it were associated with Wall Street. Becauseit was secret and because it involved Wall Street, the Jekyll Island affair has

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always been a favorite source of conspiracy theories. However, the movementtoward significant banking and monetary reform was well-known.3 It is hardlysurprising that given the real possibility of substantial reform, the bankingindustry would want some sort of input into the nature of the reforms. TheAldrich Plan which the secret meeting produced was even defeated in theHouse, so even if the Jekyll Island affair was a genuine conspiracy, it clearlyfailed.

The Aldrich Plan called for a system of fifteen regional central banks, calledNational Reserve Associations, whose actions would be coordinated by anational board of commercial bankers. The Reserve Association would makeemergency loans to member banks, create money to provide an elastic currencythat could be exchanged equally for demand deposits, and would act as a fiscalagent for the federal government. Although it was defeated, the Aldrich Planserved as an outline for the bill that eventually was adopted. 5

The problem with the Aldrich Plan was that the regional banks would becontrolled individually and nationally by bankers, a prospect that did not sit wellwith the populist Democratic party or with Wilson. As the debate began to takeshape in the spring of 1913, Congressman Arsene Pujo provided good evidencethat the nation’s credit markets were under the tight control of a handful ofbanks – the "money trusts" against which Wilson warned.1 Wilson and theDemocrats wanted a reform measure which would decentralize control awayfrom the money trusts.

The legislation that eventually emerged was the Federal Reserve Act, alsoknown at the time as the Currency Bill, or the Owen-Glass Act. The bill calledfor a system of eight to twelve mostly autonomous regional Reserve Banks thatwould be owned by the banks in their region and whose actions would becoordinated by a Federal Reserve Board appointed by the President. TheBoard’s members originally included the Secretary of the Treasury, theComptroller of the Currency, and other officials appointed by the President torepresent public interests. The proposed Federal Reserve System wouldtherefore be privately owned, but publicly controlled. Wilson signed the bill onDecember 23, 1913 and the Federal Reserve System was born.6

Conspiracy theorists have long viewed the Federal Reserve Act as a means ofgiving control of the banking system to the money trusts, when in reality theintent and effect was to wrestle control away from them. History clearlydemonstrates that in the decades prior to the Federal Reserve Act the decisionsof a few large New York banks had, at times, enormous repercussions for banksthroughout the country and the economy in general. Following the return tocentral banking, at least some measure of control was removed from them andplaced with the Federal Reserve.

References:

1. Davidson, James West, Mark A. Lytle, et al, (1998), Nation of Nations, NewYork: McGraw-Hill.

2. Galbraith, John K. (1995), Money: Whence it Came, Where it Went, Boston:Houghton Mifflin.

3. Greider, William (1987), Secrets of the Temple, New York: Simon &Schuster.

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4. Griffin, G. Edward (1995), The Creature from Jekyll Island, Appleton:American Opinion Publishing, Inc.

5. Kidwell, David S. and Richard Peterson (1997), Financial Institutions,Markets, and Money, 6th edition, Fort Worth: Dryden Press.

6. "Wilson Signs the Currency Bill," New York Times, pages 1-2, December 24,1913.

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Myth #2: The Federal Reserve Act never actually passed Congress. TheSenate voted on the bill without a quorum, so the Act is null and void.

The silliest of the Federal Reserve conspiracy theories is that the FederalReserve Act of December 23, 1913 passed illegally. The constitution stipulatesthat both the House and the Senate must have at least half their memberspresent, a quorum, to vote on any bill. According to this myth, the Senate votedon the Federal Reserve Act (known as the Currency Bill at the time) deviouslyin a late night session when most of its members had gone home or had left townfor the holiday. This was done to impose the will of a pro-banker minority onthe objecting majority. Since no quorum was present, the Federal Reserve Act isnot valid.

This idea is better described as folklore than a full-blown conspiracy theorybecause I've never been able to find it in print, only on occasion on Usenet or ine-mail from readers. Gary Kah, author of En Route to Global Occupation, cameclose when he wrote that the bill's supporters waited until its opponents were outof town and it was passed under "suspicious circumstances" (Kah, p. 13-14). Nevertheless, the myth has no basis in fact. The House passed the bill 298-60 onthe evening of Dec. 22, 1913.3 The Senate began debate the following day at10am, and passed it 43-25 at 2:30pm.4

What of the missing Senators? Since there were 48 states in 1913, forty eightvotes plus the tie-breaking vote of vice-President Thomas Marshall would havebeen sufficient to approve the bill even if all absent votes had been cast againstthe bill. However, many of the missing Senators had their positions recorded inthe Congressional Record.1 Of the 27 votes not cast, there were 11 'yeas' (infavor of the bill) and 12 'nays.'1 Even if the absentee Senators had been there,the Currency Bill would have passed easily.

President Wilson signed the Currency Bill into law in an "enthusiastic" publicceremony on Dec. 23, 1913.4

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References:

1. Congressional Record, 63rd Congress, 2nd Session, Dec. 23, 1913, pp.1487-1488.

2. Kah, Gary (1991), En Route to Global Occupation, Layfayette, La.:Huntington Press.

3. "Money bill goes to Wilson today," New York Times, pp. 1-3, Dec. 23, 1913.

4. "Wilson signs currency bill," New York Times, pp. 1-2, Dec. 24, 1913.

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Myth #3: The Federal Reserve Act and paper money are unconstitutional. Gold and silvercoins are the only constitutional forms of money.

Table of Contents:

The Constitutional basis for centralbanking Gold and silver coin

The constitutional basis for paper money Are gold and silver practicalmetals for coins?

Recent federal court rulings on the Fedand paper money

Those who hold that the constitution should be interpreted very strictly believethe Federal Reserve System and paper money are unconstitutional. Sharing theinterpretive philosophy of Thomas Jefferson, they argue that Congress has onlythose powers which the constitution specifically enumerates. If the power is notexplicitly granted, then the federal government simply does not have it. Therefore, the Federal Reserve is unconstitutional because Congress does nothave the specific power to create a central bank. In addition, the federalgovernment's power to create money -- lawful money -- is limited only tominting gold or silver coins; paper currency is forbidden.

The Constitutional Basis for Central Banking

First, the constitution grants the Congress the right to coin money and to regulateits value. It is not clear from the constitution or the Federalist Papers what theauthors meant by the term 'value.' Traditionally, it has meant the weight andmetallic content of the coin. No one challenges this interpretation. On the otherhand, the only relevant meaning of 'value' in the context of money is its value intrade, also known as its purchasing power. This a government cannot regulatemerely by an act of Congress. The government's only tool for regulating this

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latter value is altering the money supply.

Second, Congress has the right to regulate interstate commerce. Banking andother financial services clearly involves interstate commerce as the courts havecome to define it.

Finally, and perhaps most importantly, Congress has the right to make any lawthat is 'necessary and proper' for the execution of its enumerated powers (Art. I,Sec. 8, Cl. 18). A law creating a Bureau of the Mint, for example, is necessaryand proper for the Congress to exercise its right to coin money. A similarargument may justify a central bank. It facilitates the expansion and contractionof the money supply and it serves as means to regulate the banking industry.

Is this a reasonable use of the necessary and proper clause? I do not know, but atest of its meaning came early. The history of central banking in the UnitedStates does not begin with the Federal Reserve. The Bank of the United Statesreceived its charter in 1791 from the U.S. Congress and Washington signed it. Secretary of State Alexander Hamilton designed the Bank's charter by modelingit after the Bank of England, the British central bank. Secretary of State ThomasJefferson believed the Bank was unconstitutional because it was an unauthorizedextension of federal power. Congress, Jefferson argued, possessed onlydelegated powers that were specifically enumerated in the constitution. Theonly possible source of authority to charter the Bank, Jefferson believed, was inthe necessary and proper clause. However, he cautioned that if the clause couldbe interpreted so broadly in this case, then there was no real limit to whatCongress could do.2

Hamilton conceded that the constitution was silent on banking. He asserted,however, that Congress clearly had the power to tax, to borrow money, and toregulate interstate and foreign commerce. Would it be reasonable for Congressto charter a corporation to assist in carrying out these powers? He argued thatthe necessary and proper clause gave Congress implied powers -- the power toenact any law that is necessary to execute its specific powers. A “necessary” lawin this context Hamilton did not take to mean one that was absolutelyindispensable. Instead, he argued that it meant a law that was “needful, requisite,incidental, useful, or conducive to” the primary Congressional power which itsupported. Then Hamilton offered a proposed rule of discretion: “Does theproposed measure abridge a pre-existing right of any State or of any individual?”(Dunne, 19). If not, then it probably is constitutionally proper on these grounds. Hamilton’s arguments carried the day and convinced Washington.

The Supreme Court had its say on the matter in McCulloch v. Maryland (1819). It voted 9-0 to uphold the Second Bank of the United States as constitutional. The Court argued with the doctrine of implied powers, stating that to be‘necessary and proper’ the Bank needed only to be useful in helping thegovernment meet its responsibilities in maintaining the public credit andregulating the money supply. Chief Justice Marshall wrote, “After the mostdeliberate consideration, it is the unanimous and decided opinion of this courtthat the act to incorporate the Bank of the United States is a law made inpursuance of the Constitution, and is part of the supreme law of the land”(Hixson, 117). The Court affirmed this opinion in the 1824 case Osborn v. Bankof the United States (Ibid, 14).

Therefore, the historical legal precedent exists for Congress' power to create acentral bank. It formed the Federal Reserve system in 1913 to perform many ofthe same functions as its predecessors. As before, the courts have agreed that acentral bank, and the Federal Reserve in particular, is constitutional.

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The Constitutional Basis for Paper Money

Even if the Federal Reserve is a constitutionally proper institution, what of papermoney? The federal government has issued many forms and denominations ofpaper currency since 1812. It first made paper a legal tender in 1862. Does notthe constitution require the Congress to coin money, not to print it? Is this notwhat the authors of the constitution intended? Perhaps, but it's not an air-tightissue. S.P. Breckenridge wrote in Legal Tender of the significant disagreementsthe delegates to the constitutional convention had over the issue, and even overthe interpretation of the wording that they eventually adopted.

