Monetary Policy1.2

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ITNESS
ESTIMONY
WRITTEN TESTIMONY OF LAWRENCE M. PARKS, Ph.D.226,227

EXECUTIVE DIRECTOR FOUNDATION FOR THE ADVANCEMENT OF MONETARY EDUCATION
Thank you for the opportunity to testify in support of H.R. 1098, The Free Competition in Currency Act of 2011. I am honored to have been invited. I know it must sound like hyperbole, but I believe that H.R. 1098 is perhaps the most important piece of legislation to ever come before the Congress, because H.R. 1098 is necessary to make a transition from the certain catastrophic collapse of our unauthorized (by the Constitution), dishonest and unstable legal tender irredeemable paper-ticket-electronic monetary system. While I suspect that this committee will be most interested in how this bill will affect jobs, debt, economic growth, the capital markets, pensions, and a host of other important and timely topics, I will focus in my opening statement on where we are headed and on the dishonesty of our present system by highlighting some of the many misrepresentations about our money. There are three takeaway points. Our current monetary system is: (1) Not in conformity with the Constitution; (2) Dishonest; and,
[Dr. Parks submitted a slightly modified version of his testimony for inclusion in this work that corrected typographical and stylistic errors.] 227 [Dr. Parks answered additional questions for the record that can be found in Appendix B.] 887
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888RON PAULS MONETARY POLICY ANTHOLOGY
(3) Unstable and in the process of blowing up, perhaps while I am testifying here today. One can be certain of a complete collapse because there is no longer any market-based self-correcting mechanism providing negative feedback against increasing the money supply, increasing debt, and increasing leverage. Any system without a self-correcting mechanism is unstable and blows up. Where We are Headed With no exceptions, the history of legal tender irredeemable paper-ticket-electronic money is that its purchasing power always approaches its cost of production: ZERO! Here are some scenes that illustrate this point:
Exhibit 1: Sweeping Hungarian money into the sewer circa 1946
Exhibit 2: Burning German money for heat circa 1923
ROAD MAP TO SOUND MONEY TESTIMONY889
Exhibit 3: Children playing with blocks of German money circa 1923
Exhibit 4: Children playing with blocks of German money circa 1923
Exhibit 5: Burning German money to heat food circa 1923
Exhibit 6: Weighing paper money for value rather than nominal value, Germany circa 1923
Exhibit 7: Using depreciated paper money in Zimbabwe to buy lunch circa 2008
Exhibit 8: $100 Trillion Zimbabwe bill, 2008 Collapse of the Monetary System With gold-as-money, and without the banking system creating money out of nothing, the amount of financial leverage would be de minimis with no possibility of collapse. Because legal tender irredeemable paper-ticket-electronic money can be created without limit, there is no market-based self-correcting mechanism to limit financial leverage. Especially at a time when those who engage in leverage do not bear the full risk of loss, but are able pass the risk on to the public through the banking system, whose balance sheet and liabilities are de facto guaranteed by the public, financial collapse is a certainty.
Exhibit 9: Sweeping Hungarian money into the sewer circa 1946

This is a scene from Hungary after World War II. That stuff that is being swept down into the sewer is the Hungarian money of the day. Those folks standing about watching are ordinary people who might
have been saving the legal tender irredeemable paper-ticket money for later needs. A lifetimes worth of savings literally down the sewer!
While there have been many currency collapses during the 20 th century, the reason why most countries eventually recovered after a time was that they had an alternate currency: the dollar. Once the dollar is rejected, all those countries that consider dollars as part of their reserves will also experience collapses. What we define as civilization is the intricate web of understandings that we have about one another and the mutual promises we have made. For example, if I promise to meet you at two oclock and dont show up, that hurts the relationship. Aside from the mutual promises and understandings we have with family members, the most important promises in society are promises to pay: to pay pensions, salaries, suppliers, annuities, etc. When money collapses, all promises of future payment are broken, and the enormous intricate web of promises both at home and abroad breaks down. The risks to society cannot be overestimated. A breakdown in national and international currencies is certain. The challenge is to mitigate the damage and lay the groundwork to put into train a monetary system that will not break down and that serves the needs of productive enterprise. Most important, action must be taken to protect the middle class. As the British are fond of saying, its the middle class that protects us from the Barbarians. In 1997, Mr. Greenspan, when he was the Chairman of the Board of Governors of the Federal Reserve, gave a remarkable speech in Belgium where he addressed the issue of leverage and the risk to the financial system.228 He said: Central bank provision of a mechanism for converting highly illiquid portfolios229 into liquid ones230 in extraordinary circumstances has led to a greater degree of leverage in banking than market forces alone would support.231 Mr. Greenspan was confirming that the mechanism or safety net/subsidy/wealth transfer for banks, has led to more leverage than
Remarks by Chairman Alan Greenspan At the Catholic University Leuven, Leuven, Belgium January 14, 1997 229 Highly illiquid portfolios are portfolios that cannot be sold except at a substantial discount to par. 230 The most liquid portfolio consists of cash that the Federal Reserve creates out of nothing. 231 Private investors would pay less for these assets than would the Fed. In fact, depending upon how illiquid these portfolios were, private investors might pay nothing.
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would otherwise occur. For banks, this is great. They can enter into more profitable and riskier bets than they would otherwise because they know that if they lose, i.e., if their bets become illiquid worthless and cannot be soldthe Federal Reserve will convert those bets into cash. And where does the Federal Reserve get the cash? It literally creates it out of nothing, thereby diluting the purchasing power of savings and expected pensions of ordinary working people and seniors. In other words, if the banks win their bets they keep their winnings, and if they lose, the Fedread that ordinary taxpayers absorb the losses. Fantastic! Traditionally this has been accomplished by making discount or Lombard facilities available, so that individual depositories could turn illiquid assets into liquid resources and not exacerbate unsettled market conditions by the forced selling of such assets or the calling of loans. What this means is that rather than cause individual depositories (banks) to sell illiquid assets (loans) which are not goodat a presumed lossor force borrowers into bankruptcy, the Federal Reserve may buy these loans from the banks, presumably at a discount. Again, if things work out, the banks keep the profits. If the loans cannot be repaid, the Federal Reserve (really taxpayers) makes up the loss. Is it fair to taxpayers that banks keep the winnings if their bets are successful but that taxpayers make them good if they experience catastrophic losses? Isnt this just blatant wealth transfer? When the Federal Reserve and the Treasury used the Exchange Stabilization Fund to bail out Mexico in 1995, the money supplied to Mexico was quickly transferred to the Wall Street firms and banks that had purchased Mexican securities. Ignoring the fact that every so often the Mexican peso melts, to garner extra yield, U.S. financial institutions bought Mexican securities. When it appeared certain that Mexican debt would default, rather than allow these financial institutions to book a loss, our governmentread that ordinary taxpayerslent money to Mexico so that it could repay U.S. banks and Wall Street firms. Another version of this story was played out by the International Monetary Fund, in part financed by U.S. taxpayers, to bail out banks in South Korea, Indonesia, Malaysia, the Philippines, and elsewhere. More broadly, open market operations, in situations like that which followed the crash of stock markets around the world in 1987, satisfy increased needs for liquidity for the system as a whole that
otherwise could feed cumulative, self-reinforcing, contractions across many financial markets. In this and other speeches, Mr. Greenspan addresses systemic risk. Much more needs to be said about this, but, in sum, the system is perilously close to imploding or blowing up. Why should ordinary citizens be at risk that our monetary system will implode so that banks and other financial players may reap unearned profits by taking on ever-greater risks? Of course, this same leverage and risk-taking also greatly increase the possibility of bank failures. Without leverage, losses from risk-taking would be absorbed by a banks owners, virtually eliminating the chance that the bank would be unable to meet its obligations in the case of a failure. In other words, without the safety net/subsidy from taxpayers, banks would make bets and take chances while putting their own capital at risk instead of taxpayers money. This is as it should be, it seems to me. Most important, Mr. Greenspan confirmed that without leverage the possibility that depositors would not get their money back in case of a failure would be virtually eliminated. Ordinary working people and seniors would not be at risk. What an incredible acknowledgment! In other words, we can conclude that if the banks had not been induced by the safety net/subsidy to increase leverage, the banking system would not have collapsed in the 1930s and we would not have experienced the Great Depression. Many think that the Great Depression was a market failure. Mr. Greenspan has written extremely eloquently that the Great Depression was in fact caused by the Federal Reserve feeding too much credit into the banking system, i.e., enabling the banking system to increase leverage too much.232 This raises other important questions: Why should our government empower and induce banks to increase leverage when we know that can lead, and has led, to a catastrophic monetary collapse? Why should ordinary working people and seniors and the rest of us be put at risk of a monetary implosion and the total collapse of our economy? Some failures can be of a banks own making, resulting, for example, from poor credit judgments. For the most part, these failures are a normal and important part of the market process and provide discipline and information to other participants regarding the
See Greenspan, Alan; Gold and Economic Freedom; in Rand, Ayn; Capitalism the Unknown Ideal; Signet Books, 1967, pp96-101.
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level of business risks. However, because of the important roles that banks and other financial intermediaries play in our financial systems, such failures could have large ripple effects that spread throughout business and financial markets at great cost. The point of this is that it is leading up to the need to suspend normal business rules for banks by not letting them fail on account of ripple effects. Why Legal Tender Irredeemable Paper-ticket-Electronic Money is Dishonest I wish to focus first on explaining why our monetary system is dishonest. Most importantly, there are myriad misrepresentations and nondisclosure of material information about what we now call a dollar. No amount of regulation or oversight committees will cure dishonesty. The only remedy is honesty. There was a time after the Revolution when our money, as provided for by the Constitution, was gold and silver. There was no legal tender for private transactions. However, the bank notes of the first Bank of the United States were legal tender for payments to the government, e.g., tariff dues. To illustrate what in my view is the most egregious example of dishonesty, I give an example with silver, although the same principle applies to gold. It was, and remains, inconvenient to carry around silver dollars, because they are heavy and bulky. So, people deposited their silver dollars, typically in a bank, and received in exchange a promissory note, a.k.a. a banknote or a note, that bore the inscription that so many dollars were deposited and that the note was payable on demand by the bearer in silver.
Exhibit 10: United States One Dollar Note Notice that this is not a dollar. At the top of the bill are the words United States Note. Under Washingtons image, it says will
pay to the bearer on demand one dollar. As put into law by Alexander Hamilton in the Coinage Act of 1792, this is a dollar:
Exhibit 11: U.S. Silver Dollar Then, the promise to pay a dollar was defaulted, and the broken promise, the dishonored promissory note, is now represented as being a dollar!
Exhibit 12: One dollar Federal Reserve Note This is a gross misrepresentation and is dishonest. This piece of paper is not even a valid note. The signatures of the Treasurer of the United States and the Secretary of the Treasury are gratuitous and deceptive. In other words, what we use for money are just dishonored promissory notes that have been misrepresented to be dollars. All of the securities in our capital markets, at home and abroad, are denominated in dishonored promissory notes. This has immense
implications for trade, jobs, pensions, military preparedness and almost everything that is important. People have the notion that the Congress can make the dollar anything the Congress wants it to be and back it or not with specie or whatever. This is demonstrably false. The highest law of our country is the Constitution, and all laws must be in conformity with it. The word dollar is mentioned twice in the Constitution, but it is not defined in the Constitution. The word dollar appears in connection with the Slave Tax, which is no more. Much more importantly, it is mentioned in the 7 th Amendment: "In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law."233 If it were true that Congress could redefine the word dollar, that would mean that the Congress could redefine the 7 th Amendment, which is ridiculous. Further, for the 7th Amendment to have objective meaning, the word dollar must have objective meaning. What is the objective meaning of the word dollar as used in the Constitution? The word dollar in the Constitution refers to the Spanish Milled Dollar, a.k.a. a piece of eight.
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7th Amendment to the Constitution.
Exhibit 13: A Spanish Milled Dollar, a.k.a. a piece of eight or a real The Spaniards had built mints all over the colonies, and the Spanish Milled Dollar was ubiquitous. In some colonies it was made the unit of account. When independence was declared, the colonies adopted Articles of Confederation which gave Congress the power to issue paper money, called continentals. Here is an example of a continental $30 bill. Notice that it entitles the Bearer to receive Thirty Spanish milled Dollars or the Value thereof in Gold or Silver.
Exhibit 14: A $30 bill, issued by the Continental Congress for Thirty Spanish milled Dollars
After independence was achieved, and the Constitution was adopted, the U.S. did not want to rely on Spanish mints to mint its coins. The U.S. wanted its own mints to mint its own coins, including dollars. To that end, Alexander Hamilton, then Secretary of the Treasury, wrote the Coinage Act of 1792 wherein he tells us exactly what a dollar is: Dollars or Unitseach to be of the value of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy-one grains and four sixteenths parts of a grain of pure, or four hundred and sixteen grains of standard silver. 234 This definition of a dollar, 371.25 grains of fine silver, has never been changed, and cannot be changed. The Constitution requires that a dollar be a weight of silver. Some might claim that if Hamilton defined a dollar in this way, perhaps it can be defined in another way. That is not true. Hamiltons definition of a dollar was not arbitrary. All he did was to write into law what was already a fact. Here is another way of looking at this issue. Suppose we take a sign that says cat,
Exhibit 15: Sign that says cat And hang it on a dog,
Exhibit 16: Photo of a dog Does the dog become a cat?

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Coinage Act of 1792
Exhibit 17: Dog with a sign reading cat Suppose Congress passes a law that says that now all dogs with cat signs are cats?
Exhibit 18: Dog with cat sign + order of Congress Are all dogs with cat signs now cats? Conceptually, this is no different than taking a piece of paper, printing the word dollar on it, adding seals and signatures and calling it a dollar. This is precisely what has happened to our money. Clearly, there is no easy remedy. How could such an immense fraud be perpetrated? There are several reasons, but one of the most important, which HR1098 will go a long way to correcting, is that we are coerced into using fraudulent money by the legal tender statutes. By getting rid of legal tender, HR1098 is necessary, and may be sufficient, to help pave the way to an honest monetary system. Placing images of some of our most revered Founding Fathers on various bills gives bogus money the patina of legitimacy by implying that it had the imprimatur and endorsement of the Founders, when in fact they condemned paper money. Jefferson, for example, wrote:
"Paper is poverty,... it is only the ghost of money, and not money itself.235 But that its [paper moneys] abuses also are inevitable and, by breaking up the measure of value, makes a lottery of all private property, cannot be denied.236 "The trifling economy of paper, as a cheaper medium, or its convenience for transmission, weighs nothing in opposition to the advantages of the precious metals... it is liable to be abused, has been, is, and forever will be abused, in every country in which it is permitted."237 "I now deny [the Federal Government's] power of making paper money or anything else a legal tender.238 Placing Jeffersons image appear on a legal tender paper $2 irredeemable paper-ticket-dollar misrepresents Jeffersons clear condemnation of legal tender irredeemable paper-ticket-electronic money. It is dishonest.
Exhibit 19: A $2 United States Note with Jeffersons image George Washington was equally clear: in a letter he wrote to Jefferson on August 1, 1786: "Other states are falling into very foolish and wicked plans of emitting paper money."239 In addition, he wrote: "Paper money has had the effect in your state that it will ever have, to ruin commerce, oppress the honest, and open the door to every species of fraud and injustice."
Thomas Jefferson to Edward Carrington, 1788. ME 7:36 Thomas Jefferson to Josephus B. Stuart, 1817. ME 15:113 237 Thomas Jefferson to John W. Eppes, 1813. ME 13:430 238 Thomas Jefferson to John Taylor, 1798. ME 10:65 239 Letter to Jefferson on August 1, 1786
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Washington, in his circular letter of June, 1783, to the governors of the several United States, wrote that "honesty will be found on every experiment to be the best and only true policy," being convinced that "arguments deduced from this topic could with pertinency and force be made use of against any attempt to procure a paper currency." Notice that Washington is not writing from an economic point of view. He is condemning paper money as wicked, i.e., evil. The perils of paper money were well known. This is very strong language. As with Jefferson, the monetary authorities again misrepresent Washingtons heart-felt condemnation of paper money by putting his image on a legal tender irredeemable paper-ticket dollar. That is dishonest.
Exhibit 20: $1 Federal Reserve Note James Madison, the Father of the Constitution, had an unequivocal view of paper money as well: "Paper money is unjust; to creditors, if a legal tender; to debtors, if not legal tender, by increasing the difficulty of getting specie. It is unconstitutional, for it affects the rights of property as much as taking away equal value in land. [Emphasis added] Notice, as with Washington, Madison condemned paper money on moral, not economic, grounds as unjust. As the principal author of the Constitution, who better to opine on it as not permitting paper money than Madison. Again, as with Jefferson and Washington, the monetary authorities misrepresent Madisons strong condemnation of paper money by putting his image on the $5,000 legal tender irredeemable paper-ticket-dollar. That is dishonest.
Exhibit 21: $5,000 Federal Reserve Note Alexander Hamilton, Secretary of the Treasury and presidential aspirant did not condemn paper money per se, but he could not have been clearer of what he referred to as unfunded paper, the kind we have now. In June, 1783, Alexander Hamilton, in resolutions for a new constitution of the United States of America, set forth explicitly: "To emit an unfunded paper as the sign of value ought not to continue a formal part of the constitution, nor ever hereafter to be employed; being, in its nature, pregnant with abuses, and liable to be made the engine of imposition and fraud; holding out temptations equally pernicious to the integrity of government and to the morals of the people." By putting Hamiltons image on the $10 legal tender irredeemable paper-ticket-dollar, his clear condemnation of unfunded paper money is also misrepresented. That is dishonest
Exhibit 22: $10 Federal Reserve Note Consider now the all-important issue of how to get people to accept legal tender irredeemable paper-ticket-electronic money in exchange for their goods and services? Misrepresentation may not be enough. There is a need for coercion, which is provided by the legal tender laws. Fraud: Nondisclosure of Material Information and
Misrepresentations about Our Monetary System Commodity money, e.g. gold or silver, is what it is. There is nothing to disclose or misrepresent. Gold or silver is what it purports to be. When gold or silver is minted into coins by the U.S. mint, one can rely on the integrity of the coins because the penalty for malfeasance, e.g., cheating on the weight or the specie content, is punishable by death. Policing the integrity of coins produced by the U.S. mint is done by the U.S. Secret Service. It is very diligent. The Free Competition in Currency Act of 2011, by removing coercion for our monetary system, will signal folks who otherwise would not pay attention to reevaluate the merits of legal tender irredeemable paper-ticket-electronic money. A full disclosure critical review will tend to reveal: (1) Dollars are not redeemable into anything, i.e., they are not valid notes that promise to pay something of value to the bearer; (2) Dollars have value because people believe that other people, both at home and abroad, will continue to accept them for their goods and services and save them for future needs; (3) In the U.S., people are forced by law [legal tender] to accept dollars for all debts public and private; (4) Dollars are created out of nothing by the U.S. banking systemmostly by commercial banks; (5) If, in the judgment of the Federal Reserve, there needs to be additional liquidity in the system, then the Federal Reserve, on its own authority and without any oversight from Congress, may create dollars without limit. Creating additional "dollars" out of nothing will dilute the purchasing power of dollars that have been saved or promised for future payment, such as pensions; (6) Creation of new "dollars" out of thin air has depreciated "dollar" purchasing power by more than 95% since 1950; (7) Dollars are in no way obligations of the U.S. Government (the signatures of the Secretary of the Treasury and the Treasurer are gratuitous); (8) Dollars are tokens, i.e., a paper tickets or electronic blips in a computer; (9) What we call a dollar today is not in conformity with the word
dollar used in the Amendment to the United States Constitution.240 In other words, what we call a dollar is not authorized by the highest law in the land. For day-to-day transactions, none of this matters. People get paid in legal tender irredeemable paper-ticket-electronic money, and they use that money to buy what they need for daily living. It is, however, crucially important for people who save or have securities that are denominated in legal tender irredeemable paper-ticket-electronic money. A monetary system based on legal tender irredeemable paperticket-electronic money is inherently fraudulent. Frauds can be classified in three ways: Frauds in the private sector are generally limited and most times are recognized in a short period. (1) Frauds which have an indirect government imprimatur, e.g., Madoff, whose fraud continued for three decades largely because many believed that government regulations and Securities and Exchange Commission oversight would prevent such frauds lull folks into a sense of security and can continue for longer periods. (2) Frauds that have the direct participation of government by virtue of enabling legislation, e.g., the fiat money fraud, can continue for very long periods because people want to believe in their institutions, and, because government is involved, they are coerced thats what legal tender is about into participating. (3) Some misrepresentations about our monetary system are: (4) Pieces of paper gussied up with seals and signatures that have the word dollar printed on them are not dollars, as the term is used in our Constitution and as defined in the Coinage Act of 1792; (5) Federal Reserve Notes are neither in law nor in fact notes because they have neither a payee nor a due date certain, which are part of the definition and legal requirement for a note to be valid;
7th Amendment: In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law.
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7th
(6) Legal tender irredeemable paper-ticket-electronic money is not authorized by our Constitution. It is misleading to have the signatures of the Secretary of the Treasury and the Treasurer on the bills; (7) Founders such as Washington, Madison, Jefferson and many others condemned paper money on moral grounds. It is misleading to put their images on the legal tender irredeemable paper-ticket-electronic money as if they might have endorsed paper money. All frauds are eventually found out and collapse. Legal Tender Historically, some commodities were made legal tender, e.g., tobacco in the American colonies. However, there is no need to make gold a legal tender because people readily accept gold-as-money, especially for large transactions. For small transactions, historically people have always accepted silver. Fiat, irredeemable paper ticket-token or electronic-checkbook money is always made legal tender because otherwise people tend to reject fiat money for their savings or promises of future payment, e.g., annuities, rents, pensions. The biggest hurdle for irredeemable paperticket-electronic money to circulate is getting people to accept it in exchange for their goods and services and especially to save it. Legal tender is the coercion in our monetary system. Legal tender morphed from a concept called forced tender. When Marco Polo visited China in the middle of the 13 th century, he, as well as other observers, noticed that the Chinese Emperor had become fabulously wealthy by issuing paper money. Upon returning home and reporting this to the Europeans, they were incredulous. Why, they asked, would anyone accept a piece of paper, even if gussied up with seals and signatures, in exchange for their goods and services? The answer was that if one didn't accept the Emperors paper money he would be killed. This was called forced tender. In 1694, Bank of England (then a private bank) notes were made legal tender by the king. There is no death penalty for not accepting legal tender today. However, if one doesn't accept it, one is not entitled to be paid.241
Interestingly, after the French Revolution and the issuance of legal tender irredeemable paper-ticket money, called Assignats, eventually the penalty for non-acceptance was death pursuant to a special law called The Law of the Maximum.
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Legal tender was widely used in Colonial America, but opposition didn't crystalize until during the Revolution when the American experience with legal tender was a disaster. The experience of Thomas Jefferson is emblematic. Here is what happened to Jefferson. Jefferson was married to the daughter of one of the richest men in the colonies, John Wayles. Wayles died in 1773 leaving a huge estate with assets, consisting of slaves and plantations, valued at upwards of 20,000 pounds, and liabilities, consisting of monies owed to British financiers, of about 11,000 pounds. At the time, 100 pounds was a good years wages for a skilled tradesman, so the net estate was a fortune. Wales had appointed Jefferson along with Jeffersons two brothers-in-law the co-executors of his will.242 In those days, and today as well, if an executor distributes the assets of an estate without settling out the liabilities, he becomes personally liable for the liabilities. However, in this instance, since the value of the assets was so much greater than the liabilities, and, besides, Jeffersons in-laws wanted their shares, Jefferson felt comfortable in selling the assets and distributing the proceeds. At the time in Virginia, folks did not have enough cash for such a large transaction. The remedy was to use what we call today a sellers mortgage or a purchase money mortgage, or in the case of goods, vendor financing. In 1773, the procedure was for the buyer to issue a bond to the seller, and amortize the bond, which is what happened. Jefferson offered the estates British creditors a portion of the bonds to settle their claims, but they wanted specie, i.e., gold or silver. So Jefferson would need to pay off the debts from the amortization of the bond. But then in 1776 the Revolution started. Virginia issued paper money and made it legal tender. As with all paper money, its purchasing power approached its cost of production near zero and Jeffersons debtors paid off the bond with the then worthless money. But Jefferson was still personally liable for the 11,000 pounds to Wayles creditors in England. Jefferson was never able to work his way out of that debt and he died a de facto bankrupt. Along the way the Congress tried to help him out; it bought his books for $15,000 which became the Library of Congress. After he died, his possessions were auctioned, but they didn't bring enough money to satisfy the debt. So, when Jefferson said that paper money was a cheat, he wasnt hypothesizing about a theoretical construct. He was cheated big time.
Sloan, Herbert; Principle and Interest: Thomas Jefferson and the Problem of Debt; University of Virginia Press (2001).
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And here is the punch line: and so were the other gentry in Virginia including Madison and Washington. Madison, also a large plantation owner, saw the Revolution coming, and he leased his land. The people to whom he leased his land paid him with the worthless legal tender money, and similarly for George Washington. When the Founders assembled in Philadelphia at the Constitutional Convention (at that time they had gotten Jefferson out of town as our ambassador to France), they were not supposed to write a new constitution. They were to amend the Articles of Confederation which were thought to be inadequate because the Articles didn't give the general government the power to tax. The Framers used the powers granted Congress in the Articles as a template and went down the list transferring what they thought were good provisions to the Constitution. When they got to the provision whereby the Articles gave the Congress the power to issue paper money, in those days called emitting bills of credit, they debated the issue and overwhelmingly voted it down. Madisons notes contain entries to the effect that we killed paper money, and we closed the door to paper money. The principal monetary power of the general government under the Constitution, as put forth in Article I Section 8, is To coin Money, regulate the Value thereof, and of foreign Coin. There is no legal tender power to the general government, and there is no power to issue paper money.243 That was not an oversight. In addition to the Founders, ordinary people had a miserable experience with legal tender and there was near universal opposition to it. Thomas Paine, sometimes referred to as the Father of the Revolution and the author of Common Sense, wrote: "The laws of a country ought to be the standard of equity and calculated to impress on the minds of the people the moral as well as the legal obligations of political justice. But tender laws, of any kind, operate to destroy morality, and to dissolve by the pretense of law what ought to be the principle of law to support, reciprocal justice between man and man; and the punishment of a member [of Congress] who should move for such a law ought to be DEATH."244 What could be clearer than that? Jefferson also confirmed the fact that the general government does not have the power to arbitrarily
The best reference for the constitutional issues dealing with the U.S. monetary system is Dr. Edwin Vieiras magnificent Pieces of Eight: The Monetary Powers and Disabilities of the United States Constitution, Sheridan Books (2002), Edition: 2nd 244 Bancroft, George; A Plea For The Constitution Of The United States, Wounded in the House of Its Guardians; (1884)
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assign value to something that is valueless by making it legal tender. "The federal government I deny their power to make paper money a legal tender."245 Even John Marshall, the revered chief justice of the Supreme Court condemned legal tender: The inflexible adversary of paper money, detesting it with a hatred almost amounting to a passion, was the chief justice of the United States, John Marshall. While he was on the bench, no case could come before him, in which power was claimed for the United States to issue bills of credit; because at that day he and everybody else well understood and willingly acknowledged that the power to emit bills of credit was withheld from the United States, was forbidden by not being granted. But his opinion of the illegality of the issue of bills of credit by the states gave him the opportunity to declare in terms of universal application that the greatest violation of justice was committed when paper money was made a legal tender in payment of debts. But the opportunity to express his opinion, which was never offered to him as a judge, he found as a historian in his life of Washington. He claimed for himself and those with whom he acted, an "unabated zeal for the exact observance of public and private engagements." He rightly insisted that the only ways of relief for pecuniary "distresses" were "industry and frugality;" he condemned "all the wild projects of the moment;" he rejected as a delusion every attempt at relief from pecuniary distresses "by the emission of paper money;" or by "a depreciated medium of commerce." These were his opinions through life. He gave them to the public in 1807, and twenty-four years later in a revised edition of his Life of Washington he confirmed his early convictions by the authority of his maturest life.246 Years later, in 1836, legal tender was still being discussed and condemned: "Most unquestionably there is no legal tender, and there can be no legal tender, in this country, under the authority of this government or any other, but gold and silver, either the coinage of our own mints, or foreign coins, at rates regulated by congress. This is a constitutional principle, perfectly plain, and of the very highest importance. The states are expressly prohibited from making anything but gold and silver a tender in payment of debts; and
Bancroft, George; A Plea For The Constitution Of The United States, Wounded in the House of Its Guardians; (1884) 246 ibid
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although no such express prohibition is applied to congress, yet as congress has no power granted to it, in this respect, but to coin money and to regulate the value of foreign coins, it clearly has no power to substitute paper, or anything else, for coin, as a tender in payment of debts and in discharge of contracts. Congress has exercised this power, fully, in both its branches. It has coined money, and still coins it; it has regulated the value of foreign coins, and still regulates their value. The legal tender, therefore, the constitutional standard of value, is established and cannot be overthrown. To overthrow it, would shake the whole system. The constitutional tender is the thing to be preserved, and it ought to be preserved sacredly, under all circumstances."247 Given the U.S. historical record as well as the universal failure of paper money to protect savings and promises of future payment, how did it happen that gold and silver have been demonetized? As with many ill-advised actions of the general government, the assault on honest money gained traction during wartime. The Civil War was a very unpopular war, and Lincoln had trouble financing it. The Morrill Tariff, which was the governments principal source of revenue, was raised to 47%. It didn't bring in enough money. Lincoln instituted an income tax. For the most part, people rejected paying it, and, in any event, it didn't bring in much money either. In this case, the need for funds was so-great, money could not be borrowed except on terms that would have raised interest rates, some said, to as much as 20% or more. Since bank balance sheets consisted mostly of bonds, had interest rates increased so greatly, the banks would have been bankrupted. So, if one cannot tax or borrow, what does one do? Lincolns Secretary of the Treasury, the brilliant lawyer Salmon Chase, who was himself an aspirant to the presidency, agreed to print money, called Greenbacks, because the back of the bills were in green ink. But why would people accept them when they were used to, and were expecting, gold and silver for their goods and services? The answer was that the Greenbacks were made legal tender.
ibid; Extract from a speech delivered by Daniel Webster in the Senate of the United States, on the 21st of December, 1836, on the subject of the Specie Circular.
247
Exhibit 23: $1 legal tender Greenback As one might imagine, this was very controversial. There ensued a great deal of litigation. At its nadir, Greenbacks depreciated nearly 50% against gold. People who had lent gold or were expecting gold in payment felt they were being cheated. After the Civil War, the legal tender cases litigation percolated up to the Supreme Court. Lincoln had appointed Chase Chief Justice, and it was partially up to him to decide if what he had done during the Civil War was in conformity with the Constitution. The first legal tender case, Hepburn v. Griswold, was decided in 1870 at a time when there were two vacancies on the Supreme Court. Chase wrote for the majority that there was no legal tender power in the Constitution. He wrote, further, that the government had made the Greenbacks legal tender as a war measure, out of necessity. But since the Civil War was over, so was legal tender. The two open positions on the Supreme Court were filled (some said that the Court was packed) with justices who were known to be sympathetic to legal tender. The Court quickly took a new case, Knox v. Lee, and promptly reversed itself and said there was indeed a legal tender power. However, the affirmative decision relied not on the Constitution per se, nor on the legislative history, but, ruled the Court, other countries could create legal tender, and therefore, so
could the U.S. In the Courts language, legal tender was a power that accompanied sovereignty. Chase, now in the minority, wrote in his decision: The legal tender quality [of money] is only valuable for the purposes of dishonesty. In my view, Chase has this right. Further, it seems clear to me that by not giving the legal tender power to the general government, and limiting legal tender by the states to only gold and silver, mindful that the 10th Amendment to the Constitution declares The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people, it means that sovereignty over money is reserved to the people. In other words, if the people want to increase the money supply, they should mine more gold and silver, and take it to the mint to have it coined. The argument that other countries can impose legal tender and so can we brings to mind when I was a child and was remonstrated for doing something my mother disapproved of. A response from me that the other kids are doing it was rejected outright by my mom, and so should have been legal tender. In defense of this miserable decision, there was an issue of people who had borrowed Greenbacks during the Civil War who would have had to repay their debts in much more valuable gold if legal tender was rejected. Chief Justice Chases strong objection to legal tender and very strong language that it was dishonest, did not stop the monetary authorities from putting his image on the $10,000 legal tender irredeemable paper-ticket-dollar as if he might have endorsed legal tender. This is yet another misrepresentation. It is dishonest.
Exhibit 24: $10,000 legal tender Federal Reserve Note bearing the likeness of Salmon Chase.
Exhibit 25: Blowup of the legal tender wording on the $10,000 Federal Reserve Note Notice that this legend is somewhat different from the legend that appears today on Federal Reserve Notes because it includes the words that the note is redeemable in lawful money. The reason for this is that, at the time that the Federal Reserve legislation was passed, it was never anticipated that Federal Reserve Notes would be money per se. Today, all of our money is fiat, not redeemable in lawful money, and we rely solely on legal tender irredeemable paper-ticketelectronic money, all of which bears the legend: This note is legal tender for all debts public and private. What this means is that if one owes money to any entity and offers payment in Federal Reserve Note(s), if they are not accepted, then one need not pay. In addition, legal disputes settled in money are payable in the legal tender. The history of how our money became transformed from constitutionally mandated gold and silver to legal tender irredeemable paper-ticket-electronic money is not well understood. Legal tender and other important monetary concepts have been removed from textbooks and, as far as I know, are taught nowhere. Today, I cannot find a textbook that deals with the history of how our legal tender irredeemable paper-ticket-electronic money became legal tender and the controversies that resulted. While legal tender was a great benefit to those who issued money, at the end of the 19th century, it was the American Federation of Labor that was most vociferous against legal tender. "No legal tender law is ever needed to make men take good money; its only use is to make them take bad money. Kick it out!" 248 If money is good and would be preferred by the people, then why are legal tender laws necessary? And, if money is not good and would
Byington, Stephen T. The American Federationist September 1895. The American Federationist was the official monthly magazine published by the American Federation of Labor.
248
not be preferred by the people, then why in a democracy should they be forced to use it?249 "We [the American Federation of Labor] believe in a financial policy that will neither depreciate our currency at home nor abroad." "We believe in an honest dollar." By repealing legal tender, The Free Competition in Currency Act of 2011, will facilitate a transition to an honest monetary system, hopefully avoiding a catastrophic collapse. The Kind of Money We Use is a Moral Issue Commodity money is in conformity with the Eighth Commandment: Thou Shall Not Steal, and Leviticus 19:35 & 36, which says that one should not falsify weights and measures. Honesty in business dealings is considered consistent with holiness and with moral law. Fiat money violates the Eighth Commandment and the admonition that one should not tamper with weights and measures. Because it is used for future payment, money is said to serve as a store of value. The generation of fiat money, which is produced without workhow much more work is involved in producing a $100 bill as opposed to a $1 dollar bill?dilutes that which has been saved and that which has been promised for future payment. It is the same as stealing. Property Rights and Money Commodity money protects property and is protected by the notion of private property. With fiat money, when money is diluted by the creation of additional money out of nothing, the property rights of savers and those who have been promised future payments, such as pensions, are violated. James Madison, the Father of the Constitution condemned paper money, even that which might have promised redemption, on the grounds that it adversely affected property rights. Repeating the passage cited above, he wrote: "Paper money is unjust; to creditors, if a legal tender; to debtors, if not legal tender, by increasing the difficulty of getting specie. It is unconstitutional, for it affects the rights of property as much as taking away equal value in land. [Emphasis added.] For example, if one works and saves the money one receives in exchange, arguably one has a property right in the money saved. If the money is fiat, then the purchasing power can be decreased by the
249
Ibid.
issuing authority by creating out of nothing, and without work, any amount of additional money. The result will be that one has lost the value of ones work. The same logic applies to money that has been promised for future payment, e.g., pensions. Arguably, people who have earned and/or contributed to a pension plan have a property right to what they have earned when the plan vests. If a monetary authority creates additional money out-of-nothing, in effect one loses the value of his property. Where is the justice in that? Governmental Monetary Integrity With commodity money such as gold or silver, the general government tends to be completely honest about money and the monetary system, because there is little for the government to do except to coin money. There is very little wiggle room. With legal tender irredeemable paper-ticket-electronic money, because it is inherently fraudulent, the government or its agents, e.g., the Federal Reserve, engage in myriad frauds both at home and abroad. By delegating to the Federal Reserve a power that Congress does not have under the Constitution, the power to create money out of nothing, the Congress has empowered the Federal Reserve to act as a de facto agent of the general government. While almost all of what the Federal Reserve does is secret and generally not subject to discovery, occasionally evidence of gross malfeasance and fraud appears. For example, there came a time circa 1982 when the Federal Reserve helped phony up the balance sheet of the Bank of Mexico. Here are the facts. After Paul Volcker retired as Chairman of the Board of Governors of the Federal Reserve in 1987, he and Toyoo Gyohten, his former counterpart from the Bank of Japan gave a series of lectures at Princeton. Those lectures became a book, Changing Fortunes, in which the following passage appears: So it was a matter of buying time. In an effort to hold things together psychologically, we agreed with considerable unease to extend overnight swap credits once or twice to the Bank of Mexico to bolster the month-end figures for their dollar reserves. We would transfer the money each month on the day before the reserves were added up, and take it back the next day. Our unease did not arise from any fear of financial loss, but because the window dressing
disguised the full extent of the pressures on Mexico from bank lenders and from the Mexicans themselves. [Emphasis added.] This is a prima facie fraudulent transaction. The phrase window dressing is a euphemism for a misrepresentation, which is the indicium of a fraud. The issue that this raised for me is that if the Federal Reserve is willing to engage in this genre of fraudulent transactions, what might be the limit on what the Federal Reserve might or might not do. I conclude that there is no limit. Further, what possible legislation passed by Congress authorizes this? Some time ago, I submitted to the Federal Reserve a Freedom of Information request for documents dealing with this transaction. My query turned up nothing. As a small digression, some time ago as part of a larger presentation I showed this to Mr. Ed Ott, then the Executive Director of the New York City Central Labor Council. Mr. Ott connected a dot that I had not considered. He noted that after the Mexican Peso collapsed, when many ordinary Mexicans lost their savings and jobs, in order to survive, many of them illegally migrated to the U.S. to find work. In this way, fiat money has contributed to the problem of illegal immigration that some in the U.S. have complained about. The Perils of Money Creation Prior to August 15, 1971, when President Nixon temporarily, he said, defaulted on the U.S. sovereign promise to redeem dollars for foreign governments and foreign central banks at the rate of one ounce of gold for $35 (at the time it was a felony for U.S. citizens to own gold anywhere in the world), the amount of dollars created out of nothing by our banking system was ultimately limited by the amount of gold that could be claimed. After the default, the amount of dollars that could be created out of nothing has no limit. (See Exhibit 23) As Mr. Greenspan confirmed multiple times, the Federal Reserve has the power, on its own authority and without any oversight from Congress, and as recent events have shown, to create money without limit. When money is created out of nothing, it depreciates the purchasing power of money that exists, and more importantly, it depreciates money that has been promised for future payment, e.g., pensions, annuities, etc. Since 1946, about $14 trillion (M3) has been added to the economy. Where did all of this money come from? How did it get into the society? As John Kenneth Galbraith explained:
The process by which banks create money is so simple that the mind is repelled.250 Consider, for example, if one were to take a $300,000 30-year 6% fixed rate mortgage loan from a bank. The interest on the loan will be about $350,000. Where does the bank get the $300,000? Papers are passed back and forth and signed. Then a bank employee goes to a computer and types in a book entry to ones account for $300,000 and thats it! In other words, essentially for passing some paper around and keying six keystrokes, the bank will now reap $350,000 over a 30year period. Suppose the loan was for $3,000,000, yielding the bank about $3,500,000 in interest. What extra work does the bank need do to realize the additional $3,150,000? All that need be done is to add an additional zero; one more keystroke. And if the loan was for $30,000,000, yielding the bank almost $35 million in interest, all that need be done is to add two more keystrokes! Is this genre of money creation possibly in conformity with the Constitution? In what way is this related to Congress power to coin money? Is it in conformity with free market principles? Does this kind of work justify the lavish salary and bonus compensation paid to bankers? I'll have more to say about this later.
Exhibit 26: How banks create money As unbelievable and outrageous as this appears, the process is explained in official Federal Reserve publications. The Board of
250
Galbraith, John Kenneth; Money: Whence it came, where it went
Governors and the twelve regional Federal Reserve banks each maintain a Public Information Office. A large number of pamphlets, manuals, reports, videos and other publications purportedly to educate the public on why the Federal Reserve system is so wonderful are available for free or for a nominal sum. This is a great source of reading material if one is having trouble sleeping. The following quote comes from a comic book format directed at children. It explains simply: Money exists simply as a bookkeeping entry at a bank. 251 Here is a more complete explanation from a more erudite publication: If a bank makes a loan, it credits the checking account of the borrower. This creates new money in the form of additional checkable deposits for the borrower.252 In effect, the Congress has delegated to the banking system a power that the Congress does not have: the power to create legal tender irredeemable paper-ticket-electronic money out of nothing. What is the response from the financial sector? How can this be justified? First, they claim that money creation helps the economy and provides jobs by financing factories, real estate, consumer purchases, and so on. While it is true that in some cases money creation is used to build and enhance productive enterprise, mostly it is used for gambling in the capital markets, e.g., proprietary trading. Today, the major money center banks have become de facto hedge funds. Second, they claim that no one coerced another into taking a loan, and presumably the bank is satisfying a customer need while benefiting itself at the same time. In other words, they claim a winwin situation. But wait, not so fast. The rest of society ultimately pays a huge price for the banking system having the privilege of creating money out of nothing. Consider the effect on the purchasing power of money:
251 252
The Story of Money, 8th Printing, 2005, Federal Reserve Bank of New York, page 17 The Federal Reserve Today, 15th Edition, Federal Reserve Bank of Richmond, page 16
Exhibit 27: Depreciation of the dollar 1949 2008; Source: Federal Reserve CPI data. The reason why I call this stolen labor is because if one works, ones labor is transformed into money, some of which one saves. If ones savings depreciate, in effect, one has lost his labor. Who benefits? Except for waste, which is unfathomable, the principal beneficiary of legal tender irredeemable paper-ticket-electronic money is the financial sector. Its members, through a combination of fees and stock options, get to transform the legal tender irredeemable paper-ticket-electronic money into real stuff, e.g. 40,000 foot houses in multiple locations around the globe, 200 foot boats, $200 million airplanes, now. Later, when savers and those to whom money has been promised, e.g., pensioners, get their rewards, it turns out that their saved money doesn't have the purchasing power they anticipated. In effect, they have been and will be cheated. Later, I will show empirical data whereby the financial sector public company market capitalization has increased from 5% of total market capitalization in 1980 to more than 20% in 2007. How could the financial sector, which produces no final products that improve the lives of anyone, have quadrupled its share of market
capitalization in one generation? This was just blatant wealth transfer from people who earned it to the financial sector. These days, the depreciation of the dollar, usually referred to in the press as inflation, as measured by the Consumer Price Index (CPI) is thought to be benign. In my view, and that of anyone who eats food or consumes fuel, the notion that the CPI is benign is false. John Williams, a Foundation for the Advancement of Monetary Education Foundation Scholar, has had a long career as a professional economist with clients such as Boeing and IBM. Now in retirement, he runs a website service called Shadowstats.com. He claims that the methodology by which the CPI is computed has been modified multiple times since the Clinton years, incorporating innovations such as Hedonic Pricing, geometric weighting, substitution, etc. that have had the effect of reducing the CPI from what it would otherwise be had a consistent methodology been used. Here is a plot showing his findings from 1981 through July 2011:
Exhibit 28: Annual Consumer Inflation vs. Shadowstat.com computation using a consistent methodology from the early 1980s. As can be seen, using a consistent methodology, the CPI has been materially understated for almost 25 years. Here is a real-life example of how the CPI is understated for ordinary people. This graph shows my monthly healthcare premiums to Oxford for the years 2001 through 2007:
Exhibit 29: Oxford Health Plan monthly premiums for Larry Parks 2001 2007 On the next graph, I show my year-on-year percentage increased cost (which I believe is representative of the experience of most people who have healthcare insurance) and compare it to the percentage increase in the BLS medical component of the CPI:
Exhibit 30: Medical component of the CPI contrasted with increased premiums charged by Oxford Health Plan; Source: BLS and data from Larry Parks Oxford bills
Thus, the medical component of the CPI is not in conformity with the experience of virtually the entire population, which has experienced double-digit increases for health care for years. There is overwhelming empirical evidence that prices are increasing greatly for the inputs to consumer items.
Exhibit 31: Year-on-year price increases as at 1/19/2011; Source: Wall Street Journal
Exhibit 32: Year-on-year price increases as at 1/19/2011; Source: Wall Street Journal
Its hard to imagine that these large price increases will not at some point be incorporated into consumer products one way or another. For example, the media has reported on many products whose packaging and content sizes have been reduced, while maintaining the prior price per package when it contained more product. In this way, and many others, the effects of currency depreciation are being obfuscated. These graphs provide support for Mr. Williams hypothesis that using a consistent methodology the CPI has been seriously understated for almost 25 years. Since retirement schemes such as Social Security, benefits to disabled veterans, and salary increases to those who have COLA clauses (which used to be common in labor contracts) are keyed to increases in the CPI, these beneficiaries along with Treasury Inflation Protection bond holders are being cheated. Why should our government be part of a cheat? Boom & Bust in the Economy With commodity money, such as gold, and without fractional reserve lending (leverage), a.k.a. the creation of bank money by banks, economic activity expands without busts. With increasing amounts of fractional reserve lending, there are periodic booms and busts. A bust results when marginal credit that cannot be serviced is liquidated. Fiat money tends to create huge bubbles, which, when they collapseand they always collapselead to extended depressions and severe hardship, especially for ordinary working people and seniors. Likelihood, Duration, and Size of Wars Wars are very expensive. Because the only sources of revenues with commodity money are taxes, which people tend to resist, or borrowing, which drives up interest rates, there tend to be fewer and smaller wars. For example, it is less likely that the U.S. would have fought in Vietnam if President Johnson had to finance the war with taxes. Fiat currency enables politicians to generate revenues with less accountability. They are then able to act without the consent of the citizenry, which, if consulted, would probably allocate their savings differently. Thus, politicians have a freer hand to engage in military adventurism, and they do. Military Preparedness and the Ability to Wage War if Need Be
With commodity money such as gold or silver the country will have a stronger industrial base, which makes for a stronger military. Also, lower interest rates, which are a by-product of commodity money, make for a greater capacity to finance a war. With legal tender irredeemable paper-ticket-electronic money, there will be a weaker military due to a weaker industrial base. Since purchase power of the money is vulnerable to collapse, there is less of a capacity to finance a war. When a collapse arrives, the military can become fatally weakened. This is an important national security issue. Who Gets the Wealth of Society? With commodity money such as gold or silver, the wealth of society goes to the people who earn it: workers, entrepreneurs, and the producers of goods and services sold in the market in voluntary transactions. With legal tender irredeemable paper-ticket-electronic money, an inordinate amount of wealth is transferred from those who produce it to banks and financial intermediaries. Large credit-worthy borrowers benefit. Also, politicians tend to profit along with people who are direct beneficiaries of government largesse. Social Mobility: the Ability to Improve Ones Lot in Society With commodity money such as gold or silver, social mobility is high. There are innumerable stories of years gone by about people who came to America with nothing but their willingness to work who built major successes. When the U.S. had sound money, it was known worldwide as The Land of Opportunity. These days, there are innumerable stories about folks going back to their original homelands. With legal tender irredeemable paper-ticket-electronic money, social mobility is low to none. Because improving ones lot requires the accumulation of wealth, and because it is not economic to save fiat currency, the poor tend to stay poor. Social Engineering (The Redistribution of Wealth) With commodity money, such as gold and silver, social engineering is hard to do because it must be done with taxation and people tend to oppose higher taxes. They take a greater interest in where money is spent when it is their own. With legal tender irredeemable paper-ticket-electronic money, social engineering is easier to attempt by creating money out of nothing and spending it, lending it, or guaranteeing loans (where it
is known in advance that such guarantees can be met by creating additional money). Contrary to popular opinion, the empirical evidence confirms that most wealth redistribution is from the poor to the rich. No less an authority than Mr. Greenspan has confirmed that we have subsidies for the banking system. Mindful that bankers are richer than most, this means that poorer people are transferring wealth to richer people. Where is the justice in that? If we had an honest monetary system, the wealth transfer would be apparent to all and would be objected to. Unfathomable Waste There is a loss that can be even greater than the depreciation of the currency if banks make loans for enterprises that are not longterm viable. Consider the recent residential real estate debacle whereby several million homes face foreclosure. More than a million homes are vacant and many millions are underwater. A house isn't like a rock; it requires constant care and maintenance. If a leak develops, water and mold damage can result in a total loss. When a bank finances a home for which insufficient savings have been accumulated to pay for it, the bank gets upfront fees, called points. The mortgage broker gets a fee, as does the real estate agent, the appraiser, lawyers . . . a little army of beneficiaries. If the house is a new build, the builder makes a profit as well. My point is that many people get paid. If the house goes into foreclosure and results in a total loss (there are film clips on the Internet of whole new house divisions being bulldozed), the entire enterprise is for nothing. None of these folks have their compensation clawed back. However, the banks balance sheet will be replenished one way or another. It is the taxpayer, through additional currency depreciation, who ends up holding the empty bag. By making a transition to an honest monetary system, when all the facts are on the table without misrepresentations, full disclosure and no coercion, as I will explain further in the section on jobs, prices will again be stable, and savings and promises of future payment will not bear the risk of currency depreciation. The Free Competition in Currency Act of 2011 will hasten that transition. Research & Development and Science Education Because commodity money has a lower interest rate structure and a longer investment-time-horizon, there tends to be more longterm investment. Research and development tend to be long-term
activities. Thus, commodity money results in more scientific activity and the need for more science education. Because fiat currency results in a higher interest rate structure and a shorter investment-time-horizon, there tends to be less longterm investment. If interest rates are high enough, as in Mexico or Brazil, there may be no long-term investment at all and little research and development, and less demand for science education. Manufacturing Jobs and Employment With commodity money such as gold or silver, there is more investment in productive ventures; there are more and higher-paying jobs than otherwise. Because manufacturing is capital intensive, there are also more manufacturing jobs. With fiat, irredeemable paper ticket-token or electronic-checkbook money, there is less investment in long-term productive enterprise; there are fewer and lower-paying jobs. This is because fiat currencies cause higher interest rates and a shorter investment-time-horizon, causing a decrease in manufacturing activity. Generally, there is an increase in the socalled service sector because it has a much shorter investment-timehorizon. A near zero interest rate today is not a market-driven event. It is blatant market manipulation by the Federal Reserve creating additional money out of nothing to buy bonds.
Exhibit 33: U.S. Manufacturing Employment January 1980 to June 2009; Source: BLS
Exhibit 34: Manufacturing as a percent of the civilian labor force 1949 2009; Source: BLS With commodity money, job security is impacted mostly by increases in productivity, which tends to destroy some jobs and create others. Decreasing prices help offset the negative effects associated with the destruction of jobs resulting from productivity (labor saving) improvements. With fiat money, job security is impacted by rapidly changing interest and foreign exchange rates, and less of a propensity to save and invest for the long term.
Exhibit 35: Unemployed 16 years and over; Source: BLS The Free Competition in Currency Act of 2011, by speeding a transition to an honest monetary system, will help to create more and better job opportunities in the U.S. Except for those workers who do manual work without tools, e.g., picking vegetables or who are professionals working in a knowledge-
based industry, well-paying jobs require tools, or more generally, plant and equipment. The more sophisticated the tool, the more investment in research and development is required over longer periods. The source of investment is always accumulated savings, i.e., that which is not consumed from ones production. While legal tender irredeemable paper-ticket-electronic money created out of nothing by the banking system may at first blush appear to be an alternate source of funding separate from savings, in fact it dilutes the purchasing power of that which has been saved or has been promised for future payment. The only thing that gives fiat money value is that some people save it. If a country that had no accumulated savings issued paper money, that money would depreciate quickly and would, in effect, be rejected. Part of the human condition is that people must save (or someone must save on their behalf, e.g., a pension plan) for a time when they can no longer work. Labor songster, the late Joe Glazer wrote a song commemorating this at the time that Walter Reuther was negotiating the Chrysler pension plan circa 1954. The refrain is Too old to work, too young to die, how am I going to get by? Ordinary people are very security conscious and tend to allocate their savings to what they perceive to be the least risky (from the vernacular, not the financial definition) allocation. Most times, they allocate to U.S. Government bonds (in Europe, German bonds are considered safe). Ideally, however, society is best off when savings are allocated to productive enterprise. Recently, David Malpass, president of Encima Global and former Bear Stearns chief economist, wrote an insightful op-ed piece in the Wall Street Journal in which he observed: Treasury bond yields have been at near-record lows and gold prices at record highs, attracting millions of investors into idle assets through coins, exchange-traded funds, and even warehousing facilities. And, It means people would rather buy gold than hire workers or start businesses -- that they don't trust the central bank to maintain the value of their money.253 Thus, if people dont trust the efficacy of currency, they make a flight-to-safety rather than invest in productive enterprise. So far, there is substantial residual faith in the fiat dollar, as evidenced by the unsustainably low interest rates on U.S. Government securities.
Beyond the Gold and Bond Bubbles Shouldn't the Fed Try to Improve Incentives to Invest in Growing Businesses? by David Malpass, The Wall Street Journal, August 31, 2011.
253
That could change very quickly. The bottom line is that industrialization requires sound money, not money that a central bank can create, in Mr. Greenspans exact words without limit. But there is another and more toxic effect of legal tender irredeemable paper-ticket-electronic money on jobs. As the banking system increases the money supply, as mentioned previously, the purchasing power of money that exists depreciates. This is called inflation as measured by the CPI. Here is a long-term chart of M3, the so-called broad money supply, from official sources until March 2006, at which time the Federal Reserve stopped publishing this metric. The components of M3 are known, so some have constructed a proxy to continue the series. For our purposes, that proxy is meaningful. Here is a plot showing the M3 money supply from 1946 through 2008.
Gold tie to dollar broken
Exhibit 36: The broad money supply (M3) from 1946 to 2008. Source: Federal Reserve until March 2006 when the Fed stopped reporting this metric. From April 2006 to December 2008 the data reflects estimates of various observers based on known components of M3. In 1946, M3 was approximately $150 billion. By 2008, it had ballooned to $14 trillion. Contrary to what most people understand, all of our money is created by the banking system. Specifically, when
a bank makes a loan it creates the deposit with a simple book entry. The jargon for money creation is called fractional reserve lending. Notice how the money supply accelerated after the last tie to gold was broken on August 15, 1971. A great deal of the increase in the money supply went into the capital markets, thereby increasing the nominal valuations of equities. Wall Street called this wealth creation. In fact, on account of the fees that went to financial sector participants and stock options that went to those who manage publicly-traded companies, it was mostly wealth transfer. I will have more to say about this in the section on Wall Street and the Banks. Again, creating all of this new money out of nothing increased the price level. The effect on jobs has been an unmitigated disaster and from many points of view. Consider the price level of the United States from 1800 to 2006:
Exhibit 37: Price Level of the United States 1800 2006. Source: Federal Reserve Bank of Dallas. Notice that the U.S. price level was stable for about 125 years. There were little blips at the time of the War of 1812, the Civil War, WWI and WWII, but at the end of the period prices were nearly what they were in the year 1800. During the period, there were enormous improvements in manufacturing as more and better products were produced. The standard of living at the end of the period was many times greater than that of the year 1800 with innovations such as the
steam engine, railroads, telegraph and many others. Further, the growing industrial strength made the U.S. the envy of the planet. At one point it appeared that a large part of the worlds population wanted to migrate to the Land of Opportunity, also called the Land of the Free. It is significant that after FDR seized all of the monetary gold owned by U.S. citizens and made it a felony for U.S. citizens to own monetary gold anywhere in the world, the price level began to increase, especially on account of financing the Vietnam War with legal tender irredeemable paper-ticket-electronic money. At the time that president Nixon defaulted on the last promise to redeem dollars for gold to foreign countries and foreign central banks, not only did money creation accelerate, but so did the price level. What does this have to do with jobs? As the price level increased, nominal wages increased, and along with some other effects, especially taxes (which are not part of the CPI calculation), the U.S. became uncompetitive with other locales. I recall up until the last tie to gold was broken the New York City metropolitan area where I live had a large garment center manufacturing presence. Because it was cheaper to manufacture in other countries, e.g., Japan, garment manufacturing, and most labor-intensive manufacturing left the U.S. Shortly thereafter, whole industries migrated, such as shoe manufacturing. I have been told that there is only one large shoe manufacturer left in the U.S., Allen and Edmonds. As time went on the television industry, microwave ovens and myriad other industries took their jobs overseas. The spin from Wall Street was that we would be doing the creative work (we would think, and the Asians would sweat) and everyone would benefit. Forgetting the effect of legal tender irredeemable paper-ticket-electronic money in financing trade, socalled globalization was the new mantra to an improved standard of living for all. What was wrong with that argument? The fallacy with globalization is that it wasnt trade, unless one wants to think of it as trading jobs for consumer electronics. When Ricardo postulated that comparative advantage and free trade would benefit all, England was on a gold standard, and trade meant an exchange of value for value and work for work. With a legal tender irredeemable paper-ticket-electronic monetary system, money is created without work. How much more work does it take to create a $100 bill as opposed to a $1 bill? None at all. And the amount of work it takes to create a $1 bill is about two cents. In this light, globalization is not trade. It is wealth transfer.
Money Creation Effects on State and Local Taxes Commodity money tends to facilitate lower tax rates and less taxation, since citizens see how much is being extracted from them. As fiat money is created out of nothing, there tends to be inflation and ordinary working people are pushed into higher tax brackets. People pay a larger percentage of their income to taxes.
Exhibit 38: State and Local Taxes 1952 2008; Source: government data After the last tie to gold was broken in 1971, concomitant with money creation, state and local taxes increased greatly. Until recently, except for a very slight decrease in year 2003, tax collections were clearly in a long-term uptrend. Few made the connection between legal tender irredeemable paper-ticket-electronic money and tax revenues. The apparent prosperity generating the increased tax revenues was a mirage based on fiat money. The result was that state and local politicians were induced to expand public services and to make promises, such as pensions and benefits, to public employees that they should not have made and which cannot be kept. One can well understand the fury of those who have been promised pensions and benefits, having worked their entire careers in anticipation of receiving them and then being told that these promises cannot be kept. Reality must be confronted in a way that will minimize the damage and pave the way for an honest monetary system that will provide genuine prosperity going forward. The alternative of increased money creation along with so-called inflation targeting, while kicking the can down the road, will compound the catastrophe. The money issue needs to be addressed
now. The Free Competition in Currency Act of 2011 provides a clear path.
Exhibit 39: State and Local Property Taxes 1952 2008; Source: Government data A great deal of legal tender irredeemable paper-ticket-electronic money created out of nothing found its way to financing real estate. As a result, real estate values increased greatly and so did concomitant real estate taxes. One effect was that seniors whose income was fixed, and also on account of other increasing costs such as fuel, insurance, medical care etc., got squeezed out of their homes. Some, not being mindful of money creation and anticipating everincreasing values of their homes, took out additional mortgages. Everyone knows how that turned out. Few have connected the dots to legal tender irredeemable paper-ticket-electronic money. But legal tender irredeemable paper-ticket-electronic money is responsible for another and in my view more insidious effect. While bankers, Wall Street firms, mortgage brokers, real estate brokers and a small army of support personnel profited and walked off stage with major fortunes, manufacturers whose products were marginally profitable had to abandon their businesses and fire their employees. For example, a couple of years ago The New York Times ran a story about Bartlett Manufacturing Company in Cary, Illinois, which had to close its printed circuit board factory because the property taxes were no longer affordable. As can be seen from the photo, this was a machine-intensive business.254
Uchitelle, Louis; Obamas Strategy to Reverse Manufacturings Fall; The New York Times, 7/21/09
254
Exhibit 40: Bartlett Manufacturing Company shutdown on account of property taxes After he closed the business he was quoted as saying: I am going to tear down the building and sit on the land, and hopefully sell it after the recession when land prices hopefully rise. As can be seen, this is a perfectly serviceable building.
Exhibit 41: Bartlett Manufacturing Company teardown on account of property taxes
The bottom line is that legal tender irredeemable paper-ticketelectronic money has myriad adverse effects, one of which, by causing taxes to increase at the state and local level, is contributing to the destruction of industry and jobs.
Exhibit 42: year-on-year percentage change in property taxes; Source: government data
Small digression: property taxes are not included in the CPI calculation. In addition to property taxes there are many other fees and charges that increase on account of money creation.
Exhibit 43: New York City Water & Sewage Charges year-on-year change 2000 2001; Source: New York City Government
Real Wages
With commodity money, real wages tend to increase, as does the standard of living. With fiat money, real wages tend either to stagnate or decrease, as does the standard of living. This is confirmed by the empirical data.
Exhibit 44: Average Weekly Earnings Of Production And Nonsupervisory Employees, 1982-84 Dollars; Source: BLS
The tipoff that legal tender irredeemable paper-ticket-electronic money adversely affects wages is the use of the adjective real. Without the modifier are wages imaginary? Yes they are. Even with the modifier, with fiat money wages are denominated not in dollars as the term is used in the Constitution, but in dishonored promissory notes, i.e., broken promises to pay dollars (see the section: Why legal tender irredeemable paper-ticket-electronic money is dishonest). Common usage is for real to mean adjusted for inflation as measured by the CPI. As explained in the section: The perils of money creation, this adjustment understates the depreciation of the currency, and so real wages have suffered even more than shown in Exhibit 31. While there was a link to gold and our dollar was more stable, real wages had been increasing. At the inception of the Labor Movement in America, circa 1830, working people were very mindful of the perils of paper money, which, while not legal tender, was redeemable into specie on demand. The problem from Labors point of view was that redemption had to take place at the bank of issue, which was not always geographically convenient. As a result, workers paid with paper money most times suffered a redemption cost when they redeemed it for specie. Gold and silver as money, a.k.a. sound money (because it made a sound) or honest money, was one of the three issues that motivated men to join unions. The other two were the ten-hour workday and education for workers. Eli Moore, then president of the Typographers
Union in 1832, was the first union official to win a seat in Congress. He was a staunch supporter of Andrew Jackson who got rid of the Second Bank of the United States by vetoing its renewal charter and who was an outspoken supporter of gold. Propensity to Save Commodity money is very savable because it doesnt obsolesce or deteriorate and is difficult to counterfeit. Purchasing power is not diminished. Fiat money is less savable and can discourage long-term savings altogether, since its future value is always in doubt. Why save a depreciating asset? This is confirmed by the empirical data.
Exhibit 45: U.S. Personal Savings http://www.bea.gov/national/nipaweb/SelectTable.asp#S5
Rate;
source:
The only way to build a rich society and improve everyones standard of living is to save and invest. Provided one invests in a society that respects property rights and one can reasonably expect to enjoy positive results of an investment, should there be any, then one tends to risk a portion of ones accumulated savings by investing in productive enterprise. Otherwise, one might just as well spend and enjoy ones income. That is precisely what the empirical data confirms. It is invested capital, both physical and intellectual, that are a precondition for high-wage jobs. The lack of accumulated capital in most of Africa is the principal reason why wages are so low in that region. Because legal tender irredeemable paper-ticket-electronic money always depreciates, especially for long-term investments, the eventual chance that one will enjoy a positive result from risking
ones savings is less than it would otherwise be, and so there is less of it. Most important, since legal tender irredeemable paper-ticketelectronic money always depreciates, less of it is saved than otherwise. One deceptive escape hatch for some people is to allocate their savings to the equity markets and hope for the best. As will be shown, the capital markets benefit mostly those who get fees for facilitating transactions. Pensions in Peril Pension assets in physical gold are safe and secure. There is no counterparty risk. Because the amount of new gold produced each year is a tiny fraction, generally less than 2%, of the gold above ground, prices denominated in gold remain stable over time. Because it takes work to mine and produce gold, the amount of gold above ground cannot be increased by whim. With legal tender irredeemable paper-ticket-electronic money, pension assets are vulnerable to volatility in interest rates, rate-ofreturn and discount rate assumptions by those charged with contributing to defined benefit plans, whether they are private or political entities. Because fiat money can be created out of nothing without limit, the purchasing power of pensions is vulnerable to severe depreciation. The Free Competition in Currency Act of 2011, by speeding a transition to an honest monetary system, will make pensions more secure and more valuable for the putative beneficiaries. With our current legal tender irredeemable paper-ticketelectronic monetary system, the real beneficiaries of pension plans are financial sector firms, especially banks, brokerage firms, and the army of professionals who service them. If retirees receive their promised pensions and benefits, it will be a happy accident. Already, millions of steel workers, textile workers, airline workers and many others have lost promised pensions and benefits which they have earned. The short explanation is that financial sector firms get fees now in money that still has purchasing power, while pensioners are looking forward to getting their payments later. When later arrives, the money they receive will at best be worth a lot less than what they are expecting, and at worst will be worth nothing at all. In many ways, this is similar to the classic Ponzi scheme in that some people get paid sooner; when later arrives, folks are left with an empty bag.
An important way in which real assets are improperly transferred to the financial sector has to do with the manner in which assets are allocated to various financial vehicles. Today, U.S. private and state and local pension funds have approximately $9 trillion in assets.
Exhibit 46: U.S. private and state and local pension assets. Source: Federal Reserve Flow of Funds
Pension assets, while supposedly under the control and by law the fiduciary responsibility of pension plan trustees, are de facto under the control of consultants and Wall Street money managers from whom trustees take their marching orders. Order of magnitude, all factors considered, I estimate that fees and overhead for these funds is about one percent of assets, $100 billion per year. This structure is enshrined in major legislation including The Employee Retirement Income Security Act (ERISA) and The Pension Protection Act Of 2006 (PPA) which require trustees to be prudent. In case something goes horribly wrong and pension assets are dissipated, virtually everyone has been given a safe harbor if they rely upon standard industry practice. In effect, what this means is that no one will be held liable if they diversified the allocation of assets and relied upon experts. The experts, however, have a conflict of interests with the beneficiaries, because their compensation is derived from fees which they have an incentive to maximize, and the diversification of assets is based on demonstrably phony methodologies.
Over the years, along with academic experts whom the financial sector has compromised through endowed chairs, prizes 255, honorariums, research grants, consulting work, and who knows what else, demonstrably bogus methodologies have been conferred legitimacy that enhance fees to the detriment of pension plan beneficiaries. The ranks of those who might become experts is highly restricted because journals that an academic must publish in to qualify for tenure and to move up the academic food chain are, for the most part, edited by folks who are present or former employees of the banking system, and especially the Federal Reserve. One critical way the Fed exerts control on academic economists is through its relationships with the field's gatekeepers. For instance, at the Journal of Monetary Economics, a must-publish venue for rising economists, more than half of the editorial board members are currently on the Fed payroll -- and the rest have been in the past.256 These editors act as gatekeepers and do not publish anything that challenges fundamental assumptions nor the legitimacy or honesty of central banking and the legal tender irredeemable paper-ticketelectronic monetary system. Here is another example of how the Federal Reserve has compromised the Academy: In 1994, Mr. Stephen Davies wrote an article citing evidence collected by then Chairman of the House Banking Committee Henry Gonzalez showing that the Fed has spent millions hiring economics faculty members as "consultants." The article quotes Mr. Gonzalez: "The Federal Reserve employs hundreds of researchers in their [sic] research departments, but inexplicably also spends millions to pay hundreds of outside economic consultants. . . The Fed is simply buying off potential critics by holding out contracts that offer academics extra money and use of the Fed's facilities. No agency that has to justify its spending would dream of this kind of extravagance and waste." [Emphasis added.] More telling, the article continues:
The Nobel Prize in Economics, for example, is not one of the prizes that were endowed by Alfred Nobel in 1895. It came in 1968, and the endower is the Central Bank of Sweden. The real name of the prize is Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. It is a bank prize, and it is not given to anyone who might challenge the honesty or legitimacy of central banking. 256 Priceless: How The Federal Reserve Bought The Economics Profession by Ryan Grim, 9-709, http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html
255
ROAD MAP TO SOUND MONEY TESTIMONY941 Moreover, the Bond Buyer has learned that in the case of the Federal Reserve Board, all contractors are required to sign a nondisclosure statement... broadly worded to prohibit the release of any information relating to past, present or future activities that can be considered damaging to the Board.257 [Emphasis added.]
The bogus methodologies, e.g., Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM), which work to generate fees, would not be applicable if we had an honest monetary system without legal tender irredeemable paper-ticket-electronic money. Allow me to explain. Modern portfolio theory is a theory of investment which attempts to: (1) Maximize portfolio expected return for a given amount of portfolio risk; or equivalently, (2) Minimize risk for a given level of expected return, by carefully choosing the proportions of various assets. Notice the reference to risk. The meaning of risk in this context is crucial, because there needs to be some standard against which to measure risk. For MPT asset allocation, the standard is called the riskless rate-of-return, i.e., the rate of return on an asset allocation with zero risk over a period. In practice, the USD 3-month Treasury bill is considered to be a (near) riskless asset. But what about the risk that the dollar will lose purchasing power? That risk is not considered. Furthermore, in the financial sector, the word risk has yet another meaning: it means volatility. The risk of the dollar losing purchasing power is also not considered. As price volatility increases, risk is said to increase. This special and limited definition gives birth to concepts such as the risk-adjusted rate-of-return. Thus, an allocation to gold might have a lower risk-adjusted rate-of-return than, say, an allocation to equities or real estate, despite the fact that an allocation to gold increased by about 18% per year since 2001 and without any down years!
257 Davies, Stephen A.; "Some Lawmakers Claim Fed Keeps Critics at Bay With Jobs", The American Banker*Bond Buyer, December 2, 1994 page 3.
Exhibit 47: Gold appreciation vs. the dollar 2001 - 2010
But using standard industry practice, except for a unit of the Texas Teachers Retirement Fund and a few others, U.S. pension funds are believed to have less than $20 billion of their assets in gold out of their approximately $10 trillion.258
Exhibit 48: Estimated gold holdings at U.S. pension funds; Source: Texas Teachers Retirement Fund
258
An allocation to gold might pay a fee at the time of purchase, but then the fee stream stops.
From here, the story gets worse. Much worse. For almost everyone who is not in the financial sector or providing services to it, risk, according to the Oxford English Dictionary, means (Exposure to) the possibility of loss, injury, or other adverse or unwelcome circumstance. What could be a more adverse or unwelcome circumstance than having ones hard-earned savings, allocated to sovereign debt (either U.S. or some other country) and having it redeemed in currency whose purchasing power has greatly depreciated? How do the ratings agencies treat this risk in assigning ratings to various fixed income securities? This is important, because at home and abroad many pension funds are restricted by law to allocate to only investment grade securities. To check this out, I queried the major ratings agencies (Fitch Ratings, Moodys, and Standard and Poors): If the purchasing power of a sovereigns currency, e.g., in the U.S. that would be the dollar, were to fall to zero, and all of the outstanding sovereigns debt was paid down with worthless currency, would that or would that not constitute a default in the opinion of [rating agency]? Eduardo Barker, Communications Strategist, Sovereign and Latin America Moodys sent me a sheet with its explanation of sovereign ratings that did not appear to address the question along with a statement we would not comment beyond that. Fitch Ratings was more forthcoming. Brian D. Bertsch, Director, Corporate Communications, wrote me: It is very hypothetical but most likely it would not be considered a default. Standard and Poors was the most straight forward. John Piecuch, Director, Standard & Poor's Communications, wrote me: In terms of your question, even in the case of hyperinflation, a currency's purchasing power is still not zero (if it were zero, it would cease to be a currency). Even in that case, as long as the issuer were honoring the original terms of the contract (even if repaying with much cheaper currency than originally borrowed), this would not be a default. Thus, through the use of Modern Portfolio Theory and ratings from government-endorsed ratings agencies, pension plan assets are not being allocated to the one asset that would give beneficiaries the most protection against a decrease in the dollars purchasing power. Empirical evidence, in the U.S. and elsewhere, is incontrovertible that currency depreciation is a material risk. Consider again the depreciation of the dollar from 1949, according to official CPI data:
Exhibit 49: Depreciation of the Dollar 1949 2008; Source: CPI data, BLS
Balance of Trade With commodity money such as gold or silver trade balances because one is always trading work for work, and value for value. With gold-as-money, exports pay for imports and balance of trade deficits are small or nonexistent. With fiat, irredeemable paper ticket-token or electroniccheckbook money, and provided that foreigners, especially foreign central banks, continue to save legal tender irredeemable paperticket-electronic dollars, which, by the way, are legal tender only in the U.S., as history shows, enormous trade deficits are possible. Not only are foreigners going to end up with an empty bag, along the way these huge trade deficits represent lost employment at home.
Exhibit 50: U.S. Balance of Trade 1960 2009: Source: Government data
This is a really ugly chart. It provides empirical evidence that after the last tie to gold was broken in 1971, partly as a result of many U.S.-based industries moving production overseas, the U.S. began to experience enormous trade deficits. Leaving aside the trillions of dollars that have accumulated as reserves in the other countries, especially China, Japan, South Korea, etc., this also reflects a huge transfer of good-paying manufacturing jobs to other locales. While the Business Roundtable, along with the AFL-CIO and others were complaining about currency manipulators, and while Wall Street embraced the process, now called globalization and was cheerleading the globalization as concomitant to wealth creation, overlooked was the fact that the dollars accumulating overseas werent really dollars at all. It was, as Jefferson called it, only the ghost of money, and not money itself. When the legal tender irredeemable paper-ticket-electronic dollar meets its fate, in addition to folks at home, there are going to be some very unhappy and angry people overseas. Are foreigners going to continue to sell us oil along with the myriad other products we now depend on from imports to keep our society functioning? This is a risk factor policy makers need to address. Federal Taxes and Spending With commodity money such as gold or silver, as government spending increases, taxes or borrowing (delayed taxation) must increase, because there is no other source of funding. People tend to resist higher taxes, thereby limiting government spending.
With fiat, irredeemable paper ticket-token or electroniccheckbook money, since government has easy access to money created out of nothing, it does not need to increase tax rates. In effect, it can borrow by so-called monetizing debt. In time, money is depreciated, which causes prices, including the price of labor, to increase in nominal terms, along with concomitant tax collections. However, because of the delay in tax collections, spending almost always exceeds revenues. Eventually the purchasing power of the legal tender irredeemable paper-ticket-electronic money approaches its cost of production near zero there is a regime change and the party ends.
Exhibit 51: U.S. Government Receipts: 2955 2010; Source: U.S. Department of Treasury: Monthly Treasury Statement - Table 1; FRB 1.39 (for historical fills)
Notice that after the last tie to gold was broken tax collections accelerated greatly. Even before the gold link was defaulted, to fund the Vietnam War, there was material money creation. As some of that money leaked overseas to U.S. major trading partners, Great Britain, France, Japan and Germany, both Britain and France, recognizing that too many dollars were being created for the U.S. to maintain its sovereign promise to redeem dollars for gold at the rate of one ounce of gold for $35, began redeeming dollars in ever-increasing amounts. At the time when President Nixon defaulted, temporarily, he said, it was clear that had he not defaulted all of the U.S. gold would have been gone anyway.
Exhibit 52: U.S. Government Outlays 1955 2010; Source: U.S. Department of Treasury: Monthly Treasury Statement - Table 1; FRB 1.39 (for historical fills)
As federal government receipts continued to increase year-afteryear, politicians bought into the notion that this was the result of our growing economy. They were not mindful that the nominal numbers were being driven by ever-increasing money creation. True, there were some wakeup calls along the way, especially when inflation began to pick up at the end of the 1970s, but high interest rates, imposed by Mr. Volcker, appointed by President Carter, were thought to have broken the back of inflation. On April 19, 1993 Mr. Greenspan gave a speech using the word inflation an incredible 58 times, in which he stated that it is going away; it is not coming back; it is not a problem; it is diminished; it is nonrecurring; it is subdued; theres no resurgence; weve learned our lesson. Pronouncements such as these also diverted peoples attention from the amounts of money being created out of nothing. In addition, much of the newly-created money accumulated in the capital markets. The equity and real estate markets spiraled upwards. Investors were euphoric. The CPI was reformulated to take lesser account of the increase in housing prices, and so the monetary authorities could then claim that inflation was benign. Because so much of the newly-created money found its way to the fixed income market, people who should have known better adopted the view that deficits dont matter. President after president greatly increased spending. This would not have been possible if we had an honest monetary system.
Exhibit 53: U.S. Federal Deficit as a % of receipts; Source: U.S. Government
In an attempt to put the government deficit into perspective, most economists compare it to GDP. This is a grave error, in my view. The GDP, a specious metric to begin with, is not available to the government to service and, if was honestly incurred, repay its debt while meeting its promised obligations. For any entity, the money to service and repay debt must come from receipts. As shown above for the period 1955 to 1970, prior to defaulting on the last promise to redeem dollars for gold, the federal deficit as a percentage of receipts was almost always less than 10%. These days, it is painfully clear that the deficit is completely out-of-control. Theoretically spending could be reduced to bring it in line with receipts. However, that would mean defaulting on benefit promises. It is difficult to imagine how that could happen. Meanwhile, many trial balloons are appearing in the major media forecasting and endorsing currency debasement. Washington will therefore have little choice but to take the timehonoured course for big-time debtors: print more dollars, devalue the currency and service debt in ever cheaper greenbacks. In other words, the US will have to camouflage a slow-motion default because politically it is the easiest way out.259 Any inflation above 2 per cent may seem anathema to those who still remember the anti-inflation wars of the 1970s and 1980s, but a once-in-75-year crisis calls for outside-the-box measures.260
Garten, Jeffrey, Financial Times, November 30, 2009; We must get ready for a weak-dollar world 260 Rogoff, Kenneth; The bullets yet to be fired to stop the crisis; Financial Times 8/9/2011
259
In the future, central banks will have to realize that debtfinanced expansions in asset prices can be a threat. For now, it would be nice if they would at least recognize that major deflations in asset prices can be much more important than the relatively small gains in commodities that show up in the Consumer Price Index.261 Government Deficits It is difficult to sustain government deficits with commodity money because they would have to be funded by borrowing. Since a commodity money supply cannot arbitrarily be expanded, interest rates would increase if government increased borrowing. Manufacturers and others would then object to higher interest rates, causing government to reduce spending, and thereby causing deficits to decrease. With legal tender irredeemable paper-ticket-electronic money, as long as someone, such as the Bank of Japan, the Bank of China, the Federal Reserve, or banks, will purchase government securities by creating money out of nothing (called monetizing debt), deficits can be funded without greatly increasing interest rates, and deficits can grow without limit (in theory). Also, government debt can be financed by pension plans and other institutions. Eventually, the debts are defaulted. The empirical evidence confirms that government deficits are facilitated by legal tender irredeemable paper-ticket-electronic money.
Exhibit 54: U.S. Government Surplus/Deficit Cash Basis 1955 2011; Source: BLS
261
Norris, Floyd; Sometimes, Inflation Is Not Evil; The New York Times, August 11, 2011
Exhibit 55: Recent CBO Estimate of forecasted deficits; Source: Congressional Budget Office; Office of Management and Budget.
The data shows conclusively that while the dollar had a link to gold, government deficits were small. After the last tie to gold was broken, the deficits and resulting government debt accelerated greatly. Also, these deficits use the cash method of accounting. If one factors in the present value of promises, e.g., Social Security, Medicare, Medicaid, etc., then the deficits are much greater. Some estimate that the accumulated obligations are on the order of $100 to $200 trillion! Because politicians cannot renege outright on their promises, especially if they want to be reelected, there will be motivation to continue to inflate the currency until it collapses. I dont see any alternative. Thats why The Free Competition in Currency Act of 2011 is important. It provides a way to mitigate the damage and prepare our country for an honest monetary system. Financial Market Instability and the Best Argument against Gold Absent fraud and coercion, a monetary system based on gold-asmoney is stable. With Legal tender irredeemable paper-ticketelectronic monetary systems, because there is no market-based mechanism that provides negative feedback to increasing the money supply, total debt and leverage will necessarily blow up. The strongest argument against linking the dollar to gold, sometimes referred to as the gold standard, is that financial
markets are inherently unstable. Because almost all other markets depend on the financial sector for payment processing, there needs to be a lender-of-last-resort. If the dollar is tied to gold, the lender-oflast-resort may not be able to function. Therefore, it is claimed, modern financial markets require a properly managed (to quote William Niskanen, former Chairman of the CATO Institute) fiat monetary system. While it is true that over the last two centuries financial markets have been unstable, they are not inherently unstable. Misrepresentations and nondisclosure about our monetary system and about basic banking customer relationships enable financial sector firms to over-leverage. This is the root cause of financial instability. Remedies being put forth, such as a global lender of last resort, will be counterproductive and will result in greater instability. The solution is to the change the structure of the worlds monetary systems to remove the cause of such instability: the ability of banking systems to create money out of nothing. In the U.S. during the 19th and 20th centuries, there were numerous boom/bust periods in which financial markets soared and then collapsed. How come this malady wasnt common to other markets, such as the ice cream market or the automobile market? What is it about financial markets that they tend to boom and bust? Also, it is essential to understand that because financial markets are interrelated with other markets, a financial market collapse can also result in a systemic collapse. A distinguishing characteristic of financial markets that is absent from other markets is excessive leverage. On the futures exchanges, various commodities are leveraged, but no one would suggest that the markets for, say, copper or soybeans are inherently unstable. Clearly there is something different about financial markets. That difference is inadequate counterparty surveillance. And that inadequacy is the result of misrepresentations and nondisclosure, which is the indicia of fraud, on the part of key financial players: banks. From inception, banks made fundamental misrepresentations to their customers regarding the basic banking relationship in two areas. First, banks told customers that they were depositors. At best, this was misleading. In fact and in law, depositors were, and continue to be, unsecured creditors of banks. Most depositors, especially small ones, put their money in banks for safe keeping; they were not heedful of the risks they were taking. Second, banks told customers that they could get their money back on demand. However, in fact and in law, when people deposit
money in a bank, it becomes the banks money to do with as the bank pleases. The bank may loan that money to someone else, invest it in whatever, including illiquid investments, or gamble with it. Further, what banks should have told depositors was that they could get their money back on demand provided: not too many of them wanted to do so at the same time; the money had not been invested in something that was illiquid and that could not quickly, and without much loss, be converted back into cash; and, finally, that the bank had not lost the money in some venture. Third, when banks make a loan, they create the deposit with a book entry. These misrepresentations lulled depositors into acquiescing to nondisclosure on the part of banks as to what they were doing with depositors money and the amount of leverage banks were employing. If banks told depositors the truth about the basic relationship, depositors would have exerted more counterparty surveillance over banks, excessive leverage would never have occurred, and there would never have been anything approaching systemic failure, as almost occurred in 1907 and as did occur in 1932. In his book, Soros on Soros, Mr. George Soros correctly observes that a lender of last resort and the gold standard are incompatible. What made the lender of last resort bailout facility necessary were banking misrepresentations and nondisclosures. By abandoning the gold standard, banks enhanced their ability to, in effect, create money out of nothing. Whereas under the gold standard they were able to create money, called fractional reserve lending, there were some (clearly inadequate) limitations on the amount of money they could create. First and foremost, since all of the newly created money, called banknotes, which were legally promissory notes, were redeemable on demand in gold, there was a physical limit beyond which market forces would close a bank that created money greatly in excess of its capital and its reserves, thereby curtailing additional money creation. Second, with some limitations, bank officers and directors were personally liable to depositors. These two factors led many banks to keep something on the order of 40% of their reserves in gold, just in case. If those reserves could be reduced, then banks could garner more profits, and first some, and then many banks sought to do so. The notion that banks were acting improperly was well understood by some market participants. Perhaps Hugh McCulloch, our first Comptroller of the Currency, may have been somewhat over the edge, in this regard, when in 1863
he proposed that the National Bank Act be so amended that the failure of a national bank be declared prima facie fraudulent, and that the officers and directors, under whose administration such insolvency shall occur, be made personally liable for the debts of the bank, and be punished criminally, unless it shall appear, upon investigation, that its affairs were honestly administered. So much for moral hazard. And surely, here we observe the intellectual origins of prompt corrective action. [Speech by Federal Reserve Chairman Alan Greenspan before the American Bankers Association, Washington, D.C., September 18, 2000] After the Panic of 1907, which J. P. Morgan alleviated with a huge gold loan to banks so that they could meet the demands of depositors who were then withdrawing their funds, there were four words that terrified the banking community: What if he [Morgan] dies.? The answer was a government entity that would provide liquidity when the banks got caught short. Further, the formation of the Federal Reserve enabled bank reserves to be aggregated so that there would be a need for less of them, and the banks could leverage even more than before. The banking system was thus able to finance World War I. Without such financing, and had there been full disclosure at that time about the causes of bank panics, some suggest that the War would have been over in just a couple of months with no Treaty of Versailles, no destruction of the German and Austrian currencies, no Hitler, no Lenin, no Stalin, no World War II, and the murder of 150 million, excluding those who died during wars during the Twentieth Century, would not have occurred. No amount of regulation will eliminate the moral hazard issue. Further, the system, with moral hazard, is inherently unstable, and the moral hazard issue means that there will necessarily be wealth transfer from ordinary working people to those who benefit from the moral hazard: the financial sector. Not only is this unfair, it will not stand the light of day if ordinary people come to understand what is transpiring. The solution is gold-as-money. There are compelling reasons why free men and free markets choose precious metals as money. In a nutshell, because of its physical attributes, precious metal as money is the most efficient medium of exchangein terms of minimizing transaction costsfor transmitting value over time. Levels of Debt
Because with commodity money prices tend to decrease, it becomes harder to service and pay down debt, and debt is discouraged. With fiat, irredeemable paper ticket-token or electroniccheckbook money, because debt gets serviced and repaid with cheaper money, increases in debt are encouraged. This also works to decrease the purchasing power of savings and future payments, the majority of which constitute pension funds. Today, booked debt (public and private), exclusive of the present value of promised entitlements, is more than $52 trillion. Exhibits 43, 44, 45, and 46 confirm that after the last tie to gold was defaulted, temporarily promised President Nixon, on August 15, 1971, debt levels in the U.S. greatly increased.
Exhibit 56: State and Local Debt 1955 2010: Source: Federal Reserve Flow of Funds
The level of debt at the state and local level does not include the present value of promised pensions and benefits to public employees. Because of the misallocation of pension assets, also largely the result of legal tender irredeemable paper-ticket-electronic money as I have explained, state and local finances will be under ever increasing pressure to increase taxes and/or to reduce services in order to meet obligations.
Exhibit 57: State and Local Debt 1955 2010 year-on-year changes; Source: Federal Reserve Flow of Funds
The effects of fiat money on state and local debt are even more dramatic when one looks at the year-on-year change the state and local debt. Notice how much state debt accelerated after the last tie to gold was broken.
Exhibit 58: U.S. Government debt 1955 2010: Source: Federal Reserve Flow of Funds
It is now clear to many observers that U.S. Government debt is completely out-of-control. In my view, because there is neither the intention nor the ability to ever repay this debt with money of similar purchasing power at the time that the debt was incurred, this is fraudulent debt. The big losers will be ordinary people who have followed the rules, worked hard, and allocated their retirement
savings to U.S. Government securities, which they have been told are the safest in the world.
Exhibit 59: Total U.S. Debt 1955 2010; Source: Federal Reserve Flow of Funds
Total booked debt, exclusive of the present value of government and corporate promises for entitlements and pensions is now more than $52 trillion. What is the collateral of $52 trillion in debt instruments? Aside from government debt, the collateral is mostly residential and commercial mortgages along with car loans, credit card loans, etc. That collateral is melting away. This means that there are going to be material defaults, most likely through the ongoing depreciation of the currency. Every dollar of debt is somebodys asset, e.g., retirement savings. If we had an honest monetary system, these obscene debt levels would not have been possible. Long-term Interest Rates With commodity money, long-term interest rates have historically been about four percent; just equal to the time-value of money. There is good data from Great Britain going back almost 200 years attesting to this. With fiat money, interest rates include not only the timevalue of money but also an additional incrementthe so-called inflation premiumto compensate for the loss of purchasing power due to the actual and expected creation of additional money. Interest rates are much higher than with commodity money.
Exhibit 60: Long term U.S. interest rates 1800 2007;262
Notice that, from year 1800 almost until 1970, except for times of war, e.g., the War of 1812, the Civil War, and World War I, long-term interest rates hovered about 4%. It was only when the last link to gold was broken in 1971 that interest rates began to increase to unheard of levels. Is it any wonder that the price of gold accelerated greatly reaching $850 per ounce in intraday trading circa 1981? Many thought the monetary system was collapsing at that time. Low and stable long-term interest rates are necessary for longterm investment. As interest rates increase, the present value of a future payoff decreases, and activities for which the payoff is in the distant future are curtailed. For example, when I began my working career at IBM in 1964, IBM, along with Bell Labs, had one of the worlds premier research and development facilities, the Watson Research Center. In those days, IBM was engaged in research at the molecular level where a commercial product was not expected well into the 21st century. After long-term interest rates began to increase greatly the present value of future payoffs was reduced to a tiny fraction of what was originally anticipated. As a direct result, Bell Labs and almost all of IBMs pure research efforts were disbanded. If the U.S. can achieve an honest monetary system as discussed above, long-term research and development will increase greatly. This is a vital ingredient not only to increase our standard of living, but also for military preparedness.
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http://www.measuringworth.org/datasets/interestrates/result.php
Interest Rate and Foreign Exchange Rate Volatility With commodity money, such as gold or silver, there is very little interest rate or foreign exchange volatility. With fiat money, there is inherent high volatility, which tends to be hedged by derivatives, and which adds additional cost to financing. Financial sector participants benefit. Workers, manufacturers, entrepreneurs and consumers pay the cost. Almost everyone who is not a participant or supplier to the financial sector wants monetary stability. Manufacturers want low and stable interest rates so they can make long-term investments in plant, equipment, and research and development. Ordinary people want low stable interest rates so they can plan their futures, buy homes and have some idea what their return will be on assets they have saved for retirement. Those involved in international trade want stable foreign exchange rates to facilitate payment for goods to be delivered far into the future, e.g., airliners, and so on. The financial sector does not want monetary stability. Because so much of its profits derive from trading, the financial sector wants volatility. Tragically, the financial sector has been left in charge of the monetary structure, and it has rigged that structure for its own benefit (really the benefit of top management) and to the detriment of everyone else. That is why the financial sector champions legal tender irredeemable paper-ticket-electronic money. The empirical evidence confirms that legal tender irredeemable paper-ticket-electronic money results in interest rate volatility:
Exhibit 61: U.S. 10-year bond year-on-year interest rate change; Source: Federal Reserve
Prior to the last link to gold being broken by President Nixon in 1971, going back almost 200 years in Britain, and for a lesser period in the U.S., interest rates were relatively stable, very rarely moving plus or minus 20 basis points in any year. After the last link to gold was broken, year-on-year volatility reached 200 basis points and even higher. One shocking result was that interest rate volatility played havoc with defined benefit pension plans (DBPPs). The added risks to companies led many to replace DBPPs with defined contribution pension plans, which transfer the risk of the value of pension plan benefits to workers. DBPPs allocate their investments to the fixed income and equity markets. Using General Accepted Accounting Principles (GAAP), because DBPP liabilities are discounted by interest rates, interest rate volatility resulted in volatility for pension plan liabilities. In the 1980s, in addition to interest rate volatility, there was also volatility in the equity markets. Changes in pension plan assets and liabilities flowed through to the income statements of the companies affected. Thus, volatility in pension assets and liabilities resulted in volatility in reported earnings. Investors want earnings stability. Companies with great profit volatility are penalized with lower stock prices than they would otherwise enjoy. For company management, lower stock prices meant that they would be less likely to reap a benefit from their stock options. What was their remedy? Corporate management appealed to their accountants who lobbied to change GAAP to allow management to smooth interest rates and changes in equity valuations on the theory that since pensions would not be due for many years, it was unfair to pay such close attention to yearly interest rate and equity fluctuations. This led to abominations called the expected rate-of-return and a smoothed discount rate. Accountants and actuaries did the calculations for the smoothing. Management hired and paid them. Since contributions to a pension fund are considered a cost, in an effort to reduce costs, it is to managements benefit to have the assumed rate-of-return and the discount rate to be high as possible. The result is that, depending upon whom one listens to, public pension funds are underfunded by as much as $3 trillion, and the DBPPs that remain in the private sector are underfunded by about $ trillion.
There was another wrinkle to this that adversely affected pension plan beneficiaries. Because pension fund liabilities are discounted by the discount rate, the higher the discount rate, the less the present value of the liabilities. In the 1980s, on account of high interest rates, some DBPPs became over-funded. Then ensued a great deal of merger and acquisition activity whereby, if a firm could be liquidated, the pension plan could be frozen, and any overfunding could be recaptured. Recall the movie Wall Street whereby rationale for liquidating the airline Blue Star was its overfunded pension plan. Working people who are depending on their DBPPs for retirement are not going to receive pensions and benefits they are expecting. None of this would have occurred if we had an honest monetary system. By passing The Free Competition in Currency Act of 2011, an anticipated new monetary system based on gold-as-money will avoid this kind of malfeasance. For those who are engaged in international trade, stable exchange rates are essential. Foreign exchange rate volatility results in lower profit, or even losses. It reduces the international division of labor and our and our trading partners standard of living. Consider volatility between the U.S. dollar and the Canadian dollar:
Exhibit 62: Year-to-year currency volatility: Canadian dollar vs. U.S. dollar 1972 - 2008
Exhibit 63: Foreign Exchange Rate: Canadian dollar per U.S. dollar
With our European trading partners foreign exchange rate volatility is even more extreme. To protect themselves from catastrophic foreign exchange losses, firms buy derivative contracts from banks. This cost is a benefit to financial sector firms. As Mr. Paul Volcker has noted numerous times, a global economy requires a global currency. The open issue is what is the global currency going to be? If the global currency is gold, then there is no foreign exchange volatility. Of course, that will mean an end to a material profit stream for financial sector firms. Is that a contributing reason why the International Monetary Fund changed its Articles of Agreement in 1978 to prohibit member countries from linking their currencies to gold and only to gold?263 What might be the public policy justification of that prohibition? Wall Street and the Banks With commodity money, such as gold and silver, Wall Street, while important, plays a minor role. Its primary function is to help asset allocation on a much-reduced scale. With fiat, legal tender irredeemable paper-ticket-electronic money, Wall Street, because it has easy access to money created out of nothing, plays a dominant role in society.
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IMF Articles of Agreement Section 4-2b
Consider the growth of the financial sector after the last link to gold was broken in 1971.
Exhibit 64: Growth of the Financial Sector
In 1980, the broad money supply (M3) as reported by the Federal Reserve was slightly less than $2 trillion. The U.S. stock market capitalization was about $1 trillion, and financial sector firms accounted for about 5% of the total, about $50 billion. On the plot above, one can barely see the valuation of the financial sector. By 2007, the money supply, all created flat out of nothing, had zoomed to about $13 trillion, but now the market capitalization of the equity markets was about $19 trillion, and about $4 trillion of that was from financial sector firms. Forget about the multi-million dollar bonuses and salaries. That was chickenfeed compared to the value of stock options. Some folks in the financial sector garnered so much money they didn't know what to do with it. The extravagances are legend: 40,000 foot houses in multiple locations around the world, 200 foot boats, $200 million airplanes with another $100 million to outfit them. Some extreme excesses made the major media. For instance, on February 26, 2002 it was reported that six investment bankers went out for dinner and spent $60,000 for a meal! The media is fond of reporting financial sector management taking home tens of millions. Frank Raines, at one time a government employee earning government scale wages, is reported to have left Fannie Mae with more than $100 million. The question that needs to be addressed is exactly what do these folks provide to society that they should be rewarded like this?
Here is another way of looking at the data:
Exhibit 65: Financial Sector as percent of S&P500; Source: Standard & Poors
The growth of the financial sector, while noticed, was not criticized greatly because on the back of obscene money creation, equity valuations greatly increased, too. Whats to say if ones Goldman Sachs or Merrill Lynch account is growing at double digits? When the equity markets lost nearly half their value almost overnight, for some people it was a wakeup call that something is seriously wrong.264
For Bear Stearns employees, the decline was over a weekend. They went to sleep on a Friday night when their stock had a book value of about $85 per share. When they awoke Monday morning, the stock was trading for $2. There was a clean certificate from the accountants, an investment-grade rating from the rating agencies, and no malfeasance. Again, theres something wrong with a system that can destroy accumulated savings in this manner. That something is our dishonest monetary system.
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Exhibit 66: U.S. Stock Market Capitalization 1980 2005
Wall Street firm revenues, again, just for moving paper around, took off as well:
Exhibit 67: NYSE Member Firm Revenues 1965 2005; Source: SIFMA
Twenty-something-year-old youngsters, fresh out of college began taking down multimillion dollar salaries. Again, what was the product or service that they were providing to society that they should have received that level of compensation? Did they invent
anything that improved the lives of anyone? Did they cure some dread disease? Did they produce a useful product? No, no, and no. They were the fortunate beneficiaries of legal tender irredeemable paper-ticket-electronic money creation. And look what happened to bank revenues after the last link to gold was broken:
Gold tie Broken
Exhibit 68: U.S. Bank Revenues 1934 2007; Source: FDIC
And after paying out multimillion dollar salaries to talent, look at how bank net income increased after the last tie to gold was broken:
Gold tie Broken
Exhibit 69: U.S. Bank Net Income 1934 2007; Source: FDIC
Consider the tradeoffs between commodity money and legal tender irredeemable paper-ticket-electronic money for banks. With commodity money, such as gold or silver, the role of bankers is limited to: (1) storing money for safekeeping; (2) acting as intermediaries between savers and credit-worthy borrowers; and (3) facilitating the payments transfer system. with legal tender irredeemable paper-ticket-electronic money, bankers have a greatly expanded role: they sell instruments to hedge interest rate and foreign exchange volatility; and they create fiat money (in the form of credit) for which they get the interest and fees. In effect, banks traditional role as intermediaries between savers and borrowers decrease, and the banks become the equivalent of hedge funds whose downside is guaranteed and subsidized by ordinary working people. The euphemisms for these guarantees are called the lender of last resort bailout facility at the Federal Reserve, and so-called Federal Deposit Insurance, which is not insurance. Again, focusing on stock options, look at what happened to Citibank stock as a result of money creation:
Exhibit 70: Citibank stock from about 1979 to about 2009
One can well imagine the amount of wealth garnered by executives fortunate enough to have stock options with long durations.
Gold tie to dollar broken
Exhibit 71: Bank Compensation to Employees 1934 2007; Source: FDIC
While financial sector compensation appears excessive by any standard, it is important to note that these folks have done nothing wrong. George Soros once said: I'm just playing by the rules, and I didn't make up the rules. There is something seriously wrong with the rules. It is not a lack of regulation. It is our dishonest monetary structure. That needs to be changed. The Free Competition in Currency Act of 2011 is necessary to get that done.
Special Privileges for Banks and Other Financial Players With commodity money such as gold or silver, banks and other financial players receive no special privileges. Because of the instability of fiat-based monetary regimes, to protect the efficacy of the payment transfer systems, there is a need for a safety net for the financial sector. This safety net, as Mr. Greenspan has pointed out, is a subsidy to the financial sector. It constitutes wealth transfer from ordinary taxpayers to the financial sector. While regulators are charged with monitoring the financial sector to reduce or make less likely massive wealth transfer, the financial sector has a history of compromising politicians who are nominally in charge of the regulators. At the end of the day, in all cases, regulation fails and the fiat system collapses. Taxes on Money When used as money, gold and silver per se is not taxed. When not used as money, and partially in an effort to suppress its use as money, the U.S. general government has arbitrarily classified gold and silver bullion, coins, and securities representing gold and silver as collectibles and subject to taxation at a much increased level as compared to capital gains for financial securities. Local jurisdictions also apply taxes, e.g., sales taxes, on transactions in gold or silver. When used as money, fiat money per se is not taxed. However, taxes do apply for transactions whereby U.S. legal tender irredeemable paper-ticket-electronic money is converted to another countrys legal tender irredeemable paper-ticket-electronic money. Another benefit of The Free Competition in Currency Act of 2011 is that it abolishes taxation on gold and silver, the money mandated by the Constitution. Part of the human condition is that people must save for a time when they become too old or incapacitated to work. Ordinary people seek a medium that is the most secure form of savings. Today, on account of coercion, misrepresentation and nondisclosure of material information, few are saving silver or any gold. Were they to convert their labor into gold instead of legal tender irredeemable paper-ticket-electronic money or securities denominated in legal tender irredeemable paper-ticket-electronic money, why should they have to give up a portion of their savings when the legal tender irredeemable paper-ticket-electronic money depreciates? That strikes one as blatantly unjust. For example, if one works and allocates his earnings that are not consumed into gold, and the Federal Reserve, in Mr. Greenspans
exact words, creates money without limit, thereby depreciating the purchasing power of legal tender irredeemable paper-ticket-electronic money, why should one be penalized for having saved gold or silver by having to pay income or other taxes on the appreciation of his gold or silver relative to the legal tender irredeemable paper-ticket-electronic money? Without the ability to save gold or silver, ordinary people are defenseless against the loss of their savings on account of our unconstitutional and dishonest monetary system. Current taxing schemes whereby the IRS has misclassified gold and silver as collectibles subject to a 28% tax on appreciation against legal tender irredeemable paper-ticket-electronic money provide a great disincentive for such saving. Justice cries out to get rid of this and other pernicious taxing schemes. Summary and Recommendations As I hope this testimony makes clear, in every area of our economy that is important, whether it be jobs, pensions, wages, debt levels, government fiscal responsibility at all levels, etc. legal tender irredeemable paper-ticket-electronic money works to the disadvantage of ordinary people and to our nation. For all of history, there have been no successes with paper money. Every one of them has resulted in a disaster. The U.S. experience is vulnerable to being qualitatively different in three critical areas. First, in every country where the paper currency collapsed in the last century, there was always an alternate currency in which some people had saved. That alternate currency was almost always the dollar. In other words, there was always some accumulated wealth that could be used to rebuild. Because the dollar is the so-called reserve currency of the world, when the dollar collapses, most of the planet will be caught empty handed. This has the potential to almost destroy the division of labor for a long time, plunging the U.S. and much of the world into poverty. Second, the U.S. is different in a very important aspect from every other country sans Switzerland. The U.S. is an armed country. There are more than 200 million guns in the hands of the public. When the dollar collapses and people lose their savings, their pensions, their annuities, and their jobs, its hard to say what action they will take. There is the potential for serious unrest. Third, there is a contingency plan, although when I questioned authorities such as Paul Volcker, Larry Summers, and many others, they did not want to speak of it. The contingency plan, as set forth in
myriad legislation and Executive Orders, is martial law. That was what Henry Paulson was talking about when he was attempting to steamroll passing the TARP legislation. We could have a regime change that will set us back possibly for generations. Thats why it is crucial to pass The Free Competition in Currency Act of 2011 in order to mitigate the damage and prepare for an honest monetary system. Mindful that our current monetary system is well on its way to blowing up, I hope that Congress will act quickly and decisively to set things right. For the American people to accept what will be perceived as drastic changes in the monetary structure, those changes will need the imprimatur of being in conformity with the Constitution. Fortunately, that is indeed the case. While Congress is certainly culpable for allowing the monetary system to become unauthorized and dishonest, it was not this Congress. All of the malfeasance was set in train a long time ago, some as far back as 100 years ago when the Federal Reserve legislation was passed. As a practical matter, absent the debacle of a complete collapse, there can be no abrupt changes to our monetary system. That is another reason why The Free Competition in Currency Act of 2011 is so important and so timely. It leaves everything in place: the Federal Reserve, the irredeemable paper-ticket-electronic dollar (which will cease to be legal tender), and all of the mutual promises based on it. For day-to-day transactions, eliminating legal tender is irrelevant. People work, they get paid, and they exchange their pay for daily needs: food, shelter, fuel, etc. Why would anyone care if the dollar is depreciating at the Federal Reserves hoped-for rate of 2% or thereabout? I doubt they will. But there are situations where some people will care: making sure that future payment will be made at a value that one is anticipating. Fortunately, we have precedent in the U.S. to guide us to how those situations will most likely be dealt with. After the Civil War experience with Greenbacks, to protect against the depreciation of paper money, for long-term transactions, e.g., real property leases, long-term loans, bond issues, people inserted a gold clause in their contracts. 265 This provided that future payments should be made in gold at the same weight and fineness as were current at the time that contracts were entered into.
When the U.S. Government sold Liberty Bonds to help finance World War I, the bonds had a gold clause. The promise of gold redemption was defaulted when President Roosevelt seized the nations gold and made it a felony for American citizens to own monetary gold anywhere in the world.
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In this way, provided there is no discontinuity in the purchasing power of the dollar and it continues to depreciate slowly, in time we will make a transition to a gold-as-money monetary system. Our country will then reap the benefits of a sound system that will encourage savings, capital investment, high paying jobs, and all the other benefits described above in this testimony. Agreements for future payment in gold cannot be accomplished if there are taxes on the money itself. Thus, the provisions in The Free Competition in Currency Act of 2011 to eliminate any taxes on gold and silver are also essential. In addition, we need a way to get gold into the hands of the population at large. Thus, as envisioned by Alexander Hamilton, the mints should be opened for free coinage; people should be able to bring gold or silver to the mint to have it coined. While it would be helpful to allow private mints, they will certainly do no harm and may provide extra needed capacity, its not clear to me that the death penalty could apply to a private mint that cheated on its coinage, as the penalty does apply for anyone who counterfeits coins from the U.S. mint. Other recommendations that are not addressed by the proposed Act: (1) The U.S. supposedly has in the treasury about 288 million ounces of gold. (This gold reserve has not been audited since the Eisenhower years. Its time for an audit.) It would be helpful if that gold was coined and distributed per capita to every American citizen, perhaps a 25 gram coin each. a. On the theory that they cannot replenish their savings when the legal tender irredeemable paperticket-electronic dollar collapses, perhaps older people should get extra and infants none at all on the theory that their parents would take care of them. (2) Relief could be brought to the real estate market by the president declaring real estate taxes (now under the jurisdiction of state and local governments) as against public policy. Eliminating real estate taxes will boost real estate valuation by a factor of about twenty times the eliminated tax. Nationwide, real estate taxes are about $400 billion per year. Thus, order of magnitude, real estate valuations would increase by about $8 trillion. That would give relief to almost all those whose mortgages are underwater. Revenue from lost real estate taxes could be compensated by increasing
sales taxes. Errata: The original submission had the date of the Resumption Act as having been signed in 1869. The correct date of the Act is January 14, 1875.
WRITTEN TESTIMONY OF LAWRENCE H. WHITE, Ph.D.