Prior to the constitutional convention in the summer of 1787, the Statesexercised their sovereign powers over monetary matters. Most States had issuedtheir own forms of paper money, typically called ‘bills of credit’ at the time, andhad declared some foreign coins as a legal tender. By ‘legal tender’ we mean aform of money which a government specifies may be used to settle debts and topay taxes due to it. During the Revolutionary War many States issued papermoney to excess. The Congress of the Articles of Confederation had also reliedheavily on using paper money to fund its war expenditures. The States had alsodeclared various forms of paper currency, including the Congress’ emissions, alegal tender. Severe price inflation was the necessary result of thisover-indulgence in paper, and by the time the constitutional conventionconvened paper money had many enemies.

The primary foes of paper money were commercial and banking interests. Whena lender agrees to fund a loan, he charges a rate of interest which, among otherfactors, includes a premium for any expected loss in the purchasing power of theprincipal during the life of the loan. If the price level is expected to rise, say,five percent then the lender will insist on an interest of at least that amount. If inactuality the price level increases eight percent, then the lender stands to lose asmuch as three percent of his principal. If a government has the power to issuepaper money, then the potential abuse of this power increases the probability ofan unexpected inflation. Commercial concerns also were generally againstallowing paper, and for similar reasons. The sour inflationary experience of theprevious decades made the business climate less stable than it might otherwisebe with a constitutionally guaranteed gold or silver monetary standard. Inaddition, such a standard would protect the integrity of commercial contractsthat specified fixed payments in specie. These interests at the conventiontherefore had two objectives: To forbid both the States and the federalgovernment from issuing bills of credit -- the common term for paper money atthe time -- and to base the monetary system on gold or silver.

Paper money was not without its partisans, however. Agricultural interests anddebtors were fond of paper money, as well as Ben Franklin, and for many of thesame reasons. The losses a lender is likely to suffer at the hands of a paper-induced inflation are exactly offset by the gains of the borrower. The debtorwould then be able to repay a fixed debt in less valuable currency. Farmers alsogenerally favored paper money because it tended to create an economic climateof rising commodity prices relative to other goods, thereby increasing their realincome. Their monetary goal at the convention was to give the government theright to issue bills of credit or, at the very least, not to deny it the power.

Charles Pinckney of South Carolina produced a draft of a constitution that hadtwo interesting features for our purposes. From Art. VII. Sec. 1 of his draft weread “The legislature of the United States shall have power … (4) To coin money… (5) To regulate the value of foreign coin … (8) To borrow money and emit

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bills on the credit of the United States …” Also we find in Article XII: “No stateshall coin money.” We further read in Article XIII: “No state, without theconsent of the legislature of the United States, shall emit bills of credit, or makeanything but specie a tender in payment of debts.” We can glean someindication of the Founders’ intent concerning paper money from the debate onthe matter in Madison’s notes on the convention. What follows below is anexcerpt of those notes on this debate:

MR. GOUVERNEUR MORRIS [PA.] moved to strike out “and emitbills on the credit of the United States.” If the United States hadcredit such bills would be unnecessary; if they had not, unjust anduseless.

MR. BUTLER [S.C.] seconds the motion.

The fundamental theory on which the Founders created the U.S. constitution isof a government of limited powers. The federal government would have onlythose powers specifically enumerated and those reasonably necessary to enactthem. If a power is not expressly given to it, then it is denied. What RobertMorris of Pennsylvania seeks to do with the above motion is to deny the federalgovernment the specific right to issue paper money. The discussion continued:

MR. MADISON [Va.] Will it not be sufficient to prohibit makingthem a tender? This will remove the temptation to emit them withunjust views; and promissory notes in that shape may in someemergencies be best.

MR. GOUVERNEUR MORRIS: Striking out the words will stillleave room for the notes of a responsible minister, which will do allthe good without the mischief. The moneyed interests will opposethe plan of government if paper emissions be not prohibited.

MR. GORHAM [Mass.] had doubts on the subject. Congress, hethought, would not have the power unless it was expressed. Thoughhe had a mortal hatred to paper money, yet, as he could not foreseeall emergencies, he was unwilling to tie the hands of the legislature. He observed the late war could not have been carried on had such aprohibition existed.

Gorham’s thoughts on this are key to interpreting how the Founders wouldeventually resolve this issue. The Revolutionary War was financed to a greatextent on paper money the Continental Congress and later the Congress of theArticles of Confederation had issued. The Congress had no taxing authority ofits own and the newly independent States were unwilling to contribute anysignificant funds of their own for the war effort. The Congress, with limitedcredit, was therefore left to emitting paper money. Although its over-issuancewas largely responsible for the severe inflation of the time, it was also clear tothe Founders and to later historians the States could not have funded their effortin any other way. The personal financial losses many of the delegates sufferedat the hands of the paper money did much to alienate them from the medium, butit did not erase from their memory the acknowledgment of its financialcontribution to their independence. Gorham, like others at the convention,disliked paper, but were hesitant in denying forever the government’s ability touse it. Madison’s notes continued:

MR. MERCER [Md.] was a friend to paper money, though in thepresent state and temper of America he should neither propose nor

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approve of such a measure. He was consequently opposed to aprohibition of it altogether. It will stamp suspicion on thegovernment to deny it discretion on this point. It was impolitic alsoto excite the opposition of all those who were friends to papermoney. The people of property would be sure to be on the side ofthe plan, and it was impolitic to purchase their further attachmentwith the loss of the opposite class of citizens.

MR. ELLSWORTH [Conn.] thought this a favorable moment toshut and bar the door against paper money. The mischiefs of thevarious experiments which been made were now fresh in the publicmind, and had excited the disgust of all the respectable part ofAmerica. By withholding the power from the new government,more friends of influence would be gained to it than by almostanything else. Paper money can in no case be necessary. Give thegovernment credit, and other resources will offer. The power maydo harm, never good.

MR. RANDOLPH [Va.], notwithstanding his antipathy to papermoney, could not agree to strike out the words, as he could notforesee all the occasions that might arise.

Here in a microcosm is the debate on whether to deny the federal governmentthe right to issue paper money. Mercer and Ellsworth clearly represented theagricultural and commercial interests, respectively, and their positions areunderstandable within this context. Randolph, however, took the middle ground,wondering whether it was wise to tie the hands of future legislatures.

Eventually, the convention voted 9-2 to strike the clause, thereby denying thefederal government the specific power to emit bills of credit. The relevantsections of the constitution eventually approved read: Art. I. Sec. 8.: “TheCongress … shall have power … (2) to borrow money on the credit of theUnited States … (5) To coin money, regulate the value thereof, and of foreigncoin, and fix the standard weight and measures.” Art. II. Sec 10.: “No state shallcoin money nor emit bills of credit nor make anything but gold and silver coin alegal tender in payment of debts …”

These clauses have several implications relevant to the question of whethertoday’s paper money is constitutional. Among the lesser effects for our purposesis that it removed from the States their previous sovereign power to coin moneyor to emit paper money. It also restricted what they could declare a legaltender. The question, though, is whether the Congress may legally issue papermoney. Some argue that it was the Founders’ intent to bar the door to papermoney permanently and the vote to strike the bills of credit clause fromPinckney’s draft is evidence of this intent. This may be a hasty interpretation,however.

Although several members of the convention wanted to deny paper money to thefederal government and believed the act of striking the 'bills of credit' clauseaccomplished the task, not all delegates shared either this intent or thisinterpretation. Several members, as shown above, were either friends of papermoney or did not want to tie the hands of the Congress for all time. Theinterpretation of their action varies widely. Mason believed that if the powerwas not expressly given, it was denied. As far as he was concerned, theCongress could not authorize paper money. Morris, though, believed it to bepermissible for a ‘responsible minister.’ Madison, who cast the deciding vote inthe Virginia delegation to strike the clause, still viewed it as legal provided the

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notes were safe and proper. Madison wrote, “Nothing very definite can beinferred from this record” as to the views of the convention on this matter. AsPresident, Madison approved of a $36 million non-legal tender paper moneyissue to help finance the War of 1812. His actions seem to have spoken louderthan his words. Luther Martin, a delegate from Maryland, explained his views tothe Maryland legislature and stated:

Against this motion we urged that it would be improper to deprivethe Congress of that power; that it would be a noveltyunprecedented to establish a government which should not havesuch authority; that it would be impossible to look forward intofuturity so far as to decide that events might not happen that shouldrender the exercise of such a power absolutely necessary; and thatwe doubted whether if a war should take place it would be possiblefor this country to defend itself without resort to paper credit, inwhich case there would be a necessity of becoming a prey to ourenemies or violating the constitution of our government; and that,considering that our government would be principally in the handsof the wealthy, there could be little reason to fear an abuse of thepower by an unnecessary or injurous exercise of it.

It is clear the intent of the Founders was to prohibit the States from issuing papermoney. It is not clear whether the same intent applied to the Congress. WroteBreckenridge, “the clause granting to Congress the power to emit bills wasstricken out, and no prohibition was laid. Silence as to that was maintained; andall that can be said as to the interpretation of that silence is that, although therewas a strong and well-nigh universal dread of paper issues, there was a strongerdread of too narrowly limiting the powers of the new legislature; and that therewas neither a very definite nor a unanimous opinion as to the effect of strikingout the clause, or as to the extent of the power granted (p.84).” It appears theFounders, whether intentionally or not, left the paper money issue to be settledby future generations.

Recent Federal Court Rulings on the Federal Reserve and Paper Money

Below are some recent court rulings on the issues of the Federal Reserve andpaper money.

U.S. v. Rickman, 638 F.2d 182, C.A.Kan. 1980:

Federal Reserve Notes in which the defendant, charged with failureto file federal income tax returns, was paid were lawful moneywithin the meaning of the United States Constitution. 26 USCA§7203; USCA Const. Art. 1, §8, cl. 5.