PROFESSOR OF ECONOMICS GEORGE MASON UNIVERSITY
Chairman Paul, Ranking Member Clay, and members of the subcommittee: Thank you for the opportunity to discuss my views on HR 1098, the Free Competition in Currency Act of 2011 (hereafter the Act). As an economist specializing in monetary systems I have studied and written for many years about the role of free competition
in currency. Indeed the second book of my three books on the topic, published in 1989 by New York University Press, was entitled Competition and Currency.
THE BENEFITS OF CURRENCY COMPETITION It is widely understood that competition among private enterprises gives us technological improvements in all kinds of products, delivering higher quality at lower cost. For example, the competition of FedEx and UPS with the U.S. Postal Service in package delivery has been of great benefit to American consumers. Currency users also benefits from competition. My research indicates that currency has been better provided by competing private enterprises than by government monopoly. For example, private gold and silver mints during the American gold rushes provided trustworthy coins until they were suppressed by legislation. Scientific appraisals have found that the privately minted coins were produced even more precisely than the coins of the U.S. Mint. Private bankissued currency was the most popular form of money around the world until government-sponsored central banks, with few exceptions, gained exclusive note-issuing privileges. We do not rely on the Treasury or the Federal Reserve, but rather private financial institutions, to provide our checking accounts, credit cards, and travelers checks. The consumer benefits from the competition in payment services among banks. Consumers would
likewise benefit from free and fair competition among coin issuers. Although Federal Reserve Notes and Treasury coins should of course be protected from counterfeiting, there is no good case for them to enjoy monopoly privileges in the market for currency.
HR 1098 would give currency competition a chance. It would not remove the Federal Reserve from the currency market, but it would give the Fed a stronger incentive to deliver the kind of trustworthy money that consumers want. The dollar already faces salutary
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international competition from gold, silver, the euro, the Swiss Franc, and other stores of value. HR 1098 would allow salutary domestic competition between the Federal Reserve Note and other media of exchange. The Fed will have little to fear from competition so long as it provides the highest quality product on the market. Continuing to ban competition from the domestic U.S. currency market, or keeping it at a legal disadvantage, limits the options of American consumers who
use money to their disadvantage.

What sort of competition might we see if currency were free from legislated restrictions? Here is one example. In 1998 a non-profit organization launched the American Liberty Currency, a private silver-based currency intended to compete with Federal Reserve currency. In the year 2000 I wrote an article about the project, entitled A Competitor for the Fed?, published by The Foundation for Economic Educations magazine The Freeman (vol. 50, July 2000). I was skeptical that the project would attract many users, absent high inflation in the dollar. But I noted then, and I reiterate today, that in a high-inflation environment silver-backed currency with widespread
acceptance would provide a useful alternative to the Federal Reserves product. Then, if you dont like the way the federal government manages (or mismanages) the value of the fiat dollar, you arent limited to complaining. You can switch to the private alternative. If double-digit
inflation should unfortunately return to the United States, then the American public, as I wrote, would find a very practical advantage in a silver-backed alternative to the free-falling Federal Reserve note. The Act offers three reforms. I will comment on them in turn. SECTION 2 Section 2 of the Act repeals 31 USC, 5103, which presently declares that US coins and currency (including Federal Reserve notes ) are legal tender for all debts, public charges, taxes, and dues. What are the likely economic consequences of removing legal tender status from US Treasury coins and Federal Reserve notes? The immediate consequences would be minimal. New forms of currency will not be introduced into the market any faster than the public is prepared to accept them. The longer-run consequence will be to enable a more level playing field for competition in the issue of currency. Legal tender status is more limited in its scope than is sometimes believed. That Federal Reserve notes and Treasure coins have legal tender status does not mean that they are the only legal way to pay.
Any seller or creditor may (of course) voluntarily accept payment by
transfer of bank-account balances, that is, by ordinary bank check, debitcard transfer, direct deposit, or wire transfer. Travelers checks or cashiers checks may be accepted. The seller or creditor may even accept foreign currency or barter. Measured by dollar volume, payments in Federal Reserve notes or coin are a tiny share of all final payments in the United States (less than 20% of consumer payments, nearly 0% of business-to-business and financial payments). The great bulk of payments are electronic transfers of non-legal-tender bank balances.
Nor does legal-tender status mean that acceptance is mandatory when offered at a point of sale in a spot transaction. Largedenomination Federal Reserve notes are refused at many points of sale, and lawfully so. Vending machines refuse pennies. Mail-order sellers may refuse cash of any denomination. Millions of legal-tender one-dollar coins are piling up in the Federal Reserves vault in Baltimore because nobody wants them. Legal tender relates to the discharge of debts. The phrase Legal tender for all debts in 31 USC, 5103, quoted above, means that if Smith owes Jones $125, then Smiths offering Jones $125 in US coins or Federal Reserve notes legally extinguishes the debt, even if Jones would prefer payment in some other form (say, a check). In other words, the creditor is barred from refusing payment in legal tender notes or coins. There is already an important exception, however. Debts in goldclause contracts, made since 1977, are not unilaterally discharged by offer of US coin or Federal Reserve notes. 31 U.S.C. 5118(d)(2) reads: An obligation issued containing a gold clause or governed by a gold clause is discharged on payment (dollar for dollar) in United States coin or currency that is legal tender at the time of payment. This paragraph does not apply to an obligation issued after October 27, 1977. [emphasis added] That is, the holder of a gold-clause bond is free to insist on receiving payments in gold, or in an amount of dollars indexed to the price of gold, whichever the bond contract specifies. Removing legal-tender status from U.S. Treasury coins and Federal Reserve notes generally, as Section 2 of the Act does, essentially broadens the gold-clause exception to allow contractual obligations to specify payment in, or indexed to, any medium that is an alternative to Treasury coins and Federal Reserve notes. It opens the competition not just to private checks and banknotes, but also to gold units, silver units, units of foreign currency, Consumer Price Index bundles, wholesale commodity bundles, Bitcoins, and whatever
else a lender and a borrower might agree upon. If they prefer a unit for denominating their debt contract other than the Fed or Treasury dollar, they would be free to write a specifically enforceable contract in the unit of their choice. Hand-to-hand currency does not need legal tender status to make it circulate easily. In jurisdictions where private commercial banks may issue circulating currency notes or banknotes (found today in Scotland, Northern Ireland, and Hong Kong), banknotes have the same
legal status as checks. That is, they do not have legal tender status. Any creditor might refuse them if he preferred to be paid in another medium. (In Scotland and Northern Ireland, only pound sterling coins are legal tender.) I have spent a fair amount of time in Northern Ireland, visiting the Finance Department at the Queens University of Belfast, and have observed the circulation of banknotes there first-hand. There are four private banks that issue notes, and all of their notes are universally accepted. Legal tender status is clearly not necessary to have currency that circulates widely and is commonly accepted for payment of debts. Currency notes do not need legal tender status any more than credit cards, checks, debit cards, or travelers checks.
SECTION 3 Section 3 of the Act rules out federal or state taxes on preciousmetal coins, whether minted by a foreign government or by a private firm. This section would allow precious-metal coins to compete with the US Treasurys token coins (made of base metals, and denominated in fiat US dollars) without tax disadvantages (sales taxes on acquisition and capital gains taxes on holding, from which Federal Reserve Notes are exempt), and thereby a level playing field for competition among monetary standards. SECTION 4 Section 4 of the Act repeals Title 18 486 (relating to uttering or passing coins of gold, silver, or other metal) and 489 (making or possessing likeness of coins). Section 486 is a relic of the Civil War, part of an effort to bolster the use of the wartime paper greenback currency by banning competition from the private gold coins I previously mentioned. The repeal of 486, combined with the previous section, would allow silver and gold coins to compete with the Treasury and the Fed on a level playing field. I previously mentioned the American Liberty Currency project. The mover of that project, Bernard von Not Haus, was convicted in
March 2011 of violating 486, and presently awaits sentencing, for the victimless crime of producing one-ounce silver coins, of original design, that he hoped would compete with the Federal Reserves currency. Regarding this case I commend to your attention the article by Seth Lipsky, When Private Money Becomes a Felony Offense, Wall St. Journal, 31 March 2011. The repeal of 486 would avoid a repeat of the injustice done to Mr. von Not Haus. I share Mr. Lipkys view that its a losers game to suppress private money that is sound in order to protect government-issued money that is unsound. Title 18 489 of current law outlaws making or possessing any token, disk, or device in the likeness or similitude as to design, color, or the inscription thereon of any of the coins of the United States or of any foreign country issued as money, either under the authority of the United States or under the authority of any foreign government. Von NotHaus was also charged with violating this section. In my view 489 is redundant at best and over-reaching at worst. It is
redundant at best because if there is any fraudulent intent in making or passing such a device, it is already outlawed under 485, which bans the counterfeiting of US coins. To outlaw likeness or similitude as to design, color, or the inscription [emphasis added] in cases where it is not counterfeiting and has no fraudulent intent, is far too sweeping. Taken literally, 489 outlaws all commemorative silver medallionsand if you go on eBay, youll find that there are thousands of them for sale because it says that you are in violation of the law if you make or own any disk that merely has a color similar to that of a US quarter.
CONCLUSION Competition in general creates incentives to provide a high quality product by taking business away from low-quality producers. Competition in currency is a practical idea that offers sizable benefits to the public when the quality of the incumbent currency becomes doubtful. In particular, US citizens would benefit from freedom of choice among monetary alternatives though the removal of current legal restrictions and obstacles against currencies that could compete with Federal Reserve Notes and US Treasury coins. HR 1098 would give currency competition a chance.
XPERT
OMMENTARY
LLEWELLYN H. ROCKWELL, Jr.

FOUNDER AND CEO LUDWIG VON MISES INSTITUTE
ROTHBARD AND MONEY The scholarly contributions of Murray Rothbard span numerous disciplines, and may be found in dozens of books and thousands of articles. But even if we confine ourselves to the topic of money, the subject of this volume, we still find his contributions copious and significant. As an American monetary historian Rothbard traced the party politics, the pressure groups, and the academic apologists behind the various national banking schemes throughout American history. As a popularizer of monetary theory and history he showed the public what government was really up to as it took greater and greater control over money. As a business cycle expert he wrote scholarly books on the Panic of 1819 and the Great Depression, finding the roots of both in artificial credit expansion. And while the locus classicus of monetary theory in the tradition of the Austrian School is Ludwig von Mises 1912 work The Theory of Money and Credit, the most thorough shorter overview of Austrian monetary theory is surely chapter 10 of Rothbards treatise Man, Economy and State. Rothbard placed great emphasis on the central monetary insight of classical economics, namely that the quantity of money is unimportant to economic progress. There is no need for the money supply to be artificially expanded in order to keep pace with population, economic growth, or any other factor. As long as prices are free to fluctuate, changes in the purchasing power of money can
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accommodate increases in production, increases in money demand, changes in population, or whatever. If production increases, for example, prices simply fall, and the same amount of money can now facilitate an increased number of transactions commensurate with the greater abundance of goods. Any attempt by monetary policy to keep prices from falling, to accommodate an increase in the demand for money, or to establish price stability, will yield only instability, entrepreneurial confusion, and the boom-bust cycle. There is no way for central bank policy or any form of artificial credit expansion to improve upon the micro-level adjustments that take place at every moment in the market. With the exception of the Austrian School of economics, to which Rothbard made so many important contributions throughout his career, professional economists have treated money as a good that must be produced by a monopoly either the government itself or its authorized central bank. Rothbard, on the other hand, teaches that money is a commodity (albeit one with unique attributes) that can be produced without government involvement. Rothbards history of money, in fact, is a history of small steps, the importance of which are often appreciated only in hindsight, by which government insinuated its way into the business of money production. It was Carl Menger who demonstrated how money could emerge on the free market, and Ludwig von Mises who demonstrated that it had to emerge that way. In this as in so many other areas, Mises broke with the reigning orthodoxy, which in this case held that money was a creation of the state and held its value because of the states seal of approval. A corollary of the Austrian view was that fiat paper money could not simply be created ex nihilo by the state and imposed on the public. The fiat paper we use today would have to come about in some other way. It was one of Rothbards great contributions to show, in his classic What Has Government Done to Our Money? and elsewhere, the precise steps by which the fiat money in use throughout the world came into existence. First, a commodity money (for convenience, lets suppose gold) comes into existence on the market, without central direction, simply because people recognize that the use of a highly valued good as a medium of exchange, as opposed to persisting in barter, will make it easier for them to facilitate their transactions. Second, money substitutes began to be issued, and circulate instead of the gold itself. This satisfies the desires of many people for convenience. They would rather carry paper, redeemable into gold, than the gold itself. Finally, government calls in the gold that backs
the paper, keeps the gold, and leaves the people with paper money redeemable into nothing. These steps, in turn, were preceded by the seemingly minor but in retrospect portentous indeed government interventions of monopolizing the mint, establishing national names for the money in a particular country (dollars, francs, etc.), and imposing legal tender laws. Rothbard also brought the Austrian theory of the business cycle to a popular audience. Joseph Salerno, who has been called the best monetary economist working in the Austrian tradition today, was first drawn to the Austrian School by Rothbards essay Economic Depressions: Their Cause and Cure. There Rothbard laid out the problems that business cycle theory needed to solve. In particular, any theory of the cycle needed to account, first, for why entrepreneurs should make similar errors in a cluster, when these entrepreneurs have been chosen by the market for their skill at forecasting consumer demand. If these are the entrepreneurs who have done the best job of anticipating consumer demand in the past, why should they suddenly do such a poor job, and all at once? And why should these errors be especially clustered in the capital-goods sectors of the economy? According to Rothbard, competing theories could not answer either of these questions satisfactorily. Certainly any theory that tried to blame the bust on a sudden fall in consumer spending could not explain why consumer-goods industries, as an empirical fact, tended to perform relatively better than capital-goods industries. Only the Austrian theory of the business cycle adequately accounted for the phenomena we observe during the boom and bust. The cause of the entrepreneurial confusion, according to the Austrians, is the white noise the Federal Reserve introduces into the system by its manipulation of interest rates, which it accomplishes by injecting newly created money into the banking system. The artificially low rates mislead entrepreneurs into a different pattern of production than would have occurred otherwise. This structure of production is not what the free market and its price system would have led entrepreneurs to erect, and it would be sustainable only if the public were willing to defer consumption and provide investment capital to a greater degree than they actually are. With the passage of time this mismatch between consumer wants and the existing structure of production becomes evident, massive losses are suffered, and the process of reallocating resources into a sustainable pattern in the service of consumer demand commences. This latter process is the
bust, which is actually the beginning of the economys restoration to health. The concentration of losses in the capital-goods sector can be explained by the same factor: the artificially low interest rates brought about by the Feds intervention into the economy. What Austrians call the higher-order stages of production, the stages farthest removed from finished consumer goods, are more interestrate sensitive, and will therefore be given disproportionate stimulus by the Feds policy of lowering interest rates. Equipped with this theory, Rothbard wrote Americas Great Depression (1963). There Rothbard did two things. First, he showed that the Great Depression had not been the fault of unregulated capitalism. After explaining the Austrian theory of the business cycle and showing why it was superior to rival accounts, Rothbard went on to apply it to the most devastating event in U.S. economic history. In the first part of his exposition, Rothbard focused on showing the extent of the inflation during the 1920s, pointing out that the relatively flat consumer price level was misleading: given the explosion in productivity during the roaring 20s, prices should have been falling. He also pointed out how bloated the capital-goods sector became vis-a-vis consumer goods production. In other words, the ingredients and characteristics of the Austrian business cycle theory were very much present in the years leading up to the Depression. Second, Rothbard showed that the persistence of the Depression was attributable to government policy. Herbert Hoover, far from a supporter of laissez-faire, had sought to prop up wages during a business depression, spent huge sums on public works, bailed out banks and railroads, increased the governments role in agriculture, impaired the international division of labor via the Smoot-Hawley Tariff, attacked short sellers, and raised taxes, to mention just a portion of the Hoover program. Rothbard had been interested in business cycles since his days as a graduate student. He had intended to work on a history of American business cycles for his Ph.D. dissertation under Joseph Dorfman at Columbia University, but he found out that the first major cycle in American history, the Panic of 1819, provided ample material for study in itself. That dissertation eventually appeared as a book, via Columbia University Press, called The Panic of 1819: Reactions and Policies (1962). In that book, which the scholarly journals have declared to be the definitive study, Rothbard found that a great many contemporaries identified the Bank of the United States which was supposed to be a source of stability as the primary
culprit in that period of boom and bust. American statesmen who had once favored such banks, and who thought paper money inflation could be a source of economic progress, converted to hard money on the spot, and proposals for 100-percent specie banking proliferated. In A History of Money and Banking: The Colonial Era to World War II, a collection of Rothbards historical writings published after the authors death, Rothbard traced the history of money in the United States and came up with some unconventional findings. The most stable period of the nineteenth century from a monetary standpoint turns out to be the period of the Independent Treasury, the time when the banking system was burdened with the least government involvement. Whats more, the various economic cycles of the nineteenth century were consistently tied to artificial credit expansion, either participated in or connived at by government and its privileged banks. Rothbard further showed that the traditional tale of the 1870s, when the United States was supposed to have been in the middle of the Long Depression, was all wrong. This was actually a period of great prosperity, Rothbard said. Years later, economic historians have since concluded that Rothbards position had been the correct one. Rothbards treatment of the Federal Reserve System itself, which he dealt with in numerous other works, involved the same kind of analysis that historians like Gabriel Kolko and Robert Wiebe applied to other fruits of the Progressive Era. The conventional wisdom, as conveyed in the textbooks, is that the Progressives were enlightened intellectuals who sought to employ the federal regulatory apparatus in the service of the public good. The wicked, grasping private sector was to be brought to heel at last by these advocates of social justice. New Left revisionists demonstrated that this version of the Progressive Era was nothing but a caricature. The dominant theme in Progressive thought was expert control over various aspects of society and the economy. The Progressives were not populists. They placed their confidence in a technocratic elite administering federal agencies removed from regular public oversight. Whats more, the resulting regulatory apparatus tended to favor the dominant firms in the market, which is why the forces of big business were in sympathy with, rather than irreconcilably opposed to, the Progressive program. With such powerful interests as the Morgans, the Rockefellers, and Kuhn, Loeb in basic agreement on a new central bank, Rothbard wrote, who could prevail against it? It is with these insights in mind that Rothbard scrutinized the Federal Reserve. He would have none of the idea that the Fed was
the creation of far-seeing public officials who sought to subject the banking system to wise regulation for the sake of the peoples wellbeing. The Fed was created not to punish the banking system, but to make its fractional-reserve lending operate more smoothly. In The Case Against the Fed, What Has Government Done to Our Money?, and The Mystery of Banking, Rothbard took the reader through the step-by-step process by which the banks engaged in credit expansion, earning a return by lending money created out of thin air. Without a central bank to coordinate this process, Rothbard showed, the banks position was precarious. If one bank inflated more than others, those others would seek to redeem those notes for specie and the issuing bank would be unable to honor all the redemption claims coming in. The primary purpose of the central bank, therefore, in addition to propping up the banks through its various liquidity injections and its position as the lender of last resort, is to coordinate the inflationary process. When faced with the creation of new money by the Fed, the banks will inflate on top of this new money at the same rate (as determined by the Feds reserve requirement for banks). Therefore, the various redemptions will tend, on net, to cancel each other out. This is what Rothbard meant when he said the central bank made it possible to inflate the currency in a smooth, controlled, and uniform manner throughout the nation. Although Rothbard distinguished himself as a monetary theorist and as a monetary historian, he did not confine himself to theory or history. He devoted plenty of attention to the here and now to critiques of Federal Reserve policy, for example, or to criticisms of government responses to the various fiascoes, the Savings and Loan bailout among them, to which our financial system is especially prone. He likewise looked beyond the present system to a regime of sound money, and in The Case for a 100 Percent Gold Dollar and The Mystery of Banking laid out a practical, step-by-step plan to get there from here. In his work on monetary theory and history, as in his work in so many other areas, Rothbard showed from both an economic and a moral point of view why a system of liberty was preferable to a system of government control. At a time when the political class and the banking establishment are being subjected to more scrutiny than ever, the message of Rothbard takes on a special urgency. For that reason we should all be grateful that his monetary work, and that of the other great Austrian economists, is being carried on by Murray Rothbard's friend and colleague Ron Paul. By my
reckoning, no one in history has brought true monetary theory and history to a larger audience.
_____________________
Llewellyn H. Rockwell, Jr, former editorial assistant to Ludwig von Mises and congressional chief of staff to Ron Paul, is founder and CEO of the Mises Institute, executor for the estate of Murray N. Rothbard, and editor of LewRockwell.com.
EARING VIII.
SOUND MONEY: PARALLEL CURRENCIES AND THE ROADMAP TO MONETARY FREEDOM
THURSDAY, AUGUST 2, 2012

WITNESSES Lewis, Nathan, Principal, Kiku Capital Management LLC. Ebeling, Richard, Ph.D., Professor of Economics, Northwood University Gray, Rob, Executive Director, The American Open Currency Standard
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing entitled Sound Money: Parallel Currencies and the Roadmap to Monetary Freedom at 10:00 a.m. on Thursday, August 2, 2012 in Room 2128 of the Rayburn House Office Building. This hearing examined parallel currencies and alternative forms of money, the effects of parallel currencies on the economy and monetary policy, and the obstacles that prevent the circulation of alternative forms of money. This was a one-panel hearing with the following witnesses: Dr. Richard Ebeling, Professor of Economics, Northwood University Mr. Nathan Lewis, Principal, Kiku Capital Management LLC Mr. Rob Gray, Executive Director, The American Open Currency Standard
Parallel currency is a term that describes alternative currencies or forms of money circulating alongside the dominant medium of exchange. Federal Reserve Notes and dollar-denominated bank deposits are the most common media of exchange in the United States. Parallel currencies would thus be any voluntarily-chosen alternative medium of exchange. Fiat Monetary Regime Since the breakdown of the Bretton Woods system of monetary management in 1971, which tied most international currencies to the partially gold-backed U.S. dollar, most of the world has operated
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under a pure fiat currency system. 266 Under a fiat currency system, the amount of money and currency in circulation is left to the discretion of the monetary authority, whose currency is made the legal tender. In the United States, the Federal Reserve System is the monetary authority and it has been given independent authority and responsibility to control the money supply and value of the currency, with a mandate to maintain full employment and price stability. In the wake of the near-collapse of the financial system and the looming debt crises facing both Europe and the United States, those who view the pure fiat currency system as a contributing factor to these events have become both more vocal and also more widely acknowledged. These critics believe that allowing monetary authorities to create money and currency without some form of restraint has contributed to unsustainable expansion of debt, growing inflation, and instability in the global financial system. In light of continued accommodative monetary policies being deployed by monetary authorities to stave off financial crisis, some critics worry that the experiment with pure fiat money is headed toward collapse unless changes are made. To that end, some advocate allowing alternative currencies to begin circulating alongside fiat currencies for two reasons: (1) parallel currencies could restrain monetary authorities from excessive money creation by allowing competition between government fiat money and private money, and thus promote stability; and (2) if the restraint proves ineffective, having in place a system of parallel currencies provides individuals with a safeguard, in the form of an alternative monetary system, should the experiment with pure fiat currencies come to a disorderly end. Parallel Currencies Parallel currencies are based on the notion that the market for currency is like the market for any other good or service. Markets provide consumers with choices between products, and producers compete for consumers by providing the best, most efficient product. In the currency market, the best, most efficient product would be the one that best satisfies all the properties of money: durability, portability, divisibility, ease of recognition, and stability.
A fiat currency derives its value from legal statute requiring it to be accepted as payment in a transaction, typically referred to as a legal tender statute. Alternatively, a commodity-backed currency has an intrinsic value based on the value of the commodity backing the currency. Both types of currency also derive value from their use as a means of exchange, known as exchange value.
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With parallel currencies, any item could emerge as an alternative form of money, but precious metal currency would likely become the most dominant because precious metals contain all the properties necessary to be money and have historically been the forms of money most widely accepted around the world. Precious metals could circulate either as coins, paper certificates backed by coins or bullion, or as an electronic currency, all of which could be provided by private enterprises, each competing to provide the best money,i.e., the soundest, most stable, and most convenient. Obstacles to Parallel Currencies While alternatives to fiat currencies exist in the U.S., their adoption and circulation are limited because of obstacles created by the federal government. These obstacles inhibit the circulation of parallel currencies, diminish the network effects needed for widespread adoption, and limit the use of parallel currencies. Three of the major obstacles are: (1) taxes on precious metals that prevent them from circulating as money; (2) provisions of the federal criminal code that prevent the private minting of coins as currency; and (3) legal tender laws that make U.S. coins and Federal Reserve Notes payment for all debts. Taxation on Currencies Capital gains taxes assessed on the appreciation of the precious metal content of coins have deterred the use of coins made from precious metals as a means of exchange. Under 26 U.S.C. 408(m)(2), coins are declared to be collectibles and are taxed at rates different from those for other capital assets. Coins held for less than one year are taxed at the short-term capital gains rate, while coins held for longer are taxed at a rate of 28 percent. Given the steadily-increasing dollar value of gold and silver coins, using these coins to pay salaries or to make purchases would require burdensome paperwork and tax payments, which makes it prohibitively expensive for precious metal coins to circulate as a parallel currency. Private Mints From the founding of the United States to the Civil War, numerous hard money currencies circulated within this country. These currencies were U.S. Mint coins, foreign coins, and privately minted coins that circulated based on their weight in gold and silver. During this time, individuals could bring in an amount of precious metal and have it assayed and minted by local branches of the U.S.
Mint. Private mints sprang up in areas that were underserved by U.S. Mint and Assay offices. Federal laws enacted in the 1860s and 1870s outlawed the minting of currency by private mints. As greater centralization of government occurred after the Civil War, there was also a push by lawmakers for greater centralization and government control of money issuance. As legislation was passed to create a national banking system, two provisionsnow codified at 18 U.S.C. 486 and 489were enacted that prohibit the operation of private mints, outlawing the coinage of precious metal coins as currency except by the government. Legal Tender Laws Legal tender laws provide that a certain currency is legal tender: that is, the currency must be accepted for payments of debts, taxes, duties etc. Legal tender laws that apply to a certain geographic territory often ensure that the government-issued currency circulates in the economy to the exclusion of other currencies. Some historians and scholars have argued that the federal government does not have the authority under the U.S. Constitution to enact legal tender laws, but merely to coin money and regulate its value. The only reference in the Constitution to legal tender is contained in Article 1, Section 10, which prohibits states from making any Thing but gold and silver Coin a Tender in Payment of Debts. Examples of Private Currencies Liberty Dollar The Liberty Dollar was created in 1998 by Bernard von Nothaus and issued through his company, Liberty Services and was intended for use as a circulating private currency. The Liberty Dollar existed in the form of gold and silver coins, gold and silver certificates backed by those coins, and as an electronic currency. Liberty Dollar coins were minted with a suggested U.S. dollar face value. In November 2007, Liberty Services was raided by the FBI and Secret Service. Its gold, silver, platinum, and copper coins were seized by the U.S. government. Nothaus was charged in 2009 with violating 18 U.S.C. 485 (issuing coinage similar to U.S. coinage) and 18 U.S.C. 486 (minting coins of original design intended for use as money), among other laws, and was convicted in March 2011. American Open Currency Standard (AOCS)
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The AOCS was created in 2007 as an umbrella organization that both issues its own precious metal medallions and also approves those minted by other organizations which conform to AOCS standards of metal purity. Given the experience of Liberty Dollar, AOCS has been cautious to avoid some of the problems that resulted in criminal charges being filed against Bernard von Nothaus. For example, AOCS issues medallions, tokens, or rounds rather than coins and refrains from using the word coin. Their medallions are struck with a medallic orientation, meaning that the reverse is right side up when the coin is flipped on its vertical axis. This makes their product dissimilar from United States coinage, which is struck with a coin orientation, meaning that the reverse is right side up when the coin is flipped on its horizontal axis. Unlike the Liberty Dollar, AOCS medallions are not marked with the term dollar, nor are they marked with a dollar sign. AOCS-approved medallions are minted in copper (1 oz. avoirdupois), silver (1/10, 1/2, 1, and 5 troy ounces), and gold (1/10, 1/2, and 1 troy ounce). AOCS-approved medallions are minted with their weights and a face value number that corresponds proportionally to the metal content of medallions within each metal series. In general, merchants who accept AOCS medallions are willing to exchange them at a dollar to face value parity. GoldMoney GoldMoney was founded in 2001 by James Turk and his son Geoff Turk in recognition of golds usefulness as a financial asset as well as its worldwide role as money. GoldMoney now primarily sells gold, silver, platinum, and palladium to customers around the world and offers storage of those metals to its customers in warehouses in Hong Kong, the United Kingdom, and Switzerland. However, GoldMoney had long contemplated the use of gold in electronic commerce, and increased adoption of the Internet enabled GoldMoney to offer a digital gold currency, allowing its customers to make payments to each other using a patented digital gold currency with a unit of account in grams. GoldMoney holds four patents related to its digital gold currency. In January 2012, increased regulatory burdens and low usage caused GoldMoney to discontinue its digital gold currency for all customers outside of Jersey, a British crown dependency in the Channel Islands where GoldMoney is headquartered. GoldMoney has said that it plans to reinstate metal payments for its customers in other countries in the future.
RANSCRIPT
The subcommittee met, pursuant to notice, at 10:04 a.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, Luetkemeyer, Schweikert; and Green. Chairman PAUL. This hearing will come to order. Without objection, all Members opening statements will be made a part of the record. I also ask for unanimous consent to place in the record a letter with an attachment from Dr. Edwin Vieira, who could not appear on this panel today.267 Without objection, it is so ordered. I will now recognize myself for 5 minutes to make an opening statement. First, I want to welcome our panel today to discuss a very important issue dealing with monetary policy. We have had a series of hearings and discussions in this committee dealing with monetary policy, mostly directed around Federal Reserve policy and the Federal Reserve. Today, there will not be that much emphasis on the Federal Reserve itself, but rather on money: on money, the issue of what it means; what our history is like on money; whether we can have parallel currencies; and what the founders might have thought about parallel currencies. The world is in the midst of a crisis today, and many of us believe it is related to a deeply flawed monetary system, a deeply flawed understanding of what money should be, a rejection of the notion that money should have real value and that money originated in the marketplace rather than originating from a computer over at the Federal Reserve.
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The letter and attachment from Dr. Vieira can be found in Appendix C. 992
SOUND MONEY: PARALLEL CURRENCIES TRANSCRIPT 993
And though today the general public, as well as the financial markets, have a difficult time wanting to accept that or even understand it, ultimately it is the nature of money that I believe we will have to come to grips with, and make a decision about. Because as we speak, they are meeting in Europe and the ECDs are deciding what to do and manipulating their money and credit, as well as we here in the United States. We in this country have been given some benefits, definitely, by being able to issue the reserve currency of the world. And because there is no definition to money, and because we can create money out of thin air, we have had some advantages. But the whole world is engulfed in this problem because of this lack of determination, a lack of desire to understand what money is all about. So today, we want to discuss that, and get the testimony from our witnesses to try to further understand the nature of money and credit, and whether it is necessary to have a precise definition. Also, really, we want to talk about parallel currencies, concurrencies circulate next to each other. And I think the answer is rather clear. They are doing it all the time internationally. Currencies are circulating all the time, and in the computer age, they adjust their values rather quickly. But the question is, can we have parallel currencies within the United States? Would it be legal? Does it contradict the Constitution? What would the States role be in this? And what can they do? Under these circumstances, it does raise a lot of questions, because it raises tax questions and the authorities on how they are going to respond and what one can do with currencies without having the wrath of Big Brother and Big Government coming down on us, and saying, No, you cant do that. But today, we have an absolute monopoly control over money and credit. They are managing a money that they cant even define. And then they wonder why we have chaos in the marketplace. I see a time coming where there will be a response to the problems that we have, a response that I will endorse. And that is for monetary reform. But it wont happen because of our hearing today. I know we are going to have a great hearing and great testimony, and there will be lots of words of wisdom. But we are not going to walk away and all of a sudden the world is going to say, You know, that makes a lot of sense. We have to deal with this. The one thing that I am convinced of with the current system that we have, because we dont deal with the issue of money, is the financial system worldwide is going to get a lot worse, because they
are not admitting the truth of what is happening. Because the system that we have, we have had for so many years and so many decades that it has encouraged a system of horrendous debt. And not only are many of our companies and banks and States and countries insolvent, they wonder why we have a problem. But if they dont admit to it, and think that, well, the solution is just creating more money. So that is an overwhelming task for that reform. But in the meantime, is there anything that we can do to emphasize and to promote the interests of, and the understanding of what sound money would be by just permitting parallel currencies? Why cant we have the freedom to do this? We claim we live in a free country and a free society, but are we allowed to have parallel currencies, are we allowed to have competition, are we allowed to have something in addition to a cartel and a monopoly that has controlled money and credit and has created a worldwide monster for which they have no answers? That is the reason I think this is a very, very important subject. And once again, I want to welcome our panel. I would like to know now if any other Members have an opening statement. No? Okay, thank you. I will now introduce our guest speakers and the members of the panel. Our first guest, Mr. Nathan Lewis, is the principal of Kiku Capital Management, a private investment firm, and author of Gold: the Once and Future Money, which is now published in five languages. His writings can be found in the Financial Times, Forbes, and Dow Jones Newswires, among others. He has appeared on television networks, including Bloomberg TV and CNBC, and has been featured in several television documentaries. Dr. Richard Ebeling is a professor of economics at Northwood University in Midland, Michigan. He is recognized as one of the leading members of the Austrian School of Economics. He is the former president of the Foundation for Economic Education, and author of Political Economy, Public Policy, and Monetary Economics. Dr. Ebeling earned his Ph.D. in economics from Middlesex University in London. Mr. Robert Gray is founder and executive director of the American Open Currency Standard. He is responsible for the creation and successful implementation of more than 150 circulating community currencies and silver-, gold- and copper-based token fund-raising programs.
Mr. Gray helped issue the official currency of the free and independent Lakota Indian Nation, and also founded the Mulligan Mint, a full-service mint in Dallas, Texas. Without objection, your written statements will be made a part of the record, and you will now be recognized for a 5-minute summary of your testimony. I now recognize Mr. Lewis.
STATEMENT OF NATHAN LEWIS268 PRINCIPAL, KIKU CAPITAL MANAGEMENT LLC
Mr. LEWIS. Thank you. The phrase parallel currencies tends to sound rather novel and experimental to us today, living in the United States. However, most people in the world are using parallel currencies today. U.S. dollars or euros are accepted in trade in goods and services. In many countries that suffer from low-quality domestic currencies, the largest corporations finance themselves with dollar-denominated debt. The governments of such countries themselves issue dollar-denominated government bonds. By the end of World War II, the U.S. dollar, which had been considered an emerging market currency in 1900, had proved to be the most reliable currency in the world. In practical terms, this meant that the U.S. dollar remained on a gold standard system while once-prominent European currencies were devalued and political situations became unstable. The dollar thus became the parallel currency of choice worldwide. In 1971, the United States abandoned its then-nearly two-century-old commitment to the gold standard system. At this point, historically, currencies were often discarded for whatever the highest quality, most reliable alternative was which, in practice, meant a gold standard currency from a large developed country. Despite the U.S.s poor currency management since 1971, the alternatives have been even worse. This why the U.S. dollar remains the most popular currency in the world, and serves as a parallel currency in many, if not most, countries today. Today, there are no particularly onerous barriers against using a parallel currency in the United States. People are free to do business in euros or Russian rubles if they so choose. There are over 150 currencies in the world, all of which could conceivably be used as parallel currencies within the United States or other countries.
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[The prepared statement of Mr. Lewis can be found on page 1023.]
However, all of them are floating fiat currencies generally of lower quality than the U.S. dollar or euro. There is hardly any reason to introduce another. Plus, the most meaningful new parallel currency to be introduced in the United States or in another country would be one based on gold. Although the use of other countries national currencies is largely accepted in the United States, the issuance of alternative currencies within the United States can run afoul of what are collectively known as legal tender laws, both de jure and de facto. The one person who attempted to issue a gold- and silver-based parallel currency in the United States was arrested in 2009 and convicted of charges related to counterfeiting and declared to be a domestic terrorist. Gold, today, is regarded as a collectible, and subject to a different system of taxation than if one were to do a similar transaction using foreign currency such as euros or Canadian dollars. In addition, purchases or sales of small quantities of gold are subject to sales taxes in many States. Thus, in practice, the U.S. Federal Government makes a powerful effort to suppress the introduction and use of alternative gold-and silver-based currencies today. This state of affairs has become intolerable to many. In 2011, the State of Utah declared that it would consider U.S. Mint gold and silver coins and monetary instruments based on these coins to be legal as currency. This included the removal of all State-level taxes on transactions in gold and silver bullion. Twelve other State legislatures have had similar bills proposed. The Utah example could serve as a template for similar Federal-level legislation to legalize gold- and silver-based currencies within the United States. According to a study of 775 floating currencies by Mike Hewitt, no floating fiat currency has ever maintained its value. The average life expectancy of a floating fiat currency was found to be 27 years. The U.S. dollar, which has been a floating fiat currency for 41 years now, is thus an unusual example of longevity. However, todays extreme reliance upon easy money approaches to deal with economic problems, with the Federal Reserve promising unprecedented zero percent policy rates for years, and real interest rates deeply negative, suggests to many that the floating fiat dollar does not have a long or successful future. Governments of China, Russia, Malaysia, Switzerland, the Gulf States, and others have complained about the potential consequences of todays aggressive easy money techniques not only at the Federal Reserve, but also the European Central Bank, the Bank of England,
and the Bank of Japan, and have made preliminary steps toward a future alternative, including discussions of new gold-based parallel currencies. On the international scale, the parallel gold-based currency, or many such currencies, would help ease this transition and form the basis of a new monetary order if that should become necessary. Each individual would be free to make increasing use of the gold-based alternative as it best suited their interests. It would be no great day of transition, but a smooth, extended process, perhaps over years. The existence of a high-quality alternative could help people avoid much of the potentially disastrous consequences if todays floating fiat currencies meet the same end as the 599 floating currencies that no longer exist. Thank you. Chairman PAUL. I thank you. And now, we will go to Dr. Ebeling.
STATEMENT OF RICHARD M. EBELING269 PROFESSOR OF ECONOMICS, NORTHWOOD UNIVERSITY
Mr. EBELING. Chairman Paul, and members of the subcommittee, I would like to thank you for this opportunity to share some ideas on this important theme of sound money, parallel currencies, and the roadmap to monetary freedom. To discuss a possible roadmap to monitor a freedom in the United States requires us to first determine what may be viewed as sound or unsound money. Through most of the first 150 years of U.S. history, sound money was considered to be the one based on a commodity standard, most frequently gold or silver. In contrast, the history of paper, or fiat, monies were seen as an account of abuse, mismanagement, and financial disaster, and therefore were viewed as unsound monies. The histories of our own American Continental notes during the Revolution, the assignat during the French Revolution, and the greenbacks and the Confederate notes during the American Civil War all warned of the dangers of unrestricted and discretionary government power over the monetary printing press. That result was that in the second half of the 19th Century, all of the major countries of the world moved towards a monetary standard based upon a commodity, in this case, gold. The important matter to be emphasizedthat while it assured a degree of monetary stability while governments basically followed the
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[The prepared statement of Dr. Ebeling can be found on page 1038.]
rules of the gold standardthat is, a fixed ratio was established between a unit of gold and the amount of notes or account deposits that were extended after a deposit was made; the ability to redeem them at that fixed rate; the monetary authority of the central banks at that time basically following the rules of the road of limiting the amount of notes or accounts open to the amount of gold that had been deposited, withdrawing notes and accounts when gold was withdrawn, the fact remains that it still was a system of governmentmanaged money. And once the ideologies and philosophies of the time changed and the shift was to a more activist government policy in the 20th Century of government targeting price levels, government attempting to influence and manipulate output and employment or inflation targets and so on, the reins of ability to manipulate the monetary system were already in the hands of the authority given responsibility for money and credit in the economy. That raises the entire issue as to whether it is desirable to have government managing a monetary and banking system at all. The free market case for competition in general and, therefore, a similar case in the case of money is the fact that competition in a market does at least two essential things. First, it decentralizes the impact of errors. If a businessman makes a mistake in his entrepreneurial judgments, it may have a negative effect on himself, some of his employees, or a few suppliers of the good that he produces. But it is decentralized. It does not affect the entire economy. When a central bank makes a mistake, its impact is potentially on the entire economy as a whole, since the monetary authority influences interest rates in general, affects the supply of money in the economy in general, distorts relative prices, and impacts the general rate of inflation in the economy as a whole. Second, it is only through competition that we discover innovative and creative ways to give people the things that they want. And this, market advocates have argued, is no less true in the case of money. If government did not monopolize the control of money, individuals in the market would determine what commodities such as gold and silver they choose to use as media of exchange. What type of financial intermediation and forms of financial intermediation they found most advantageous and profitable to use. And a diversity of such formsas banks offered different features, issuing their own notes based upon commodity money depositsand therefore acting as a check and a balance on each other to give
consumers what they wanted while restraining their ability to abuse their particular individual authorities. So how would one move towards such a system of free banking and competitive choice in currency? I would like to suggest the following steps. First, the repeal of the Federal Reserve Act of 1913 and all complementary and related legislation giving the Federal Government authority and control over the monetary and banking system. Second, the repeal of the legal tender laws, giving the government the power to specify the medium of exchange through which people will transact and enter into contract. Third, repeal all restrictions and regulations on the free entry into banking business and the practice of interstate banking. Fourth, repeal all restrictions on the right of private banks to issue their own bank notes and to open accounts denominated in foreign currencies or in weights of gold and silver. Fifth, repeal all Federal and State government rules, laws, and regulations concerning bank reserve requirements, interest rates, and capital requirements. And sixth, abolish the Federal Deposit Insurance Corporation. Any deposit insurance arrangements and agreements between banks and their customers and between associations of banks should be private, voluntary, and market-based. In the absence of government regulation of this type, we would naturally move towards a system of competitive currencies and free banking. Thank you. Chairman PAUL. I thank the gentleman. And now, we will go to Mr. Gray.
STATEMENT OF ROBERT J. GRAY270 EXECUTIVE DIRECTOR THE AMERICAN OPEN CURRENCY STANDARD
Mr. GRAY. Thank you, Mr. Chairman, and members of the subcommittee. My name is Rob Gray, and I was asked to testify today on the theory of competing currencies and the practical challenges that make such a theory difficult or impossible to implement. For nearly 5 years now, I have successfully directed the American Open Currency Standard, the standard for private voluntary silver, copper, and gold currencies that compete with each other, not against the U.S. dollar. Allow me to clarify. We do not consider AOCS-
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approved medallions produced and traded in our private barter marketplace competition at all to the U.S. Federal Reserve note. Because fair competition, as one would find in the free market, assumes the existence of a level playing field, existence of a standard set of rules. Those players who wish to compete honestly do so by simply relying on the merit of the value that they bring to the market. Well, no fair challenge can be made between honest men and thieves. Now let me be clear that when I say, thieves, I refer directly to the current private central bank and the men in government who allow it to exist. It brings us to a critical point. According to your employee handbook, article one, section eight says that Congress shall have the power to coin money and regulate the value thereof. I would argue that since 1913, Congress has failed to do the job with which it has been tasked. In the free market, since our inception, the Open Currency Standard has enjoyed nearly 5 years of growth and success, and our mission of issuing a means that allows valuable exchanges among those who produce. In the next 5 years, we expect to expand our offerings and to increase our ability to keep up with the demand for our private currency. We are doing the job today that Congress would not. But back to theory. The use of community currencies here in the United States became popular back in the early 1930s. At the time, the theory was that a group of the worlds most powerful men were intentionally and systematically removing currency from circulation, creating artificial scarcity of money across the country. Small cities and towns felt it worse than anyone, but life did go on. Then, during the greatest economic depression the country had ever seen, individuals across the country developed their own mediums of exchange. They still needed things like food, clothing, and daily essentials; they still needed to live. And they didnt have time to sit around and wait for the government to fix the problem. And so, according to historical records, thousands of community currencies were created, circulated, and traded in places where the scarcity of dollars was interfering with humans desire to live. Individuals took it upon themselves back then to secure the means for their own survival and potential prosperity. More recently, community currencies have sprung up across Europe, as the euro and other national currencies become increasingly unavailable and undependable. Today, communities all across the
eurozone trade their own money instead of the euro. Community currencies today are not simply a good idea in theory. Right now, alternative and complementary currencies circulate widely across the country in many different forms. Ithaca, New York, has Ithaca Hours that are loosely based on the value of time. Berkshire, Massachusetts, uses a fiat-backed fiat system. And many more communities circulate gold, silver, and copper AOCS-approved barter tokens as a medium of exchange. As for the practical challenges in the issuance and circulation of complementary currencies, there are plenty. In a voluntary system, those that participate in the trading of private currencies must deal with the possibility of counterfeiting, fraud, scarcity, acceptance, accounting, storage, and other issues, all without the luxury of Big Brother holding a gun to anyones head to ensure their success. But even with all these risks, the market still moves on. As in any free market, good ideas circulate with success and bad ones eventually fade away. Participants voluntarily choose to accept and circulate the highest quality currencies in exchange for their best production. Merchants accept complementary currencies based on the premise that someone else is willing to do the same thing later. Issues arise and are worked out by the market with only one light to guide themthe mutual exchange of value. No guns, no laws, nor force, just the willingness to think outside the box and act on principle. Complimentary currencies are not new, in theory or in practice. Private currencies circulated long before governments erected themselves to interfere. But what is new, however, is the publics apathy towards the government and the Federal Reserve, and their policies. You have managed somehow for the last 100 years to convince the citizens of this country that you are relevant. But now, just recently, we are beginning to see the tides change on this. And once it catches on, you will be rendered completely obsolete. The greatest hurdle you will face over the next 100 years is trying to convince We the People that you are still necessary in spite of your failure to get the job done. Sure, some will rely on your for handouts. That is what they have always known their entire lives, and they will be slaves right up to the point of their own destruction. But they dont know any better, and I dont blame them for their ignorance. In the future, you will not have to worry about Million Man Marches or citizen journalists trying to catch you on camera.
What you need to fear is no one paying attention to you. The next American revolution will be fought not with bullets and bombs, but instead it will be won with the opposite consciousness. To that end, I am here today to propose a solution. My understanding of this committee is that you want to be part of the solution. You want to believe that you are doing something good for the country. And so today, the greatest gift that you can offer to the people that you clearly representnot to the legislature, but directly to the publicis what I call IR1207, Individual Resolution 1207, commonly referred to as Ignore the Fed. Store your wealth in silver, bank with non-fractional banks that pay real money on deposits, use the card service network to satisfy dollar obligations, do not try to compete with the Federal Reserve system; simply ignore them. I ask you to leave the Fed their Federal Reserve notes and leave us our gold, silver, and copper. Do not push to redefine whatever representations we choose for our wealth. Let the Fed do what it wants with their legal tender, so long as they leave our money alone. I warn you, honest money legislation is a wolf in sheeps clothing. The greatest thing this body can do is exactly what it has done so far: absolutely nothing. All I ask is that you stay out of the markets way. The people in our world are very happy to go right along saving you from your own destruction by producing value against all odds, regulations, codes, and challenges that you throw our way, but leave our money alone. It doesnt belong to you, and it never will. The bottom line is very simple. Humanity is not going to wait for permission to survive. Things that cannot go on forever simply wont. The market will move on with or without you. And based on your rate of success to date, our preference is certainly without you. Thank you for the time.
[QUESTIONS & ANSWERS]
Chairman PAUL. Thank you. I will now yield myself 5 minutes for questioning. First off, I would like to talk about the legal tender laws a little bit more. I want to pose a question for all three of you. It was mentioned in your testimony about how important legal tender laws are and whether or not we can ignore them. How important are the legal tender laws, and how important is it that we get rid of the legal tender laws if we really want to have a parallel currency and be assured that we can do it? Can we ignore it?
Should we work to repeal it? How far can you go without dealing with this issue? Because it does provide the monopoly that will not go away easily. So if each one of you could expand your thoughts on the importance of legal tender laws and what we should try to do, and is it absolutely necessary that we do something before we can advance the cause of competition or parallel currencies? Mr. Lewis? Mr. LEWIS. Although I think that some communities are using small-scale metallic currencies, more or less under the radar, if a large corporationlet us take Ford Motors, for examplewould begin to do business in gold and silver coins or related currencies, they would immediately come under Federal scrutiny and basically be prevented from doing so. What I would like to see is basically for gold and silver, and currencies based on gold and silver, to be treated as legal currency within the United States. In practice, this will require a declaration of some sort to make it effective. And ultimately, at the very least, to be able to treat gold and silver the same way we treat euros or Canadian dollars today. We can all do business in them in the United States, even though they are not necessarily declared as legal tender, and so on and so forth. It would be better to have a more official declaration to say, yes, we accept gold and silver as a legitimate means of monetary transaction and a legitimate foundation for business. Chairman PAUL. Thank you. Dr. Ebeling? Mr. EBELING. Yes. Anyone who has traveled in a country that has been experiencing severe, or even hyperinflation knows that in spite of official legal tender lawsthat is, the government declaring a certain money or its currency the lawful moneypeople start using alternative currencies that they view, given their circumstances, as having more confidence in shorter certain value. So in spite of laws and regulations, at the end of the day what people will choose to use as money, even when it breaks the law, they will follow what they view as most effective and self-interested for themselves in the marketplace to secure their wealth and their transaction opportunities for themselves and their families. But the fact remains that while the market, in a sense, finally supersedes and no longer recognizes government laws when it becomes serious enough, it is crucially important if we could eliminate the legal tender restrictions in the United States. Because basically,
it would say that now individualsand the law, the government, the courtswill respect the contracting and the exchanging of any form of medium of exchange that the individual citizens of the society choose to use. That would go a long way. For example, a well-known Nobel Laureate, Austrian economist Friedrich Hayek, once made the case for what he called choice in currency. He was doing this before the euro in the context of Europe. But he said one way to tame the inflationary tendencies of government is to allow citizens within their own country just to use the currencies of other countries within their domestic exchanges if they choose. To be able to say I dont trust, and have confidence in, the monetary authority to restrain itself in issuing excessive quantities of that money. Also, if you eliminated the legal tender laws, then the people themselves would decide do we want to use dollars, do we want to use alternative to dollars, how much do we want to use notes, how much do we want to use, actually, coins of various sorts? And it would be basically saying consumer sovereignty, consumer choice. But if we could do that, that would be the essential roadway, and path, to restoring a system of monetary freedom. But if, in the United States, we were to ever experienceand, of course, we hope we never doa serious and hyperinflation, the market would basically tell the government what it thinks of its money because people will choose to use alternative currencies of choice. Chairman PAUL. Thank you. Mr. Gray? Mr. GRAY. Mr. Chairman, before addressing or issuing the answer to that question, can you please summarize for me your understanding of the legal tender laws as they exist today? Chairman PAUL. Not at this moment. I would like you to answer the question first. Mr. GRAY. My answer is, very simply, leave them alone. My understanding of the legal tender laws is that the U.S. dollar, the Federal Reserve note, can be used to satisfy debt obligations. We dont need to change that at all. There is no law that restricts us from privately minting coinagetokens, medallions as we refer to them. There is no law that restricts us from engaging in private barter transactions with other men. And so, we dont need to change anything about the legal tender laws in order to do exactly what we are doing right now. Chairman PAUL. Okay. I now yield 5 minutes to Mr. Luetkemeyer from Missouri.
Mr. LUETKEMEYER. Thank you, Mr. Chairman. As you talk about the different parallel currencies, I think we have a parallel currency situation over in Europe right now that is pretty obvious. How is the euro working over there, in your judgment, all three of you? Mr. EBELING. I will begin by saying I think it is an unmitigated disaster. The fact is, this was not a choice by the people either making their demonstrated choice in market exchanges or even in a political vote or a referendum. This was basically imposed upon many of the E.U. countries as a discretionary choice of the politicians. Some of the more prominent countries wanted to have a unified currency so as to be able to have the political clout to look down the dollar in the eye, to be explicit. That is my view of why the French were pushing it. The result is that this currency has been imposed upon systems that follow different regulatory paths, different fiscal paths in terms of debt and deficits, all of which has created this problem. A lot of people in Europe are saying, Oh, it would be disastrous if the Greeks pulled out and reestablished the drachma, for example, or the Spaniards were to reestablish a peso, for instance. I think that would be the path to denationalize, or rather deinternationalize this monetary system because it is not working. And it is dependent upon a central bank in one location to make the monetary choices and decisions for all of the hundreds of millions of people who participate in this system, rather than allowing even the competition of the national central banks, as had existed before. Because if you felt that the lira was being inflated, people escaped into marks. That was the pattern in the post-war period. Where does an Italian escape to now as easily as into the market as was historically the case? So even in terms of competitive national currencies, the unification under the euro has been a disaster, and certainly for the freedom of the people there. Mr. LUETKEMEYER. Mr. Lewis? Mr. LEWIS. I would generally agree with Dr. Ebeling. I dont think the euro is a case of a parallel currency so much as a shared monopoly currency. With parallel currency, the idea is having the choice of two highly viable alternatives. For example, the euros, maybe, in Turkey, where the Turkish lira has a rather poor history, often people use Deutsch Marks in the past and now use the euro. So I think that is probably a bad example of a parallel currency. Thank you.
Mr. LUETKEMEYER. Mr. Gray? Mr. GRAY. I think the key thing to consider with what is going on right now in Europe, besides the fact that there is just no confidence whatsoever in the banking system is that still, in our country here today, we do have confidence in our currency, we do have confidence, for the most part, in the banking system, for whatever reason. And that is very different over in Europe right now. As soon as money shows up and the banks are unfrozen, the people make a run on the bank. They pull out as much currency as they can, they turn it into anything they can get their hands on that is valuable; whether that is another currency, or hard goods, or gold and silver. It is the same thing that we are seeing now that we saw in hyperinflation just before World War II, where the race was on to get rid of the currency as quickly as possible. The advantage we have right now is that we dont have that yet in our country. And I think the opportunity that lies before us is to help the people of this country get out of that system, deleverage the system, so that they dont have to experience the panics and the fear that are being experienced right now in Europe today. Mr. LUETKEMEYER. You had a key word there that really describes all monetary systems and, basically, even economics. And that is confidence. If people dont have confidence that the money that they are exchanging for goods is worth that amount of money, or whatever it is, there is very little transaction that takes place. And so really, even at the highest levels of the biggest banks, we found in 2008 that it wasnt necessarily the entity that they were dealing with. It was the confidence in that entity to be able to transact business. And so basically, you have a fall-back on confidence, which leads me to the question with regards to what we are talking about this morning, sound money and parallel money. If you work in a different monetary system parallel to another one, where is the level of confidence going to come from that allows that business to be transacted in a parallel currency? Mr. GRAY. The simple answer to that question is the confidence comes from the fact that the currency is not based on debt. Every national fiat currency is put into circulation through loans and debt. And so people today are starting to understand that there is so much money out there that people owe in loans, mortgages, credit card bills, all these derivatives out theretrillions and trillions of dollarsand all that money has to be paid back eventually.
That is where the lack of confidence comes from. And so when you start thinking and talking about alternative currencies, especially those that are issued in gold, silver, copper, and something real, some sort of commodity, people who understand the concept begin to realize that those are debt-free currencies that dont need to be paid back at some point to some bank. Think about all the money that the people of America owe to the banks. Think about all the people who are in debt, all the States and the municipalities, the colleges, universities. Everyone is in debt. The real question is, who owns the other side of that debt? And that is where the lack of confidence comes from. The fact that people are starting to ask that question, and realize that there is really no money out there to begin with. Mr. LUETKEMEYER. I see my time is up. Thank you, Mr. Chairman. Chairman PAUL. Thank you. If the gentleman from Arizona is ready, he could be recognized. If not, we can wait a couple of minutes. Are you ready? Okay, thank you. I will go on and have a second round of questions. The question of taxation comes up with money, as well, because we think money is a commodity. And our government tends to think that any time you have a commodity transaction, you pay taxes on it. You have sales taxes and you have capital gains taxes. And that, I think, curtails this development of parallel currencies. And I dont know how we could ignore this if we really want to promote some competition or allowing another currency. Because if you tax one currency but not another one, it is hardly a parallel currency. It is at a tremendous disadvantage. So if a parallel currency really got off the ground, because of the conditions or the people became knowledgeable and they thought it was wise to do it, the people in Washington dont like to have their powers undermined. So they have the power of the IRS. Isnt this a significant concern, or do you think we can just sort of bypass it, and say, Well, its a problem, but not a big problem. We will just go do our thing, and it can work. What is your opinion about the tax issue when it comes to a parallel currency, all three of you? Mr. LEWIS. I think there arejust as you can have under-thetable transactions in U.S. dollars, small-scale that maybe you dont report to the IRS, you can also do so. And maybe people are doing so with gold and silver coins or copper coins today. But as soon as you get the business of any scale, you cant break the laws that easily.
I think that ultimately, just as you say, we have taxes that apply to transactions in dollars, capital gains taxes, for example. We have taxes that apply to transactions in euros and Canadian dollars and many other currencies. We have many thousands of corporations doing business in many currencies worldwide. I think we should recognize that because gold and silver and related instruments are not recognized as currencies, they are under a different system of taxation. Gold, for example, has a different tax rate because it is a collectible. But I think more importantly, lets just take a very simple transaction. I wanted to buy a car from the Ford Motor Company, I wanted to pay them in gold coins, U.S. Mint American Eagles produced by the government. When I give the gold coin to the auto dealer, that would be considered basically a sale of the coin and you would have to pay capital gains tax, taxes on what the dollar value of the coin was when you acquired it and when you dis-acquired and so on and so forth. Which is very different than if I were to, for some reason, do the same transaction in euros where that would not apply. So I think that at the very minimum, we should endeavor to treat these the way we would treat other national currencies today, which we are actually doing business in. Not so much in the United States, but what American citizens, the American corporations are doing every day and accountants are very familiar with how this works. So I think that there is definitely something for the Federal Government to do there to legitimize that and treat it as the same way we treat other national currencies today. Thank you. Mr. EBELING. Yes, I would argue that the parallel way of thinking about this is, in international trade, what we call the most favored nation clause. Any agreement that you reached with country X, you give the same best-favor treatment with import duties and so on to all other countries with which you trade. The parallel argument would be that the government should recognize that anything that people use as a medium of exchange in transactions should be viewed as anything that they have historically viewed as a transaction. Basically, that there shouldnt be these extra taxes. That was just pointed out. So that if people are now using gold and silver coins, the transaction should be more taxed or treated in a different way than any transaction with the Federal Reserves own note. That gives a level playing field with neither an advantage nor disadvantage for the use of one currency versus the other.
Because otherwise, the government creates stumbling blocks and hurdles to give people those fair and level playing field choices. So the parallel should be some taxing of media of exchange along this notion of the most favored nation clause. Chairman PAUL. Mr. Gray? Mr. GRAY. First of all, Mr. Chairman, I want to clarify that we are not tax experts and we are not allowed to give tax advice, nor do we give tax advice to anyone who participates in our system. Our job is, very simply, to issue the currency and make sure we guarantee the weight and the purity. So we are just keeping an eye on what is going out there. But tax applications vary from State to State, municipality to municipality. Some States, some cities and towns, allow you to barter. They say, well, you can do 100 barter transactions per month or per year, and they dont look at is as being under the table or underhanded. They look at it as just being private trade that is not a taxable event. Certainly, my understanding is that the Federal Government would like us to report the profit or gain from any transaction. That is kind of strange because in a barter transaction, there is not really any profit or gain on either side of it. But in our voluntary system, we encourage the participants to explore and decide for themselves based on their own morals and values what their tax obligation is, and to report and to remit accordingly. Chairman PAUL. Thank you. Now, I recognize Mr. Luetkemeyer from Missouri again. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Following up again on my comments earlier with regards to the confidence in the system and the ability to protect the citizens whenever you transact business like this, Dr. Ebeling, I think in your testimony you abolish the Federal Deposit Insurance Corporation. While you may not like it, that is also one of the things that adds confidence to the person who deposits money in the bank. To realize that if they deposit the money there, they are going to be able to get it back. Without that, the consumer is going to have to do an awful lot of work. And as you gentlemen have described this morning, parallel monetary systemsyou are going to put a tremendous onus on the individual to make sure that they get value back for whatever they exchange their money for, and that that money will have value down the road so they will not lose value and business continue to be transacted in that same form.
And so, I think one of the advantages of the system we have now is that it takes a lot of the work in trying to find ways for the money to be able to be secured and have confidence in away from the consumer. Am I wrong in that, or do you agree with that statement? Mr. EBELING. I think that the problem with deposit insurance is that it creates a degree of confidence, but a false sense of security. The fact is, is that the impression is made that the bank is serving as a depository for your money and that it is always guaranteed to be gotten back. The fact is, you put money into a bank to earn interest. The bank can pay you interest only through one way, and that is extending it and pooling your savings with others to worthy borrowers. They pay interest for the loan, the bank receives that loan. They take what they view as their service charge for financial intermediation, and then you as the depositor receive your interest, whether it be a savings account or most forms of checking accounts which pay interest now. The fact is, you are putting your money at risk. You are lending it to others through the banks good services. Federal Deposit Insurance has created this impression as if there is no risk with your money. And the fact is, I think the people would be more cautious and more attentive to the nature of the bank that they are doing business with, what the track record of the bank is in managing your funds, along with those of other depositors. And on that basis, seeing what private insurance or guarantees or other forms of assurances bank competitively would establish. We take for granted that when you go in and buy, for example, a microwave or an oven or a refrigerator, what if it doesnt work? Most large companies, for brand name reputation, give you various warranties and guarantees. And it is important for the companys success to stand by and guarantee that warranty and guarantee. Various banks, for competitive advantage, would offer various types of, perhaps, guarantees and warranties on deposits, but with the understanding that nothing is certain. In a money market mutual fund, you realize that the value of your account may go up or down depending upon the value of the portfolio of the company with which you are dealing. The fact is, that is the case of a bank, too. Mr. LUETKEMEYER. You are mixing apples and oranges here. You are talking about an investment account, where you know that the money is going to be invested and it has the ability to go up and
down, versus a deposit where you put the money in and you are going to write checks on that account. And I think the deposit insurance takes some of the risk away. Over the last 4 years, we as a society have been educated to the fact that banks manage risk. That is what they do. Before, people thought they just take deposits, make loans, and turn around and pay out dividends and interest and whatever. That is not what happens. They manage risk. And so, the deposit insurance actually minimizes the risk. It doesnt take it all away, but it minimizes it so that it gives some level of confidence to that investor. And I dont think you can sit there and say that somebody who invests in a money market account or some sort of investment account at the bank, that is a totally different relationship between the bank and the individual customer. I have some concerns about that. Mr. EBELING. If I could just sort of follow up on that, the mistake is that people view their checking accountsI have a checking account, as I know you haveyou feel as if, well, I have deposited my paycheck and I can draw that money down by writing checks or using my debit card, etc. The fact is, that is not a warehouse deposit or like a safety deposit box. The fact is, under our current banking system that money is then takenwhich you are viewing as 100 percent accessible to youand using it as part of their investment funds to lenders. It is at risk as much as a savings account is, where you know that during the period of like a time deposit your money is being lent out to a lender. The fact is, to a borrower, the same things applies with our checking accounts. People are given a false sense of security that this is not an investment account, when it is. It is as much of a risk as when you put your money in the bank and a savings account and you more consciously know the bank is using your money for a period of time with a risky loan. Checking accounts are, in fact, with our system no different. And if you didnt have deposit insurance, I would suggest that people would become more aware of it and be more cautious, informed and intelligent in what type of banking institution they did business with. I am talking about the long-run, institutional incentives of a system. Mr. LUETKEMEYER. I see my time is up. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I now recognize the gentleman from Arizona, Mr. Schweikert.
Mr. SCHWEIKERT. Thank you, Mr. Chairman. This may be a slightly more ethereal question, but I am trying to also understand how much of this is actually going on around us. And actually, also, if you have ever looked at the differential in high transaction cost jurisdictions: high sales tax; the barter economy; some of these things I now see on the Internet. What was one of them called? Something coin, where you can actually developwhat was it? Mr. GRAY. Big Coin, I believe? Mr. SCHWEIKERT. Yes. And I think there are two or three versions of that, where, because of certain transactions or uses of Web sites or these things, you actually build accounts. How much of this is there already, even though in the scale it may be very small? Is there actually, in sort of the barterer of economy, of this Internet exchange of value that is out there? I remember there was an explosion of it in the early 1980s, very early 1980s, when inflationso I would trade something with my dentist for this. And even though inflation and other things, I knew I was getting a certain service for a certain service. What is out there today? Mr. GRAY. It is pretty substantial. The first thing to take a look at is the gray and black economics of the world which, right now, are really the only segment of the global marketplace that is actually growing. A lot of that is done with barter, direct trade. Some of it is done with alternative community currency, some of it is done with gold and silver. So it is happening right now across the globe in a very big way. In the United States, there are probably 400 to 600 different community currencies in circulation right now. The total value of the currency in circulation is probably somewhere between $1 billion and $5 billion, I would estimate. So it is small, but it is consistently growing. Mr. SCHWEIKERT. I dont think a lot of folks even understand. My little sister was part of a baby-sitting exchange. She puts in so many hours, and she gets so many hours over there. In many ways, that was a barter economy, and folks dont realize they were basically transacting value for value. What happens if we wake up tomorrow and a handful of our trading partners, competitors move to a basket or currencies? And so China and a couple other countries say, We are going to do this new blended currency. Does that actually now create a new method of exchange?
I have been trying to figure out if that actually creates an additional value of exchange with which we would have to deal. Mr. GRAY. I think on the macro level in the global economy, yes, it does. As far as the micro level and the baby-sitters and the pet groomers and people in small towns and cities across the country, I dont think they would notice that any more than they notice, and are affected by, the international currency problems we have right now. So I think, yes, globally sure. Mr. SCHWEIKERT. But where that more comes from, Mr. Chairman, and to whoever would like to answer this, I dont know how often you see this, but I used to see it in the old days. A contract would have a gold clause in it, particularly contracts that were coming out of the late 1970s, very early 1980s when there was high inflation, saying, Hey, we are going to write the contract denominated in U.S. dollars, but there will be a gold peg on it so if somehow inflation mightby the time we are going to do the take-down. I am curious if we are seeing any more of that type of hedging. And that is actually what a blended commodity currency would do, also. I told you this was going to be a bit ethereal. Mr. EBELING. I think what is sometimes being proposed, the Chinese and the Russians have talked about this instead of the dollar as an international currency for a lot of transactions. What this idea of a basket of commodities or series is, is to try to have an index of what currency A, let us say the U.S. dollar, is worth as sort of an index, or composite, of these other currencies to determine some value. But the fact is that what would still be traded is actually some currency A for currency B. But the market estimate of what currency A is worth in relation to currency B would be that the currency B would, in fact, have its value based upon some composite index. It is a way of determining the exchange ratio, not so much that you would be trading the basket of the currencies for this other good, or this other currency. Mr. SCHWEIKERT. And my fear is, oftenand my good friend, Mr. Luetkemeyer, I think, that was also part of the dialogue of it sometimes, it is not only you get back your dollar-for-dollar invested, but what was the actual ultimate purchasing power of that dollar when you get it back. And I think that is actually a much more honest way to look at the value of a transaction. Mr. EBELING. Right. And see, what happensagain, as I mentioned in an earlier questionis that if you have traveled in a country that is dealing with a severe or a hyperinflation, the uncertainty and
instability of that nations own currency has reached such a point that people no longer either use that currency, or they calculate its real value in another currency, whether it be, let us say, a dollar or an ounce of gold. And they say that based upon this other currency, that is what we are going to view as the value of my own currency in buying commodities. Mr. SCHWEIKERT. Mr. Chairman, I know I am way over time. But if you have done lots of traveling, particularly in the third world, you will often see, here is the price in the local and here is the price, as I had an experience in Myanmar. There was a price for green, which was U.S. currency. So thank you, Mr. Chairman. Chairman PAUL. Thank you. We will be having a vote shortly, but I believe we have time for another round of questions. I have a question for Dr. Ebeling. And it is a more generalized and philosophic question. Under the system we have today, it is very unfair to one group, where another group, I think, benefits. And if you look at runaway inflation, it is not usually those who have been able to park their money overseas and escape the harm. Many times it is the average person who had savings in accounts and they lose everything. I think what we are dealing with on a monetary system is a reflection of a bigger philosophy. And that is the philosophy of government, big government, and why we spend so much money. And money is not so much a means of exchange, like it should be. It is the vehicle for taxation. Because we have big government for various reasons and there is never enough tax money. But there is also the printing press and there is the printing of money. Which is really a tax on the people, the middle class and the poor. Many people endorse that system because they have been convinced that the current system is helpful to the poor. We can have housing programs and we can provide welfare, and they really like the system. They dont want to give up on it. Now, we might agree that a sound monetary system would be more fair and it wouldnt be beneficial to the very, very wealthy and to the Wall Streets and the bankers. But what about if we got a little further along on parallel currencies? Do you see any way this could give a temporary reprieve, or would it once again been seen oh, this is just another gimmick to protect the rich, and the poor dont know anything about this, they
cant use this currency, and it is really not a solution; it doesnt even address the subject of this inequity in the system that we have today. Do you have any thoughts on that at all? Mr. EBELING. Yes, I think that is an important point. We can see the problem sort of magnified as one reads about it in the press, for example, is what has happened in Greece right now. The fact is, is that for years, decades, the Greek government promised more than it has turned out it can pay for, either with taxes or with continuing borrowing. That is one of the reasons some in Greece want to return to a drachma so they can just print the money that they need to cover the promises for which the real resources in the society are not available. It is the long run versus the short run. In the short run, if the government can tax, borrow or print money, it can create the illusion of generating wealth and benefits and special opportunities for various segments of the society. But in the longer run, the problem is that eventually the piper has to be paid. The tax money runs out. Or it cant borrow anymore, or it becomes very expensive, as the Spanish and the Italians are now finding, as well as the Greeks. Or they resort to printing money. But at the end of the day printing money dilutes the value of every unit of money in peoples pockets. It destroys savings, it undermines the ability to undertake exchanges. It diminishes the ability for profit-making decision-making. And therefore, it is most devastating on the poor. The analogy is like the kid who goes to the circus and he eats too much cotton candy. And his Uncle Bob who took him said, Gee, I am sorry that you have a tummy ache, so to make you feel better heres more cotton candy. That is just exacerbating the problem. At the end of the day, the boy gets home and he has a big tummy ache. And that is what has to be emphasized, the illusion Chairman PAUL. Okay, I want to interrupt for a minute because I want to know about whether the parallel currencies affect this in any way, positively or negatively. Or does it help this inequity and this disadvantage over the kind of system we have today? Mr. EBELING. Yes, I would argue that if people had a choice in currencywhether they be rich, middle-income or poorthey would have a way to park their income and wealth in an alternative medium of exchange, a unit of account, that they could have greater security of, that its value is more certain and more stable based upon their fears and expectations about the trend their own national currency is following.
Chairman PAUL. So there is even an advantage to incrementalism in moving in this direction if it is available to the people rather than saying, Well, we cant do a thing until we repeal the Federal Reserve Act, and that sort of thing. Mr. EBELING. Absolutely. Chairman PAUL. Okay, very good. Now, I want to go to Mr. Luetkemeyer, if he has another question. Mr. LUETKEMEYER. Thank you, Mr. Chairman. To follow up on that, how do you protect the citizen to make sure that they dont get slipped up on with going to alternative or parallel currencies? How do they have, how can they enablewe have a whole group of folks here this morning. How can each one of them know that if they want to transact business and each one of them a different currency, it is going to be something that they will be able to trade down the road? Mr. LEWIS. This relates to your previous comment about confidence. In practice, it will be a process of some institution establishing a track record. And also the institution being sort of visibly considered to be a long-term Mr. LUETKEMEYER. So in other words, whether it is a country or city or a state, whatever entity produces the currency there will have to be a certain level of confidence in that entity to be able to Mr. LEWIS. Right. Mr. LUETKEMEYER. There would Mr. LEWIS. And it will have to be earned. You cant decree it. You cant have an advertising campaign. We are kind of talking about these very small kind of neighborhood currencies. And on a larger scale, that might be where we would begin. On a larger scale, it could be Citibank, it could be the State of Utah. I know some of my colleagues here would be appalled at the idea of the U.S. Federal Government issuing a parallel gold currency. But I think it is an interesting idea. Or it might be the state of Russia. In practice, the one that has the most confidence will be the one that people use. The reason that people used the U.S. dollar after World War II is because it had a long history, over 100 years, of sticking to the gold standard. It had a stable political system, it was militarily impervious. And that is why they used that instead of the currency of China or what have you. It will be, ultimately, a process of track record, and probably very large organizations will dominate. Mr. LUETKEMEYER. Okay, Mr. Lewis, we have before us this morning your book. I was trying to read the cover and the back of it
here, as well as the inside slips. Can you just briefly tell me how you would like to see usor could be enabled to be able to move over to the gold standard? What are your thoughts on it? Mr. LEWIS. Ideally, you would all have an epiphany and understand that this is the best system for all of us. However, in practice, one of the reasons we are here today, I think, is that typically, people have these epiphanies after a tremendous catastrophe. It happened many, many times in the past. Usually, things go all the way. You dont stop halfway and say, Oh, I think I know where this is going. Let us stop now and switch to a gold standard system. Usually, you end up in disaster. Whether it be China in 1949; the hyperinflation, Japan in 1949; hyperinflation, United States in 1784; hyperinflation, Germany 1923. Hyperinflation, you tend to end up with some kind of catastrophe beforehand. One of the nice things about the parallel currency idea is maybe you can avoid that process, that political cycle. You could establish something, even by the Federal Government or by very many means, and you could have the two options available. So when people simply decide to do business in one currency or anothersay I am going to write the contract in U.S. gold dollars, not U.S. Bernanke bucks, they will start to buy and sell and do business in that way. And then over a period of a few years, perhaps, people will just naturally decide which system they like better, the Bernanke system or the gold system, and they can migrate and, eventually, have a very smooth, non-disruptive transition between one and the other, ideally. Mr. LUETKEMEYER. But even in your system of moving over to the gold standard, there still has to be a level of confidence and that as the backup, as the standard, would it not? Mr. LEWIS. You would have to haveultimately every currency has an issuer. And ideally, that issuer will have a track record of managing the currency correctly. And will likely probably be, in my opinion, a large institution, maybe a national government, maybe a State government, maybe amaybe a large bank, maybe some other large institution that emerges. We are simply not going to have the entire United States do business in a currency that is issued by something ina little storefront in Miami or something of that sort when we get to that scale. So the institution will earn the confidence. Mr. LUETKEMEYER. All right, thank you. Thank you, Mr. Chairman. Chairman PAUL. I thank the gentleman.
The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for Members to submit written questions to these witnesses and to place their responses in the record. This hearing is now adjourned. I appreciate your appearance today. Thank you very much. {Whereupon, at 11:08 a.m., the hearing was adjourned.}
TATEMENTS
STATEMENT FOR THE RECORD HON. RON PAUL