U.S. v. Wangrund, 533 F.2d 495; C.A.Cal. 1976

The statute establishing Federal Reserve Notes as legal tender for alldebts, public and private, including taxes, is within the constitutionalauthority of Congress; thus the defendant could not overturn hisconviction on two counts of wilful failure to make an income taxreturn on the theory that he did not receive money since checks hereceived as compensation for his services could be cashed only forFederal Reserve Notes which were not redeemable in specie. 26USCA §61, §7203; USCA Const. art. 1, §8; Coinage Act of 1965,§102; 31 USCA §392.

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Nixon v. Individual Head of St. Joseph Mortgage Company, 615 F.Supp. 890,affirmed 787 F.2d 596. D.C.Ind. 1985.

Federal Reserve notes are legal tender.

Ginter v. Southern, 611 F.2d 1226, certiorari denied 100 S.Ct 2946, 446 US 967,64 L.E.d.2d 827. C.A.Ark. 1979.

Tax protestor's claims concerning the constitutionality of the FederalReserve System, Internal Revenue Code and establishment of taxcourt were so frivolous as not to require discussion and detail.USCA Const. Amends. 5, 13; 28 USCA §1346; 26 USCA §6532, 26USCA §7422.

U.S. v. Schmitz, 542 F.2d 782 certiorari denied 97 S.Ct. 1134, 429 US 1105, 51L.Ed.2d 556. C.A.Cal. 1976.

Federal Reserve Notes constitute legal tender and are taxabledollars. USCA Const. Art. 1, §10.

Milam v. U.S., 524 F.2d 629. C.A.Cal. 1974.

The statute which delegates to the Federal Reserve System thepower to issue circulating notes for money borrowed and the powerto define the quality and force of those notes as currency is valid ...Although golden eagles, double eagles, and silver dollars werelovely to look at and delightful to hold, the holder of a $50 FederalReserve Bank Note, although entitled to redeem his note, was notentitled to do so in precious metal. Federal Reserve Act, §16, 12USCA §411; Coinage Act of 1965, §102, 31 USCA §392.

Moreover, the paper money issue is an irrelevant one. If we replace each allpaper that has "one dollar" printed on it with a coin that has "one dollar"stamped on it, what will we gain? We willl have achieved compliance with theliteral words of the constitution at the expense of a convenient and popular formof money.

Gold and Silver Coin

It is also sometimes argued that the constitution permits the minting only of goldor silver coins. This is a misinterpretation, as a federal court makes clear in U.S.v. Rifen, 577 F.2d 1111. C.A.Mo. 1978:

The United States Constitution prohibits states from declaring legaltender anything other than gold or silver but does not limit Congress'power to declare what shall be legal tender for all debts ... FederalReserve Notes are taxable dollars. Coinage Act of 1965, §102, 31USCA §392; USCA Const. Art. 1, §10.

This point is made further in Nixon v. Phillipoff, 615 F.Supp. 890, affirmed 787F.2d 596. D.C.Ind. 1985:

The provision of the Constitution [USCA Const Art. 1, §8, cl. 5]which gives Congress the right to coin money, and regulate thevalue thereof, gives Congress exclusive ability to determine whatwill be legal tender throughout the country ... The provision of theConstitution [USCA Const. Art. 1, §10, cl. 1] which mandates that

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no state shall make anything but gold or silver coin tender inpayment of debts acts only to remove from states inherent soverignpower to declare currency, thus leaving Congress as the sole declarant of what constitutes legal tender; the provision does notrequire states to accept only gold and silver as tender ... FederalReserve Notes are legal tender for any debt or public charge ...Using or accepting Federal Reserve Notes as payment for state courtfiling fees was completely proper under the Constitution. USCAConst. Art. 1, §8, cl. 5; 31 USCA §5103.

The court made the point again somewhat humourously in Foret v. Wilson, 725F.2d 400. C.A.La. 1984:

Gold and silver coin do not constitute the only legal tender by theUnited States; thus, the appellant, who bid $2.80 in silver dimes on aforeclosed property requiring a minimum bid of $80,000 underLouisiana law, was not entitled to the deed to the property.

Are Gold and Silver Practical Metals for Coins?

We could replace all our paper money with coins containing the appropriateamount of a precious metal. Gone would be the $1 Federal Reserve Note, and inits place a coin with $1 stamped on it. Apparently, this would make the papermoney opponents happy. Or would it? As it turns out, the amount of gold thatwould need to be in a $1 coin would be so tiny it would barely be there at all.

In the summer of 1999, the price of gold is about $250/oz. Therefore, a $1 coinwould need 1/250ths ounce of gold in it; that is to say, it would contain 0.4%gold and 99.6% base metals. A quarter-dollar would have 0.1% gold and 99.9%base metals. A $20 coin would have 8.0% gold and 92% base metals. If anymore gold than that were included, then it would pay to melt the coins and sellthe gold, and then we'd be without a physical medium of exchange.

Silver has the same problem. The price of silver is about $5/oz., so we couldmint a $5 coin containing 100% silver. A $1 coin would have 20% silver. Aquarter would have about 5% silver and 95% base metals. Could anyonehonestly tell the difference between the quarter we have now and one with 5%silver?

References:

Breckenridge, S.P., Legal Tender, N.Y.: Greenwood Press, 1903, 1969.

Dunne, Gerald T., Monetary Decisions of the Supreme Court, Rutgers Univ.Press, 1960.

Hixson, William F., Triumph of the Bankers: Money and Banking in theEighteenth and Nineteenth Centuries, Praeger, 1993.

Footnotes:

1. I have no formal legal training and do not consider myself a constitutionalscholar.

2. Then, curiously, in the memorandum in which he articulated his thoughts onthis matter, Jefferson advised that if the President felt that the pros and cons of

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constitutionality seemed about equal, then out of respect to the Congress whichpassed the legislation the President could sign it (Dunne, p. 17-19).

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Myth #4: The Federal Reserve is a privately owned bank out to make aprofit at the taxpayers' expense.

This myth claims that the 12 Federal Reserve banks are privately owned andtherefore want to earn a profit just like any other company. Of course, the Fedholds the reigns of monetary policy, so naturally they will use it for the benefit oftheir owners and not the economy at large. And finally, since the Fed owns lotsof government bonds, much of the Fed's profits come at the taxpayers' expensethrough the interest paid to the Fed on those bonds. Like many of the otherFederal Reserve myths, this one has a small degree of truth to it, but also has afair amount of misinterpretation and it leaves out a number of crucial details.

Organization of the Federal Reserve System

The Federal Reserve System is sometimes described as a quasi-governmentagency because it contains elements of both the private sector and ofgovernment control. The System has three organization levels: member banks,Federal Reserve Banks, and the Board of Governors. Let's examine eachbriefly.

Member banks are at the bottom of the organization chart. These arecommercial banks and S&Ls who have joined the Federal Reserve System(FRS). By law, all nationally chartered banks must join, and any state charteredbank has the option to join (12 USCA §282). By joining the FRS a member bankis becoming a shareholder -- an owner -- in its regional Federal Reserve Bank. For example, suppose you and I open a new nationally chartered bank inCharlotte, North Carolina. According to the district map, we see that Charlotteis in the Richmond Federal Reserve district, so our new bank will have tobecome a member of the Richmond Federal Reserve Bank. So, the claim thatthe "Fed is privately owned" is correct -- each Federal Reserve Bank is ownedby private for-profit commercial banks and S&Ls.

Why are member banks -- the owners -- at the bottom of the organization chart? They are at the bottom because unlike the shareholders of a typical corporation

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such as IBM, member banks have very little power over how their regionalFederal Reserve Bank is run. And they have no control at all over monetarypolicy. Shareholders of IBM elect the company's board of directors who in turnchoose the firm's CEO, so they have a collective say on the company'soperations. Member banks also get to select 6 of the 9 directors of their regionalFederal Reserve Bank, but these directors control only the Bank's dailyoperations, not monetary policy which is the most important function of theFederal Reserve System (12 USCA §301 and 12 USCA §302).

At the middle level in the organization chart are the 12 regional Federal ReserveBanks. They have a variety of powers and duties, some of which are:

Buy and sell government bonds in the secondary markets (open marketoperations)Lend reserves to member banksOffer check-clearing services to member and non-member banksIssue Federal Reserve Notes and collect worn-out ones for destructionEnforce reserve requirements and other regulations of the member banksMonitor banking and economic activity within their respective district

In terms of monetary policy, the most important power is the first one -- openmarket operations. Buying government bonds in the secondary marketsincreases the amount of reserves in the banking system, puts downward pressureon interest rates, and tends to expand the money supply. Selling governmentbonds does the opposite. This is the monetary policy function that is most oftenassociated with the Fed (What is monetary policy?). However, a FederalReserve Bank can only employ open market operations with the explicitapproval of the Board of Governors (12 USCA §355).

Finally, at the top of the structure chart is the Board of Governors. The Board isa 7-member panel who is appointed by the President of the United States andconfirmed by the Senate (12 USCA §241). The Board's current Chair is AlanGreenspan. Among its responsibilities:

Determine open market policiesSet the required reserve ratio for member banksSet the Discount RateDeciding how much new currency to printMonitor the health of the U.S. economyReport to Congress periodically on the state of the U.S. economy

It's single most important duty is deciding its open market policy, that is, whetherit should order the Federal Reserve Banks to buy or sell government bonds, andif so, how much. This decision is made in conjunction with the Federal OpenMarket Committee. The FOMC is a 12-member panel can consists of all theBoard members, the president of the New York Federal Reserve Bank, and 4presidents from the other Federal Reserve Banks on a rotating basis. Thepresidents are appointed by each Bank's board of directors, pending approvalfrom the Board of Governors (12 USCA §341).

Thus, all the key monetary policy decisions -- the ones that affect interest rates --are made by a government agency whose members are selected by the Presidentof the United States. The Fed may be privately owned, but it is controlled by thegovernment.

The Fed and Taxpayers

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The second part of this myth is that the Fed is a drain on the Treasury, andtherefore a drain on taxpayers. This is untrue. The Federal Reserve Banks areentirely self-financing institutions; they do not receive any tax dollars allocatedto them from the federal budget. Let's take a look at the table below to seeexactly where they get their money and how they spend it:

1999 Combined Statements of Income of the Federal Reserve Banks (in millions)

Interest income Interest on U.S. government securities $28,216 Interest on foreign securities 225 Interest on loans todepository institutions 11 Other income 688 ------- Total operatingincome 29,140

Operating expenses Salaries and benefits 1,446 Occupancy expense 189 Assessments by Board ofGovernors 699 Equipment expense 242 Other 302 ------- Total operating expenses 2,878

Net Income Prior to Distribution $26,262

Distribution of Net Income Dividends paid to member banks 374 Transferred to surplus 479 Payments to U.S.Treasury 25,409 ------- Total distribution 26,262

Source: 86th Annual Report of the Board of Governors, p.335.

We can see from the top of the table that the Fed's primary source of income isinterest from government bonds. This money is paid to the Fed by the U.S.Treasury. Is this not de facto evidence the Fed is leaching off the taxpayers? No, it is not. The Treasury is obligated to pay interest to whomever owns thosebonds. If the Fed did not own them, then the interest would have been paid tosomeone else. In fact, from the Treasury's perspective, it is a good thing the Fedholds those bonds. At the bottom of the table, we see the Fed makes asubstantial annual payment to the Treasury. The higher the Fed's net income is,the larger the payment to the Treasury. In other words, the Treasury gets back asignificant amount of the interest paid to the Fed. Thus, government bonds heldby the Fed are essentially interest-free loans to the government.

Conclusion

The regional Federal Reserve Banks are private owned, but they are controlledby the Board of Governors -- a federal agency whose members are appointed bythe President and confirmed by the Senate. The Board sets monetary policy andthe Federal Reserve Banks execute it. In addition, the Fed does not use anytaxpayer money to fund its operations. While the Fed does collect interest ongovernment bonds, the Treasury would have had to make such payment even ifthey Fed did not hold any bonds. Moreover, the Fed rebates a significant shareof its net income to the Treasury each year, revenues the government would nothave at all if the Fed owned no government bonds.

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Myth #5. The Federal Reserve is owned and controlled by foreigners.

Introduction

The Federal Reserve System is the primary regulatory agency governing the U.S.banking industry. It has singular importance in setting monetary policy andmany economists believe it has substantial influence on the course of thebusiness cycle. Yet, could it be that the most important economic institution inthe United States is actually owned by foreigners? Gary Kah (1991) and EustaceMullins (1983) authored separate books alleging that a secretive internationalbanking elite owns and controls the Fed. Furthermore, his shadowy group usesits power to manipulate financial markets and to control the U.S. economy.

The focus of both books is the Federal Reserve Bank of New York. What wetypically call the ‘Fed’ is actually a two level system: 12 regional FederalReserve Banks (the New York Fed is one of them) and the Board of Governorsthat runs them (Alan Greenspan is the Board’s chair). Gary Kah claimedforeigners directly own the New York Fed, the largest and most important of thedozen regional institutions. Through it the international collaborators control theentire Federal Reserve System and reap its gigantic profits. Eustace Mullinsagreed on the importance of the New York Fed, but instead claimed it is ownedindirectly by foreigners – through a European banking club he termed the“London Connection” which controls the Fed’s policies from abroad.

Are any of allegations true? In this article I focus on whether foreigners own theFederal Reserve Bank of New York either directly or indirectly, whether itcontrols the enitre of the Federal Reserve System, and whether foreignersreceive the Fed’s large annual profits.

Who Owns the New York Federal Reserve?

Each of the twelve Federal Reserve Banks is organized as a corporation in muchthe same way as many other firms. According to Kah, foreigners own acontrolling interest in the shares of the New York Fed. He claimed that “Swiss

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and Saudi Arabian contacts” identified the top eight shareholders as

Rothschild Banks of London and BerlinLazard Brothers Banks of ParisIsrael Moses Seif Banks of ItalyWarburg Bank of Hamburg and AmsterdamLehman Brothers of New YorkKuhn, Loeb Bank of New YorkChase Manhatten Bank, andGoldman, Sachs of New York (Kah, p. 13).

He also described these groups as the bank’s “Class A shareholders” (p. 14). This is curious because Federal Reserve stock is not classified in this manner. Itcan be either “member stock” or “public stock,” but there are no such things as‘Class A’ shares. However, the directors of a Federal Reserve Bank areseparated into classes A, B, and C depending on how they are appointed (12USCA §302). This may have been the source of Kah’s confusion.

Eustace Mullins compiled a very different list. He reported that the top 8stockholders of the New York Fed were

CitibankChase Manhatten BankMorgan Guaranty TrustChemical BankManufacturers Hanover TrustBankers Trust CompanyNational Bank of North America, andBank of New York.

According to Mullins these institutions in 1983 owned a combined 63% of theNew York Fed’s stock. These American banks, in turn, were owned byEuropean financial institutions. Since the commercial banks in the New YorkFed's district elect its board of directors, the London Connection is able to usetheir American agents to pick the Bank's directors and ultimately control thewhole Federal Reserve System. He explained,

... The most powerful men in the United States were themselvesanswerable to another power, a foreign power, and a power whichhad been steadfastly seeking to extend its control over the youngrepublic since its very inception. The power was the financial powerof England, centered in the London Branch of the House ofRothschild. The fact was that in 1910, the United States was for allpractical purposes being ruled from England, and so it is today(Mullins, p. 47-48).

He remarked further that the day the Federal Reserve Act was passed in 1913,“the Constitution ceased to be the governing covenant of the American people,and our liberties were handed over to a small group of international bankers” (p.29).

Clearly, there is a discrepancy between the two lists. According to Kah,foreigners own shares of the New York Fed directly, but Mullins stated theyowned and controlled the Fed indirectly through ownership of American banks. So who is right? Mullins cited the Federal Reserve Bulletin for his informationon share ownership, but that publication has never reported the shareholder listof any Federal Reserve Bank. Kah’s source is equally elusive – unnamed Swiss

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and Saudi Arabian contacts. Despite the difficulty in verifying their sources, itmay be possible that both men are correct. The two authors published their listseight years apart. Since Mullins’ was the earlier of the two, it may be possiblethat sometime between 1983 and 1991 foreigners acquired a substantial amountof stock in the New York Fed. Of course, it is also possible that they're bothwrong.

To clarify this mystery, let’s first look at the Federal Reserve Act of 1913. Thelaw requires that all nationally chartered commercial banks and S&Ls buy stockin their regional Federal Reserve Bank, thereby becoming “member banks” (12USCA §282). State chartered banks may also join voluntarily. The amount ofstock a given bank must purchase is proportional to the bank’s size, so we wouldexpect that the largest shareholders to be the biggest commercial banksoperating in the district. This agrees with Mullins since all of the banks on hislist were the largest banks in the New York region in 1983.

Gary Kah’s list of alleged shareholders is more suspect. The law does not permitthe stock of a Federal Reserve Bank to be traded publicly like the stock of atypical corporation (12 USCA §286). The original Federal Reserve Act calledfor each regional Bank to sell stock to raise at least $4 million to beginoperations (12 USCA §281). The stock was to be sold only to banks, not to thepublic. Only in the event that sales to member banks did not raise the necessary$4 million would the regional Fed Banks be permitted to sell shares to thepublic. However, all Banks raised the requisite amount of capital. No stock inany Federal Reserve Bank has ever been sold to the public, to foreigners, or toany non-bank U.S. firm (Woodward, 1996). Foreign interests comprise half ofthe alleged owners on Kah’s list. Moreover, three of the hypothesized Americanowners are not even banks: Goldman-Sachs, Lehman Brothers, and Kuhn-Loebare all investment banks, not commercial banks, and so are ineligible to own anyshares of a Federal Reserve Bank. The law prohibits the general public,non-bank firms, and foreigners from owning anything more than a trivial amountof stock in any Federal Reserve Bank (12 USCA §283). The only institution onKah's list that could possibly own shares of the New York Fed is ChaseManhatten. All the others named on the list are incorrect. Kah's list is mostlybunk.

Fortunately, we can take a more direct approach to the question of ownership ofthe New York Fed and the other Federal Reserve Banks. The New York Fedreports that its eight largest member banks on June 30, 1997 were:

Chase Manhatten BankCitibankMorgan Guaranty Trust CompanyFleet BankBankers TrustBank of New YorkMarine Midland Bank, andSummit Bank.3

All of the major shareholders seen here and all of the banks on the complete listare either nationally- or state-charted banks. All of them are American-owned. Kah’s claim that foreigners directly own the N.Y. Fed is completely wrong. Thislist is consistent, however, with Mullins in that all the owners are domestic banksfunctioning within the N.Y. Federal Reserve district. The discrepancies arelikely due to mergers or other significant changes in the size of district bankssince the publication of Mullins’ list. To obtain a list of member banks of other

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Federal Reserve banks, click here.

Global Domination Through the Back Door?

Although foreigners do not own the New York Federal Reserve Bank directly,perhaps, Mullins argued, they own and control it indirectly via ownership ofdomestic banks. Since the money-center banks of New York own the largestportion of stock in the New York Fed, they hand-pick its board of directors andpresident. This would give them, and hence the London Connection, controlover Fed operations and U.S. monetary policy.

The Securities and Exchange Commission requires that firms whose stock istraded publicly report their major stockholders each year. The reports identifyall institutional shareholders (primarily, firms owning stock in other companies),all company officials who own shares in their firm, and any individual orinstitution owning more than 5% of the firm’s stock. These reports show thatonly one of the N.Y. Fed’s current largest shareholders, Citicorp, has any majorforeign stockholders. As of January 1996, Price Alwaleed Bin Talad of SaudiArabia owned 8.9% of Citicorp stock.2 None of the member banks on theabove list have any significant portion of shares held by any foreign individual orinstitution. Mullins' claim that foreigners own the N.Y. Federal Reserveindirectly is also wrong.