REPRESENTATIVE, 14TH DISTRICT OF TX CHAIRMAN, SUBCOMMITTEE ON DOMESTIC MONETARY POLICY & TECHNOLOGY U.S. HOUSE OF REPRESENTATIVES
One of the most pressing issues of our time is the push for monetary freedom. The only sound monetary system is one which protects sound money and allows consumers, businesses, and investors the freedom to transact in the currency of their choice. The importance of sound money is summed up nicely by Ludwig von Mises: It is impossible to grasp the meaning of the idea of sound money if one does not realize that it was devised as an instrument for the protection of civil liberties against despotic inroads on the part of governments. It is no wonder that governments fight tooth and nail against sound money, as sound money protects the well-being of the middle class and the poor while preventing the expansion of government. Governments throughout history have sought to monopolize the issuance of money, either directly or through the creation of central banks. The growth of central banking in the 20 th century allowed governments to monetize their debt in an indirect manner while still ensuring a ready market for government debt. And central banks' slow but sure debasement of the currency allowed governments to repay their debts in devalued money. What debtor would not want such a sweetheart deal? Indeed, the 20th century witnessed a revolt by governments against the strictures of sound money. In some countries such as
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Weimar Germany the revolution came quickly and the results were both immediately apparent and instantaneously disastrous. In other countries such as the United States, the revolt came more gradually, with the destructive effects of money printing only recently becoming apparent to more and more Americans. Over the past 100 years, the Federal Reserve has continually pumped new money into the economy, resulting in a 96 percent devaluation of the dollar. This devaluation does not affect everyone equally, as the banks who receive this new money first benefit from using it before prices rise, while average Americans suffer the price rises first and receive only a trickle of money well afterward. In this way the Fed enriches Wall Street while impoverishing Main Street, leading to a growing disparity of wealth. The wealthy are always able to protect the value of their assets against inflation to an extent that the middle class and poor cannot. Anyone with enough money and resources can set up a foreign bank account denominated in euros or Hong Kong dollars, or purchase gold and silver that will be safely stored in London or Singapore. The rich are best able to purchase precious metals, the only ones able to invest in high-yielding hedge funds, and the ones most able to shelter their assets from punitive taxation. All the legislation and regulation that ostensibly protects the average American from losing money in fact does exactly the opposite. It keeps the average American from being able to defend against inflation by investing in precious metals, forces him into mediocre investment opportunities that do not even keep up with inflation, and leaves him at the mercy of the taxman. Compared to their counterparts in other countries, the average American has far fewer financial options available to them. Mexican workers can set up accounts that are denominated in ounces of silver, and can take delivery of that silver whenever they want, tax-free. In Singapore and some other Asian countries, individuals can set up bank accounts denominated in gold and silver. Debit cards can be linked to gold and silver accounts so that customers can use their gold and silver to make point of sale transactions, a service which is only available to non-Americans. In short, Americans have far fewer options to protect their wealth than citizens of many foreign countries do. The solution to this problem is to legalize monetary freedom and allow the circulation of parallel and competing currencies. There is no reason why Americans should not be able to transact, save, and invest in the currency of their choosing. Unfortunately, decades of
SOUND MONEY: PARALLEL CURRENCIES STATEMENTS 1021
government restrictions and regulations have hampered and prevented the circulation of parallel currencies and destroyed the familiarity of Americans with any sort of money aside from Federal Reserve Notes or bank deposits denominated in U.S. dollars. The thought of introducing parallel currencies undoubtedly scares many people who understandably wish to minimize their financial risk. All financial activity is fraught with risk. Most people understand the risks inherent in stock or bond investment, but the risk of holding savings accounts or cash is still drastically underappreciated. Everyone is familiar with the maxim Don't put all your eggs in one basket and investors and savers are constantly urged to diversify their portfolios, yet the U.S. government continues to set roadblocks that force Americans to transact and save in dollars that continue to depreciate. According to the government's official figures, price inflation runs around two percent per year which means that, since interest rates on savings accounts are near zero, the real rate of return on savings accounts is negative. Anyone holding a savings account or cash is losing nearly two percent of the value of his savings per year with this relatively mild inflation. Some private economists estimate that actual price inflation is running closer to nine percent per year, which would make the loss from holding dollars enormous. Even greater danger comes during bouts of hyperinflation, such as during Weimar Germany and more recently in Zimbabwe. But when Zimbabwe's dollar became worthless, people began to use U.S. dollars, South African rand, and Zambian kwacha to conduct transactions. Similarly in Weimar Germany, many individuals resorted to using dollars, pounds, and precious metals. So despite the economic hardship wrought by hyperinflation, not all economic activity ground to a halt, largely due to the circulation of parallel currencies. Should the United States ever face a hyperinflationary crisis, which due to the Fed's quantitative easing is very possible, the only means of survival would be through the use of parallel currencies. It is horribly unjust to force the American people to do business with a dollar that is continuously debased by the Federal Reserve. Forcing a monopoly currency with legal tender status onto the people benefits the issuer (government) while harming consumers, investors, and savers. The American people should be free to use the currency of their choice, whether gold, silver, or other currencies, with no legal restrictions or punitive taxation standing in the way. Restoring the
monetary system envisioned by the Constitution is the only way to ensure the economic security of the American people.
ITNESS
ESTIMONY
WRITTEN TESTIMONY OF NATHAN LEWIS

PRINCIPAL KIKU CAPITAL MANAGEMENT LLC
Use of Parallel Currencies The phrase parallel currencies tends to sound rather novel and experimental to us today, living in the United States. However, most people in the world are using parallel currencies today. Many of us have found that, when traveling to some foreign countries, that shops and restaurants are happy to accept U.S. dollars in return for their goods and services. Often, people there also use U.S. dollars among themselves, in their own commerce and business dealings. In this case, the U.S. dollar is serving as a parallel currency, alongside the currency issued by the domestic government, such as Costa Rican coln or Vietnamese dong. In such places, the U.S. dollar is used not only by sidewalk vendors, but often by the largest corporations in the country. Throughout Latin America, until only a few years ago, large corporations would typically finance their operations with loans or debt denominated in U.S. dollars. Indeed, the governments of these countries themselves borrowed in dollars, issuing dollar-denominated government bonds. After many decades of bad experience, nobody would buy a bond denominated in the local currency, which the government could devalue at a whim. Before the introduction of the Euro in 1999, German marks were popular throughout Europe. During the 1990s, governments with a history of poor currency
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management, such as that of Greece, issued government debt denominated in German marks. It is perhaps only in the United States, and more recently in the eurozone, that people are not already accustomed to using a variety of currencies in their daily business and commerce. Large U.S. corporations regularly do business in a variety of currencies, and investors commonly buy or sell foreign stocks or bonds using foreign currencies. For most of us, however, we have no reason to use the Ukrainian hryvna in our daily affairs. We would much rather use dollars. Ukrainians, at some points in their history, have also preferred to use U.S. dollars. Why is that? It is because the dollar has consistently been one of the best-managed, highest-quality currencies in the world. For 182 years, from the founding of the United States in 1789 to 1971, the United States government adhered to the principle of a gold standard for the dollar, even if, in practice, it deviated from that ideal from time to time. The United States was following the example demonstrated by the best European governments, especially Britain, whose gold standard system can be traced to 1698. However, during the 20 century, those European governments made a mess of things numerous times, and their currencies became unreliable. The British pound, like most of the currencies of Europe, became a floating currency at the onset of World War I, and soon depreciated in value. People didnt even know if France or Britain would exist after the war. In the early 1920s, more European currencies became unreliable, with the hyperinflation of the German mark perhaps the best remembered example. By 1926, Europe had mostly reconstructed the world gold standard system that existed before the war, just in time for the chaos of the Great Depression. During the Great Depression, currencies everywhere were devalued, led by Britain in 1931. Also, we tend to forget today that several European governments also defaulted on their sovereign debt during the 1930s, including Austria, Germany, Greece, Hungary, Poland, Romania and Turkey. By the end of World War II, the U.S. dollar, which had been considered an emerging-market currency in 1900, had proved to be the most reliable currency in the world. It thus became the parallel currency of choice worldwide, and U.S. tourists in the 1950s found that they could spend their dollars throughout Europe. The British pound still had some fans, but after a devaluation in 1949 and again in 1967, few people were willing to give Britain anymore chances. In 1971, the United States abandoned its then nearly twoth
SOUND MONEY: PARALLEL CURRENCIES TESTIMONY 1025
century-old commitment to the gold standard system. At this point, historically, currencies were often discarded for whatever the highestquality, most reliable alternative was, which in practice meant a gold standard currency from a large developed country. However, a consequence of the U.S.s abandonment of the gold standard in 1971, due to the nature of the Bretton Woods system, was that other governments currencies left gold too. There was no gold standard alternative in the world. Since 1971, the value of the U.S. dollar has fallen from 1/35 of an ounce of gold to about 1/1600 of an ounce today. The dollar today is worth only 1/46 of its value during the Kennedy administration. As bad as this is, the alternatives have been even worse. This is why the U.S. dollar remains the most popular currency in the world, and serves as a parallel currency in many, if not most, countries today.
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After several centuries of stability, the dollar became a floating fiat currency in 1971. Since then, it has fallen to about 1/46 of its prior value. The decline in the 1780s represents the hyperinflation of the Continental dollar.
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Use of Parallel Currencies in the U.S. Today Today, there are no particularly onerous barriers against using a parallel currency in the United States. People are free to do business in euros or Russian rubles if they choose to. It would be easier if there were no tax consequences from this, such as a capital gains tax. This
is the case in Switzerland or Hong Kong, where people can do business in the currency of their choice without tax issues. At least one country, Zimbabwe, has no official currency, but rather a formal multi-currency policy where people can do business using any currency the like. In practice, this has turned out to be primarily U.S. dollars, with some use of South African rands. Historically the preferred currency of business, in any country, is one based on a gold standard system. British pounds, and later U.S. dollars, became the preferred parallel currency throughout the world for this reason. It was the currency people chose to use instead of their own governments fiat junk. Some people today, including myself, think that the United States should return to the monetary principles of the countrys first 182 years in other words, a gold standard system. However, that idea remains contentious, particularly among those who believe that a currency should be used as a tool for economic manipulation. Our present chief currency manager, Benjamin Bernanke, spent his academic career arguing for the merits of economic manipulation via currency manipulation. A gold standard system would prevent such things. However, even among academics who share Mr. Bernankes viewpoints, the idea of letting people choose whatever currency suits them best remains a popular one. The concept of parallel currencies, including those based on gold, within the United States seems to be relatively uncontroversial among the economic mainstream. Today, there are over 150 currencies in the world, all of which could conceivably be used as parallel currencies within the United States or other countries. However, all of them are floating fiat currencies, generally of lower quality than the U.S. dollar or euro. There is hardly any reason to introduce another. Thus, the most meaningful new parallel currency to be introduced, in the U.S. or in another country, would be one based on gold. Difficulties of Using Gold-and Silver-Based Parallel Currencies in the U.S. Today Although the use of other countries national currencies is largely accepted in the U.S., the issuance of alternative currencies within the U.S. can run afoul of what are collectively known as legal tender laws, both de jure and de facto. Beginning in 1998, a private businessman, Bernard von NotHaus, issued a system of coinage and paper bills called Liberty Dollars that represented warehouse receipts for gold and silver bullion. The notes and coins bore no resemblance
Federal Reserve Notes or U.S. Mint coins. About 250,000people apparently participated in the system. Although other alternative currencies have existed, such as Phoenix dollars, Baltimores BNote, BerkShares, Ithaca Hours, and bitcoin, this was apparently the only such system based on gold and silver.
Liberty Dollar notes and coins.
In 2006, the U.S. Mint issued a press release stating that the U.S. Justice Department had determined that using Liberty Dollars was a Federal crime. The press release stated: Under 18 U.S.C. 486, it is a Federal crime to pass, or attempt to pass, any coins of gold or silver intended for use as current money except as authorized by law. ... NORFEDs "Liberty Dollar" medallions are specifically marketed to be used as current money in order to limit reliance on, and to compete with the circulating coinage of the United States. Consequently, prosecutors with the United States Department of Justice have concluded that the use of NORFEDs "Liberty Dollar" medallions violates 18 U.S.C. 486, and is a crime. In 2007, the Federal Bureau of Investigation (FBI) raided the warehouse used by the Liberty Dollar system at the Sunshine Mint in Coeur DAlene, Idaho, confiscating a reported$7 million of gold and silver bullion. The seizure warrant was for money laundering, mail fraud, wire fraud, counterfeiting, and conspiracy. In 2009, von NotHaus was arrested and charged with: one count of conspiracy to possess and sell coins in resemblance and similitude of coins of a denomination higher than five cents, and silver coins in resemblance of genuine coins of the United States in denominations
of five dollars and greater, in violation of 18 U.S.C. 485, 18 U.S.C. 486,and 18 U.S.C. 371; one count of mail fraud in violation of 18 U.S.C. 1341 and 18 U.S.C. 2; one count of selling, and possessing with intent to defraud, coins of resemblance and similitude of United States coins in denominations of five cents and higher, in violation of18 U.S.C. 485 and 18 U.S.C. 2; and one count of uttering, passing, and attempting to utter and pass, silver coins in resemblance of genuine U.S. coins in denominations of five dollars or greater, in violation of 18 U.S.C. 486 and 18 U.S.C. 2. In 2011, von NotHaus was convicted on several counts, and faced up to 15 years of jail time. In 2011, von NotHaus was labeled a domestic terrorist by the FBI. Conceivably, people today could do business using gold coins produced by the U.S. Mint, such as the popular American Eagle gold and silver coins. However, they too would face unusual difficulties. Despite its long history as the foundation of monetary systems in the United States and elsewhere, gold today is regarded as a collectible, and subject to a different system of taxation than if one were to do a similar transaction using foreign currencies such as euros or Canadian dollars. The capital gains tax rate on collectibles held for one year or longer is 28%, compared to 15% for stocks and bonds. For example, if a house were purchased using U.S. Mint gold coins, the transfer of the coins to the seller would be regarded as a sale of gold bullion for tax purposes, and subject to capital gains taxes. If the same transaction were done with euros, no such taxes would apply. (Capital gains taxes would apply to the eventual sale of the house, and if the euros were converted back to dollars.) In addition, purchases or sales of small quantities of gold are subject to sales taxes in many states. California, for example, charges sales tax on bullion sales of less than $1,500. Thus, a businessman who wished to pay employees using a 1/10 ounce U.S. Mint gold bullion coin, or one-ounce U.S. Mint silver coins, may face sales taxes on his sale of the bullion coins to the employee. (No such sales taxes apply to purchases of euros.) Also, transactions in gold bullion are now subject to onerous surveillance, which does not apply to similar transactions in foreign currencies. To give an idea of the present state of affairs, here is some information from bullion dealer metallixdirectgold.com:
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SOUND MONEY: PARALLEL CURRENCIES TESTIMONY 1029 4. COMPLIANCE WITH GOVERNMENT RECORDED CONVERSATIONS. AGENCIES;
A. Documentation for Payment. Several states require that we obtain your drivers license number or other government-issued identification and a sworn statement from You as to the Merchandise and compliance with applicable law before we process any payment to You. Certain localities require completion of forms and a waiting period for a transaction in precious metal. If merchandise contains by weight or volume 50% or more of precious metal and is valued at more than $3,000, federal anti-money laundering laws obligate us to obtain certain completed forms and identity information from you before we process the transaction (such local, state and federal documentation, Compliance Documents). You agree to supply such Compliance Documents to us upon our request. . If You fail to provide such Compliance Documents to us within 5 Business Days after the date of our notice to You requesting such information, we have the option to terminate the proposed Transaction and return your Merchandise in the form in which You furnished it to us or in a different form in accordance with this Agreement without providing You with additional notices.
Thus, in practice, the U.S. Federal Government makes a powerful effort to suppress the introduction and use of alternative gold-and silver-based currencies today. This state of affairs has become intolerable to many. In 2011, the State of Utah declared that it would consider U.S. Mint gold and silver coins (and monetary instruments based on these coins) to be legal as currency. This included the removal of all state-level taxes on transactions in gold and silver bullion. The Utah example has been widely followed. Twelve other state legislatures have had similar bills proposed. 271The Utah example could serve as a template for similar Federal-level legislation to legalize gold and silver (and associated monetary instruments) as currency within the United States. Parallel Currencies Issued by National and State Governments In the last decade, some governments have taken steps to introduce gold-based parallel currencies, intended to circulate alongside their existing currencies, and to be used internationally. In 2002, the prime minister of Malaysia proposed the introduction of a gold dinar currency, for use throughout the Islamic world. In 2006, gold dinar coins (containing 4.25 grams of gold) were introduced by the government of the Malaysian state of Kelantan. This was
South Carolina, North Carolina, Alabama, Virginia, Tennessee, Missouri, Idaho, California,Colorado, Washington, Indiana and Minnesota.
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followed by the state of Perak in 2011. The coins have been quite popular. However, the effort to create a usable international currency based on the gold dinar has been hindered, in my opinion, by the fact that small denomination banknotes and coins have not yet been issued. Gold coins are much too valuable (have a high denomination) to be useful in small daily transactions by themselves. Also, banking arrangements based on the new currency have apparently not been established yet.
Malaysian gold dinar and silver dirham coins, produced by the state of Kelantan. In 2002, the prime minister of Malaysia stated the intent to create a gold dinar system to serve the entire Islamic world.
In 2011, the Swiss Parliament began discussions on the creation of a gold franc, which would be issued by the Swiss national government and circulate in parallel with the existing Swiss franc, a floating fiat currency. The initiative is part of the Healthy Currency campaign sponsored by the conservative Swiss Peoples Party. Governments of the Gulf States have discussed a common currency tentatively named the khaleeji, which some have speculated would be based on gold. In August 2011, the DubaiMulti Commodities Center introduced a gold coin, called the khalifa, intended to serve as legal currency. The DMCC is in talks with the central bank of the UAE to designate the coin as legal tender throughout the UAE and Middle East.
Proposed khalifa coin, intended to serve as legal currency in the Gulf States region.
What if the U.S. Federal government itself issued a parallel currency, in particular one based on a gold standard system? It could be quite popular both in the U.S. and abroad. The U.S. Federal government already has a long history of this. From 1882 to 1933, the Federal government issued gold certificates a form of banknote, or paper money, redeemable for gold bullion that constituted a major part of the U.S. currency system. During that time, both U.S. Treasury gold certificates and National Bank Notes issued by a menagerie of private banks circulated alongside. The gold certificates were more popular, due to their uniformity and the fact that people trusted the reliability of the Federal government far more than the small commercial banks of the day. In 1914, gold certificates accounted for32% of circulating currency in the United States.
U.S. Treasury Gold Certificate, series 1922. These gold certificates circulated alongside many other types of banknotes, including Federal Reserve Notes and National Bank Notes. People were free to choose which banknote they preferred.
If the Federal government does not wish to undertake such a program, a state government, such as the State of Utah, could conceivably issue its own parallel currency. Historically, before 1971, there was little reason for national governments to issue their own parallel currencies, because their primary currencies were already operating on a gold standard system. However, there is at least one example: in 1922, the Russian government introduced the gold-based chervonets currency, to circulate alongside the ruble, which at the time was a floating fiat currency. By 1947, the ruble itself had been pegged to gold, thus negating any need for a parallel gold-based currency. Thus, the chervonets was retired.
1937 Russian gold chervonets banknote. The chervonets was introduced by the Russian national government as a parallel currency to the floating fiat ruble
in 1922.
A similar example comes from Germany. In November of 1923, a new currency based on gold, the rentenmark, was introduced to replace the hyperinflated Reichsmark. For a short period, the two currencies circulated alongside, the rentenmark pegged to gold and the reichsmark continuing its plunge into oblivion. The rentenmark was quickly adopted by all, and the Reichsmark in effect disappeared from circulation.
German rentenmark banknote. The rentenmark was introduced by the nationally-sanctioned Rentenbank as a gold-based parallel currency, at first circulating alongside the hyperinflated reichsmark.
Gold and silver have reportedly been declared legal currency in China, and major state-owned commercial banks there now offer goldand silver-denominated bank accounts. 272 Significance of Gold-Based Parallel Currencies Today The discussion today around parallel currencies is part of a broader discussion: whether to have a currency that can be manipulated for economic effect, or to have a currency which is as stable and reliable as possible, free of human intervention. Traditionally, these have been known as soft money and hard money, and, in practice, have meant either a floating fiat currency, or a gold standard system. The two options are, for the most part, mutually exclusive: it is not possible to have a gold standard system and a policy of monetary manipulation together for any length of time.
See for example: http://businesstimes.com.vn/chinas-banks-use-gold-as-legal-currency/
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Both options have been used, by one government or another, for literally thousands of years. We have a lot of experience in these matters. For the entire post-medieval history of capitalism -stretching from the Italian city-states of the Renaissance era, through the heyday of Amsterdam as the worlds financial center in the 17 century, through the entire history of the Industrial Revolution with London as the worlds financial center in the 19
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century, into the
20 century with the U.S. as the leader of the capitalist world a gold standard system was the preferred monetary foundation. The worldwide transition to floating fiat currencies, or soft money, in 1971 reflected the increasing popularity of currency manipulation ideas beginning in the 1930s. However, it also reflected simple incompetence. It was an accident. In 1971, the Bretton Woods gold standard system had delivered twenty years that were among the most prosperous in world history. There was no reason to change it. President Nixon himself said that the end of the gold standard in August 1971 would be temporary. Indeed, he tried to reinstate it with the Smithsonian Agreement in December 1971, which he called the most significant monetary agreement in the world. Thus, it is not surprising today that we are again trying to find a way back to the world gold standard system, which worked so well for literally centuries. Rather than endlessly debating the merits of one system or another, a simpler method is to make both options available, and allow people to choose which they prefer. Just as people in Turkey today choose to do business either in the Turkish lira or euros, as suits their needs, people in the U.S. or elsewhere could choose to do business either in floating fiat dollars or some gold-based alternative. According to a study of 775 floating fiat currencies by Michael Hewitt273, no floating fiat currency has ever maintained its value. In 20% of cases, they were destroyed in hyperinflation; 21% were destroyed by war; 12% disappeared in independence; 24%underwent a monetary reform; and 23% exist today, awaiting their final outcome. The average life expectancy of a floating fiat currency was found to be 27 years. The U.S. dollar, which has been a floating fiat currency for 41 years now, is thus an unusual example of longevity. However, todays extreme reliance upon easy money approaches to deal with economic problems with the Federal Reserve promising
Hewitt, Michael. The Fate of Paper Money, dollardaze.org, January 7, 2009.http://dollardaze.org/blog/?post_id=00405
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unprecedented zero percent policy rates for years, and real interest rates deeply negative suggests to many that the floating fiat dollar does not have a long or successful future. Unfortunately, with world currency arrangements still very dollar-centric, the management of the dollar has consequences for everyone. Governments of China, Russia, the Gulf States and others have complained about the potential consequences of todays aggressive soft money techniques -not only at the Federal Reserve but also the European Central Bank, Bank of England, and Bank of Japan --and have made preliminary steps toward a future alternative.
At a G8 meeting in July 2009, Russian President Dmitry Medvedev illustrated his call for a supranational currency to replace the dollar with a coin that he called a sample of a united future world currency. The coin is half-ounce gold bullion coin. Such a supranational currency would be, in effect, a parallel currency, used alongside national currencies.
The coin held by President Medvedev. source: futureworldcurrency.com
On the international scale, a parallel gold-based currency, or many such currencies, would help ease this transition, and form the basis of a new monetary order if that should become necessary. Each individual would be free to make increasing use of the gold-based alternative, as it best suited their interests. There would be no great day of transition, but a smooth extended process perhaps over years. The existence of a high-quality alternative could help people avoid much of the potentially disastrous consequences if todays floating fiat currencies meet the same end as the 599 floating currencies that no longer exist. If the United States government wishes to retain its leadership role in world monetary affairs, I suggest that this alternative be created in the United States either by federal or state governments themselves, or by allowing private institutions to do so. Otherwise, governments that are clearly establishing the foundation for a future dollar alternative, likely based on gold, will take that role in the future.
WRITTEN TESTIMONY OF RICHARD EBELING, Ph.D.

PROFESSOR OF ECONOMICS NORTHWOOD UNIVERSITY
The gold standard alone is what the nineteenth-century freedomloving leaders (who championed representative government, civil liberties, and prosperity for all) called sound money. The eminence and usefulness of the gold standard consists in the fact that it makes the supply of money depend on the profitability of mining gold, and thus checks large-scale inflationary ventures on the part of governments. 274 --Ludwig von Mises
To discuss a possible roadmap to monetary freedom in the United States requires us to first determine what may be viewed as a sound or unsound money. Through most of the first 150 years of U.S. history, sound money was considered to be one based on a commodity standard, most frequently either gold or silver. In contrast, the history of paper, or fiat, monies was seen as an account of abuse, mismanagement and financial disaster, and thus unsound money. The histories of the Continental Notes during the American Revolution, the Assignats during the French Revolution, and then Greenbacks and the Confederate Notes during the American Civil War, all warned of the dangers of unrestricted and discretionary government power over the monetary printing press. 275 This view was summed up in the middle of the nineteenth century by the famous British economist, John Stuart Mill, whose Principles of Political Economy was a widely used textbook for decades not only in his native Great Britain, but in the United States, as well:
Ludwig von Mises, The Gold Problem, [1965] in Planning for Freedom (South Holland, Ill: Libertarian Press, 1980); see, also, Richard M. Ebeling, Austrian Economics and the Political Economy of Freedom (Northampton, MA: Edward Elgar, 2003), Chapter 5: Ludwig von Mises and the Gold Standard, pp. 136-158. 275 On the American Continental Notes, the French Revolutionary Assignats, and the Greenbacks and Confederate currency during the American Civil War, see, J. Laurence Laughlin, A New Exposition of Money, Credit and Prices, Vol. II (Chicago: University of Chicago Press, 1931), pp. 147-185 & 302-341; Edwin W. Kemmerer, Money (New York: MacMillan, 1935) pp. 173-197 & 230-270; and, Richard M. Ebeling, Inflation and Controls in Revolutionary France: The Political Economy of the French Revolution, in Stephen Tonsor, ed., Reflections on the French Revolution (Washington, D.C.: Regnary Gateway, 1990) pp. 138-156; and Richard M. Ebeling, The Great French Inflation, The Freeman: Ideas on Liberty (July/August, 2007) pp. 2-3. 1038
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SOUND MONEY: PARALLEL CURRENCIES TESTIMONY 1039 The issuers may add to it indefinitely, lowering its value and raising prices in proportion; they may, in other words depreciate the currency without limit. Such a power, in whomsoever vested, is an intolerable evil To be able to pay off the national debt, defray the expenses of government without taxation, and in fine, to make the fortunes of the entire community, is a brilliant prospect, when once a man is capable of believing that printing a few characters on bits of paper will do it There is therefore a preponderance of reasons in favor of a convertible, in preference to even the bestregulated inconvertible currency. The temptation to over-issue, in certain financial emergencies is so strong, that nothing is admissible which can tend, in however slight a degree, to weaken the barriers that restrain it.276
Episodes of great inflations in countries like Germany, Austria, and China in the twentieth century only have reinforced the advocates of sound money on the dangers of paper money in the hands of any political authority.277 The importance of a monetary system based on gold, therefore, is that it limits the range of discretion open to governments to manipulate the quantity and value of money. The fundamental rule that the supply of money in the economy is anchored to the profitability of gold production as determined by market forces depoliticizes the monetary system to a significant degree. Given an established redemption ratio between bank notes and deposit accounts and a quantity of gold on deposit in banks; given fixed reserve requirements on checking and other forms of bank deposits; given an established rule of the right of free import and export of gold between one's own country and the rest of the world; and assuming that the political authority with responsibility over the country's monetary system does not interfere with these conditions and rules, then political influences on the value and quantity of money would be minimized. The Gold Standard in Practice In the second half of the nineteenth century most of the major nations of the world put into place national monetary systems based
John Stuart Mill, Principles of Political Economy, with Some Applications to Social Philosophy (Fairfield, N.J.: Augustus M. Kelley, [1871] 1976) pp. 544-546. 277 For a brief history of the great inflations during and after the First World War, and especially in Germany and Austria in the early 1920s, see, Richard M. Ebeling, The Lasting Legacy of World War I: Big Government, Paper Money, and Inflation Economic Education Bulletin, Vol. XLVIII, No. 11 Great Barrington, MA: American Institute for Economic Research, November 2008); and on the hyperinflation in China during the 1930s and 1940s, see, Richard M. Ebeling, The Great Chinese Inflation, The Freeman: Ideas on Liberty (December 2004), pp. 2-3.
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on gold. By the fact that such a large number of countries had each linked their respective currencies to gold at some fixed rate of redemption in this manner, there emerged an international gold standard. A person in any one of those countries could enter any number of established, authorized banks and trade in a certain quantity of bank notes for a stipulated sum of gold, in the form of either coin or bullion. He could transport that sum of gold to any of the other gold-based countries and readily convert it at a fixed rate of exchange into the currency of the country to which he had traveled. As Murray Rothbard expressed it in, What Has Government Done to Our Money?:
The world was on a gold standard, which meant that each national currency (the dollar, pound, franc, etc.) was merely a name for a certain definite weight of gold. The dollar, for example, was defined as 1/20 of a gold ounce, the pound sterling as slightly less than 1/4 of a gold ounce This meant that the exchange rates between various national currencies were fixed, not because they were arbitrarily controlled by government, but in the same way that one pound of weight is defined as being equal to sixteen ounces.278
Why did governments recognize and (with occasional exceptions) follow the rules of the gold standard through most of the nineteenth century? Because the gold standard was considered an integral element in the reigning political philosophy of the time, classical liberalism. As the German free-market economist Wilhelm Roepke explained in International Order and Economic Integration:
The international open society of the nineteenth century was the creation of the liberal spirit in the widest sense, [guided by] the liberal principle that economic affairs should be free from political direction, the principle of a thorough separation between the spheres of government and of economy . . . The economic process was thereby removed from the sphere of officialdom, of public and penal law, in short from the sphere of the stat' to that of the market, of private law, of property, in short to the sphere of society.279
At the same time, said Roepke,

This [liberal] principle also solved an extremely important special problem of international integration . . . i.e., the problem of an international monetary system . . . in the form of a gold standard . . . It was a monetary system which rested upon the structural Murray N. Rothbard, What Has Government Done to Our Money? (Auburn, AL: Ludwig von Mises Institute, 1990) p. 23-24. 279 Wilhelm Roepke, International Order and Economic Integration (Dordrecht, Holland: D. Reidel Publishing, 1959) p. 75.
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SOUND MONEY: PARALLEL CURRENCIES TESTIMONY 1041 similarity of the national systems, and which made currency dependent, not upon political decisions of national governments and their direction, but upon the objective economic laws, which applied once a national currency was linked to gold . . . But it was at the same time a phenomenon with a moral foundation . . . The obligations, namely, which a conscientious conformity with the rules of the gold standard imposed upon all participating countries formed at the same time a part of that system of written and unwritten standards which . . . comprised the [international] liberal order.280
In the nineteenth century, the ruling idea had been liberty. The wealth of nations was seen as arising from individual freedom in a social order respecting private property in the means of production. The relationships among men, it was believed, should be based on voluntary exchange for mutual benefit. Just as there were no inherent antagonisms among men in a free market within the same nation, there were no inherent antagonisms among men living in different nations. The mutual gains from trade could be expanded by extending the principle of division of labor to a global scale. If men were to benefit from those possibilities, a stable, sound, and trustworthy monetary order had to assist in the internationalization of trade. Gold was considered the commodity most proven through the ages to serve that function. And preservation of the gold standard, therefore, was given a prominent place among the limited duties assigned to the classical-liberal state in that earlier era. In the nineteenth century there also was a greater humility among those who constructed and implemented various government economic policies. There was a general agreement with Adam Smiths observation that the statesman, who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate, and which would nowhere be so dangerous as in the hands of a man who had the folly and presumption enough to fancy himself fit to exercise it. 281 The Gold Standard, Central Banking, and Changing Monetary Policy Goals The classical liberals were deeply suspicious of government abuse of the printing press. They believed that only a monetary system
Ibid., pp. 76-77. Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: New Modern Library, [1776] 1937), Book IV, Chapter II, p. 423.
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under which all bank-issued notes and other deposit claims were redeemable on demand for gold could act as a sufficient check against the abuse and debasement of a currency. However, even in the high-water mark of classical liberalism in the nineteenth century, practically all advocates of the free market and free trade believed that money was the one exception to the principle of private enterprise. The international monetary order of the last century, of which Wilhelm Roepke spoke in such glowing terms, was nonetheless the creation of a planning mentality. The decision to go on the gold standard in each of the major Western nations was a matter of state policy. A central-banking structure for the management and control of a gold-backed currency was established in each country by its respective government, either by giving a private bank the monopoly control over gold reserves and issuing banknotes or by establishing a state institution assigned the task of managing the monetary system within the borders of a nation. The United States was the last of the major Western nations to establish a central bank, but it finally did so in 1913. Central-banking authorities were given the power and responsibility to manage the gold reserves at their disposal and the quantity of notes and other bank deposit claims outstanding to maintain the soundness of the monetary system and to counteract various short-term fluctuations in the national currencys foreignexchange rate, the balance of payments, and the quantity of financial credit available in the countrys economy. Their policy tools included manipulation of short-term interest rates and the buying and selling of private-sector bills of trade and securities. While the goals for monetary policy may have been considered modest and limited in the eyes of the classical liberals of the nineteenth century, it remained a fact that the monetary system was a subject for national government policy. In an era of relatively unrestricted free-market capitalism, money and the monetary system were a nationalized industry. And as such, even most of the advocates of economic liberty argued for monetary socialism and monetary central planning. They failed to call for and defend the privatization of the most important commodity in a market economy the medium of exchange. What they forgot was that once a government has control and responsibility for the monetary system within a country, little was outside the power of that government to influence and manipulate. This was clearly stated by a prominent German economist named
Gustav Stolper while a refugee in the United States from war-torn Europe during the Second World War:
Hardly ever do the advocates of free capitalism realize how utterly their ideal was frustrated at the moment the state assumed control of the monetary system . . . A free capitalism with government responsibility for money and credit has lost its innocence. From that point on it is no longer a matter of principle but one of expediency how far one wishes or permits governmental interference to go. Money control is the supreme and most comprehensive of all government controls short of expropriation.282
As a result, when economic collectivism, socialism, and interventionism gained popularity and power in the early decades of the twentieth century, money was the one area in which the centralplanning ideal was already triumphant. For a hundred years, now, in the United States it had been taken for granted that the state should have either direct or indirect monopoly control over the supply of money in the market. In the nearly one hundred years since the First World War, the goals assigned to monetary central planning changed, but the instrument for their application remained the same central bank management of the money supply. In the 1920s, Federal Reserve policy was heavily focused on price level stabilization; its result was generating a variety of imbalances between saving and investment that set the stage for the Great Depression. 283 Beginning in the 1930s, under the growing influence of Keynesian Economics the goal was to influence the levels of aggregate employment and output in the economy. After the disastrous experience with Keynesian-generated stagflation in the 1970s a combination of significantly rising prices and persistently high unemployment the monetary authorities in the 1980s and 1990s focused on slowing down and controlling inflation. 284 In the late 1990s, the Federal Reserve switched back to a more activist monetary policy that fed the excesses of the high tech bubble that
Gustav Stolper, This Age of Fable in the Political and Economic World (New York: Reynal & Hitchcock, 1942), p. 42. 283 For an analysis of the Federal Reserve policy in the 1920s, and the contrasting interpretations on the causes and cures for the Great Depression given by the Austrian Economists and the Keynesians, see, Richard M. Ebeling, Political Economy, Public Policy, and Monetary Economics: Ludwig von Mises and the Austrian Tradition (London/New York: Routledge, 2010), Chapter 7: The Austrian Economists and the Keynesian Revolution: The Great Depression and the Economics of the Short-Run, pp. 203-272. 284 On the stagflation of the 1970s, see, Gottfried Haberler, The Problem of Stagflation: Reflections on the Microfoundation of Macroeconomic Theory and Policy (Washington, D.C.: American Enterprise Institute, 1985).
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went bust shortly after the turn of the new century. Then, in 2003, fearful of hypothetical deflationary forces, 285 the Federal Reserve went on a policy of monetary expansion that created the monetary and credit wherewithal that produced the housing and investment and consumer spending boom that went dramatically burst in 2008 and from which we are still attempting to recover, especially in terms of employment.286 In addition, throughout the last century, governments including the United States government loosened the limits that gold placed on the ability of their central banks to expand the money supply and manipulate the amount of credit created and issued through the banking system to further changing monetary and fiscal goals. For decades, now, governments including the United States government have completely eliminated this break on their discretionary monetary policy by virtually ending any connection between the paper currencies they control and gold. The world economy operates in an economic environment of paper monies under the monopoly control central banks.
Central Banking is a Form of Central Planning With the Same Defects One of the primary benefits of economic freedom is that it decentralizes the negative effects that may arise from ordinary human error. Every one of us makes decisions that we hope will produce outcomes we desire. Yet the actual outcomes from our actions often fail to match up to the hopes that motivated them. A businessman who misreads market trends in planning his private company's production and marketing strategies may experience losses that require him to cut back his activities, resulting in some of his employees' losing their jobs and in
See, Richard Ebeling, The Hubris of Central Bankers and the Ghosts of Deflation Past, In Defense of Capitalism & Human Progress blog (July 5, 2010), http://blogs.northwood.edu/indefenseofcapitalism/2010/07/05/the-hubris-of-centralbankers-and-the-ghosts-of-deflation-past-by/ 286 On the current economic crisis, see my testimony before the House of Representatives Subcommittee on Domestic Monetary Policy and Technology delivered on May 11, 2011: Richard M. Ebeling, Monetary Policy, the Federal Reserve, and the National Debt Problem, In Defense of Capitalism & Human Progress blog (May 11, 2011), http://blogs.northwood.edu/indefenseofcapitalism/2011/05/.
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resource suppliers' experiencing fewer sales because the losssuffering businessman reduces his orders for what they have for sale. But the negative ripple effects from his entrepreneurial mistakes are localized within one corner of the overall market. Other sectors of the market need not be directly penalized or subject to the unfortunate effects of his poor judgment. Profit-making enterprises can freely go about their business hiring, producing, and then selling the goods that they have more correctly anticipated the consuming public actually desires to buy. Under government central planning, however, errors committed by the central planners are more likely to have an impact on the economy as a whole. Every sector of the economy is directly interlocked within the centrally planned blueprint for the allocation of resources, the quantities of different goods and services to be produced, and the distribution of the output to the consuming public. Centralized failures in resource use or production decisions more directly affect every sector of the economy, since nothing can happen in any of the government-run industries independently of how the central planners try to fix their mistakes. Everyone more directly feels the consequences of the central planners' errors and must wait for those planners to devise a revised central plan to correct the problem. Monetary central planning suffers from the same sort of defect. Changes in the money supply emanate from one central source and are determined by the monetary central planners' conceptions of the "optimal" or desired quantity of money that should be available in the economy. Their central decision can indirectly influence the pattern of interest rates (at least in the short run) and the market structure of relative prices and inevitably bring about changes in the general value, or purchasing power, of the monetary unit. The monetary central planners' policies work their way through the entire economy, possibly bringing about a cycle of an inflationary boom followed by general economic downturn or even depression. Halting the inflation and bringing an unsustainable boom to an end depends upon the monetary central planners' discovery that things may have gone too far and a decision by them to reverse the course of monetary policy. Many, if not most, sectors of the market will then have to modify and correct investment, production, and employment decisions that had been made under the false, inflationary price signals the central planners' monetary policy has artificially created. Capital, wealth, and income spending patterns in
the market will have been misdirected and partly wasted because of the errors committed by the monetary central planners. The opponents of central banking have argued that the occurrence of such errors would be less frequent and discovered more quickly under a system of competitive free banking. Any private bank that over-issued its currency would soon discover its mistake through the feedback of a loss of gold or other reserves through the interbank clearing process and withdrawal by its depositors. The bank would realize the necessity of reversing course to ensure that its gold- and other-reserve position was not seriously threatened and avoid the risk of losing the confidence of its own customers because of heavy withdrawals by depositors. Moreover, the effect of such a private bank's following a loose and easy monetary policy would be localized by the fact that only its banknotes and check money would be increasing in supply because of the additional spending of those to whom that bank had extended additional loans. It could neither force an economy-wide monetary expansion throughout the entire banking system nor create an economy-wide price-inflationary effect. Any negative consequences, while being unfortunate, would be limited to a relatively narrow arena of market decisions and transactions. Free Banking and the Benefits of Market Competition One of the strongest arguments that advocates of the free market have made over the last 200 years has been to point out the benefits of competition and the harmfulness of government-supported monopoly. In a competitive market, individuals are at liberty to creatively transform the existing patterns of producing and consuming in ways they think will make life better and less expensive for themselves and other members of society as a whole. Wherever legalized monopoly exists, the privileged producer is protected from potential rivals who would enter his corner of the market and supply an alternative product or service to those consumers who might prefer it to the one marketed by the monopolist. Innovation and opportunity are either prevented or delayed from developing in this politically guarded sector of the economy. Production methods remain unchanged or are modified only with great delay. Product improvements are slow in being developed and introduced. Incentives for cost efficiencies are less pressing and, when utilized, are often only sluggishly passed on to consumers in the form of lower sale prices.
Those who have the vision and daring to enter the market and successfully innovate and create newer or better products than the existing suppliers are offering are stymied or blocked from doing so in the protected sectors of the economy. They are forced to apply their entrepreneurial drive in less-profitable directions or are dissuaded by the political restrictions from even attempting to do so. The product improvements they would have supplied to the consuming public remain invisible might-have-beens lost to society. Furthermore, as Friedrich A. Hayek especially emphasized, market competition is the great discovery procedure through which it is determined who can produce the better product with the most desired features and qualities and at the lowest possible price at any given time.287 It is the peaceful market method through which each participant in the social system of division of labor finds his most highly valued use as judged by the relative pattern and intensity of consumer demand for the various goods supplied. Competition's dynamic quality is that it is a never-ending process. In the arena of exchange, every day offers new opportunities and allows entrepreneurs and innovators to create new opportunities that they are free to test on the market in terms of possible profitability. Every political restriction or barrier placed in the way of competition, therefore, closes the door on some potential creativity, risk-taking, and entrepreneurial discovery of more efficient and rational uses of men, materials, and money in the interdependent and mutually beneficial relationships of market specialization and cooperation. The choice is always between market freedom and political constraint, between the competitive process and governmentally created monopoly. This general argument in favor of market competition and against politically provided monopoly is no less valid in the arena of money and banking. The participants in the market may choose money they find most advantageous to use, or government can impose the use of a medium of exchange on society and monopolize control over its supply and value. The benefit from market-chosen money is that it reflects the preferences and uses of the exchange participants themselves. Participants in the market process will sort out which commodities offer those qualities and characteristics most useful and convenient in a medium of exchange. As the Austrian economists persuasively demonstrated, while money is one of those social
F. A. Hayek, Competition as a Discovery Procedure, [1969] in New Studies in Philosophy, Politics, Economics and the History of Ideas (Chicago: University of Chicago Press, 1978) pp. 179-190.
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institutions that are the results of human action but not of human design, it nonetheless remains the spontaneous composite outcome of multitudes of individual choices freely made by buying and selling in the marketplace. The alternative is what the American economist Francis A. Walker referred to in 1887 as political money. Political money is one that the government determines shall be used as money and whose supply is made to depend upon law or the will of the ruler. He warned that under the best of circumstances the successful management of a government-controlled money would depend upon an exercise of prudence, virtue and self-control, beyond what is reasonably and fairly to be expected of men in masses, and of rulers and legislators as we find them. Governments would, in the long run, always be tempted to abuse the printing press for various political reasons.288 But besides the dangers of political mischief, the fact is that the government monetary monopoly prevents the market from easily discovering whether, over time, market participants would find it more advantageous to use some particular commodity or several alternative commodities as different types of media of exchange to serve changing and differing purposes. The optimal supply of money becomes an arbitrary decision by the central monetary monopoly authority rather than the more natural market result of the interactions between market demanders desiring to use money for various purposes and market suppliers supplying the amount of commodity money that reflects the profitability of mining various metals and minting them into money-usable forms. But commodity money, as history has shown, has its inconveniences in everyday transactions in the market. There are benefits from financial depositories for purposes of safety and lowering the costs of facilitating transactions. But what type of financial and banking institutions would market participants find most useful and desirable under a regime of money and banking freedom? The answer is that we don't know at this time precisely
Francis A. Walker, Political Economy (New York: Henry Holt, 1887) p. 352. After the last one hundred years of even further monetary mischief and abuse than those in the nineteenth century had learned from, Walkers further comment is more pertinent today than when he wrote it, p. 353: The man who advocates government issues [of paper money], without being prepared to show reasonable ground for believing that they will not be so abused as to accomplish more evil than of benefit, is not entitled to be listened to. After the experiences of the last hundred years intelligent men rightly refuse to take the trouble even to discuss political schemes that assume an impossible virtue, or which disregard the actual conditions under which alone they could be set to work.
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because government has monopolized the supplying of money; and it imposes, through various state and federal regulations, an institutional straitjacket that prevents the discovery of the actual and full array of preferences and possibilities that a free market in monetary institutions might be able to provide and develop over time. The increasing globalization of commerce, trade, and financial intermediation during the last several decades has certainly demonstrated that there is a far greater range of possibilities that market suppliers of these services could provide and for which there are clear and profitable market demands than traditionally thought 20 or 30 years ago. But even in this more vibrant global competitive environment, it remains the case that whatever options have begun to emerge has done so in a restrictive climate of national and international governmental regulations, agreements, and constraints. Suppose that monetary and banking freedom were established. 289 What type of banking system would then come into existence? Some advocates of monetary freedom have insisted that a free banking system should be based on a 100 percent commodity money reserve. Others have argued that a free banking system would be based on a form of fractional-reserve banking, with the competitive nature of the banking structure serving as the check and balance on any excessive note issue by individual banks.
The literature on the potential, nature and workings of a private, competitive banking system with complete monetary freedom is large. Among the important works are: Ludwig von Mises, Monetary Stabilization and Cyclical Policy [1928] in On the Manipulation of Money and Credit (Indianapolis, IN: Liberty Fund, 2010); Mises, Human Action: A Treatise on Economics (Chicago: Henry Regnary, 3rd revised ed., 1966), pp. 440-448; Mises, The Theory of Money and Credit (Indianapolis, IN: Liberty Fund, [1953] 1981) pp. 434-438; Vera Smith, The Rational of Central Banking and the Free Banking Alternative (Indianapolis, IN: Liberty Fund, [1936] 1990); F. A. Hayek. Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies, [1978] in Stephen Kresge, ed., The Collected Works of F. A. Hayek, Vol. 6: Good Money, Part II (Chicago: University of Chicago Press, 1999) pp. 128-229; Lawrence H. White, Free Banking in Britain: Theory, Evidence, and Debate, 1800-1845 (Cambridge: Cambridge University Press, 1984); White, Competition and Currency: Essays on Free Banking (New York: New York University Press, 1989); White, The Theory of Monetary Institutions (Wiley-Blackwell, 1999); George A. Selgin, The Theory of Free Banking: Money Supply Under Competitive Note Issue (Totowa, N.J.: Rowman & Littlefield, 1988); Selgin, Bank Deregulation and Monetary Order (New York: Routledge, 1996); Kevin Dowd, Private Money: The Path to Monetary Stability (London: Institute of Economic Affairs, 1988); Dowd, The State and the Monetary System (New York: St. Martins Press, 1989); Dowd, Laissez-Faire Banking (New York: Routledge, 1993); Kevin Dowd, ed., The Experience of Free Banking (New York Routledge, 1993); Steven Horwitz, Monetary Evolution, Free Banking and Economic Order (Boulder, CO: Westview Press, 1992); Murray N. Rothbard, The Case for a 100 Percent Dollar (Auburn, AL: Ludwig von Mises Institute, 1991); Mark Skousen, Economics of a Pure Gold Standard (Auburn, AL: Ludwig von Mises Institute, 1988).
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Until monetary and banking freedom is established, we have no way of knowing which of the two alternatives would be the most preferred. This is for the simple reason that under the present government-managed and government-planned monetary and banking system, market competition is not allowed to demonstrate which options suppliers of financial intermediation might find it profitable to offer and which options users of money and financial institutions would decide are the ones best fitting their needs and preferences. Given the diversity in people's tastes and preferences, the differing degrees of risk people are willing to bear for a promised interest return on their money, and the variety of market situations in which different types of monetary and financial instruments might be most useful for certain domestic and international transactions, it probably would be the case that a spectrum of financial institutions would come into existence side by side. At one end of this spectrum would be 100 percent reserve banks that guaranteed complete and immediate redemption of all commodity money deposits, even if every depositor were to appear at that bank within a very short period of time. Along the rest of the spectrum would be various fractional-reserve banks at which lower or no fees would be charged for serving as a warehousing facility for deposited commodity money. Their checking accounts might offer different interest payments depending on the fractional-reserve basis on which they were issued and on the degree of risk or uncertainty concerning the banks' ability to redeem all deposits immediately under exceptional circumstances. Some banks might offer both types: they might issue some bank notes and checking accounts that were guaranteed to be 100 percent redeemable on the basis of commodity money deposited against them; and they might issue other bank notes and checking accounts that, under exceptional circumstances, were not 100 percent redeemable. And these banks might offer option clauses stipulating that if any designated notes or checking accounts were not redeemed on demand for some limited period of time, the note and account holder would receive a compensating rate of interest for the inconvenience and cost to himself. Whether most banks would be closer to the 100 percent reserve end of this spectrum or farther from it is not - and cannot be - known until the monetary and banking system is set free from government regulation, planning, and control. As long as the government remains as the monetary monopolist, there is just no way to know all the
possibilities that the market could or would generate. Indeed, for all we know, the market might devise and evolve a monetary and banking system different from that conceived even by the most imaginative free-banking advocates. Competition is thwarted by government monopoly money, and the creative possibilities that only free competition can discover remain invisible "might- have-beens." How then can the existing system be moved towards a regime of monetary and banking freedom? For a System of Monetary and Banking Freedom The great tragedy of the twentieth century was the arrogant and futile belief that man can master, control, and plan society. Man has found it difficult to accept that his mind is too finite to know enough to organize and direct his overall social surroundings according to an overarching design. The famous American journalist, Walter Lippmann, neatly explained the nature of this problem in his 1937 book, An Inquiry into the Principles of the Good Society:
The thinker, as he sits in his study drawing his plans for the direction of society, will do no thinking if his breakfast has not been produced for him by a social process that is beyond his detailed comprehension. He knows that his breakfast depends upon workers on the coffee plantations of Brazil, the citrus groves of Florida, the sugar fields of Cuba, the wheat farms of the Dakotas, the dairies of New York; that it has been assembled by ships, railroads, and trucks, has been cooked with coal from Pennsylvania in utensils made of aluminum, china, steel, and glass. But the intricacy of one breakfast, if every process that brought it to the table had deliberately to be planned, would be beyond the understanding of any mind. Only because he can count upon an infinitely complex system of working routines can a man eat his breakfast and then think about a new social order. The things he can think about are few compared with those that he must presuppose.... Of the little he has learned, he can, moreover, at any one time comprehend only a part, and of that part he can attend only to a fragment. The essential limitation, therefore, of all policy, of all government, is that the human mind must take a partial and simplified view of existence. The ocean of experience cannot be poured into the bottles of his intelligence.... Men deceive themselves when they imagine that they can take charge of the social order. They can never do more than break in at some point and cause a diversion.290
Money is one of those institutions that owes its origin and early development to social processes beyond what individual minds could
Walter Lippmann, An Inquiry into the Principles of the Good Society (Boston: Little, Brown, 1937) pp. 30 & 32.
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have fully anticipated or comprehended.291 But money's evolution has been constantly diverted from what would have been its marketdetermined course by governments and political authorities that saw in its control an ability to plunder the wealth of entire populations. Debasement and depreciation of media of exchange through monetary manipulation has been the hallmark of recorded history. To prevent such abuses and their deleterious effects, advocates of freedom supported the gold standard to impose an external check on monetary expansion. Paper money was to be convertible, redeemable on demand to banknote and checking account holders at a fixed ratio of redemption. But even this limit on government-managed money was eliminated in the twentieth century by the hubris of the centralplanning mentality, under which money, too, was to be completely under the control of the monetary central planners as part of the vision of designing and directing the economic affairs of society. Monetary central planning is one of the last vestiges of generally accepted out-and-out socialist central planning in the world. The fact is that even if monetary policy could somehow be shielded from the pressures and pulls of ideological and special-interest politics, there is no way to successfully centrally manage the monetary system. Government can no more correctly plan for the optimal quantity of money or the properly stabilized general scale of prices than it can properly plan for the optimal supply and pricing of shoes, cigars, soap, or scissors. The best monetary policy, therefore, is no monetary policy at all. The advocate of the free market believes that ending all trade restrictions or barriers and permitting free trade would eliminate the need for foreign trade policies. He also believes that the need for domestic regulatory policies would be eliminated by abolishing the regulatory agencies and repealing the antitrust laws and simply permitting market-guided competition and exchange. And logically the need for monetary policy would be eliminated by abolishing government monopoly control and regulation over the monetary and banking system. As Austrian economist Hans Sennholz once concisely expressed it,
We seek no reform law, no restoration law, no conversion or parity, no government cooperation: merely freedom.... In freedom, the money and banking industry can create sound and honest Carl Menger, On the Origin of Money, [1892] in Richard M. Ebeling, ed., Austrian Economics: A Reader (Hillsdale, MI: Hillsdale College Press, 1910) pp. 483-504..
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SOUND MONEY: PARALLEL CURRENCIES TESTIMONY 1053 currencies, just as other free industries can provide efficient and reliable products. Freedom of money and freedom of banking, these are the principles that must guide our steps.292
An Agenda for Monetary Freedom So what steps might be undertaken to move the American economy in the direction of establishing a regime of monetary freedom? At a minimum, they should include the following: (1) The repeal of the Federal Reserve Act of 1913, and all complementary and related legislation giving the federal government authority and control over the monetary and banking system. (2) The repeal of legal-tender laws, that gives government power to specify the medium through which all debts and other financial obligations, public and private, may be settled. Individuals, in their domestic and foreign transactions, would determine through contract the form of payment they mutually found most satisfactory for fulfilling all financial obligations and responsibilities into which they entered. (3) Repeal all restrictions and regulations on the free entry into the banking business and in the practice of interstate banking. (4) Repeal all restrictions on the right of private banks to issue their own bank notes and to open accounts denominated in foreign currencies or in weights of gold and silver. (5) Repeal of all federal and state government rules, laws, and regulations concerning bank-reserve requirements, interest rates, and capital requirements. (6) Abolish the Federal Deposit Insurance Corporation. Any deposit insurance arrangements and agreements between banks and their customers and between associations of banks would be private, voluntary, and market-based. In the absence of government regulation and monopoly control, a free monetary and banking system would exist; it would not have to be created, designed, or supported. A market-based system would naturally emerge, take form, and develop out of the prior system of monetary central planning.
Hans Sennholz, Money and Freedom (Cedar Fall, IA: Center for Futures Education, 1985) pp. 77 & 83.
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What would be its shape and structure over time? What innovations and variety of services would a network of free, private banks offer to the public over time? What set of market-determined commodities might be selected as the most convenient and useful media of exchange? What types of money substitutes would be supplied and demanded in a free-market world of commerce and finance? Would many or most banks operate on the basis of fractional or 100% reserves? There are no definite answers to these questions, nor can there be. It is deceptive to believe, as Walter Lippmann explained, that we could comprehend and anticipate all the outcomes that will arise from all the market interactions and discovered opportunities that the complex processes of the free society would generate. It is why liberty is so important. It allows for the possibilities that can only emerge if freedom prevails. It's why monetary freedom, too, must be on the agenda for economic liberty in this new twenty-first century.
WRITTEN TESTIMONY OF ROB GRAY