Moreover, the ownership rights of Federal Reserve Bank stock are different thanthe common stock of typical corporations. Usually, the number of votes ashareholder has is proportional to the number of shares he owns. However,ownership of Federal Reserve Bank stock entitles the shareholder to one votewhen voting for its regional Federal Reserve Bank officials regardless of howmany total shares the member bank may own. A group of internationalconspirators would need to purchase a controlling interest in a majority of thebanks operating in the N.Y. district to guarantee the election of their desiredminions to the N.Y. Fed’s board of directors. Buying that much stock in somany U.S. banks would require an outlay of hundreds of billions of dollars.Surely there must be a cheaper path to global domination.

Mullins’ premise here is that the member banks control the policies of the N.Y.Fed. In the next section I detail why this is wrong, but an historical example alsoillustrates the fault of this assumption. Galbraith (1990) recounts that in thespring of 1929 the New York Stock Exchange was booming. Prices there hadbeen rising considerably, extending the bull market that began in 1924. TheFederal Reserve Board decided to take steps to arrest the speculative bubble thatappeared to be forming: It raised the cost banks had to pay to borrow from theFederal Reserve and it increased speculators’ margin requirements. CharlesMitchell, then the head of National City Bank (now Citicorp, one of the largestshareholders of the N.Y. Fed at the time), was so irritated by this decision that ina bank statement he wrote, “We feel that we have an obligation which isparamount to any Federal Reserve warning, or anything else, to avert anydangerous crisis in the money market” (Galbraith, p. 57). National City Bankpromised to increase lending to offset any restrictive policies of the FederalReserve. Wrote Galbraith, “The effect was more than satisfactory: the markettook off again. In the three summer months, the increase in prices outran all ofthe quite impressive increase that had occurred during the entire previous year”(Ibid). If the Fed and its policies were really under the control of its majorstockholders, then why did the Federal Reserve Board clearly defy the intent ofits single largest shareholder?

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Does the New York Fed Call the Shots?

Mullins and Kah both argue that by controlling the New York Federal ReserveBank, the international banking elite command the entire Federal ReserveSystem and thus direct U.S. monetary policy for their own profit. “For allpractical purposes,” Kah writes, “the Federal Reserve Bank of New York is theFederal Reserve” (Kah, p.13; emphasis his). This is the linchpin of theirconspiracy theory because it provides the mechanism by which the internationalbankers can execute their plans. A brief look at how the Fed’s powers areactually distributed shows that this key assumption in the conspiracy theory iswrong.

The Federal Reserve System is controlled not by the New York Federal ReserveBank, but by the Board of Governors (the Board) and the Federal Open MarketCommittee (FOMC). The Board is a seven-member panel appointed by thePresident and approved by the Senate. It determines the interest rate for loansto commercial banks and thrifts, selects the required reserve ratio whichdetermines how much of customer deposits a bank must keep on hand (a factorthat significantly affects a bank’s ability create new credit), and also decideshow much new currency Federal Reserve Banks may issue each year (12 USCA§248). The FOMC consists of the members of the Board, the president of theNew York Fed, and four presidents from other regional Federal Reserve Banks. It formulates open market policy which determines how much in governmentbonds the Fed Banks may buy or sell – the major tool of monetary policy (12USCA §263).

The key point is that a Federal Reserve Bank cannot change its discount rate orrequired reserve ratio, issue additional currency, or purchase government bondswithout the explicit approval of either the Board or the FOMC. The New YorkFederal Reserve Bank, through its direct and permanent representation on theFOMC, has more say on monetary policy than any other Federal Reserve Bank,but it still only has one vote of twelve on the FOMC and no say at all in settingthe discount rate or the required reserve ratio. If it wanted monetary policy togo in one direction, while the Board and the rest of the FOMC wanted policy togo another, then the New York Fed would be out-voted. The powers over U.S.monetary policy rest firmly with the publicly-appointed Board of Governors andthe Federal Open Market Committee, not with the New York Federal ReserveBank or a group of international conspirators.

Mullins also made a great to-do about the Federal Advisory Council. This is apanel of twelve representatives appointed by the board of directors of each FedBank. The Council meets at least four times each year with the members of theBoard to give them their advice and to discuss general economic conditions (12USCA §261). Many of the members have been bankers, a point not at all missedby Mullins. He speculates that this Council of bankers is able to force its will onthe Board of Governors:

The claim that the “advice” of the council members is not bindingon the Governors or that it carries no weight is to claim that fourtimes a year, twelve of the most influential bankers in the UnitedStates take time from their work to travel to Washington to meetwith the Federal Reserve Board merely to drink coffee andexchange pleasantries (Mullins, p. 45).

A point Mullins neglects entirely is that the Council has no voting power inBoard meetings, and thus has no direct input into monetary policy. In support ofhis hypothesis Mullins offers no evidence, not even an anecdote. Moreover, his

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Council theory is inconsistent with his general thesis that the LondonConnection runs the Federal Reserve System via their imagined control of theN.Y. Fed. If this were true, then why would they also need the Council?

Who Gets the Fed’s Profits?

Gary Kah and Thomas Schauf (1992) also maintain that the huge profits of theFederal Reserve System are diverted to its foreign owners through the dividendspaid to its stockholders. Kah reports “Each year billions of dollars are ‘earned’by Class A stockholders of the Federal Reserve” (Kah, p. 20). Schauf furtherlaments by asking, “When are the profits of the Fed going to start flowing intothe Treasury so that average Americans are no longer burdened with excessive,unnecessary taxes?”

The Federal Reserve System certainly makes large profits. According to theBoard’s 1999 Annual Report, the System had net income totaling $26.2 billion,which would qualify it as one of the most profitable companies in the world ifthe System were a typical corporation. How were these profits distributed? $342 million, or 1.4% of the profits, were paid to member banks as dividends. Another $479 million, or 1.8%, was retained by the 12 Reserve Banks. Thebalance of $25.4 billion -- or 96.9% of the profits -- was paid to the Treasury. Obviously, Schauf's statement that the member banks are getting "billions" individends every year is absurd. In addition, the Fed has been rebating its profitsto the Treasury since 1947.

Conclusion

The allegation that an international banking cartel controls the Federal Reserveis wrong. Contrary to Kah’s claim, foreigners do not own any stock in the NewYork Federal Reserve Bank. Neither do they currently own any significantshares of the domestic banks that actually do own shares in the N.Y. Fed. Moreover, the central assumption that control of the New York Federal Reserveis the same as control of the whole System is badly mistaken. Also, the profits ofthe Federal Reserve System, again contrary to the conspiracy theorists, arefunneled almost entirely back to the federal government, not to an internationalbanking elite. If the U.S. central bank is in the grip of an internationalconspiracy, then Mullins, Kah, et al have certainly not uncovered it.

Footnotes:

1. State chartered banks have the option of becoming member banks of theFederal Reserve System. Interestingly, only 10% of have done so.

2. Compact Disclosure CD-ROM, v3.0

References:

82nd Annual Report, 1995, Board of Governors of the Federal Reserve System, U.S. Government Printing Office.

Galbraith, John K. (1990), A Short History of Financial Euphoria. New York:Whittle Direct Books.

Kah, Gary (1991), En Route to Global Occupation. Lafayette, La.: HuntingtonHouse.

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Mullins, Eustace (1983), Secrets of the Federal Reserve. Staunton, Va.:Bankers Research Institute.

Schauf, Thomas (1992), The Federal Reserve, Streamwood, IL: FED-UP, Inc.

Woodward, G. Thomas (1996), “Money and the Federal Reserve System: Mythand Reality.” Congressional Research Service.

United States Code Annotated, 1994. U.S. Government Printing Office.

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Myth #6: The Federal Reserve has never been audited.

An often repeated Federal Reserve conspiracy theory is that the Fed has neverbeen audited. "Every year Congress introduces legislation to audit the FED,"wrote Thomas Schauf, "and every year it is defeated."7 Why? Conspiracytheorists such as Schauf, Gary Kah (1991), and Pat Robertson (1994) say thereason is that the Fed is involved in an international plot to subvert U.S.sovereignty and create a one-world government. Naturally, the Fed will notpermit Congress to audit its activities, lest it discover this treasonous plan andshut it down.

How much truth is there to this claim? Has the Fed ever been audited byCongress or anyone else? The Fed controls U.S. monetary policy and can actwith a great deal of independence from Congress and the executive branch. Clearly, such awesome power requires some sort of regular public oversight atthe very least to insure that the Fed is doing its job efficiently and effectively,and to detect any abuses of power or fraud. This essay explores the claim thatthe Fed has never been audited and finds that it is completely false.