EXECUTIVE DIRECTOR THE AMERICAN OPEN CURRENCY STANDARD
Mr. Chairman and Members of the Committee, My name is Rob Gray and I was asked to testify today on the theory of competing currencies, and the practical challenges that make such a theory difficult or impossible to implement. For nearly 5 years now, I've successfully directed the American Open Currency Standard -the standard for private voluntary and complementary currencies that compete against each other, not against the US dollar. Allow me to clarify: we do not consider AOCS Approved medallions produced and traded in our private barter marketplace 'competition' to the US Federal Reserve Note. Because "fair competition", as one would find in the "free market", assumes the existence of a level playing field, the existence of a standard set of rules. Those players who wish to compete honestly do so by relying simply on the merit of the value they bring to the market. No fair challenge can be made between honest men and thieves. Let me be clear that when I say thieves: I refer to the current private central bank and the men in government who allow it to exist. This brings us to a critical point: according to your Employee Handbook, Article 1, Section 8 says: "The Congress shall have the Power ...To coin Money, regulate the Value thereof... For anyone who has been a manager or business owner, it is not uncommon to find that you may have an employee who may choose to not do the work that is delegated to them, or even that they simply do it very badly. When such a time comes it is necessary for the manager or owner to step in and do the work themselves. I would argue that since 1913, Congress has failed to do the job with which it had been tasked. We the people are now bypassing you and are no longer waiting for you to make it right. It is far better to simply walk away from the system. We are walking away from toxic thoughts, relationships, investments and careers. We are taking the hard intellectual journey to rid ourselves of the indoctrination that keeps us in this system. We are realizing the power we have in ourselves and the everyday choices that we make to either empower some soulless collective or our own families. We are realizing that we simply need to withdraw our time, energy, and money from banks, politicians and corporations that do not serve our interests. In the time since our inception, the American Open Currency
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Standard has enjoyed nearly five years of growth and success in our mission of issuing a means that allows valuable exchanges among men who produce. In the next five years, we expect to expand our offerings and to increase our ability to keep up with the demand for our private currency. We are doing the job Congress would not. The use of community currencies here in the US became popular back in the early 1930's. You see, at the time, the theory was that a group of the world's most powerful men, many of them international bankers, were intentionally and systematically removing currency from circulation, creating an artificial scarcity of money across America. Small cities and towns felt it worse than anyone. But life did go on. Then, during the greatest economic depression this country had ever seen, individuals across this country developed their own mediums of exchange. They still needed things -food, clothing, daily essentials -they still needed to live, and they didn't have time to wait for the government to fix the problem, and they certainly weren't going to rely on the same bankers that caused the crash to offer solutions. And so, according to historical records, thousands of community currencies were created, circulated and traded in places where the scarcity of dollars was interfering with the human desire to live, and the market's desire to trade. And since their elected employees were not doing the job for which they were hired, these individuals took it upon themselves to secure the means to their own survival and potential prosperity. More recently, community currencies have sprung up across Europe as the Euro and national fiat currencies become increasingly unavailable and undependable. Today, communities all across the Eurozone trade their own money instead of the Euro. Community currencies are not simply a good idea in theory; they are necessary, alive, and true examples of the free market's unwillingness to be artificially manipulated. Right now alternative and complementary currencies circulate widely across this country and in many different forms: Ithaca, New York uses a local fiat currency based loosely on the value of time; Berkshire, Massachusetts uses a fiat-backed fiat system, while many more communities circulate gold, silver and copper AOCS Approved barter tokens as a medium of exchange. How they are issued, accepted, accounted for and reported varies widely, as the participants and procedures are as different as the markets they serve. As for practical issues to overcome in the issuance and circulation of complementary currencies, there are plenty. In a voluntary system,
those that participate in the trading of private currencies must deal with the possibility of counterfeiting, fraud, scarcity, acceptance, accounting, storage and other issues, all without the luxury of big brother holding a gun to anyone's head to ensure their success. Even with all the risks, the market moves on. As in any free market, good ideas circulate with success, and bad ones eventually fade away. Participants voluntarily choose to accept and circulate the highest quality and most valuable currencies in exchange for their best production. Merchants accept complementary currencies based on the premise that someone else is willing to do the same later. Issues arise and are worked out by the market with only one light to guide them: the mutual exchange of value. No guns, no laws, no force: just the willingness to think outside the box and act on principle. Complementary currencies are not new, in theory or in practice. Further, private currencies circulated long before governments erected themselves to interfere. What's new, however, is the public's apathy towards you and your policies. You've managed for the last hundred years somehow to convince the citizenry that you're relevant. Now, just recently, we're beginning to see the tides change on this. And once it catches on, you'll be rendered completely obsolete. The greatest hurdle you will face over the next few years is trying to convince "we, the people" that you are still necessary in spite of your failures to get the job done. Sure, some will continue to rely on you for hand-outs; it's what they've known their entire lives and they will be slaves right up and to the point of their own destruction. They don't know any better and I don't blame them for their ignorance. But as you continue to squeeze the life out of the middle class, watch out for their greatest weapon: apathy. They may not be ready to admit it, but soon they'll turn their backs on you and never believe another lie -the lie that you are willing and able to do the job for which you were hired. In the future you will not have to worry about million man marches or citizen journalists trying to catch you on camera. What you need to fear is no one paying attention to you. The next American revolution will not be fought with bullets and bombs; it will be won with the opposite consciousness. "It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." ~Henry Ford To that end, I'm here today to propose a solution. My understanding of this subcommittee is that you desire to be part of the solution. You want to believe you're doing something good for the country. Today, the greatest gift you can offer to the people you
clearly represent is to introduce, not to the legislature but directly to the public, what I call IR 1207 -Individual Resolution 1207 commonly referred to as 'Ignore the Fed'. Store your wealth in silver. Bank with a non-fractional bank that pays real money on deposits. Use the card services network to satisfy dollar obligations. Do not try to compete with the federal reserve system: ignore them. This country has succeeded in doing away with two central banks already over the course of its history -it is learning to do the same again. Congressman Paul: on July 13, 2011, you asked Federal Reserve Chairman, Ben Bernanke, a question: 'Is gold money?' I ask that same question of you here today: is gold money? Is silver money? They most certainly are not. At least not by the current definition as handed down by Congress' money-issuing surrogate, the Federal Reserve. And that's just fine. I respectfully petition you, sir, to seriously reconsider your position on this matter. The government has perverted the word money. My wife is a nutritionist, and she tells people, 'If your grandparents wouldn't recognize it as food, don't eat it.' I suggest to you that if your great-grandparents wouldn't recognize it as money, don't accept or spend it. A great philosopher once said "When destroyers appear among men, they start by destroying money, ...." Today, conventional wisdom tells us that money is a worthless pile of paper. And for the last 100 years Congress has for a third time (again) shunned its responsibility when it comes to issuing money. Since the creation of the Federal Reserve and Congress' abdication of their responsibility, the dollar has lost 98% of its value. I don't suspect anyone would call that stellar job performance. I must be blunt and say that, as employees, Congress, you have not been successful in your charge to "...coin money and regulate the value thereof..." and therefore your services in this area are no longer needed. It is sad that even the men and women in this chamber either do not understand the system they serve or are so dependent upon the system's favors that they dare not speak in opposition to it.
"It is difficult to get a man to understand something, when his salary depends upon his not understanding it!" ~Upton Sinclair
I ask you to leave the Fed their money and leave the people our silver, gold and copper. Do not push to redefine whatever representations we choose for our wealth as 'money'. Let the Fed do what it wants with their 'money', so long as they leave us alone. I warn you: 'honest money legislation' is a wolf in sheep's clothing. The record of Congress over time has proven that it will make a miserable
failure of this aspect of human survival as it has so many others. The greatest thing this Congress can do is exactly what you've done so far: nothing. "The nine most terrifying words in the English language are, "I'm from the government and I'm here to help." --Ronald Reagan. I will not facilitate this government to "help" understand, control and ultimately destroy alternative currencies. All I ask is that you stay out of our way. The people in our world are happy to go right along saving you from your own destruction by producing value against all the odds, regulations, codes, and challenges thrown our way. But leave our money alone. It doesn't belong to you, and it never will. If you really want to help, I would recommend that instead of trying to DO something, you could start by undoing some things. But that list is far too long for me to get into here today and as a responsible employer, I'll allow you some room for creativity. One last thing I would like to leave you all to ponder... How is it possible for every single person in the world to be in debt with credit card debt, student debt, consumer debt, auto debt, and mortgages? How is it possible that every small business and corporation in the world is also in debt? And finally how is it possible that every single local, county, province, state and nation on earth is also in debt? Who owns the other side of that debt? When you understand that, maybe just maybe, something positive will come out of this chamber. The bottom line is simple: humanity is not going to wait for permission to survive. Things that cannot go on forever... won't. The market will move on -with or without you. And, based on your rate of success to date, our preference is without you. I thank you for your attention to this matter of life and death.
There are thousands hacking at the branches of evil to one who is striking at the root. ~ Henry David Thoreau
XPERT
OMMENTARY
JAMES TURK293
FOUNDER & CHAIRMAN GOLDMONEY
GOLD THE BARBAROUS RELIC IS NOT WHAT YOU THINK A Note from James Turk Dear Reader, The world today is a very different place than when I wrote this monograph six years ago. Unfortunately, by different I do not mean better, at least in regard to my main point central banks are still the barbarous relic, not gold. One noticeable difference from back then is the precipitous drop, particularly after the 2008 financial crisis, in the esteem with which central banks were previously viewed. The central bankers themselves are squandering this esteem. Their disregard for society is palpable, as despite their rhetoric to the contrary, they unfailingly and single-mindedly cater to their own interests and of course those politicians who put banking favours ahead of the interests of the people they supposedly represent. Central bankers are completely out of control. Having descended from the useful role they filled decades ago, their sole objective now is
[This essay is derived from Mr. Turks presentation at the Gold Rush 21 Conference (www.goldrush21.com) held in Dawson City, Yukon, Canada, August 8, 2005. This monograph and the introductory note are published with Mr. Turks permission.]
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to protect the people in finance and government who participate in and profit from the outrageous cartel power central banks now exercise. By creating unlimited amounts of currency, they serve the omnipotent state that they indirectly control though their monetary power over politicians. They use this control over the political process to protect their interests and maintain their grip on economic activity. But perhaps things are changing. An unreasonable burden has been placed on the backs of taxpayers around the globe by serial bailouts of foolhardy, reckless bankers. Combined with a corrupt system that allows unlimited quantities of money to be created out of thin air, and people everywhere are beginning to understand that a central bank does not serve their best interests, much less even care about their point of view. In the past central bankers have overcome this reality by claiming that they are a conduit to prosperity, which although false, has nevertheless enabled them to practice their financial witchcraft to create recurring booms and busts to societys detriment. During particularly tough economic times like the present, their arguments ring hollow. So instead central bankers and their apologists are now taking a new tack. They threaten us with a collapse of the whole financial edifice if their advice is not followed or if they are forced to disclose for public scrutiny the schemes and stratagems they concoct behind closed doors. When doing so, they blatantly ignore that this monetary system cobbled together over decades is rotten to the core with bad loans made by their banker collaborators. It is also inherently unfair given that bankers benefit during good times, and are then bailed out by taxpayers when the boom of illusory prosperity they created inevitably turns into the reality of a bust. Despite the growing questions about their role and increasing awareness of their dubious track record, central bankers continue to run roughshod throughout the world by financing bubbles, debasing currency, bailing out irresponsible bankers and providing an unending stream of untrustworthy currency to profligate politicians. As the global financial crisis continues to damage economies and cause incalculable hardship, politicians under the control of central bankers are putting the ever-growing burden of banker bailouts on
the backs of taxpayers. To what end? Hopefully to the end of central banking as it is currently practised, and the speedy restoration of sound money by people everywhere who are now awakening to the fact that central banking and not gold is the barbarous relic. Sincerely, James Turk Director, GoldMoney Foundation October 2011
Gold The Barbarous Relic is Not What You Think I am no fan of Keynesian economics. I find most Keynesian economic theories to be just plain wrong. But for the sake of truth and accuracy, I would like to correct a terrible injustice levied upon Keynes and, at the same time, also correct an equally terrible injustice that time and again is inflicted upon gold. How many times have you heard gold described as the barbarous relic? It is a favorite phrase of gold-bashers everywhere who are trying to make gold the object of derision. I cringe every time I hear it, which is all too frequently, because gold is neither barbarous nor a relic, as can be explained easily by the following chart.
Source: GoldMoney.com
This chart presents a base 100 analysis of crude oil prices in terms of dollars and grams of gold (goldgrams). In other words, to establish the comparison depicted above, it is assumed in this analysis that one barrel of crude oil equals $100 and 100 goldgrams as of December 1945. The month-end price is calculated afterward based on the actual dollar price of crude oil and the prevailing dollarto-goldgram rate of exchange. Gold Is Neither Barbarous nor a Relic The price of crude oil in goldgrams essentially is unchanged throughout the period measured. It is clear, then, that gold communicates the economic value of oil very effectively, and the communication of economic value is the primary feature of money. Because money is the tool upon which economic activity is based, which is a reality that makes money central to society, money is not barbaric. Consequently, gold cannot possibly be barbaric because gold is money. Gold also is not a relic because gold communicates value today as effectively as it did 50 years ago and much better than does the United States dollar, a point demonstrated clearly by the chart above. In contrast to national fiat currencies today, gold tends to hold its value; in other words, the purchasing power of gold remains relatively unchanged.294 In fact, this precious attribute of gold is timeless because the above-ground stock of gold grows approximately at the same rate as world population growth and new wealth creation.295 How could anything as valuable and useful as gold be
There are many examples that illustrate golds ability to maintain its purchasing power. Items as dissimilar as mens suits, Colt-45 revolvers, and the set menu lunch at Londons Savoy Hotel have been used to demonstrate that gold retains its purchasing power because the price of these items in terms of gold remains relatively unchanged over long periods of time. For a detailed analysis of the historical relationship of gold to commodity prices, see Roy W. Jastram, The Golden Constant: The English and American Experience, 1560-1976, New York, NY: John Wiley and Sons (1977). 295 This observation rests largely upon logic because it is difficult to locate all the hard facts needed to support it. World population growth is estimated at 1.14 per cent annually. See www.cia.gov/cia/publications/factbook/print/xx.html. The World Gold Council estimates that, as of 2002, 147,000 tons of gold have been mined throughout history. See www.gold.org/value/stts/faqs/index.html. Allowing for additional production since then of about 2,500 tons per year, total production is 167,000 tons. Because gold is accumulated in contrast to other commodities, all of which are consumed most of this gold still exists in the
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barbaric? And because gold is as useful today as it ever was, how could it possibly be a relic? While the pejorative reference to gold usually is attributed to Keynes, here is what he really wrote in 1923 in A Tract on Monetary Reform: [T]he gold standard is already a barbarous relic. The reader should note that gold is not the barbarous relic but, rather, in Keyness view, the gold standard. There is a big difference between the two concepts. The gold standard is the mechanism by which national currencies at one time were defined as weights of, and redeemable into, gold. Though the United States continued to define the dollar in terms of gold when Keynes penned those now infamous words after World War I, it had become the exception. Most of Europe had stopped the redeemability of paper currency into gold with the outbreak of hostilities in 1914. What is more, after the war, European countries were slow to return to the gold standard because their currencies had become terribly debased by the expansion of credit and the concurrent printing of money that had occurred during the intervening years. In effect, by the 1920s, the classical gold standard was essentially dead, which was the reality observed by Keynes. It was dead because banking interests, working hand in hand with governments, killed it. They killed it because governments wanted more money to meet their growing spending aspirations, and seeing the profit opportunity that this circumstance presented, bankers wanted to lend that money to them. The discipline of the classical gold standard prevented the unbridled extension of credit and the resulting creation of new
current above-ground stock. The weight of gold lost due to shipwrecks, attrition of circulating coinage, etc., is unknowable, but it generally is believed to be fairly small because of the care given to gold in view of its high value. If we assume, therefore, that the above-ground gold stock is around 162,500 tons after adjusting for the weight of gold lost over time, then 2,500 tons of new production is increasing that stock by around 1.54 per cent annually. The rate of new wealth creation is harder to determine. The CIA Factbook referenced above estimates that world gross domestic product (GDP) grew by 4.9 per cent last year, but not all of this economic production increased the worlds net wealth. In my view, therefore, it is not unreasonable to assume that the rate of new wealth creation remains approximately somewhere between 1.14 and 1.66 per cent, which explains why the purchasing power of gold remains consistent over long periods of time.
money, which meant that it had to go.296 So is that why the gold standard had become a barbarous relic? To answer this question, we have to understand why the gold standard came into existence in the first place. The origin of the gold standard can be traced back to events resulting from the formation of the Bank of England in 1694. However, to be able to really understand the gold standard and to explain Keyness trenchant observation, we have to go back even further into monetary history to extract one key truth the history of money is actually the history of currency. The Distinction between Money and Currency It is important to note that money does not really change. Money is the function it performs, so money is still the same thing it always has been from the moment when it first was invented in prehistory.297 Namely, money is a mental tool used for economic calculation298 that ingeniously enables each of us to communicate what we value in an exchange. What changes throughout monetary history is currency. It evolves, and the biggest change ever occurred in 1694. Until 1694, currency was always an asset in the hands of whoever held it, something tangible. Gold and silver were the most popular forms of currency, but history records that other assets were also used, such as cows, food crops, shells, beads, and other tangible items considered to be useful or rare. The nature of currency evolved as mankind progressed, and various scientific achievements made
Of the books that explain how and why banking interests and governments killed the gold standard, my favorite is Edwin Vieira, Jr., Pieces of Eight: The Monetary Powers and Disabilities of the United States Constitution, Fredericksburg, VA: Sheridan Books (2002), www.piecesofeight.us. For my recent review of this book, see www.fgmr.com/pieces8.htm. 297 By its classic definition, money is both a medium of exchange and a store of value. However, this definition better describes currency than money. In its broadest sense, which is how I use the term here, money is simply a means that enables economic calculation. 298 See, Ludwig von Mises, Human Action, 4th ed., Irvington-on-Hudson, NY: Foundation for Economic Education (1996), p. 209. Mises describes the exchange ratios between money and the various goods and services as the mental tools of economic planning. Given that money is the means that enables individuals to communicate their subjective views of value, money itself also is a mental tool. Mises states (p. 177) that Language is a tool of thinking as it is a tool of social action. In my view, the same thing can be said about money because, like language, money is a means of communicating.
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currency more efficient and more reliable. For example, if you look at the evolution of coins over the centuries, you can see marked improvement. The improvements were important. As coins became more reliable, the costs of conducting commerce were reduced, and reducing costs is always a good thing. By lowering the impediments to commerce and the costs of handling currency and making payments are an impediment commerce itself is promoted, and as commerce expands and develops, our living standards rise. So it was natural that new advancements that improved the currency of the day were welcomed widely, as was the advancement introduced by the Bank of England concurrent with its creation in 1694. Gold and silver coins had disadvantages that were wellrecognised. They were bulky, hard to carry, impractical in large denominations because of the weight that would be required, etc. What is worse, coins wore out from usage, wasting some of the precious gold and silver contained in them. To overcome the shortcomings of precious metal coinage, the Bank of England introduced an important advancement that made currency more efficient. That innovation enabled gold and silver coins to remain safe and secure in the Banks vault while paper promises to pay weights of precious metal dubbed banknotes circulated as currency in place of the coins. Paper as a circulating medium had obvious advantages of efficiency and cost and at any time or in other words, on demand could be redeemed for coinage. What is more, because it was opened under a Royal Charter, the Bank of England and its paper currency were perceived to be safe, and so they were for about three years. By 1697, the worlds first banking crisis was under way. The Bank of England had issued far more paper than it had physical metal on hand,299 primarily silver, because that still was the preferred metal of the day in England. Therefore, the crisis arose because people rushed to convert their paper currency into
This process is known as fractional reserve banking. Under the gold standard as it generally operated, banks only kept in reserve a fraction of the total weight of metal needed to redeem all their liabilities to pay out metal. For a detailed discussion of fractional reserves, see Murray N. Rothbard, The Case for a 100 Percent Gold Dollar: In Search of a Monetary Constitution, Leland B. Yeager, ed., Cambridge, MA: Harvard University Press (1962), pp. 94-136, and Auburn, AL: Ludwig von Mises Institute (1991), www.mises.org/story/1829.
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silver coin, with the result that the Bank of Englands new currency appeared to be a failure. Despite ongoing monetary upheaval, the Bank of England persevered (even back then, government-sponsored enterprises seemed to take on a death-defying life of their own). But that monetary crisis did have one beneficial and constructive result: It made self-evident to everyone at the time that a paper currency promising to pay metal (a money substitute) was different from money (gold or silver) itself. After all, a bank liability is fundamentally different from a tangible asset. What the Bank of England had done was to stand currency on its head. Until 1694, currency always had been a tangible asset (mainly gold and silver fabricated into coins). Thereafter, the new paper currency was not money; it was only a money substitute circulating in place of coin. This new currency was no longer a tangible asset; it had become a liability of a financial institution. This difference is as great as that between night and day, or more to the point, between assets and liabilities.300 The impact of this change was so profound that it had an invasive impact on the economy, with many adverse consequences. The insidious monetary turmoil wrought by the Bank of Englands new currency persisted. To figure it all out, William III of England turned for help to the greatest mind of the day: Sir Isaac Newton, who was appointed Master of the Mint in 1699. Over the next several years, Newton restored order where there had been Bank of England-created chaos. He did this by inventing and putting into practice what we now call the classical gold standard. That was a monetary system operating under rules 301 that
Until the introduction of paper currency, payment risk was limited to making sure the coins accepted as payment in a transaction were genuine. Similarly, the seller still needed to make sure that the paper currency received was not counterfeit. But paper currency introduced a new type of payment risk default. Even if the paper currency was genuine, the paper could prove to be worthless if the issuer of that currency defaulted on its liabilities for example, in the case of a bank failure. There is no default risk if one accepts gold in payment, which explains why gold often is referred to as the only currency that is not someones liability. Consequently, in contrast to all national currencies, finality of payment in gold is not contingent on the creditworthiness of a counterparty. 301 The key rules accomplished the following: (1) defined the British pound in terms of a specific and unchanging weight of gold, (2) confirmed that pound banknotes circulating as money substitutes were redeemable into coinage upon demand of the holder of the banknote,
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Newton established that were followed voluntarily by banks and later by other governments that eventually adopted in their own country the Bank of Englands paper currency innovation. Newtons rules resulted in automaticity, which is what made the gold standard so effective. It was reliable and predictable. It was selfregulating when left unhindered, with capital flows over time tending to harmonise trade imbalances that arose from disparate economic conditions in different countries. Newton recognised that the paper banknote was an important advancement that made currency more efficient. But he also understood that paper currency was not money and, even more so, that paper currency could be created to excess, which would result in monetary turmoil that in turn would have an adverse impact on economic activity. In other words, he realised that paper currency was useful, but only if it had some standard by which it could be measured and controlled. He achieved these objectives with the gold standard that he created. The Demise of the Gold Standard Newtons invention remained largely untouched from its implementation in 1707 until 1914. I say largely because the rules of his classical gold standard occasionally were broken. During periods of war, for example, the redeemability of paper into coinage
(3) confirmed that pound coins and pound banknotes were of equivalent value, meaning that they could be exchanged one for one, and (4) established that the Bank of England was responsible for maintaining prudent policies to ensure redeemability of banknotes into coinage, which was essential for an orderly monetary system. The practical result is that it became accepted Bank of England practice in the 18th and 19th centuries to maintain a gold reserve nominally equal to approximately 40 per cent of its gold liabilities. But see, John H. Wood, A History of Central Banking in Great Britain and the United States, New York, New York: Cambridge University Press (2005), where Wood observes that, in practice, the Bank maintained only a thin film of gold, at times as low as only six per cent of gold liabilities. The British pound became the worlds international reserve currency, largely supplanting gold in that role, because even though the banknotes were not 100 per cent backed by gold, the pound generally was considered to be as good as gold. The expansion of the British Empire was not just the result of the Royal Navy; sound money also played an important role. The pound managed as it was under the classical gold standard enabled the global expansion of commerce. The gold standard had become, in effect, the global monetary system. In all but name, it was a sterling [i.e., British pound] standard. See Niall Ferguson, Empire: The Rise and Demise of the British World Order and the Lessons for Global Power, New York, NY: Basic Books (2003), p. 245.
often was suspended, and credit was expanded beyond the prudent limits that normally prevailed. But the rules governing the gold standard remained in place, more or less, with the wartime suspensions usually lifted soon after hostilities ceased. Further, redeemability of banknotes into coin was re-established at the prewar rates, which deflated the war-induced credit expansions. Over time, however, bankers and politicians began to understand that, if they broke Newtons rules, they could gain an advantage. Bankers would make a greater profit because they could expand credit (make loans) beyond the self-imposed constraints. Politicians could gain greater power because, instead of being restricted to just spending gold, they envisioned creating a seemingly unlimited amount of money substitutes and spending those instead. Newtons rules were voluntary and worked only insofar as banks and governments agreed to them. By the 20th century, bankers and politicians were not just breaking the rules they were discarding them. Thus, given the powerful interests lining up against it, it is not surprising that the classical gold standard began to be depicted as undesirable, despite its splendid 200-year track record of maintaining relatively stable prices. What was worse, the classical gold standard started to be blamed for things for which it was not responsible. For example, it was not the gold standard that caused the Great Depression but, rather, imprudent credit expansion by banks, which was made worse by the growth of government and the rising expenditures that the burden of government entailed. 302 The last vestiges of the gold standard were jettisoned in August 1971, 303 ushering in the present era of fiat currency regimes. It should be clear by now why Keynes was taking a potshot at the gold standard. It is not surprising that Keynes whose iconoclastic theories supported government management of the monetary system
The cause of the Great Depression should be placed where it properly belongs: at the doors of politicians, bureaucrats, and the mass of enlightened economists. Murray N. Rothbard, Americas Great Depression, 3rd ed., Lanham, MD: Sheed and Ward, Inc.(1975), p. 295. 303 On August 15, 1971, President Nixon declared the US Treasurys gold window at the Federal Reserve Bank of New York to be closed, which meant that foreign dollar claims no longer were redeemable in gold. See William A. Safire, Before the Fall: Inside the Pre-Watergate Nixon White House, Garden City, NY: Doubleday (1975), pp.509-528.
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would claim that the gold standard was a barbarous relic. Even though Keynes was no fan of gold, he no doubt understood that it would be foolhardy to attack gold itself. That would come later, from anti-gold propagandists and central bank apologists misusing what Keynes really wrote. But that is not quite the whole story. The Real Barbarous Relic There is indeed a barbarous relic, but we now know that it is neither gold nor the gold standard because of the useful role that gold played for two centuries before World War I. Rather, the barbarous relic is central banking itself. Central banks are barbarous in part because they conspired to put an end to Newtons brilliant invention that safeguarded sound money for 200 years. It is the process of central banking itself, as it has come to be practised, that deserves to feel the publics wrath. Central banking is barbarous for the following reasons: (1) Money is a product of the free market. It is a fundamental building block of our society because it allows people to interact with one another in the market process. Money existed long before governments and central banks began to manage it. Tragically, instead of being a neutral and unfettered tool in commerce, fair to one and all, money now has become a matter of force and decree, which is disruptive to the market process and therefore harmful to society. (2) Prior to the creation of the Bank of England, every exchange in the trading activity that we call the market process tendered value for value. In other words, gold was exchanged for land, silver for food, etc. assets were traded for assets.304 The Bank of England changed this process by creating money substitutes. Its banknotes are not a tangible asset like gold or silver. Banknotes are merely money substitutes and not money itself. Money substitutes are a liability of the bank issuing that paper currency, and money substitutes create all sorts of payment risk that one does not have when using tangible assets as currency.
From Franklin Sanders, ed., The Moneychanger (July 2005), www.themoneychanger.com, which included a noteworthy critique of central banking.
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(3) Central banks act in secrecy; consequently, they are not held accountable. For example, the so-called Open Market Committee of the Federal Reserve is far from open. It meets and makes decisions behind closed doors, and the minutes released one month later are thoroughly redacted, leaving outsiders in the dark about the members deliberations. Central bankers consider themselves and act as if they were above the law. Moreover, this secrecy favors the insiders, and it is this fundamental principle upon which central banks market intervention has been constructed, including, for example, their intervention in the gold market.305 (4) Central banks have freed governments from having to ask their citizens through their elected representatives for more taxes.306 Central banks can acquire government debt and use it to create currency out of thin air for governments to spend on their latest whims. Even worse, through their policies that create inflation, central banks enable governments to steal from their citizens. (5) There are several tools in the central banks arsenal, and one of them is disinformation, which they regularly practise. For example, central banks have come to make us believe that inflation is rising prices. But wet streets do not cause rain. By changing the definition of inflation to one of rising prices rather than what it really is monetary debasement engineered by central banks the true culprits (the central banks themselves) are masked. (6) Not only are central banks guilty of disinformation, but deception is one of their most frequently used tools. The history of banking is replete with examples that demonstrate not just a lack of disclosure but, rather, outright deception. To give just one example, consider how central banks today account for their gold loans. They carry both gold in the vault and gold out on loan as one line item on their balance sheets.307 In effect, central banks are saying that they can
See the work published at www.GATA.org for a detailed analysis of this intervention. I also recommend the analysis of John Embry and Andrew Hepburn, Not Free, Not Fair: The LongTerm Manipulation of the Gold Price, Sprott Asset Management, Toronto, Canada (August 2004), www.sprott.ca. 306 Sanders (2005), note 9 above. 307 See, e.g., the European Central Banks balance sheet,
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ignore the truthful disclosure established by Generally Accepted Accounting Principles, and as a result they can report both cash and accounts receivable as one and the same thing. Accounting like that would make even the fraudsters at Enron blush. (7) Central banks in effect have turned the market into a command, i.e., state-run, economy. The power to create money out of thin air brings with it the much greater power to control a nations economy and therefore the economic destiny of millions. Central bankers today act like politburo members in the former Soviet Union, who pulled strings and pushed buttons to try making the economy which means each and every one of us who participate in the economy bend to their control. But it is not only the economic destiny of millions that is determined by central banks; subtle but potentially more disturbing issues are raised by the exercise of power by central banks (8) Central bankers and their comrades in government know that the command economy power that they have claimed forces them to walk a fine line between prosperity and economic collapse, given the inherent fragility of the credit-based monetary system that they operate. To try to reduce this evergrowing fragility in a vain attempt to make it easier for central banks to control the command economy effectively and totally governments take away peoples freedom. Central banks usher in controls like the reporting of bank accounts and funds transfers and policies such as the too big to fail doctrine that underwrites bad decisions at banks with taxpayers money. Controls perpetuate a central banks stranglehold on power regardless of whether they are doing a good or a bad job and it is usually bad in commanding the economy. (9) The command economy that central banks operate encourages the growth of debt, rather than savings. Banks want to expand their balance sheets i.e., to make more loans in order to earn greater profits, and governments want central banks to accommodate this objective. The resulting credit expansion provides the public with opportunities to acquire new things, which creates an illusion of prosperity that makes
www.ecb.int/pub/annual/html/index.en.html.
people believe that their wealth is rising. The result of this debt-induced, pseudo prosperity is a complacent populace, the net effect of which tends to perpetuate governmental power and politicians perquisites. Instead of following a sound and time-tested, pay as you go policy, consumers, businesses, and governments have adopted a new creed buy now and pay later. The mountain of debt that exists in the United States today and the excessive consumption that continues to enlarge that mountain are the direct results of central banks activity and their need to grow more debt to avoid the inevitable bust that would follow if the debt growth were to stop. Newsletter writer Richard Russell explains it very simply in just three words: Inflate or die. 308 This is why US Federal Reserve Chairman Ben Bernanke famously said (in a speech given before he was appointed Fed chief) that he would drop $100 bills from helicopters if necessary to inflate the economy.309 (10) What central banks do domestically, they also do to the international monetary system. Thus, the inherent fragility and the huge structural imbalances arising from cross-border trading exist today because of central banks actions. The automaticity of the classical gold standard ensured that imbalances such as trade deficits were relatively short-lived. In contrast, present central bank policies have perpetuated longrunning US trade deficits, which are now several decades old and still growing.310 The debt being created to finance these deficits has an impact on the monetary environment of each US trading partner. Thus, central bank-engineered imbalances are not just domestic problems; they also have global implications.
Richard Russell is the editor of Dow Theory Letters, www.dowtheoryletters.com/dtlol.nsf. 309 See www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm 310 According to the International Monetary Funds statistics, the last year in which the United States had a trade surplus was 1975. The trade deficit, about $624 billion in 2004, was about 5.3 per cent of US gross domestic product. IMF, International Financial Statistics (November 2005) and International Financial Statistics Yearbook (1995).
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Barbarians Dwelling in Relics In sum, central banking has proved to be barbarous indeed, but only one-half of the demonstration is completed at this point. Barbarity being established, one also needs to know why central banking is a relic, but that demonstration is easy. Central banking has been around for more than 300 years. In that time, an institution becomes either a venerable object or an obsolete relic. If central banks once served a useful purpose, it was when they were governed by the discipline of the classical gold standard. Having abandoned Newtons rules, central banks now are abusive to free markets and antithetical to sound money. The reasons that make central banks barbarous also make them an unwanted relic. Central banks are a relic of empire, nationalism, and war. Having existed now for hundreds of years, central banks have survived not because they advance commerce or contribute to raising mankinds standard of living, but because they are disingenuous, slavish parasites, dutifully serving the omnipotent state, no matter how mindless or harmful the states bidding might be. Central banks pursue reckless policies that erode and in some cases destroy the value of their currencies. Because of that recklessness, central banking is not only a barbarous relic, it has become dangerous as well. When confronted with attempts by anti-gold propagandists to bash gold, we now know how to respond. The barbarous relic is central banking, and any central bank that prevents the restoration of sound money increases the danger that the relic poses to the public interest. Not too many years from now, when the US dollar collapses as just one in a long list of fiat currencies that have collapsed before it, people will look back and ask themselves how it was possible that barbarous institutions like central banks could have hoodwinked so many people into thinking that they were acting in the public interest. The answer is that central banks have created the illusion of prosperity. Because people think that they are well off, they have no reason to question basic tenets that they are led to believe. For this reason, people are easily cozened into believing that gold is the
barbarous relic, that central banks are doing a good job, that officially measured inflation is low, and that their financial future is secure. However, nothing could be further from the truth. Their misguided beliefs reflect what some on Wall Street like to call the bubble mentality, and while it may be true that this condition is a state of mind, it also is true that it arises without any thinking going into it. Conclusion: Let Gold Circulate as Currency Again The gold standard is dead, but as the chart at the beginning of this essay shows, gold remains the standard. It is the value by which all things are measured, just as it was when Newtons great invention, the classical gold standard, reigned supreme. This observation is important. For gold to achieve its greatest usefulness, it needs to circulate once again as a parallel currency that competes with government-controlled and central bank-managed national currencies. The future of gold depends on the opportunity for gold to do what it always has done throughout history, namely to provide a neutral tool that people can use voluntarily without force or coercion as currency. We should be able to use gold as we go about our business each day, participating in the market economy to fulfill our needs and wants. Fortunately, currency is evolving yet again. In this high-tech age, gold is now being used as currency in economic transactions. Digital gold currency311 provides the means to achieve economic growth and prosperity with sound money while escaping the state-run currency of central banking. This achievement is a welcome advance in freemarket currency because it restores golds rightful and traditional role as a circulating medium unfettered by government control and central bank restrictions, but it also does more. Digital gold currency makes evident golds enduring usefulness, proving that gold is neither barbarous nor a relic.
Digital gold currency is the invention of GoldMoney.com, which has been awarded three US patents.
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ART 3:
OVERSIGHT
IMPACT OF MONETARY POLICY ON THE ECONOMY: A REGIONAL FED PERSPECTIVE ON INFLATION, UNEMPLOYMENT, AND QE3 FEDERAL RESERVE LENDING DISCLOSURE: FOIA, DODD-FRANK, AND THE DATA DUMP AUDIT THE FED: DODD-FRANK, QE3, AND FEDERAL RESERVE TRANSPARENCY FEDERAL RESERVE AID TO THE EUROZONE: ITS IMPACT ON THE U.S. AND THE DOLLAR INVESTIGATING THE GOLD: H.R. 1459, THE GOLD RESERVE TRANSPARENCY ACT OF 2011 AND THE OVERSIGHT OF UNITED STATES GOLD HOLDINGS
X. XI. XII. XIII.
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EARING IX.
IMPACT OF MONETARY POLICY ON THE ECONOMY: A REGIONAL FED PERSPECTIVE ON INFLATION, UNEMPLOYMENT, AND QE3MONEY
TUESDAY, JULY 26, 2011

WITNESSES Hoenig, Dr. Thomas M., President, Federal Reserve Bank of Kansas City
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing on the Impact of Monetary Policy on the Economy: A Regional Fed Perspective on Inflation, Unemployment, and QE3 at 2:00 p.m. on July 26, 2011 in Room 2128 of the Rayburn House Office Building. Numerous regional Federal Reserve Bank presidents were approached to testify about their views on inflation, unemployment, and the Feds monetary policy. All but one of the presidents approached to testify either declined or were unable to testify. This was a one-panel hearing with the following witness: Dr. Thomas M. Hoenig, President, Federal Reserve Bank of Kansas City
Dr. Hoenig was asked to provide a regional Federal Reserve Bank perspective on the role of the Federal Reserve in the economy, focusing on the Federal Reserves execution of its mandate of price stability and full employment. Regional Federal Reserve Banks are supposed to be attuned to the economic conditions within their districts and to bring their knowledge and expertise to bear when meeting with other Fed officials. While Fed Chairman Bernankes statements and speeches receive significant amounts of media coverage, the views of the regional Federal Reserve Bank presidents do not receive similar attention. This hearing examined the extensive liquidity operations undertaken by the Federal Reserve over the past few years; further actions that may be taken in the future by the Federal Reserve, including the possibility of further rounds of quantitative easing; and the outlook for inflation, unemployment, and GDP growth. The hearing also examined the exit strategies available to the Federal Reserve given its substantial involvement in the economy, the size of its balance sheet, and the excess reserves held by the banking system.
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Regional Structure of the Fed The Federal Reserve System is the central bank of the United States. The Federal Reserve formulates the nations monetary policy, supervises and regulates banks, and provides a variety of financial services to depository institutions and the federal government. The Federal Reserve System consists of four major components: the Board of Governors, the twelve regional Federal Reserve Banks, the Federal Open Market Committee (FOMC), and member banks of the Federal Reserve System. The twelve regional Federal Reserve Banks are responsible for the day-to-day operations of the Federal Reserve System, providing services to member banks within their districts, as well as regulating those banks. The regional Federal Reserve Banks are not entities of the federal government, like the Board of Governors, but private institutions chartered by the federal government and owned by the member banks in their districts. The board of directors of each regional Federal Reserve Bank appoints its own president of the Reserve Bank, who must then also be approved by the Board of Governors. The regional Federal Reserve Banks aim to balance the influence of the nations financial centers on monetary policy at meetings of the FOMC, and to provide input on economic conditions across the country. The FOMC sets the nations monetary policy. The FOMC consists of up to twelve voting members: the seven members of the Board of Governors, who are political appointees of the President of the United States, and five of the twelve regional Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York is a permanent voting member of the FOMC. The other four regional slots rotate annually among the other Reserve Bank presidents. Federal Reserve Policies During and After the Financial Crisis During the financial crisis, the Federal Reserve undertook extraordinary measures to provide liquidity to the financial system. As the crisis deepened, the Federal Reserve began providing direct liquidity to the financial system, exercising its emergency lending authority, creating new credit facilities, and providing direct loans to non-bank financial firmsallowing non-banks and non-members of the Federal Reserve System to borrow directly from the Fed for the first time since the Great Depression. Most emergency lending was
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conducted through the Federal Reserve Bank of New York, although other regional Reserve Banks also engaged in significant amounts of lending. At the peak of the Federal Reserves emergency lending actions in December 2008, the Federal Reserves balance sheet had more than doubled, by $1.4 trillion, to over $2.2 trillion. From December 2008 to July 2011, the FOMC voted to keep the target federal funds rate between 0 and percent, the longest the Federal Reserve had held its target rate that low in modern times. The FOMC stated that it would maintain the target federal funds rate near zero as long as bank lending remained limited, unemployment remained high, and GDP growth was expected to remain low. While the intensity of the financial crisis subsided in 2009, the Fed continued its accommodative monetary policies to prod the economy to grow. In February 2009, the Federal Reserve began to purchase large amounts of mortgage-backed securities (MBS) through its Mortgage-Backed Securities Purchase Program, the first installment of what has come to be known as quantitative easing (QE). By the summer of 2010, one year after the National Bureau of Economic Research had declared an end date of the recession, unemployment remained high and GDP growth remained sluggish. The Federal Reserve then engaged in a second round of quantitative easing, known as QE2, by purchasing $600 billion in Treasury securities between November 2010 and June 2011 in order to force down long-term interest rates to try to stimulate economic growth. When QE2 ended in June 2011, the Federal Reserves balance sheet was approaching $3 trillion and unemployment stood at 9.1%. Inflation measures saw a slight uptick at the beginning of 2011, mostly due to the rising prices of oil and other commodities. In addition, the inflation measure used by the Federal Reserve that excludes food and energy costs (core consumer price index or core CPI) also saw an upward trend during that time. Concerns with Fed Policy Many mainstream economists consider the actions taken by the Federal Reserve during the financial crisis to have been necessary to avoid a collapse of the financial system. In light of persistently poor economic performance since the supposed end of the recession, however, differences of opinion emerged about the Federal Reserves later actions, such as maintaining a low target federal funds rate for an extended period and engaging in quantitative easing. The possibility that the Federal Reserve would embark on successive
rounds of quantitative easing only intensified the debate over monetary policy. The FOMC decisions to maintain the low target federal funds rate were unanimous until 2010, when President Hoenig began to dissent and vote against the FOMC policy. Instead of supporting maintenance of a low target rate, President Hoenig called for a rate increase because of his concerns about inflation. While other regional Reserve Bank FOMC members expressed similar concerns about inflation, they continued to vote to keep the target federal funds rate near zero. Nonetheless, President Hoenigs willingness to vote against the FOMC policy, as well as his willingness to be outspoken about his dissent, has helped to embolden other Reserve Bank presidents to speak out, leading to a livelier debate about the Feds monetary policy and the effects it has on the economy. Some economists attributed a non-trivial portion of the recent rise in prices to the Federal Reserves current monetary policy and to QE2, which they believed has greatly expanded the money supply. As Milton Friedman once said, [i]nflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. Critics of QE2 believed that the Federal Reserves purchase of assets accelerated the expansion of the money supply and thus fuels inflation. Other economists, most notably from the Austrian School of economic thought, also expressed concern that cheap funds resulting from the low target federal funds would prevent bad debts from clearing and could fuel another speculative bubble similar to the housing market bubble that precipitated the financial crisis. These economists pointed to the low target rate that the Federal Reserve maintained after the bursting of the dot-com bubble as one factor that helped inflate the real estate bubble, and they worry that a similar scenario may be developing. As of June 2011, excess reserves held by depository institutions stood at nearly $1.6 trillion. The Federal Reserve announced that it still had a number of tools available to stimulate the economy if economic conditions continued to worsen, and to withdraw liquidity support if improvements in the economy warranted a less-accommodative policy to ward off heightened inflation expectations. Some believed that the Federal Reserve had few policy tools left that it could use to further stimulate economic activity, while others believed that any additional options would only be minute variations on previous policies to purchase more securities and further increase bank reserves. In Congressional
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testimony at that time, Chairman Bernanke noted an additional option: more explicit guidance about the period over which the federal funds rate and the balance sheet would remain at current levels. While the Federal Reserve continued to weigh its options for further stimulating the economy through monetary policy, many believed that the time had come for the Federal Reserve to tighten monetary policy, given that the accommodative monetary policy had neither spurred employment nor economic growth, but had instead raised the spectre of future inflation. And of course, those from the Austrian School viewed the Federal Reserve exiting its heavy involvement in the economy as necessary to promote a healthy economic recovery.
RANSCRIPT
The subcommittee met, pursuant to notice, at 2:12 p.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, Jones, Lucas, Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Green. Ex officio present: Representative Bachus. Chairman PAUL. This hearing will come to order. Without objection, all members opening statements will be made a part of the record. I want to welcome our witness today, President Hoenig. And I will begin the hearing with my opening statement. Over the years, I have been interested in the transparency of the Federal Reserve (the Fed), and the Fed has been interested in the independence of the Fed. But since I know what Mr. Hoenig is interested in, I think he truly represents the right kind of independence that I like, because he is a rare individual to be at the Fed, or on occasion to be a member of the FOMC. But I want to note that last year when virtually everybody was endorsing and welcoming QE2, he was dissenting against this position, I believe, about 8 times. So that to me is truly remarkable and shows that he is, obviously, an independent thinker. My interest, of course, in the monetary system has been related to the accumulation of debt. I believe they are related and that the size of government is indirectly affected by monetary policy as well. If debt can be easily monetized, the temptation for Congress to spend money is always there. And I think that is a big, big distortion. Mr. Hoenig has made his points made very clear, that maybe interest rates of 0 to 0.5 percent might be too much, and he actually has made statements about part of our problem prior to the crash of 2008 was the fact that interest rates were too low for too long.
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IMPACT OF MONETARY POLICY TRANSCRIPT1087
And I often think about and like to clarify and expand as much as possible the relationship of the problems that we have today to our privilege of issuing the reserve currency of the world. Obviously, nobody has quite that same benefit. And, therefore, our debt and our bubbles can get far more exaggerated than if you are an independent country and your debt is numbered in a currency that the world doesnt accept like they accept our dollars. So though that might be a very positive thing in the short run, and give us some benefits, it also may be misleading to us, because it is deceiving us into thinking that this process can go on forever. Today, we are in the middle of a default crisis. We are worrying about whether the national debt is going to be increased. And I have an opinion that once the debt gets so big, default is virtually impossible to stop and that the default that we are worrying about right now is not strange and brand new, because in many ways, our country has already defaulted. If you look at our inability to follow up on the promises to pay a gold certificate in the 1930s, that was a form of default. And then, we promised to pay foreigners gold for $35, and we eventually had to quit doing that. We promised to pay the American citizens a dollar for a silver certificate, and we defaulted on that. And eventually, those silver certificates were not worth a silver dollar, but they were then worth a Federal Reserve Note. And even in 1978, we met a major crisis. It was a dollar crisis, and we were not able to maintain the value of the dollar. And we went hat in hand to the IMF and actually got approximately $25 billion to $30 billion of boost to prop up our dollar at that time. So for me, that is a form of default, and I believe we have embarked on a system where default is going to come. And I think the argument and the impasse is because nobody wants to really admit that the default is here, and we have to face up to it. The argument is, how do we default? Are we going to quit sending the checks out, or are we going to do the ordinary thing that countries have done for years and that we continually do, and that is, we pay off our debt with money with a lot less value. To me, that is a default, but I see that as being unfair, because some people suffer more than others. And, therefore, we will eventually be pushed into some serious talks about monetary reform, which I believe are actually occurring already in international circles. But my 5 minutes has expired. And now, I will yield 5 minutes to Mr. Clay.
Mr. CLAY. Thank you, Mr. Chairman. And thank you for conducting this hearing on the impact of monetary policy and the state of the economy. The Full Employment and Balanced Growth Act of 1978, better known as Humphrey-Hawkins, set four benchmarks for the economy: full employment; growth in production; price stability; and the balance of trade and budget. The Humphrey-Hawkins Act also charges the Federal Reserve with a dual mandate: maintaining stable prices; and promoting full employment. According to the Department of Labor, in June, the Nations unemployment rate was 9.2 percent. Over 14 million Americans are looking for work. Another 5 million are underemployed at jobs that pay much less than they previously earned, and offer few benefits. And in urban areas like the district that I represent in St. Louis, the unemployment rate among African Americans and other minorities is over 16 percent. The Majority party has been in power in this House for over 200 days, and yet we have not seen one jobs bill, and America is still waiting. I am eager to hear what additional steps the Federal Reserve is willing to take to free up the flow of credit to small businesses and to encourage major banks to finally invest in this recovery, instead of sitting on the sidelines with trillions of dollars that could be creating millions of jobs. I also look forward to the witness comments regarding what other urgent steps Congress can take to spur private sector job growth and restore confidence in our economic future. And with that, Mr. Chairman, I yield back. Chairman PAUL. I thank the gentleman. Now, I yield to Mr. Luetkemeyer. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Thank you, Mr. Chairman, for holding this hearing today and for continuing the dialogue. I first want to recognize todays witness. President Tom Hoenig has been a voice for reasons and fiscal conservatism during a time when many of our economic policies have been weak. Tom has often been a lone dissenter who has encouraged sound economic principles over politically expedient ones. Our Nation is grateful for his service. President Hoenig has expressed concern over Federal Reserve monetary policies. Personally, I remain troubled by the expansionary
role the Fed seems to have been championing over the last several years. What is more upsetting is the fact that we dont seem to be any closer to changing course and abandoning these policies, even though they dont seem to have worked. While a Federal program of quantitative easing looms, our economy remains stagnant. Our jobless rate continues to hover above 9 percent. Bank lending is still constrained. And we have seen little evidence of a long-term economic growth. Abroad, the credit markets have indicated that austere measures are being taken by troubled governments. We are headed down an identical path. Since 2008, the Fed has purchased several trillion dollars of U.S. treasuries, many of which are still held by the bank. We have been warned time and time again that unless we get our fiscal house in order, our credit rating is likely to be downgraded. Considering the amount of treasuries held by the Fed, the solvency of our central bank will undoubtedly be affected by this downgrade, should it occur. The current state of our economy, combined with the problems we could face in the near future, results in a recipe for economic distress. The Fed must begin to seriously examine the policies in place and plan for worst-case scenarios that could overwhelm our Nation in the coming months. Congress rarely hears from the 12 regional Fed Presidents. This is unfortunate, given their role as a financial regulator in our communities and as an independent voting member on the Federal Open Market Committee. I appreciate President Hoenigs willingness to be here today, and I look forward to his testimony. With that, Mr. Chairman, I yield back. Chairman PAUL. I thank the gentleman. I now yield to Mr. Green from Texas. Mr. GREEN. Thank you, Mr. Chairman. And Dr. Hoenig, thank you for appearing today, sir. I trust that you will find our committee hospitable. I think that we have many concerns that we can address. And, of course, I am concerned about inflation, concerned about unemployment, concerned about the quantitative easing and the possibility of another round of quantitative easing. But I must also say to you, I still believe in America. I really dont want this to come across as, we have lost faith in the country that has produced so much for so many. America is still a pretty good place to
live. A pretty good place to have your dreams, your hopes, and your aspirations fulfilled. So as II will speak for myselfmake my queries and make my inquiries known, I dont want to give the impression that I no longer have faith and belief in this, the greatest country in the world. I am concerned, sir, about the widening gap, and I am not sure that you can address this, but if you have some intelligence that you will share, I would appreciate it, but the widening gap between what we commonly call the haves and the have-nots. That is a real concern. I have seen some information published indicating that Latinos, African Americans and Asians have had a great widening in the gap between these groups and some others. That concerns me. I am also concerned about this crisis that you have very little control overyou may be able to influence it, but little control and that is the raising of the debt ceiling, as we call it. This ceiling is something that has become a crisis, but it really is a political problem that has somehow evolved into a crisis, a political problem that has evolved into an economic crisis, if you will, only because the politics have not come together appropriately. And I still believe that we will get it right. I think that there is still time for us to raise the debt ceiling. But these are some of the concerns that I hope you will be able to address today from your regional perch. I think highly of you, and I am interested in hearing your views. I have a lot of respect for you, and I thank you for appearing. I yield back the balance of my time, Mr. Chairman. Chairman PAUL. I thank the gentleman. Now, I yield to the full committees chairman, Mr. Bachus. Chairman BACHUS. Thank you, Chairman Paul. I commend you for holding this hearing to examine the state of the economy from the perspective of a regional Federal Reserve Bank President, and I thank you for inviting Governor Hoenig, whom I consider to be a superb regional President. Tom Hoenig, or Dr. Hoenig, is the longest-serving of the 12 Presidents of the regional Federal Reserve Banks. Perhaps happily for him, but sadly for many of us who admire his wisdom, he is soon to retire from that post. You will be missed. Dr. Hoenig has been a steadfast, independent voice among those in the inner circle of Federal Reserve Chairman Ben Bernanke, and before that, Chairman Alan Greenspan. He has been particularly
outspoken recently in cautioning against the overly stimulative efforts of the Fed, including the so-called QE2, quantitative easing program that ended last month after adding an additional $600 billion in bonds onto the Feds balance sheet. The New York Times said that Dr. Hoenigs cautious views were clearly shaped by having worked at the Kansas City Fed during the runaway inflation of the 1970s and the bank failures of the 1980s, and seem rooted in an agrarian and populist tradition that is mistrustful of concentrations of power. I think that is a healthy fear. It is not surprising, then, that Dr. Hoenig has spoken forcefully on the subject of downsizing the biggest of the countrys large banks, including a 2009 speech he titled, Too Big Has Failed. I can tell you that on this side of the aisle, many of us are in wholehearted agreement with you. And we have looked on with alarm as there has been a greater and greater concentration of too-big-to-fail institutions. I mention all this not only to salute you, Dr. Hoenig, for your career and your, I guess, bravery in speaking out, but also to make a comparison between your views and the view that is held by some in Washington that regional Fed Presidents should not be allowed to vote on monetary policy moves made by the Federal Open Market Committee. Somehow, this view holds that regional Fed Presidents are captive of big business and the industry, and I can tell that you are a very good exhibit against that. In fact, I think that more often than not our regional banks are more attuned to Main Street. And of course, you are not the only independent thinker among the regional Bank Presidents, but your appearance here today will serve as a good rebuttal to the view that the Federal Reserve Bank Board of Governors in Washington, D.C., need less input from the regional Feds and the rest of the country. Actually, they need more. So thank you, Doctor. And I yield back the balance of my time. Chairman PAUL. I thank the chairman. And if there are no other opening statements, we will go to the introduction of the witness. I want to welcome Dr. Thomas Hoenig, who has been the President of the Federal Reserve Bank of Kansas City for the past 20 years and is the longest-serving policymaker at the Fed. While a voting member of the Federal Open Market Committee in 2010, he voted against keeping interest rates at zero, casting the only no vote at all 8 FOMC meetings.
He has been a vocal critic of the Feds zero interest rate policy and QE2. He will be retiring in October, having reached the Feds required retirement age of 65. Mr. Hoenig, you are recognized.
STATEMENT OF DR. THOMAS M. HOENIG312 PRESIDENT, FEDERAL RESERVE BANK OF KANSAS CITY
Mr. HOENIG. Thank you, Chairman Paul, and members of the subcommittee. I want to thank you for this opportunity to discuss my views on the economy from the perspective of a President of the Federal Reserve Bank of Kansas City, and, as you said, a 20-year member of the Federal Open Market Committee (FOMC). The Federal Reserves mandate reads: The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economys long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. Within the context, then, of long-run, the role of the central bank is in fact to provide liquidity in a crisis and to create and foster an environment that supports long-run economic health. For that reason, as the financial crisis took hold in 2008, I supported the FOMCs cuts to the Federal funds rate that pushed the target range to 0 percent to 0.25 percent, as well as the other emergency liquidity actions taken to stanch the crisis. However, though I would support a generally accommodative monetary policy today, I have raised questions regarding the advisability of keeping the emergency monetary policy in place for 32 months with the promise of keeping it there for an extended period. I have several concerns with zero rates. First, a guarantee of zero rates affects the allocation of resources. It is generally accepted that no good, service or transaction trades efficiently at the price of zero. Credit is no exception. Rather, a zero-rate policy increases the risk of misallocating real resources, creating a new set of imbalances or possibly a new set of bubbles. For example, in the Tenth Federal Reserve District, fertile farmland was selling for $6,000 an acre just 2 years ago. That land today is selling for as much as $12,000 an acre, reflecting high commodity prices but also the fact that farmland loans increasingly carry an
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[The prepared statement of President Hoenig can be found on page 1123.]
interest rate of far less than the 7.5 percent historic average for such loans. And with such low rates of return on financial assets, investors are quickly bidding up the price of farmland in search of a marginally better return. I was in the banking supervision area during the banking crisis of the 1980s, when the collapse of a speculative bubble dramatically and negatively affected the agriculture, real estate, and energy industries, almost simultaneously. Because of this bubble, in the Federal Reserve Bank of Kansas Citys district alone, I was involved in the closing of nearly 350 regional and community banks. Farms were lost, communities were devastated, and thousands of jobs were lost in the energy and real estate sectors. I am confident that the highly accommodative monetary policy of the decade of the 1970s contributed to this crisis. Another important effect of zero rates is that it redistributes wealth in this country from the saver to the debtor by pushing interest rates on deposits and other types of assets below what they would otherwise be. This requires savers and those on fixed incomes to subsidize borrowers. This may be necessary during a crisis in order to avoid even more dire outcomes, but the longer it continues, the more dramatic the redistribution of wealth. In addition, historically low rates affect the incentives of how the largest banks allocate assets. They can borrow for essentially a quarter-point and lend it back to the Federal Government by purchasing bonds and notes that pay about 3 percent. It provides them a means to generate earnings and restore capital but it also reflects a subsidy to their operations. It is not the Federal Reserves job to pave the yield curve with guaranteed returns for any sector of the economy, and we should not be guaranteeing a return for Wall Street or any special interest groups. Finally, my view is that unemployment is too high today, in part because interest rates were held to an artificially low level during the period of the early 2000s. In 2003, unemployment at 6.5 percent was thought to be too high. The Federal funds rate was continuously lowered to a level of 1 percent in an effort to avoid deflation and to lower unemployment. The policy worked, but only in the short run. The full effect, however, was that the United States experienced a credit boom with consumers increasing their debt from 80 percent of disposable income to 125 percent. Banks increased their leverage ratiosasset to equity capitalfrom 15-to-1 to 30-to-1. This very active credit environment persisted over time and contributed to the bubble in the housing market. In just 5 years, the housing bubble
collapsed and asset values have fallen dramatically. The debt levels, however, remain, impeding our ability to recover from this recession. I would argue that the result of our short-run focus in 2003 was to contribute to 10 percent unemployment 5 years later. That said, I am not advocating for tight monetary policy. I am advocating that the FOMC carefully move to non-zero rates. This will allow the market to begin to read credit conditions and allocate resources according to their best use rather than a response to artificial incentives. More than a year ago, I advocated removing the extended period language to prepare the markets for a move to 1 percent by the fall of 2010. Then, depending on how the economy performed, I would move rates back towards more historic levels. I want to see people back to work, but I want them back to work with some assurance of stability. I want to see our economy grow in a manner that encourages stable economic growth, stable prices, and long-run full employment. If zero rates could accomplish this goal, then I would support interest rates at zero. Monetary policy, though, cannot solve every problem. I believe we put the economy at greater risk by attempting to do so. Thank you, Mr. Chairman, and I do look forward to the committees questions. Chairman PAUL. I thank you for your statement, and I would note that without objection, your written statement will be made a part of the record as well. Mr. HOENIG. Thank you.
Chairman PAUL. I would like now to yield to Mr. Bachus for any questions he would like to ask. Chairman BACHUS. I thank the chairman. Dr. Hoenig, as I said in my opening statement, you have been firmly outspoken about monetary policy decisions. The Fed recently issued guidelines on how and when Federal Open Market Committee members should discuss or could discuss monetary policy decisions. Do you view this as an attempt to control the message or to stifle dissenting voices? And probably more importantly, Chairman Bernanke has promised a more open Fed, a more transparent Federal Reserve. And these guidelines, at least to me, seem a little inconsistent with restrictions on your ability to speak out. But I would like to know your views on that.
Mr. HOENIG. I hope not. I think part of the reason for the guidelines are that there were instances, frankly, where I would wake up on a Thursday morning and find what the future policy might be in the Wall Street Journal, not having known about it. And I think I raise objections to those kind of leaks and ask that they be vigorously pursued, to be quite frank. So I hope that is the reason. Secondly, my approach is that I speak publicly, on the record. I try not to speak off the record, so that there isnt any confusion. And so when I come here, or wherever I go, I speak my views. I dont consult with the Board of Governors. I dont ask permission. I have until October, I realize, but I have never done so, and if I were staying on, I wouldnt do so in the future. So I think it is a matter of personal choice. I dont think any of the members should disclose confidential information or leak to the media in advance. I strongly object to that, and I would have every intention to speak on the record my views publicly, regardless of what that statement might otherwise say. And I dont think that statement prevents me from doing so. Chairman BACHUS. Good, so the guidelines are more designed to keep unauthorized releases and releases that arent a part of the public record? Mr. HOENIG. That is the context in which they came up. The fact that they are there, I think could have the effect of stifling some, but I think that is a matter of someone saying, I have spoken to this. This is my view, and show the leadership to speak their views. Chairman BACHUS. Okay, good. And I am glad to hear that. I think that affirmationI think Chairman Bernanke has tried to have a more open Fed, and I think he has been very candid with our committee. In your testimony, you used the rapid increase in farmland value as an example of, maybe, credit misallocation resulting from what you see as a too-low Federal funds rate. Do you see any other bubbles building? Mr. HOENIG. I dontin fact, when people have asked me about the land, I have not said it is a bubble, but I Chairman BACHUS. Oh, yes. Mr. HOENIG. But I do say that we have conditions. We have created conditions. Zero interest rates, QE1, QE2 create conditions that are amenable to bubbles.
And where we see asset values moving quickly, one example is in the farmland. I think you can see it in other areas, some of the bond markets and so forth. And so you have to be aware of that. I think my issue is that, when you create conditions for certain outcomes, they will eventually arrive unless you withdraw those conditions in a timely fashion. And I think that is really the issue at hand. Chairman BACHUS. Okay. The Fed used to say it specifically did not want to use monetary policy to reduce froth in the markets. Chairman Greenspan said it in front of this committee any number of times, or made that statement. But is it appropriate for the Fed to avoid dealing with the buildup of asset bubbles but, on the other hand, conduct monetary policy aimed at reflating a market? Mr. HOENIG. I think my view is that monetary policy should be conducted with a long-term focus, with, if you will, boundaries around its discretion, and therefore should not be in a position of creating froth in the market any more than it should try and somehow pinpoint some sector of the economy that it thinks is too frothy, and try and adjust that. So, really, what you have to do is conduct monetary policy towards the long run. It is when you try and fine-tune monetary policy, direct it towards particular sectors, or to offset every short-term decline in the economy with extensive easing of monetary policy, that you create instability, as likely as deal with it. Chairman BACHUS. Thank you. I will come back in the second round and ask otherI do want to say this, and I am just throwing it out for thought and not asking for a reply now. I have actually believed that QE2 gave the Congress an opportunity tosome time to move to make some long-term structural changes in our entitlement programs. It is an opportunity that, whether it was intended for that purpose or not, it certainly gave us an opportunity, and kept financing the debt at a low rate, or lower rate, maybe. But the Congress has squandered that opportunity, at least at this time. So I do believe that Chairman Bernankes job has been made harder by the inability of this Congress to make the tough decisions and particularly to make needed structural changes in our entitlement programs. And I think we will continue to make problems for the Fed and probably result in inflation ourselves, some of our actions. So, thank you.
Chairman PAUL. I thank the gentleman. I yield 5 minutes to Mr. Green. Mr. GREEN. Thank you. Again, I thank you for appearing today, sir. Let us start with the debt ceiling. And if you could, be as terse as possible, because I have a couple of other questions. Can you give your opinion as to the consequences of our failure to raise the debt ceiling? And if you can be brief, I would appreciate it, although I know it is impossible on this question. Mr. HOENIG. The failure to address your budget issues is an action. It is a choice. And the consequences of doing that are to add to the uncertainty in the economy. So the effects will be, I think, in that sense, adverse. I think the economy would do well with addressing the budget crisis and the budget problems and providing more stability and more certainty. Mr. GREEN. In your opinion, would it be better to not raise the debt ceiling or to raise it and have it done in what we call a clean fashionif it were those two choices? I know there are many others, but is it better to raise it and have a clean raising of the debt ceiling, as opposed to not raise it at all? Mr. HOENIG. The only answer I can give you to that is you really needthat is the Congress area of responsibility Mr. GREEN. But I am talking about the consequences. Mr. HOENIG. But you need to deal with it as forthrightly as possible. Mr. GREEN. I understand, but are the consequences more severe if we dont raise it than if we raise it with a clean ceiling? Mr. HOENIG. I think the consequences are there regardless. It is a matter of the timing of the consequences and how you want to accept those Mr. GREEN. So in your opinion, it could be just as bad to raise the debt ceiling as we have done in the past, just have a clean raising of the debt ceiling. That would be just as bad as not raising it at all? Mr. HOENIG. I dont know what the consequences will be any more than anyone else does. Mr. GREEN. I know, but you are in the business of prognosticating, because that is what you do to decide whether you should raise it the 1 percent that you are talking about here. Mr. HOENIG. If you want my prognosis, honestly, I think what you need to do is address the budget crisis.
Mr. GREEN. I understand, but I am not ready to go there, you see. I am giving you a set of circumstances and I am asking you, if you would, to address this set of circumstances. I know what you would like to do. I have been reading a little bit, here, and I understand your point of view. But I am taking you out of your comfort zone andfrom time to time Mr. HOENIG. But it is not mine to decide. It is yours. Mr. GREEN. I dont want you to decide. I just want you to tell me about consequences of not deciding. Mr. HOENIG. If you dont raise the ceiling immediately, then the Congress and whomever else has to prioritize its future cash flows. If you do raise it, you also will have to prioritize it over time. In either case, you have Mr. GREEN. Let us go to another area, because Mr. HOENIG. you have to make choices. Mr. GREEN. I understand. My time is about up. Let me go to another area quickly. You wanted to prepare the market for a 1 percent increase by the fall of 2010. Is that a fair statement? Mr. HOENIG. Yes. And that was in an earlier part of 2010. Mr. GREEN. Okay. All right, I understand the circumstances were different than now. But if we had done this, we had prepared the market, as you had hoped we would, what were your thoughts in terms of what would occur? Mr. HOENIG. Interest rates would still be at historic low levels. Monetary policy would continue to be highly accommodative, but yet you would be off of zero. You would be no longer pumping enormous amounts of liquidity into the market. And the market would know. Right now, the marketwhat you are doing is you are at zero. So you are creatingthe market is adjusting to zero, in all its allocations, in its investments, in its bond funds, in its land, around an equilibrium of zero. I think most people acknowledge that zero is not sustainable. So the longer you allow that to continue, the longer you allow that allocation of credit and assets around zero, the more fragile the equilibrium and the sharper the consequences when you finally do remove that zero. And I think, the more Mr. GREEN. I wanted to have a quick follow up, because I only have 30-plus seconds.
You do agree that we dont have as much lending now as we need for the economy to recover. And if we dont have that lending at zero, what would be the circumstance at 1 percent? Mr. HOENIG. I dont think that the issue around lending is related to the immediate policy of the Fed funds rate being zero. It is around the issues of the fiscal uncertainty. It is around the issues of whether we have a resurgence of manufacturing in this country that is sustainable. It is around the issues of how we create goods, because it is the creation of goods and services that brings jobs in. And I dont think that the marginal choice for most businesses around whether they would do this of zero or a half a percentage point or 1 percentage point is the deciding factor in that instance. Mr. GREEN. My time is up. And you have been very generous, Mr. Chairman. I thank you. And I will wait for a second round. Chairman PAUL. Thank you. Mr. GREEN. And I will follow up. Chairman PAUL. I thank the gentleman. I will now take my 5 minutes. I want to talk about the relationship of Federal Reserve policy and monetary policy with the debt increase. We all know that the Federal Reserve is the lender of last resort. The economy gets into trouble, liquidity dries up, the Fed is supposed to be there to help out. But could it be that this concept of lender of last resort contributes to the deficit problem? And what I am thinking about here is that politicians, we in the Congress, get pressure from a lot of areas to spend money. And sometimes spending money helps us get reelected. So, there are a lot of domestic needs, needs in our districts. And also, there is a lot of activity around the world, both violent and nonviolent, that requires a lot of money. And in the inflationary part of the cycle when things seem to be going well, it is very tempting for Congress to spend a lot of money. But if the Fed is always there to keep interest rates low, doesnt that just encourage us? Congress generally is undisciplined, but doesnt the policy feed into this? Because if the Fed didnt do this, if they werent our lender of last resort and interest rates started bumping up, we couldnt blame the Fed for our problems, we would have to blame ourselveshigh interest ratesbecause we are sucking up all the credit. Do you see a relationship between Fed policy and the encouragement or allowing Congress to spend more than they should be?
Mr. HOENIG. I think there is always the danger that the central bank can be put in the position of buying the governments debt. That is why you have an independent central bank and why the independent central bank has to pursue long-run monetary policy geared towards what the basic money-based requirements and needs are for the growth of that economy. And it does require not only that the Congress be disciplined, but that the central bank be disciplined as well and not allow themselves to get drawn into that, yes. Chairman PAUL. But in a way, doesnt your testimony verify that maybe the Fed didnt do their job because they kept interest rates too low for too long, and we were part of the problem. So how do you protect against that, if the Fed is as fallible as the Congress? Mr. HOENIG. There is no system that is infallible. Whether it is the central bank doing this or the Congress doing it, there is no system that is infallible. Yes, I think that in the early part of the decade of the 2000s as I have said many timesthe policy was kept too accommodative for too long. The consequence of that was to create a credit bubble. It affected not only the Congress, but, of course, the credit markets generally became very active. That is why we had the tremendous expansion in credit in housing and later the consequence. That is an area that we have to learn from and go forward from. I dont think it is directly related in terms of the Congress and the debt, but it is related to the economic conditions broadly and the expansion of monetary policy during that period. And I think we have to be careful and mindful of that as a central bank. Chairman PAUL. I would agree that no system is infallible, but it seems like we might get better information from the marketplace, dealing with interest rates. Prices are very important in the economy, and nobody is out there advocating wage and price controls. We have tried it and, hopefully, they never bring that back again. But in a way, arent we dealing with a price control and you are looking for the price of money, the cost of money? I think you talk about that, that the cost was too low. And it causes a misallocation of resources. So how do you know what the right price is? Mr. HOENIG. I agree that you need to have a disciplined monetary policy that has a range. Our long-term growth over this decade has been about 3 percent real growth. Our policy should be mindful of that as we conduct monetary policy going forward.
And when we do go to zero and leave it there for an extended period, in reaction to a crisis, that is one thing. If we leave it there on a continuing basis, we do increase the risk that we misprice credit and misallocate resources, yes. Chairman PAUL. It seems like it is a contest between confidence in the market setting the price or the interest rates versus somebody dealing with monetary policy. And some of us have come to the conclusion that we like the market to set that. We would like to see maybe the retirees get more for their CDs. Mr. HOENIG. Right, and I understand, but the market makes terrible mistakes as well. And the market is responsible because it gets, if you will, euphoric in a direction, creates its own bubble around credit, because we are a fractional reserve system. It crashes. The market itself isnt prefect either. It causes Chairman PAUL. My time is up, but we are going to have a second round, and I want to ask about the fractional reserve system. Mr. HOENIG. Okay. Chairman PAUL. And now, I yield 5 minutes to Mr. Luetkemeyer. Mr. LUETKEMEYER. Thank you, Mr. Chairman. And welcome to my fellow Missourian. Mr. HOENIG. Thank you. Mr. LUETKEMEYER. Dr. Hoenig, it is good to have you here. Mr. HOENIG. Thank you. Mr. LUETKEMEYER. Since 2008, the Fed has purchased several trillion dollars worth of U.S. securities, treasury bills. And as we have seen over in Europe, over there the countries, in order to get their debt sold, have had to go to some very austere measures, sometimes go back 2 or 3 times to review their plans. Every time their interest rates have gone up in order to be able to accommodate them. We are being told by the credit markets that if we dont do something within the next couple of weeks here, we are going to have our securities downgraded. How does that affect the solvency of the Federal Reserve to have all of those securities that they are holding all be downgraded suddenly? Mr. HOENIG. It depends on how the markets view this downgrade. If it is downgraded and it doesnt affect the market pricing on those securities, because they have confidence that the Congress of the United States will come to a correct solution on that, I dont think it will have much effect at all on our solvency. If the Congress fails to act, it will have a more lasting effect. But they are anticipating that the Congress will act.
Mr. LUETKEMEYER. As a former examiner, I am sure youit would be interesting to have the Fed on the problem list, wouldnt it? Mr. HOENIG. Yes. Mr. LUETKEMEYER. Along that line, though, the same thing is happening with the rest of the banks in this country. If, for instance, we did get downgraded, suddenly now those banksso your local community banks got a whole fistful of U.S. treasuries. And now they are being downgraded, and suddenly that affects their capital. It affects their rating. How would you view that situation thenagain, as a former examinerthe calamity that would happen to our local community banks? Mr. HOENIG. If there was a serious effect from the downgrade on the pricing of the bonds to where there was capital loss in the bank, then of course it would have negative effects. I think the question is whether it would be a pricing effect, and I think that depends very much on the actions of the Congress. Mr. LUETKEMEYER. It is an action that could happen on the part of the credit markets to where it could be an increase in risk that would have to be assumed there. Mr. HOENIG. The failure to act is an action. Mr. LUETKEMEYER. Okay. Thank you. With regards toyou mentioned a while agomy time is running out herelet me get to QE3. We had Chairman Bernanke in here not too long ago, and he wouldnt say anything about QE3. But since he has been here, he certainly has not denied thinking about QE3. And to me, this is a devastating situation. We have had a number of economists in here since he has been here, and every one of them I have asked the same question, Do you see interest rates going up this fall as soon as QE2 stops here? And every one of them said Yes, unless you do a QE3, in which case you will probably have inflation. Would you concur with that or do you have a different opinion on that? Mr. HOENIG. First of all, I am not a supporter of QE3. I wasnt a supporter of QE2. I think, by ceasing QE2, I dont know that interest rates necessarily will go up significantly. It depends on a whole host of factors in terms of how the economy is doing. It is not just whether you stop QE2 over time. I dont think we should mainly try and manage interest rates down. That is kind of the point of my testimony. I think
there are consequences of doing that, that misallocate resources, and we have to be mindful of that. Mr. LUETKEMEYER. Obviously, I agree with that. I am just going along that line of thought, that among other things, the Feds job is to look long term with regards to interest rates, with regards to unemployment. And to me, this would seem to fit into a QE2, QE3. Where do we stop this? At some point, we have to get control ofat some point, the economy has to be resilient enough to stand on its own two feet. We have to wean them off this. If we are going to absorb all the debt that we are incurringand every budget whether it is Democrat, Republican or whomever, we have debt out there. Everybody is agreeing we are going to have more debt. So we are going to have to have somebody to purchase it. And if the Fed doesnt purchase it, somebody else is going to have to. Mr. HOENIG. Correct. Mr. LUETKEMEYER. And if we get our securities downgraded, risk is there, interest rates are going to necessarily go up. So long term, how do you manage those monies to see that you can minimize that? What would be your idea or a solution? Mr. HOENIG. I think that the mandate is a long-term mandate, and we need to keep that in mind. And if we do and if we pursue a policy that is long-run oriented towards price stability, then the economya market economy adjusts on its own. The market is not particularly brilliant, but it is harsh. It corrects itself when there is a misallocation. And so that is why monetary policy has to look to the long run, provide sufficient liquidity, but not try and fine-tune or manage the economy so that markets can in fact discipline themselves. So we should not be doing QE3. This is my view. There are plenty of excess reserves out there on the order of $2 trillion. I think that is plenty. Let the markets begin to heal, and let this market of ours allocate resources in our economy. And we should not try and finetune that. I think when we do that, we inject instability as well, more likely than we do stability. So we have to be very mindful of that. In the short run, we can really inject instability. We have to have a long-run focus. And that is hard, I realize, but necessary. Mr. LUETKEMEYER. Thank you for your comments. And thank you for your indulgence, Mr. Chairman. Chairman PAUL. I thank the gentleman. I recognize Mr. Lucas for 5 minutes.
Mr. LUCAS. Thank you, Mr. Chairman. Doctor, as you are well aware, of course, I live in the great Kansas City district in western Oklahoma. And about the time you were out doing all that hard work in the early 1980s, I was a senior at Oklahoma State. And I will always think of my fathers lecture in the spring of 1982 when I would occasionally go to land sales with my grandfather: Keep your hands in your pockets and your mouth shut. It was wonderful advice in 1982. The reason I bring that up is we are now dealing with a set of circumstances here that you have discussed and touched around the edges that in some ways is reminiscent of those early 1980s. You remember, and sometimes there is an occasional view here that nothing is interconnected, that we are all little islands in the world. You remember when Penn Square Bank went down, an energyconcentrated banking establishment, which then took down, directly or indirectly, Continental Illinois in Chicago, took down Seafirst in Seattle, took down two major, historic long-term players. Partly that, in my opinion, and you can offer yours and I would be pleased to hear it, as a result of perhaps misguided fiscal policy by Congress and perhaps misguided monetary policy by the Fed in that late 1970s and early 1980s period. But it had a devastating consequence, and it wasnt just Oklahoma that imploded. We sucked people under with us. I guess that brings me to my real question, and whatever comments you would care to offer. As my colleagues have alluded to, with the Fed balance sheet at a little under $3 trillion now, and even by a Texans definitions, Mr. Chairman, that is a lot of money. It took us 15 years to recover from the agriculture and the energy sector hangover from credit that started in 1982. In my opinion, in my quadrant, it was 1997 before the ship righted itself. Three trillion dollars is a whole lot more credit than Penn Square was manipulating. When the right policy decisions are made, how long is it going to take this credit hangover to clear? Mr. HOENIG. Let me first comment. I was on the discount window on Penn Square and was part of the group that recommended against lending against Penn Square. And I think it was the right decision there, although the consequences, as you said, were very harsh. Mr. LUCAS. And for the record, a few officers of Penn Square did go to the Federal penitentiary. It was more than just a few bad decisions. Mr. HOENIG. They did. Absolutely.
To your question of the degree of liquidity, the amount of time it will take to bring the liquidity off our balance sheet, the $3 trillion, I think, is reasonably a period of years. Because we have brought this on, I think if you bring it out too sharply, you will shock the economy. And in our last minutes, the Open Market Committee talked about how they would go about doing it in terms of rates and no longer renewing their debt instruments. But even under those, it will take years. How many years? It depends on how the economy does. It depends on what the roll-off of these instruments, the speed of the roll-off of these instruments and whether we choose to sell those. I dont know how long, other than I know it will take years, and there are risks to doing that. And that is my point about zero interest rates and creating what I call fragile equilibriums around this very liquid policy that when you finally do begin to move has a negative effect, a negative consequence on the economy, both nationally and regionally. And that does get my attention. Mr. LUCAS. Is it a fair statement to say, Doctor, that, of course, we will make a decision at some point. We will, at some point, I hope, achieve a consensus. We have legitimate disagreements within the ranks of the House over what the right policy is. Mr. HOENIG. Right. Mr. LUCAS. That is the nature of the body. But at some point, we will arrive at something. If we make the wrong decision, whatever decision we come to, are the consequences as frightening as I suspect they are? Mr. HOENIG. Any time Mr. LUCAS. Without commenting on any particular decision. Mr. HOENIG. Right, anytime you make a wrong decision, there are usually negative consequences. And if you make the wrong decision, there will be negative consequences, whatever that is. Mr. LUCAS. And the financial markets are sophisticated enough that they will respond moment by moment with whatever policy decisions we make, and will, as prudent money managers, use what I would define from an Oklahoma perspective as defensive policies if they need to. And that will ripple, too. Mr. HOENIG. The greater the uncertainty you create, the more defensive the actions will be. That much we can be sure of. Mr. LUCAS. Thank you, Mr. President. Thank you, Mr. Chairman. I yield back the time that I have left. Chairman PAUL. I thank the gentleman. We will go ahead and start a second round of questioning.
If we look at the markets in the last couple of weeks, in light of all the conversation about whether or not the debt limit will be raised, my estimation or my observation is that the markets arent that worried. Would you agree with that? Or do you think the markets are showing problems, or at least potential problems? Mr. HOENIG. To this point, I think the markets at least strike me as having the view that there will be a solution. And as long as that view is in place, they will tend to stay calm. If they lose that or if they begin to see more instability, more uncertainty around it, and therefore actions, then they wouldas I said earliertake more defensive actions. But right now, I think they have confidence in you, the Congress, and the President to come to some kind of agreement. Chairman PAUL. In monetary history, it has been said that when countries get to a certain level of debt, they have a lot of trouble, and the debt eventually has to be liquidated. I personally think we are at that point, so there will be liquidation of debt. As a matter of fact, free market individuals recognize that whether it is government debt or whether it is private debt, liquidation actually serves a purpose in order to get back to square one and have economic growth again. When we liquidate debt, I believe I mentioned in my opening statement, you can do it in two different ways. You can just default, which great nations dont do. Small nations will. But we are nowhere close, I believe, to doing that. I dont believe that for a minute. But I do worry about the other part. I worry about the liquidation of debt, because if it is inevitable that the debt will be liquidated and what we do may be prolonging the agony, that is what I worry about, that instead of allowing the liquidation and rapidly getting back to square one like we did in 1921, that we prolong this, such as Japan did and such as we did in the 1930s. Do you agree with that? Do you have concerns that liquidation will come in the form of inflation? And if you want to prevent that, what are your other options, if we are not going to default on our payments, which of course, I dont believe we will? Mr. HOENIG. First of all, I agree with you. I dont think great nations default on their debt. Second of all, I will say that I agree with you also, that we have leveraged our economy. As I mentioned in my remarks, the consumer has raised their debt-to-disposable income from 80 percent to 90 percent to 125 percent. The Federal Government has raised its debt to in gross numbers 100 percent of GDP. So we have increased our debt.
My concern is that, maybe back to your earlier point, perhaps, but when you have that kind of debt, over time there is increased pressure on the central banks to help relieve that debt pressure by helping finance that debt. That puts pressure on the central bank. If they do that, it does risk inflationary outbreak, and then you basically repay your debt in cheaper dollars. Chairman PAUL. But isnt that Mr. HOENIG. That is a risk, so how do you avoid that? The way you avoid that is you take, either through the Congress, through special committees, whatever, and develop a long-run plan that shows the American people how we are going to deal with our debt, Federal and otherwise, but in the Congress, Federal debt, and how the debtto-GDP ratio is going to be brought back down. And if it does that in a systematic fashion, with a strong binding point, then you will take care of the debt in a responsible way. Chairman PAUL. But it seems to me in that attempt, the Fed came in and they propped up banks and corporations, that they were the ones that have been benefiting from this, and now they have been able to get back on their feet again. At the same time, it really didnt help the people. The jobs didnt come back and the people lost their houses. So it seems like it is a failed policy to me. Mr. HOENIG. I understand your point. My concern is that we have in this country allowed to develop too-big-to-fail institutions, the largest financial institutions, who bulked their assets, and became so important to the economy that any one of them that failed would bring down and risk the economy. The market understood that and therefore gave them an advantage in terms of their position in the market, lowered their cost of capital, and allowed them unfettered access. And when we allowed that part, the safety net portion of that to get in with the high-risk portion, the investment bank, it only increased that by factors. So we do need to address the issue of too-big-to-fail. We do need to think about how we separate out the safety net from the high risk so that the economy can function under a market discipline, or at least more under market discipline, and we would all benefit from that. Chairman PAUL. My 5 minutes are up, and I now yield to Mr. Green. Mr. GREEN. Thank you, Mr. Chairman. I will be honored to let you have 30 seconds of my 5 minutes, if you need it.
Let us talk for a moment about lowering the debt-to-GDP ratio. Do you agree that there is more than one way to do it? Mr. HOENIG. Of course. Mr. GREEN. Do you agree that cutting is a way to do it? Mr. HOENIG. You can grow your economy Mr. GREEN. Grow the economy. You could also increase revenue. Mr. HOENIG. Of course. That is up to the Congress, how they Mr. GREEN. I understand. But I just want you to be on the record indicating that we have more than one way to do it. Mr. HOENIG. Right. And every choice has a consequence. Mr. GREEN. Every choice has consequences. And not making a choice at all has its consequences as well. Mr. HOENIG. That is a choice. Mr. GREEN. Yes, sir. Let us move to another area. You talked about markets and the market being calm. You do agree that the markets, generally speaking, dont like big surprises. When you give the market a big surprise, it has a reaction to a surprise. If you lead the market to believe that you are going in one direction, and if you go in another direction, then the market responds. Mr. HOENIG. Correct. Mr. GREEN. I think one of the best examples of this occurred when we had the $700 billion TARP vote, and the market anticipated one thing, and when the vote went another way, we saw the market spiral downward. You recall that, I am sure. Mr. HOENIG. Sure. Mr. GREEN. So you agree that markets dont, generally speaking, want to be shocked with surprises. Mr. HOENIG. Correct. Mr. GREEN. Okay. If this is true, and you have indicated that the market currently believes that we are going to resolve thisand, by the way, I pray that we willbut you agree that failure to bring about the resolution that the market anticipates will create a reaction in the market. Mr. HOENIG. Sure. It certainly will. If the market is thinking one thing and you do something else, there will be a reaction. Mr. GREEN. One final question Mr. HOENIG. And that also happens on Main Street. Mr. GREEN. Yes. And Home Street as well. Mr. HOENIG. As well. Mr. GREEN. Yes. But let us go back now to your support for the 0 to 0.25 target.
Mr. HOENIG. I do not support it. Mr. GREEN. You do not support it. But in 2008, you supported the cut in the Federal funds rate that pushed us to this target range, did you not? Mr. HOENIG. I wasnt voting, but I am sure I would have supported it. Yes. Mr. GREEN. Okay. And, by the way, reasonable people can have opinions that differ Mr. HOENIG. Absolutely. Mr. GREEN. even on the things that you supported, true? Mr. HOENIG. Absolutely. Mr. GREEN. And Mr. Bernanke, whom I happen to think highly of and I have a great deal of respect for, and he has opinions that are very well-respected, and there are other members of the board with opinions, and you meet and you confer and you vote, and then you come to conclusions. Mr. HOENIG. Correct. Mr. GREEN. So at the time what you were trying to do was provide what I am going to call a soft landing. Is that a fair statement, that we didnt want the economy to just crash? Mr. HOENIG. Well Mr. GREEN. We wanted it to land a little bit softer than if we had done nothing at all. Mr. HOENIG. Soft landing is a generous term. I think we did want to avoid a crash and depression, yes. Mr. GREEN. Yes, a crash and a depression. And if you say that you wanted to avoid it, it says to me that you are of the opinion that had we not acted, there could have been a crash and a depression. Mr. HOENIG. Counterfactuals are always there, and that is a possibility, yes. Mr. GREEN. And counterfactuals are hard to prove. Mr. HOENIG. Right. Mr. GREEN. But the reason you acted the way you did was because there was this concernand I am being kind by saying concern, because there are a lot of other ways to connote what was happeningbut there were these concerns that we were headed for something close to a crash or a depression. And your actions, probably if you were to write a book, you would say that your actions helped to avert this, would you not? Mr. HOENIG. If you are speaking of our movement to zero interest rates and the liquidity we provided, yes, sir.
Mr. GREEN. Yes. Yes, that liquidity was helpful. Mr. HOENIG. Yes. Mr. GREEN. And just as it is difficult to prove a counterfactual as it relates to what you did, it is equally as difficult to prove it with reference to what Congress has done. Do you agree? Mr. HOENIG. I assume so, yes. Mr. GREEN. Okay. All right. What I am trying to do is establish this, sir. People of good will, and I consider you a person of good will, acted at a time of crisis Mr. HOENIG. Correct. Mr. GREEN. a time when it appeared as though we were about to go over the edge into an abyss unlike many of us had seen in our lifetimes. And many of these things that we did, we wont be able to prove that we averted a great cataclysm, but we can surely conclude that what we did probably helped to avoid a rougher landing, a harder landing than we had. Mr. HOENIG. Right. Mr. GREEN. I want to thank you, Mr. Chairman. I will yield back the balance of my time. Chairman PAUL. Thank you. I thank the gentleman. I will yield to Mr. Luetkemeyer. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Dr. Hoenig, I have been watching what is going on over in Europe very carefully, and it is very concerning to me. And I know that in discussing this issue with a couple of other Fed members board membersthey dont seem to be quite as concerned about it as I am, so maybe I am an alarmist here. I dont know. But I certainly see a contagion there that could easily spread to this country, especially whenever you look at our banks having about $1.3 trillion loaned to the various governments, invested in bonds of the various governments over there as well as, now, Dodd-Frank tying all those big banks together with too big to fail. It looks like there is a lot of connectivity between all of these things here. And you look at a line of dominoes, and it looks like we are in that line of dominoes. So I know that the Fed has a swap line with the European central bank and perhaps some other reserve banks over there as well. And I am just wondering what your view is of that situation, how concerned are you? Mr. HOENIG. I am concerneddo you mean about the European situation?
Mr. LUETKEMEYER. Yes, the European situation and how it will affect us or what kind of exposure we might have, our monetary policy, how it interacts. It is kind of a big question, but Mr. HOENIG. I understand your concern. The issues around those countries that keep coming up are also really around the banks, the European banks, because they, obviously, have exposure there. And that is a big part of the efforts we are trying to do to resolve this. And like the United States, as I read itand I only know from what I read in the paperthey are working toward some kind of solution, resolution around that. But I think it proves to me not only in the United States, but internationally that we have institutions that are too big to fail. And that is what this is really about. We have taken the market discipline away. We are now working with institutions globally that are extremely important to those economies, to our economy. And to me, the whole issue continues to be around institutions that are so large that their own difficulties have broad effects on the economy, and that makes them too big to fail and therefore forces, if you will, governments to come in and bail them out. And that is really what, I think, is going on in Europe and that is really what has gone on in our crisis in the United States. Until we change that formula, until we break those institutions up into those that are under the safety net and those that are allowed to engage in high-risk activities, we will have these crises periodically into the futurenot right away, perhaps, but in years to come. Mr. LUETKEMEYER. And the pitfall there is that we have our taxpayer dollars at risk, because we are backing these too-big-to-fail folks. Is that right? Mr. HOENIG. When you put a safety net over them and put the governments implied or explicit guarantee, the taxpayer is the backstop, yes. Mr. LUETKEMEYER. In your positionand you are an economist, and having dealt with all of the financial things over the last several years, what do you see as the biggest concern to our economy today, whether it is international problems here we just discussed or oil prices or our monetary policy, our wars or What do you see as the biggest concern and how we can go to it from a financial aspect there? Mr. HOENIG. That is a pretty important question. Number one, I think that as far as our financial system goes, I continue to believe that too big to fail is an area that needs to be
further addressed, and these institutions need to have their risk better divided between what is under the safety net and what is not. Number two, I think that the budget crisis in the United States is important because it is drawing all of our attention into that. And yet the economy is in difficulty and we should be thinking about our policies, do we want to see if we can bring greater manufacturing onshore? In 1960, 25 percent of our GDP was contributed by manufacturing. Today, it is 12.5 percent. We have 14 million people out of work. So what is our attitude towards manufacturing? What is our attitude towards creating businesses that create things then that hire people? By not being able to pay attention to that in the Congress and elsewhere, I think we are handicapping ourselves in an international, global, competitive market, and we need to pay more attention to it so we have a brighter future. I think that is essential. Mr. LUETKEMEYER. I appreciate your comments. My time is up. Thank you again for visiting with us today. I always enjoy discussing things with you. I really appreciate your perspective and all your hard work as well. I thank you again for your service, sir. Mr. HOENIG. Thank you, Congressman. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Chairman PAUL. I thank the gentleman. I have another additional question. If you care to stick around, you may. But I am not going to let you go so easily. I need to find some answers. But I am very glad you are here and willing to take our questions. In your introductory statement, you mentioned that one of the responsibilities of the Federal Reserve was to have maximum employment, which sounds like a good idea, and stable prices. I would look around and I would say, results arent all that good. When you look at stable prices of housing, you even brought up the subject of unstable prices in farmland. That quite possibly could be a bubble. I would think that if you looked at bonds in prices, they are very unstable. And who knows where that is going. If the market overrides, which I believe is possible, markets are very, very powerful. I know the Fed is very powerful, but I also know markets are very powerful. But also in your statement, I want to get back to it, we talked a little bit about this, and you said, I have several concerns with zero
rates. First, a guarantee of zero rates affects the allocation of resources. To me, I think that is very key and very important, because it really brings up the subject that the free market economists are very attuned to. Ludwig von Mises, in his Human Action, talks about this as the misallocations and of malinvestment, excessive debt, money going into the wrong sectors, like farmland maybe or NASDAQ bubbles and houses. But he took that and carried it much further. It seems like you have part of that philosophy, but not the full philosophy, but you are, I am sure, aware of what von Mises says about the Austrian theory of the business cycle. Mr. HOENIG. Sure. Chairman PAUL. How do you look at that? Can you say something favorable about his approach to it? Or can you draw a sharp line where interest rates are harmful and know how to divide the two? And what is your opinion of the Austrian business cycle theory? Mr. HOENIG. I have read Human Action. I have a lot of respect for von Mises and I have a lot of respect for the Austrian school of thinking. I think it has value. I understand that when you overinvest, when you leave things artificially low and you overinvest you create a correction by doing that. There is an action with that. My view is that is why central banks have to be mindful. No matter what the system is, if you have markets and capitalism, you are going to have cycles and you are going to have crises. And what you want the central bank to do is address the crises and provide over a long period of time a base liquidity of money that allows your economy to grow. When you move beyond that, when you find the central bank focusing on short-term issues, trying to manage the economy, trying to fine-tune it, then you create, if you will, impulses of instability, because you are trying to take care of short-run issues instead of looking to the long run. That is why when I say the duty of a central banker is to think long run, and that I think I am in agreement with the Austrian school, but I do think there is a role for central banks, as I have said. Chairman PAUL. I certainly agree with your point. Once they overextend, they are into central economic planning, except many have accepted the notion that you get into central economic planning
earlier than that, at the initial stages of believing that you can know what the interest rates should be. Maybe you can give me a quick comment on this. Do you think the problems in the world todaytry to put that in perspective. I think it is a very big problem, because I dont think we have faced it quite the same way, because we have a fiat dollar standard, and we are the issuers of the reserve currency of the world. Do you think that has had an effect on what we are facing, the fact that we are issuing the reserve currency in the world, and it is much different than anything we faced before? Mr. HOENIG. What I think is that the fact that we are the reserve currency is a consequence of decades of very good economic policy, the fact that we have had an economy that has grown, become very important to the world, and therefore, its currency has become very important. I think that is a consequence, something you, as someone also said, you have earned. With that is carried a responsibility to look to long-run policy. And to your point, if you have a gold standard, that is a legitimate alternative monetary base for your economy. But it does not eliminate crises. There is gold hoarding, there is positioning, there is mercantile practices. You will have crises. So it doesnt matter if it is Congress, it doesnt matter if it is the central bank, it doesnt matter what the standard is. Good policy leads to good outcomes. Bad policy leads to bad outcomes. That is what you have to keep in mind. Chairman PAUL. I would question whether we earned it or not. In some ways I think it was defaulted, because we were the standard. At least we pretended to be a good reserve standard, even though we werent allowed to own gold. It was an international gold standard. And then the confidence continued, surprisingly to some people. So that is just a matter of an understanding or semantics about whether it was earned or we defaulted into it. But I have one more question. Because I have been interested in the monetary issues, I am delighted that you are here and so willing to visit with us. But last week, I learned that gold was not money. So I have been able to put that out of my mind. Gold is not money, so I am still trying to figure out what money is. And I have asked these questions a lot of times, I have asked the Federal Reserve Board Chairmen over the years. And if I asked about dollar policy, they would say, We are not in charge of dollar policy.
They are in charge of creating all this money and regulating interest rates, but they are not in charge of the dollar. The Secretary of the Treasury does that. But the Secretary of the Treasury doesnt give me any straight answers. What I need to know from you to further my education is, tell me what a dollar is and where can I find the definition in our code? Mr. HOENIG. The denomination is, I thinkor the title was given back at just about the founding of our country. It was based on a gold standard at that time. But money is, as you know, a medium of exchange, deferred means of payment and stored value. And as long as the public and the world understands that the dollar that is produced by the central bank of the United States, the base money, and then credit goes on beyond that, it is money. As long as they take it as a medium of exchange, deferred payment and stored value. When that is lost, then it will no longer be money. Chairman PAUL. But it is a note, it is a promise to pay. Actually, you are right about it being Mr. HOENIG. But it fills the three functions of money. Gold can do the same thing. And if Congress designated that gold was the medium of exchange Chairman PAUL. This is why I am looking through the code, because the code, when I understand it, actually in the early years they wrote a dollar into the Constitution like they would write a yard, because everybody knew what it was, they didnt even define it, it was so well known. It was 371 grains of silver. But that has never been changed, as best as I can tell, and all of a sudden now we have a Federal Reserve Note, a promise to pay nothing, is now the dollar standard and we can create them at will out of thin air. And then sometimes people wonder why we have a shaky, rocky economy. I will keep looking for the definition of a dollar. But as best as I can tell, we have never said a dollar is a Federal Reserve Note. And the dollar under the code still says it is 371 grains of silver. I yield to Mr. Luetkemeyer. Mr. LUETKEMEYER. I just have one follow-up question on something the chairman asked a minute ago with regards to the role of currency. Because I think one of the consequences of us not doing something to resolve our debt crisis here and then be downgraded, it would
seem to me to be a step down the path toward allowing ourselves to be no longer the worlds reserve currency. With China sitting over on the sidelines watching us twiddle our thumbs and waiting for an opportunity to get in the game, this is an opportunity. We are stumbling here and allowing them to do that. What would be your thoughts on that comment? Mr. HOENIG. I do think it is a serious matter. I think the U.S. currency, the dollar, is the reserve currency of the world and will remain so for some time. And part of it is, what are your alternatives? You always have to ask the question. And the United States, for all of our issues and all the debate going on right now, it still has the deepest markets, is a market economy, has all the advantages. It has open capital markets. China doesnt have that. Europe has its issues. So we still are the dominant economy. However, there is nothing guaranteed about that. That can change based upon the policies we choose going forward from here, both from a fiscal side and from a monetary side and from basically how we choose to have our economy operate in terms of the private sector and markets. Those will all define the future of us as an economy and therefore the future of us as a nation as a reserve currency. It will be what we choose to do. Mr. LUETKEMEYER. You just made the case from the standpoint that almost by default, we are the reserve currency, because China doesnt have all its ducks in a row yet to be that currency. Europe has its own set of problems. And so you look for the safest harbor, you look for the strongest economy. We are still there. But if we keep twiddling our thumbs here, it could be endangered from the standpoint of the world sort of looking at us and saying, Those guys cant get their act together Mr. HOENIG. I agree with that. Mr. LUETKEMEYER. and their economy is stumbling along. They dont have a manufacturing base anymore, and they are going to import almost all the oil, which means they are going to be at the mercy of the oil companies and the oil cartels around the world. And all of a sudden our economy is looked at as kind of a shaky thing versus a very stable thing. And now, we have those other folks coming in there to fill the void. And to me this debt debate, one of the sidelights and one of the side consequences is that we are going down this road, and nobody is thinking about allowing China to get their foot in the door on the world currency side.
It is not going to happen today or tomorrow, but I have heard some people project that in 5 or 10 years, if we dont get our fiscal house in order, by that time they will be in a position economically where they will have resolved a lot of the issues that you talked about, and they may be knocking on the door. Mr. HOENIG. I agree. Mr. LUETKEMEYER. So what do you see on the horizon for that? Mr. HOENIG. I think that the debates that are going on right now are about the long-run future of this countryhow we choose to deal with our debt, how we choose to deal with our economy going forward. Those are the debates that are in place right now. My point is that monetary policy cannot manage the short run, it has to have a long-run focus also. And the Congress and how we choose to have our markets operate are choices that lie ahead of us. If we dont choose well, in a generation, I think the answer to that question could be different. So it is in our power to change this or to keep us on the right path, but you have to choose to do it. And these debates are about the long run. There is no question about it. Mr. LUETKEMEYER. I certainly appreciate your common sense and intellectual approach to all of our problems, Dr. Hoenig, and I hope that you stay engaged in some aspect Mr. HOENIG. I hope so, too. Mr. LUETKEMEYER. of monetary and fiscal and economic policy here. You are too much of a prized jewel to walk away from this. So thank you again for your service. Thank you, Mr. Chairman. Chairman PAUL. Thank you very much. We are about to close, but I do have one more short question I think you can answer rather quickly. What would be the ramifications if they stripped away the voting rights of the regional Fed Presidents from the FOMC? Mr. HOENIG. The ramifications would be you would lose an important set of voices in the Federal Open Market Committee. And I think it would be a mistake. Right now in my region, as I deal with our board, a rancher from Wyoming, a bookseller in Oklahoma, a labor leader in Omaha that is all input that comes into the process. I think you would lose that voice, and you would lose that input. And you can say, make them advisers. But let me just tell you, voting and advising are two different things, and they are not even close to one another.
I would just say, since you have asked, I have been there. It is not democratic. It is not part of the political process. And my answer has been the selection of my successor will be a process that relies on our board, who represent, like I said, a grain dealer in Kansas City, an entrepreneur in Denver, a labor leader, a bookseller, a manufacturer, and a rancher from all over our region, six of our seven States. And they very carefully go through a search, and then it has to be approved by the Board of Governors, the political appointees. So, to me, that is a very democratic process. And it is in contrast to, if you select a Secretary of the Treasury who happensif you are a Democrat and you select a former chairman of Goldman Sachs and you are a Republican and you select a chairman from Goldman Sachs, that is political, but I dont know that it is any more democratic than our process, and I dont recommend it. Chairman PAUL. I thank you. I thank you for being here. The Chair notes that some members may have additional questions for this witness, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to this witness and to place his responses in the record. This hearing is now adjourned. {Whereupon, at 3:37 p.m., the hearing was adjourned.}
TATEMENTS

Today's hearing is the second in a series of hearings examining the relationship between Federal Reserve policy and the performance of the United States economy. Today we are receiving testimony from the Federal Reserve banks. Of the half-dozen Reserve banks we contacted, only President Hoenig was willing to testify in front of this subcommittee, and we welcome him here today. Like many critics of the Fed's monetary policy, I fear that quantitative easing will soon return. Despite what we hear from the cheerleaders in government and in the media, the economy remains in a complete shambles. Unemployment remains high and seven million jobs lost during the recession have yet to be regained. The Federal Reserve has kept interest rates at or near zero for over two and a half years and pumped trillions of dollars into the banking system in a vain attempt to revive the economy. Yet even now after the failure of the zero interest rate policy (ZIRP) and quantitative easing have become readily apparent, we still hear calls for more stimulus, more easing, more lose money. Like any other government program, the solution for failure is to throw more money at the problem, never mind the fact that throwing more bad money after good in such instances has never succeeded. Reading the press releases from the Federal Open Market Committee (FOMC) we see that the FOMC intends to keep interest
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rates at a low level for an extended period. Chairman Bernanke has hinted at a further round of quantitative easing, the effects of which will undoubtedly be calamitous. Moneyholders seek a return on their holdings, and in an era of near-zero interest courtesy of the Fed, saving makes no sense. Combined with the still-shaky condition of the banking and financial sector, it is not surprising that much of the recently-created easy money has flowed into tangibles such as agricultural commodities, metals, and land. Rather than allowing the housing bubble to burst, overall prices to return to normal and overleveraged banks to break up, the Fed has thrown more fuel onto the fire and created the conditions for an even larger bubble that will eventually burst. The Fed's easy money policy has also enabled the federal government to increase its total debt by 56% since 2008, an increase of over $5 trillion. Thanks to the Fed driving down interest rates and purchasing debt as fast as the Treasury has issued it, the federal government faces a crunch not only in terms of running up against the debt ceiling, but also in the structure of the debt. Large amounts of short-term debt are coming due in a short period of time. ZIRP and quantitative easing cannot hold down interest rates forever, as at some point investors will rebel and insist on higher interest rates for US debt. At this point this maturing debt will either have to be paid off or rolled over at higher interest rates, both of which will be very costly for taxpayers. While I disagree with Pres. Hoenig on many matters of monetary policy and especially on key policy issues such as the existence of the Federal Reserve System, we both have been critical of the Fed's policy of quantitative easing and its maintenance of zero interest rates. Pres. Hoenig has been the most outspoken member of the Federal Reserve System against Chairman Bernanke's policies, consistently voting against the Chairman during meetings of the Federal Open Market Committee last year. Due to Pres. Hoenig's impending retirement, the Fed will lose a much-needed counterbalance to the inflationists who dominate at the Fed. Both Pres. Hoenig and I realize that printing money out of thin air as the Fed has done and threatens to continue to do is not a panacea. If zero interest rates and quantitative easing could really solve unemployment, there would be no reason not to maintain such policies in perpetuity. Such policies, however, lead to the formation of asset bubbles, as both Pres. Hoenig and I know. Chairman Bernankes predecessor Alan Greenspan fueled the dot-com bubble and attempted to stave off its collapse by resorting to one percent
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interest rates. That created the housing bubble whose collapse Chairman Bernanke is attempting to stymie through zero percent interest and massive quantitative easing. The next bubble is already forming, although which sector will be hit hardest remains to be seen. Pres. Hoenig has alluded to some possible bubble sectors in his district, so I look forward to his testimony and his answers to our questions.
ITNESS
ESTIMONY
WRITTEN TESTIMONY OF THOMAS M. HOENIG, Ph.D.

PRESIDENT FEDERAL RESERVE BANK OF KANSAS CITY Chairman Paul, Ranking Member Clay and members of the subcommittee, thank you for the opportunity to discuss my views on the economy from the perspective of president of the Federal Reserve Bank of Kansas City and as a 20-year member of the Federal Reserve Systems Federal Open Market Committee (FOMC). The Feds mandate reads: The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. The role of a central bank is to provide liquidity in a crisis and to create and foster an environment that supports long-run economic health. For that reason, as the financial crisis took hold in 2008, I supported the FOMCs cuts to the federal funds rate that pushed the target range to 0 percent to 0.25 percent, as well as the other emergency liquidity actions taken to staunch the crisis. However, though I would support a generally accommodative monetary policy today, I have raised questions regarding the advisability of keeping the emergency monetary policy in place for 32 months with the promise of keeping it there for an extended period. I have several concerns with zero rates. First, a guarantee of zero rates affects the allocation of resources. It is generally accepted that no good, service or transaction trades efficiently at the price of zero. Credit is no exception. Rather, a zero-rate policy increases the risk of
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misallocating real resources, creating a new set of imbalances or possibly a new set of bubbles. For example, in the Tenth Federal Reserve District, fertile farmland was selling for $6,000 an acre two years ago. That land today is selling for as much as $12,000 an acre, reflecting high commodity prices but also the fact that farmland loans increasingly carry an interest rate of far less than the 7.5 percent historic average for such loans. And with such low rates of return on financial assets, investors are quickly bidding up the price of farmland in search of a marginally better return. I was in the banking supervision area during the banking crisis of the 1980s, when the collapse of a speculative bubble dramatically and negatively affected the agriculture, real estate and energy industries, almost simultaneously. Because of this bubble, in the Federal Reserve Bank of Kansas Citys district alone, I was involved in the closing of nearly 350 regional and community banks. Farms were lost, communities were devastated, and thousands of jobs were lost in the energy and real estate sectors. I am confident that the highly accommodative monetary policy of the decade of the 70s contributed to this crisis. Another important effect of zero rates is that it redistributes wealth in this country from the saver to debtor by pushing interest rates on deposits and other types of assets below what they would otherwise be. This requires savers and those on fixed incomes to subsidize borrowers. This may be necessary during a crisis in order to avoid even more dire outcomes, but the longer it continues, the more dramatic the redistribution of wealth. In addition, historically low rates affect the incentives of how the largest banks allocate assets. They can borrow for essentially a quarter-point and lend it back to the federal government by purchasing bonds and notes that pay about 3 percent. It provides them a means to generate earnings and restore capital but it also reflects a subsidy to their operations. It is not the Federal Reserves job to pave the yield curve with guaranteed returns for any sector of the economy, and we should not be guaranteeing a return for Wall Street or any special interest groups. Finally, my view is that unemployment is high today, in part, because interest rates were held to an artificially low level during the period of the early 2000s. In 2003, unemployment at 6.5 percent was thought to be too high. The federal funds rate was continuously lowered to a level of 1 percent in an effort to avoid deflation and to lower unemployment. The policy worked in the short term.
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The full effect, however, was that the U.S. experienced a credit boom with consumers increasing their debt from 80 percent of disposable income to 125 percent. Banks increased their leverage ratios--assets to equity capital-- from 15-to-1 to 30-to-1. This very active credit environment persisted over time and contributed to the bubble in the housing market. In just five years, the housing bubble collapsed and asset values have fallen dramatically. The debt levels, however, remain, impeding our ability to recover from this recession. I would argue that the result of our short-run focus in 2003 was to contribute to 10 percent unemployment five years later. That said, I am not advocating for tight monetary policy. Im advocating that the FOMC move to carefully move to non-zero rates. This will allow the market to begin to read credit conditions and allocate resources according to their best use rather than in response to artificial incentives. More than a year ago, I advocated removing the extended period language to prepare the markets for a move to 1 percent by the fall of 2010. Then, depending on how the economy performed, I would move rates back toward more historic levels. I want to see people back to work, but I want them back to work with some assurance stability. I want to see our economy grow in a manner that encourages stable economic growth, stable prices and long-run full employment. If zero interest rates could accomplish this goal, then I would support interest rates at zero. In my written testimony, I have included three speeches that describe in more detail my position on monetary policy. Monetary policy cannot solve every problem. I believe we put the economy at greater risk by attempting to do so. Thank you Mr. Chaiman. I look forward to your questions. REBALANCING TOWARD SUSTAINABLE GROWTH
THOMAS M. HOENIG, PRESIDENT FEDERAL RESERVEBANK OF KANSAS CITY313 THE ROTARY CLUB OF DES MOINES AND THE GREATER DES MOINES PARTNERSHIP DES MOINES, IOWA JUNE 30, 2011
Introduction
The views expressed by the author are his own and do not necessarily reflect those of the Federal Reserve System, its governors, officers or representatives.
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The U.S. economic recovery is under way, but it remains more uncertain and volatile than anyone would like. Some believe that the Federal Reserve can speed up the recovery by keeping the federal funds rate near zero, where it has been for nearly two-and-a-half years, and by promising to keep it there for an extended period. If I judgedor if evidence suggestedthat a zero rate would solve our countrys unemployment problem or speed up the recovery without causing other adverse consequences, I would support it. However, monetary policy is not a tool that can solve every problem. In today's remarks, I will outline my current views on the economy, and suggest what alternative options and policies our leaders might consider as we search for ways to build a stronger, more resilient economy. U.S. economic conditions First, it is a testament to the U.S. economic system that even as this nation carries a heavy public and private debt burden, the economy is completing its second year in recovery. The level of activity, as measured by GDP, has now surpassed its pre-recession peak after growing at a nearly 3-percent pace last year. However, I am concerned that in working to offset the effects of this devastating crisis and to restore the economy to health, an extended zero-interestrate policy is producing new sources of fragility that we need to be aware of and allow for in our future policy choices. Governments, businesses and consumers have made financial choices and allocated resources with an understanding that a zerointerest-rate policy will remain in place indefinitely. The longer we leave interest rates at zero, the more asset values will be defined by these low rates and the greater the negative impact will be once the inevitable move up in rates begins. Complicating the fragility around monetary policy, fiscal policy as a pro-growth policy instrument also appears to be approaching its limit. The governments stimulus efforts to support the economy, along with lower tax revenues, have resulted in historically large fiscal deficits and a very large debt level. Without a dramatic change, the deficit and the debt will only become more daunting with the rising cost of entitlement programs and likely higher interest rates. For well over a decade, the U.S. consumer has been a principal source of world demand and economic growth. As a result, the United States has incurred consistently large trade deficits, contributing to imbalances in the global economy. As we have painfully learned from the housing bust, growth built on imbalances is ultimately
unsustainable. Circumstances require, therefore, that we transition from an economy that relies too heavily on consumption and government spending for growth toward more sustainable sources of demand and economic prosperity. How we undertake this transition will define our economy and countrys economic future. To start, over the next several years, we must change our national savings, consumption and investment habits. Such shifts, though fundamental to long-term economic health, are admittedly difficult to accomplish. They require changes in behavior and expectations. They involve dramatic shifts in resource use, which are not painless as workers are temporarily displaced and industries are disrupted. The pain is immediate, and the payoff comes slowly. However, the gains also can be significant, as more sustainable longrun economic growth is well worth the effort and sacrifice. In a recent visit to Singapore, I witnessed that nations commitment to job creation. For example, during the recent crisis and recession, Singapore developed a program to retrain unemployed workers to ensure they would have the skills needed when its manufacturing sector recovered. As is well understood, workforce training matters. I spoke with individuals who described the drive to bring new factories on-line, with the goal of bringing a factory on-line with minimal delays and, by their description, without compromising safety. Lessons from Germany Other countries have made similar changes out of necessity or during a time of economic distress such as we are experiencing today. Countries have made deliberate choices and not relied on chance to change economic incentives and behavior that served to improve economic performance. I'm not advocating that we pick winners and losersin fact, that is my biggest argument against too-big-to-fail financial institutions. Rather, I have observed a number of countries that are building and expanding their manufacturing basessuch as Korea, Singapore and Chinathat have been able to experience strong GDP growth over long periods of time. Germany offers another example of a country having made significant changes to accomplish real employment goals. In the mid1990s, Germanys trade deficit was similar to that of the United States. Since then, Germany has moved away from trade deficits to surging surpluses, while the United States has continued to run large trade deficits. Complementing this shift, German levels of
employment have made great strides, and its unemployment rate has touched its lowest point in nearly 20 years. I am not suggesting that the United States attempt to be Germany or Singapore, two countries that differ from us in many ways. I am also not advocating that we suddenly strive to achieve a large U.S. trade surplus. This might only create other global imbalances and distortions. However, adjustments in our economy are necessary, and other countries have shown it can be done. Perhaps the most immediate, and obvious, observation is the simplest: We must change our national savings rate. To rebalance the U.S. trade position from deficit to balance requires that the sum of private and public savings match domestic investment. In other words, a country must not produce less than it consumes if it wishes to balance its trade position with the rest of the world. During the 2000s, Germanys personal savings rate increased and is currently about double the U.S. rate. German households paid down debt and avoided heavily relying on debt, in contrast to the United States and so many other countries households. The personal savings rate in the United States has modestly increased since the start of the recession, which is an important positive trend. Unfortunately, this improvement has been more than offset by the dramatic deterioration in public saving reflected in the nations fiscal deficits. Though a significant amount of the recent deterioration in public finances is related to the U.S. financial crisis, the fact remains that our national savings crisis has been under way for nearly three decades. Since the early 1980s, our nation has consistently chosen to spend rather than save, as witnessed by the long-term decline in our private savings rate and our tendency toward fiscal deficits. Most importantly, when we look across the more developed countries, we see that those with higher national savings rates tend to have smaller trade deficits and higher domestic production per person. Germany has also benefitted from managing unit labor costs in a manner that keeps its labor force globally competitive. Over the last decade, the German economy experienced relatively modest wage increases and important productivity gains. Both of these factors contributed to keeping unit labor costs in check. However, another important component of its success came in the form of labor policy reforms. In the early 2000s, Germany, with labor and management input, passed a series of labor market enhancements called the Hartz laws. These laws modified some of the more generous employee
benefits and reduced restrictions on temporary workers and the ability to lay off workers. Germanys reforms also sought to incentivize unemployed workers to transition to employment by making changes to job training programs for the unemployed and creating targeted subsidies to support some manufacturing job creation. Finally, Germany developed export markets by focusing on meeting the needs of parts of the world experiencing the fastest growth and demonstrating strong demand for capital goods that German manufacturers produce: emerging economies in Asia, Europe and Latin America. The United States is well-positioned to match this kind of performance, if it chooses to do so. For example, since 2000, the share of our exports going to the BRIC countriesBrazil, Russia, India and Chinahas more than doubled. If we choose to increase our savings rate, if government, labor and management see the mutual advantage of investing in and building a competitive manufacturing environment, then job growth will follow. As the U.S. economy shifts gears to shrink its trade imbalances, many parts of the country will have a role to play. I fully expect Iowa to be an integral participant in this shift. Iowa already possesses a strong manufacturing base that is a key driver of the state economy. By some estimates, about half of the manufacturing firms in the state are small-and medium-sized enterprises, which provide some parallels with Germanys renowned export powerhouses, known as the Mittelstand. Real Solutions versus Economic Shortcuts Rebalancing our economy and improving our trade position is a necessary development, but unfortunately, it will take time. And as our immediate desire is to rush to improve our economy, I warn against the all-too-common impulse to take shortcuts and suffer their unintended consequences. Here in Iowa, for example, one area where I suspect this tradeoff might be playing out is in the recent rapid runup in agricultural land prices. Agricultural exports have played a significant role in the rapid rise of land prices. Since 2000, agricultural exports from Iowa have increased by a factor of six. A portion of this growth reflects surging commodity prices due to factors on the supply sidesuch as extreme weather in parts of the worldand on the demand side, including the well-documented, rapidly growing food demands of emerging economies.
In addition to anticipated strong future demand for agricultural commodities, there is another factor affecting these prices: exceptionally low interest rates. As a bank regulator in the 1980s, responsible for financial institutions in Nebraska, Kansas, Oklahoma, Missouri, Wyoming, Colorado and New Mexico, I witnessed the devastating effects of easy credit and leverage in agriculture, real estate and energy. We closed or assisted nearly 350 banks in our region alone. With interest rates near zero and with additional massive liquidity poured into our economy, all interest rates are affected. Therefore, asset values of every kind are also being affected, including land values in Iowa. Loans for land are available at rates well below historical levelsin some instances, 400 basis points below historical averages. The effect on land assets, like any asset, is to artificially boost its value. And there is ample experience that tells us that if rates were to rise quickly, this would affect world demand for commodities and raise the cost of capital on land almost instantly. Whennot ifthe adjustment occurs, we will see a dramatic drop in values. In the meantime, if operators and speculators have incurred large amounts of debt, then a new crisis will emerge. Finally, we know that a crisis can affect more than one segment of the economy. It nearly always affects the broad economy and employment. Shortcuts dont work. We need to focus on the real economy. We need to focus on real reform. Conclusion My point today is simply that as powerful as monetary policy is, it sometimes is not enough. It cannot ensure an economy that balances its savings and investing needs. It by itself cannot correct our current account deficit or enhance savings and investment. These will require important changes in our real economy. Providing the right environment in which government can play its role in supporting business and the consumer to save, invest, manufacture and service national and global needs in the end will create real income and wealth. We need to focus on long-term, stable monetary policy and fiscal policy goals that support these broader goals. Having seen the effects of financial crisis after financial crisis as short-term policies beget short-term policies, we should know that an ever-present short-run focus, even if well intentioned, is the road to ruin.
THE FEDERAL RESERVES MANDATE: LONG RUN THOMAS M. HOENIG, PRESIDENT, FEDERAL RESERVE BANK OF KANSAS CITY314 NATIONAL ASSOCIATION OF BUSINESS ECONOMISTS ANNUAL MEETING DENVER, COLORADO OCTOBER 12, 2010 Introduction and Framework Thank you, and it is a pleasure to welcome you to Denver. This is the largest metropolitan area in the Tenth Federal Reserve District and home to one of three branches of the Federal Reserve Bank of Kansas City. The Denver branch serves Colorado, Wyoming and New Mexicothree of the seven states of our region. I appreciate this opportunity to engage and interact with business economists from around the country regarding the policy choices now confronting the nation, especially those confronting the Federal Reserve. In setting out my views, Ill first spend a minute describing the economys performance and then turn to the matter of quantitative easing versus my preferred path of gradual steps to a renormalization of monetary policy. Short-Term Outlook Currently, a major and necessary rebalancing is taking place within our economy. This includes the deleveraging of consumers, businesses and financial institutions, and it's during a time that state and local governments are struggling with budgets and mounting debt loads. In this context, a modest recovery with positive overall data trends should be seen as highly encouraging. Following a bounce back from restocking earlier this year, the economy has slowed but it has not faltered. GDP growth has averaged about a 2 percent annual pace since the first of the year. Industrial production is showing growth of almost 6 percent, and high-tech more than double that. The consumer continues to buy goods, with personal income growing at more than a 3 percent rate, personal consumption expenditures at about 3 percent, and retail sales at more than 4 percent. And the U.S. economy has added more than 850,000 net new private sector jobs since the first of the year. While modest, these are positive trends for the U.S. economy.
The views expressed by the author are his own and do not necessarily reflect those of the Federal Reserve System, its governors, officers or representatives.
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The issue is, of course, that while private jobs are being added within the economy, it is not enough to bring unemployment down to where we all would like to see it. Unemployment remains stubbornly high at 9.6 percent. With such numbers, there is, understandably, a desire and considerable pressure for the Federal Reserve to do something, anything to get the economy back to full employment. And for many, including many economists, this means having the Federal Reserve maintain its zero interest rate policy or further still, engage in a second round of quantitative easing now called QE2. Some are even suggesting these actions are necessary for the Federal Reserve to comply with its statutory mandate. Interpreting the Policy Mandate The FOMCs policy mandate is defined in the Federal Reserve Act, which requires that: The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. There is, within the Act, a clear recognition that our policy goals are long-run in nature. In this way, the Act recognizes that monetary policy works with long and variable lags. Thus, the FOMC should focus on fostering maximum employment and stable prices in the timeframe that monetary policy can legitimately affect the future. The FOMC must be mindful of this fact and be cautious in pursuing elusive short-term goals that have unintended and sometimes disruptive effects. In recent weeks, some have argued that with inflation low and the jobless rate high, the Federal Reserve should provide additional accommodation. Such an action the purchase of assets by the central bank as a policy easing tool would mark a second round of quantitative easing. While there are several ways to accomplish this, many suggest that the most likely method would be for the Federal Reserve to purchase additional long-term securities, including U.S. Treasuries. Proponents of QE2 argue that it would provide a near-term boost to the economy by lowering long-term interest rates while raising inflation. These benefits would arise from the purchase of U.S. Treasury securities, which would lead to lower U.S. Treasury and corporate rates. These lower interest rates would then stimulate consumer and business demand in several ways, including
encouraging mortgage refinancing that could lead to increased consumer spending, boosting exports through a likely lower exchange rate, and fostering higher equity prices, thereby creating additional wealth. Such a move is said to be consistent with the FOMCs September 21, 2010 announcement, which stated that it was prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate. Such easing, it is hoped, would bring inflation back up to something closer to 2 percent, a rate that many judge to be consistent with the Federal Reserves mandate. In addition, higher inflation would increase demand as consumers move purchases forward to avoid paying higher prices in the future. So, with these purported benefits, why would anyone disagree? New Risks and QE2 I believe there are legitimate reasons to be cautious when considering this approach. A meaningful evaluation of QE2 must consider not simply whether benefits actually exist but, if they do, how large they are and whether they are larger than possible costs. Based on recent research and the earlier program of purchasing long-term securities known as LSAPI think the benefits are likely to be smaller than the costs. Some estimates suggest that purchasing $500 billion of long-term securities might reduce interest rates by as little as 10 to 25 basis points. The LSAP program was effective, in part, because we were in a crisis. Financial markets were not functioning properly, or at all, during the depths of the financial crisis. In such a situation, it is reasonable that central bank purchases would be useful and effective. However, currently the markets are far calmer than in the fall of 2008. The financial crisis has passed and financial markets are operating more normally. One could argue, in fact, that with markets mostly restored to pre-crisis functioning, the effect of asset purchases could be even smaller than the 10 to 25 basis point estimate. I would also suggest that even if we achieved slightly lower interest rates, the effect on economic activity is likely to be small. Interest rates have systematically been brought down to unprecedented low levels and kept there for an extended period. The economys response has been positive but modest. In fact, right now the economy and banking system are awash in liquidity with trillions of dollars lying idle or searching for places to be deployed or, perhaps more recently, going into inflation hedges.
Dumping another trillion dollars into the system now will most likely mean they will follow the same path into excess reserves, or government securities, or safe asset purchases. The effect on equity prices is likely to be minor as well. There simply is no strong evidence the additional liquidity would be particularly effective in spurring new investment, accelerating consumption, or cushioning or accelerating the deleveraging that is hopefully winding down. If the purported benefits are small, what are the possible costs? First, without clear terms and goals, quantitative easing becomes an open-ended commitment that leads to maintaining the funds rate too low and the Federal Reserves balance sheet too large. The result is a further misallocation of resources, more imbalances and more volatility. There is no working framework that defines how a quantitative easing program would be managed. How long would the program continue, and what would be the ultimate size? Would purchases of long-term assets continue until the unemployment rate is 9 percent or 8 percent or even less? Would purchases continue until inflation rises to 2 percent or 3 percent or more? Would the program aim to reduce the 10-year Treasury rate to 2 percent or 2 percent or even less? Without answers to these and other questions, QE2 becomes an open-ended policy that introduces additional uncertainty into markets with few offsetting benefits. As central bank assets expand under quantitative easing, what will be the exit strategy? In the midst of a financial crisis, we may not have the luxury of thinking about the exit strategy. In current circumstances, however, we must define an exit strategy if the objective is to raise inflation but contain interest rate expectations. If history is any indication, without an exit strategy the natural tendency will be to maintain an accommodative policy for too long. While I agree that the tools are available to reduce excess reserves when that becomes appropriate, I do not believe that the Federal Reserve, or anyone else, has the foresight to do it at the right time or right speed. It may work in theory. In practice, however, the Federal Reserve doesnt have a good track record of withdrawing policy accommodation in a timely manner. Second, we risk undermining Federal Reserve independence. QE2 actions approach fiscal policy actions. Purchasing private assets or long-term Treasury securities shifts risk from investors to the Federal Reserve and, ultimately, to U.S. taxpayers. It also encourages greater attempts to influence what assets the Federal Reserve purchases. When the Federal Reserve
buys long-term securities such as the $1.2 trillion in mortgage backed securities it purchased during the financial crisis it favors some segments of the market over others. And when the Federal Reserve is a ready buyer of government debt, it becomes a convenient source of cash for fiscal programs. During a crisis this may be justified, but as a policy instrument during normal times it is very dangerous precedent. Third, rather than inflation rising to 2 or 3 percent, and demand rising in a systematic fashion, we have no idea at what level inflation might settle. It could remain where it is or inflation expectations could become unanchored and perhaps increase to 4 or 5 percent. Not knowing what the outcome might be makes quantitative easing a very risky strategy. It amounts to attempting to fine-tune inflation expectationsa variable we cannot precisely or accurately measureover the next decade. And why might inflation expectations become unanchored? The budget deficit for 2011 is expected to be about $1 trillion. Even if the Federal Reserve were to purchase only $500 billionand this amount in itself is a source of considerable uncertaintythat would appear to monetize one-half of the 2011 budget deficit. In addition, the size of the Federal Reserves balance sheetnow and over the next decadewill influence inflation expectations. Expanding the balance sheet by another $500 billion to $1 trillion over the next year, and perhaps keeping the balance sheet at $3 trillion for the next several years, or increasing it even further, risks undermining the publics confidence in the Feds commitment to long run price stability, a key element of its mandate. While QE2 might work in clean theoretical models, I am less confident it will work in the real world. Again, I will note that the FOMC has never shown itself very good at fine-tuning exercises or in setting and managing inflation and inflation expectations to achieve the desired results. Given the likely size of actions and the time horizon over which QE2 would be in place, inflation expectations might very well increase beyond targeted levels, soon followed by a rise in long-term Treasury rates, thereby negating one of the textbook benefits of the policy. Non-Zero Rates as an Option At this point, with a modest recovery underway and inflation low and stable, I believe the economy would be better served by beginning to normalize monetary policy. If long run stability is the goal, then re-
normalizing policy is an important step toward realizing that goal. How might we achieve this goal? First, rather than expand the Federal Reserves balance sheet by purchasing additional U.S. Treasury securities, the Fed should consider discontinuing the policy of reinvesting principal payments from agency debt and mortgage-backed securities into Treasury securities. Given where we are, we would need to make such a change slowly but systematically. Allowing maturing mortgage backed securities to roll off, the Federal Reserves balance sheet would shrink gradually, with relatively small consequences for financial markets. Second, we should take the first early steps to normalize interest rate policy. This is not a call for high rates but a call for non-zero rates. In 2003 the FOMC delayed our efforts to raise rates. In that period we reduced the federal funds rate to 1 percent and committed to keeping it there for a considerable period. This policy fostered conditions that let to rapid credit growth, financial imbalances and the eventual financial collapse from which we are still recovering. Had we been more forceful in our action to renormalize policy then, its likely we might have suffered far less in 2008 through 2010. Also, any effort to renormalize policy would include signaling a clear intention to remove the commitment to maintain the federal funds rate at 0 to percent for an extended period. As the public adjusts to this, we should then turn to determining the pace at which we return the funds rate to 1 percent. Once there, we should pause, assess and determine what additional adjustment might be warranted. A 1 percent federal funds rate is extremely accommodative, but from that point we could better judge the workings of the interbank and lending markets and determine the order of policy actions that would support sustained long-term growth. Other Concerns Regarding Zero Rates These are difficult times, no doubt, and it is tempting to think that zero interest rates can spark a quick recovery. However, we should not ignore the possible unintended consequences of such actions. Zero rates distort market functioning, including the interbank money and credit markets; zero rates lead to a search for yield and, ultimately, the mispricing of risk; zero rates subsidize borrowers at the expense of savers. Finally, it is important to note, that business contacts continue to tell me that interest rates are not the pressing issue. Rather, they are
concerned with uncertainties around our tax structure; they are desperate to see this matter settled. They need time to work through the recent healthcare changes; and they are quite uncertain about how our unsustainable fiscal policy will be addressed. They are insistent that as these matters are addressed, they will once again invest and hire. QE2 cannot offset the fundamental factors that continue to impede our progress. Conclusion We are recovering from a set of shocks, and it will take time. These shocks did not develop overnight, but came after years of interest rates that were too low, leverage that was too high, and financial supervision that was too lax. If we have learned anything from this crisis, as well as past crises, it is that we must be careful not to repeat the policy patterns we have used in previous recoveries, such as 1990-91 and 2001. If we again leave rates too low for too long out of fear that the recovery is not strong enough, we are almost assured of suffering these same consequences yet again. I am fully committed to the Federal Reserve's dual mandate to maintain longrun growth so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates. WHAT ABOUT ZERO? THOMAS M. HOENIG, PRESIDENT, FEDERAL RESERVE BANK OF KANSAS CITY SANTA FE, NEW MEXICO APRIL 7, 2010 Introduction Good afternoon. Im pleased to be in New Mexico today, and I extend my congratulations and best wishes to the city of Santa Fe on its 400 anniversary. Last week, The Wall Street Journals front page featured an article with a headline focused on the epic comeback of the corporate bond market. The article chronicled how a record $31.5 billion in new high-yield, high-risk junk bonds came on the market last month and how investments in bond mutual funds last year were the highest on record. Thanks to the combination of near-zero shortterm interest rates and the Federal Reserves large-scale purchases of mortgage-backed securities, investors are flush with cash. And, as is sometimes the case, cash earning so little is an enticement to take on
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additional risk in hopes of higher returns. The bond market is not the only place where we are seeing the impact of cash-rich investors. Our contacts within the Tenth Federal Reserve District have shared anecdotal information suggesting that operators and investors in the Midwest are buying farmland and bidding up the price. Weve seen this in the agricultural regions of our District in the past, notably in the run-up to the banking crisis of the 1980s. Events such as these, along with new economic research now coming to light, are beginning to document a story about long-run risks that are created when money and credit are easy for too long, when interest rates are near zero, and when financial imbalances risk macroeconomic and financial instability. As we all know, the last couple of years have been an extraordinary period in our nations economic history. In response to the crisis, the Federal Reserve took unprecedented steps to drive down long-term interest rates and provide direct support to a fragile housing market. This was in addition to the steps taken by the administration and the Treasury. We will long study these events. Although we may disagree on the specifics of the actions taken during that period, most agree that without strong intervention, the outcome would have been dire. But as the economy turns the corner and we move beyond the crisis, what about the challenges we now face, and what about policy actions over the next several quarters? The economy appears to be on the road to recovery, and we find ourselves having to face important questions of how the Federal Reserve will unwind the policy response to the crisis. In particular, what are the hazards of holding the federal funds rate target close to zero? The risks of raising rates too soon are clear and compelling. My comments, however, concern the risks of raising rates too late. Such risks also can be significant but all too often seem more distant and less compelling, and therefore hold great long-term danger for us all. The Economic Outlook As a preface to a discussion on the issues, I first should outline my expectation for the U.S. economy. Policy choices can be realistically considered only after first defining how we judge current conditions and our outlook for the future. From my vantage point, the outlook is generally good. A number of indicators suggest the economy has begun to recover and is expanding at a steady pace since hitting bottom last summer. GDP
grew nearly 4 percent in the second half of last year, and growth of almost 3 percent is expected in the first quarter of this year. The pace of growth should modestly pick up over time, and looking ahead, I expect GDP growth of about 3 percent for 2010. While labor markets remain weak, they seem to have stabilized. The pace of job losses gradually slowed over the course of 2009 and early 2010. In the first three months of the year, unemployment has remained essentially unchanged at 9.7 percent. Importantly though, Fridays report from the Labor Department showed the largest increase in non-farm payrolls in three years with more than 160,000 jobs added. Further, forward-looking indicators such as temporary help services, which has grown rapidly since the middle of last year, suggest broader job growth will continue. This is good news because such progress is essential for sustained growth. And like most, I am following it carefully. Unfortunately, it tends to lag the recovery and makes the implementation of policy always difficult to manage during the early stages of a recovery. Consumer spending has been growing at a solid pace, and most forecasters put first quarter consumption growth at more than 3 percent. These are critical improvements because consumer spending, which has accounted for about 70 percent of GDP, will be a critical force strengthening the recovery. The manufacturing sector has followed the consumer and also has been expanding at a strong pace. Production has increased at an annual rate of about 8 percent since hitting bottom last summer. In turn, business spending on equipment and software appears to be picking up. These are encouraging signs that the forces necessary for a sustained recovery seem to be moving into place and that this is not just a temporary boost from the fiscal stimulus package and sharp slowing in the pace of inventory liquidation. Residential and non-residential construction continues to struggle, although to varying degrees. Residential construction spending has fallen sharply in the last few months after a strong uptick in the second half of last year, thanks in large part to the homebuyer tax credit. Looking ahead, spending should pick up considerably in response to the extended tax credit and then rise at a more moderate pace after the credit expires. The picture is considerably bleaker for the non-residential sector. Private spending fell at an annualized rate of more than 25 percent in the last three months and is likely to fall further for most or all of this year. There has been an increase in vacancy rates for office, retail, and industrial space. Meanwhile, non-residential property values are
down. The soft market is due in part to problems with financing. With many banks facing the prospect of considerable losses in commercial real estate, lending remains weak. Looking at the economy more broadly, inflation has drifted lower in recent months and is following the pattern common during and after a recession. While energy prices have kept consumer price inflation at around 2 percent, inflation in non-food and non-energy price core inflation stands at about 1 percent. In the absence of any current cost pressures from tight labor markets or other input prices, inflation will likely remain low for the next year or two. Risks of a Commitment to Near-Zero Rates With the economy gradually recovering from a severe recession, monetary policy is by any measure highly accommodative. The key challenge for the Federal Reserves Federal Open Market Committee, is the question, For how much longer should it remain so? The FOMC statement, issued after several meetings including the most recent, has said that conditions will likely warrant keeping the fed funds rate, which is our key monetary policy tool, at exceptionally low levels for an extended period. The statement elaborates that this view is based on economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations. By itself, the current state of the economy warrants an accommodative monetary policy. However, as the economy continues to improve, risks emerge around the act of holding rates low for an extended period. I have dissented at the last two FOMC meetings specifically because I believe the extended period language is no longer warranted and I am concerned about the buildup of financial imbalances creating long-run risks. There is no question that low interest rates stimulate the interest-sensitive sectors of the economy and can, if held there too long, distort the allocation of resources in the economy. Artificially low interest rates tend to promote consumer spending over saving and, over time, systematically affect investment decisions and the relative cost and allocation of capital within the economy. Today, as we look back over the past decade, there is a case to be made that too many resources were channeled into financial market activities and into real estate construction, both residential and nonresidential. Some researchers have argued that keeping interest rates very low in 2002-2004 contributed to the housing boom and bust.
Exceptionally low rates, while perhaps not the single cause, played an important role in creating the conditions leading to our recent crisis. We now find ourselves with a Federal Reserve System balance sheet that is more than twice its size of two years ago. The federal funds rate is near zero and the expectation, as signaled by the FOMC, is that rates will remain so for an extended period. And the market appears to interpret the extended period as at least six months. Such actions, moreover, have the effect of encouraging investors to place bets that rely on the continuance of exceptionally easy monetary policy. I have no doubt that many on Wall Street are looking at this as a rare opportunity. These actions are not taken to enrich one group over another. They are taken with the well intended purpose of assuring a strong economic recovery and to create an environment of sustained job growth and strong business investment. I take no exception to this goal. However, the unintended negative consequences of such actions are real and severe if the monetary authority goes too long in creating such conditions. Low rates, over time, systematically contribute to the buildup of financial imbalances by leading banks and investors to search for yield. The Wall Street Journal article tells a story about the market coming back that also makes my point. The search for yield involves investing in less-liquid assets and using short-term sources of funds to invest in long-term assets, which are necessarily riskier. Together, these forces lead banks and investors to take on additional risk, increase leverage, and in time bring in growing imbalances, perhaps a bubble and a financial collapse. I make no pretense that I, or anyone, can reliably identify and prick an economic bubble in a timely fashion. However, I am confident that holding rates down at artificially low levels over extended periods encourages bubbles, because it encourages debt over equity and consumption over savings. While we may not know where the bubble will emerge, these conditions left unchanged will invite a credit boom and, inevitably, a bust. What Next? So, what options are available to policymakers? I appreciate the inclination for staying the course that financial markets have come to expect: keeping the federal funds rate target near zero and maintaining a commitment to very low rates for an extended period of time. That view is motivated by concerns over an unemployment rate of nearly 10 percent and persuaded by the fact
that core inflation remains below 2 percent. Continuing with current policy may also reflect confidence that the longer-term risks of financial imbalances are quite small and could be mitigated as they emerge. The Federal Reserve could correct imbalances through interest rate action or regulatory changes as the imbalances become apparent later. However, in times of uncertainty policymakers tend to reassure themselves that an accommodative course of action can be reversed always in a timely fashion. Inevitably, though, the policy bias is to delay, to let accommodative conditions stand, and to reverse only when the economy is beyond recovery and into an expansion. The outcome too often is greater inflation, significant credit and market imbalances, and an eventual financial crisis. An alternative policy option is to be more proactive, but cautious. This would require initiating a reversal of policy earlier in the recovery while the data are still mixed but generally positive. Small reversals in rates would leave policy highly accommodative and supportive of our economys recovery but would put more weight on mitigating the risk of longer-run financial imbalances. It would end the borrowing subsidy more quickly and would moderate credit conditions in a more timely fashion. It would reduce the likelihood that inflationary pressures might build, or that financial imbalances might emerge. And over time it would contribute to greater macroeconomic stability. Under this policy course, the FOMC would initiate sometime soon the process of raising the federal funds rate target toward 1 percent. I would view a move to 1 percent as simply a continuation of our strategy to remove measures that were originally implemented in response to the intensification of the financial crisis that erupted in the fall of 2008. In addition, a federal funds rate of 1 percent would still represent highly accommodative policy. From this point, further adjustments of the federal funds rate would depend on how economic and financial conditions develop. Conclusion As we look forward from here, I expect that all options will be considered and discussed fully as we navigate the course of monetary policy. As we consider our choices, I want to end my remarks by emphasizing that I am confident all of us want the best outcomes for the U.S. economy. The Federal Reserve understands its mission of stable prices and long-term, stable growth. Perhaps because I have been part of the history of the central bank for these past three
decades, I am as concerned about the introduction of instability into the economy as I am about managing it when it occurs. I am convinced that the time is right to put the market on notice that it must again manage its risk, be accountable for its actions, and cease its reliance on assurances that the Federal Reserve, not they, will manage the risks they must deal with in a market economy.
EARING X.
FEDERAL RESERVE LENDING DISCLOSURE: FOIA, DODD-FRANK, AND THE DATA DUMP
WEDNESDAY, JUNE 1, 2011

WITNESSES Alvarez, Scott G., General Counsel, Board of Governors of the Federal Reserve System Baxter, Thomas C. Jr., General Counsel, Federal Reserve Bank of New York
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing entitled Federal Reserve Lending Disclosure: FOIA, Dodd-Frank, and the Data Dump at 2:00 p.m. on Wednesday, June 1, 2011 in Room 2128 of the Rayburn House Office Building. The hearing examined information disclosed by the Federal Reserve in compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) and the Freedom of Information Act (FOIA). Witnesses discussed information released by the Federal Reserve in December 2010 regarding emergency lending facilities and open market operations; documents released in March 2011 on discount window lending during the financial crisis; and the Federal Reserves compliance going forward with provisions of the DoddFrank Act requiring the Federal Reserve to disclose additional information. This was a one-panel hearing. The witnesses were: Scott Alvarez, General Counsel, Board of Governors of the Federal Reserve System Thomas C. Baxter, Jr., General Counsel, Federal Reserve Bank of New York.
Fed Operations The Federal Reserve System was established in 1913 as the central banking system of the United States. The Federal Reserve Board (the Board) formulates the monetary policy of the nation, supervises and regulates banks, and provides financial services to depository financial institutions and the federal government. In addition, the Federal Reserve serves as a lender of last resort through the operation of the discount window.
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The discount window provides financial institutions with an outlet to exchange illiquid assets for liquid assets on a short-term basis to meet immediate obligations. Loans are secured by collateral, and the rate available through the discount window is typically higher than the federal funds rate (the overnight rate at which banks normally loan to each other), which discourages banks from relying on the discount window under normal circumstances. The Federal Reserve Board also has emergency lending authorities, set forth in Section 13(3) of the Federal Reserve Act. To invoke these emergency powers, the Board must make a finding of unusual and exigent circumstances, such as an institutions inability to obtain credit from other banking institutions, and the Board must support the step through a vote. The Dodd-Frank Act added restrictions to the use of the 13(3) authorities, so that they can no longer be used for the benefit of individual business entities. Emergency Lending Facilities The Federal Reserve Board used its emergency lending authority extensively and creatively during the financial crisis, creating a number of temporary lending programs to address perceived financial market liquidity shortages. As market conditions deteriorated and numerous companies experienced funding problems, the Board created lending facilities on an ad hoc basis, initially creating facilities to support individual entities and gradually creating larger facilities to provide market-wide assistance. Facilities were created by the Board and operated by the regional banks to provide liquidity to institutions and to stimulate the market for assets which had become illiquid. By the beginning of 2010, the Federal Reserve Board had injected large amounts of liquidity into the marketplace, expanding its balance sheet from roughly $870 billion in August of 2007 to over $2.2 trillion by the beginning of 2010. The Board also created several emergency facilities to address disruptions in financial markets, including the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), the TermAsset Backed Loan Facility (TALF), the Primary Dealer Credit Facility (PDCF), the Commercial Paper Funding Facility (CPFF), the Term Securities Lending Facility (TSLF), the TSLF Options Program (TOP), and the Term Auction Facility (TAF). The Board created dollar liquidity swaps with foreign central banks, assisted JP Morgan Chase in acquiring Bear Stearns by creating the Maiden Lane facility, and provided assistance to the American International Group (AIG) through the creation of Maiden Lane II and III.
FED DATA DUMP TRANSCRIPT 1149
The TAF and the CPFF were the most heavily used facilities. The TAF was the largest single temporary credit facility. The Board was concerned that firms appeared to be avoiding the discount window, perhaps fearing borrowing from the discount window would stigmatize them as weak institutions. To counteract widespread liquidity shortages, the Board created a facility that offered liquidity in the form of short-term (28-day maturity), fully collateralized loans. The CPFF was created by the Board to provide a liquidity backstop to U.S. issuers of commercial paper. Many large firms issue commercial paper, which is short-term debt purchased by investors. Money market mutual funds (MMMFs) invest heavily in commercial paper. In September 2008, as market fears spread and a major MMMF (the Reserve Primary Fund) announced it had broken the buck, investors fled MMMFs, choking off a key source of short-term funding for the corporate sector. The Board created the CPFF in response. As part of this program, the Federal Reserve Bank of New York financed the purchase of highly rated unsecured and assetbacked commercial paper from eligible issuers. The CPFF closed in February 2010. During the crisis, the Board provided only limited information about its lending decisions undertaken under these various emergency facilities. Information about lending facilities was limited to what could be discerned from statements on the Boards weekly H.4.1 (Factors Affecting Reserve Balances) data release. Congressional interest in conducting thorough oversight of the Boards intervention into the economy clashed with the Boards desire to maintain its independence from political control and to protect borrowers expectations of confidentiality. The media also sought information about the Boards lending facilities, arguing that the public had a right to know who had borrowed from these lending facilities because taxpayers were the ultimate backstop if the borrowers defaulted or if collateral proved insufficient. Freedom of Information Requests In 2008, Bloomberg News and the Fox News Network each sought information from the Federal Reserve under FOIA about the users of the Boards temporary and emergency lending programs. Bloomberg requested information about users of three emergency lending facilities the Primary Dealer Credit Facility, the Term Securities Lending Facility and the Term Auction Facility and information about users of the discount window during the crisis. Bloombergs FOIA request sought information on each loan, including the name of
the borrower, the amount borrowed, the origination and maturity dates and the collateral pledged. Bloomberg also requested details on loans made by the Federal Reserve Bank of New York to J.P. Morgan Chase to facilitate the acquisition of Bear Stearns. Fox News FOIA request sought information on the borrowers, loan amounts, and collateral pledged for all of the Boards temporary and emergency lending programs. The Board refused to provide the information, arguing that the information was exempt from disclosure under exceptions contained within FOIA. Bloomberg and Fox sued to obtain the information, and in March 2010, the United States Court of Appeals for the Second Circuit held that the information was subject to FOIA and directed the Board to search the Federal Reserve Systems records for responsive information to the FOIA requests and to disclose it. In response to the Second Circuits order, the Board released internal documents to the news organizations on March 11, 2011, covering all the lending facilities, including the discount window, from August 2007 to March 2010. The Fed delivered an estimated 29,000 documents with redactions. The documents were not organized or delivered in any particular order.315 Statutorily Required Disclosures By statute, Congress also directed the Board to release additional information on the emergency lending facilities. Section 1109(c) of the Dodd-Frank Act required the Board to disclose detailed information about entities that borrowed from credit facilities established under Section 13(3) and about entities that participated in the agency mortgage-backed securities purchase program, used foreign currency liquidity swap lines, or borrowed through the TAF. The Dodd-Frank Act required the Board to disclose the type of assistance, the value or amount of the assistance, the date on which it was provided, the specific terms of expected repayment, including repayment time, interest charges, collateral, limitations on executive compensation or dividends and other terms, and the rationale for each such facility or program. As required by Section 1109(c), the Board released information on December 1, 2010, regarding transactions made through emergency
The Board delivered 894 PDF files on CD-ROM to Bloomberg headquarters. Bloomberg uploaded the files onto the Internet in the same format that the Board delivered them to Bloomberg, available at: http://cdn.gotraffic.net/downloads/30110331_fed_release_documents.zip. Last accessed on December 11, 2012.
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lending facilities from December 1, 2007, until March 2010. The documents were made available on the Boards website by means of a spreadsheet that listed each transaction, the name of the borrower, the date, the lending bank, the loan amount, the interest rate, the amount and type of collateral.316 Additional Federal Reserve Board Disclosures Section 1109(a) of the Dodd-Frank Act required the Government Accountability Office (GAO) to review all loans and other Federal Reserve transactions between December 1, 2007, and July 21, 2010, that were effected under lending facilities and programs developed by the Federal Reserve during the financial crisis. The GAOs review focused on operational integrity, internal controls, collateral policy, favoritism and other factors. Section 1102(a) gave the GAO the authority to audit any special credit facility created pursuant to Section 13(3) of the Federal Reserve Act. Activities related to the Federal Reserves conduct of monetary policy remain beyond the GAOs audit authority. Section 1103(b) requires disclosure of information about entities that use the discount window or section 13(3) lending facilities. The Board will be required to disclose information about borrowers from the discount window two years after the loan is made. The Board will be required to disclose information about borrowers from other lending facilities one year after authorization for the facility is terminated. These sections are a modified and significantly more limited version of language originally introduced by Subcommittee Chairman Ron Paul in H.R. 1207 during the 111th Congress, which influenced discussions on increasing transparency of the Federal Reserve during the crisis.
The Board published the data required by Dodd-Frank on its website at http://federalreserve.gov/newsevents/reform_transaction.htm. Last accessed on December 11, 2012. The credit facilities are listed as separate hyperlinks under the heading Facilities and Programs, with each facility webpage containing an Excel data file link.
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RANSCRIPT
The subcommittee met, pursuant to notice, at 3:40 p.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, Jones, Luetkemeyer, Schweikert; Clay, Maloney, and Green. Ex officio present: Representative Bachus. Chairman PAUL. This hearing will come to order. I would like to advise the members that the microphones we have improvised will be live all the time. So be careful what you say; the microphone is on. I imagine that is true down there, as well. First, I want to welcome our two witnesses, and I will introduce them a little bit later. But, once again, I apologize to everybody for the inconvenience. I apologize to myself, because nobody likes to be inconvenienced. But it looks like we have a system set up here so that we can pursue our hearing. And, without objection, all members opening statements will be made a part of the record. I will go ahead with an opening statement, and I will have time for anybody else who wants to have an opening statement. I want to emphasize that I consider these hearings to be very, very important. They have come about because of many things that have happened over the last few years, and a lot of movement in the country for more transparency, in general, as well as with the Federal Reserve System. And I think my position on this is fairly well-known. But, also, there has been legislation passed. The Dodd-Frank bill has stipulations about more information coming to us. That legislation passed last year. There have also been the court cases that are under the Freedom of Information Act. We will be dealing with a lot of that today. And, also, the provisions in the law that was language that was put in by, basically, Senator Sanders, that has required some additional information.
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But, what is referred to today so often in hearings on the materials that came out of the Freedom of Information Act, it is called the dump. And I find that rather interesting, to call it that, because it sounds like a lot of material was dumped. And when you think of 29,000 pages of technical information, it is very large, and a lot of people have been studying it. Our staffs have been working very hard, and, quite frankly, it isnt all that easy to figure out. It reminds me of a story that was told, supposedly a true story, that an individual was being audited by the Federal Reserve. And they came to him, and they said, We want 5 years of everything that you have ever done, every receipt you have ever had. And, of course, that made him very unhappy, so he put them all together in a bushel basket and he dumped them. And I will tell you what, it didnt go over very well, and he got into a lot of trouble. I am not suggesting this is similar, but it is a story that reminds me, when I look and try to figure out really what we have, it is a lot of material, and to sort this out is not easy. One argument, and I understand the argument very clearly, on the hesitancy of the Federal Reserve not to give out too much information too early, with the idea that it might be proprietary and it might set the stage for concerns in the market. But, I think it is in contrast to the purpose of the SEC. The SEC has a purpose to investigate, demand reports, and get the information out immediately, and that is their responsibility. And if a company doesnt let us know exactly what they are doing and what their accounting procedures are, they get into a lot of difficulty. But the argument seems to be different for the Federal Reserve, that, oh, if we have information about a bank that might be in difficulty, in a market situation, that information should be available to us. So I take the position that information shouldnt be that detrimental to us and the more we can get, the better. I am hopeful that today we will be able to ask some pertinent questions to get more information and that members can follow up with more questions later on, and that there will be more transparency without ever injuring anybody. That certainly would be my goal. I would now like to yield 5 minutes to Mr. Clay. Mr. CLAY. Thank you, Mr. Chairman. And thank you so much for holding this hearing to examine information disclosed by the Federal Reserve in compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Freedom of Information Act. Also, I want to thank the witnesses for appearing today.
Due to the U.S. financial crisis, the Congress passed the DoddFrank Wall Street Reform and Consumer Protection Act of 2010. This legislation was crafted as a response to the financial crisis, which has cost nearly 10 million American jobs and over $10 trillion in household wealth. Nearly 4 million families have lost their homes to foreclosure and an additional 4.5 million have slipped into the foreclosure process or are seriously behind on their mortgage payment. According to the Financial Crisis Inquiry Report, a combination of excessive borrowing, risky investments, and a lack of transparency put the financial system on a collision course of self-destruction. In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed too much, leaving them vulnerable to financial distress if the value of their investments declined even modestly. For example, as of 2007, the 5 major investment banks were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40:1, meaning for every $40 in assets, there was only $1 in capital to cover losses. Less than a 3 percent drop in asset value could wipe out a company. Leverage was often hidden in off-balance-sheet entities, in derivatives positions, and through window dressing of financial reports available to the investing public. Within the financial system, the danger of this debt was increased because transparency was not required or desired. Undercover corporate dealings assisted in the financial meltdown which still plagues us today. In order for democracy and capitalism to exist correctly, transparency must be at the core. Trust and transparency and the rule of law are fundamental to this Nations success. And business depends in some way on trusta trust that business produces good products and a trust that business will deliver good services. Democracy depends in some way on trust. Transparency promotes government accountability, free and fair elections, competition and free markets; and the rules of law are critical to it. The Dodd-Frank Wall Street Reform and Consumer Protection Act addresses these issues by reforming the Federal Reserve in two ways: One, it limits the Federal Reserves 13(3) emergency lending authority by prohibiting emergency lending to an individual entity. The Secretary of the Treasury must approve any lending program, and the program must be broad-based and loans cannot be made to
insolvent firms. Collateral must be sufficient to protect taxpayers from losses. And two, it requires the Federal Reserve to disclose counterparties and information about amounts, terms, and conditions of 13(3) and discount window lending, and open-market transactions on an ongoing basis, with specified time delays. These are just a few examples of the importance of the DoddFrank Wall Street Reform and Consumer Protection Act. Thank you, Mr. Chairman. I look forward to the witnesses comments. Chairman PAUL. I thank the gentleman. Mr. Luetkemeyer, you are recognized for an opening statement. Okay. There are no more opening statements, so I will go ahead and introduce our witnesses. First, we have Mr. Scott Alvarez, who is General Counsel at the Board of Governors, a post he has held since 2004. He has been with the Board for 30 years. And, also, Mr. Thomas Baxter, Jr., has been General Counsel and Executive Vice President of the legal group at the Federal Reserve Bank of New York since 1995. He also serves as Deputy General Counsel of the FOMC. Mr. Baxter has been with the New York Fed for more than 30 years. It has been agreed upon by the witnesses, Ranking Member Clay, and myself that Mr. Alvarez will deliver the oral remarks for the joint written testimony of Mr. Alvarez and Mr. Baxter. This testimony may run longer than the customary 5 minutes. And without objection, your joint written statement will be made a part of the record. I now yield to Mr. Alvarez.
JOINT STATEMENT OF317 SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM AND THOMAS C. BAXTER, JR., GENERAL COUNSEL FEDERAL RESERVE BANK OF NEW YORK
Mr. ALVAREZ. Chairman Paul, Ranking Member Clay, members of the subcommittee, Thomas Baxter, the General Counsel of the Federal Reserve Bank of New York, and I appreciate the opportunity to discuss the ways the Federal Reserve informs the Congress and the American people about its policies and actions. Central bank lending facilitates the implementation of monetary policy and allows the central bank to address short-term liquidity pressures in the banking system. This role of lender of last resort is a
[The joint prepared statement of Mr. Alvarez and Mr. Baxter can be found on page 1194.]
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critical one, long filled by central banks around the world, especially during times of economic crisis, when discount window lending can mitigate strains in financial markets that could otherwise escalate and lead to sharp declines in output and employment. In the United States, all discount window loans are fully secured, and the Federal Reserve has not suffered a loss to date on its discount window lending. The Federal Reserve regularly releases significant detailed information about its operations in order to promote the understanding of how the Federal Reserve fosters financial stability and economic stability and to facilitate an evaluation of our actions while preserving the ability to effectively fulfill the responsibilities that Congress has given the Federal Reserve. Since 1914, the Federal Reserve has published its balance sheet every week. We also publish full financial statements annually that are audited by an independent public accounting firm, which for the last 4 years has been Deloitte & Touche. These audits cover Maiden Lane, Maiden Lane II, and Maiden Lane III, as well as the transactions conducted through the discount window and with foreign central banks. The Federal Reserve also publishes a special monthly report to Congress, posted on our Web site, that details the Federal Reserves emergency lending programs, including providing information on the amount of lending under each program, the type and level of collateral associated with those loans, and information about the borrowers under those facilities. In addition, the Federal Reserve Bank of New York maintains a Web site that includes schedules of purchases and sales of securities as part of open-market operations, with CUSIP information describing the securities involved. The Federal Reserve is fully cooperating with the GAO in an extensive review of each of the special lending facilities developed during the crisis. This review will assess operational integrity, internal controls, security and collateral policies, policies governing third-party contractors, and the existence of any conflicts of interest or inappropriate favoritism in the establishment or operation of the facilities. As provided by the Dodd-Frank Act, on December 1, 2010, the Board published detailed information on its Web site about the Federal Reserves actions during the financial crisis. This release includes the names of borrowers, the amount borrowed, the date
credit was extended, the interest rate charged, information about collateral, and the description of the credit terms under each facility. Similar information was provided for the draws of foreign central banks on their dollar liquidity swap lines with the Federal Reserve. For agency MBS transactions, details included the name of the counterparty, the security purchased or sold, and the date, amount, and price of the transaction. On March 31, 2011, the Federal Reserve released documents related to the discount window in response to requests filed under the Freedom of Information Act. The March 31st release included documents containing information related to borrowers at the discount window between August 8, 2007, and March 1, 2010, that was not required to be disclosed under the Dodd-Frank Act. Going forward, the Dodd-Frank Act provides for the release of information on any broad-based emergency lending facility 1 year after the termination of the facility, as well as a GAO audit of the facility. The Act also provides for the release of information regarding discount window lending and open-market operations conducted after July 21, 2010, with a 2-year lag. For lending facilities, including both emergency lending facilities and the discount window, and for open-market operations, the Federal Reserve will publish information disclosing the identity of the borrower or counterparty, transaction amount, interest rate or discount paid, and the collateral pledged. The Federal Reserve believes the lags provided by the DoddFrank Act for the release of transaction-level information establish an important balance between the publics interest in information about participants in transactions with the Federal Reserve and the need to ensure that the system can effectively use its congressionally authorized power to maintain the stability of the financial system and implement monetary policy. We will carefully monitor developments in the use of the discount window and other Federal Reserve facilities and keep the Congress informed about their effectiveness. The Federal Reserve has worked and will continue to work with the Congress to ensure that our operations promote the highest standards of accountability, stewardship, and policy effectiveness, consistent with meeting our statutory responsibilities. We appreciate the opportunity to describe the Federal Reserves efforts on this important subject and are happy to answer any questions you may have. And we will be responsive to any written questions you may submit, as well.
Thank you very much, Mr. Chairman. Chairman PAUL. I thank the gentleman.
I will yield myself 5 minutes, but announce that we will likely be able to have repeat questioning. I think the time will permit that. But I will start off with 5 minutes. I first want to ask unanimous consent to submit an article for the record from Bloomberg called, Fed Gave Banks Crisis Gains on $80 Billion Secretive Loans as Low as 0.01%. Without objection, it is so ordered.318 I want to refer to one document. And this little document from the material that we got from the Federal Reserve is called a Chart Pack of Market Monitoring Metrics for Fed Facilities. I am sure you know all 29,000 pages, and you probably know exactly what I am talking about, but it tells you about the problem that we have in trying to find out information. And this particular document has 327 pages to it, but, in this particular document, it has some interesting material that I did not know about, and I want to ask about it. It reveals that there was a previously undisclosed Fed lending program known as the singletranche open-market operations, and it is referred to as ST OMO. This is something new, and it allows the Fed to give .01 percent that is, free moneyto companies like Goldman Sachs and was essentially a free loan to these well-connected businesses. But, also, the problem that we had in analyzing this to find out information that we are looking for is, it turns out that, just in this particular area, 81 percent of the contents has been redacted. So, we end up with a lot of pages, and then we end up with 19 percent that actually has information that we have to sort out. The question is, why were these details not mentioned? Is it that everything has to be done in secret? We would like to know, the people would like to know, but we didnt see any evidence until this was dug out of here. And maybe it was mistakenly not redacted or something like that. It makes us wonder why we dont know about this. That, of course, is one of my big beefs with the Federal Reserve, that the central bank wields so much power, so much financial power, you literally can have transactions greater than what we can do with
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[The article Rep. Paul placed in the hearing record can be found in Appendix D.]
our own budget. And that is why it is a deep concern to me, but to many other people as well. But why was this not published? And are these and other programs that have yet to be disclosedare there others? Why were so many pages redacted? Can you really claim this to be in compliance with FOIA, the Freedom of Information Act, when we dont know what has been excluded? I would like to get your reaction to this and for you to talk specifically about this one program and what has been going on with it. Mr. ALVAREZ. Mr. Chairman, the program you refer to, the singletranche OMO program, was not a secret program. It was actually publicly announced by the Federal Reserve on March 7, 2008, when the program began. It was a short-term program that ended in January of 2009. And transactions that were conducted under that program as part of our open-market operations were reported, along with other open-market operations, on the New York Federal Reserve Bank Web site very quickly after the transactions occurred. The documents you have before you are from the response for the Freedom of Information Act request. And so that, itself, should explain why there are redactions. The way the Freedom of Information Act works, it is a request for certain types of information in documents. First, the agency collects all documents that may have any information that relates to the request. Then, information that is not requested is taken out of the documents, redacted from the documents, simply because it is not responsive to the request. So, it is not a desire to keep things secret. It is, instead, a desire to be responsive to the request. Often, when a requester asks for documents, there is information that is extraneous or not the kind of information that was requested, not relevant to the request, and that is taken out of the documentation. And that is why you see redaction in the documents before you. These documents were reviewed by the court and released by the court in accordance with the Freedom of Information Act. Chairman PAUL. Does that mean, if somebody were to follow up and broaden that request, all that material could become available? Would they have to just change the Freedom of Information Act request? Mr. ALVAREZ. If another request was made for a broader range of information, we would review that information, determine what is confidential and what could be released, and a decision then would be made on that request.
Chairman PAUL. Could it be made so broad that you just turn over everything? Mr. ALVAREZ. I am not sure there are enough people in the world to look at everything we have to turn over, but we would do the best we could. Chairman PAUL. Okay. My 5 minutes is up, and I now yield to Mr. Clay. Mr. CLAY. Thank you, Mr. Chairman. And thank you, Mr. Alvarez. Just one question. Has the dramatic and, I believe, welcome increase in transparency, including your own initiatives and those called for in the Wall Street Reform Act of 2010, had any adverse or troubling consequences either for policymaking at the Fed or for the financial institutions that you regulate and interact with? Mr. ALVAREZ. We think the increases in transparency, particularly around monetary policy, that we have taken in the last few years have been very helpful and responsive and have improved understanding of the Federal Reserve and the policy actions we are trying to take. We have provided a lot of detailed information about the credit transactions we engaged in during the crisis. Congress, we think, struck a very important balance between the need for access to that information and providing a delay so that participants in the transaction dont experience the stigma that often occurs when there is an immediate release of information, allowing, therefore, an explanation for why institutions have participated in the facilities. We are monitoring whether there will be any effect. We, of course, wont know until we see how these facilities operate in the future. We will keep the Congress informed on the effectiveness. If there is any bad effect, we will let you know. Mr. CLAY. So you will inform the Congress as to if there needs to be changes in the Mr. ALVAREZ. Absolutely. Mr. CLAY. Okay. Thank you for your response. And, at this time, Mr. Chairman, I would like to yield the balance of my time to the gentlewoman from New York. Mrs. MALONEY. I thank the gentleman for yielding, and I thank the chairman for holding this important hearing. And I welcome both of our witnesses. And I think we all have to remember that we were really on the verge of collapse, that this was awe had the great recession instead
of a great depression because of the monetary policy and many of the steps that we took. One of those steps that we have taken to stabilize our markets and move forward is the Dodd-Frank bill. And, in that, we required the GAO to conduct an audit of the Federal Reserve, and we also required the Fed to make information about the transactions through emergency lending facilities from December 2008 to March 2010 available to the public. In addition, Dodd-Frank required that the Fed disclose information about the entities that used the discount window or under I believe it was section 13(3) lending facilities. But in addition to what we required in Dodd-Frank, the Federal Reserve is also already subject to robust congressional oversight. And I would like to ask our two witnesses, can you give the committee some examples of the types of congressional oversight that you are already required to do, even before Dodd-Frank? Mr. ALVAREZ. Two of the most important types of oversight are: The Chairman of the Federal Reserve, who is also the Chairman of the FOMC, provides testimony on the economy twice each year, on the call of the House and the Senate. And that is an important check on monetary policy and the state of the economy. Another important method is this hearing and hearings like this that we are going through. The staff and the Governors and the Chairman of the Federal Reserve, and the Presidents of the Reserve Bank have often been called to Congress to report on every aspect of our duties and how we implement various policies. And you use those as oversight of us, and we explain positions that we have taken. So, I think it is the interaction between the Congress and the Federal Reserve in testimonies, in particular, that have been an effective form of oversight. Mrs. MALONEY. Okay. My time is about to expire, but, as you know, there is a GAO audit authority now. Was there anything that is excluded from the GAO audit authority? Mr. ALVAREZ. The GAO is authorized to audit a full range of the Federal Reserves responsibilities. That includes all of the emergency transactions, the discount window, our supervisory authority, our consumer authority, all the various aspects of authority. An area that Congress has reserved is the implementation of monetary policy, the actual policymaking decision process. The GAO does look at how we implement the policy, in the form of making sure that transactions actually occur as appropriate, that they are accounted for properly on the balance sheet, that they are fully
disclosed. But the decision-making process for monetary policy is the one thing outside the GAOs scope of authority. Mrs. MALONEY. Mr. Chairman, may I follow up with one brief question on what are the arguments for excluding it? Why was that excluded? What is the argument for it? Mr. Alvarez? Mr. ALVAREZ. The importance of allowing the Federal Reserve and the FOMC to conduct monetary policy independently has been demonstrated throughout the world in both actions by other central banks and in a variety of studies of monetary policy. The point, I think, is that the Congress wanted to reserve to the FOMC the ability to have discussions that are full and free and frank and to explore all the possible alternatives for monetary policy to reach the best monetary policy decision. Moreover, the GAO doesnt do audits in the sense of a technical audit like a financial auditor might do, but does performance reviews and policy reviews. So that would mean that the GAO would review the alternatives considered for monetary policy, how the decisions were made, whether the decisions were actually appropriate. That would cause second-guessing of the FOMC, cast into doubt whether the FOMC was actually making the policy decisions or whether the GAO was making policy decisions in monetary policy, and make it more difficult for the monetary policy to be done effectively by the Federal Reserve. Mrs. MALONEY. Thank you. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I now yield 5 minutes to the vice chairman, Mr. Jones from North Carolina. Mr. JONES. Mr. Chairman, thank you very much. And I appreciate you holding these hearings, as others have said. I am going to take a little different approach. I represent the Third District of eastern North Carolina. It is a great district to represent, the home to the Camp Lejeune Marine Base, Cherry Point Marine Air Station, and the Outer Banks. The frustration of the average businessperson down in my district is very deep and severe. And we have had numerous inquiries from the Third District, the citizens of the Third District, about the Federal Reserve and how decisions are made. I know you cannot go into some of the backroom negotiations at the Reserve; I am not even asking that. But how do you say to the small-business owner that, in this crisis situation, we seem to find
ways to help foreign banks, foreign entities? And I am looking here at the note that my staff prepared for meHarley-Davidson, McDonalds, GE, Verizon, Toyota. And yet, I have people in my district saying, I go to the local banks, and I cant get any loans, and my credit has always been good. Why and how does the Federal Reserve seem to be able to find the way to help these entities that are gigantic? And through greed and manipulation, they cheated, and, yet, they get bailed out. They get the help, when the average businessperson down in eastern North Carolina and probably across America, they cant even go to a bank that they have been banking with for 15 or 20 years and get a loan. And yet, here we are at the Federal Reserve, looking at those foreign banks who might need some help or these corporations that might need some help. It really isthat is why this hearing is very important. The transparency, the trustand that is a big word to me, trustis just not there with the average system, when it comes to the Federal Reserve. And yet, if it had not been for the push byI wont name all the entities that pushedto tell you to show the bottom line, to show what was in the closet of decisions, who was being helped, we never would have known it. And yet, I know you gentlemen are attorneys, and you are probably not at the position where the person ought to be here who ought to be putting a hand on the Bible to tell the truth to the American people. That is my concern, is, how do we build the confidence of the American people when we see what is happening at the Federal Reserve? Mr. ALVAREZ. Congressman, we understand that and feel that same frustration. The programs that were designed and implemented by the Federal Reserve during the financial crisis were not designed to aid big companies for the sake of aiding big companies. The programs that we designedfor example, the TALF programwere designed to pass money and credit and liquidity on to the American people. So, for example, the TALF resulted in 3 million more auto loans during the crisis than would have occurred, a million more student loans, and almost a million small-business loans. The programs you are talking about that aided Harley-Davidson and Toyota and other companies were the commercial paper facility, which provided short-term funding to those companies so they could continue to keep employment up and manufacturing up in the United
States, so that they could continue to provide jobs and provide opportunities in the United States. Our efforts were all designed to try to keep the economy moving in order to help individuals and small businesses, not for the sake of helping the larger institutions. And I understand that there is a different perception. Part of that perception, I think, comes from the fact that most of the financial tools that we were given are designed to work through banks or work through large markets. So we use the tools the best we can in order to have the funding aid the broadest range of people possible. Mr. JONES. Mr. Chairman, I know my time is about up. But I guess, in a way, that if it had not been for Bloomberg and the Wall Street Journal and all of these raising the questions, doing investigation, I dont know if we would be having this hearing today. I dont know. Chairman PAUL. I thank the gentleman. I yield 5 minutes to Mrs. Maloney from New York. Mrs. MALONEY. I thank the chairman for yielding. And, as he is well aware, on Friday the jobs numbers come out. And the economy has been improving, not as fast as we would all like, but we are digging our way out of that hole. And now that we have the benefit of hindsight and we are slowly recovering from the financial crisis of 2008, I know that some have taken the positiona position that I do not agree withthat the Feds lending during this time actually helped contribute to the crisis. And some have argued that the Fed didnt need to take the actions that it took because the situation would have stabilized on its own. But I would like to ask our panelists today, isnt it true that, without the actions that the Fed took, that by not setting up the facilities it did, by not giving institutions access to the discount window to provide additional liquidity to our economy, that the crisis would have been far worse? So your comments, please, Mr. Alvarez and Mr. Baxter? Mr. ALVAREZ. Thank you, Congresswoman. We believe that the facilities that the Federal Reserve established did ease the crisis, and they certainly were designed to do that. The studies that are beginning to come forward now show that they actually were successful in unfreezing various markets the commercial paper market, the asset-backed securities market and providing liquidity to the financial system that was important for the financial system to continue to operate.
The funding that we provided was without any losses to the taxpayer. Indeed, the emergency lending facilities resulted in $9 billion worth of interest and fees that were passed on to the Treasury. As I was explaining to Congressman Jones, the facilities were designed to provide real relief to American consumers and small businesses in the form of student loans, auto loans, small-business loans, credit card loans, as well as allowing the operation of companies that relied on the commercial paper market, which had frozen up, to continue to find a source of funding to keep their operations going. So, we think that the facilities were successful and were a good use of taxpayer funds. Mrs. MALONEY. I would say that there is an impressionI hear it, and I think other Members of Congress hear itthat is out there, that all of the actions the Fed took during the crisis served only to help financial institutions. But I want to make clear the point that, and I want to make sure that people understand, that all of these actions were in the form of loans, and, in fact, over $125 billion has been returned to the Treasury over and above what was loaned out. That is what I read. I want to know if that is true. Is that true? Mr. ALVAREZ. We have, in the last 2 years, provided about $127 billion in earnings to the Treasury. Yes, that is correct. Mrs. MALONEY. But can you bring this down to Main Street? Can you give the committee members and the general public some examples of how that lending helped not only stabilize the economy and keep our financial institutions in place, but literally helped Main Street and working men and women? Mr. ALVAREZ. I would like to return to the TALF program, which was one specifically designed to make sure that loans were made in the United States to help students obtain education loans for college, to help small businesses have SBA loans, credit card loans, to provide auto lending, to provide equipment leasing, and a variety of other kinds of loans that were not being made during the financial crisis because of liquidity shortages. That program was extraordinarily successful Mrs. MALONEY. Is it still operating? Mr. ALVAREZ. It is. It has closed, but there are still about $14 billion in loans outstanding. There were $70 billion of credits extended through the program through its life. Much of it has been repaid. Mrs. MALONEY. I would like to ask about a number of programs that the Fed engages in, including holding gold for foreign countries,
account services, and liquidity programs. In your experience, are these common activities for central banks? Mr. BAXTER. Yes, Congresswoman, they are common for central banks. It is common for central banks around the world to hold reserves, and, as you know, the dollar is the principal reserve currency. At the Federal Reserve in New York, we hold over $3 trillion on behalf of foreign central banks and countries. It is very important to hold those sizable reserves because those sizable reserves are principally invested in Treasury securities, which helps to finance the debt of the United States. So, holding dollar reserves is a very important function of the Federal Reserve, and we do that at the New York Fed. And it is similar to functions that other foreign central banks perform around the world. Mrs. MALONEY. My time has expired. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I yield 5 minutes to Mr. Green from Texas. Mr. GREEN. Thank you, Mr. Chairman. I thank the witnesses for appearing, as well. I am interested in the central banks of other countries as compared to our country and this disclosure that they engage in compared to our country. I know that the systems are not going to be the same, but with reference to disclosure, can you give us some indication so that we can have some sort of comparison? Mr. ALVAREZ. The practices of disclosure vary quite a bit across the world, but I believe the Federal Reserve is one of the, if not the, most transparent central banks. Many central banks in developed countries do not, for example, announce their policy decision or the votes that are taken. The Federal Reserve does both of those. Many central banks do not provide minutes for their meetings. The Federal Reserve provides minutes 3 weeks after each meeting. Many foreign central banks do not publish at all the transcripts of their meetings, and the Federal Reserve publishes the transcript 5 years after each meeting. On the discount window lending, that is a common power that foreign central banks have, but they are much less transparent in that area, as well. Indeed, you may recall that, at the start of the crisis, it was a leak about a discount window loan made by the Bank of England to Northern Rock that resulted in a run on Northern Rock there. So, the foreign countries tend to be more circumspect about the information they disclose about their discount window lending operation. Mr. GREEN. Yes, sir?
Mr. BAXTER. With respect to the incident that Mr. Alvarez described, the British Parliament has written a report, which is entitled, The Run on the Rock, and it has a section that describes how that run began. And that was triggered by public reports about a borrowing by Northern Rock at the Bank of England. With the permission of the Chair, we could submit that report for the benefit of the subcommittee. Mr. GREEN. Thank you. One other quick question, Mr. Chairman, if I may. I know that you probably have gone through this, but explain to those who are viewing why it is important to have disclosure and why you try to achieve this balance that you have with reference to disclosure. For example, why not just have a CPA come in or someone come in and just audit everything all the time every day? What is the downside? Mr. ALVAREZ. We do have a CPA come inDeloitte & Touche, currentlyto do an audit of our financial statements, including all of our transactions, our discount window lending and our open-market transactions. The thought on disclosure is that disclosing the names of borrowers and the amount they have borrowed provides the American people with more information to make sure that the Federal Reserve is acting in a responsible way in its lending facilities. The balance on the other side is that the discount window is a very important tool both in good times and in badin good times, for providing short-term liquidity to institutions when they need it and also as a monetary policy tool to help reduce the volatility of interest rates; and in emergency times, to provide liquidity to institutions that are generally healthy, but where panic has caused asset values to be out of whack, as it were, so that the institution cant fund itself in an appropriate way. So the discount window is a very important tool. The concern is that, because it is often used by both healthy and troubled institutions, the public will be confused if it sees the names of a borrower at the discount window and not be certain if that institution is healthy or not. And if a healthy institution is wrongly thought to be troubled because it has accessed the discount window, then that could cause problems for that institution. That causes institutions to back away from using the discount window, and that makes it a much less effective tool, both in good times and in bad times, for addressing liquidity crises.
So it is important to have a balance in the disclosure. That is why we think the lag time, the 2-year period between the actual loan and the announcement of the borrower, is important. That leaves the institution some period of time to explain itself, to demonstrate its health, and to not be tied to a troubled transaction at a difficult time. Mr. GREEN. I think my time is up. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I would like to direct this question to Mr. Baxter. And I want to follow up on Mr. Jones question about how some of these decisions are made and how sometimes the big guy seems to benefit and the little people lose their mortgages and lose their homes and they lose their jobs. And, quite frankly, it is very difficult at times in this country, because it seems like people are too-little-to-save there are people who are too-big-to-forget about them, too-big-to-let-them-fail. But I want to direct a question about the foreign loans. And it seems to me from the figures I look at, that nearly one-third of all the loans during this period of time went to foreign banks. And, at one time, at the peak of this, 88 percent of these overall discount window loans went to foreign banks. But at the New York Fed, I think practically, essentially 100 percent of the loans were going to foreign banks. And the answer I get is that, they are foreign banks but they have subsidiaries, and they qualify under the rulesI wouldnt say under the law, but under the rulesthat they can go to the discount window. But it just seems to be way out of proportion, when you think of that tremendous amount of loaning that went to these foreign banks. And this is not easy for the average American citizen to understand. Could you enlighten us on why it seems to be disproportionate? I am sure they dont represent that percentage of the financial problems that existed. A third of the problems didnt deal with foreign banks, surely. What is the explanation for that? Mr. BAXTER. Yes, Chairman Paul. Thank you for that question. First, the starting point is Federal statutory law. And section 13, paragraph 14, of the Federal Reserve Act says to the Federal Reserve that, with respect to discount window borrowing, we are to treat the branch or the agency of a foreign bank just like we treat our own U.S.-charterd depository institutions. So, there is this principle of national treatment that we start with, and it is a principle that is embedded in the Federal Reserve Act itself. And so, we must treat the branch and agency of a foreign bank in the same manner we treat our own. That is the starting point.
The second is, New York is the money center of the United States. And with respect to foreign banks that intend to come to our country and invest in our people and form branches and agencies in the United States, many of those foreign banking organizations look to form those organizations in the money center, which is in New York. The short answer to your question, Chairman Paul, is the law requires us to lend to branches and agencies. And with respect to New York in particular, that tends to be the place where foreign banking organizations enter our country. Chairman PAUL. Okay. Proportionately, it still seems to be out of whack. Wouldnt the system invite foreign banks? They are making most of their money overseas. Just open up a subsidiary in New York. And, therefore, they get the line of credit and the protection of the bank, and it is almost like free insurance for them. Do you think this is a good idea, that a foreign bank, all they have to do is open up and get these bailouts? It just doesnt seem fair at all. Mr. BAXTER. These were loans, Chairman Paul. They werent gifts in any way. And the foreign banks have to repay, just like everyone else, the principal and interest. Second, if a foreign bankand some dodecides that they would prefer not to form a branch or an agency but to start a subsidiary bank in the United States, that is their option. And some foreign banks do just that. And, of course, the subsidiary bank, which would have a U.S. charter, that has access to the discount window as well. Mr. ALVAREZ. I would add one more thing. There is a limit on the amount that they can borrow. They are limited by the amount of collateral that they have, that they can post at the discount window. So, that is dollar collateral in the United States. That doesnt allow the foreign bank to borrow to the full extent of its assets worldwide. It borrows in order to support its dollar activities. And those dollar activities are largely, though not exclusivelyyou have a point therebut largely in the United States. Chairman PAUL. Could the argument be made that maybe the banks in Greece should have had a lot more subsidiaries in New York, and maybe then Greece wouldnt be in so much trouble, the Fed would have bailed them out too? Mr. ALVAREZ. No, their assets are in Greece, so they are Greek assets. And they would go to the Greek central bank to borrow there, not to the United States. Chairman PAUL. Okay. Mr. Green, do you have any more questions?
No? Okay. Mr. Jones, for 5 minutes. Mr. JONES. Mr. Chairman, thank you again. Looking through a lot of these reportsand I want to go to Libya and see if you can help me understand the rationale by the Treasury and the Reserve. I will just read one paragraph: Arab Banking Corporation, the lender part-owned by the Central Bank of Libya, used a New York branch to get 73 loans from the U.S. Federal Reserve in the 18 months after Lehman Brothers Holdings collapsed. Help me understand, so that I can explain to people back in my district, that here we are, an undeclared war. Any timeand I thank God we havent lost any American military at this point, but we certainly have fired a bunch of missiles. And we are spending millions and millions of dollars, probably billions by now. And we are helping other countries. What is the protection if Libya is Gaddafi and Gaddafi is Libya or, at least, it has been for a period of timeand we have made these loans to their affiliate or to Libyan banks, their relationships, what happens in a wartime situation, where we are trying to drive Gaddafi out of business and we have made these loans to him or to Libya? How do you explain to that person that each and every one of us, on both sides of the political aisle, has talked about today that cant get the loans? How do you explain this to Walter Jones, who happens to be a Member of the Congress, so he can explain it to his people back home? Mr. ALVAREZ. The Arab Banking Corporation is a bank located in Bahrain. It is not located in Libya. The Libyans bought a substantial part of that bank after all the loans that were extended by the Federal Reserve were repaid. We work with the Treasury Department and the State Department, which have responsibility for identifying banks that the United States should not deal with for foreign policy reasons. The responsibility for designating those banks rests with them. We consult with them to make sure that we dont lend to institutions that they have determined we should not be lending to. At the time our credits were extended, Arab Banking Corporation was not identified by Treasury or State Department as a bank that was of concern. It was a foreign bank that had an operation in the United States that was well-rated in all other respects, like another foreign bank from a foreign country. Mr. JONES. Mr. Chairman, I tell you, knowing that you, for many years, have picked up more and more support for your legislation to
audit the Federal Reserve, I wish, truthfullyand it has nothing to do with you gentlemen here today, but I am telling you that the distrust out here by the American people is as deep and as severe as I have ever seen it. And not only Congress itself, not only the Administration, but the Federal Reserve is just, at this point, at a very low ebb as it relates to trust. And I am not talking about you personally. You are two men of high integrity, I know that. But, right now, the Federal Reserve is not held in high esteem by many people in this country. I will yield back. Chairman PAUL. I thank the gentleman. I have a few short questions, and then we will finish up. One thing is, on a follow-up on what Mr. Jones says, is, the confidence is very low. But when you speak of independenceand I understand your terms, and I disagree with the need for that, but I understand it. But what people hear, when you say independence, they hear secrecy. You are going to keep it from us. And like the point I made at the beginning, the SEC is to pressure companies to reveal information, where the Federal Reserve does the opposite. They wantno, we cant tell anything because it might disturb the markets. I have one question: During the crisis or at any time that you are aware of, has the Federal Reserve or Treasury participated in any gold swaps arrangements? Mr. ALVAREZ. The Federal Reserve does not own any gold at all. We have not owned gold since 1934. So we have not engaged in any gold swaps. Chairman PAUL. But it appears on your balance sheet that you hold gold. Mr. ALVAREZ. What appears on our balance sheet is gold certificates. Before 1934, the Federal Reserve did own gold. We turned that over, by law, to the Treasury and received, in return for that, gold certificates. Chairman PAUL. If the Treasury entered intobecause under the Exchange Stabilization Fund, I would assume they probably have the legal authority to do itthey wouldnt be able to do it, then, because you have the securities for essentially all the gold? Mr. ALVAREZ. No, we have no interest in the gold that is owned by the Treasury. We have simply an accounting document that is called gold certificates that represents the value at a statutory rate of the gold that we gave to the Treasury in 1934.
Chairman PAUL. It is still measured at $42 an ounce, which makes no sense whatsoever. But, the conventional wisdom today says that gold is really not money. We dont want it to be money. If you are for the gold standard, there is something wrong with you. And, yet, we hold the gold. And, there has been the suggestion made, and I have sort of encouraged the suggestion, if gold is not money and it is an asset and you dont even use it because it is on your balance sheets and you dont even use it at the real value, whywould you have a position on this? Why shouldnt the Treasury just sell the gold and give it back to the people? The people had it at one time. Let the people have it. Would you have any objection to that? Would you advise us and say, No, that is not good; we ought to hold the gold? Do you think holding the gold is a good idea or a bad idea? Mr. ALVAREZ. I have no position on that at all. That is clearly a matter for the Treasury. Chairman PAUL. No position? Mr. ALVAREZ. It is a matter for the Treasury. It is not within the purview of the Federal Reserve. Chairman PAUL. Mr. Baxter, would you have an opinion? Mr. BAXTER. My opinion is, I agree with Mr. Alvarez. Chairman PAUL. No position. It is amazing, because I have asked questions of the Federal Reserve, the Members of the Board, for years. And whether it has been Mr. GreenspanI cant recall exactly what I have asked Mr. Bernankebut it is always, Well, no, we have to hold on to these assets. But if it is not money and we dont need it and we are not going on a gold standard, I would think that they shouldnt be holding it. The reason I ask that is, the truth is, gold is money. And people dont throw it away, and people do cling to it. But I would be real-ly there are a lot of people who suspect, because of this lack of transparency, that there have been a tremendous amount of gold swaps and loans made and central banks sold a lot of gold off after the last 10 years. A lot of the gold has left the West and has gone to the East. And the central banks now have positive trade balances; they buy up the gold. There has to be a message in there and a significance, even for those who dont want the restraints of gold, there has to be a message out there that we should look at, because we are in a financial mess and it has to do with our monetary system, and it is being reflected
today in rising prices and a weak economy. And just printing all this money isnt doing any good. All this stuff that has been done for 30 yearswhen you look at the economic statistics now, they are horrible. And these people who lost their jobs, they are still unemployed. The people who bought stocks in the year 2000, if they held on, they probably havent even broken even. They probably lost purchasing power. So, eventually, I thinkI know this is off the subject a little bit. But it is reflected only in that we dont know exactly what goes on. And people, when they dont know, then they get suspicious, and they say, Well, it is kept secret from us. Why arent we allowed to know? And we just march on. And the type of dollars we are talking about, and when we hear about this money going to central banks and banks that Qadhafi was a part owner in, this really stirs up the emotions of a lot of people. I do appreciate you being here. And I know that there will be a lot of questions, there will be written questions submitted. And we would appreciate your cooperation in sending us your answers. The Chair notes that some members may have additional questions for this panel which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. Also, I would like to emphasize at this time that this hearing deals with a very complex matter and is a large amount of material. And, therefore, written questions, I am sure, will be followed up. So I ask for as much cooperation as you can give us, because there are times when questions are sent in and they sort of get lost. But because there is so much and it is complicated and now that our time looks like it is going to be shortened, we may have to depend a lot on our written questions. So we ask you for your cooperation there. And I thank you. Mr. ALVAREZ. Thank you very much. Mr. BAXTER. Thank you, Mr. Chairman. Chairman PAUL. This hearing is adjourned. [Whereupon, at 4:40 p.m., the hearing was adjourned.]
UESTIONS
FOR THE RECORD