A Brief History of Federal Reserve Audits

Since its inception in 1913 the Federal Reserve System has been subjected to avariety of financial and performance audits by Congress, the executive branch,and private accounting firms, although responsibility for this task has shiftedfrom time to time. From 1913 to 1921 the Board of Governors, then known asthe Federal Reserve Board which sets monetary policy and regulates theactivities of the Federal Reserve Banks, was audited annually by the U.S.Treasury Department. In 1921 Congress created the Government AccountingOffice (GAO) and assigned it to audit the Board until 1933. In the Banking Actof 1933, Congress voted specifically to remove the Board from the GAO'sjurisdiction. From 1933 to 1952 audit teams from the twelve Federal ReserveBanks performed the annual examination of the BOG's books. From 1952 to1978, the Board, under authorization from Congress, decided to employnationally recognize accounting firms to conduct the audits of itself to insure

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independent oversight. This provided an external evaluation of the adequacyand effectiveness of the examination procedures.1

In 1978 Congress passed the Federal Banking Agency Audit Act (31 USCA§714). It placed the Federal Reserve System back under the auditing authorityof the GAO. The Act significantly increased the access of the GAO to theFederal Reserve Banks, the Board, and the Federal Open Market Committee(the FOMC). Since then, the GAO has conducted over 100 financial audits andperformance audits of the three Federal Reserve bodies.3

Scope of GAO Audits

Some of the more important GAO performance audits of the Fed have been inthe areas of bank supervision, payment systems activities, and governmentsecurities activities. In the first area, the GAO examined how well the Fed wasenforcing its regulatory powers over its member banks. In 1992 it drew attentionto the Fed's sluggish compliance with regulatory reforms mandated by theForeign Bank Supervision Act of 1991. In examining the Fed's payment systemactivities, the GAO made the Fed aware of how its pricing policies for suchservices as check-clearing affected private suppliers of check-clearing services,and also suggested ways to speed up the process of check collections. Securitymarkets for government debt is a crucial market, and GAO performance auditsof the Fed have lead to more openness in the primary dealer system, particularlyconcerning the disclosure of price information. The GAO is also involved inseveral ongoing performance audits of the Fed such as analysis of risks andbenefits of interstate banking, regulation of derivatives, and the budget of theFederal Reserve system.2

Audits By Private Accounting Firms

Financial audits of the Fed are also conducted regularly. Each Reserve Bank isaudited every year by independent General Auditors who report directly to theBoard of Governors. These examinations involve financial statement audits andreviews on the effectiveness of financial controls. Each Reserve Bank also hasits own internal audit mechanisms. The Board contracts each year with anoutside accounting firm to evaluate the audit program's effectiveness. PriceWaterhouse conducted an audit of the Board's 1994, 1995, 1996, 1997, and1998 financial statements and filed this report in the Board's 1996 AnnualReport (nearly identical ones appear in other Annual Reports):

We have audited the accompanying balance sheets of the Board ofGovernors of the Federal Reserve System (the Board) as ofDecember 31, 1995 and 1994, and the related statements ofrevenues and expenses for the years then ended. These financialstatements are the responsibility of the Board's management. Ourresponsibility is to express an opinion on these financial statementsbased on our audits.

We conducted our audits in accordance with generally acceptedaccounting standards and Government Accounting Standards issuedby the Comptroller General of the United States. Those standardsrequire that we plan and perform the audits to obtain reasonableassurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial

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statements. An audit also includes assessing the accountingprinciples used and significant estmates made by management, aswell as evaluating the overall financial statement presentation. Webelieve that our audits provide a reasonable basis for our opinion.

In our opinion the financial statements referred to above presentfairly, in all material respects, the financial position of the Board asof December 31, 1995 and 1994, and the results of its operationsand its cash flows for the years then ended in conformity with generally accepted accounting principles.

As discussed in Notes 1 and 3 to the financial statements, the Boardimplemented Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits, effectiveJanuary 1, 1994. In accordance with Government AccountingStandards, we have also issued a report dated March 25, 1996 onour consideration of the Board's internal control structure and areport dated March 25, 1996 on its compliance with laws andregulations.4

The Board has also contracted with Coopers & Lybrand to conduct annualfinancial audits of the Board and the individual Federal Reserve Banks.

Exemptions to the Scope of GAO Audits

The Government Accounting Office does not have complete access to all aspectsof the Federal Reserve System. The law excludes the following areas from GAOinspections (31 USCA §714):

(1) transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;

(2) deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, open market operations;

(3) transactions made under the direction of the Federal Open Market Committee; or

(4) a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to items.

In 1993 Wayne D. Angell, then a member of the Board of Governors, submittedtestimony before a House subcommittee on the reasons for the restrictions onGAO access. He commented,

By excluding these areas, the Act attempts to balance the need forpublic accountability of the Federal Reserve through GAO auditsagainst the need to insulate the central bank's monetary policyfunctions from short-term political pressures and to ensure thatforeign central banks and governmental entities can transactbusiness in the U.S. financial markets through the Federal Reserveon a confidential basis.2

In reference to a bill that would lift the constraints placed on the GAO's auditauthority over the Federal Reserve, Angell stated,

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The benefits, if any, of broadening the GAO's authority into theareas of monetary policy and transactions with foreign officialentities would be small. With regard to purely financial audits, theFederal Reserve Act already requires that the Board conduct anannual financial examination of each Reserve Bank...The process ofconducting financial audits is reviewed by a public accounting firmto confirm that the methods and techniques being employed areeffective and that the program follows generally accepted auditingstandards...Further, a private accounting firm audits the Board'sbalance sheet...Finally, and more broadly, the Congress has, ineffect, mandated its own review of monetary policy by requiringsemiannual reports to Congress on monetary policy under the FullEmployment and Balanced Growth Act of 1978...In addition, thereis a vast and continuously updated body of literature and expertevaluation of U.S. monetary policy. In this environment, thecontribution that a GAO audit would make to the active publicdiscussion of the conduct of monetary policy is not likely tooutweigh the disadvantages of expanding GAO audit authority inthis area.2

For more on GAO restrictions, you can search the Government Printing Officewebsite for GAO report T-GGD-94-44, entitled "Federal Reserve System Audits:Restrictions on GAO's Access."

The Budget of the Federal Reserve and Other Oversight

The budget of the Federal Reserve system is determined by each Bank and theBoard of Governors. Stephen L. Neal, the Chair of the House Subcommittee onDomestic Monetary Policy in 1991, stated that "Congress plays no direct role insetting or authorizing the Fed's budget. Control of its own budget is an essentialcomponent of the independence the Fed must enjoy."1 Additional oversight ofthe Federal Reserve System derives from the ability of Congress to expand or tocontract the Fed's powers. On numerous occasions Congress has seen fit tochange the Fed's structure, alter its mission, and grant it new or differentpowers. In 1935 Congress changed the composition of the Board of Governorsto give it more independence, and it allowed the Board to determine the discountrate for all Federal Reserve Banks rather than allow each Bank to set its ownrate. In1978 Congress mandated the Fed's new goal to be full employment andprice stability. In 1980 Congress granted the Fed new regulatory powers overnon-member banks.

Many other government reports on the audits of the Federal Reserve system areavailable on-line through the Government Printing Office website. Threeinteresting GAO reports on Federal Reserve finances and performance are:

Federal Reserve Banks: Innaccurate Reporting of Currency at theLos Angeles Branch, (9/30/96, GAO report AMID-96-146).

Federal Reserve Banks: Internal Control, Accounting, and AuditingIssues, (2/9/96, GAO report AMID-96-5).

Federal Reserve System: Current and Future Challenges RequireSystemwide Attention, (6/17/96, GGD-96-128).

Conclusion

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It is obvious that the Federal Reserve System is and has always been audited. Itis difficult to imagine how Kah, Schauf, and other conspiracy theorists could nothave come across this evidence in the course of their research. Perhaps they aremerely poor researchers. Or maybe they are reluctant to acknowledge factswhich contradict their basic thesis. Either way, their credibility among skepticalreaders takes a sharp hit by making such obvious factual errors.

For more on how the Federal Reserve system is audited, see the New YorkFederal Reserve's FedPoints.

References

1. "The Budget of the Federal Reserve System," Hearing before theSubcommittee on Domestic Monetary Policy...[House], July 18, 1991, U.S.Government Printing Office, Serial no. 102-59.

2. H.R. 28: "Federal Reserve Accountability Act of 1993," Hearing before theSubcommittee on Domestic Monetary Policy...[House], October 27, 1993, U.S.Government Printing Office, Serial no. 103-86.

3. Public Law 95-320, "Federal Banking Agency Audit Act," July 21, 1978.

4. Annual Report, 1996, Board of Governors of the Federal Reserve System.

5. Kah, Gary (1991), En Route to Global Occupation. Layfayette, La.:Huntington House.

6. Robertson, Pat (1994). The Turning Tide. Dallas: Word Publishing.

7. Schauf, Thomas (1992). The Federal Reserve. Streamwood, IL: FED-UP, Inc.

8. United States Code Annotated, U.S. Government Printing Office.

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by Edward Flaherty (last updated September 5, 2000)

Myth #7: The Federal Reserve charges interest on the currency we use.

In my experience this particular myth has alarmed more people than any other. The Federal Reserve is a bank, no? Banks do not lend money for free, right? Our currency comes into circulation only when the government borrowscurrency from the Fed -- at interest -- and then spends it into the economy,right?. This means we, as citizens, pay interest on the very currency that weuse. Conspiracy theorists believe this is part of the alleged "New World Order"plot to bankrupt the United States.

What is the truth here? Does the government really pay interest on our papermoney, Federal Reserve Notes? Thomas Schauf of FED-UP, Inc. circulates aninformation letter in which he writes:

Why pay interest on our currency? A typical incorrect answer is -the FED profits are returned to the U.S. Treasury. The truth is, theFED is a private bank in business for profit. We pay roughly $300billion in interest on our artificial debt and by special agreement, theU.S. Treasury receives $20 billion in return. Taxpayers lose $280billion to the FED banking system per year ... Your local library hasthese dollar figures. The numbers don't lie.5

Schauf also argues that the Federal Reserve system is part of an internationalbanking conspiracy, and that President Kennedy might have been assassinatedbecause he allegedly attempted to curb the power of the Federal Reserve (SeeMyth #9). This currency interest issue is also raised by other conspiracytheorists. Television evangelist Pat Robertson in his book The New World Orderand Jacques Jaikaran in Debt Virus make identical claims.

How accurate are these claims? Some of Schauf's statement is correct. TheTreasury Department prints Federal Reserve Notes and then sells them to theFederal Reserve system for an average cost of about 4 cents per bill (seeFedPoint #1). However, the Fed must present as collateral for the currency an

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amount of Treasury securities that is equivalent in value to the currencypurchased. The Federal Reserve collects interest on all the Treasury securities itowns, including the ones held as collateral. This is as far into the realm of fact asSchauf's statement can take his reader.