FROM CHAIRMAN RON PAUL TO THE HONORABLE SCOTT ALVAREZ, GENERAL COUNSEL, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM AND THOMAS C. BAXTER, GENERAL COUNSEL, FEDERAL RESERVE BANK OF NEW YORK
Question 1: In testimony before the Subcommittee on June 1, 2011, Federal Reserve Bank of New York (FRBNY) General Counsel, Thomas Baxter, indicated that the FRBNY's lending during the financial crisis was more heavily weighted toward foreign institutions because New York, as a leading financial center, attracted more foreign institutions. However, this response did not explain the disproportionate use of Federal Reserve lending facilities by foreign institutions. Can the Federal Reserve provide statistics on the proportion of foreign institutions relative to U.S. institutions that are part of the Federal Reserve System? Can the Federal Reserve explain the factors that contributed to disproportionate borrowing by foreign institutions, especially in the following lending facilities which provided more than 50% of their total lending to foreign institutions: Commercial Paper Funding Facility, Mortgage-Backed Securities Purchase Program, Term Auction Facility; and Term Securities Lending Facility? Answer: As required by the provisions of the International Banking Act of 1978 and the Monetary Control Act of 1980, branches and agencies of foreign banks operating in the United States (foreign branches) have long had access to the Federal
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Reserve's lending facilities on the same basis as domestic depository institutions. Foreign branches have a large presence in U.S. financial markets; in aggregate, they provide substantial amounts of credit to U.S. households and businesses and are active participants in U.S. fixed-income markets. In aggregate, these institutions account for about 10 percent of bank credit extended in the United States. Unlike most domestic banks, foreign branches do not have a large retail deposit base. As a result, they rely heavily on wholesale funding sources such as large time deposits and repurchase agreements to fund their assets. For example, these funding sources account for about 70 percent of the total liabilities of foreign branches. In contrast, large time deposits and repurchase agreements account for only about 10 percent of the liabilities of U.S. chartered depository institutions. As a result, foreign branches were particularly vulnerable to the intense liquidity pressures evident during the crisis when wholesale funding markets were severely disrupted. These institutions turned to the Federal Reserve's liquidity programs to address their dollar liquidity pressures and to avoid fire sales of assets that would otherwise have been necessary. The availability of these liquidity programs to foreign-owned financial institutions operating in the United States helped to address the severe strains in U.S. financial markets during the crisis and to support the flow of credit to U.S. households and businesses. Question 2: The Federal Reserve created the Term Asset-Backed Securities Loan Facility (T ALF), which was intended to "lend up to 5200 billion ...to holders of certain AAA-rated ABS (asset-backed securities]." When TALF data was released in December 2010, they revealed that 18% of T ALF loans were backed by subprime credit card and auto loan securities, 17% were backed by "legacy" (i.e. troubled) commercial real estate securities, and 13% were backed by student loan securities. Similarly, the Term Securities Lending Facility (TSLF) was to "lend up to 5200 billion...to primary dealers securedby...securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS." Data released for the TSLF revealed that 14% of loans were backed by collateral rated below AAA. Over 50% of all
collateral posted consisted of agency-backed MBS or CMO (collateralized mortgage obligations), whose ratings were not published. While it has generally been assumed that these Agency securities have a AAA rating due to their implicit government backing, the high collateral-to-loan ratio of the TSLF (4 to 1) implies that these securities were not in fact performing at a AAA level-not to mention that no one knew what any mortgage securities were actually worth during the financial crisis. Given that the Federal Reserve stated to the public that it would accept high-rated collateral in conducting loan operations through these facilities, yet nonetheless loaned funds against questionable or low-rated collateral, how is the public to trust the public statements made by the Federal Reserve? In accepting lower grade collateral than the lending facility originally intended, was there a protocol the Reserve Banks were to follow in accepting lower rated collateral? If not, how were determinations made about what collateral was acceptable? Additionally, what surety was given that AAA-rated collateral was truly AAA, especially given the uncertain quality of many MBS at the time? Answer: The TALF program accepted only AAA-rated securities backed by loan types approved by the Board of Governors and consistent with the program terms published on the websites of the Federal Reserve Bank of New York and Board of Governors. In addition to the AAA credit rating requirement, there were a number of additional requirements designed to ensure the quality of the collateral pledged to the program. For example, each loan was fully collateralized and the value of all collateral was discounted in determining the size of the loan it could support; for non-mortgage-backed ABS, an outside auditor had to attest to the accuracy of the information provided by the sponsor and issuer of all newly issued collateral regarding compliance with TALF collateral eligibility requirements; legacy CMBS were subject to an additional internal credit review by FRBNY staff; and TALF borrowers always had their own money at risk in a first-loss position if the collateral did not perform to expectations. Partly in response to the conservative terms offered on the TALF program, about four-fifths of TALF loans have been repaid early, all outstanding collateral is performing to
expectations, and all the outstanding loans remain well collateralized. The Federal Reserve established the Term Securities Lending Facility (TSLF) in 2008 as a means of addressing the pressures faced by primary dealers in accessing term financing. When collateral markets became illiquid in 2008, primary dealers had increased difficulty obtaining funding and, therefore, were less able to support broader markets. The details, including the terms of acceptable collateral, were made public at the very start of the facility. Under this program, the Federal Reserve temporarily loaned its relatively liquid Treasury securities to primary dealers in exchange for less liquid securities that were harder to finance during a period of financial market stress. The TSLF loans were made with recourse to the borrower, meaning that the borrower was obligated to repay the loan regardless of the value of the collateral. In addition, the borrower pledged securities as collateral that met certain eligibility criteria, such as carrying an investment grade rating by major nationally recognized statistical rating organizations (NRSRO). All U.S. Treasury and U.S. government agency securities posted as collateral to the TSLF met the TSLF program criteria for collateral. The FRBNY conducts its own due diligence and analysis of collateral pledged against loans on a post-lending basis, primarily reviewing information provided by clearing banks, to ensure that these securities adhere to the eligibility requirements of the particular lending program in which the loan was made. The collateral-to-loan ratio throughout the TSLF program was approximately 106%, not 400% as noted in the question. This ratio was driven by the haircuts specified on the collateral schedule and the composition of securities pledged as collateral. This ratio does not provide information on the performance of the pledged collateral. All credit extended under the TSLF has been fully repaid, with interest. Question 3: The Commercial Paper Funding Facility (CPFF) provided 60% of its total lending to foreign institutions. The CPFF also supplied funding predominantly to large firms, such as Harley Davidson, Chrysler, Caterpillar, ING, and AIG. To what extent did smaller firms that issued commercial paper know about and have access
to the CPFF? What efforts were made by the Federal Reserve to ensure that all eligible parties were made aware of the facility? Answer: The Board of Governors announced the creation of the facility on October 7, 2008 via a public press statement posted on its website. Information on how to access the facility was made available on both the FRBNY's website and the Board's website. As with other major Federal Reserve announcements, major media organizations reported on the CPFF to the general public. Following the initial announcement, FRBNY staff reached out to many CP market participants to inform them of the CPFF and receive feedback. The outreach included working with the FRBNY's Primary Dealers, the Depository Trust & Clearing Corporation (DTCC), the Securities Industry and Financial Markets Association (SIFMA) and the Commercial Paper Industry Working Group (CPIWG), who service or represent CP issuers in the market, to ensure information was disseminated to a wide group of CP market constituents. The CPFF was open to any CP issuer who met the program eligibility requirements. To register for the facility, the CP issuer must have been a U.S. issuer issuing U.S. dollardenominated commercial paper (including asset-backed commercial paper (ABCP)) that was rated at least A-1/P-1/F1 by a major NRSRO and, if rated by multiple major NRSROs, rated at least A-1/P-1/F1 by two or more major NRSROs. Only issuers that were active between January 1 and August 31, 2008 were eligible to issue to the facility. Inactive ABCP issuers were ineligible to participate in the CPFF from January 2009 on. An issuer was deemed inactive if it did not issue ABCP to entities other than the sponsoring institution for any consecutive period of three months. Many large firms and a smaller-number of mid-sized firms registered for the program, though not all chose to issue to the facility. The composition of firms was largely reflective of the highly rated CP market more generally. Large firms with access to capital markets encompass the large majority of the CP market. Mid-sized firms have historically represented a much smaller segment of the highly rated CP market and small firms typically do not issue CP.
Question 4: The Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) loaned primarily to two firms, JP Morgan and State Street. Each of the Maiden Lane facilities was set up to assist a particular institution. To what extent were lending facilities set up for the benefit of specific firms facing financial difficulties? To what extent were lending facilities created at the behest of specific firms, either through formal or informal lobbying? Answer: The AMLF was introduced to help money market mutual funds (MMMFs) meet investors' demands for redemptions in October 2008. While banking firms were intermediate participants in the AMLF, it was not established to assist banking firms. Under the AMLF, the Federal Reserve Bank of Boston lent to financial institutions that in turn used the funds to purchase asset backed securities from MMMFs in order to allow MMMFs to meet redemption demands by customers. Eleven banking entities from six organizations borrowed from the AMLF. These firms used AMLF loans to finance purchases of assets from nearly 200 money funds. All AMLF loans were repaid in full, on time, with interest. The Federal Reserve authorized the establishment of six special facilities to provide assistance to specific institutions under section 13(3) of the Federal Reserve Act in the pursuit of financial stability during the crisis. The establishment of these facilities was aimed at stabilizing the financial system and mitigating the impact of financial stresses on the economy. Two of these facilities, those set up for Citigroup and Bank of America, ultimately did not require a loan from the Federal Reserve. The loans provided to the four remaining facilities, Maiden Lane LLC, Maiden Lane II LLC, Maiden Lane III LLC and AIG Revolving Credit Facility were fully collateralized. Maiden Lane LLC received a loan from the Federal Reserve Bank of New York of $28.8 billion to purchase assets from Bear Stearns to support JP Morgan Chase's acquisition of Bear Stearns. The Bear Stearns merger with JP Morgan Chase prevented a disorderly failure of Bear Stearns and potentially severe consequences on market functioning and
the economy. Maiden Lane II LLC received a loan from the Federal Reserve Bank of New York of $19.5 billion to purchase residential mortgage-backed securities (RMBS) from AIG's insurance subsidiaries in order to alleviate capital and liquidity drains on AIG. Maiden Lane III LLC received a loan from the Federal" Reserve Bank of New York of $24.3 billion to purchase collateralized debt obligations (COOs) from certain counterparties of AIG Financial Products (AIGFP) in exchange for terminating the related credit default swaps (CDS) contracts between the counterparty and AIGFP which were contributing to capital and liquidity drains on AIG. The AIG Revolving Credit Facility (RCF) was a credit line extended by the Federal Reserve Bank of New York for up to $85 billion to AIG. The RCF, Maiden Lane II LLC and Maiden Lane III LLC prevented a failure of AIG which would have had widespread consequences for the economy and indirectly impacted millions of Americans. Question 5: Given that information pertaining to discount window transactions during the financial crisis has been disclosed to the public, through the Bloomberg News and Fox News FOIA requests, without causing any material harm to institutions that used the discount window, will the Federal Reserve disclose the details of discount window transactions that occurred during the financial crisis on the Board's website in the same manner disclosures were made of the other facilities and programs conducted by the Federal Reserve during the crisis? If not, please provide an explanation of why the Federal Reserve will not make such information available. Answer: The FOIA Service Center page of the Board's public website makes available to any person upon request a copy of the records released on March 31, 2011 in the Fox News and Bloomberg FOIA lawsuits. Any person wishing to obtain a copy may submit a request using the Board's electronic FOIA request form, or by calling the Board's FOIA Service Center. The Board's public announcement, describing the records released on March 31, 2011 and the method for obtaining
copies can be found at: http://www.federalreserve.gov/generalinfo/foia/servicecenter.cf m. The March 31, 2011 releases resulted from litigation under the Freedom of Information Act ("FOIA"). Because FOIA requires disclosure of documents, as opposed to the underlying data or information, the Board made responsive documents available to the requesters and the public as noted above. The Board's December 1, 2010 disclosures of section 13(3) lending information were made pursuant to section 1109(c) of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"), which requires publication of specified information "on [the Board's] website .... " 124 Stat. 2129. The Federal Reserve's discount window has been an important source of liquidity for depository institutions, especially during times of financial stress. Discount window credit is a common and important tool among central banks around the world and one of the most important tools during a financial crisis. Unlike grant programs, the discount window involves the extension of credit on a fully secured basis. To date, the Federal Reserve has never lost money on discount window lending. Depository institutions have argued that public disclosure of information regarding borrowing at the discount window will discourage use of the discount window. They contend that, because both healthy and troubled depository institutions access the discount window, the public may misconstrue use of the discount window as a sign of financial weakness. Indeed, disclosure of access to credit from the Bank of England by Northern Rock led to runs on that institution. In accordance with the Dodd-Frank Act, the Board will disclose information regarding borrowings through the discount window, including the identity of the borrowers, amount borrowed, terms of the borrowing and collateral information, no later than eight quarters following any discount window transaction entered into after July 21, 2010. The Board believes that the disclosure of discount window borrowing after a reasonable delay appropriately balances the
need to hold the Federal Reserve accountable for its lending activities with the concerns about the viability of discount window. We will continue to inform Congress of any concerns that arise as we implement this provision. Question 6: Given that information pertaining to certain "covered transactions", a definition which includes open market operations, will have to be disclosed to the public under the provisions of the Dodd-Frank Act, will the Federal Reserve disclose the details of open market operations that took place during the financial crisis and before the passage of Dodd-Frank, such as Single-Tranche Open Market Operations? If not, please provide an explanation of why the Federal Reserve will not make such information available. Answer: As required by section 1109(c) of the Dodd-Frank Act, on December 1, 2010, the Board published detailed information on transactions conducted under the Federal Reserve's Agency Mortgage-Backed Securities Program, which were undertaken prior to the enactment of the Dodd-Frank Act pursuant to the System's open market operation (OMO) authority. In addition, the Federal Reserve has released significant information about single-tranche OMOs, which were conducted with the intention of mitigating heightened liquidity stress that was occurring in funding markets during the financial crisis in 2008. The program itself had been disclosed publicly at the time of its inception, each auction was announced to the public on the website of the FRBNY at the same time it was announced to the primary dealers, and each auction's aggregated results were immediately posted to the same website. Additional aggregated information on the single tranche OMO program was included in the Board's H.4.1 weekly data release on the condition of the Federal Reserve Banks and in the System Open Market Account annual report for 2009. Information on single-tranche OMO transactions has also been made public in connection with the Fox FOIA litigation. On July 6, 2011, the Board published additional data concerning the program, including trade and settlement dates, counterparty names, amounts, and rates for
all transactions under the program. This information may be found at: http://www.federalreserve.gov/monetarypolicy/bst_tranche.ht m Question 7: Will the details of the "QE2" program and ongoing rollovers of maturing MBS into Treasury debt securities be disclosed to the public? If not, please provide an explanation of why the Federal Reserve will not publicize such information. Answer: The Federal Reserve has provided to the public a substantial amount of information concerning the program to purchase longer-term Treasury bonds. The Federal Open Market Committee announced on November 3, 2010 that, in order to promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee would purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, at a pace of about $75 billion per month. The FOMC's announcement can be found at: http://www.federalreserve.gov/newsevents/press/monetarv/20 101103a.htm. The program is part of the FOMC's open market operations ("OMO").319 Moreover, the current holdings of SOMA, including maturity date, CUSIP, coupon, par value and other information regarding securities held in SOMA can be found at: http://www.newyorkfed.org/markets/soma/sysopen_accholding s.html. In the Dodd-Frank Act, Congress gave careful consideration to the public's interest in greater transparency in OMO transactions and to the legitimate expectations of
Additional details regarding the program, including the Trading Desk at the Federal Reserve Bank of New York's plans for distributing purchases of Treasury securities for the System Open Market Account ("SOMA"), were made available November 3, 2010 on the Federal Reserve Bank of New York's website at: http:/{www.newyorkfed.orglmarkets/opolicy/operatingpolicylOlI03.html. The Federal Reserve Bank of New York currently publishes a list of F AQs regarding the purchase program which provides information such as: the maturity sectors of Treasury securities the Desk planned to purchase, how much the Desk planned to purchase in each issue, how much the Desk planned to purchase each month in Treasury securities, and other information. The F AQs can be found at: http:/{www.newyorkfed.orglmarketsllttreasfag.html.
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confidentiality of parties to OMO transactions and the potential effects that premature disclosure of counter-party information could have on the Federal Reserve's ability to execute OMO transactions efficiently and at the best price. In striking this balance, Congress concluded that the Board should be permitted to delay the release of information about OMO transactions. In accordance with the Dodd-Frank Act, the Board will disclose counter-party information with respect to OMO transactions, including the reinvestments of maturing MBS into Treasury securities, conducted after July 21, 2010, no later than eight quarters after the transactions. Question 8: The documents released by the Federal Reserve in response to the Freedom of Information Act requests from Bloomberg News and Fox News contained large amounts of information that was redacted. The Federal Reserve has indicated that the information was determined not responsive to the FOIA requests and was therefore redacted. Is the Federal Reserve willing to release all of these records in their original form to the House Committee on Financial Services? If not, please explain why. Answer: In providing to Bloomberg News and Fox News the documents at issue in their FOIA litigation, the Board redacted from those documents certain information that was not sought by the requests. Should the Board receive a request from the House Committee on Financial Services for the unredacted documents at issue in the Bloomberg/Fox FOIA litigation, it will work with the Committee, as it has in the past in response to other similar requests, to assist the Committee in accessing the information it needs. Question 9: In the documents disclosed by the Federal Reserve on discount window transactions, it appears that banks, especially primary dealers, used the discount window like a revolving line of credit, essentially acquiring longer term funding through what is typically an overnight program. Why was the discount window used in such a fashion even when emergency lending facilities were set up to provide longer term financing through programs such as the TSLF or PDCF?
Answer: The Term Securities Lending Facility (TSLF) and the Primary Dealer Credit facility (PDCF) were liquidity facilities set up during the financial crisis for primary dealers. Under the TSLF, primary dealers engaged in temporary swap transactions with the Federal Reserve Bank of New York in which the dealer received Treasury securities and pledged other high-quality securities as collateral. The swaps were priced through competitive auctions and had maturities of28 days. The PDCF extended overnight loans to primary dealers against collateral that was eligible for tri-party repurchase agreements. Primary dealers were discouraged from using the PDCF as a source of longer-term funds by usage fees that rose with the frequency of borrowing. All credit extended under both the TSLF and the PDCF has been fully repaid, with interest. Discount window loans (primary, secondary, and seasonal credit) are available only to depository institutions, that is, commercial banks, thrifts, credit unions, and U.S. branches and agencies of foreign banks. None of the primary dealers at this time or over the past few years were depository institutions, so none of the primary dealers have had access to the discount window. Although there is no prohibition against primary dealers being depository institutions, currently all primary dealers are broker dealers. In several cases, however, the broker-dealer subsidiaries of bank holding companies are primary dealers. In such cases, the commercial bank subsidiary of the holding company is eligible to borrow from the discount window and the primary dealer !broker-dealer subsidiary would have been able to borrow from the other lending facilities established for the primary dealers. Easing the terms on primary credit (discount window) loans was one of the first steps the Federal Reserve took in response to the financial crisis. The easing was intended to increase the liquidity of depository institutions and thereby support their ability to lend to businesses and households. On August 17, 2007, the Federal Reserve narrowed the spread of the primary credit rate over the FOMC's target rate from 100 basis points to 50 basis points, and lengthened the maximum maturity from overnight to 30 days. On March 16, 2008, the Federal Reserve lowered the spread to 25 basis points and
extended the maximum maturity to 90 days. The easing of terms on discount window borrowing was part of the Federal Reserve's broader efforts to address strains in term funding markets and the liquidity strains in financial markets. As financial market conditions improved, the Federal Reserve normalized the terms on primary credit. Over the first few months of 2010, the Federal Reserve returned the typical maximum maturity on primary credit to overnight and widened the spread of the primary credit rate over the top of the FOMC's range for the federal funds rate to 50 basis points. By June 2010, borrowing had again fallen near zero. Question 10: What was the necessity of setting up Single-Tranche Open Market Operations (ST OMO) and programs such as the TSLF when they accomplished essentially the same task of providing 28-day credit? Was the existence of these separate operations due to the fact that the TSLF allowed the Fed to purchase secondary credit and not just primary credit, something not legally permissible under the ST OMO conducted through the Fed's open market operation authority? Both the single-tranche (ST) OMO and the TSLF programs were aimed at relieving strains in the term funding markets. Since these strains were quite significant, the Federal Reserve provided more than one way to help alleviate the pressures. Both programs addressed term funding pressures for the primary dealers, though the mechanics were different, as was the list of eligible securities. Mechanically, the ST OMO allowed primary dealers to bid at auction for direct 28-day financing of any of their OMOeligible securities (i.e., U.S. Government securities and U.S. agency issued or guaranteed securities); they pledged their securities and received funds in exchange, With TSLF, however, the dealers bid at auction to essentially swap their program-eligible securities for U.S. Treasury securities, which they then had to finance in the market. Presumably it was easier for them to find term financing for the U.S. Treasury securities they received than it was for them to finance the securities they pledged into the program. So, after winning a TSLF auction, the primary dealer would still have to obtain financing for the U.S. Treasury securities they received from
the FRBNY. .. There are other key differences between the ST OMO and TSLF programs. The ST OMO program relied on standard legal authorities for open market operations, and transactions under this program were very similar to the shorter-term repo operations long conducted by the Federal Reserve in implementing monetary policy. Under this program, primary dealers could deliver as collateral any of the types of securities--Treasuries, agencies, and agency MBS--that are typically accepted in open market operations. The legal authority for a key part of the TSLF--the so-called "schedule 2" TSLF operations-relied partly on the Federal Reserve's emergency lending authority in section 13(3) of the Federal Reserve Act. Under TSLF, primary dealers could borrow Treasury securities from the Federal Reserve for a period of 28 days. In contrast to the ST OMO program, under the TSLF primary dealers could pledge as collateral a range of highly rated private securities. Rates and amounts borrowed by individual primary dealers under the TSLF were determined through competitive auctions. Initially, the securities accepted as collateral in TSLF operations were limited to AAA-rated securities. Later as the crisis intensified in September of 2008, the range of collateral accepted was expanded to include all investment-grade securities. The ability of primary dealers to finance private investment-grade securities through the TSLF was very important in addressing the disruptions in financial markets during the crisis. Question 11: Can the Federal Reserve provide to the Committee a graph and/or spreadsheet for each of the emergency lending facilities (including the ST OMO) showing the high, low, and average rates charged in the facility over its lifetime in conjunction with the prevailing market rate for the same type of transaction over the same period? Answer: [See Appendix D]
TATEMENTS

Today's hearing deals with one of the most pressing issues this subcommittee will face during this Congress, the issue of Federal Reserve transparency. While the Federal Reserve is still far less transparent than it should be, recent disclosures of the Federal Reserves lending programs have greatly increased our knowledge of the Fed's monetary policy during the height of the financial crisis. In December 2010 and March 2011, a remarkable thing happened: the Fed disclosed information on its lending facilities and discount window operations, including who borrowed money, what amounts were loaned, maturity dates, interest rates, and collateral. It took an act of Congress, the Dodd-Frank Act, to bring about the December releases that discovered the details of the emergency lending facilities set up by the Fed during the crisis. The March 2011 disclosures covered discount window lending, the oldest Fed lending tool, whose operations had never before been disclosed. It took a three year legal battle regarding the Freedom of Information Acts (FOIA) applicability to the Fed in order to gain access to this information. The suits brought by Bloomberg and Fox News resulted in 29,000 pages of unorganized, heavily redacted documents being provided. Combining these two data releases has given us a fuller, if still woefully incomplete, picture of the Feds operations during the financial crisis and the nearly $3 trillion balance sheet it has built up.
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FED DATA DUMP STATEMENTS1189
On November 25, 2008, the Fed created the Term Asset-Backed Securities Loan Facility (TALF) which was intended to lend up to $200 billion... to holders of certain AAA-rated ABS [asset-backed securities]. When the Fed released TALF data in December of 2010, 18% of TALF loans were backed by subprime credit card and auto loan securities, 17% of TALF loans were backed by legacy, a.k.a. troubled, commercial real estate securities, and 13% of TALF loans were backed by student loan securities. On March 11, 2008, the Fed created the Term Securities Lending Facility (TSLF) to lend up to $200 billion...to primary dealers... secured... by... securities, including federal agency debt, federal agency residential mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. When the Fed released TSLF data in December of 2010, 26% of loans were backed by AAA/Aaa-rated securities, 17% were backed by non-AAA-rated securities, and 57% of loans were backed by collateral whose rating was not published by the Fed. Recent news reports have brought to light the existence of a previously undisclosed Fed lending program known as single-tranche open market operations (ST OMO). This program loaned money at rates as low as 0.01% to major firms such as Goldman Sachs, and was essentially a free loan to these politically well-connected firms. Data about this program was not published, but instead was gleaned through examination of charts published in March as a result of the Fed's Freedom of Information Act (FOIA) disclosure. The charts were found within a 327-page document which had 81% of its content redacted. Out of the funds loaned through the Fed's credit facilities, nearly one-third was loaned to foreign banks. Some facilities and programs, such as the Mortgage-Backed Securities Purchase Program, the Commercial Paper Funding Facility, and the TSLF, provided more than half of their funding to foreign banks. During the peak of the financial crisis, up to 88% of overall discount window lending went to foreign banks, and nearly 100% of the New York Fed's discount window lending went to foreign banks. Not surprisingly, these data disclosures have raised significant new questions about the Fed's behavior. Among many questions raised are: Why did foreign firms receive such a large percentage of Fed lending? What advantages were given to large financial institutions that had access to multiple lending facilities for prolonged periods of time? Did extending loans to non-financial firms go beyond the Feds emergency lending authority? Why did investors who participated in TALF have to have a relationship with the Feds
primary dealers, and did this give an unfair advantage to wealthy investors, such as the wives of two Morgan Stanley executives? Why did the Fed set up single-tranche open-market operations (ST OMO) which gave primary dealers access to $80 billion at rates as low as 0.01%, essentially providing a direct government subsidy to these firms, and why did the Fed only disclose this information in chart form? Are there other programs that have yet to be disclosed? Why were so many pages redacted in the 327-page document that alluded to ST OMO? Can you really claim to be in compliance with FOIA when such significant portions of documents are redacted? How can we trust that this data was not responsive to the FOIA request? Are we to trust the nontransparent Fed that we really don't need to see that information? If the Fed claims to lend against AAA collateral and then does not, can we trust anything the Fed publishes in a press release? Can we trust that collateral classified by the Fed as AAA really is AAA? More issues emerge from the Feds handling of the FOIA requests brought by Bloomberg and Fox News. The Fed used several arguments in refusing to comply. Among them was the Feds claim that it was a private institution and not subject to FOIA, since the documents requested were held by the New York Fed, a private bank, and thus exempt. Fortunately for the American people, the court rejected that assertion. But what exactly is the legal relationship between the private regional banks and the Board of Governors? The Fed also claimed that lending records of discount window borrowers were privileged or confidential information that could cause imminent competitive harm if disclosed, or even cause a run on banks, and therefore should be exempt from FOIA. This has been the Feds long-standing defense of the secrecy of the discount window. One of the judges in the case summed up the Feds secrecy succinctly: [T]he risk of looking weak to competitors and shareholders is an inherent risk of market participation; information tending to increase that risk does not make the information privileged or confidential. Given the massive amount of data released last December and this March, and the fact that much information in the March data release was redacted, it is all but certain that there remains much to be discovered about the Fed's bailouts through the discount window and its credit facilities. The Federal Reserve's actions in bailing out Wall Street through credit facilities and quantitative easing provoked a backlash among the American people and among many members of Congress. Trillions of dollars worth of loans and guarantees were provided to rich bankers and their worthless holdings of mortgage
debt were snapped up by the Fed, while Main Street Americans continued to suffocate under harsh taxation and the prospect of increasing inflation. These events have awakened many Americans to the problems with the Fed's loose monetary policy, the bubbles it has created in the past, and the potential hyperinflation it might cause in the future. We should not neglect the fundamental need for more transparency of the Fed and a thorough audit that can help shed light on operations of the Federal Reserve System. We need stronger audit authority over the Fed, both looking back at previous market interventions and also ensuring that any future credit facilities, bailout vehicles, or large-scale asset purchase programs are subject to oversight. At this hearing we hope to receive substantive answers from the Fed about its lending behavior during the worst part of the financial crisis, and we hope to receive assurances about the Fed's future compliance with the Dodd-Frank bill's requirements for public access to lending information. Aside from our ability to ask questions at the hearing, the hearing record will remain open for 30 days to allow the Fed time to respond to our written questions. At a time when the Fed's balance sheet is rapidly approaching the $3 trillion dollar mark, it is absolutely imperative that the Fed come clean with the details of its open market operations, lending operations, and asset purchases. Pumping trillions of dollars into the banking system with no oversight by Congress and no accountability to the American people cannot be allowed to continue.
STATEMENT FOR THE RECORD HON. WM. LACY CLAY

REPRESENTATIVE, 1ST DISTRICT OF MO U.S. HOUSE OF REPRESENTATIVES
Thank you Mr. Chairman For holding this hearing to examine information disclosed by the Federal Reserve in compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Freedom of Information Act. Also, I want to thank the witnesses for appearing. Due to the U.S. financial crisis, the United States Congress passed the Dodd-Frank Wall Street Reform and Consumer protection Act of 2010. This Legislation was crafted as a response to the financial crisis which has cost nearly 10 million American jobs and over $10 trillion in household wealth. Nearly 4 million families have lost their homes to foreclosure and an additional 4.5 million have slipped into the foreclosure process or are seriously behind on their mortgage payment. According to the financial crisis inquiry report; a combination of excessive borrowing, risky investments, and the lack of transparency put the financial system on a collision course of self destruction. In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed too much, leaving them vulnerable to financial distress if the value of the investments declined even modestly. For example, as of 2007, the five major investment banks were operating with extraordinarily thin capital. By one measure, their leverage ratios were as high as 40 to 1, meaning for every $40 in assets, there was only $1 in capital to cover losses. Less than a 3% drop in asset value could wipe out a company. Leverage was often hidden in off-balance sheet entities; in derivatives positions; and through window dressing of financial reports available to the investing public. Within the financial system, the danger of this debt was increased because transparency was not required or desired; undercover corporate dealings assisted in the financial meltdown which still plagues us today. In order for democracy and capitalism to exist correctly, transparency must be at the core; trust, transparency and the rule of law are fundamental to this nation success. Business depends in some way on trust; a trust that business produces good products and a trust that business will deliver good services.
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Democracy depends in some way on trust. Transparency promotes government accountability, free and fair election, competition and free markets, and the rule of law are critical to it. The Dodd-Frank Wall Street Reform and Consumer Protection Act addresses these issues by reforming the Federal Reserve: 1) It limits the Federal Reserves 13 (3) emergency lending authority by prohibiting emergency lending to an individual entity. The secretary of Treasury must approve any lending program, program must be broad based, and loans cannot be made to insolvent firms. Collateral must be sufficient to protect taxpayers from losses. 2) It requires the Federal Reserve to disclose counterparties and information about amounts, terms and conditions of 13 (3) and discount window lending, and Open Market transactions on an ongoing basis with specified time delays. These are just a few examples of the importance of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Thank you again Mr. Chairman and I look forward to the witnesses comments!
ITNESS
ESTIMONY
JOINT WRITTEN TESTIMONY OF SCOTT G. ALVAREZ

GENERAL COUNSEL BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM AND
MR. THOMAS C. BAXTER, JR.

GENERAL COUNSEL FEDERAL RESERVE BANK OF NEW YORK
Chairman Paul, Ranking Member Clay, and members of the Subcommittee, we appreciate the opportunity to discuss the different ways in which the Federal Reserve informs the Congress and the American people about our policies and actions. The Federal Reserve regularly releases significant, detailed information about its operations. Our aim in doing so is to promote understanding of how the Federal Reserve fosters financial and economic stability and to facilitate an evaluation of our actions while also preserving the ability to effectively fulfill the responsibilities that the Congress has given the Federal Reserve. In that context, we will describe the Federal Reserves compliance with the disclosure provisions of the DoddFrank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), including the data we released in December 2010 about the transactions we conducted to stabilize markets during the recent financial crisis, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis. We will also address our March 2011 release, under the Freedom of Information Act, of documents regarding the use of the Federal Reserves discount window during the crisis.
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FED DATA DUMP TESTIMONY1195
The role of lender of last resort is a critical responsibility long filled by central banks around the world. Central bank lending facilitates the implementation of monetary policy and allows the central bank to address short-term liquidity pressures in the banking system. During normal times, the Federal Reserve's discount window provides a backup source of liquidity for depository institutions in sound financial condition to address unexpected, short-term funding pressures. In doing so, the discount window facilitates the smooth and efficient flow of credit to U.S. households and businesses. In periods of crisis, the discount window is a tool that can be used to support market liquidity, and thereby mitigate strains in financial markets that could otherwise escalate and lead to sharp declines in output and employment. All discount window loans are fully secured and the Federal Reserve has not suffered a loss on any discount window loans. Disclosure and Integrity of the Federal Reserves Financial Statements Since it began operation in 1914, the Federal Reserve has published full financial statements. We release our balance sheet every week, both by individual Reserve Bank and on a consolidated basis for the entire Federal Reserve System. 320 In addition, the Federal Reserve publishes annual financial statements with information on our assets and liabilities as well as income and expenses in the same detail as a publicly traded corporation. 321 During the recent financial crisis, the Federal Reserve expanded its weekly balance sheet disclosures to include information about the amount of credit outstanding under each of the credit facilities established during the crisis. The Federal Reserve also initiated in June 2009 a special monthly report, which we provide to the Congress and publish on the Boards website, that provides additional detail about the Federal Reserves emergency lending programs, including information on the amount of lending under each program, a description of the type and level of collateral associated with those
This information is published each Thursday, for the week ending the preceding Wednesday, through the Federal Reserves H.4.1 Statistical Release, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks. The current release, as well as past releases dating from 1996, is available on the Boards website at www.federalreserve.gov/releases/h41/default.htm. The website also provides descriptive information and an interactive guide for each table in the release. 321 This information is included in the Boards annual report, which is submitted to the Congress each spring and published on the Boards website at www.federalreserve.gov/boarddocs/rptcongress.
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loans, and information about the borrowers under those facilities. 322 This report includes aggregate information about credit provided to depository institutions through the discount window as well as information on the Federal Reserves securities holdings and the holdings of Maiden Lane, Maiden Lane II, and Maiden Lane III. The Boards website also contains detailed information about the terms and conditions of each of the emergency lending programs, the availability of discount window lending, the swap lines opened with foreign central banks, and the arrangements with third-party vendors used by the System during the financial crisis, as well as expansive data and numerous reports and other information on all aspects of Federal Reserve operations.323 The Federal Reserve Bank of New York (FRBNY) also maintains a website that offers detailed information on open market operations taken to implement the monetary policy decisions of the Federal Open Market Committee. This information includes schedules of purchases and sales of securities as part of open market operations with CUSIP information describing the securities involved. With this information, a description of every open market operation can be examined shortly after it is conducted. Other open market information available on the FRBNY website includes summary and individual data on the securities held in the System Open Market Account and information about the federal funds rate. 324 The site also contains a great deal of additional data related to FRBNY operations, including the names of the primary dealers, some legal forms for transacting business, and other information about fiscal agency activities on behalf of the U.S. Treasury. The Federal Reserves annual financial statements are audited by an independent public accounting firm, which performs customary procedures to assure their accuracy and integrity. For the last four years, for example, Deloitte and Touche has audited the financial statements of the Federal Reserve Board and the Federal Reserve System as a whole. In each year, the Federal Reserve has received a clean auditor opinion, meaning that the financial statements present fairly the financial positions of the Federal Reserve. Further, the
See the Monthly Report on Credit and Liquidity Programs and the Balance Sheet, available at www.federalreserve.gov/monetarypolicy/clbsreports.htm. For more information on the various Federal Reserve liquidity and credit facilities and further background on the Federal Reserves balance sheet, see www.federalreserve.gov/monetarypolicy/bst.htm. 323 The Boards website is at www.federalreserve.gov. 324 FRBNYs website is at www.newyorkfed.org. See www.newyorkfed.org/markets/openmarket.html for information about open market operations.
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external auditor also opines that the Federal Reserve has maintained effective internal controls over financial reporting. The independent audit also covers transactions conducted through each of the special lending facilities established by the Federal Reserve under section 13(3) of the Federal Reserve Act and the financial statements of Maiden Lane, Maiden Lane II, and Maiden Lane III, as well as the transactions conducted through the discount window and with foreign central banks. By statute, the Boards Office of Inspector General (OIG) is responsible for ensuring that the auditor and the audits are independent. The results of these financial audits are reported annually to the Congress along with the audited financial statements of the Federal Reserve System and published on the Boards website.325 In addition to these audits, the Federal Reserve, and in particular, the special lending facilities established by the Federal Reserve during the recent financial crisis, have been subject to a number of other audits and reviews. These include special audits by the Office of the Special Inspector General for the Troubled Asset Relief Program for each program that involved any funding from the TARP program.326 The Congressional Oversight Panel and the Financial Crisis Inquiry Commission also conducted reviews and both have issued public reports.327 Moreover, the Federal Reserves financial statements and a broad range of our functions are subject to review by the Government Accountability Office (GAO). For example, in recent years the GAO has conducted reviews of the policies and practices of the Federal Reserve in its supervision and regulation of bank holding companies, state-chartered banks that are members of the Federal Reserve System, and other banking organizations. It has also conducted reviews of the Federal Reserve in other areas, including our oversight and operation of payment systems; our implementation and enforcement of consumer protection laws; our policies on the acquisition of U.S. banking organizations by sovereign wealth funds; our efforts to address cyber security; and the need for financial regulatory reform. These reviews are not limited to auditing the
The latest Annual Report of the Board of Governors of the Federal Reserve System is available on the Boards website at www.federalreserve.gov/boarddocs/rptcongress. 326 See www.sigtarp.gov/audits.shtml. 327 See Congressional Oversight Panel (2011), March Oversight ReportThe Final Report of the Congressional Oversight Panel (Washington: GPO, March 16), www.gpo.gov/fdsys/pkg/CHRG112shrg64832/pdf/CHRG-112shrg64832.pdf; The Financial Crisis Inquiry Commission (2011), The Financial Crisis Inquiry Report (Washington: GPO, January), www.gpoaccess.gov/fcic/fcic.pdf.
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integrity of the financial statements or public reporting of these activities. Rather, the GAO reviews the development of policies and provides assessments of and suggestions regarding appropriate policies. In response to a directive from the Congress in the Dodd-Frank Act, the GAO is currently conducting a special review of all loans and other Federal Reserve transactions between December 1, 2007, and July 21, 2010, under the special lending facilities and other programs developed during the financial crisis. 328 This review will assess operational integrity, internal controls, security and collateral policies, policies governing third-party contractors, and the existence of any conflicts of interest or inappropriate favoritism in the establishment or operations of the facilities.329 The Federal Reserve is fully cooperating with the GAO in its conduct of this extensive review and will continue its close cooperation with the GAO to assist in its reviews of Federal Reserve functions generally. Recent Information Releases As provided by the Dodd-Frank Act, on December 1, 2010, the Board published detailed information on its website about the Federal Reserves actions during the financial crisis, including transactions to stabilize markets, restore the flow of credit to American families and businesses, and support economic recovery and job creation in the aftermath of the crisis. 330 331 In the December 1 data release, the Federal Reserve provided vast amounts of information about the programs and the terms and conditions of the individual transactions made under them. The information provided detailed explanations as well as definitions of
This audit is being undertaken pursuant to section 1109 of the Dodd-Frank Act and is to be completed in July 2011. 329 See 31 U.S.C. 714(f). 330 See section 1103(b) of the Dodd-Frank Act. The data released on December 1, 2010, included transaction-level information about the following programs: the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF); the Term AssetBacked Securities Loan Facility (TALF); the Primary Dealer Credit Facility (PDCF); the Commercial Paper Funding Facility (CPFF); the Term Securities Lending Facility (TSLF); the TSLF Options Program (TOP); the Term Auction Facility (TAF); agency MBS purchases; dollar liquidity swap lines with foreign central banks; assistance to Bear Stearns, including Maiden Lane; and assistance to American International Group, including Maiden Lane II and III. The information can be found on the Boards website at www.federalreserve.gov/newsevents/press/monetary/20101201a.htm. 331 The Dodd-Frank Act has substantially modified the ability of the Federal Reserve to extend emergency credit to single identified non-banking companies. Now, credit under section 13(3) of the Federal Reserve Act may only be offered through credit facilities with broad-based eligibility.
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the material terms for each facility. Data concerning the material terms were made available in multiple formats, including Excel files that allow users to search, sort, and filter the data for each program in multiple categories. For the broad-based lending facilities, details included the name of the borrower, the amount borrowed, the date the credit was extended, the interest rate charged, information about collateral, and other relevant credit terms. Similar information was provided for the draws of foreign central banks on their dollar liquidity swap lines with the Federal Reserve. For agency MBS transactions, details included the name of the counterparty, the security purchased or sold, and the date, amount, and price of the transaction. In addition, as mandated by the Dodd-Frank Act, the Boards website directly links to the Federal Reserves audit-related information, including GAO reports, annual audited financial statements, and reports related to emergency lending authority provided to the Congress.332 The Board has also charged staff with identifying other information that could be posted to this site that would help to explain the accounting, financial reporting, and internal controls of the Board and the Reserve Banks. On March 31, 2011, the Federal Reserve released documents related to the discount window in response to requests filed by Bloomberg L.P. and Fox News Network LLC under the Freedom of Information Act. Discount window lending under section 10B of the Federal Reserve Act offers secured, short-term loans from the Reserve Banks to depository institutions located in the lending Reserve Banks district. The March 31 release included documents containing information related to borrowers at the discount window between August 8, 2007, and March 1, 2010, that was not required to be disclosed under the Dodd-Frank Act. Future Information Disclosures Going forward, the Dodd-Frank Act provides for the release of information on any broad-based emergency lending facility one year after the termination of the facility. The act also provides for the release of information regarding discount window lending and open market operations conducted by the Federal Reserve after July 21, 2010, with a two-year lag. For lending facilities (including both emergency lending facilities and the discount window) and for open market operations, the Federal Reserve will publish information
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See www.federalreserve.gov/newsevents/reform_audit.htm.
disclosing the identity of the borrower or counterparty, transaction amount, interest rate or discount paid, and collateral pledged. The Federal Reserve believes that the lags provided by the DoddFrank Act for the release of transaction-level information about open market operations, emergency lending facilities, and discount window lending activities establish an important balance between the publics interest in information about participants in transactions with the Federal Reserve and the need to ensure that the System can effectively use its congressionally authorized powers to maintain the stability of the financial system and implement monetary policy. We remain concerned that a more rapid release of information about borrowers accessing the discount window and emergency lending facilities could impair the ability of the Federal Reserve to provide the liquidity needed to ensure the smooth working of the financial system. If institutions believe that publication of their use of Federal Reserve lending facilities will impair public confidence in the institution, then institutions may choose not to participate in these facilities. Experience has shown that banks unwillingness to use the discount window can result in more volatile short-term interest rates and reduced financial market liquidity that, in turn, can contribute to declining asset prices and reduced lending to consumers and small businesses. We will carefully monitor developments in the use of the discount window and other Federal Reserve facilities and keep the Congress informed about their effectiveness. Conclusion The Federal Reserve has worked and will continue to work with the Congress to ensure that our operations promote the highest standards of accountability, stewardship, and policy effectiveness, consistent with meeting our statutory responsibilities. We appreciate the opportunity to describe the Federal Reserves efforts on this important subject and are happy to answer any questions you may have.
EARING XI.
AUDIT THE FED: DODD-FRANK, QE3, AND FEDERAL RESERVE TRANSPARENCY
TUESDAY, OCTOBER 4, 2011

WITNESSES Brown, Orice Williams, Managing Director, Financial Markets and Community Investment, U.S. Government Accountability Ofice Auerbach, Robert D., Ph.D.,Professor of Public Affairs, Lyndon B. Johnson School of Public Affairs, University of Texas Austin Calabria, Mark A., Ph.D., Director of Financial Regulations Studies, Cato Institute
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing entitled Audit the Fed: Dodd-Frank, QE3, and Federal Reserve Transparency on Tuesday, October 4, 2011 at 10:00 a.m. in Room 2128 of the Rayburn House Office Building. This hearing examined the audit findings by the Government Accountability Office (GAO) of their Federal Reserve audit, which was mandated by the Dodd-Frank Wall-Street Reform and Consumer Protection Act (P.L. 111-203). Also discussed were earlier legislative efforts to audit the Federal Reserve; current statutory Federal Reserve audit and data disclosure requirements; and the larger issue of the economic and public policy importance of requiring transparency in the Federal Reserves actions particularly in light of the Federal Reserves monetary policy efforts during the financial crisis of 2008-2009, its continued unconventional support to financial markets, and its engagement in the Eurozones financial crisis. This was a two-panel hearing with the following witnesses: Panel I Ms. Orice Williams Brown, Managing Director, Financial Markets and Community Investment, GAO Dr. Robert D. Auerbach, Professor of Public Affairs, Lyndon B. Johnson School of Public Affairs, University of Texas, Austin Dr. Mark A. Calabria, Director of Financial Regulation Studies, Cato Institute
Panel II
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History The Federal Reserve System has been the central bank of the United States for nearly 100 years. Over the course of that century, the Federal Reserve has steadily gained more power over the nations monetary policy, while Congress has simultaneously abdicated its own Constitutional responsibility for, and authority over, monetary policy. Throughout its long history, the Federal Reserve has provided very little disclosure to the public regarding its operations and actions. For the past several decades, numerous bills requiring audits, greater disclosure, and other accountability from the Federal Reserve to Congress about its conduct of monetary policy have been introduced in Congress, but have met with steep opposition. Advocates for these bills have consistently cited the seminal impact the Federal Reserves monetary actions and policies have on the nations economic and fiscal well-being as justification for requiring greater public disclosure regarding the Federal Reserves actions and decision-making. Opponents argue that auditing and disclosing the Federal Reserves conduct of monetary policy would interfere with the Federal Reserves independence by subjecting its monetary policy decision-making to political pressure. Limited Audit Authority Although current law technically subjects the Federal Reserve to audits, the scope of those audits is limited. In 1999, the Gramm-Leach-Bliley Act (P.L. 106-102) required annual independent audits of the financial statements of each regional Federal Reserve Bank and the Board of Governors. Prior to that, P.L. 95-320 enacted in 1978 also authorized the GAO to conduct limited audits of the Federal Reserve. Despite that authorization, the GAO never actually audited the Federal Reserve. In hearings on the 1978 legislation, and again after the bill was enacted, GAO officials said that the GAO could not satisfactorily audit the Federal Reserve without being able to audit its open market operations as well, which it was not authorized to do. In fact, the GAO currently lacks the authority to fully audit the following Federal Reserve actions: (1) Transactions for or with a foreign central bank, government of a foreign country, or non-private international financing organization;
AUDIT THE FED BACKGROUND 1205
a) Deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations; b) Transactions made under the direction of the Federal Open Market Committee; and c) Discussions or communications among or between members of the Board and officers and employees of the Federal Reserve System related to items (1)-(3).333
In the 111th Congress, concerns about the Federal Reserves extraordinary actions in its conduct of monetary policy and its extensive assistance to financial markets during the 2008-2009 financial crisis led to a renewed interest in fully auditing the Federal Reserve. Several legislative proposals were introduced in both houses of Congress to provide the public greater transparency for the Federal Reserves actions that helped pick winners and losers in the financial system. Among the bills was H.R. 1207, the popularly titled Audit the Fed bill, which repealed all of the current statutory restrictions on the GAOs ability to fully audit the Federal Reserve. H.R. 1207 was introduced by then-Ranking Member of the Domestic Monetary Policy Subcommittee, Rep. Ron Paul. The bill was cosponsored by 320 Members of the House on both sides of the aisle and formed the basis of the audit provisions in the original House-passed version of what eventually became known as the Dodd-Frank Act. The Dodd-Frank GAO Audit of the Federal Reserves Emergency Lending Facilities Unfortunately, the final language of the Dodd-Frank Act as passed into law mandated only a one-time GAO audit of the Federal Reserveand then only of the procedural elements of its emergency lending facilities. The GAO was a given a year from the laws passage to issue both the required audit and a report on it. While the language enacted was much narrower in scope than the original House-passed audit requirement, the provision still constituted the first statutorily enacted directive authorizing the GAO to examine the Federal Reserves conduct of monetary policy. The Feds Emergency Lending Authority
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31 U.S.C. 714(b)
Section 13(3) of the Federal Reserve Act grants the Federal Reserve the authority to lend money to institutions under unusual and exigent circumstances. During the financial crisis, the Federal Reserve relied upon Section 13(3) to create several new lending facilities and to lend to non-depository institutions. The Dodd-Frank Act required the GAO to audit these emergency lending facilities that the Federal Reserve had operated between December 2007 and July 2010. The GAO evaluated the lending facilities and presented its 334 findings in an audit and report issued in July, 2011. The GAO report included the following information: (1) A description of the basis and purpose for the establishment of the programs, ostensibly to stabilize markets and institutions through liquidity programs. (2) An assessment of the Reserve Banks control over financial reporting and accounting. The GAO found no significant accounting, financial reporting, or internal control issues concerning the emergency programs. (3) An evaluation of the Reserve Banks policies and practices for the use, selection, and payment of vendors. The GAO found that the individual Reserve Banks would benefit from strengthened guidance for noncompetitive contracts awarded in exigent circumstances. (4) An evaluation of the policies for identifying and managing conflicts of interest for Reserve Bank employees, vendors, and members of Reserve Bank boards of directors. The GAO found that conflict-of-interest polices could be strengthened. (5) An assessment of the security and collateral policies in place to mitigate risk of losses. The GAO found risk management policies and practices for future emergency programs could be strengthened. (6) An examination of whether competing eligible participants were treated equitably. The GAO found that the Federal Reserve Board lacked guidance and documentation regarding decisions about granting access for some participants to the emergency facilities.
U.S. Government Accountability Office, Federal Reserve System: Opportunities Exist to Strengthen Policies and Process for Managing Emergency Assistance, GAO-11-696 (July 2011), available at http://www.gao.gov/new.items/d11696.pdf. Last accessed December 11, 2012.
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The GAO report also compiled much of the publicly available information that had been released by the Federal Reserve in December 2010 as required by Dodd-Franks disclosure provisions. The information was published on the Board of Governors website and included detailed information about individual transactions and the entities that had borrowed funds from the emergency lending facilities. That information was presented in spreadsheets for each program with thousands of entries each, which helped to coin the phrase Data Dump. The GAO tabulated the Federal Reserves total transaction amounts for its emergency lending facilities on both a term-adjusted, and non-term-adjusted, basis. Non-term-adjusted lending totaled more than $16 trillion, and term-adjusted lending totaled $1.1 trillion. The GAO found that large global institutions were among the largest recipients of the Federal Reserves emergency lending -receiving over 50 percent of the total dollar amounts provided by the Term Auction Facility and the Commercial Paper Funding Facility. Notwithstanding the data compiled and presented by the GAO, many argue that the audit mandated by the Dodd-Frank Act provided insufficient information regarding the decision-making and the amounts provided by the Feds emergency lending facilities. They point out that although the GAO audit examined the procedures and protocols that governed the lending facilities, it did not examine the actual lending transactions themselves and the individual evaluations and decisions the Federal Reserve made regarding them. In addition, the Dodd-Frank audit language also did not authorize the GAO to audit the Feds discount window or open market operations.335 The Future of Federal Reserve Transparency In addition to the one-time audit requirement, the Dodd-Frank Act contained other provisions that provide additional on-going transparency for the Federal Reserves operations. Under Section 1102, the GAO is authorized to audit any special credit facility created under the Federal Reserves emergency lending authority. The Federal Reserve under section 1103 must disclose information about discount window borrowing by a financial institution two years after a loan is made. Also under section 1103, the Federal Reserve
The Federal Reserve released data on some discount window and open market operations in March 2011, in response to Freedom of Information Act requests from Bloomberg News and FOX News. The Federal Reserve had initially refused to provide the information, and the news agencies sued to obtain the data.
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must disclose information about open market operations two years after a transaction occurs,336 and disclose information about borrowers from emergency lending facilities one year after authorization for that facility is terminated. Notwithstanding the provisions of the Dodd-Frank Act, the Federal Reserves subsequent and continued interventions in the markets long after the worst of the financial crisis passed led to calls for increased transparency. Among these interventions were the Federal Reserves quantitative-easing programs (so-called QE1 and QE2337); the Federal Open Market Committees announcement that it would sell $400 billion in short-term bonds in order to purchase longterm bonds (the so-called Operation Twist); the Federal Reserves swap agreements with foreign central banks; and its agreement with four foreign central banks to make unlimited dollar funding available to European banks. While the Dodd-Frank Act has made the Federal Reserve more transparent in regards to its mechanics, monetary policy operations and the decision-making criteria regarding them remain largely exempt from effective, much less timely, oversight. The unprecedented scope, novelty, and self-determined expansions of its authority evidenced by the Federal Reserves monetary efforts during the financial crisis and its aftermath have raised fundamental questions about Congresss ability to oversee the Federal Reserve -- and ensure that Federal Reserve officials are held accountable for their actions. The quantitative easing programs, for example, have raised concerns that the Federal Reserve may be purchasing bonds from favored institutions or that advance notice of the Federal Reserves buying programs may signal to market participants that they should purchase or sell certain assets to gain profits or avoid losses. The delay between the conduct of open market operations and disclosures about those operations also makes oversight of those operations difficult. The Federal Reserve is not required to disclose information about open market operations until two years after they take place. Because the last three major asset purchase programs have taken place over the last two and a half years, there are concerns that information about these programs will not be released
336Discount
window transactions and open market transactions that took place before the Dodd-Frank Act was enacted are exempt from these disclosure requirements. Except for the FOIA requests from Bloomberg and FOX News, these transactions would still be undisclosed. 337 As of December 2012, the Fed had begun further quantitative easing programs that were to purchase a total of $85 billion per month of mortgage-backed securities and Treasuries. These programs were referred to as QE3 and an extension of QE3 respectivelyalthough the term QE infinity had been used as well, since the Fed gave no end date for the programs.
in time for Congress to provide effective oversight of these programs. In addition, the Federal Reserve has opened swap lines with foreign central banks to provide dollar liquidity to foreign markets; however, the frequency with which these lines have been opened and the size of the swap lines haves led some to question whether the Federal Reserve is bailing out insolvent European banksultimately at U.S. taxpayers, savers, and consumers expense. Proponents of Federal Reserve independence believe that the conduct of monetary policy requires that the Federal Reserve be insulated from political influence. However, the large sums being lent and circulated by the Federal Reserve could affect the U.S. economy as well as holders of dollars and dollar-denominated assets. With such large sums and consequences at stake, Americans should be as worried about the Federal Reserves influence in picking winners and losers in financial markets. Given the significant effects that actions taken by the Federal Reserve have upon the economy, advocates of greater transparency continue to look for ways to increase accountability and oversight over the Federal Reserve. Of particular note was the passage of H.R. 459, the Federal Reserve Transparency Act, in the 112 th Congress, A reintroduced version of Rep. Pauls H.R. 1207 Audit the Fed bill from the 111th Congress, the bill passed with an overwhelming bipartisan majority of 327 to 98 in July 2012.
RANSCRIPT
The subcommittee met, pursuant to notice, at 10:05 a.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, Luetkemeyer, Huizenga, Hayworth, Schweikert; and Peters. Chairman PAUL. This hearing will come to order. Without objection, all members opening statements will be made a part of the record. This morning, we are holding a hearing entitled, Audit the Fed: Dodd-Frank, QE3, and Federal Reserve Transparency. I will yield myself 5 minutes for opening remarks. Transparency of the Federal Reserve has been an issue that I have been working on for many years, and I consider it very, very important, and we have been making some progress on this. Back in the 1970s, there was a major effort made to get more transparency of the Fed, but unfortunately it actually backfired and gave more protection to the Fed from any inquiries made by the Congress. One thing I would like to make clear is my efforts to have more transparency of the Fed arent equated to that of wanting Congress to manage day-to-day operations of the monetary policy. Quite frankly, I think managing of the monetary policy should be more involved with a free market, free market of interest rates, rather than anybody believing they can manage that from a day-to-day viewpoint. Frequently, it is said that the independence of the Fed must be protected at all costs. I usually think once there is an emphasis on independence of the Fed, it usually means the secrecy of the Fed, and it is quite a bit of a difference, but the Fed hides behind this independence so there is no political influence. But I think more people now are starting to realize that the Fed isnt truly independent from political influence because indirectly, and sometimes more directly, it is involved in political decisions or at
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least private and secret decisions made to serve some political interest. The Constitution is rather clear on if anybody is to have any oversight, it would be the Congress rather than the Executive Branch. The ability to do this, of course, has been hindered. The Congress created the Federal Reserve with the Federal Reserve Act of 1913, and therefore, obviously the Congress has something to say about it. Not only did they create the Fed, but they have changed the rules. Congress has passed laws giving instructions to the Federal Reserve, so clearly, Congress has the responsibility of oversight of the Federal Reserve. I think it is very interesting that one of the arguments for independence is that we cant allow the people to know what is going on with the banks; that if all of the sudden, we knew that a bank was having a problem, this would be bad information for the people to know. And then that is used as an excuse to prop up certain banks and make sure bailouts occur and that there is a lender of last resort, and there is no confusion or, otherwise, no correction that might be necessary. But in many ways, the Fed performs a function exactly opposite of what the SEC is supposed to do. The SEC is a regulator that is supposed to go in and look at the books and throw out some rules so that people know what is going on and get information out. It seems to me at least, that the Federal Reserve does exactly the opposite. The significance of monetary policy is really the overriding issue about the Federal Reserve, and what has happened since 1913 and actually what is happening today, because we are in the midst of a major crisis, and there are many of us who have come to the conclusion that the business cycle is very much related to monetary policy. So, if the business cycle is related to monetary policy, this should be of vital interest to all of us. If we connect the two, the Federal Reserve and the business cycle, then we see that recessions and depressions are a result of the business cycle. First, you have the boom and you have to have the correction, so you have to have the bust. The other important relationship of the Federal Reserve to what Congress does, and for too long, it has actually been symbiotic, the Congress has been negligent in oversight, but they have been very complacent about deficits being accommodated. If the Fed was not so accommodative and always buy the debt and keep interest rates artificially low, there would be a lot more restraints on the Congress. But as long as Congress wants to spend money and they dont want to
raise taxesthat is not popularand borrowing becomes difficult, then there is a better way from their viewpoint to do it, and that is just to allow the Fed to create money out of thin air, which for those of us who believe in less government is better than more government, whether it is warfare or welfare, we see that the Federal Reserve has a strong influence in allowing our government to grow. So I am very pleased to chair this hearing today, and I am very pleased to know that we are making progress. We didnt get a full audit last year, but we did get an audit coming out of the Dodd-Frank Act. We did get a lot more information, and today we are going to receive more information, as well as the court cases that have come about. So compared to even 4 years ago, a lot of progress has been made in the right direction, but from my view point, we have a long way to go. I have concluded my opening statement. Do any other members wish to make an opening statement?
[PANEL I]
Okay. We will then go ahead and start with our first panel. Our first panel consists of Ms. Orice Williams Brown, who has spent her 21-year career in civil service at the GAO office. She is currently the Managing Director of GAOs Financial Markets and Community Investment team. Her portfolio of work includes banking, securities futures, and insurance issues. Most recently, she has been responsible for leading much of GAOs work on the financial crisis, Treasurys Troubled Asset Relief Program, the Federal Reserve System and its emergency lending programs, and regulatory reform. Ms. Brown received her MBA with a concentration in finance from Virginia Tech. I now recognize Ms. Brown for her testimony.
STATEMENT OF ORICE WILLIAMS BROWN338 MANAGING DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE
Ms. BROWN. Thank you. Chairman Paul, members of the subcommittee, I am pleased to be here today to discuss our recent report on the Federal Reserves emergency programs. As you well know, the study was required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. It is the first comprehensive assessment of the Federal Reserves use of emergency authority under section 13(3) of the Federal Reserve Act in response to the recent financial crisis. It also covers a number of programs that
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[The prepared statement of Ms. Williams Brown can be found on page 1252.]
were carried out under sections 10(b) and 14 of the Federal Reserve Act. This morning, I would like to briefly highlight a few of our findings. First, we found that the Federal Reserve and its emergency programs were subject to a number of internal and external audits. None of these audits found material weaknesses, and when issues were uncovered, the reserve banks generally addressed the deficiency in a timely manner. However, we did find that some operational audits had not been completed until the emergency programs had been operational for over a year. Second, the New York Fed was the primary player in executing most of the emergency programs authorized by the Board of Governors and the Open Market Committee. However, one program, the Term Auction Facility, was executed across all 12 Federal Reserve Banks through their discount window operations. To implement and operate the various programs, the New York Fed used over 100 vendors to provide a variety of services, ranging from legal services to asset management. We found that most of the contracts were awarded noncompetitively and they were not recompeted after the period of exigency had passed. For a significant portion of vendor fees, Reserve Banks were reimbursed by program recipients or fees were paid from program income. Third, we found that while the Federal Reserve took steps to manage conflicts of interest, opportunities exist to strengthen its policies for employees, directors, and vendors. During the crisis, the New York Fed expanded its guidance and monitoring for employee conflicts. However, while the crisis highlighted the potential for Reserve Banks to provide emergency assistance to a broad range of institutions, the New York Fed had not yet revised its conflict policies and procedures to more fully reflect potential conflicts that could arise with this new, expanded role. Fourth, we looked at the Federal Reserves risk management practices. We found that it took steps to mitigate the risk of loss, such as requiring collateral amounts beyond the loan exposure for the early programs, and accepting only highly rated assets as collateral for some of the latter, more novel, programs. For actions to assist individual institutions, it negotiated specific protections. Over time, the New York Fed expanded its risk management capabilities and strengthened its management of risks across all programs. However, we found that neither the Reserve Bank nor the Board of Governors tracked total potential loss exposures across all emergency programs.
Finally, we found that while the Board of Governors took steps to promote consistent treatment of participants, it lacked guidance and documentation for some decisions. For example, Reserve Banks lacked documented procedures to guide decisions about restricting or denying access to the programs. We made seven recommendations to the Board of Governors to strengthen policies for managing noncompetitive vendor selections, conflicts of interests, risks related to emergency lending, and documentation of emergency program decisions. In response, the Reserve Board indicated that it recognized the benefits of our recommendations and would strongly consider how best to respond. In closing, I would also note that many of these programs were established at the height of the financial crisis, and little public information was provided initially. Over time, the Board of Governors and the New York Fed increased the amount of information provided to the public, and going forward, the Dodd-Frank Act requires even greater transparency and accountability for any future actions. Mr. Chairman and members of the subcommittee, this concludes my oral statement, and I will be happy to answer any questions at this time. Thank you. Chairman PAUL. Thank you very much.
[PANEL I QUESTIONS & ANSWERS]
I will yield 5 minutes to myself for questions. Overall, having done this audit and been involved, was there any one thing that you were more frustrated with? Was there any obstacle or misunderstanding or the law was confusing? Or was this a pretty clear-cut responsibility and there werent that many problems? How do you look at it in general? Ms. BROWN. In general, I would say that the Act laid out a pretty clear level of expectation for us in terms of what was expected, the programs that we were to cover, and exactly what aspects of the program and the operations of the programs that we were supposed to cover. So I would say it was fairly straightforward. Chairman PAUL. Okay. And this was a 1-year audit; you just have to perform this one time? Ms. BROWN. Correct. Chairman PAUL. Would there be much of a problem if we were doing this every year as far as accomplishing what you have done? What kind of a task is this? Ms. BROWN. This particular audit, while it was fairly straightforward, was an enormous undertaking given the number of emer-
gency programs involved. Going forward, ifone, we would have to keep in mind the current structure that we have around the future ability to perform perform audits. And Dodd-Frank includes in section 1102 some additional authority for us to look at any future credit facilities that the Fed may establish and also certain open market or monetary policy activities that are delineated in the Dodd-Frank Act. So if we were asked to audit those, we would look at any particular request in turn, and approach it very much the way we approach this. Chairman PAUL. And from your own experience, you have not had to look into the Federal Reserve in the way you did this time? Is this something rather unique for your experience? Ms. BROWN. Yes. Chairman PAUL. Many say that it is unnecessary to audit the Fed because they are already audited annually by an independent auditor. These audits are of the Feds financial statements and became a legal requirement in the late 1990s. Can you describe to us the difference between these financial audits that they would like to say, well, they are all inclusive and we know everything, versus an audit conducted by the GAOcould you describe the difference between the two? Ms. BROWN. Yes. GAO actually also does financial audits and we do performance evaluations, and the audit that we did and issued in July of 2011 falls under the program evaluation performance audit arena, and the biggest difference is that we in this were asked to look at specific operational issues. We were asked to look at the operational integrity issues like internal controls over the operations of the programs. We were also asked to look at how the programs were implemented and stood up. Financial audits tend to focus on ifwhether or not the financial statements are being fairly and accurately presented and the controls around the financial reporting. So it tends to be much broader and also more in-depth. Chairman PAUL. Along that line, I want to follow up with a similar question. The Dodd-Frank GAO audit has been described as a procedural audit. It seems that most of the analysis was looking at the protocol and guidelines in place for the various emergency lending facilities. What do we know about individual transactions? How were they conducted, how was collateral evaluated, and who all had knowledge and access to the facilities and those things in general? Are they included in the GAOs audit or were they not part of the directives given by the Dodd-Frank Act, especially on the individual transactions, and who knew about them and why they occurred?
Ms. BROWN. We were specifically asked to look at the operational aspects of the program, but that includes looking at certain individual transactions, specifically when it came to assistance to individual institutions. But in terms of looking at the broad-based programs, we did look at eligibility requirements. We looked at who the largest users were of the particular programs, and we also looked at how the decision was made from the perspective of who approved the particular emergency programwas it the Board of Governors, was it the Open Market Committeeand then how the particular Reserve Bank implemented the action that had been authorized by the Board of Governors or the FOMC. Chairman PAUL. Thank you. My 5 minutes has expired. So we will move on to the next member, the gentleman from Missouri, Blaine Luetkemeyer, for 5 minutes. Mr. LUETKEMEYER. Thank you, Mr. Chairman. One of the things that is concerning to me is the fact that all banks, credit unions, thrifts, what have you, they have some entity that provides oversight over them. And yet the Fed, which is the central bank basically, I guess you would say, of our country, has very little if any oversight over it, you know. And some of the things that you say here are the things that were notbecause of the prohibitions you were not able to go into. I think it is kind of interesting. Where do you think we need to draw the line on this? Ms. BROWN. GAOs position is that this is a policy decision, and wherever the line is drawn and the bar is set for us to do whatever action, we will do what Congress asks us to do. Mr. LUETKEMEYER. Okay. Along that line, with regard to the emergency loans that were done during the height of the situation we had in this country, you say in here that the Federal Reserve banks required borrowers in several programs to post collateral in excess of the loan amount, programs that do not require pledge assets with high ratings, etc., etc. Did you see in the way that they handled the loans, was it, in normal banking termsin other words, did they have the normal set of requirements for collateral excess over the loan they made, normal repayment terms, or what did you see there? Ms. BROWN. We did look at the security and collateral procedures around loans that were made and we evaluated the processes they had in place. And we found that they did have controls around those, that they did have requirements that certain loans be overcollateralized. And in other cases, there was a requirement that the collateral posted be highly rated. So there were certain controls that were built around the loans that were being made.
Mr. LUETKEMEYER. Did you see anything there that was of concern to you? Ms. BROWN. We didnt see anything that raised a major concern. We did point out that some of the internal audits that had been done had raised some questions around increasing the controls around the collateral, and we did look at the extent to which those had been addressed, and we found that at some point when an issue was raised, the bank would take steps to improve the controls that were in place. Mr. LUETKEMEYER. Have all of those loans been paid back? Ms. BROWN. For many of the broad programs, they have been. There are outstanding loans for the three Maiden Lane LLCs related to the assistance to Bear Stearns and AIG. Mr. LUETKEMEYER. Okay. The point I am going to try and get to here, though, is they havent all been paid back? Ms. BROWN. Correct. Mr. LUETKEMEYER. Your audit authority is over with; is that correct? Ms. BROWN. Correct. Mr. LUETKEMEYER. Therefore, at this point, there is no audit authority on those loans that have been paid subsequent to your audit or those that are yet to be paid; is that correct? Ms. BROWN. In all cases except for any that involve assistance to individual institutions. Mr. LUETKEMEYER. Do you think it would be a good idea if we went back and had a requirement to audit those whenever they are all paid off to see if everything is done according to sound financial tenets? Ms. BROWN. It is something that if we were asked to do, we would definitely do. Mr. LUETKEMEYER. That is a policy decision, right? Ms. BROWN. Yes. Mr. LUETKEMEYER. Okay. With regard to the open market operations of the Fed, one of the things it says here is that they are not required to disclose their operations until 2 years after they take place. How do you get ahold of information that is pertinent, that is time-sensitive, that we can actually get a good job of seeing everything that is going on here? If we cant do it within a 2-year timeframe, that seems almost beyond the ability to implement any sort of controls or corrections.
Ms. BROWN. We would note that in the audit that we did that was issued in July, it was done in many cases less than a 2-year time period. Mr. LUETKEMEYER. And one more quick question: With regard to the swap lines of things that they have with foreign banks, were you able to do anything at all with oversight of that? Were you able to look into any of the activities along those lines? Ms. BROWN. That was one of the specific programs listed under our authority in Dodd-Frank. Mr. LUETKEMEYER. What did you find? Ms. BROWN. We basically looked at how they were structured. We found that the Fed had engaged in a number of swap line transactions with foreign central banks, and the biggest takeaway was that once the Fed engaged in the swap with the foreign central bank, any activity of the central bankthe foreign central bank was really, from the Feds perspective, that was the central banks responsibility, and the foreign central bank assumed any credit risk from the activities that it engaged in. Mr. LUETKEMEYER. If the chairman will bear with me, just one more question. Do you see any risk to the Fed with the way it is structured right now? Ms. BROWN. That is one program that remains open, and the authority for that program is open through August of 2012. It was one of the programs that had been extended, and as with swaps, there is currency risk associated with currency swap-type of transactions. Mr. LUETKEMEYER. Okay. I see my time is up. Thank you, Mr. Chairman, for your indulgence. Chairman PAUL. Thank you. I now yield 5 minutes to Congresswoman Hayworth from New York. Dr. HAYWORTH. Thank you, Mr. Chairman, and thank you for conducting this hearing. Thank you, Ms. Williams Brown, for being with us. There is a notable statement in the GAO report that some Federal Reserve Board decisions to extend credit to certain borrowers were not fully documented. And I was wondering if you could elaborate on that. What sort of documentation would you like to have seen? Was there an explanation as to why the documentation was lacking? Ms. BROWN. In the area of documentation prior to Dodd-Frank, there wasnt an explicit requirement for the Fed to document its decisions. From an audit perspective, that often presents a challenge
in determining exactly what happened. So that requires us to have a number of conversations with the relevant players. But what we noted is, with the programs, there were generally broad eligibility requirements, and institutions that were generally considered to be in good financial condition were able to participate in a particular program. But to the extent that there were exceptions that didnt necessarily appear to coincide with the particular process in place, we had to have conversations to find out why things happened. One example is with the commercial paper lending facility. An AIG subsidiary was allowed to continue to participate in the facility, even though they no longer met the new requirementsand that is, that they had been an active participant in the commercial paper marketbut they were still allowed to participate in the facility. Dr. HAYWORTH. Is there further work ongoing to determine why that was allowed to occur or Ms. BROWN. No. Dr. HAYWORTH. So that now lies with us, I guess, here to Ms. BROWN. And we did make a recommendation to the Fed, going forward, that if they were to engage in credit facilities or any emergency lending in the future, that it is important to document decisions, and the Dodd-Frank Act now has a reporting requirement. So we pointed out that in order to fulfill that reporting requirement in the future, there is documentation that has to go along with the decision-making. Dr. HAYWORTH. In order to encourage Ms. BROWN. Report it. Dr. HAYWORTH. And presumably to encourage sound decisionmaking Ms. BROWN. Yes. Dr. HAYWORTH. so that we are not doing things that dont make sense fiscally. Ms. BROWN. Yes, that. And to be able to then report to the Congress what was being done and why. Dr. HAYWORTH. Thank you, Ms. Williams Brown, I appreciate that. Mr. Chairman, I yield back the remainder of my time. Chairman PAUL. I now yield 5 minutes to the Congressman from Arizona, Mr. Schweikert. Mr. SCHWEIKERT. Thank you, Mr. Chairman. Ms. Williams Brown, part of this is actuallyand my good friend from New York was almost touching on parts of this. First of all, on the emergency facilities, were you able to take a look at how well
documented the requests were, the systemization of the decisionmaking? And part of where I am leading on this is just your opinion, when you are playing auditor, if we were to have another hiccup, do they have mechanical rules and steps that are consistent? What did you see? Ms. BROWN. In the retrospective audit, there werent requirements for them to document specific decision points. So from that perspective, it required us to go back and attempt to reconstruct how decisions were made. Going forward, there are new requirements in terms of being able to report out that should help provide some additional structure around it, and that is one of the things that we also spoke to in some of our recommendations. Mr. SCHWEIKERT. I heard some discussions abouteven before some of the new requirements. But do they seem to now have been adopted in theif you and I were to lay out a flowchart and say, here is our decision-making process, with you and I also understanding this may be a process that sometimes has to be done very quickly. Ms. BROWN. Correct. Mr. SCHWEIKERT. But it also helps to know what checkboxes you are going through saying, okay, we have this, we have this, we have this. And from what you are seeing, have those documentation requirements, the new ones, been built into the system? Ms. BROWN. I will say that since July, we havent gone back to update the status of the recommendations that we made. So I cant say if they have addressed the recommendations that we made, for example, for a better documentation process. That is not something I am in a position today to say that they have or have not done those types of things. Mr. SCHWEIKERT. Okay. Mr. Chairman, Ms. Williams Brown, with thatbecause where I am sort of hunting is, how did they document what assets were being pledged future forward, what was being swapped, and how well that was locked in, saying, yes, you are pledging this, and once you have pledged it, you cant go and touch it anywhere else, and we also have the proper mechanics telling us any exposure, like are there any sort ofwhere these assets may have also lent out their value to other pledges? I am justI am trying to understand the decision tree, but also the quality of the documentation on assets pledged. Ms. BROWN. In terms of pledging collateral and tracking that, we did look at the control process around the collateral process, and we did specific drilldowns on two of the facilities that the borrowers
were able to pledge a wide variety of collateral for a single loan. And we did a drilldown to look at the collateral that was pledged, and we also did some independent evaluation and testing to make sure that those controls around those were operational. So there was a process around that. Mr. SCHWEIKERT. When you were looking at some of that, did you find some of the assets didnt reallyultimately, the market valueadd up to what they were put into the pledge? Ms. BROWN. We looked at the pricing of the collateral, and we found in a small percent of cases, somewhere around 2 percent, that there was some discrepancy in the price of the particular collateral that we tracked versus what was included in the data that we had gotten from the Federal Reserve. But we did not find any type of systematic bias one way or the other in terms of how that collateral had been priced. Mr. SCHWEIKERT. But only about 2 percent? Ms. BROWN. It was a fairly small percentage. Mr. SCHWEIKERT. I am surprised. And would some of that have been MBS, mortgage-backed securities, because of the way you would price it? Ms. BROWN. Right. I think it cut across a variety of other types of collateral that had been posted. Mr. SCHWEIKERT. Last one, and I am partially doing this from writing, and seeing if I can find it in my notes, and this one may be asking more of an opinion. The Inspector General for the Fed, I think, has also been given additional duties for the Consumer Financial Protection Bureau; almost wearing two hats, even though they are now separated. Any opinion on whether that works? Ms. BROWN. That is not something we have specifically looked at, so I am not in a position to offer an opinion. Mr. SCHWEIKERT. Gosh darn on that one. Mr. Chairman, I yield back my time. Thank you. Chairman PAUL. I thank the gentleman. I yield 5 minutes to the gentleman from Michigan, Mr. Huizenga. Mr. HUIZENGA. Thank you, Mr. Chairman, and I just want to express my appreciation for you holding this hearing. I think this is very important. I appreciate your time coming in as well, and I wont plan on using this full 5 minutes. But I am struck by the theme that we are hearing of a need for oversight, and I dont want to put words in your mouth, but that certainly is the tone that I am catching, that this is a good thing that
we shouldor that has happened. I think it is up to us, then, to decide whether this is something we should continue. It seems to me that we should. I am curious a bit about if you could talkand I apologize if you hadI had to step out for a phone call, but maybe you touched on this. I am wondering if you could talk a little bit about what some of the lending facilities were used by branches and subsidiaries of foreign banks, and were you really able to determine why several of those emergency lending facilities were primarily used by foreign institutions? I wonder if you could talk a little bit about that. Ms. BROWN. We did look at the largest users across the facilities, and we did find that there are certain facilities that tended to be used by the branches and agencies of foreign banks. And in conversations and following up with the Federal Reserve about the reason for that, we found that usually the largest lenders of facilities were driven by the composition of the market. So if it is a market that there were major foreign banks that had branches and agencies in the United States, they would have been as likely as a U.S. bank to tap a particular facility. Mr. HUIZENGA. And so that wasnt necessarily a region when you are saying that could be a product line or Ms. BROWN. Product line or a particular market that they were active in, because many of the broad-based programs were aimed at a particular disruption that was going on in a particular market. Commercial paper, some of the money market mutual funds had also experienced problems. Mr. HUIZENGA. Thank you. And could you characterize the ratio of domestic versus the foreign? Ms. BROWN. It really varies by program, and I would be more than happy to provide a breakdown for each facility for the record. Mr. HUIZENGA. That would be great. How many facilities, as you are using the term facility, how many facilities are there? How many breakdowns do you think that would be? Ms. BROWN. There wereI think it was somewhere in the 10 to 12 range. Mr. HUIZENGA. Okay. I would appreciate the follow-up on that. So thank you. Thank you, Mr. Chairman. I appreciate that and I yield back. Chairman PAUL. Thank you. And I now yield additional time to the gentleman from Missouri, Mr. Luetkemeyer, for a follow-up question.
Mr. LUETKEMEYER. Thank you, Mr. Chairman. I would like to follow up just a little bit more on the swap line discussion we had a little bit ago. Can you tell me how many times the line has been used, or is it just beyond thisnumber of times per dayor has it just been only 3 or 4 times in the last 6 or 8 months? Ms. BROWN. I am not sure that we tracked it by the number of times used, but we focused on the number of foreign central banks that were permitted to participate in the swap line. And there, would have been through the July timeframe. Mr. LUETKEMEYER. Do you have an idea of how many times that was? We had the Chairman in here not too long ago, and he indicated that there was almost zero activity. Ms. BROWN. I will say that when we issued our report, as of the end of June, the balance on the swap lines was zero at that time. So it may have been used and repaid. Mr. LUETKEMEYER. Okay. Looking at those transactions, did you see anything in there that would pose a risk to the Fed or, therefore, our taxpayers? Ms. BROWN. I think the potential forbecause the Fed would be swapping dollars for foreign currency, with an agreement that the foreign central bank would reverse the swap at the same rate that the otherto the extent that rates move, there is a potential risk built into. Mr. LUETKEMEYER. Did you see where it is a pass-through from other existing banks over in Europe through the central bank there, or was it just a direct swap through the European Central Bank? Ms. BROWN. It wasonce the swap happened with the particular central bank that the Fed engaged in swap activity with, the Federal Reserve didnt track what happened to those dollars once they were in the hands of the foreign central bank. Mr. LUETKEMEYER. Okay. So basically there is a firewall, then, between the transaction and wherever else those moneys would go to, those other dollars would go to? Ms. BROWN. Correct. Mr. LUETKEMEYER. Is that a fair statement? Ms. BROWN. I guess I am pausing on the firewall, but there is definitely a separation, yes. Mr. LUETKEMEYER. Okay. There is no tangible liability exposure to us from one of the other banks in Europe that is going to be passed through the European Central Bank? I guess that is a better way to put it.
Ms. BROWN. The Central Bank would assume that risk. Mr. LUETKEMEYER. Okay. So basically, then, there is no other risk that the Fed has assumed from those activities. Ms. BROWN. Right, beyond the swap. Mr. LUETKEMEYER. Okay. And the only risk that you see there is just the normal currency activity or the daily ups-and-downs of the value of the currency itself? All those other things in the transaction Ms. BROWN. There could potentially be others, but that was the one that immediately comes to mind. Mr. LUETKEMEYER. Has the biggest risk? Ms. BROWN. I would say that is the one that immediately comes to mind to me, and I do have a total on the number of transactions; 569, that is how many transactions there were. Mr. LUETKEMEYER. During what time period? Ms. BROWN. This would have been from the beginning of the program through June 29, 2011. Mr. LUETKEMEYER. Really? Okay. One more quick question. In your report, you indicate that there isthe GAO found that conflictof-interest policies could be strengthened. Can you give me an example of where there is a conflict of interest that you found, that there is a problem or exposure or concern? Ms. BROWN. We found a number that raised issues. They raised an appearance of a conflict, and one had to do with senior Federal Reserve Bank of New York officials. They held stock in some of the institutions that had received assistance. AIG was one example. Mr. LUETKEMEYER. Did you see a pattern with individuals or with particular companies, particular entities, like through AIG or other companies or other entities that were out there, that they were trying to work with? Ms. BROWN. I wouldnt say we observed any type of pattern. We observed with the vendors that there were situations that the Federal Reserve Bank of New York, for example, could have taken additional steps to strengthen their management of conflicts of interest that may have existed within vendors, and done additional oversight of what the vendors were actually doing to make sure that they werent exposed to conflicts. Mr. LUETKEMEYER. Okay. Very good. Thank you, Mr. Chairman. I appreciate the second round. Chairman PAUL. Thank you. And I now yield for follow-up question to Mr. Schweikert from Arizona.
Mr. SCHWEIKERT. And forgive me, I just want to make sure I was listening carefully to Congressman Luetkemeyer. On facilities that were with foreign central banks, was there a currency risk when the assets were moved back? Ms. BROWN. That issue really comes up on the dollar swap lines, because that is actually a swap of U.S. dollars for foreign currency, with the agreement to reverse the swap. Mr. SCHWEIKERT. It would be an unusual instrument to unwind it back to the value of the previous swap if there had been movement in the currency? That sort of defeats the purpose a bit. Ms. BROWN. It is the nature of the swap, that you agree to exchange the currency and reverse it at a particular price, at a particular date in the future. Mr. SCHWEIKERT. Okay. So there wasfrom what you were seeing, there was always a pledge on the value at the end Ms. BROWN. For the dollar swap line only. Mr. SCHWEIKERT. Yes, that is the only one I was interested in. Second of all, and I know this is a little on the annoying side, but if you would have one of your staff reach out to our office sometime in a couple of weeks, we would love to be able to chase down in writing as you were saying, it was 2 percent that you saw thatof pledged assets that you thought may have been outliers. And this is one of those occasions I have to go through my file cabinet and find an article from a couple of months ago that I think was talking about specifically private label MBS that may have been pledged, that may have been much further in the dispute of what its true value was. And I am just trying to get my head around having read one thing and now in testimony making sure I am using the same definitions today. Ms. BROWN. It is not only an issue of the same definitions, but this is something that could vary from facility to facility. And my comment was specific to two credit facilities; but this could actually be the case in one of the others. Mr. SCHWEIKERT. It absolutely would be that way. It would absolutely be that way. There were five hundred and some different ones, as I think I just heard you say Ms. BROWN. For the transactions for the dollar swap lines, yes. Mr. SCHWEIKERT. Okay. Last one is: Also, as long as we are asking to throw something into note, so that Inspector General comment beforeI know this really isnt your areabut I would love someone, if there is a policy statement somewhere in the agency in regard to whether this really works to have one Inspector General
doing both the Consumer Financial Protection Bureau and the Fed, even though they now wear very separate hats. And with that, Mr. Chairman, I yield back, and I thank you. Chairman PAUL. I thank you. Does anybody else have any followup questions? If not, I want to thank the witness for appearing. And also, without objection, your written statement will be made a part of the record, and you are now dismissed and the second panel may come to the table. Ms. BROWN. Thank you.
[PANEL II]
Chairman PAUL. We will now receive testimony from our second panel. Our first panelist, Dr. Robert Auerbach, is Professor of Public Affairs at the LBJ School of Public Affairs at the University of Texas in Austin. He was an economist with the House of Representatives Committee on Financial Services, formerly the Committee on Banking, Finance, and Urban Affairs, for 11 years. He assisted Chairman Henry Reuss in the 1970s and the 1980s and Chairman Henry Gonzalez in the 1990s with oversight of the Fed, spanning four Fed Chairmen: Burns; Miller; Volcker; and Greenspan. He is the author of the book, Deception and Abuse at the Fed: Henry B. Gonzalez Battles Alan Greenspans Bank. He received two masters degrees in economics, one from the University of Chicago and one from Roosevelt University under Abba Lerner. He received his Ph.D. in economics from the University of Chicago where he studied under Milton Friedman. Our second panelist is Dr. Mark Calabria who is the Director of Financial Regulation Studies at the CATO Institute. Prior to joining CATO in 2009, he spent 7 years as a member of the senior professional staff of the Senate Committee on Banking, Housing, & Urban Affairs, where he handled issues related to housing, mortgage finance, economics, banking, and insurance. Dr. Calabria has served as Deputy Assistant Secretary for Regulatory Affairs at the Department of Housing and Urban Development and has been a research associate with the U.S. Census Bureaus Center for Economic Studies. He is a frequent contributor to the New York Post, National Review, and Investors Business Daily, and frequently appears on CNBC, Bloomberg, Fox Business, BBC, and BNN. He received his Ph.D. in economics from George Mason University.
I would like to now recognize the second panel and also, under unanimous consent, your written testimony will be made a part of the record. So I recognize Dr. Auerbach.
STATEMENT OF ROBERT D. AUERBACH, PH.D.339 PROFESSOR OF PUBLIC AFFAIRS LYNDON B. JOHNSON SCHOOL OF PUBLIC AFFAIRS UNIVERSITY OF TEXAS AT AUSTIN
Mr. AUERBACH. Thank you very much, Chairman Paul and members of the subcommittee. I am honored to come back here where I worked for 11 years. One thing you left out: I also worked in the Reagan Administration, saying the same things, in between the periods I worked at the Treasury Department. I want to talk about transparency at the Fed. The Fed is the powerful central bank of the United States that controls the money supply, regulates the banking system, and since 1962 makes loans to foreign banks without congressional authorization. The historical record of Federal Reserve officials blocking transparency and individual accountability, including destroying source records of its policymaking committee since 1995, is clear. I want to especially thank Chairman Ron Paul and Senator Bernie Sanders for finally getting some kind of an audit at the Federal Reserve in the Dodd-Frank Act. In 1976, when I was here, I assisted Henry Reuss in putting up an audit bill of the Fed. The Fed immediately mounted a huge lobbying campaign using the bankers that it regulates to come to Washington and go into all the offices here and stop the audit. Chairman Reuss went to the Floor of the House later when we got direct evidence of how the Fed used their offices and their facilities to organize the bankers they regulate to come to the Congress and lobby. Finally, the bill was passed in 1978 down the hall at the Government Operations Committee with two glaring no-audit parts of the bill. One is anything to do with monetary policy or international transactions at the Fed. Let me just talk one moment about those two areas. In the monetary policy area, there are tremendous opportunities to make billions of dollars on inside information from the many leaks of Fed monetary policy which I helped the committee investigate for many years. Let me just give you one little taste of it.
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[The prepared statement of Dr. Auerbach can be found on page 1281.]
First of all, then-Chairman Greenspan said after a number of leaks, when the newspapers were publishing what they had said the previous day in their secret meetings, that we are beginning to look like a bunch of buffoons. They had at those secret meetings at the Kansas City Fed, where I used to work, central bankers from Bulgaria, China, the Czech Republic, Hungary, Poland, Romania, and Russia attending and listening to interest rate information that they would not give the Congress at that time. Finally, the Federal Reserve decided that they would not like to have any more public minutes of their central policymaking committee. That was Arthur Burns in 1976 from a law then that was being passed, Government in the Sunshine Act, and a suit from a student at a university in Washington, D.C. So the Fed voted then in 1976, a 101 vote, that they would no longer have any transcripts of their central policymaking committee, and it was a 10 1 vote and the 17-year lie began. Finally, in 1992 I came back for the second time, and I spoke with the great Henry B., as we called him in his district in San Antonio: How could it be that the most powerful central bank in the world had no transcripts of its meetings that they used to send out? What happened to them? So, Mr. Gonzalez had all the Fed Presidents come. All but two showed up. Chairman Greenspan sat in the middle, right where I am sitting, Members of the Board of Governors on each side, and they misled the Congress. We put a lot of heat on them because they were Federal witnesses, and a few days later the Cleveland Fed broke and said, well, they had had a meeting 4 days earlier where they just decided how they would mislead the Congress. One person at that meeting, a staff person, a very good staff person who used to work with me at the Kansas City Fed, but he was assisting Greenspan, said, the Chairman is not highlighting these transcripts. We are not waving red flags. And when Congressman Maurice Hinchey had asked him at the hearing right here, Do you have any records? Greenspan replied, just some notes we keep. After that, Greenspan sent a letter over here and said, this is 17 years later, we have those transcripts. I took a group of Republican and Democratic staffers over to the Board of Governors and found them right around the corner from Greenspans office neatly typed. So they decided then that they would start issuing the transcripts again after a 5-year lag, much too long for timely accountability. After I left the committee, and went down to Texas, I read that they had decided in 1995 to shred the records of the Federal Open
Market Committee. Those transcripts had been kept and sent to the National Archives, but they decided to destroy them. So I wrote a letter to Alan Greenspan asking why they were doing that, and his Vice Chairman, a very good person inside the Fedthese are good people; they just have bad policiesDonald Kohn, who worked there for many years and became Vice Chairman, started at the Kansas City Fed, he wrote to me saying yes, we decided to destroy the transcripts of the meetings, but we think it is legal. I just want to go through a few other things on the audits so you can get an idea of how bad the audits have been of the Fed, just two little points. One is the Los Angeles branch of the Kansas City Fed. You can ask me questions about it, when we found out that the auditing system there was corrupt. I took an excellent GAO team. Zoliason went in there and found that the system was completely corrupt. Greenspan admitted in a letter to the committee that they knew that the employees of the Fed had stolen at least $500,000 in the previous 10 years from the vault system of the 12 banks. One other thing, and then I will quit. The airplane fleet of the Fed, 50-plus airplanes, the audit there was a joke. There was no audit. The people running the fleet in Boston used to laugh about it. And they appeared here. Mr. Castle allowed them to come, and they were very courageous, and they talked about it right in the committee room here. Carolyn Maloney, Congresswoman Maloney, helped in investigating them. That was a completely corrupted thing. It was typified by their backup plane that the Fed paid for in Teterboro airport that didnt exist most of the time. That is all I am going to say about that. I have two other points. One is about paying off all the economists throughout academia on investigation of Henry B. Gonzalez; and what I consider malpractice, the present monetary policy of the Fed that was begun in October 2008 that has caused a lot of unemployment in the United States. Chairman PAUL. Thank you. We will go to Dr. Calabria now.
STATEMENT OF MARK A. CALABRIA, PH.D.340 DIRECTOR OF FINANCIAL REGULATION STUDIES CATO INSTITUTE
Mr. CALABRIA. Chairman Paul, distinguished members of the subcommittee, I thank you for the invitation to appear at todays important hearing.
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[The prepared statement of Dr. Calabria can be found on page 1291.]
As the subcommittee is well aware, the events of 2008 witnessed not only unprecedented disruptions to our financial markets, but also extraordinary responses on the part of our financial regulators and central bank. No entity was more deeply involved than the Federal Reserve System, particularly the New York Federal Reserve. Yet the Fed has consistently and repeatedly resisted efforts to bring accountability and transparency to its actions. Congress and the public repeatedly warned that if details of the Feds actions became public, further panic would ensue in our financial markets. Yet when that information, such as AIGs derivatives counterparties, finally did become public, disruptions were minimal or nonexistent. Despite some notable attempts by the Fed to increase its communications with the public, I believe, given its track record, the public cannot rely on the Fed to voluntarily provide us with sufficient information to monitor its activities and judge the effectiveness of its actions. While the requirements of the Dodd-Frank Act in relation to auditing the Feds activities are an important advance, they fall far too short of providing sufficient oversight of the Federal Reserve. What auditing has been conducted so far has been focused on the Feds response to the crisis. Accordingly, much of the audit requirements in Dodd-Frank have something of an historical feel about them. However, it is not enough just to get history right, although we are lucky if we do that, but also to ensure that future mistakes are avoided. I can think of few areas requiring as much mistake avoidance as monetary policy. The Feds role in helping to create the crisis via its easy money policies in the aftermath of the dot.com bubble and the events of 9/11 remain largely uninvestigated by Congress. If we truly wish to end financial crises, then I believe it is absolutely essential that Congress receive a full and objective evaluation of the Feds role in fostering the housing bubble, particularly as it relates to monetary policy decisions between 2002 and 2005. Disagreement as to the appropriate stance of current monetary policy I think also demonstrates Congress need for objective, independent analysis of monetary policy. Some might object that a GAO audit of the Fed subjects the Fed to political pressure. I think that such an objection ignores the simple fact that the GAO is not a political organization. As mentioned, I served as staff on the Banking Committee for a number of years. I can say through all of my interactions with GAO, they are independent, they are unbiased, they are nonpolitical. I have
not always agreed with the conclusions of GAO, but I have never felt that any of those disagreements were the result of politics or bias. I think the subcommittee should also keep in mind that GAO exists for a very simple reason: that no Member of Congress or their staff are fully knowledgeable about the functioning of all the various government agencies. GAO simply exists to inform. I would argue that there are few areas less understood than monetary policy and macroeconomics. Hence, I would argue there are few areas more in need of an audit than monetary policy and macroeconomics. Again, the purpose of GAO here is to try to provide some information so that Members can more actively engage, I think, and more effectively engage in oversight of the Federal Reserve. Another objection to a GAO audit of the Fed is that such an audit would compromise the Feds independence and subject it to political influence. I think such an objection confuses the very nature of Fed independence. The Feds authority to regulate the value of money is one that is delegated from Congress. As Congress can and has legislated changes to the Fed, it should be beyond a doubt that the Fed is not independent of Congress; it is quite the opposite. It is a creature of Congress, and Congress has every right in that avenue to interject and regulate the activities of the Fed itself. Setting aside the debate of the desirability and legitimacy of socalled independent agencies, it should be clear that their independence in any operational sense is supposed to be from the Executive Branch, not from Congress. It should also be clear, however, that in recent years, the Federal Reserve has coordinated its actions quite closely with the Treasury Department, in my opinion eroding any independence from the Treasury. The revolving door, both at the political and career levels, between the Federal Reserve and the Treasury Department further undermines the Feds operational independence. I believe a GAO audit would help shine light on this relationship, actually helping to insulate the Federal Reserve from continued interference by the Treasury Department. Again, the Dodd-Frank Act has made important advances in bringing transparency and accountability to the Federal Reserve. Unfortunately, it falls short in allowing Congress and the public to truly gauge the effectiveness of the Federal Reserve. In order to improve Federal Reserve transparency, I would suggest that Congress mandate a regular audit of all Federal Reserve activities, including monetary policy. Such audits could be performed in a manner so as to minimize the disruptions to any ongoing deliberations of the Federal Open Market Committee. For instance,
these audits could be kept confidential for a short amount of time, 6 months, a year. That is certainly something that could be done not to try to unduly influence ongoing activities, but again, this audit should be made public at some point. I think it is also important to emphasize that evaluating the effectiveness of any government agency is made all the more difficult when that agency faces a variety of competing and sometimes conflicting objectives. If the Federal Reserve feels it is free to abandon price stability in order to achieve other objectives, such as rescue the financial industry or misguided attempts to influence the labor market, then I believe the value of an audit may potentially be very limited. At a minimum, Congress should consider restricting the Federal Reserve to a single goal, that of price stability. Congress should also restrict the ability of the Fed to have discretion implementing that goal. On a very basic level, a central bank that is free to define price stability or define its own objective is a central bank without any meaningful constraints. With that, again, I thank the chairman, I thank the subcommittee, and I look forward to your questions. Chairman PAUL. Thank you very much.
Chairman PAUL. I yield myself 5 minutes for questioning. My first question is for Dr. Calabria. I want you to follow up I know you have talked about it in your statementon this relationship of the Fed and the Treasury. You indicate that if there is to be any oversight or connection, it is more with the Congress than with the Executive Branch and the Treasury. Could you talk a little bit more about that, and exactly what you mean? And what has happened in the past that might suggest that we should be looking into the relationship of Treasury and the Fed and how that could be a negative, or why some people think it is a positive? Mr. CALABRIA. There are a variety of different things. I will most directly touch on first the negotiation, implementation of DoddFrank. Treasury was the point person in negotiating Dodd-Frank for the Administration, yet several of the senior advisors at Treasury representing the Administration were staff on loan from the Federal Reserve. So again, I think many of us remember there was about a whole 5 minutes during the Dodd-Frank negotiations where maybe there really were going to be serious constraints on the Federal Reserve, where there would be a serious examination of the bank
supervision and regulatory powers. Again, I think the Congress and GAO should take a look at whether the Fed should be supervising banks in general, and whether that conflicts and provides any conflict of interest with the monetary policy decisions. But, having essentially Federal Reserve staff at Treasury negotiating on behalf of the Administration certainly, in my opinion, meant that there was going to be no chance that Congress was actually going to be able to peel back any of the powers of the Federal Reserve. So, again, the Treasury relies very heavily on Federal Reserve expertise and legislative decisionmaking. Most importantly, however, and it is important to keep in mind that Fed independence really came out of this Treasury-Fed accord where, prior to the 1960s, the Federal Reserve supported Treasury prices essentially and tried to maintain the price of long-term Treasurys in order so that the Treasury Department could more easily and more cheaply fund its activities. And again, if you have this relationshipand you see this particularly with the second round of quantitative easing where the amount that the Fed was purchasing on a monthly basis was coincidentally very close to the amount that was being issued by the Treasury. And so the extent that we go down that road of potentially monetarizing the debt, which I think is the ultimate concern, that you have the Treasury market supported by the Federal Reserve, which, of course, reduces discipline on not only the Treasury, but reduces discipline on Congress to get its fiscal house in order. So again, we rely on the markets to send us signals, and the Treasury market should be sending us a signal that we are headed towards a financial train wreck, but it is, of course, not, because the Federal Reserve is intervening in that market to reduce the price cycle that we would be receiving. So that is an important part of the debt market. I think it is ultimately one of the more important aspects of this, but, again, you also see it in financial regulation. I want to emphasize again the nature of independence is supposed to be not from Congress, but from the Executive Branch. There is a variety of literature, for instance, in economics that talks about a political business cycle where you would see the Federal Reserve try to loosen monetary policy in expectation of Presidential elections. Again, I would say that the empirical results in this literature are mixed, but, again, the emphasis is on the Administration. We know that in terms of any Presidents reelection, it is going to be far more important what the Fed does compared to what any Member of
Congress wants. So again, there are far different interests and far different incentives in Congress, where you have a unified incentive in the Executive Branch. So, I would emphasize again the importance is to draw some independence from the Executive Branch and the Federal Reserve rather than from Congress. Chairman PAUL. So just in summary, the way I understand that is when they talk about independence, they are really not talking about independence, they want to eliminate the role of the Congress, which you are arguing has a responsibility. So they want to be excluded from that supervision, but they dont want to be independent from the Treasury. What about political or private interest influence? When the bailouts came, there had to have been some special interests and political interests. Would thatcould that be said to be not independent either, but influenced by not only the Treasury, but outside interests? Do you think there is muchshould there be concern about that? Mr. CALABRIA. I think there should absolutely be strong concern about that on several levels. One could just look at monetary policy where monetary policy is conducted in partnership with the Federal Reserves primary dealers in which it buys and sells Treasury securities with to conduct its monetary policy. Of course, if you are doing bank supervision, you have a financial crisis, and these primary dealers find themselves in trouble, the Federal Reserve has an incentive to try to essentially make sure that those primary dealers survive. And, of course, it doesnt want to make any of that public. I am sure you could ask any of the largest firms that were assisted. Whether it was Goldman or whether it was Societe Generale, they have not welcomed the attention that they have gotten when all of this information has come out. We heard a little bit earlier about the GAO report. One of the things that struck me is that if you look through the tables and you look through the information in the GAO report, regardless of the program, it is the same companies that keep repeatedly coming up. Repeatedly we see Citi, repeatedly we see Bank of America, repeatedly we see Morgan Stanley. Regardless of the program, it seems to be that the concentration of the benefits of these programs are with a handful of corporations. And, of course, those corporations, I think, do not want the public attention that they have repeatedly received incredible assistance from the Federal Reserve or credible assistance that has been off budget.
So again, that relationship and that revolving door, we have seen it. And again, this is something that was talked about in Dodd-Frank, some of the governance issues. We all remember very much the role of Goldman essentially being the Chair of the Board at the New York Fed and some of the conflict of interest there. And certainly those were saying that the current president of New York Fed is a former Goldman employee. So not only am I concerned about the revolving door between Treasury and the Fed, I am also very concerned about the revolving door between Wall Street and the Fed. Chairman PAUL. Thank you. I yield 5 minutes to Mr. Luetkemeyer from Missouri. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Dr. Auerbach, in your testimony you mentioned two or three things; the L.A. Fed whenever there was some corruption exposed, and some folks stole some money, the Federal airplanethe Federal Reserve airplane fleet. The audits that are being performed or should be performed, would they have caught these abuses? Mr. AUERBACH. Did the audits have abuses? Mr. LUETKEMEYER. Would the audits that are being proposed in other words, right now we have the Inspector General folks, or GAO, they are now doing the audit on the emergency loan program that was administered. Mr. AUERBACH. Right. They dont touch any of these. Mr. LUETKEMEYER. You are saying we should expand Mr. AUERBACH. Definitely. Mr. LUETKEMEYER. audit procedures because existing auditing procedures are not catching these things? Mr. AUERBACH. Definitely. There are tremendous problems inside the Fed, and the in-house audits were no good at the Boston Fed. The courageous people there who testified right here about it said that someone came from upstairs at the Boston Fed near the harbor. Officials of the Fed are at the top; the people who run the airplane fleet were down below. Someone came down asking, is everything all right here? That was about the extent of the in-house audit. There were all kinds of corruptions, and so many corruptions that Henry Gonzalez, the Chairman, asked me to call the Janet Reno Justice Department, which I did, and they didnt want to get into it. Nobody likes to attack the Fed in Washington. So they said, call the Inspector General at the Fed, which I did, a very nice man, Brent Bowen, and he said, I dont know if I have jurisdiction up in Boston. And that is one of the major problems of the Fed and this new consumer protection agency that is located inside the Fed. The IG of
the Federal Reserve is appointed by the head of the Federal Reserve, so how can they investigate these things? Chairman Bernanke cannot be investigated, and his officials are the people they appoint. This should be a Presidential appointment and an independent IG at the Fed, if you want to start cleaning up this mess. Mr. LUETKEMEYER. Do you think there is anything that should be off limits whenever it comes to disclosure of the Fed activities? Mr. AUERBACH. That is a very interesting question, because the Fed is now shredding their documents. But Arthur Burns, who was the head of the Fed back in the 1970s, he died in 1987, and he sent his transcripts of the meetings up to the University of Michigan, the Ford Library. They had people from the National Archives, professional archivists who took out anything that had to do anything with national security, personnel. They were lightly edited. So I was able to go up there and get copies of them all. They are very different from the kind of thing that the Fed issues. Ask any reporter who has received something from the Fed; it is mostly blanked out. This was a much better record. What should be done now is that the Fed should be told that they cannot destroy those records. The records go to the National Archives after 30 years. There will be somebody looking at that. And also on the FOIA requests, you should get professional archivists who know the rules in cooperation with the Fed instead of sending reporters blank pages. Mr. LUETKEMEYER. Dr. Calabria, what do you think about that? Are there some things that you believe should not be disclosed or are off limits, or do you think everything is open to everybody? Mr. CALABRIA. I think the way I would look at it is the question of when should it be disclosed. Ultimately, any sort of deliberations, any sort of economic forecasts should be disclosed at some point. I would be comfortable having some sort of time lag. For instance, one of the things that Dodd-Frank does, and I think does correctly, despite much of what the bill doesnt do correctly, is require a disclosure of future discount window lending. And so the concern for the Federal Reserve would be if you disclose at the time that banks are coming to the discount window, that is a signal that such banks are weak, and I think that is a legitimate concern to raise. But I think if youand again, in Dodd-Frank it allows up to a 2year delay for that disclosure. I would prefer something closer to a year, but I doI would say a 6-month, a year delay on something like discount window is legitimate in that it will not scare away people from using a discount window. Of course, we could have a totally
separate discussion of whether this should be a lender of last resort in a discount window. But again, if you are going to have one, and you want it to be effective, a delay in disclosure in that, I think, is reasonable. A delay on disclosure on deliberations at the Federal Open Market Committee meetings, I think, is again reasonable. Ultimately, in a timely basis, all of this information should be made public, and I want to emphasize 5, 10 years is not timely. So again, we need to get it out in a reasonable amount of time. Mr. LUETKEMEYER. Thank you. I yield back, Mr. Chairman. Chairman PAUL. I thank the gentleman, and we will go into a second series of questions. This question is for Dr. Auerbach, and it has to do with what you talked about when you were trying get an audit in the 1970s, and you didnt get too far in the Banking Committee even though it was the chairman of the Banking Committee who wanted to do it. Then they took it and they sent it over to the Government Operations Committee. And then when they gave the authority for the audit, it was actually exactly the opposite and closed that. I want you to expand on that. And also, why dont you tell me why it is that the individuals either in the Fed or see to it that their people get in the Fed, how come they have this much power that they are able to control even the Banking Committee chairman and then pass legislation exactly opposite of it? I think it was at that time that they really put into it toseems like where the greatest protection is on these foreign operations, I think that is where there is a lot of mischief, and even now with our partial audit, we hear about it, but we dont know exactly what transpired. Could you expand on that a little bit? Mr. AUERBACH. Sure. Let me take the second part first on international operations. You were right about the bill that was finally passed where the GAO is not allowed to go into anything that has to do with the operations, international operations, or monetary policy, trophies that remained on the shelf of the Fed for a long time. In international operations, when the Fed goes, for instance, and notifies brokers all over the world, brokers who are not investigated by anybody in the United States, and tells them, we want to buy, say, 5 billion in euros, that information is given to the brokers ahead of time. I am not saying the brokers are dishonest, but when there are billions at stake in these markets, they can place orders, or people in their office can place orders, long before the order is consummated.
The chairman wrote to Alan Greenspan and asked, Why are you doing this? Why not just make an announcement that you are going in with 5 billion and let everybody in the market get in on it at the same time? And he wrote back, I think there is only about a 10minute delay between the time we tell them to do it and they make these huge purchases. That is ample time to make a lot of money in the market. And so, the international operations should be audited by the GAO. It is really important, and I think when the Fed is going to do something, they should announce it. I disagree a little bit with Dr. Calabria. I would not leave these decisions for discount rate changes and for anything the Federal Open Market Committee does for more than 6 monthseven that is very longbecause there have been so many leaks at the Fed. The FBI has been called in, all the rest. It is going to leak out anyway. There are several ways it leaks out. One is when we asked how many people at the Fed know about these secret interest rate decisions, we got a whole bunch of pages, single-spaced, of hundreds of people all over the country on these conference calls. And as Greenspan reported, he was saying he opens the Singapore edition of the Wall Street Journal and found out what the Fed did at their meetings before. So you cant tie up information that is so valuable for months that just benefits inside traders. And those trophies, when they did go over and put them in there, it kept the GAO out of a lot of the problems. Can I say one other thing that I think is important? We have sitting in the audience Walter Charlton, who has had suits against the GAO since 1983 because the GAO has had a policy, alleged policy against older workers. I had excellent GAO people who were at the Los Angeles Fed who did the audits. They were excellent. They were old-timers at the GAO who knew how a central bank works, and knew what to get into and what to look at. The suits now in the courts all these years, some of them have been adjudicated. The suits allege that they try to get rid of the older people. In a recent suit, I gather that after a joint session of Congress, 200 were rehired by the GAO. But they try to get rid of the older people, people who are 55 or older, around there, and hire young people. And I know they hire young people, because I used to have lunch with David Walker when he came to the LBJ school to get some of our excellent young students, but that lowers the amount they have to pay the people by a huge amount. But what we need in the GAO are experienced auditors who know how central banks work and can get in there and really find out what
is going on. That takes a lot of training to find out how to audit a vault facility. The vault facility, since we found that team that was in there that I worked with, was excellent. They found out what was missing. It was just awful. The main ledger, the vault on the computer, everybody could get in there without a password. What happened to those officials when that went public? Nothing has happened since then at the Fed. I think it is very important to get better GAO auditorsnow, maybe they have themwho are experienced on how to audit a huge, enormous central bank with 20,000 employees. And they have vaults all over the country that hold all the money for the commercial banks, and the Bureau of Engraving ships it there. All the new money is in there also. It is a national security problem, and if Greenspan thought that the employees were stealing $500,000 in 10 yearswe thought that was a tremendous understatement and so did the GAO crewbut I believe shortly thereafter, most of them were no longer at the GAO. Chairman PAUL. Thank you. I yield 5 minutes to Mr. Luetkemeyer. Mr. LUETKEMEYER. Thank you, Mr. Chairman. I have a feeling that both of you gentlemen have a lot more to say and a lot more suggestions for us, so I think I will just use my time a little differently this time. Dr. Calabria, you were the Director of Financial Regulatory Studies. What one regulation would you suggest would be impactful. Audit the full Fed? Is there something else that you see that would really protect our monetary system and really make an impact? What would be your suggestion? Mr. CALABRIA. I think the focus really needs to be on defining and limiting the discretion for the Fed on price stability. So, again, you can do things like reduceeliminate the dual mandate, having some sort of inflation targeting. I would emphasize that ultimately what is going to be a constraint on the Fed is some sort of competition, so obviously encouraging alternative monetary mechanisms is something we should be looking at the in the long run, but certainly trying to find a way to constrain the Fed. So I would have a full audit. I would get rid of the dual mandates. I would put some statutory flesh around what exactly price stability means, because again, you can get rid of the dual mandate, but if the Fed decides that price stability is 3 or 4 percent, it
doesnt really matter. You have to take some of these definitions back into Congress. And again, I want to emphasize one of the reasons I think the Federal Reserve has been so effective over the years at thwarting Congress is that they come up here and they give you all this gobbledygook about M1, M2, and all this, and they try to confuse you. Again, the most important thing is to get information out there so that Members of Congress can even start with the very right questions and can push them and basically not let them get around that. So the most important thing we can do is educate Congress and the public on how exactly monetary policy works. Mr. LUETKEMEYER. Very good. I asked for one, and got three. Must be D.C. Thank you. Dr. Auerbach, with regard to the same question, you have had a lot of advice for us in some of your previous comments here. What piece of advice or regulation would you suggest? Mr. AUERBACH. Price stability is certainly important, but the Fed should understand it is the 1949 Employment Act that said they have to do full employment also; that price stability helps produce full employment. And right now we have quite a bit of inflation. Year over year, 1 month it was 4 percent, then 5 percent. Then Chairman Bernanke testified that he doesnt see any inflation. How high does it have to go before he sees it? That is year-over-year inflation. The other thing that I think that Congress should have something to say about is what I call malpractice at the Fed. In September 2008, when Lehman Brothers collapsed and the markets went crazy all over the world, one month later, the Fed decided that they would start paying the banks interest in order for them to hold their reserves. I have that diagramI wonder if you would put it upof the amount ofthere it is. The amount of excess reserve. You will notice that sincethis is the Federal Reserve of St. Louis. It is zero. All of a sudden in 2010, the banks are intelligent. They say, look, we can get a quarter percent interest risk-free from the Fed; why should we loan it to businesses? So the Fed begins pumping in their monetary base, they pumped in $1.9 trillion. How much of that got out for loans to banks and to businesses? $1.7 trillion was parked as excess reserves. It is there today. The total today is $1.6 trillion in excess reserves. It went through the roof. We are in a position today where people inside the Fed, economists inside the Fed, like William Gavin, a great economist at the St.
Louis Fed, published in their literature for the banks it is a much better investment to hold the money as excess reserves, tie it up, than to lend it out to people, because they get a quarter percent for sure, and we are in a terrible environment. What should be done immediately? I call this malpractice. It has certainly increased unemployment in the United States. The Fed must stop paying the banks to hold reserves instead of lending it to businesses. And if they do that, they have to be very careful that the money supply doesnt balloon out or we will have a huge inflation. They will have to slightly raise their target interest rate to about a half percent. They should be doing that. They have been at zero long enough, and you can see what good that has done for the country. Mr. LUETKEMEYER. Thank you very much. I yield back. Chairman PAUL. Thank you. I have one more question for the two of you. We talk about the transparency, and how to get information out, and how dangerous it is if someone gets the information, they can make some money on it because they anticipate what the market will do. And also, there is so often the unintended consequences of manipulating what they do, the economic consequences. And we talk and discuss, and there was a slight disagreement on exactly when we release information, when did the Fed do this, and when do we get a record of the history. My question is a little bit different. It has actually to do with monetary policy per se, not how we tellhow the Fed manages monetary policy. My viewpoint, they have had two mandates, full employment, and I dont think either one of you enjoy that. If you really look at the old-fashioned way of measuring it, it is probably over 20 percent. Dr. Auerbach admitted that price stability, they are not doing very well there. But I got the indication from both of you that it wasnt the principle of setting the interest rates, it is how they do it, and when it is released, and the details of it. But what about the question of whether or not they should be messing around with interest rates? Most economists these days, ever since the 1970s, they have played down wage and price controls. Wage and price controls arent very good as a solution to solve the problem of price inflation created by too much money. But setting interest rates is a pretty big deal. If interest rates if prices are the signal that tells the businessman what to do and the consumer what to do, the supply and demandand, of course, freemarket economists predicted that socialism would absolutely fail without a pricing structurewhy is it that we have accepted this idea that the Fed is all-knowing with their record?
So could you each tell me, do you think it would be bad to have a system where the Fed wasnt involved with setting interest rates, and maybe market rates would help? Maybe market rates would help savings. Maybe interest rates would go up, and the people who tend not to want to gamble in the stock market and the bond market, wouldnt this be a help to the economy? Could both of you make a comment about whether or not the Fed should be setting interest rates? Mr. AUERBACH. I think that is a really good question. In 1979, we had a little party right here in this room, and the new Chairman was coming on board. He was a very good Chairman, Chairman Volcker. And at that time, by 1980, the inflation of the United States was going over 13 percent. Interest rates went up over 20 percent. There were mass bankruptcies in the country. And Volcker was laughing with us and said to two of us from the University of Chicago, you give me a pain in my you know what, and we laughed together. But then Volcker decided he wouldnt control interest rates, he would control the money supply and stop printing so much money, which he did. He paid a big price, but he stopped the country from going into a terrible inflation. I was in the Reagan Administration, and we had a double-dip recession, 10 percent unemployed, but then we had a long period of no inflation. So he did a great job, but we paid a terrible price. But when Alan Greenspan came in, the idea of controlling the money supply was considered, oh, that is University of Chicago monetarists, and they dont know what they are doing. So by the end of the 1980s, he decided the Fed would no longer target money. He would do what other central banks do: just target the interest rates. And I think they should do both. They should watch the money supply, but they should do what Congressman Paul said: try to let the interest rates go to market rates instead of sitting on them. Mr. CALABRIA. I would start by saying that I believe there is probably no more important price in the economy than the interest rate. You really do balance savings investment and you balance time preferences. Accordingly, when we get that wrong, we get a whole lot wrong, and you can have all sorts of disruptions to the economy. So ultimately, the answer should be a very strong no, we should not have the Fed manipulating what is the most important price in the economy. Chairman PAUL. I thank the panel for appearing. The Chair notes that some of the members may have additional questions for
the first and second panel of witnesses which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. This committee is now adjourned. {Whereupon, at 11:40 a.m., the hearing was adjourned.}
UESTIONS
FOR THE RECORD
[GAO] ADDENDUM TO THREE RESPONSES PROVIDED BY MS. ORICE WILLIAMS BROWN
The first is a clarification and amplification to my response to Rep. Leutkemeyers questions on the risk of the dollar swap line transactions to the Federal Reserve. As stated on p.19 of our report (GAO-11-696), in a typical swap line transaction, the Federal Reserve Bank of New York (FRBN[Y]) exchanged dollars for the foreign central banks currency at the prevailing exchange rate and the foreign central bank agreed to buy back its currency (to unwind the exchange) at this same exchange rate at an agreed upon future date. The foreign central bank would then lend the dollars to banks in its jurisdiction. Foreign central banks assumed the risk of losses on these dollar loans and paid FRBNY the interest collected on these loans. FRBNY did not pay interest on the foreign currency it received under the swap lines. To avoid difficulties that could arise for foreign central banks in managing the level of their currency reserves, FRBNY agreed not to lend or invest the foreign currency. However, as I noted at the hearing, in the unlikely event that a foreign central bank would fail to repay the dollars, FRBNY would be exposed to currency risk related to the foreign currency it held to collateralize the dollar swap transaction. For example, if a foreign central bank defaulted on a dollar swap line, the value of its currency held by FRBNY could decline significantly in value, exposing FRBNY to losses. The second item is a follow up to my response to Rep. Schweikerts question on GAOs opinion with respect to the Federal
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Reserve Inspector Generals additional duties to audit the Consumer Financial Protection Bureau (CFPB). While GAO has not specifically examined the Federal Reserve IGs new duties, we have commented on the consolidation of IG offices in our prior work (see GAO-02-575 and GAO-04-117T). As you know, the Dodd-Frank Act provides that the Federal Reserve IG shall have all the authorities and responsibilities provided by the Inspector General Act of 1978 (IG Act) with respect to CFPB, as if the Bureau were part of the Federal Reserve Board. This provision essentially consolidates the oversight of both the Board and the Bureau under one IG. In our prior report, Inspectors General: Office Consolidation and Related Issues (GAO-02575), we addressed the issue of consolidating IG oversight so that certain IG offices would have oversight authorities and responsibilities for a number of other federal agencies, much like the Dodd-Frank Act tasks FRB IG with the oversight of CFPB.. Our report stated that such consolidation would serve to enhance the overall independence, economy, efficiency, and effectiveness of the IG community. We also stated that consolidation of IG offices would serve to strengthen the ability of IGs to improve the allocation of human and financial resources. Our report added that any weaknesses associated with IG consolidation could be mitigated by providing an IG presence at each agency to plan oversight and provide adequate audit coverage. Therefore, the Federal Reserve IG would be expected to maintain a presence at CFPB to provide adequate oversight. Also, as our report explains, this type of consolidation is already being applied across the government with examples of the State Department IG providing oversight for the Broadcasting Board of Governors; the Agency for International Development IG providing oversight of the Overseas Private Investment Corporation and the Millennium Challenge Corporation; and the Transportation IG providing oversight of the National Transportation Safety Board. In addition, our report recommended that the Congress consider elevating the FRB IG to appointment by the President with Senate confirmation rather than appointment by the FRB Chairman . Finally, table 1 [Table 4] responds to Rep. Huizengas question on the usage of broad-based emergency lending facilities by entities with a foreign parent company. As I testified, the use by U.S. branches and agencies of foreign-owned banks varied by program. While there are eight broad-based programs, not all were used by entities owned by a foreign-parent company. The dollar swap lines were used by foreign central banks, for example.
Table 4
TATEMENTS

In his 1974 Nobel Prize address, the late Austrian economist Friedrich von Hayek attacked the pretense of knowledge, the idea that policymakers have sufficient knowledge and power to shape society as they wish. Our political leaders failed to take Hayek's message to heart, as succeeding generations have continued to allow this intellectual arrogance to continue unabated. Just as the New Mandarins squandered America's wealth, resources, and young men during the 1960s, today's economic Mandarins seem hell-bent on destroying every last vestige of the free market and driving the economy into ruin. Congress has abdicated its oversight over these expert economists at the Federal Reserve, to the detriment of the economic well-being of the American people. Despite overwhelming grassroots support behind auditing the Fed, only incremental progress has been made toward unmasking the Federal Reserve's activities. Full transparency of the Fed's operations remains an elusive goal, but one towards which I intend to devote my remaining time in Congress. The Fed has been given a monopoly by Congress to conduct monetary policy, and in so doing it tinkers with the most important price of all, the rate of interest. Interest rates reflect the price of time, and changes in the interest rate affect the structure of production. Forcing changes to the interest rate, as the Fed does, has a more pronounced effect on the economy than any law Congress has ever passed. Interest rates are used by individuals to make decisions
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about what type of investments they undertake, how much money they invest, and for how long. The higher the interest rate, the more likely an individual is to save money; the lower the interest rate, the less likely he is to save. Borrowers take the interest rate into account when borrowing money to buy a house, pay college tuition, or start or expand a business. The lower the interest rate, the cheaper it becomes to borrow money and the more likely individuals are to borrow; the higher the interest rate, the less likely they are to borrow. In a free market, some people will want to save while others will want to borrow, and the interest rate is the price that coordinates the actions of borrowers and savers. Manipulating the interest rate as the Federal Reserve does causes an enormous ripple effect throughout the economy. Most people do not think about how interest rates came to be, they merely make their economic calculations and decisions based on what the prevailing rate of interest is. Every day people go to work, buy and sell goods, and move their money in and out of the banking system. The isolated actions undertaken by individuals combine to create the market. The market is a truly awesome thing which most of us take for granted. No one marvels that bananas and oranges are available in supermarkets year-round, that cars from Germany and Japan travel our roads, or that our houses have electric lighting and indoor plumbing. Yet it was the actions of millions of people, each acting in his own self-interest and without any knowledge of how his actions might affect other people down the road, that resulted in each of those things happening. When government begins to interfere in that process, it leads to all sorts of problems. As we meet here in this hearing room, the Federal Reserve is engaging in the second coming of Operation Twist, attempting to force already-low interest rates even lower. This crisis was begun because of the Federal Reserve's low interest rate policy which distorted the economy by shuttling resources and investment that would have been better allocated elsewhere into the housing sector. Instead of recognizing the futility of trying to inflate our way to prosperity with artificially low interest rates, and allowing the interest rates to reset to a true, market-determined rate, and allowing prices to fall so as to allow malinvested resources to be put to better use, the Fed repeated the mistakes of the past by pumping more money into the economy. With an official inflation rate of nearly four percent, interest rates on savings accounts of well less than one percent, and a stock market that has stagnated over the past three years, there is no incentive whatsoever for consumers to
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save or invest. Money sitting in the bank a year ago would have lost nearly four percent of its value by now, money invested in the stock market just as much, and money invested in Treasury bonds over one and a quarter percent. Is it any wonder that people have decided to consume rather than to save? Savings and investment are required for economic growth, deferring present consumption in the hopes of gaining some greater future consumption. Imagine savings and investment in terms of wheat. Most of the wheat that is grown will be consumed after harvest, but a small amount will have to be saved for seed, in order to grow next year's crop. The more that is able to be saved for seed, the larger the crop will be in future years, enabling increased wheat consumption. What the Federal Reserve's actions are telling people is: don't save, there is no need. Consume that seed and don't worry about the future. And that is what this country has been doing for years. Capital is being consumed through the government's spurring of consumption, encouraging people to take on debt to fund frivolous spending and failing not only to increase present capital but also failing to replenish capital that is used up in the production process. This all leads us to the need for Federal Reserve transparency. Congressional oversight of the Fed amounts to about twelve hours of hearings per year, and that's as far as it goes. Of those twelve hours, no more than five or ten minutes goes to any one Congressman, who has the opportunity to ask at most one question of Chairman Bernanke every six months. To claim that this is effective oversight is laughable. Even the increased amount of data disclosure mandated by the Dodd-Frank Act, a relative sea change, is only due to be released two years after the fact. The legislative cycle in Congress is so fast that many of us up here do not even remember what took place two weeks ago, let alone two years ago. Trying to set up a hearing such as this one requires weeks, if not months, of advance planning. To imagine that two years after the fact Congress will really seek to dig into the details of the Federal Reserve's lending activities defies common sense. Two years ago the Fed was already well into its first round of quantitative easing, it has since completed a second round, and it is now embarking on a third intervention into bond markets. Attempting to audit the Fed through passage of new legislation is time-consuming as well. It took nearly a year and a half of effort to enact the few measures that made it into the Dodd-Frank Act. And this year my Audit the Fed bill has been referred, not to the Financial Services Committee as Fed audit bills have been for 40+ years, but to
the Oversight and Government Reform Committee. While I am hopeful that Chairman Issa will act on that bill, which has over 180 cosponsors, time is quickly slipping away for this Congress to act. While the Federal Reserve is not fully transparent, what is transparent are the effects the Fed's policy actions have on everyday people. A young couple is thrilled that interest rates are at historic lows so they take out a mortgage in order to buy the house they had always wanted. But as the Fed continues to print money in order to suppress interest rates, the price of food and heating begins to rise. Expenses rise faster than their paycheck, and they find themselves falling behind on their mortgage and eventually face foreclosure. Or imagine the elderly retiree dependent on Social Security and a small amount of savings. She has not received a cost of living increase to her Social Security in years, despite the ever-increasing cost of food and health care. Extended low interest rates mean that her savings account earns almost no interest each year, so her savings are rapidly depleting. She fears that within a couple of years she may be left with no money and no way to support herself. And then there is the single mother who has been laid off from work for the past 18 months because the rising prices of production inputs caused by the Fed's inflationary monetary policy forced her employer to downsize the company in order to reduce costs. And with prices for the company's finished goods continuing to rise as the Fed continues pumping new money into the economy, consumer demand has dropped, making it all the more likely that her company will never be able to rehire her. But rest assured, the Fed tells us, as long as the bankers are doing alright, everything will be fine. Indeed, the banks do appear to be doing fine. Flush with cash and receiving interest payments from the Fed on their excess reserves, the financial sector has continued to record amazing profits. Every time a new piece of disappointing economic data comes out, we hear renewed cries from Wall Street for more action on the part of the Federal Reserve. Amazingly, some people are complaining that the latest round of $400 billion in bond purchases is too small. The fact that a $400 billion operation, equivalent to half the size of the Fed's pre-crisis balance sheet, is considered paltry is a sad indicator of how easily so many Americans are willing to accept big government. Bailouts of the financial sector are the new normal, only now they are conducted covertly through the Fed rather than through Congressional action so as not to arouse public ire as in 2008. The Federal Reserve is a creature of Congress and should be treated as such, not as an organization exempt from Congressional
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oversight. Claims from the Fed and its defenders that a full audit of the Fed would endanger the Fed's independence are an attempt at provoking fears that Congress would directly intervene in the conduct of monetary policy. A bill that sets interest rates would endanger the Fed's independence; a bill that audits the Fed does not. Nowhere in any audit proposals has anyone ever expressed the desire that Congress dictate monetary policy or attempt to set interest rates. Congress does not have this power, nor should it, but it is accountable to the people through the ballot box; not so with the Federal Reserve, which tries to remain unaccountable both to Congress and to the American people. Pumping trillions of dollars into the economy with no oversight and accountability cannot be allowed to continue. Audit the Fed now.
ITNESS
ESTIMONY
WRITTEN TESTIMONY OF ORICE WILIAMS BROWN

MANAGING DIRECTOR FINANCIAL MARKETS AND COMMUNITY INVESTMENT GOVERNMENT ACCOUNTABILITY OFFICE
FEDERAL RESERVE SYSTEM: OPPORTUNITIES EXIST TO STRENGTHEN POLICIES AND PROCESSES FOR MANAGING EMERGENCY ASSISTANCE
Highlights of GAO-12-122T, a testimony before the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services, House of Representatives Why GAO Did This Study The Dodd-Frank Wall Street Reform and Consumer Protection Act directed GAO to conduct a one-time audit of the emergency loan programs and other assistance authorized by the Board of Governors of the Federal Reserve System (Federal Reserve Board) during the recent financial crisis. This testimony summarizes the results of GAOs July 2011 report (GAO-11-696) examining the emergency actions taken by the Federal Reserve Board from December 1, 2007, through July 21, 2010. For these actions, where relevant, this statement addresses (1) accounting and financial reporting internal controls; (2) the use, selection, and payment of vendors; (3) management of conflicts of interest; (4) policies in place to secure loan repayment; and (5) the treatment of program participants. To meet these objectives, GAO reviewed program documentation, analyzed
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program data, and interviewed officials from the Federal Reserve Board and Reserve Banks (Federal Reserve System). What GAO Recommends GAO made seven recommendations to the Federal Reserve Board to strengthen policies for managing noncompetitive vendor selections, conflicts of interest, risks related to emergency lending, and documentation of emergency program decisions. The Federal Reserve Board agreed that GAOs recommendations would benefit its response to future crises and agreed to strongly consider how best to respond to them. What GAO Found On numerous occasions in 2008 and 2009, the Federal Reserve Board invoked emergency authority under the Federal Reserve Act of 1913 to authorize new broad-based programs and financial assistance to individual institutions to stabilize financial markets. Loans outstanding for the emergency programs peaked at more than $1 trillion in late 2008. The Federal Reserve Board directed the Federal Reserve Bank of New York (FRBNY) to implement most of these emergency actions. In a few cases, the Federal Reserve Board authorized a Reserve Bank to lend to a limited liability corporation (LLC) to finance the purchase of assets from a single institution. In 2009 and 2010, FRBNY also executed large-scale purchases of agency mortgage-backed securities to support the housing market. The Reserve Banks and LLCs financial statements, which include the emergency programs accounts and activities, and their related financial reporting internal controls, are audited annually by an independent auditing firm. These independent financial statement audits, as well as other audits and reviews conducted by the Federal Reserve Board, its Inspector General, and the Reserve Banks internal audit function, did not report any significant accounting or financial reporting internal control issues concerning the emergency programs. The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4 million from 2008 through 2010 to help carry out their emergency activities. A few contracts accounted for most of the spending on vendor services. For a significant portion of the fees, program recipients reimbursed the Reserve Banks or the fees were paid from program income. The Reserve Banks relied more extensively on vendors for programs that assisted a single institution than for broad-based programs. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively,
primarily due to exigent circumstances. These contract awards were consistent with FRBNYs acquisition policies, but the policies could be improved by providing additional guidance on the use of competition exceptions, such as seeking as much competition as practicable and limiting the duration of noncompetitive contracts to the exigency period. To better ensure that Reserve Banks do not miss opportunities to obtain competition and receive the most favorable terms for services acquired, GAO recommended that they revise their acquisition policies to provide such guidance. FRBNY took steps to manage conflicts of interest for its employees, directors, and program vendors, but opportunities exist to strengthen its conflict policies. In particular, FRBNY expanded its guidance and monitoring for employee conflicts, but new roles assumed by FRBNY and its employees during the crisis gave rise to potential conflicts that were not specifically addressed in the Code of Conduct or other FRBNY policies. For example, FRBNYs existing restrictions on its employees financial interests did not specifically prohibit investments in certain nonbank institutions that received emergency assistance. To manage potential conflicts related to employees holdings of such investments, FRBNY relied on provisions in its code that incorporate requirements of a federal criminal conflict of interest statute and its regulations. Given the magnitude of the assistance and the publics heightened attention to the appearance of conflicts related to Reserve Banks emergency actions, existing policies and procedures for managing employee conflicts may not be sufficient to avoid the appearance of a conflict in all situations. As the Federal Reserve System considers revising its conflict policies given its new authority to regulate certain nonbank institutions, GAO recommended it consider how potential conflicts from emergency lending could inform any changes. FRBNY managed vendor conflict issues through contract protections and actions to help ensure compliance with relevant contract provisions, but these efforts had limitations. For example, while FRBNY negotiated important contract protections, it lacked written guidance on protections that should be included to help ensure vendors fully identify and remediate conflicts. Further, FRBNYs on-site reviews of vendor compliance in some instances occurred as far as 12 months into a contract. FRBNY implemented a new vendor management policy but has not yet finalized another new policy with comprehensive guidance on vendor conflict issues. GAO recommended FRBNY finalize this new policy to reduce the risk that vendors may not be required to take steps to fully identify and mitigate all conflicts.
While the Federal Reserve System took steps to mitigate risk of losses on its emergency loans, opportunities exist to strengthen risk management practices for future crisis lending. The Federal Reserve Board approved program terms and conditions designed to mitigate risk of losses and one or more Reserve Banks were responsible for managing such risk for each program. Reserve Banks required borrowers under several programs to post collateral in excess of the loan amount. For programs that did not have this requirement, Reserve Banks required borrowers to pledge assets with high credit ratings as collateral. For loans to specific institutions, Reserve Banks negotiated loss protections with the private sector and hired vendors to help oversee the portfolios that collateralized loans. The emergency programs that have closed have not incurred losses and FRBNY does not project any losses on its outstanding loans. To manage risks posed by these new lending activities, Reserve Banks implemented new controls and FRBNY strengthened its risk management function. In mid-2009, FRBNY created a new risk management division and enhanced its risk analytics capabilities. But neither FRBNY nor the Federal Reserve Board tracked total exposure and stressed losses that could occur in adverse economic scenarios across all emergency programs. Further, the Federal Reserve Systems procedures for managing borrower risks did not provide comprehensive guidance for how Reserve Banks should exercise discretion to restrict program access for higher-risk borrowers that were otherwise eligible for the Term Auction Facility (TAF) and emergency programs for primary dealers. To strengthen practices for managing risk of losses in the event of a future crisis, GAO recommended that the Federal Reserve System document a plan for more comprehensive risk tracking and strengthen procedures to manage program access for higher-risk borrowers. While the Federal Reserve System took steps to promote consistent treatment of eligible program participants, it did not always document processes and decisions related to restricting access for some institutions. Reserve Banks generally offered assistance on the same terms to institutions that met announced eligibility requirements. For example, all eligible borrowers generally could borrow at the same interest rate and against the same types of eligible collateral. Because Reserve Banks lacked specific procedures that staff should follow to exercise discretion and document actions to restrict higher-risk eligible borrowers for a few programs, the Federal Reserve System lacked assurance that Reserve Banks applied such restrictions consistently. Also, the Federal Reserve Board did not
fully document its justification for extending credit on terms similar to the Primary Dealer Credit Facility (PDCF) to affiliates of a few PDCF-eligible institutions and did not provide written guidance to Reserve Banks on types of program decisions that would benefit from consultation with the Federal Reserve Board. In 2009, FRBNY allowed one entity to continue to issue to the Commercial Paper Funding Facility, even though a change in program terms by the Federal Reserve Board likely would have made it ineligible. FRBNY staff said they consulted the Federal Reserve Board regarding this situation, but did not document this consultation and did not have any formal guidance as to whether such continued use required approval by the Federal Reserve Board. To better ensure an appropriate level of transparency and accountability for decisions to extend or restrict access to emergency assistance, GAO recommended that the Federal Reserve Board set forth its process for documenting its rationale for emergency authorizations and document its guidance to Reserve Banks on program decisions that require consultation with the Federal Reserve Board. [Testimony] Chairman Paul, Ranking Member Clay, and Members of the Subcommittee: Thank you for the opportunity to discuss our work on the emergency assistance the Federal Reserve System provided to certain financial markets and financial institutions during the financial crisis that began in summer 2007.341 From late 2007 through mid-2010, Reserve Banks provided more than a trillion dollars in emergency loans to the financial sector to address strains in credit markets and to avert failures of individual institutions believed to be a threat to the stability of the financial system. The scale and nature of this assistance amounted to an unprecedented expansion of the Federal Reserve Systems traditional role as lender-of-last-resort to depository institutions. In March 2008, the Federal Reserve Board cited unusual and exigent circumstances in invoking its emergency authority under section 13(3) of the Federal Reserve Act of 1913 to authorize a Reserve Bank to extend credit to nondepository
The Federal Reserve System consists of the Board of Governors of the Federal Reserve Systema federal agencyand 12 regional Reserve Banks. For this testimony, I use Federal Reserve Board to refer to the federal agency and Federal Reserve System to refer collectively to the federal agency and one or more of the Reserve Banks.
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institutions. For the first time since the Great Depression, a Reserve Bank extended credit under this authority. The Federal Reserve Board would invoke this authority on three other occasions within that month and on several occasions in late 2008 when the failure of Lehman Brothers Holdings Inc. (Lehman Brothers) triggered a severe intensification of the financial crisis. 342 The Federal Reserve Bank of New York (FRBNY), which operated most of these programs under authorization from the Federal Reserve Board, faced a number of unique operational challenges related to implementation and oversight for numerous emergency programs, many of which required large vendor procurements to fill gaps in Federal Reserve System expertise. To date, most of the Reserve Banks emergency loans have been repaid, and FRBNY projects repayment on all outstanding loans. My statement today is based on our July 2011 report.343 We completed this work in response to a mandate contained in Title XI of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Table 1 [Table 5] lists all programs covered by our review, including the broad-based programs and assistance extended to individual institutions. For these emergency programs or actions, where relevant, I will discuss (1) the Reserve Banks controls over financial reporting and accounting; (2) the Reserve Banks policies and practices for the use, selection, and payment of vendors; (3) the effectiveness of policies and practices for identifying and managing conflicts of interest for Reserve Bank employees, Reserve Bank vendors, and members of Reserve Banks boards of directors; (4) the effectiveness of security and collateral policies in place to mitigate risk of losses; and (5) the extent to which program implementation resulted in consistent and equitable treatment of eligible participants.
Lehman Brothers was an investment banking institution that offered equity, fixed-income, trading, investment banking, asset management, and other financial services. According to the bankruptcy examiner appointed by the bankruptcy court, Lehman Brothers originated mortgages, securitized them, and then sold the securitized assets. Although headquartered in New York, Lehman Brothers operated globally. Lehman Brothers had $639 billion in total assets and $613 billion in total debts as of May 31, 2008, the date of its last audited financial statements. 343GAO, Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance, GAO-11-696 (Washington, D.C.: July 21, 2011).
342
Table 5
To conduct the work for our report, we reviewed documentation supporting the Federal Reserve Boards authorizations for the emergency programs, Federal Reserve System documents and press releases describing the purpose of the programs, and other relevant program documentation, including announced terms and conditions. To assess Reserve Banks controls over financial reporting and accounting, we developed an audit strategy designed to leverage, to the extent possible, the audit work specific to the emergency programs performed by the Federal Reserve Systems external and internal auditors. For example, we reviewed the external auditors key audit documentation including audit strategy, planning, and accounting memoranda; internal control and account balance testing audit procedures and results; and summary memoranda. We evaluated the quality of this documentation against relevant auditing standards. To evaluate the Reserve Banks policies and practices for the use, selection, and payment of vendors, we analyzed Reserve Banks acquisition policies and guidance, vendor contracts, and vendor payment information. To evaluate the effectiveness of Reserve Bank polices and practices for managing conflicts of interest, we reviewed relevant Reserve Bank policies, including FRBNYs Code of Conduct, and relevant statutory prohibitions on conflicts of interest that apply to federal government and Federal Reserve System employees and federal government guidance for agencies management of employee conflicts of interest. To assess the effectiveness of security and collateral policies in place to mitigate risk of losses, we reviewed relevant documentation to identify key features of security and collateral policies and determine how these policies were designed to mitigate risk of losses for each emergency program. We obtained and analyzed documentation of steps taken by the Reserve Banks to develop risk governance structures and practices needed to manage the risks associated with the emergency programs. To examine the extent to which program implementation resulted in consistent and equitable treatment of eligible participants, we reviewed and analyzed documentation of the basis for the Federal Reserve Boards decisions about which types of institutions would be eligible to participate in the emergency programs. To determine the extent to which the Reserve Banks offered the same terms and conditions to all participants, which for some programs included financial institutions affiliated with Reserve Bank directors, we reviewed documentation of program terms and conditions and obtained and analyzed program transaction data. For parts of our methodology that involved the analysis of computerprocessed data, we assessed the reliability of these data and
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determined that they were sufficiently reliable for our purposes. For all objectives, we interviewed staff at the Federal Reserve Board, FRBNY, the Federal Reserve Bank of Boston, and the Federal Reserve Bank of Richmond. The work on which this statement is based was conducted from August 2010 through July 2011 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. Background The Federal Reserve Act of 1913 established the Federal Reserve System as the countrys central bank. The Federal Reserve System consists of the Federal Reserve Board located in Washington, D.C.; 12 Reserve Banks, which have 24 branches located throughout the nation; and the Federal Open Market Committee (FOMC), which is responsible for directing open market operations to influence the total amount of money and credit available in the economy. Each Reserve Bank is a federally chartered corporation with a board of directors. The Federal Reserve Act authorizes the Reserve Banks to make discount window loans, execute monetary policy operations at the direction of the FOMC, and examine bank holding companies and member banks under rules and regulations prescribed by the Federal Reserve Board, among other things. The Federal Reserve Board and the Reserve Banks are selffunded entities that deduct their expenses from their revenue and transfer the remaining amount to Treasury. 344 Federal Reserve System revenues transferred to Treasury have increased substantially in recent years, chiefly as a result of interest income earned from the Federal Reserve Systems large-scale emergency programs. To the extent that Reserve Banks suffer losses on emergency loans, these losses would be deducted from the excess earnings transferred to Treasury.
Between late 2007 and early 2009, the Federal Reserve Board created more than a dozen new emergency programs to stabilize financial
These excess earnings remitted to Treasury consist of Reserve Bank earnings after providing for operating expenditures, capital paid out in dividends to banks that are members of the Federal Reserve System, and an amount reserved by Reserve Banks to equate surplus with capital paid in.
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markets and provided financial assistance to avert the failures of a few individual institutions. The Federal Reserve Board authorized most of this emergency assistance under emergency authority contained in section 13(3) of the Federal Reserve Act.345 Three of the programs covered by this reviewthe Term Auction Facility, the dollar swap lines with foreign central banks, and the Agency Mortgage-Backed Securities Purchase Programwere authorized under other provisions of the Federal Reserve Act that do not require a determination that emergency conditions exist, although the swap lines and the Agency MBS program did require authorization by the FOMC. In many cases, the decisions by the Federal Reserve Board, the FOMC, and the Reserve Banks about the authorization, initial terms of, or implementation of the Federal Reserve Systems emergency assistance were made over the course of only days or weeks as the Federal Reserve Board sought to act quickly to address rapidly deteriorating market conditions. FRBNY implemented most of these emergency activities under authorization from the Federal Reserve Board. In a few cases, the Federal Reserve Board authorized FRBNY to lend to a limited liability corporation (LLC) to finance the purchase of assets from a single institution. The LLCs created to assist individual institutions were Maiden Lane, Maiden Lane II, and Maiden Lane III. In 2009, FRBNY, at the direction of the FOMC, began large-scale purchases of mortgagebacked securities (MBS) issued by the housing governmentsponsored enterprises, Fannie Mae and Freddie Mac, or guaranteed by Ginnie Mae.346 Purchases of these agency MBS were intended to provide support to the mortgage and housing markets and to foster improved conditions in financial markets more generally. Most of the Federal Reserve Boards broad-based emergency programs closed on February 1, 2010. Figure 1 [
Figure 38] provides a timeline for the establishment, modification, and termination of Federal Reserve System emergency programs subject to this review.
At the time of these authorizations, section 13(3) allowed the Federal Reserve Board, in unusual and exigent circumstances, to authorize any Reserve Bank to extend credit in the form of a discount to individuals, partnerships, or corporations when the credit was indorsed or otherwise secured to the satisfaction of the Reserve Bank, after obtaining evidence that the individual, partnership, or corporation was unable to secure adequate credit accommodations from other banking institutions. As a result of amendments to section 13(3) made by the DoddFrank Act, the Federal Reserve Board can now authorize 13(3) lending only through programs or facilities with broad-based eligibility.
345
Mortgage-backed securities are securities that represent claims to the cash flows from pools of mortgage loans, such as mortgages on residential property.
346
Figure 38
The Federal Reserve System and Its Emergency Activities Were Subject to Multiple Audits and Reviews The Reserve Banks and LLCs financial statements, which include the emergency programs accounts and activities, and their related financial reporting internal controls, are audited annually by an independent auditing firm. In addition, the Federal Reserve System has a number of internal entities that conduct audits and reviews of the Reserve Banks, including the emergency programs. As shown in figure 2 [Figure 39], these other audits and reviews were conducted by the Federal Reserve Boards Division of Reserve Bank Operations and Payment Systems (RBOPS), the Federal Reserve Boards Office of Inspector General, and individual Reserve Banks internal audit function. The independent financial statement audits and other reviews did not identify significant accounting or financial reporting internal control issues concerning the emergency programs.
Figure 39
Reserve Banks Would Benefit From Strengthening Guidance for Noncompetitive Contracts Awarded in Exigent Circumstances Reserve Banks Relied Extensively on Vendors to Establish and Operate the Emergency Programs, Particularly Those Designed to Assist Single Institutions From 2008 through 2010, vendors were paid $659.4 million across 103 contracts to help establish and operate the Reserve Banks emergency programs. The 10 largest contracts accounted for 74 percent of the total amount paid to all vendors. FRBNY was responsible for creating and operating all but two emergency programs and assistance and therefore awarded nearly all of the contracts.347 See table 2 for the total number and value of contracts for the emergency programs and assistance. As shown in table 2 [Table 6], the Reserve Banks relied on vendors more extensively for programs that assisted single institutions than for broad-based emergency programs. The assistance provided to individual institutions was generally secured by existing assets that either belonged to or were purchased from the institution, its subsidiaries, or counterparties. 348 The Reserve Banks did not have sufficient expertise available to evaluate these assets and therefore used vendors to do so. For example, FRBNY used a vendor to evaluate divestiture scenarios associated with the assistance to AIG. It also hired vendors to manage assets held by the Maiden Lanes. For the broad-based emergency programs, FRBNY hired vendors primarily for transaction-based services and collateral monitoring. Under these programs, the Reserve Banks purchased assets or extended loans in accordance with each programs terms and conditions. Because of this, the services that vendors provided for these programs were focused more on assisting with transaction execution than analyzing and managing securities, as was the case for the single institution assistance.
The Federal Reserve Bank of Boston entered into a single $25,000 contract for AMLF and the Federal Reserve Bank of Richmond entered into three contracts totaling $22.8 million for the Bank of America ring-fencing agreement. 348 Any loans made under the Bank of America or Citigroup ring-fencing agreements were to be secured by specified pools of assets belonging to each institution. However, no loans were extended under the programs.
347
Table 6
Reserve Banks Awarded Largest Contracts Noncompetitvely and Would Benefit From Additional Guidance on Seeking Competition Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively, primarily due to exigent circumstances. These contract awards were consistent with FRBNYs existing acquisition policy, which applied to all services associated with the emergency programs and single-institution assistance.349 Under FRBNY policy, noncompetitive processes can be used in special circumstances, such as when a service is available from only one vendor or in exigent circumstances. FRBNY cited exigent circumstances for the majority of the noncompetitive contract awards.350 FRBNY officials said that the success of a program was often dependent on having vendors in place quickly to begin setting up the operating framework for the program. FRBNYs policy did not provide additional guidance on the use of competition exceptions, such as seeking as much competition as practicable and limiting the duration of noncompetitive contracts to the exigency period. To better ensure that Reserve Banks do not miss opportunities to obtain competition and receive the most favorable terms for services acquired, we recommended that they revise their acquisition policies to provide such guidance. Vendor Fees Generally Came from Program Income or Participants From 2008 through 2010, vendors were paid $659.4 million through a variety of fee structures. For a significant portion of the fees, program recipients reimbursed the Reserve Banks or the fees were paid from program income. The Reserve Banks generally used traditional market conventions when determining fee structures. For example, investment managers were generally paid a percentage of the portfolio value and law firms were generally paid an hourly rate. Fees for these contracts were subject to negotiation between the Reserve Banks and vendors. For some of the large contracts that were awarded noncompetitively, FRBNY offered vendors a series of counterproposals and was able to negotiate lower fees than initially proposed.
FRBNY is a private corporation and not subject to the Federal Acquisition Regulation. Of the noncompetitive contracts we reviewed, FRBNY awarded three under the sole-source exception, when a service was available from only one vendor.
349 350
Opportunities exist to strengthen conflict policies for employees, directors, and program vendors During the crisis, FRBNY took steps to manage conflicts of interest related to emergency programs for its employees, program vendors, and members of its Board of Directors, but opportunities exist to strengthen its conflicts policies. During the Crisis, FRBNY Expanded Its Efforts to Manage Employee Conflicts Historically, FRBNY has managed potential and actual conflicts of interest for its employees primarily through enforcement of its Code of Conduct, which outlines broad principles for ethical behavior and specific restrictions on financial interests and other activities, such as restrictions on employees investments in depository institutions and bank holding companies, and incorporates the requirements of a federal criminal statute and its regulations. During the crisis, FRBNY expanded its guidance and monitoring for employee conflicts. However, while the crisis highlighted the potential for Reserve Banks to provide emergency assistance to a broad range of institutions, FRBNY has not yet revised its conflict policies and procedures to more fully reflect potential conflicts that could arise with this expanded role. For example, specific investment restrictions in FRBNYs Code of Conduct continue to focus on traditional Reserve Bank counterpartiesdepository institutions or their affiliates and the primary dealersand have not been expanded to further restrict employees financial interests in certain nonbank institutions that have participated in FRBNY emergency programs and could become eligible for future ones, if warranted. Given the magnitude of the assistance and the publics heightened attention to the appearance of conflicts related to Reserve Banks emergency actions, existing policies and procedures for managing employee conflicts may not be sufficient to avoid the appearance of a conflict in all situations. During our review, Federal Reserve Board and FRBNY staff told us that the Federal Reserve System plans to review and update the Reserve Banks Codes of Conduct as needed given the Federal Reserve Systems recently expanded role in regulating systemically significant financial institutions. In light of this ongoing effort, we recommended that the Federal Reserve System consider how potential conflicts from emergency lending could inform any changes.
FRBNY Primarily Used Contract Protections to Manage Risks Related to Vendor Conflicts, and the Lack of a Comprehensive Policy Created Certain Limitations FRBNY managed risks related to vendor conflicts of interest primarily through contract protections and oversight of vendor compliance with these contracts, but these efforts have certain limitations. For example, while FRBNYs Legal Division negotiated contract provisions intended to help ensure that vendors took appropriate steps to mitigate conflicts of interest related to the services they provided for FRBNY, FRBNY lacked written guidance on protections that should be included to help ensure vendors fully identify and remediate conflicts. Rather than requiring written conflict remediation plans that were specific to the services provided for FRBNY, FRBNY generally reviewed and allowed vendors to rely on their existing enterprisewide policies for identifying conflicts. However, in some situations, FRBNY requested additional programspecific controls be developed. Further, FRBNYs on-site reviews of vendor compliance in some instances occurred as far as 12 months into a contract. In May 2010, FRBNY implemented a new vendor management policy but had not yet finalized more comprehensive guidance on vendor conflict issues. As a result, we recommended that FRBNY finalize this new policy to reduce the risk that vendors may not be required to take steps to fully identify and mitigate all conflicts. Reserve Bank Directors Are Generally Subject to the Same Conflict Rules as Federal Employees and a Few Directors Played a Limited Role in Risk Oversight of the Programs Individuals serving on the boards of directors of the Reserve Banks are generally subject to the same conflict-of-interest statute and regulations as federal employees. A number of Reserve Bank directors were affiliated with institutions that borrowed from the emergency programs, but Reserve Bank directors did not participate directly in making decisions about authorizing, setting the terms, or approving a borrowers participation in the emergency programs. Rather FRBNYs Board of Directors assisted the Reserve Bank in helping ensure risks were managed through FRBNYs Audit and Operational Risk Committee.351 According to the Federal Reserve
FRBNYs Audit and Operational Risk Committee, which includes directors, is appointed by its Board of Directors to assist the board in monitoring, (1) the integrity of the financial statements of the Reserve Bank, (2) the Reserve Banks external auditors qualifications and independence, (3) the performance of the Reserve Banks internal audit function and external
351
Board officials, Reserve Banks granted access to borrowing institutions affiliated with Reserve Bank directors only if these institutions satisfied the proper criteria, regardless of potential director-affiliated outreach or whether the institution was affiliated with a director. Our review of the implementation of several program requirements did not find evidence that would indicate a systemic bias towards favoring one or more eligible institutions. Opportunities Exist to Strengthen Risk Management Policies and Practices for Future Emergency Programs The Federal Reserve Board approved key program terms and conditions that served to mitigate risk of losses and delegated responsibility to one or more Reserve Banks for executing each emergency lending program and managing its risk of losses. The Federal Reserve Boards early broad-based lending programsTerm Auction Facility, Term Securities Lending Facility, and Primary Dealer Credit Facilityrequired borrowers to pledge collateral in excess of the loan amount as well as other features intended to mitigate risk of losses.352 The Federal Reserve Boards broad-based programs launched in late 2008 and early 2009 employed more novel lending structures to provide liquidity support to a broader range of key credit markets. These later broad-based liquidity programs included Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, Commercial Paper Funding Facility, Money Market Investor Funding Facility, and Term Asset-Backed Securities Loan Facility. These liquidity programs, with the exception of the Term Asset-Backed Securities Loan Facility, did not require overcollateralization. To help mitigate the risk of losses, the Term Asset-Backed Securities Loan Facility, as well as the programs that did not require overcollateralization, accepted only highly-rated assets as collateral. In addition, Commercial Paper Funding Facility, Money Market Investor Funding Facility, and Term Asset-Backed Securities Loan Facility incorporated various security features, such as the accumulation of excess interest and fee income to absorb
auditors, (4) internal controls and the measurement of operational risk, and (5) the compliance by the Reserve Bank with legal and regulatory requirements. The Audit and Operational Risk Committee also assesses the effectiveness of (2), (3), (4), and (5). We use the term overcollateralized to refer to Reserve Bank lending for which borrowers were required to pledge collateral in excess of the loan amount. By using this term, we do not intend to suggest that the amount of excess collateral required was inappropriately excessive given the Federal Reserve Boards policy objectives.
352
losses, to provide additional loss protection. Also, for the assistance to specific institutions, the Reserve Banks negotiated loss protections with the institutions and hired vendors to help oversee the portfolios collateralizing loans. For each of the Maiden Lane transactions, FRBNY extended a senior loan to the LLC and this loan was collateralized by the portfolio of assets held by the LLC. JP Morgan Chase & Co. agreed to take a first loss position of $1.15 billion for Maiden Lane and AIG agreed to assume a similar first loss position for Maiden Lanes II and III. As of July 2011, most of the Federal Reserve Boards emergency loan programs had closed and all of those that had closed had closed without losses. Moreover, currently, the Federal Reserve Board does not project any losses on FRBNYs outstanding loans to Term Asset-Backed Securities Loan Facility borrowers and the Maiden Lane LLCs. Opportunities Exist for the Reserve Banks to Continue to Strengthen Policies for Future Emergency Programs To manage risks posed by the emergency programs, Reserve Banks developed new controls and FRBNY strengthened its risk management practices over time. In particular, FRBNY expanded its risk management function and enhanced its risk reporting and risk analytics capabilities. For example, in summer 2009, FRBNY expanded its risk management capabilities by adding expertise that would come to be organized as two new functions, Structured Products and Risk Analytics. Although FRBNY has improved its ability to monitor and manage risks from emergency lending, opportunities exist for FRBNY and the Federal Reserve System as a whole to strengthen risk management procedures and practices for any future emergency lending. Specifically, neither FRBNY nor the Federal Reserve Board tracked total potential exposures in adverse economic scenarios across all emergency programs. Moreover, the Federal Reserve Systems existing procedures lack specific guidance on how Reserve Banks should exercise discretion to restrict or deny program access for higher-risk borrowers that were otherwise eligible for the Term Auction Facility and emergency programs for primary dealers. To strengthen practices for managing risk of losses in the event of a future crisis, we recommended that the Federal Reserve System document a plan for more comprehensive risk tracking and strengthen procedures to manage program access for higher-risk borrowers.
While the Federal Reserve Board Took Steps to Promote Consistent Treatment of Participants, It Lacked Guidance and Documentation for Some Access Decisions The Federal Reserve Board and the Reserve Banks took steps to promote consistent treatment of eligible program participants and generally offered assistance on the same terms and conditions to eligible institutions in the broad-based emergency programs. However, in a few programs, the Reserve Banks placed restrictions on some participants that presented higher risk but lacked specific guidance to do so. Further, certain Federal Reserve Board decisions to extend credit to certain borrowers were not fully documented. The Federal Reserve Board Designed Program Eligibility Requirements to Target Assistance to Groups of Institutions Facing Liquidity Strains The Federal Reserve Board created each broad-based emergency program to address liquidity strains in a particular credit market and designed program eligibility requirements primarily to target significant participants in these markets. The emergency programs extended loans both directly to institutions facing liquidity strains and through intermediary borrowers. For programs that extended credit directly, the Federal Reserve Board took steps to limit program eligibility to institutions it considered to be generally sound. For example, Term Auction Facility loans were auctioned to depository institutions eligible to borrow from the discount window and expected by their local Reserve Bank to remain primary-credit-eligible during the term the Term Auction Facility loan would be outstanding. 353 For programs that provided loans to intermediary borrowers, the Federal Reserve Board based eligibility requirements in part on the ability of borrowing institutions, as a group, to channel sufficient liquidity support to eligible sellers. For example, eligible Term Asset-Backed Securities Loan Facility borrowers included a broad range of institutions ranging from depository institutions to U.S. organized investment funds. Federal Reserve Board officials told us that broad participation in Term Asset-Backed Securities Loan Facility was
The Reserve Banks extend discount window credit to U.S. depository institutions (including U.S. branches and agencies of foreign banks) under three programs, one of which is the primary credit program. Primary credit is available to generally sound depository institutions, typically on an overnight basis. To assess whether a depository institution is in sound financial condition, its Reserve Bank can regularly review the institutions condition, using supervisory ratings and data on adequacy of the institutions capital.
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intended to facilitate the program goal of encouraging the flow of credit to consumers and small businesses. While Reserve Banks Generally Offered the Same Terms to Eligible Participants, Some Programs Lacked Documented Procedures to Systematically Apply Special Restrictions The Federal Reserve Board promoted consistent treatment of eligible participants in its emergency programs by generally offering assistance on the same terms and conditions to all eligible participants. For example, institutions that met the announced eligibility requirements for a particular emergency program generally could borrow at the same interest rate, against the same types of collateral, and where relevant, with the same schedule of haircuts applied to their collateral. As previously discussed, for a few programs, FRBNYs procedures did not have specific guidance to help ensure that restrictions were applied consistently to higher-risk borrowers. Moreover, the Federal Reserve Board could not readily provide documentation of all Term Auction Facility restrictions placed on individual institutions. By having written procedures to guide decision-making for restrictions and suggestions for documentation of the rationale for such decisions, the Federal Reserve Board may be able to better review such decisions and help ensure that future implementation of emergency lending programs will result in consistent treatment of higher-risk borrowers. Our review of Federal Reserve System data for selected programs found that incorrect application of certain program requirements was generally infrequent and that cases of incorrect application of criteria did not appear to indicate intentional preferential treatment of one or more program participants. The Federal Reserve Board Did Not Fully Document the Basis for Extending Credit to a Few Affiliates of Primary Dealers The Federal Reserve Board did not fully document the basis for its decisions to extend credit on terms similar to those available at PDCF to certain broker-dealer affiliates of four of the primary dealers. In September and November of 2008, the Federal Reserve Board invoked section 13(3) of the Federal Reserve Act to authorize FRBNY to extend credit to the London-based broker-dealer subsidiaries of Merrill Lynch, Goldman Sachs, Morgan Stanley, and Citigroup, as well as the U.S. broker-dealer subsidiaries of Merrill Lynch, Goldman Sachs, and Morgan Stanley. Federal Reserve Board officials told us that the Federal Reserve Board did not consider the extension of credit to these subsidiaries to be a legal extension of
PDCF but separate actions to specifically assist these four primary dealers by using PDCF as an operational tool. Federal Reserve Board officials told us that the Federal Reserve Board did not draft detailed memoranda to document the rationale for all uses of section 13(3) authority but that unusual and exigent circumstances existed in each of these cases as critical funding markets were in crisis. However, without more complete documentation, how assistance to these broker-dealer subsidiaries satisfied the statutory requirements for using this authority remains unclear. Moreover, without more complete public disclosure of the basis for these actions, these decisions may not be subject to an appropriate level of transparency and accountability. The Dodd-Frank Act includes new requirements for the Federal Reserve Board to report to Congress on any loan or financial assistance authorized under section 13(3), including the justification for the exercise of authority; the identity of the recipient; the date, amount, and form of the assistance; and the material terms of the assistance. To address these new reporting requirements, we recommended that the Federal Reserve Board set forth its process for documenting its rationale for emergency authorizations. The Federal Reserve Board Generally Has Not Provided Documented Guidance to Reserve Banks on Types of Program Decisions That Require Consultation with the Federal Reserve Board In authorizing the Reserve Banks to operate its emergency programs, the Federal Reserve Board has not provided documented guidance on the types of program policy decisionsincluding allowing atypical uses of broad-based assistancethat should be reviewed by the Federal Reserve Board. Standards for internal control for federal government agencies provide that transactions and other significant events should be authorized and executed only by persons acting within the scope of their authority. Outside of the established protocols for the discount window, FRBNY staff said that the Federal Reserve Board generally did not provide written guidance on expectations for types of decisions or events requiring formal Federal Reserve Board review, although program decisions that deviated from policy set by the Federal Reserve Board were generally understood to require Board staff consultation. In 2009, FRBNY allowed an AIGsponsored entity to continue to issue to the Commercial Paper Funding Facility, even though a change in program terms by the Federal Reserve Board likely would have made it ineligible. FRBNY staff said they consulted the Federal Reserve Board regarding this situation, but did not document this consultation and did not have
any formal guidance as to whether such continued use required approval by the Federal Reserve Board. To better ensure an appropriate level of transparency and accountability for decisions to extend or restrict access to emergency assistance, we recommended that the Federal Reserve Board document its guidance to Reserve Banks on program decisions that require consultation with the Federal Reserve Board. The Federal Reserve Board Took Steps to Prevent Use that Would Be Inconsistent with Its Policy Objectives To assess whether program use was consistent with the Federal Reserve Boards announced policy objectives, we analyzed program transaction data to identify significant trends in borrowers use of the programs. Our analysis showed that large global institutions were among the largest users of several programs. U.S. branches and agencies of foreign banks and U.S. subsidiaries of foreign institutions received over half of the total dollar amount of Commercial Paper Funding Facility and Term Auction Facility loans (see fig. 3) [Figure 40]. According to Federal Reserve Board staff, they designed program terms and conditions to discourage use that would have been inconsistent with program policy objectives. Program termssuch as the interest charged and haircuts appliedgenerally were designed to be favorable only for institutions facing liquidity strains. Use of the programs generally peaked during the height of the financial crisis and fell as market conditions recovered (see fig. 4) [Figure 41]. Within and across the programs, certain participants used the programs more frequently and were slower to exit than others. Reserve Bank officials noted that market conditions and the speed with which the participant recovered affected use of the program by individual institutions. As a result of its monitoring of program usage, the Federal Reserve Board modified terms and conditions of several programs to reinforce policy objectives and program goals.
Figure 40
Figure 41
Concluding Observations During the financial crisis that began in the summer of 2007, the Federal Reserve System took unprecedented steps to stabilize financial markets and support the liquidity needs of failing institutions that it considered to be systemically significant. To varying degrees, these emergency actions involved the Reserve Banks in activities that went beyond their traditional responsibilities. Over time, FRBNY and the other Reserve Banks took steps to improve program management and oversight for these emergency actions, in many cases in response to recommendations made by their external auditor, Reserve Bank internal audit functions, or the Federal
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Reserve Boards RBOPS. However, the Reserve Banks have not yet fully incorporated some lessons learned from the crisis into their policies for managing use of vendors, risk of losses from emergency lending, and conflicts of interest. Such enhanced policies could offer additional insights to guide future Federal Reserve System action, should it ever be warranted. We made seven recommendations to the Chairman of the Federal Reserve Board to further strengthen Federal Reserve System policies for selecting vendors, ensuring the transparency and consistency of decision making involving implementation of any future emergency programs, and managing risks related to these programs. In its comments on our report, the Federal Reserve Board agreed to give our recommendations serious attention and to strongly consider how to respond to them. Mr. Chairman, Ranking Member Clay, and Members of the Subcommittee, this completes my prepared statement. I am prepared to respond to any questions you or other Members of the Subcommittee may have at this time.
WRITTEN TESTIMONY OF ROBERT D. AUERBACH, Ph.D.