What Schauf doesn't say is that nearly all the Federal Reserve's net earnings arerepaid to the Treasury. This is done per an agreement between the Board ofGovernors and the Treasury. Schauf even says this "typical" answer isincorrect. The table below indicates otherwise.

1999 Combined Statements of Income of the Federal Reserve Banks (in millions)

Interest income Interest on U.S. government securities $28,216 Interest on foreign securities 225 Interest on loans todepository institutions 11 Other income 688 ------- Total operatingincome 29,140

Operating expenses Salaries and benefits 1,446 Occupancy expense 189 Assessments by Board ofGovernors 699 Equipment expense 242 Other 302 ------- Total operatingexpenses 2,878

Net Income Prior to Distribution $26,262

Distribution of Net Income Dividends paid to memberbanks 374 Transferred to surplus 479 Payments to U.S. Treasury 25,409 ------- Totaldistribution 26,262

Source: 86th Annual Report of the Board of Governors, p.335.

We can see from the table that the Fed's chief source of income is interest ongovernment bonds. However, we can also see that 97% of the Fed's net incomegoes back to the Treasury.

Shauf is barking up the wrong tree when he complains that the Fed's portfolio ofgovernment bonds is costly to the Treasury. The Treasury would have to payinterest on those bonds regardless of who owns them. At least when the Fedowns a bond, the Treasury is going to get back a substantial portion of theinterest. From the Treasury's point of view, the more bonds the Fed owns, thebetter.

Moreover, it is unclear how Schauf believes the Fed drains $280 billion fromtaxpayers every year. The Fed is entirely self-financed as the data above shows;it receives no outlay from Congress. Perhaps he thinks the Fed receives all theinterest payments on the national debt, which in 1999 summed $353 billion.6 That's not true, either. The Fed owns only about 8.7% of the total national debt,so the vast bulk of the interest payments are going elsewhere.

Schauf believes the Treasury ought to issue its own currency in the form ofUnited States Notes, a form of currency issued on a few occasions in the past(there are still some in circulation, although the total amount is limited by law). A 1953 series A note is shown below.

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<<SNIP>>

Current paper money has the inscription "Federal Reserve Note" across the top,whereas the bill above has "United States Note."

Schauf and the Coalition argue this would be an "interest-free" form ofcurrency. However, there is no functional difference between U.S. Notes andthe Federal Reserve notes we now use. Neither impose a net interest burden onthe Treasury. The key difference between the two currencies is who controls theissuance. The publicly-appointed Board of Governors now controls theemissions of Federal Reserve Notes and can make monetary policy decisionslargely independent of political pressure. The issuance of U.S. Notes, on theother hand, would be controlled by the Treasury Department, an arm of theexecutive branch and a purely political entity. Monetary policy, in thiseconomist's view, ought to be based on the needs of the economy, not on theneeds of current incumbent political party.

Like many others, this Federal Reserve myth is also incorrect. Schauf and theCoalition err in the argument by ignoring entirely the funds rebated from the Fedto the Treasury each year. This key detail essentially means that the bonds heldby the Federal Reserve are interest-free loans to the federal government -- theequivalent of printing money. Federal Reserve Notes do not cost the Treasuryany net interest. Indeed, Mr. Schauf, the numbers do not lie.

References:

2. Board of Governors of the Federal Reserve System, Annual Report, 1999.

3. Jaikaran, Jacques (1995), Debt Virus: A Compelling Solution to the World'sDebt Problems, Lakewood, Co.: Glenbridge Publishing.

4. Robertson, Pat (1994), The New World Order, Dallas: Word Publishing.

5. Schauf, Thomas (1992), The Federal Reserve. Streamwood, IL: FED-UP, Inc.

6. Office of the Public Debt, U.S. Treasury.

7. Ownership of Federal Securities, Treasury Bulletin, June 2000.

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by Edward Flaherty (last updated September 6, 2000)

Myth #8: If it were not for the Federal Reserve charging the governmentinterest, the budget would be balanced and we would have no nationaldebt.

A popular misconception about the Federal Reserve is that it has something todo with the national debt. The argument is that because the government mustpay interest on the money it has borrowed over the years, today's budget deficitis higher than what it would otherwise be. If only the Fed wouldn't chargeinterest on the debt, the government would not have a deficit.

Several things make this argument wrong. First, the Federal Reserve holds verylittle of the national debt. Of the $5.7 trillion in government bonds currentlyoutstanding, the Fed holds only about 8.7%. 2 This means that the bulk of theinterest payments go not to the Federal Reserve, but to the other bondholders.

Second, nearly all the interest paid to the Federal Reserve is rebated to theTreasury. This means that the bonds held by the Fed carry no net interestobligation for the Treasury. For example, in 1999 the Fed collected $28.2 billionin interest on its portfolio of government bonds, but it rebated $25.4 billion tothe Treasury.1

Third, to say that the budget deficit would be smaller but for the interestpayments is an exersize in absurd logic. One could just as easily say that thedeficit is caused by defense spending, Medicare, or any other combination ofprograms with spending that sums to the amount of the budget deficit. Onecould also blame Congress for not raising enough taxes to cover their spendingplans or for spending too much in the first place.

Finally, placing blame for the national debt at the door of the Federal Reservedemonstrates an ignorance of how our government works. The national debt hasbut one cause: Congress. The debt is the sum of all the budget deficits and

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budget surpluses the federal government has ever had. It is Congress, not theFederal Reserve, that determines federal spending and tax rates. Therefore, it isCongress, not the Federal Reserve, who is responsible for it.

References:

1. 86th Annual Report of the Board of Governors 2. Treasury Bulletin, June2000, p.49.

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Myth #9: President Kennedy was assassinated because he tried to usurp the FederalReserve's power. Executive Order 11,110 proves it. (Last updated 9/4/2000)

Presidential Executive Order 11,110 is quite infamous among conspiracy buffs. Jim Marrs, author of Crossfire: The Plot that Killed Kennedy, writes that theorder instructs the Treasury secretary to issue about $4.2 billion in silvercertificates as a form of currency in place of Federal Reserve Notes.1 Writtenby John F. Kennedy, Marrs also speculates this order was part of a larger plan byKennedy to reduce the influence of the Federal Reserve by giving the Treasurymore power to issue currency. The order wassigned June 4, 1963. A fewmonths later, of course, Kennedy was killed, and conspiracy theoristshypothesize a link between the murder and E.O. 11,110. They argue that theFederal Reserve was somehow involved in the assassination to protect its powerover monetary policy.

The executive order modifies a pre-existing order issued by Harry Truman in1951. E.O. 10,289 states "The Secretary of the Treasury is hereby designatedand empowered to perform the following-described functions of the Presidentwithout the approval, ratification, or other action of the President..." The orderthen lists tasks (a) through (h) which the Treasurer can now do without botheringthe President. None of the powers assigned to the Treasury in E.O. 10,289 relateto money or to monetary policy. Kennedy's E.O. 11,110 then instructs that

SECTION 1. Executive Order No. 10289 of September 9, 1951, asamended, is hereby further amended (a) By adding at the end ofparagraph 1 thereof the following subparagraph (j):

'(j) The authority vested in the President by paragraph (b) of section43 of the Act of May 12, 1933, as amended (31 U.S.C. 821(b)), toissue silver certificates against any silver bullion, silver, or standardsilver dollars in the Treasury not then held for redemption of anoutstanding silver certificates, to prescribe the denominations ofsuch silver certificates, and to coin standard silver dollars andsubsidiary silver currency for their redemption,' and (b) By revokingsubparagraphs (b) and (c) of paragraph 2 thereof.

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SECTION 2. The amendments made by this Order shall not affectany act done, or any right accruing or accrued or any suit orproceeding had or commenced in any civil or criminal cause prior tothe date of this Order but all such liabilities shall continue anymaybe enforced as if said amendments had not been made.

John F. Kennedy, THE WHITE HOUSE, June 4, 1963.

To understand exactly what Kennedy's order was trying to do, we mustunderstand the purpose of the legislation which gave the order its underlyingauthority. The Agricultural Adjustment Act of 1933 (ch. 25, 48 Stat 51) towhich Kennedy refers permits the President to issue silver certificates in variousdenominations (mostly $1, $2, $5, and $10) and in any total volume so long asthe Treasury has enough silver on hand to redeem the certificates for a specificquantity and fineness of silver and that the total volume of such currency doesnot exceed $3 billion. The Silver Purchase Act of 1934 (ch. 674,48 Stat 1178)also grants this power to the Treasury Secretary subject to similar limitations. Nowhere in the text of the order is a quantity of money mentioned, so it isunclear how Marrs arrived at his $4.2 billion figure. Moreover, the Presidentcould not have authorized such a large issue because it would have exceeded thestatutory limit.2

As economic activity grew in the fifties and sixties, the public demand for lowdenomination currency grew, increasing the Treasury's need for silver to backadditional certificate issues and to mint new coins (dimes, quarters, half-dollars).However, during the late fifties the price of silver began to rise and reached thepoint that the market value of the silver contained in the coins and backing thecertificates was greater than the face value of the money itself.2

To conserve the Treasury's silver needs, the Silver Purchase Act and relatedmeasures were repealed by Congress in 1963 with Public Law 88-36. Followingthe repeal, only the President could authorize new silver certificate issues, andno longer the Treasury Secretary. The law, signed by Kennedy himself, alsopermits the Federal Reserve to issue small denomination bills to replace theoutgoing silver certificates (prior to the act, the Fed could only issue FederalReserve Notes in larger denominations). The Treasury's shrinking silver stockcould then be used to mint coins only and not have to back currency. The repealleft only the President with the authority to issue silver certificates, however itdid permit him to delegate this authority. E.O. 11,110 does this by transferringthe authority from the President to the Treasury Secretary.2

E.O. 11,110 did not create authority to issue new silver certificates, it onlyaffected who could give the order. The purpose of the order was to facilitate thereduction of certificates in circulation, not to increase them. In October 1964 theTreasury ceased issuing them entirely. The Coinage Act of 1965 (PL 89-81)ended the practice of using silver in most U.S. coins, and in 1968 Congress endedthe redeemability of silver certificates (PL 90-29). E.O. 11,110 was neverreversed by President Johnson and remained on the books until 1987 when therewas a general cleaning-up of executive orders (E.O. 12,608, 9/9/87). However,by this time the remaining legislative authority behind E.O. 11,110 had beenrepealed by Congress with PL 97-258 in 1982.2

In summary, E.O. 11,110 did not create new authority to issue additional silvercertificates. In fact, its intention was to ease the process for their removal so thatsmall denomination Federal Reserve Notes could replace them in accordancewith a law Kennedy himself signed. If Kennedy had really sought to reduce

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Federal Reserve power, then why did he sign a bill that gave the Fed still morepower?

Marrs also makes some other factual errors in his conspiracy tale that suggest heis not very familiar with the Federal Reserve or the financial system. He writesthat a source of tension between the Federal Reserve and the KennedyAdministration was the Treasury's desire to allow banks to underwrite state andlocal government bonds, thereby weakening the "dominant" Federal Reservebanks. However, such a move, which was later permitted by Congress, wouldnot have affected the Federal Reserve system because it had never beeninvolved in underwriting bond issues. Marrs also claims that Kennedy signed abill that changed the backing of small denomination currency from silver to goldto "add strength to the weakened U.S. currency." This is completely false. U.S.currency has not been on the gold standard since 1934, and silver certificates, astheir name suggests, had never been redeemable in anything but silver. Inaddition, U.S. currency was not "weak" during Kennedy's time: There had notbeen any significant inflation since the late forties, and the exchange rate valueof the dollar was fixed according to the Bretton Woods agreement.

In the introduction to his book, Marrs advises the reader not to trust his book. This appears to be good advice.

References:

1. Marrs, Jim (1989), Crossfire: The Plot that Killed Kennedy, New York:Carroll & Graf Publishers.

2. Woodward, G. Thomas (1996), "Money and the Federal Reserve System:Myth and Reality," Congressional Research Service.

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by Edward Flaherty (last updated September 6, 2000)

Myth #10. The Legendary Tirade of Louis T. McFadden

Louis T. McFadden was a member of the House of Representatives in thetwenties and thirties and is one of the heroes of the Federal Reserve conspiracytheorists. A Republican from Canton, Pennsylvania, he was the chair of theHouse Banking and Currency Committee during the twenties, but was merely aCommittee member by 1932. He used his position in Congress occasionally tocrusade against the Federal Reserve, a stance Gary Kah implies may have costMcFadden his life.

On June 10, 1932 the House was debating a bill which would would expand thetypes of securities the Federal Reserve could trade when conducting monetarypolicy. McFadden used this opportunity to launch a twenty-five minute tiradeagainst the Federal Reserve, and in so doing became a legendary championamongst conspiracy theorists. However, just because a claim appears in theCongressional Record does not necessarily mean it is true. McFadden began...

Mr. Chairman, we have in this country one of the most corruptinstitutions the world has ever known. I refer to the FederalReserve Board and the Federal reserve banks. The Federal ReserveBoard, a Government board, has cheated the Government of theUnited States out of enough money to pay the national debt. Thedepredations and the iniquities of the Federal Reserve Board andthe Federal reserve banks acting together have cost this countryenough money to pay the national debt several times over. This evilinstitution has impoverished and ruined the people of the UnitedStates; has bankrupted itself, and has practically bankrupted ourGovernment. It has done this through defects of the law underwhich it operates, through the maladministration of that law by theFederal Reserve Board and through the corrupt practices of themoneyed vultures who control it.1

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Once the hyperbole and histrionics are deducted, there is little remaining ofsubstance in the above quotation. McFadden makes the claim that the FederalReserve had cost the federal government enough money to "pay the nationaldebt several times over." Is he correct?

Disbursements of Federal Reserve Net Income, 1914-1931 (in millions)

Total Revenues $970.7 NetExpenses 363.3 ------- Net Income 607.4

Distribution of Net Income: Paid asdividends 102.0 Payments to Treasury 147.1 Retained by Fed 358.3

Source: Annual Report, 1995, Board of Governors, p. 358.

In this table we see that from 1914 to 1931 the Federal Reserve systemcollectively earned profits totaling $607 million. About $102 million wasdistributed to member banks as dividends, and about $147 million was paid tothe Treasury as a "franchise tax." The Federal Reserve banks kept the remaining$359 million. The national debt in 1932 was $19.5 billion, so even if the FederalReserve had been paying all its profits to the government during this time, itwould have been enough to pay only 3 percent of the national debt -- a far cryfrom McFadden's "several times over."4 Moreover, the Federal Reserve's totalrevenues for the period were $971 million, so if the entirety of the System'srevenues had gone straight to the Treasury, it still would not have been sufficientto make McFadden's claim even remotely accurate.

McFadden then covered a wide variety of topics related to the Federal ReserveBoard. He accused it of assisting Trotsky's efforts during the RussianRevolution, of being controlled by international bankers, of debasing thecurrency, and of many other fascinating transgressions. He also invoked thetestimony of Father Charles E. Coughlin, the Catholic priest who would laterbecome famous for his radio broadcasts in support of Hitler's National Socialistagenda.

We can study the accuracy of these claims, as well. The first one is new to me,and I have not the slightest idea whether it is true, although given that McFaddenhad trouble with a claim which could be easily verified, it seems wise to invokeskepticism on his more fantastic accusations. Generally, this accusation isconsistent with the "Protocols of the Learned Elders of Zion," originallypublished in 1903 in czarist Russia. It is supposed to be an "internal" documentproving the alleged international Jewish conspiracy, but it is now known to havebeen a hoax.2 Henry Ford popularized translations of it into English in the 1920sand this may have been McFadden's source. The second claim is false, as I showin my article, Do Foreigners Own the Fed? The claim that the Fed debased thecurrency is also false. To "debase" a currency means to reduce its purchasingpower, which happens when the general level of prices rises over time. This isusually caused by excessive growth of the money supply, yet in 1932 the pricelevel was lower than it was in 1914, indicating that the opposite of a debasementhad occurred.

McFadden also made some important and accurate arguments. During hisspeech on the House floor, he stated,

From the Atlantic to the Pacific our country has been ravaged and

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laid waste by the evil practices of the Federal Reserve Board andthe Federal reserve banks and the interests which control them ...This is an era of economic misery and for the conditions that causedthat misery, the Federal Reserve Board and the Federal Reservebanks are fully liable.1

What did McFadden mean by "economic misery?" They year he spoke, 1932,was the very worst time of the Great Depression. The unemployment rate wasapproaching 25 percent of the labor force, which to this day stands as record forthe U.S. economy. Homelessness, deprivation, and starvation, usually reservedfor the ultra-poor in this country, were now stalking millions of former membersof the middle class. "Economic misery" was an understatement.

Most economic historians would agree with McFadden that the policies of theFed during this period were the primary cause of the Depression. A mildrecession in the summer of 1929 turned into a banking panic after the stockmarket crash in October of that year. Banks, which owned stocks and madeloans to customers for the purpose of acquiring stocks, suddenly found a large portion of their assets nearly worthless as a result of the crash. Many of thembegan to fail, taking with them the deposits of millions of families (at the timethere was no deposit insurance).

This sort of thing had happened many times before, but the Federal Reserve wascreated in 1913 in part to mitigate its effects as the banking system's "lender oflast resort." In the midst of the first severe wave of bank failures in 1930, theFed was deadlocked on what to do, eventually deciding to do nothing. Severalmore waves of bank failures followed and the Depression was well underway. Thus, the crisis can reasonably be blamed on the erroneous policies of theFederal Reserve Board (The classic book, A Monetary History of the UnitedStates by Milton Friedman and Anna Schwartz, provides a detailed accounting ofthe Fed's internal policy debates during this critical time).

In my view, however, McFadden goes too far in terming the Fed's policies as"evil" or its consequences deliberate. As Friedman and Schwartz showed, theFed essentially made an honest error in judgment. There is absolutely noevidence that the Federal Reserve intended to create the Great Depression. Such a motive would have made no sense from the Fed's point of view. TheDepression created a highly unstable economic and political environment. Whywould it have intentionally created the sort of conditions that would haveseriously endangered its own existence?

Finally, after McFadden's twenty-five minutes of ranting had expired, SenatorBenjamin Strong of Kansas commented on the oratory he had just heard:

There is a disease that afflicts mankind which is very vicious. Itwarps the judgment, it narrows the vision, it even causes men to seered, to make mountains out of mole hills. This disease hassometimes been referred to as B.A. Ladies may refer to it as"tummy" ache, but out in the wide-open spaces men call it the"belly" ache, and I know of no man of my acquaintance that has thisdisease in so violent a form as the gentleman from Pennsylvania,Mr. McFadden.

I have not the time to refer to the many charges he makes againstthe Federal Reserve system, but I call attention to the fact that for12 years he has been the chairman of the Banking and CurrencyCommittee of this House and did not see fit during that time to

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remedy any of the evils of which he now complains. It seems to meentirely out of place to wait until he is retired as chairman of thatgreat committee and then assault all of the institutions of which ithas control.1

Strong's statement suggested that McFadden's rant was little more than politicalbluster. If McFadden had really been the anti-Fed crusader some people todaymake him out to have been, then why did he not do anything about the Fed whenhe had the chance? More likely, he was making political points with hisconstituents by placing blame for the Great Depression at the door of the FederalReserve. While this may have been justifiable, he went too far by implying theFed intended to wreck the economy.

References:

1. Congressional Record, June 1, 1932 to June 11, 1932, U.S. GovernmentPrinting Office.

2. Johnson, George (1983). Architects of Fear. Boston: Houghton Mifflin.

3. Kah, Gary (1991). EnRoute to Global Occupation. Layfayette, La.:Huntington House Publishers.

4. Office of the Public Debt, U.S. Treasury Department.

[Read more from McFadden on a conspiracist website]

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