PROFESSOR OF PUBLIC AFFAIRS LYNDON B. JOHNSON SCHOOL OF PUBLIC AFFAIRS UNIVERSITY OF TEXAS AT AUSTIN
Introduction Thank you Chairman Ron Paul, Ranking Member William Lacy Clay and members of the subcommittee for this opportunity to testify on transparency at the Federal Reserve. My name is Robert Auerbach. I am a Professor of Public Policy at the Lyndon B. Johnson School of Public Affairs at the University of Texas in Austin. On two separate occasions I had the honor to serve as an economist on the staff of this Committee (1977-81 and 1992-1997) and my 2008 book, Deception and Abuse at the Fed: Henry B. Gonzalez Battles Alan Greenspans Bank details the oversight investigations that I staffed while serving Committee Chairman Henry S. Reuss in the late 1970's and Committee Chairman/Ranking Member Henry B. Gonzalez in the 1990's. I have also served as an economist in the U.S. Treasury's Office of Domestic Monetary Affairs during the Reagan Administration and at the Federal Reserve System. The Fed is the powerful central bank of the United States that controls the money supply, regulates the banking system and, since 1962, makes loans to foreign countries without Congressional 354 authorization. The historical record summarized below, describing Federal Reserve officials blocking transparency and individual accountability, including destroying source records of its policymaking committee since 1995, leads to the following suggested remedies: Independent Inspector General: The Inspector General of the Federal Reserve should not be appointed by the chairman of the Federal Reserve Board as is currently the case. The IG should be a Presidential nominee whose credentials, abilities and independence are examined during a Senate confirmation process. Preserve Transcripts: The Federal Reserve should stop destroying the source transcripts and should stop turning off the recording system at its policy making committee, the Federal Open Market Committee (FOMC). This practice was
354
Auerbach, Deception and Abuse at the Fed, pp. 69 - 73. 1281
approved in 1995 by an unrecorded vote of the FOMC directed by then-Chairman Alan Greenspan.355 Provide Minutes to Congress: The minutes of the boards of directors meetings at the Federal Reserves 12 district banks and the transcripts of the meetings of the Federal Reserve Board of Governors and of the FOMC, should be sent to the House and Senate banking committees within six months of the meetings. Trained archivists at the National Archives and Records Administration should edit those records to remove prescribed items in cooperation with the Federal Reserve. Senate Confirmation of Bank Presidents: The 12 Federal Reserve regional bank presidents who are eligible to vote on the money supply as members of the FOMC should be confirmed by the Senate. The presidents wield enormous power as members of the FOMC and they should be fully vetted in the confirmation process. I want to commend full committee Ranking Member Barnie Frank for addressing the regional bank presidents role on the FOMC with H.R. 1512, although rather than removing them from the FOMC as proposed in the bill I would recommend Senate confirmation.
Fed Audits Chairman Ron Paul and Senator Bernie Sanders deserve great praise for their leadership in enacting the current Government Accountability Office (GAO) audit of the Federal Reserve as part of the Dodd-Frank Act. The Senate unanimously approved, by a 90 to 0 vote, the Sanders amendment to require disclosure of the recipients of the Fed's emergency loans. Hopefully this Congressional action set a precedent for fuller continuing audits of Federal Reserve operations. In 1976, House Committee on Banking, Finance and Urban Affairs Chairman Henry Reuss proposed a GAO audit of the Fed. The Fed orchestrated a massive lobbying campaign using the officials of private banks to lobby to stop the audit bill. Evidence of the lobbying campaign came from minutes of the board of directors of each of the 12 district Federal Reserve Banks. Chairman Reuss requested minutes from district bank meetings from 1972, 1974, and 1975. After a six-month delay with letters back and forth and meetings between Chairman Reuss and Federal Reserve Chairman Arthur Burns, the minutes arrived at the Congress. One
355
Auerbach, Deception and Abuse at the Fed, pp. 103 - 104.
response to the Reuss request for records was given by a St. Louis Fed President, as reported on the transcript: "I would also think that if this involves a lot of work, which it will, needless work, that someone on Mr. Reuss Committee, a friendly individual should know what were being called upon to do. Because I think this can be used against Reuss if we react intelligently and as I see it in the St. Louis case, its appalling how skimpy or meaningless our minutes are, Im sure we did this with great wisdom knowing that a man named Reuss would ask for them. The minutes are really terribly shallow. Tell nothing."356 (Emphasis added) Chairman Reuss delivered a floor speech in 1976 detailing the evidence of the Feds orchestrated lobby against the audit bill entitled: "What the Secret Minutes of the Federal Reserve Banks Meetings Disclose". The speech led to the passage of the Federal Reserve Reform Act of 1977 which brought Fed Bank directors under the federal government conflict of interest laws. Despite this victory, the Fed won the first round on the audit effort. Chairman Reusss audit bill could not garner enough support to pass out of the Committee. It was shunted to the Government Operations Committee where it passed in 1978, but only after glaring no-audit barriers on any Fed operations connected to monetary policy or international transactions were added. In the Fed's monetary policy operations billions of dollars can be made from inside information from leaks of Fed policy. It is very difficult to police these leaks of inside information. One necessary step to stop leaks is to severely limit the interest rate policy information in the Federal Reserve to a few people. This has not happened. Many hundreds of Federal Reserve employees -- over 500 employees -- are directly involved in the secret meetings or in preparing information that has been discussed at these meetings. The House Banking Committee received information in 1997 about non-Federal Reserve employees at Federal Reserve meetings where inside information was discussed. Congressmen Gonzalez and Maurice Hinchey asked Greenspan about the apparent leak of discount rate information and the presence of these people at Federal Reserve meetings. Greenspan was forced to admit that some nonFederal Reserve people had attended Federal Reserve meetings where the Federal Reserve=s future interest rate policy was discussed.357 Greenspan included a 23-page enclosure listing
356 357
November 16, 1976 FOMC transcript, p.17. Greenspan letter of April 25, 1997.
hundreds of people at the Board of Governors in Washington, D.C. and in the 12 Federal Reserve Banks around the country who have access to at least some secret Federal Reserve information about nonpublic Federal Reserve interest rate policy. Names of Avisiting scholars@ were listed who had attended preFOMC meetings at three Federal Reserve Banks. Greenspan also wrote: At the Federal Reserve Bank of Kansas City, over the 3-year period, a total of 28 foreign central bankers have attended 16 different Board of Directors meetings, including the discussion and vote on discount rates. Those attending included Acentral bankers from Bulgaria, China, the Czech Republic, Hungry, Poland, Romania and Russia. 358 At the December 19, 1989 FOMC meeting Greenspan warned about the ill effects of continuing leaks from the FOMCs supposedly secret meetings and said that "we're beginning to look like buffoons": [. . . ] I would like to raise again a problem that continues to confront this organization with continuous damaging and corrosive effects, and that is the issue of leaks out of this Committee. We have two extraordinary leaks, and perhaps more, in recent days: in which John Berry at The Washington Post in late November had the time and content of a telephone conference; previous to that we had The Wall Street Journal knowing about telephone conferences and knowing a number of things that could only have come out of this Committee. As best I can judge from feedback Im getting from friends of ours the credibility of this organization is beginning to recede and we're beginning to look like buffoons to some of them. [. . . ] 359 FOMC Records In 1976 two threats to Fed secrecy created high anxiety at the Federal Reserve Board of Governors. First, David Merrill, a law student at Georgetown University, brought a legal action challenging the 45-day delay in releasing the "Directive" on monetary policy. 360 It is a short report on policy actions that were authorized at the FOMC
Greenspan letter to Chairman Gonzalez, April 25, 1997, p. 2. Chapter 9, "Valuable Secrets and the Return of Greenspan's "Prophetic Touch" in Deception and Abuse at the Fed . 360 The secret meetings at the Board of Governors in Washington D.C. revealed great alarm about transparency at the Arthur Burns Fed. This response was revealed in the FOMC transcripts Burns left upon his death in 1987 to the President R. Gerald Ford Library on the University of Michigan campus. The archivists of the National Archives and Records Administration lightly edited the transcripts.
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meeting. The Federal District Court agreed with Merrill. The Fed appealed up to the Supreme Court which remanded it back to the district court. Lacking funds for further extensive adjudication Merrill could not pursue the case. The Fed has all the money it needs or can order from the Bureau of Engraving and Printing to hire private law firms and fight any legal action. The second attack on the Feds secrecy was Congressional consideration of the Government in the Sunshine Act that was signed into law September 13, 1976. That law required that: "The agency shall make promptly available to the public, in a place easily accessible to the public, the transcript, electronic recording or minutes of the meeting." The Fed frantically tried to protect itself from such transparency and individual accountability. Fearing the new legislation and the pending legal action for the disclosure of their records, Federal Reserve Chairman Arthur Burns led the Federal Reserve Open Market Committee in a 10 to 1 vote to discontinue transcripts of its meetings in 1976. That vote began the official 17-year Fed lie asserting that no transcripts were being maintained of FOMC meetings. In 1992 I returned to the Banking Committee staff of thenChairman Henry B. Gonzalez. Chairman Gonzalez and I could not believe that the most powerful central bank in the world, operating in our great democracy, had no complete records of its policy making committee, the FOMC. On October 19, 1993, Chairman Gonzalez convened a Fed oversight hearing focusing on transcripts. Seventeen officials of the Fed, seven members of the Board of Governors and ten of the twelve presidents of the Federal Reserve District Banks, testified in the Banking Committee chamber. Chairman Greenspan sat in the center of the long row of Fed officials. Prior to the hearing, Chairman Gonzalez sent the witnesses specific instructions that they reveal details of what records are kept by the Fed of their meetings. A top Fed staff person, who would become vice chairman of the Board of Governors, explained on a confidential FOMC conference call four days before their Congressional testimony that Greenspan clearly intended to mislead Congress about written records of the FOMC: "The Chairman is not highlighting these transcripts ...We're not waving red flags." 361 Jim McTague, now the Washington editor of Barrons, wrote about Greenspan's testimony: "In a performance that would have made professor Irwin Corey weep with admiration Mr. Greenspan
361
FOMC conference call transcript, October 15, 1993, p. 20.
avoided drawing attention to the existence of transcripts ... Corey famously performed as a double-talking comedian.362 Several days after the hearing, the Cleveland Fed broke the silence and misdirection and informed the Congress of the deception. Chairman Greenspan then sent a letter admitting that transcripts existed. He claimed to have had memory problems. I led a group of Republican and Democratic staff to the Board of Governors where Fed staff showed us 17 years of neatly typed transcripts around the corner from Chairman Greenspan's office. Under pressure from this Gonzalez investigation the Fed ended its 17-year lie by again issuing the transcripts but only with a 5-year lag, too long to establish timely individual accountability. In 1995 Greenspan held a non-recorded vote of the FOMC no finger prints to destroy the source FOMC transcripts. I was informed by the Fed Vice Chairman Donald Kohn that this destruction would continue and that it was legal. 363 Previously these source records had been sent to the National Archives. That same year the shredding machines at the Fed destroyed the source FOMC records when Fed officials bypassed the Congress and voted $5 billion to support the Mexican peso. That loan was collateralized by revenue from Mexicos oil industry. When the loan authorization was sent to the New York Federal Reserve Bank and was public information the peso stopped falling. The loan to Mexico that had been authorized was then not needed and was not made. Investigations of Fed Operations Congresswoman Carolyn Maloney joined Chairman Gonzalez in an investigation from 1995 to 1997 of the Feds more than 50 contracted airplanes that were delivering paper checks across the country. The investigation found evidence of corruption in this system typified by the backup plane at Teterboro Airport. The Fed paid for this contracted plane that people at that Fed facility called the phantom plane because it was not present at Teterboro much of the time. We also uncovered evidence of nearly nonexistent in-house audits. Officials covered losses in the airplane fleet operations by transferring money from the Fed's employee pension fund.
Greenspan Has Himself to Blame for Fervid Interest in Transcripts, American Banker, December 1, 1993, p. 24. 363 A letter from then Vice Chairman Donald Kohn to Robert Auerbach September 1, 2001. Included in Auerbach, "Stop the Fed From Shredding Its Record," Huffington Post, December 9, 2001.
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The Reno Justice Department refused the Gonzalez request to investigate the extensive corruption found in the management of the airplane fleet and referred the Gonzalez inquiry to the Feds Inspector General. The IG told me he did not know if he had jurisdiction because the fleet was managed by the Boston regional Fed Bank. That weak dodge is consistent with my prior experience and underlies the importance of changing the structure of the Feds IG. The Fed's Report to Congress and the Dodd-Frank law grant the Chairman of the Federal Reserve the authority to appoint his own Inspector General who is charged with investigating the Fed bureaucracy and who also serves as the IG for the new Consumer Financial Protection Bureau. This is a clear conflict as Chairman Bernanke can prohibit the Fed's Inspector General from carrying out or completing an audit or investigation or from issuing a subpoena ..."364 Another Gonzalez investigation began in 1997 when the Congress received information about alleged corrupt accounting at the cash section of the Los Angeles branch of the San Francisco Federal Reserve Bank that includes vaults containing cash and coins. The GAO assisted the Gonzalez's investigation. During the investigation Chairman Greenspan informed Ranking Member Gonzalez that the Federal Reserve knew that nearly $500 thousand that had been stolen from Fed vaults by Fed employees from 1987 to 1996. 365 The Gonzalez/GAO investigation indicated this was an understatement. The following selections are from the September 30, 1996 published report of an excellent GAO team that investigated the cash section at the Los Angeles Branch of the Federal Reserve in coordination with a Gonzalez investigation. The report indicates how desperately the Fed operations need a complete competent audit. It is a matter of national security: A bank had brought a deposit of $432,000 to the Fed and Fed employees mistakenly entered the transaction as $8,640,000. When
Section 1081 of the Dodd-Frank Wall Street Reform and Consumer Protection Act states that, the Chairman of the Board of Governors of the Federal Reserve System shall appoint the Inspector General of the Board of Governors of the Federal Reserve System and the Bureau of Consumer Financial Protection. The Inspector General of the Board of Governors of the Federal Reserve System and the Bureau of Consumer Financial Protection shall have all of the authorities and responsibilities provided by this Act with respect to the Bureau of Consumer Financial Protection, as if the Bureau were part of the Board of Governors of the Federal Reserve System. 365 Federal Reserve Board of Governors Chairman Alan Greenspan letter to Ranking Member Gonzalez, December 5, 1996.
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Fed employees in the cash department counted the deposit they discovered an $8,208,000 mistake they overrode the system control in the cash inventory system and forwarded the money for further processing. Although this error was corrected when the problem was detected at the end of the day, this resulted in an erroneous entry being made in the L.A. Banks ledger for $8,640,000 that increased the cash in the vault amount and the depository institutions account. L.A. Bank officials had no explanation for why this occurred. The GAO also reported: We found that the October, November, and December 1995 monthly currency activity reports of the L.A. Bank were prepared and reported incorrectly. We confirmed that the reported receipts from currency deposited in the L.A. Bank by depository institutions (receipts from circulation) were not taken from the L.A. Banks cash inventory records (in other words, independently determined) but rather forced to ensure that the currency activity reports agreed with the daily balance sheet for the last day of the month. The reports were prepared incorrectly at the direction of the L.A. Banks management. L.A. Bank officials stated that the practice of forcing the reports to agree had been in place for some time. We found that problems in currency reporting are linked to the limitations in the design of the underlying cash inventory system. The L.A. Banks inability to precisely summarize currency activity from its cash inventory records raises serious questions about the integrity of its accounting and internal controls. We attempted to perform a comprehensive review of the L.A. Banks internal controls and accounting practices over the money flowing through the Bank. Our efforts to perform a comprehensive review were substantially limited by the L.A. banks inability to provide the information needed for such a review.[...] we requested that the Bank provide us with [ . . . ] a general ledger history of all of the activity in its general ledger cash accounts for October through December 1995" [The bank did not provide the] general ledger of cash transactions because Bank officials stated that it would take them 3 weeks. 366 This excellent GAO report demonstrates that the agency is capable of conducting exemplary audits of Fed operations if it is not constrained by statutory limitations and as long as experienced staff lead the investigations. The Fed vault facilities are a crucial part of
Federal Reserve Banks, Inaccurate Reporting of Currency at the Los Angeles Branch, Report to the Ranking Minority Member [The Honorable Henry B. Gonzalez], Committee on Banking and Financial Services, House of Representatives. GAO/AIMD-96-146, September 30, 1996. See also "EMBEZZLING FED MONEY AND FALSIFYING ACCOUNTING RECORDS," Deception and Abuse At the Fed," pp. 55-60.
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the nations payment system and should be a national security priority with full accountability to the Congress. The Fed banks contain uncirculated currency and coin transferred from the Bureau of Engraving and Printing. They also receive cash from banks throughout the country. The cash sections and vaults of the Federal Reserve District Banks and branches need to be investigated and audited with personnel who are experienced in central bank operations, independent of Fed officials and instructed to make thorough audits. Academic Independence Future GAO audits should target the massive number of Fed payments to academics who are not employed at the Federal Reserve. A Gonzalez investigation found that the Federal Reserve sent money and provided other benefits to economists throughout academia who specialize in monetary and financial subjects, and who were not employees of the Federal Reserve. The Fed itself employed over 500 economists so the need to make all these outside payments is highly questionable.367 Some academics received checks from a number of (up to five) district Fed Banks. Reuters reported Milton Friedman's views on this problem in 1993: the Feds relatively enhanced standing among the public has been aided by the fact the Fed has always paid a great deal of attention to soothing the people in the media and buying up its most likely critics' Recognizing that the Fed employs probably half of the monetary economists in the U.S. and has visiting appointments for two-thirds of the rest he [Friedman] saw few among the academic community who were prepared to criticize the Fed policy. 368 Conclusion The current GAO audit of the Federal Reserve is a historic step towards greater transparency at the central bank. The Fed has a long history of fighting outside audits as various Fed officials have complained that they would constitute an infringement on central bank independence. In fact, the Feds mythical flag of independence from politics, a favorite Fed mantra to avoid individual responsibility,
After the chapter in my book, When 500 economists are not enough, was published on Huffington Post, September 7, 2009, Ryan Grim followed up with an up to date article: Priceless: How the Fed Bought the Economics Profession, September 7, 2009. 368 Reuters interview reported July 7, 1993.
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is merely a shield intended to protect the institution from being forced to act in a more transparent fashion. Ongoing audits do not infringe on the Feds independence which is protected in a myriad of ways, including self-funding and terms for members of the Board of Governors of 14 years. Board of Governor members can only be removed by impeachment and that has never happened. Their long terms and very little chance of being impeached should allow independent votes. It has not prevented the fact that monetary policy has been very poor in periods such as the 1970s and since October 2008. I have been writing and speaking about the Federal Reserves present misguided policy since 2009. 369 Complete GAO audits and the other improvements I have described are essential for establishing a timely authentic record of policy actions and individual responsibility for the powerful unelected officials at the nation's central bank.
The Bernanke Fed Is in a Deep Hole With a $1.6 Trillion Time Bomb, Huffington Post/AOL, August 29, 2011.
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WRITTEN TESTIMONY OF MARK A. CALABRIA, Ph.D.

DIRECTOR OF FINANCIAL REGULATION STUDIES CATO INSTITUTE
Chairman Paul, Ranking Member Clay, and distinguished members of the Subcommittee, I thank you for the invitation to appear at todays important hearing. I am Mark Calabria, Director of Financial Regulation Studies at the Cato Institute, a nonprofit, nonpartisan public policy research institute located here in Washington, DC. Before I begin my testimony, I would like to make clear that my comments are solely my own and do not represent any official policy positions of the Cato Institute. In addition, outside of my interest as a citizen and taxpayer, I have no direct financial interest in the subject matter before the Committee today, nor do I represent any entities that do. The Federal Reserve and the Financial Crisis As the Subcommittee is well aware, the events of 2008 witnessed not only unprecedented disruptions to our financial markets, but also extraordinary responses on the part of our financial regulators and central bank. No entity was more deeply involved than the Federal Reserve System (Fed), particularly the Federal Reserve Bank of New York. Yet the Fed has consistently and repeated resisted efforts to bring any accountability and transparency to its actions. Congress and the public were regularly warned that if the details of the Feds actions became public, further panic would ensue in our financial markets. For instance I distinctly remember, as a staffer for the Senate Banking Committee, listening to then Fed Vice Chair Donald Kohn tell that Committee that making the names of AIGs derivatives counterparties public would severely harm our financial markets. When those names were eventually released our world did not come to an end. In short, the Fed has a long tradition and strong preference for secrecy. Despite some notable attempts by the Fed to increase its communications with the public, I believe, given its track record, the public cannot rely on the Fed to voluntarily provide us with sufficient information to monitor its activities and judge the effectiveness of its actions. And while the requirements of the DoddFrank Wall Street Reform and Consumer Protection Act (DoddFrank), in relation to auditing the Feds activities are an important
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advance, they fall far too short of providing sufficient oversight of the Fed. What auditing has been conducted has so far been focused on the Feds response to the crisis. Among economists, on both the right and the left, there remains considerable concern and debate over the Feds role in helping to create the crisis via its easy money policies in the aftermath of the dot-com bubble and the events of 9/11. If we truly wish to end financial crises, then I believe it is absolutely essential that Congress receive a full and objective evaluation of the Feds role in fostering the housing bubble, particularly as it relates to monetary policy decisions made between 2002 and 2005. Federal Reserve Audit Requirements under Dodd-Frank The primary audit requirements of Dodd-Frank, as they relate to the Feds actions during the financial crisis, are contained in Section 1109, which directs GAO to:
conduct a onetime audit of all loans and other financial assistance provided during the period beginning on December 1, 2007 and ending on the date of enactment of this Act by the Board of Governors or a Federal reserve bank under the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Term Asset-Backed Securities Loan Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, the Term Securities Lending Facility, the Term Auction Facility, Maiden Lane, Maiden Lane II, Maiden Lane III, the agency Mortgage-Backed Securities program, foreign currency liquidity swap lines, and any other program created as a result of section 13(3) of the Federal Reserve Act.
That audit was delivered to Congress in July. Importantly, the audit required by Dodd-Frank goes beyond a simple accounting of what was lent to whom, but also requires GAO to evaluate the effectiveness and policies of the various lending facilities. As GAOs audit makes clear, the Fed, and in particular the New York Fed, exercised considerable discretion in designing these lending programs and often did so in an extremely ad hoc manner. While it does appear that the Fed made attempts to treat all program participants fairly and equally, a lack of appropriate internal controls within these programs left open considerable potential for abuse. In addition to the audit requirements of Section 1109, DoddFrank also requires under Section 1103(b) that the Fed provide:
disclosure in a timely manner consistent with the purposes of this Act of information concerning the borrowers and counterparties
AUDIT THE FED TESTIMONY 1293 participating in emergency credit facilities, discount window lending programs, and open market operations authorized or conducted by the Board or a Federal reserve bank...
The importance of Section 1103(b) is that participants in future discount window lending will eventually be identified to the public, along with the terms of such lending. Given that Dodd-Frank gives the Fed approximately two years to disclose such information in relation to discount window lending, I believe the risk that such disclosure will dissuade financial institutions from the use of the discount window has been minimized. Of course, if such disclosure encourages financial institutions to manage their operations in such a way to avoid the need for access to the discount window, then the strength of our financial system would likely be improved. While Sections 1102, 1103 and 1109 of Dodd-Frank are without doubt improvements in Federal Reserve transparency, and some of the few positive provisions in the Act, they fall short of truly bringing the operations of the Fed into the light of day. Although I believe it to be a grave mistake to continue to entrust the Federal Reserve with bank supervision and regulation, Congress has chosen to maintain, and extend, that situation. The requirements of Section 1108(b) of Dodd-Frank requiring the Feds Vice Chair for Supervision to regularly appear before Congress should increase transparency and improve Congressional oversight as it relates to the Feds bank supervision responsibilities. The Federal Reserve Needs a Full and Continuous Audit The non-monetary actions of the Federal Reserve in 2008 and 2009 will likely be debated for decades among economists and historians. Just as the causes of the Great Depression and the effectiveness of the New Deal remain in contention, so will recent actions. What we all can perhaps agree on, or at least hope, is that the extraordinary measures, by Congress, the Federal Reserve and the Treasury, will not be repeated soon or repeated often. Accordingly, much of the audit requirements in Dodd-Frank have something of an historical feel to them. However, it is not enough to just get history right, but also to insure that future mistakes are avoided. I can think of few areas requiring as much mistakeavoidance as monetary policy. Others have already laid out the case that easy money 370 contributed to the crisis, so I will not repeat that argument here. I do believe, however, that the role of easy money in the fostering a
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See John Taylor, Getting Off Track. Hoover Institute Press. 2009.
housing bubble demonstrates the need for an on-going GAO audit of the Federal Reserves monetary functions. Disagreement as to the appropriate stance of current monetary policy also demonstrates the need for objective, independent analysis. Whats GAO for? GAO, the US Government Accountability Office, states its mission is to support the Congress in meeting its constitutional responsibilities and to help improve the performance and ensure the accountability of the federal government for the benefit of the American people. We provide Congress with timely information that is objective, fact-based, nonpartisan, nonideological, fair, and balanced. (www.gao.gov). Quite simply GAO is not a political organization. As someone who has interacted repeatedly and regularly with GAO over the last decade, including serving as a Congressional staff liaison for requested GAO reports, I can say they are independent, unbiased and non-political. I have not always agreed with the conclusions of GAO, but I have never felt as if such disagreements were the result of politics or bias. Subjecting the Federal Reserves monetary policy function to a GAO audit does not subject the Fed to politics such a claim is not only insulting to GAO, it is insulting to the very concept of Congressional oversight. GAO exists for the very simple reason that no one member of Congress, or their staff, fully understand and are knowledgeable about the functioning of the various government agencies. GAO exists to inform. And there are few areas less understood by Congress than monetary policy and macroeconomics. Hence there are few areas more in need of a GAO audit than the Fed. While the impact of getting wheat support prices or fair market rents wrong is not insignificant, getting monetary policy wrong can be disastrous for an economy. On Fed Independence A common objection to a GAO audit of the Fed is that such would compromise the Feds independence and subject its actions to political influence. Such an objection confuses the very nature of Fed independence. The Feds authority to regulate the value of money is one delegated from Congress. As Congress can, and has, legislated changes to the Fed, it should be clear beyond a doubt that the Fed is not independent of Congress. It is a creature of Congress.
Setting aside the debate over the desirability and legitimacy of socalled independent agencies, it should be clear that their independence, in an operational sense, is from the Executive Branch. It should also be clear, however, that in recent years the Fed has coordinated its actions quite closely with the Treasury Department, eroding any real independence. The revolving door, both at the political and career levels, between the Fed and the Treasury Department further undermines the Feds operational independence. A GAO audit could shine a light on this relationship, helping to insulate the Fed from continued interference by the Treasury Department. Improving Federal Reserve Transparency The Dodd-Frank Act made important advances in bringing transparency and accountability to the Federal Reserve. Unfortunately it falls short in allowing Congress, and the public, to truly gauge the effectiveness of the Federal Reserve. In order to improve Federal Reserve Transparency, Congress should mandate a regular GAO audit of all Fed activities, including monetary policy. Such audits can be performed in such a manner so as to minimize their disruptions to any on-going deliberations of the Federal Open Market Committee (FOMC). For instance audits can be kept confidential for a year after each FOMC meeting. Evaluating the effectiveness of any government agency is made all the more difficult when that agency faces a variety of competing and sometimes conflicting objectives. If the Fed feels it is free to abandon price stability in order to achieve other objectives, such as supporting the financial industry or misguided attempts to influence the labor market, then an audit will have limited value. At a minimum Congress should restrict the Federal Reserve to a single goal, that of price stability. Congress should also restrict the Feds discretion in implementing that goal. A central bank that is free to define price stability as whatever it wants is a central bank without any meaningful constraint. Chairman Paul, Ranking Member Clay and members of the Subcommittee, I again thank you for the invitation to appear at todays important hearing. I firmly believe our monetary system was a central driver of the financial crisis and that its deep flaws remain in place. In order to both prevent future financial crises and protect our society from the significant harm that results from inflation, a vigorous debate as to the performance of the Federal Reserve is long overdue.
EARING XII.
FEDERAL RESERVE AID TO THE EUROZONE: ITS IMPACT ON THE U.S. AND THE DOLLAR
TUESDAY, MARCH 27, 2012

WITNESSES Dudley, William C., President, Federal Reserve Bank of New York Kamin, Steven B., Director, Division of International Finance, Board of Governors, Federal Reserve System
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing entitled Federal Reserve Aid to the Eurozone: Its Impact on the U.S. and the Dollar at 10:00 a.m. on Tuesday, March 27, 2012 in Room 2128 of the Rayburn House Office Building. The hearing examined the Federal Reserves assistance to the Eurozone and the effect of that assistance on the U.S. economy, the U.S. monetary system, and the dollar. In particular, this hearing explored the central bank currency swap line arrangements set up between the Federal Reserve and the central banks of England, Switzerland, Japan, Canada, and the European Central Bank (ECB). This was a one-panel hearing with the following witnesses: Mr. William C. Dudley, President and Chief Executive Officer, Federal Reserve Bank of New York Dr. Steven B. Kamin, Director, Division of International Finance, Board of Governors of the Federal Reserve System
The Eurozone Crisis In late 2009, the revelation that the Greek government had misrepresented the extent of its indebtedness triggered a crisis that spread from Greece to other European countries as financial markets became concerned, first about the extent to which financial institutions were exposed to Greek debt, and then about the extent to which other European countries were facing budget problems similar to Greece. Concerns about the stability and solvency of the Eurozone371 and its member nations made it more difficult and more
The Eurozone comprises the 17 nations in the European Monetary Union that adopted the euro as their common currency. These nations are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. 1299
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expensive for European nations to borrow, which has in turn resulted in a sovereign debt crisis that affected several Eurozone countries and created economic instability throughout Europe. The underlying cause of this crisis was that some members of the Eurozone had borrowed too much. Under the 1997 Stability and Growth Pact, an agreement among the member states of the European Union to facilitate and maintain the stability of the European Monetary Union, member states were required to run budget deficits no larger than 3% of their gross domestic product (GDP) and to cap their national debts below 60% of their GDP. Without any punishment for transgressing the limits, however, these fiscal limits were largely ignored by member states, and in recent years particularly those states in the Eurozone periphery such as Greece, Ireland, and Portugal, and even larger member states such as Spain and Italy. Under the Basel II capital adequacy standards, all Eurozone sovereign debt was treated as risk-free, which meant that financial institutions holding sovereign debt could earn interest on that debt without having to hold additional capital against it. (The Basel III capital adequacy standards continue to treat all sovereign debt as risk-free.) But as the extent of the budget deficits being run by countries in the Eurozone periphery became known, financial markets began charging risk premiums on the debt issued by those countries that reflected the risk that those countries might default. These premiums, in turn, dried up financing to European banks as investors became increasingly wary of lending to Europe. In the Eurozone, medium- and long-term dollar funding declined significantly as market sentiment deteriorated; unsecured dollar funding could not be obtained for terms longer than a week. Central Bank Liquidity Swap Lines To offset the shortfall in private dollar funding to the Eurozone and to improve dollar liquidity in global money markets, in May 2010 the Federal Reserve re-established temporary reciprocal currency agreements known as swap lines with the central banks of England, Japan, Switzerland, Canada, and the ECB. Under these swap lines, the Federal Reserve swapped dollars for foreign currencies for a fixed period of time and at fixed exchange rates, charging interest. Fixed exchange rates were supposed to ensure that fluctuations in the price of currencies would not affect repayments and that the Federal Reserve was repaid in dollars exactly what it had swapped. The terms of the swaps ranged from
FED AID TO EUROZONE BACKGROUND1301
one week to three months and the swaps were managed primarily by the Federal Reserve Bank of New York. Originally set to expire in January 2011, the swap lines were renewed several times. In November 2011, the Federal Reserve reauthorized the swap lines until February 2013 and reduced the interest rate, which had been set at 100 basis points over the overnight index swap (OIS) rate, to 50 basis points over the OIS. Before the Federal Reserve reduced the interest rate, the swap lines were little-used and rarely reached more than $2 billion outstanding at any one time. After the Federal Reserve reduced the interest rate on these swap lines in November 2011, use of the swap lines jumped to nearly $55 billion, and peaked at $109 billion in February 2012. While this is a comparatively small sum compared to swap line use at the peak of the 2008-2009 financial crisis, when they totaled $583 billion, nonetheless the amount outstanding as of March 14, 2012 was nearly equal to the U.S.s IMF quota of approximately $65 billion. The Federal Reserve explained that swap lines were designed to improve liquidity conditions in global money markets and to minimize the risk that strains abroad could spread to U.S. markets, by providing foreign central banks with the capacity to deliver U.S. dollar funding to institutions in their jurisdictions. 372 By providing liquidity to central banks rather than directly to foreign financial institutions, the Federal Reserve maintained that credit risks from the currency swaps were borne by the foreign central bank and not by the U.S. taxpayer. For example, if the Federal Reserve held euros that it received in exchange for providing dollars to the ECB then the ECB would be liable for returning those dollars once the swaps mature. It is therefore the ECBs responsibility to collect adequate collateral from the financial institutions to which it lends dollars in order to ensure that it can repay the dollars it received from Federal Reserve when the swap unwinds. In February 2012, Federal Reserve Chairman Ben Bernanke stated in testimony before the Financial Services Committee that the Federal Reserves swap lines were a very safe proposition. First, our counterparty is the ECB. It is not banks. It is not Greece. It is the European Central Bank itself, which in turn is well-capitalized and has behind it the national central banks of 17 countries.
372Federal
Reserve Bank of New York, Central Bank Liquidity Swaps, March 19, 2012, available at http://www.newyorkfed.org/markets/liquidity_swap.html. Last accessed December 11, 2012. [should probably check all other hyperlinks in other memos to make sure they still work and add their access date.]
European Central Bank as Counterparty The composition of the ECBs balance sheet, however, generated concern about the ECBs capitalization and the counterparty risk it posed to the Federal Reserve. The ECB significantly expanded its role in response to the Eurozone crisis. In December 2011 the ECB reduced its policy interest rate (the ECBs equivalent to the federal funds rate), reduced reserve requirements, expanded the categories of collateral it would accept for ECB refinancing operations, and began providing three-year loans to banks in the form of long-term refinancing operations (LTRO). LTRO was a significant departure from the ECBs usual practice: the ECB historically supplied shortterm loans to European banks, usually for terms no longer than three months. In its first LTRO offering in December 2011, the ECB lent 489 billion ($638 billion373) to more than 500 Eurozone banks, the largest infusion of cash into the banking system since the introduction of the euro in 1999. In its second LTRO offering in February 2012, which was advertised as the final offering, the ECB lent 530 billion ($708 billion374) to 800 Eurozone banks. These large operations raised concerns about the quality of the collateral securing the loans made by the ECB as well as concerns about the ECBs leverage ratio. Before its first LTRO offering, the ECB relaxed its rules regarding the collateral that banks could post as security for ECB loans. For the first time in its history, the ECB began accepting lower-rated securities, including lower-rated government bonds, as collateral. But subsequent to the February LTRO offering, the ECB began to use margin calls to require banks to increase the collateral posted with the ECB. These collateral increases were requested after the loans had been made and appeared on the ECBs balance sheet as deposits related to margin calls on credit extended to counterparties. While this line item was normally around 2 billion or less, the margin calls increased to over 17.3 billion ($22.7 billion375) as of March 13, 2012. The increase in margin calls led to concerns about the deteriorating value of the collateral held by the ECB, and some speculated that the deterioration was being driven by the falling value of the large amounts of Greek, Italian, and Spanish bonds held by the ECB.
According to the exchange rate of 12/21/11, when LTRO 1 took place. According to the exchange rate of 2/29/12, when LTRO 2 took place. 375 According to the exchange rate of 3/13/12
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The ECBs capital and reserves stood in March 2012 at 83 billion ($111 billion376) with total assets at 3 trillion (about $4 trillion), creating a leverage ratio of 36 to 1. By way of comparison, the Federal Reserve had a leverage ratio of about 54 to 1 ($3 trillion in assets with $55 billion in capital). While the ECBs may have looked better on paper, some remained concerned that that ratio was too high for it to be a safe counterparty to the Federal Reserve, particularly because the ECBs balance sheet largely consisted of sovereign debt that had a high risk of default, such as Greek bonds. Former ECB Executive Board Member Juergen Stark said that the ECBs balance sheet is not only gigantic in its dimension but also alarming in its quality.377 Macroeconomic Effects of Increased Dollar Liquidity By making it easier and cheaper for Eurozone institutions to borrow dollars, the swap lines raised concerns about the effects that increased dollar liquidity would have on the international economy. A few smaller central banks, including those of Switzerland and Israel, began investing part of their dollar reserves directly in U.S. stocks. Eurozone banks began to move out of euro assets into dollar assets because it was cheaper to borrow dollars than euros. While the provision of dollar liquidity by the Federal Reserve was intended to help mitigate the effects of the Eurozone crisis, it was not clear whether Eurozone banks purchases of dollar-denominated assets instead of euro-denominated assets was reducing risk or increasing it. While dollar-denominated assets may have been a less-risky asset in the short term in order to help strengthen the balance sheets of Eurozone banks, the decision of Eurozone banks to opt out of euro markets and into safer dollar markets may have played a role in reducing liquidity to euro bond markets, putting an even greater financial strain on Eurozone governments, banks, and financial markets. In addition, critics of the swap lines, such as Gerald P. ODriscoll, Jr., former vice president of the Federal Reserve Bank of Dallas, contended that the swap lines amounted to a U.S. bailout of European banks and fostered moral hazard, distorting the economy as a result of credit allocation by the government. But the President of the Federal Reserve Bank of New York, William Dudley, pointed
According to exchange rate of 3/27/12 Andrea Thomas, Ex-ECB Stark: Banks balance sheet alarming, Wall Street Journal MarketWatch, March 8, 2012, accessed available at http://www.marketwatch.com/story/execb-stark-banks-balance-sheet-alarming-2012-03-08. Last accessed December 11, 2012.
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out that the swap lines helped support the availability of credit to U.S. households and businesses. 378 Because foreign financial institutions provided roughly $900 billion in financing within the U.S., Mr. Dudley expressed concerns that an impairment of access to dollar funding could have raised the costs for borrowing and lending in the U.S. Increases in the cost of dollar funding, however, did not necessarily mean that funding was unavailable, but rather that the cost of lending had risen to reflect more accurately the risks of lending to Eurozone institutions, given their exposure to European sovereign debt. By providing dollar liquidity at lower rates than the market was then offering, the Federal Reserve was encouraging unsound investments or impeding economic recovery by preventing the liquidation of bad investments. Given that financial institutions held $1.6 trillion in excess reserves at the Federal Reserve, it was not clear that U.S. financial markets would have been affected if foreign financing had declined because European access to dollar funding was curtailed. Additional Federal Reserve Assistance Chairman Bernanke indicated to Members of Congress that the Federal Reserve had neither the authority nor the intention to bail out European governments or financial institutions. But in testimony before Congress in December 2011, Mr. Dudley said that the Federal Reserve has the authority to buy sovereign debt and that that option should not be ruled out. Central Banks and Monetary Policy Since the onset of the financial crisis in 2008, the worlds central banks have injected large amounts of liquidity into the economy in an attempt to stave off further crisis. Accommodative monetary policy resulted in central banks moving from a focus on maintaining price stability to a policy of supporting the banking sector and providing relief from sovereign debt problems. While the actions of central banks were once perceived as necessary to stem the economic crisis, it remains to be seen how these large increases in the supply of money worldwide will affect economic activity. In the U.S. as of March 2012, price inflation appeared to be picking up in various economic sectors.
William Dudley, Federal Reserve Bank of New York, Letter to the Editor Regarding Central Bank Liquidity Swaps, March 19, 2012, available at http://www.newyorkfed.org/markets/statement_0105_2012.html. Last accessed December 11, 2012.
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Oil and gasoline prices rose sharply over the preceding month, the consumer price index increased at an annual rate of nearly 3%, and 10-year Treasury bond yields spiked roughly 40 basis points in the first quarter of 2012. If the accommodative monetary policies undertaken by the worlds central banks prevent needed readjustments from taking place in the global economy, or if inexpensive financing misdirects resources and results in malinvestment and unsustainable booms, these policies could sow the seeds for an even greater crisis.
RANSCRIPT
The subcommittee met, pursuant to notice, at 10:03 a.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, McHenry, Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Green. Chairman PAUL. This hearing will now come to order. Without objection, all Members opening statements will be made a part of the record. I will now recognize myself for 5 minutes to make an opening statement. First, I would like to thank Dr. Kamin and Dr. Dudley for appearing today to discuss a very important subject that the world is looking at constantly: a major debt crisis that exists around the world. It has a great deal of significance not only for world finance, but also for the American taxpayer and the value of the U.S. dollar, and indirectly, the deficits that are run up because they are all interconnected. The crisis we face right now is a crisis in debt and how we handle this debt. Who gets stuck with the debt? Who gets the bailout? How does the debt get defaulted on? How do you liquidate the debt? And there are different ways of liquidating debt. When you cant pay the bills and you write them off the books, that is liquidating debt and that helps to solve the problem. Other times, governments and central banks participate in liquidating debt by diminishing real debt, and that is by purposely devaluing the currency and, of course, that has been used historically many, many times and is one of the most common ways of liquidating debt. So if you can devalue a currency by 50 percent, you can get rid of real debt by half if your prices go up. And there certainly seems to be
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a concerted effort around the world, and even within our own country, to handle debt in that fashion. But in the process, the question really is: Who gets stuck with it? Who gets the most penalties? And if you happen to be on the receiving end of being too-big-to-fail and you get some benefits from the system, but the debt is not liquidated, it is passed on, it is transferred from one group of individuals to another. Nevertheless, it is still a pain. But it is just a matter of picking and choosing who will receive the most harm. The problem I see right now in dealing with this debt crisis is can the U.S. dollar and the U.S. economy and the U.S. taxpayer bear the burden? And this is the way it seems because now, the European Central Bank (ECB) is asking us to continue to do what we have done over these last few years, to use the dollar to actually bail them out. On paper, it looks like the balance sheet is better with the Europeans. Their assets-to-capital ratio is better than our bank. And yet, the dependency is for the United States to bail them out and it seems like it is working. Of course, we have the advantage of issuing the reserve currency of the world which has given us, in a deceptive way, some advantages over many, many decades. But the big question is: How long can that happen? Will we always have the benefits? Will other countries finally get together, as they talk about constantly, and replace the dollar? And certainly, the dollar isnt getting to be a stronger reserve currency; if anything, it is getting slightly weaker. And someday, there may be some real challenges to the dollar, so there has to be a limit to this. We talk about the Greek crisis, which is major and significant, and we are dealing with it on a daily basis. This might just be the beginning of a much bigger crisis when you look at the different countries, whether it is Portugal or Spain or Italy. And this thing couldit is much bigger than we are willing to admit. In many, many ways, I think we are in denial of how serious this problem is. So we have to face up to the fact that there is a cost. I see it is going to be a cost against the value of the dollar. Some people say, This is good. We want a weaker dollar because it is going to help our trade; it is going to help our exports. And now, there are currency wars going on. All we do is complain about the Chinese having too weak a currency. At the same time, we triple our balance sheet and triple the monetary base. Now, that is deliberately trying to weaken a currency too. So there will be limits on that. I think we are facing that. We are up
against the wall on this. And very soon, I think we are going to have to admit that you cant solve the problem of debt with more debt. You cant solve the problem of a weak currency by making the currency even weaker. You cant solve the problem by having the moral hazard of a guaranteed bailout that peoplethere is always going to be a lender of last resort, and if you are too-big-to-fail, you are going to be taken care of. Some people may suffer, but others will be taken care of. I think there are limits. I think we are facing that. I think we are in denial. We wont admit how serious it is; but I believe that we will be forced to, not because of the politics of it as much as because of the economics. I complain about the power of governments and central banks, but ultimately, there are economic rules and lawseconomic laws probably much stronger than all of us. And you cant dictate and mandate forever. You can kid people for a long time. But right now, it is an illusion that we can trust the dollar to bail out the world. And soon, we are going to see the end of that and that is why many of us believe that the crisis is far from over and that we have to face up to those facts. Now, I would like to recognize Mr. Clay for his opening statement. Mr. CLAY. Thank you, Chairman Paul, and thank you for holding this hearing to examine the Federal Reserves assistance to the Eurozone and the effect of that assistance on the U.S. economy, monetary system, and the dollar. The focus of this hearing is to examine the Federal Reserves Central Banks currency swap-line arrangements with central banks of Europe, England, Switzerland, Japan, and Canada. Also, I want to thank the witnesses for appearing before us today. When the new Greek government came into power in late 2009, they revealed that the previous Greek government had not been reporting the budget deficit accurately. This has led to major economic challenges and concerns to other parts of Europe and the United States. The first concern is the high levels of public debt in some Eurozone countries. Three Eurozone major governmentsGreece, Ireland and Portugalhave had to borrow money from the European Central Bank and the International Monetary Fund in order to avoid defaulting on their debt. Currently, the Greek government is negotiating losses on bonds held by private creditors. Investors have started to demand higher
interest rates for buying and holding Italian and Spanish bonds. The Italian government debt is forecast to be $2.8 billion in 2012, which is greater than Spain, Portugal, Greece, and Ireland combined. The second concern is the lack of growth and the high unemployment in the Eurozone. In January of this year, the IMF downgraded its growth forecast for the Eurozone from growing by 1.1 percent in 2012 to contracting by 0.5 percent. The third concern is the weakness of the Eurozones banking system, which holds high levels of public debt. In December of last year, the European Banking Authority estimated that European banks need about $152 billion of additional capital in order to withstand a range of shocks and still maintain adequate capital. The fourth concern is persistent trade imbalances within the Eurozone. The Eurozone core countries tend to run trade surpluses with the Eurozone periphery countries. And the periphery countries tend to run trade deficits with the core countries. To help ease the financial crisis in the Eurozone, the Federal Reserve opened the currency swap line. Under a swap line with the European Central Bank, the ECB temporarily receives U.S. dollars and the Federal Reserve temporarily receives euros. After a fixed period of time, the transaction is reversed. Interest on swaps is paid to the Federal Reserve at the rate that the foreign central bank charges to its dollar borrower. The temporary swaps are repaid at the exchange rate prevailing at the time of the original swap, meaning that there is no downside risk for the Federal Reserve if the dollar appreciates in the meantime. All of these concerns have raised questions about the economic stability of the Eurozone countries. I look forward to the witnesses comments regarding these concerns and actions taken by the Federal Reserve Bank to address these concerns. And again, thank you for conducting this hearing. I yield back. Chairman PAUL. I thank the gentleman. Now, I will recognize Mr. Luetkemeyer for his opening statement. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Over the past several years, many of my colleagues and I have expressed serious concerns regarding U.S. exposure to the Eurozone. Like many of my colleagues, my concerns have been met at times with cynicism and assurance of an efficient recovery with little or no contagion. Yet here we sit today, continuing to talk about the Eurozone crisis, and hearing once again that our Nation wont be dramatically impacted.
Certain scholars and fellow officials said that the crisis wouldnt spread. It has now impacted several European nations with effects ranging from default and upheaval in Greece to bank failures and increased risk in the perceived financial stalwart of France. This hasnt badly taken a toll on U.S. markets. I believe it has a potential to take a toll on our Nations economy as a whole. Chairman Bernanke testified recently in this committee that the two greatest threats to our economy are rising gas prices and the Eurozone problems. Secretary Geithner testified in this committee just last week, and seemed concerned as well about the possibility of a eurozone contagion, although he was optimistic things would work themselves out. Regardless of what we hear today, we are in fact exposed. Our financial institutions, industries, and government are all exposed, and as a result, so are the taxpayers. Our economies are and always will be deeply connected. It is our responsibility to ensure that this exposure is managed thoughtfully and to ensure that the U.S. taxpayers are not again on the hook for the failure of the financial institutions not only domestic but foreign as well. Mr. Chairman, I look forward to an enlightened discussion with our panel. This is an important topic and one that merits great transparency and attention. I thank you, and I yield back. Chairman PAUL. I thank the gentleman. Now, I would like to introduce our witnesses for today. Dr. William Dudley is the President of the Federal Reserve Bank of New York. Before taking over as President of the New York Fed in 2009, Dr. Dudley had been Executive Vice President of the Markets Group at the New York Fed, where he managed the Systems open market account for the Federal Open Market Committee. Prior to joining the New York Fed in 2007, Dr. Dudley was a partner and managing director at Goldman Sachs and company, and was Goldmans chief U.S. economist for a decade. Dr. Dudley also serves as chairman of the Committee on Payments and Settlement Systems of the Bank for International Settlements and as a member of the Board of Directors of the Bank for International Settlements. Dr. Dudley received his bachelors degree from New College of Florida and received his Ph.D. in economics from the University of California, Berkeley. Dr. Steven Kamin is the Director of the Division of International Finance for the Board of Governors of the Federal Reserve System. He joined the Federal Reserve System Board in 1987, and was appointed to the official staff in 1999.
Prior to taking over the Division of International Finance in December of 2011, Dr. Kamin was Deputy Director of the Division. He has also served as a visiting economist at the Bank for International Settlements, a senior economist for international financial affairs at the Council of Economic Advisors, and as a consultant for the World Bank. Dr. Kamin received his bachelors degree from the University of California, Berkeley and received his Ph.D. in economics from the Massachusetts Institute of Technology. Without objection, your full written statements will be made a part of the record. You will now each be recognized for a 5-minute summary of your testimony. Dr. Dudley?
STATEMENT OF WILLIAM C. DUDLEY379 PRESIDENT FEDERAL RESERVE BANK OF NEW YORK
Mr. DUDLEY. Thank you. Chairman Paul, Ranking Member Clay, and members of the subcommittee, my name is Bill Dudley and I am the President of the Federal Reserve Bank of New York. It is an honor to testify today about the economic and fiscal challenges facing Europe and the Federal Reserves effort to support financial stability in the United States. Let me preface these remarks by stating that the views expressed in my written and oral testimony are solely my own and do not represent the official views of the Federal Reserve Board, the Federal Open Market Committee or any other part of the Federal Reserve System. Additionally, because I am precluded by law from discussing confidential supervisory information, I will not be able to speak about the financial condition or regulatory treatment or rating of any individual financial institution. The economic situation in Europe has been unsettled for the better part of 2 years with pressure on sovereign debt markets and local banking systems. The strains in European markets have affected the U.S. economy. The euro area has the capacity, including the fiscal capacity, to overcome its challenges. However, the politics are very difficult, both because the problem has many dimensions and because many different countries and institutions in the euro area have to coordi-
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nate their actions in order to achieve a coherent and effective policy response. Europes leadership has affirmed its commitment to the European Union and a single-currency union on numerous occasions. And the leadership is working harder than ever to achieve greater policy coordination in areas such as fiscal policy. A more robust and resilient European Union would be a welcome development for the United States. Three recent developments are especially encouraging in that regard. First, liquidity concerns have eased significantly following the European Central Banks long-term financing operations in December and February. Through this program, the ECB provides 3-year loans to European banks at low rates, accepting a wider range of collateral in return. Second, earlier this month the Greek government worked with European leaders and its largest creditors to restructure the bulk of its 206 billion euros of outstanding privately held bonds. This not only helped reduce Greeks total indebtedness, it also helped calm persistent worries that a disorderly Greek default could become the trigger for a global economic crisis. Third, leaders in most euro-area countries have approved a new treaty designed to increase fiscal coordination. The new rules already appear to be making a difference. While difficult work still lies ahead, countries in the euro area have made meaningful progress towards achieving long-term fiscal sustainability. Looking to the future, the difficult work that remains also presents special risks, both for Europe and for the United States. If Europe fails to chart an effective course forward, this could have a number of negative implications here. In particular, there are three areas of potential risk that I would like to highlight for the subcommittee today. First, if economic conditions in Europe were to weaken significantly, the demand for U.S. exports would decrease. This would hurt domestic growth and have a negative impact on U.S. jobs. It is important to recognize that the euro area is the worlds second largest economy after the United States, and it is an important trading partner for us. Also, Europe is a significant investor in the U.S. economy and vice versa. Second, deterioration in the European economy could put pressure on U.S. banking systems. As the recent round of stress tests reveals, U.S. banks are much more robust and resilient than they were a few years ago. They have bolstered their capital significantly,
built up their loan loss reserves, and have significantly higher liquidity bumpers. The good news in the United States means that we are better able to handle bad news from Europe. With that said, the exposures of U.S. banks climb sharply when one also considers their exposures to the core European countries and to the overall European banking system. Third, severe stresses in European financial markets would disrupt financial markets here, which could harm the real economy. Stress in the financial markets causes banks to more carefully husband their balance sheets. When that phenomenon occurs, the availability of credit to U.S. households and businesses becomes constrained. Such conditions could also cause equity prices to fall, impairing the value of American pension and 401(k) holdings. This would damage the U.S. recovery and result in slower output growth and less job creation. At a time when the U.S. employment rate is very high, this is a particularly unacceptable outcome. In the extreme, U.S. financial markets could become so impaired that the flow of credit to households and businesses could dry up. In todays globally integrated economy, banks headquartered abroad play an important role in providing credit and other financial services in the United States. About $1 trillion in worldwide dollar financing comes from foreign banks; $700 billion in the form of loans within the United States. For these banks to provide U.S. dollar loans, they have to maintain access to U.S. dollar funding. At a time when it is already hard enough for American families and businesses to get the credit they need, they have a strong interest in making sure these banks continue to be active in the U.S. dollar markets. It is in our national interest to make sure that non-U.S. banks remain able to access the U.S. dollar funding that they need to be able to continue to finance their U.S. dollar assets. If access to dollar funding were to become severely impaired, this could necessitate the abrupt forward sales of dollar assets by these banks, which could seriously disrupt U.S. markets and adversely affect American businesses, consumers, and jobs. One way we can help to support the availability of dollar funding and ensure that credit continues to flow to American households and businesses is by engaging in currency swaps with other central banks. Such swaps are a policy tool that the Federal Reserve has used to support dollar liquidity for nearly 50 years.
More recently, the Federal Reserve established dollar-swap lines with major central banks during the global financial crisis of 2008, and reactivated them in May 2010. The swaps are intended to create a credible backstop to support but not supplant private markets. Banks with surplus dollars are more likely to lend to banks in need of dollars if they know that the borrowing bank will be able to obtain the dollars it needs to repay the loan if necessary from its central bank. Our principal aim is to protect U.S. banks, businesses, and consumers from adverse economic trends abroad. I am pleased that the swaps seem to be working. In conjunction with ECBs long-term refinancing operations, the swaps have helped European banks avoid the significant liquidity pressures we feared a few months ago. And they have reduced the risks that they would need to sell off their U.S. dollar assets abruptly. In conclusion, I am hopeful that Europe can effectively address its current fiscal challenges. The Federal Reserve is actively and carefully assessing the situation and the potential impact on the U.S. economy. At this time, although I do not anticipate further efforts by the Federal Reserve to address the potential spillover effect of Europe on the United States, we will continue to monitor the situation closely. Thank you for your invitation to testify today and I look forward to answering your questions. Chairman PAUL. Thank you, Dr. Dudley. Dr. Kamin?
STATEMENT OF STEVEN B. KAMIN380 DIRECTOR, DIVISION OF INTERNATIONAL FINANCE BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM
Mr. KAMIN. Thank you, Chairman Paul, and members of the subcommittee, for inviting me to talk about the economic situation in Europe and actions taken by the Federal Reserve in response to this situation. In the past several months, European authorities have provided additional liquidity to banks, bolstered bank capital requirements, developed rules to strengthen fiscal discipline, and explored means of enlarging the euro-area financial backstop. Stresses in financial markets have eased, but these markets remain under strain. The fiscal and financial strains in Europe have
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spilled over to the United States by restraining our exports, depressing confidence, and adding to the pressure on U.S. financial markets. Of note, foreign financial institutions, especially those in Europe, have found it more difficult to borrow dollars. These institutions make loans to U.S. households and firms as well as to borrowers in other countries who use those loans to purchase U.S. goods and services. While strains have eased somewhat of late, difficulties borrowing dollars by European institutions may make it harder for U.S. households and firms to get loans and for U.S. businesses to sell their products abroad. Moreover, these disruptions could spill over into U.S. money markets, raising the cost of funding for U.S. financial institutions. To address these risks to the United States, on November 30th, the Federal Reserve announced, jointly with the European Central Bank or ECB, and the central banks of Canada, Japan, Switzerland, and the United Kingdom that it would revise, extend, and expand its swap lines with these institutions. The measures were motivated by the need to ease strains in global financial markets which, if left unchecked, could impair the supply of credit to households and businesses in the United States and impede our economic recovery. Three steps were described in the announcement. First, we reduced the pricing of the dollar swap lines from a spread of 100 basis points over the overnight index swap rate to 50 basis points over that rate. This has enabled foreign central banks to reduce the cost of the dollar loans they provide to financial institutions in their jurisdictions. This, in turn, has helped alleviate global financial strains and put foreign institutions in a better position to maintain their supply of credit, including to U.S. residents. Second, we extended the closing date for these lines from August 1, 2012, to February 1, 2013, demonstrating that central banks are prepared to work together for a sustained period to support global liquidity conditions. Third, we agreed to establish swap lines in the currencies of other participating central banks. These lines would allow the Federal Reserve to draw foreign currencies and provide them to U.S. financial institutions on a secured basis. U.S. financial institutions are not experiencing any foreign currency liquidity pressures at present, but
we judged it prudent to make such arrangements should the need arise in the future. Information on the swap lines is fully disclosed on the Web sites of the Federal Reserve Board and the Federal Reserve Bank of New York. I also want to underscore that the swap transactions are safe and secure. First, the swap transactions present no exchange rate or interest rate risk because the terms of each drawing and repayment are set at the time the draw is initiated. Second, each drawing on the swap lines must be approved by the Fed, providing us with control over the use of the facility. Third, the foreign currency held by the Fed during the term of the swap provides an important safeguard. Fourth, our counterparties are the foreign central banks, not the private institutions to which the central banks lend. The Feds history of close interaction with these central banks provides a track record justifying a high degree of trust and cooperation. Finally, the short tenor of the swaps means that positions could be wound down relatively quickly were it judged appropriate to do so. Notable, the Fed has not lost a penny on these swap lines since they were established in 2007. In fact, fees on these swaps have added to the earnings that the Fed remits to taxpayers. To conclude, following the changes that we made to our swap line arrangements last November, the amount of dollar funding for the swap lines increased substantially. Subsequently, as measures of dollar funding costs declined, usage of the swap lines has fallen back. Ultimately, however, a sustained further easing of financial strains here and abroad will require European authorities to follow through on their policy commitments in the months ahead. We are closely monitoring events in Europe and their spillovers to the U.S. economy and financial system. Thank you, again, for inviting me to appear before you today. I would be happy to answer any questions you may have. Chairman PAUL. Thank you, Dr. Kamin.
I will start off with the questioning. For Dr. Dudley, I wanted to see if we could start off by seeing if we could agree with what the problem isin my opening statement, I emphasize that the debt is the problem; that we are in a worldwide debt crisis.
Do you generally agree with that and how serious to you think it is? Mr. DUDLEY. I think you are certainly correct that there is a question of debt sustainability in Europe in terms of the fiscal budget deficit path for some countriesnot all countries, some countries and there is alsoand that is also implicated some of the European banks to have large exposures to that sovereign debt. And so what is important is that these countries have an opportunity to undertake the fiscal consolidations that they need to demonstrate to the market that they can actually be on a sustainable path. ECBs long-term refinancing operations and, I think, the dollar swaps have helped create some time for this to take place, but for this to work out well, these countries still have to take the appropriate steps. Chairman PAUL. So far, if we date the crisis back to 2008 and 2009, and if it was a debt crisis that was a problem, if you look at everybodys debt, it is exploding, including ours. How do you solve the problem of debt with exponentially increasing the debt? It seems like our problems are just compounded. How do you get around to either stop accumulating more debt or do you believe you have to liquidate debt? Some people believe you have to get rid of the debt in order to get growth again because the debt will consume us and interest rates are bumping up already. And as I said in my opening statement, the Fed will have some ability to manipulate interest rates in the economy, but ultimately, the economic laws are pretty powerful, so interest rates are liable to go up. So how can we solve the problem of debt with more debt, and what is your opinion of liquidating that? Is that important? Mr. DUDLEY. I think that you are right, obviously, more debt does not solve the problem of too much debt. I think the good news in the United States, and I will speak about the United States, is that there has actually been a significant amount of deleveraging that has taken place among U.S. households over the last few years. Debt-to-income ratios have come down. Debt service relative to income has come down. So U.S. households, I think, are in significantly better shape than they were a few years ago. The second area where we see a pretty big change in terms of deleveraging of the United States is in the state of health of the U.S. banking system. U.S. banks, compared to 5 or 6 years ago, have much more capital and much bigger liquidity buffers.
So while I think it is too soon to say that the deleveraging process in the United States is over, we have made a considerable amount of progress in working our way out of the problems that we faced in 2007 and 2008. Chairman PAUL. But isnt it true that mortgage debt is still on the books? It has been transferred; maybe the Fed owns that debt. We dont even know what the real value is of most of it. And banks still hold some mortgage debt and it might be at a nominal value so in that sense of that debt being liquidated, maybe some individuals have straightened out their bank accounts, but there are still millions of peopleif they really were improving, they could make their payments again, but debt is still the problem. You say that some are deleveraged, but has there been any real liquidation of debt when it comes to mortgage and the derivatives because governments are involved in thateither the Central Bank or some of our programs are involved. It seems like none of that has been deleveraged. If anything, that looks like it is getting worse. Mr. DUDLEY. On the mortgage front, there has been some deleveraging, because banks have taken mortgage losses. Also, in certain cases, especially among private holders of mortgage debt, there has been some principal forgiveness, principal reductions. So you have actually seen, for example, last year, total household debt outstanding, according to the flow of funds, which is the broadest measure of household credit, was roughly flat last year; so nominal GDP was growing. Debt that was held by households was flat. So you are actually seeing the debt burden become less overwhelming. Chairman PAUL. Yes. The promises that we made and the involvement we have with Europe that our finances are so good with our debt and our dollar that we have been standing and saying, Yes, we will be there. The Chairman of the Fed has said, We are not ignoring this. If necessary, we have been there before, we will be back again. What is the limit to this? What is the limit to us making these promises that we can always be available? Isnt there a limit to what the dollar will sustain? Wont it eventually have to stop or do you think we can do this if another crisis hits and there is a big downturn, and you have to inject trillions of dollars again, what is the limiting factor to the dollar and the United States economy bailing out the world? Mr. DUDLEY. I think that, from my perspective, we want to make the decisions based on what is in our self-interest, what is best for
households and businesses. And, in that calculation, if we decide that intervention can help household and businesses, at higher benefits than cost, then we want to proceed. If we dont reach that calculation, if we think that there is too much risk involved in the program or that the program is going to lead to moral hazard and is going to be counterproductive, then we dont want to undertake it. So I dont think that the Federal Reserve has made any decisions about what future interventions we would or would not do, except that we will do interventions that are consistent with our dual mandate, as set by Congress, to achieve maximum employment and price stability, sustain financial stability in the United States, and do what is best for households and businesses here. That is why we are doing this program; not for Europe, but for ourselves. Chairman PAUL. Dr. Kamin, did you want to make a comment? Mr. KAMIN. Yes, do you mind? Could I add a few words, Chairman Paul? Just to add to the comments that President Dudley madeour purpose in the swap lines, in particular, is not to, in some sense, fully back or to make whole all the debts that have accumulated around the world. That is very far from our purpose. Our key strategy and our key intent in this regard is to make sure that foreign financial institutions could maintain the flow of credit, both to U.S. households and firms, and to firms and households around the world that in turn buy U.S. goods and services. So the intent was mainly to help alleviate the liquidity pressures that could lead these foreign institutions to wind down their assets too quickly, and thus injure the U.S. recovery. Thank you. Chairman PAUL. Thank you. Mr. Clay? Mr. CLAY. Thank you, Chairman Paul. Let me follow Chairman Pauls line of questioning. Dr. Dudley, in your opening statement you mention that severe stress in European markets will create stress in the U.S. economy. Are we that tied to the European economy and that married to that system that it would have that kind of reaction, a chain reaction? Mr. DUDLEY. I think we live in a global economy, and what happens in the other big economies of the world definitely affects us. As I noted in my testimony, there are sort of three channels by which Europe could affect us in a negative fashion. One, if the European
economy is in recession or very weak, that is going to reduce the demand for our exports. So that has effects on U.S. production and employment here in the United States. Two, if Europe were to be in a difficult position, and the European banking system were to worsen, that would have consequences for U.S. banks that have exposure to the European banks. And three, if Europe were to perform badly, that would have negative effects on financial markets around the world. And that would have implications for our financial markets, and therefore, investment and growth here in the United States. So there are definitely significant channels by how Europe can affect the United States. Mr. CLAY. Dr. Dudley, have actions taken by the Federal Reserve regarding the currency swap line arrangements been beneficial or detrimental to the U.S. economy? Mr. DUDLEY. We think that the swap lines have had their desired effects, because they have basically given a source of a backstop to other sources of funding to European banks. So as a consequence of them having this backstop available, if they were to need it, they dont have to be as fearful about their ability to obtain funding. And therefore, they can manage their dollar loans to U.S. businesses and households in a more orderly fashion. We follow the activities of European banks in the United States through their U.S. branches and subsidiaries, and they are definitely reducing their exposure in the United States. But I think because of the dollar swaps, this is happening in an orderly way, rather than a disorderly way. And so, we dont see that their reduction in the business that they are doing in the United States is having any damaging effects on the U.S. economy, which is really what our goal is; to prevent any damaging effects on the U.S. economy. Mr. CLAY. Okay. Dr. Kamin, would you like to add something? Mr. KAMIN. Yes, thank you, if I could just add to those remarks. Over the past couple of years, as the crisis in Europe has progressed, we have seen several periods when the financial situation in Europe deteriorated fairly dramatically. And during those periods, we could see some very obvious spillovers to financial markets, both in the United States and around the world. During those periods of deterioration, investors became worried, and around the world they retreated from assets they perceived to be more risky. And what that led to, both in Europe and the United
States and elsewhere, was sharp declines in stock prices, increases in interest rates line of credits, and other developments that were associated with retreats from risk and flights to quality. So, we have seen those episodes very clearly. Now, more recently, since we changed the pricing of our swap lines, since the ECD introduced many measures to add liquidity to banks, and since European leaders have taken other actions, we have seen financial conditions in Europethis is more or less since Decemberimprove quite markedly. And that has been an important contributing factor to the improvement to the tone in financial markets in the United States. So those connections are definitely there. Mr. CLAY. Dr. Kamin, share with us the effects that the rise in gasoline prices around the world and in the United Stateswhat effects will this rise in gas prices have on the economies of Europe and the United States? Mr. KAMIN. The effects that higher oil prices will have on both the United States and on Europe are, in broad qualitative terms, relatively similar. Both broad economies import oil. There is a greater dependence on imported oil in Europe than in the United States, but both do. So, when oil prices rise, that acts as a tax on consumers of oil in both countries. And as a result, that diminishes the purchasing power that consumers in those counties have to basically spend on other goods. So, it basically acts as a brake on economic recovery and all else being equal, may make it more difficult to create jobs. In addition to the effects on unemployment and economic activity, increases in oil prices have the effect of raising at least some portion of the consumer basket of prices. As long as oil prices will continue to rise, that should lead to a temporary increase in inflation. But that also poses concerns. So obviously, recent increases in oil and gasoline prices are something that we monitor very carefully. Mr. CLAY. Thank you. And my time is up. Chairman PAUL. I thank the gentleman. Now, I recognize Mr. Luetkemeyer from Missouri. Mr. LUETKEMEYER. Thank you, Mr. Chairman. Gentlemen, correct me if I am wrong, but I believe that the swap dollars that areI guess eurosthat are on the other end with the European Central Bank, they secure those, do they not, whenever they loan them back out on their other end?
And would you agree that there is a problem from the standpoint that what we have been told and what we find recently is they are taking a little more exposure, a little more risk, with some of the investments that they are taking as collateral for those? Would that be a fair statement? Mr. DUDLEY. They have broadened out the collateral eligibility, but they also have significant haircuts for that collateral. So, they take more collateral than the value of the money that they are actually lending out. Mr. LUETKEMEYER. Instead of one-to-one, it may be two-to-one, as they take additional collateral? Mr. DUDLEY. They adjust for what they perceive to be the quality of the collateral. Mr. LUETKEMEYER. Because I know that former executive board member Juergen Stark recently said that the balance sheet of the ECB is not only gigantic in dimension, but also alarming in its quality. Would you agree with that statement? Mr. DUDLEY. I dont have enough information to assess the quality of the ECB balance sheet. But my dealings with the ECB suggest that they are quite prudent in terms of how they run their operations. Mr. LUETKEMEYER. Yes, but arent you one of the leading experts on swaps between the United States and Europe? Mr. DUDLEY. But I do not conduct the daily operations of the ECB in lending money to their banks, versus collateral that they take. Mr. LUETKEMEYER. Okay. One of the concerns that I have is with regard to the quality of the economies over there. We keep talking saying, They have dodged the bullet. They are getting better. They are improving. And yet, we see, and we had Secretary Geithner here just last week, and he acknowledged that the European continent as a whole is still struggling. I think the comment was made in testimony today that it is a negative position as far as the growth of the economy yet. Greece is probably 4/10ths or 4 percent negative growth. It is fine to sit here and go through a workout and restructure your debt, but if you dont have the ability to repay it, because you dont have an economy that grows fast enough to repay it, what do you have? I think we have to look at the revenue side. We may be able to restructure the debt so that it can work. But if you dont have enough cash flow, enough revenue coming in, we are still in trouble. Where do you see that going?
Mr. DUDLEY. I certainly accept your observation that the European economy is very weak, and that weakness is going to persist for a while as these governments engage in further fiscal actions to get their budget deficits on a sustainable course. But that fact I think in no way creates risk for us in terms of our swap agreements with the European Central Bank. We think we are very well secured in those transactions. We fully anticipate being fully repaid. During the depths of the financial crisis in 2008 and 2009, a far worse economic environment than the one in which we are today, with far greater amounts of swaps outstanding, we were fully repaid. We didnt lose a penny. In fact, the total profit to the U.S. taxpayers for the swaps that were engaged in during that period was about $4 billion of profit to the U.S. taxpayer. Mr. LUETKEMEYER. The point I am getting to, though, is if you have weak collateral for the European Central Bank swap lines and their economy is not going anywhere, that even getsto me, that makes the debt that isor the collateral that is securing that line even weaker. And so therefore, whether we may have two-to-one or three-toone, if you have nothing supplyingyou have 2 or 3 times nothing securing the debt, that is pretty concerning to me. Quick question for youdo you think that the swap lines enhance the dollar as the world reserve currency, or do you think it hurts it? Mr. DUDLEY. I think Mr. LUETKEMEYER. I would like a comment from both of you, please. Mr. DUDLEY. I dont think it is a major factor, but I think at the margin it probably enhances the dollar as a reserve currency. In other words, the fact that the Federal Reserve is willing to engage in dollar swaps probably makes people more comfortable to use the dollars to finance international transactions around the world. I dont think this is a major factor though in terms of why we are engaging in swaps, or should be a major factor in terms of why we are engaging in swaps. I think the main reason why we are engaging in swaps is we dont want European banks to quickly exit their dollar lending business here in the United States, with that exit causing harm to U.S. households and businesses. Mr. LUETKEMEYER. Dr. Kamin? Mr. KAMIN. If I could add to that, clearly, key factors that are underpinning the dollars status as a global reserve currency are the breadth and depth of U.S. financial markets. And in particular,
including but not limited to the status of U.S. Treasuries. All that is underpinned by the vitality of the U.S. economy and its consistent record of being able to innovate and grow. The purpose of the swap lines is ultimately focused on continuing to preserve the vitality of the American economy and by making sure that foreign financial institutions have the funding they need to continue the flow of credit to American households and firms. Insofar, then, as the swap lines can contribute to the continued vitality, the continued recovery of the U.S. economy, it undoubtedly is a plus as far as the dollars reserve status. Although, as President Dudley has pointed out, it is probably one of many factors and not necessarily the most important. Mr. LUETKEMEYER. Okay. Thank you very much. I see my time has expired. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I now recognize the gentlelady from New York, Mrs. Maloney. Mrs. MALONEY. Thank you. I want to welcome both of the panelists, particularly Dr. William Dudley, who is the President of the Federal Reserve Banks of New York. So welcome, Dr. Dudley. And I would like to begin questioning by asking you, regarding the Federal Reserves foreign exchange swap lines, can you tell me what your track record has been with these programs? Have they been successful? Have there been any losses to the taxpayers? Have there been any gains for the taxpayers; and if so, how much? And welcome. Mr. DUDLEY. Thank you. Mrs. MALONEY. Thank you for your service, both of you. Thank you. Mr. DUDLEY. Thank you, Congressman Maloney. The track record is excellent, in two dimensions. One, the swap lines that we have engaged with have accomplished the goal that we set for them, which is basically to support U.S. financial markets and ensure the flow of credit to U.S. households and businesses. And two, we have managed to do so in a way that has been extraordinarily safe. As I noted earlier, there have been no losses on any swap programs that we have ever engaged in, going back to 1962; and in terms of the swaps that we enacted during the financial crisis in 2008 and 2009 and ongoing, total profits for the taxpayers of about $4 billion.
So no losses, profit for the taxpayers; has had the beneficial effect that we wanted in terms of supporting the financial system and supporting the flow of credit to U.S. households and businesses. So I think that they have worked very well. Thank you. Mrs. MALONEY. Thank you very much. And I would like to ask Dr. Kamin about a statement that Treasury Undersecretary Brainard has stated; that the Administrations position in Europe is not to seek additional funding for the IMF. And to quote her directly, she said, The challenge Europe faces is within the capacity of the Europeans to manage. Europe accounts for roughly 16 percent of our exports; in my opinion, and correct me if I am wrong, accounting for the stabilization of many jobs here in the United States, probably thousands of jobs. What occurs abroad is going to have a direct effect on the recovery here at home in the United States. Do you believe the stabilization of European markets is critical to our economic recovery here at home, making systems like the Federal Reserve foreign exchange swap lines crucial? Mr. KAMIN. Thank you, Congresswoman Maloney. In response to your questions, first of all, I absolutely agree that it is critical that the Europe financial and economic situation be stabilized. As you have pointed out, Europe is a major trading partner of the United States. And as we discussed earlier, its financial conditions in Europe are highly intertwined with those in the United States. So a stabilization of the European situation really is very important, both for the United States financial conditions as well as the continued growth of exports and the real economy, and thus jobs. Now, as regards the issue of IMF policy, the Treasury Department is our liege on that, on the issue of IMF policy, so I cant speak directly to their statements. But I will note, as Treasury officials have noted as well, as well as Federal Reserve officials, that Europe is a verythe euro area is a very large and comparatively wealthy economy relative to many others in the world. And they do have very many substantial resources that could be brought to bear on their situation. And so it is critical for them to do so. Thank you. Mrs. MALONEY. Thank you. And Dr. Dudley, I would like to ask you, as countries and international markets form individual firewalls to stave off residual financial distress, are we always and likewise creating firewalls through various other areas in policies involving capital and liquidity
requirements that could have an effect on our economy here in the United States? Mr. DUDLEY. We think it is very important to have a financial system that is resilient and robust. And towards that end, Congress, the Administration, and the regulatory community in the United States have been working hard to bolster the capital and liquidity among U.S. financial firms. I have to say that we are in much better shape than we were a few years ago in both those regards. And I think that is good news because it means that if there are shocks emanating from abroad or emanating in the United States, that U.S. banks are in much better shape to absorb those shocks and to continue to function and supply credit to U.S. households and businesses. Mrs. MALONEY. Could I ask for an additional 10 seconds? Do you believe that we should do everything we can to contain the European crisis, to ensure that there is no spillover here in the United States, and to stabilize that region and our own economy? Yes or no? Mr. DUDLEY. I think we should do everything that is prudent to stabilize the European economy. Obviously, we should do what is in our self-interest in terms of what is best for the United States; and all our policies are enacted through that prism. Mrs. MALONEY. Okay. Dr. Kamin? Mr. KAMIN. Yes. That was exactly my thought. Definitely everything that is prudent and appropriate. Mrs. MALONEY. Okay. Thank you. I yield back. Thank you, Mr. Chairman. Chairman PAUL. Thank you. Did Mr. Luetkemeyer have a unanimous consent request? Mr. LUETKEMEYER. Yes, Mr. Chairman. I would like to ask unanimous consent to place in the record the article which I referred to this morning. It is a MarketWatch article by Andrea Thomas with regards to the comment of executive board member Juergen Stark.381 Chairman PAUL. Without objection, it is so ordered. Mr. LUETKEMEYER. Thank you, sir. Chairman PAUL. I now recognize Mr. Schweikert from Arizona.
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[The article Rep. Luetkemeyer placed in the hearing record can be found in Appendix E.]
Mr. SCHWEIKERT. Thank you, Mr. Chairman. Congressman Luetkemeyer stole one of the number-one questions I was interested in pursuing, and that was the credit quality of what is being pledged. Can I get into something that is a little more conceptual? But this one actually really does bother me. I am trying to get my head around the interconnectivity of euroyen, euros relationship to Singapore. And ultimately, as we are providing interlocking swap facilities, what happens when the debt cascade happens somewhere else in the world? Does that cascade end up tagging Europe, which tags us? And how much ultimately is there in true net reserves in central banks around the world when you start looking at the net borrowing compared to the net savings countries? Dr. Kamin, I would love it if you would start with that one. Mr. KAMIN. Thank you. I will be happy to. So to start with, as we have come to recognize only too well, we have a very globalized financial system. And disturbances that occur in one part of the world are transmitted around the world through numerous channels and through numerous markets. That was quite evident during the global financial crisis of 2008 and 2009. And we have seen it more recently with the European fiscal and financial crisis as deteriorations there Mr. SCHWEIKERT. Can I beg of you to pull the microphone a little closer to you? Mr. KAMIN. Thank you. We have seen it more recently during the European financial crisis in the last couple of years. So Mr. SCHWEIKERT. And almost to thewhat I am somewhat hunting is I have been tracking some data coming out of Japan, and there are some very worrisome signs in the net debt. How does that play into this interconnectivity? Mr. KAMIN. What we have seen, then, is that in situations that occur like this, some dollar-funding problems, which is to say problems with banks getting funding in dollars in order to continue their flow of financing, they tend not to basically stay in one part of the world. There is a very easy capacity for those problems to spill out all over the world. And it was in large part for that reason that we didnt just establish the swap lines with the ECB. We also established them with central banks around the world so that problems as they arose in different parts of the world could be addressed. And as is evident from the data on the swap lines that we publish on our Web site, the take-up of these swap lines, in other words the
distribution of funds to institutions in different regions, has not been limited exclusively to the euro area, although that is where most of the money has gone. Mr. SCHWEIKERT. Dr. Dudley? Mr. DUDLEY. I certainly agree with Dr. Kamins answer to that. The world is very interconnected, and problems in one part of the world can definitely have ripple effects through the other parts of the world. That is why we did set up these swap lines with five central banks rather than just the European Central Bank. And there are some draws on those swap lines from some of these other central banks. Mr. SCHWEIKERT. Dr. Dudley, as to that concept, help me get my head around it. Considering the nature of our balance sheets today after the 2008 crisis, both Europe and the United States, some of our partners in Japan, around other places in the world, if today Europe this became a very hard recession and we had something like the Tequila Crisis from 15 years ago or some sort of cascade out there, do we have enough capacity, particularly if we also had different regions of the world competing for access to those swap lines? Do you believe our balance sheets are capable of stabilizing? Mr. DUDLEY. It is hard to know what would happen in a given scenario, so it is hard to speculate. One thing that I think is important though is that the foreign countries around the world are a bit better protected themselves in terms of sharp changes in capital inflows to capital outflows in the sense that they have very large foreign exchange reserves compared to what they had 20 or 30 years ago. So, the ability of countries to bear a reversal from capital inflows to capital outflows is much better generally around the world than it was 20 or 30 years ago. And part of that is my concern over the interest-rate spike, particularly with our net debt coverage; the interest rate spike and where our WAM is on our U.S. sovereign debt. A couple of years of higher interest rates would be devastating budget-wise. So, I am fearful of a cascade somewhere else truly affecting us. Mr. SCHWEIKERT. I talked in a recent speech about debt service problems for the United States that are not really visible yet because U.S. interest rates are so low. And if the United States does not get its fiscal house in order over the medium term, there is a chance that U.S. interest rates will rise.
And that debt interest burden on the U.S. fiscal position will become quite significant. So, this is just another reason why the United States does need to get its fiscal house in order over the medium to longer term. Thank you for your tolerance, Mr. Chairman. Thank you. Chairman PAUL. I thank the gentleman. Now, I recognize the gentleman from North Carolina, Mr. McHenry. Mr. MCHENRY. Thank you, Mr. Chairman. And thank you both for being here. We had a similar hearing in my subcommittee of the Committee on Oversight and Government Reform. And the times have changed slightly in the last couple of months, so I do want to touch on some of the things that I raised then, just to see if things have changed. Dr. Dudley, can you explain under what circumstances the Fed would consider purchasing European sovereigns directly? Mr. DUDLEY. The Federal Reserve has a small foreign exchange reserve portfolio that we manage for ourselves and for Treasury. And so we do actually own a very small amount of European sovereign debt as part of that foreign exchange reserve portfolio. With the exception of that portfolio, which we periodically roll over maturing securities, I think the bar, as I said in our hearing a few months ago, was extraordinarily high for the Federal Reserve to actually go out and buy foreign sovereign debt for its own portfolio apart from these very small foreign exchange reserves holdings that we have. Mr. MCHENRY. So, roughly what dollar amount do we have? Mr. DUDLEY. I think it is on the order of $20 billion, $25 billion total. It consists of cash, sovereign debt of a couple countries, and then there are some reversed repurchase agreements where we basically have executed against dealers and taken Mr. MCHENRY. So, for context Mr. DUDLEY. It is a tinyand it is based Mr. MCHENRY. $25 billion to what of your total holdings, just so we have Mr. DUDLEY. The total portfolio is about almost $3 trillion, not quite $3 trillion. Mr. MCHENRY. Okay. So, it is de minimis Mr. DUDLEY. It is de minimis and it hasnt changed in size or composition over Mr. MCHENRY. Do you have statutory authority to expand that? Could you ramp it up to $500 billion?
Mr. DUDLEY. We have legal authority under the Federal Reserve Act to buy foreign sovereign debt. I dont see the circumstances under which we would ever be willing to do that, except with the exception of managing this foreign exchange reserve portfolio. Mr. MCHENRY. Okay. Now, in terms of the long-term refinancing operation the European Central Bank has undertaken with the 3-year notes, in essence it looks similar in concept to TARP, doesnt it? Mr. DUDLEY. It is a little different in the sense that TARP was money that Congress appropriated and then was used by the Treasury as capital to put into banks or put into other entities to recapitalize them. The long-term refinancing operation is a loan from the European Central Bank to its banks against collateral that they pledged. So, it is a lending operation, not a capital investment. Mr. MCHENRY. So, the TARP really wasnt a lending operation so you had to pay it back with fines and penalties and interest? It seems to me Mr. DUDLEY. TARP could be used for many purposes. It could be lent out and it could be used as capital. But if you look at how the TARP money was used and the bulk of it, the bulk of it was used for capital investments. Mr. MCHENRY. I think we are battling semantics here because in essence they are similar in dollar amounts, similar in terms of their intent. Now, really at the root, what is the European problem? Is it a problem of indebted countries? Is that the root of what we are contending with right now? Mr. DUDLEY. I think that is part of it. Part of it is you have some countries in Europe that have budget deficits that are unsustainably high and debt burdens that are continuing to climb. So, that is problem number one. But problem number two is they are doing so in a system of 17 countries with a common currency where the individual countries dont have control over their own monetary policy. They dont have their own currency and there is a lack of fiscal transfers within Europe to support countries that are in a weaker position relative to those that are in a stronger position. So, there are some things that are very special about Europes that are part of the European Union, the system of how the system is
arranged that are very different than anything that applies to the United States. Mr. MCHENRY. So, what happened with much of this long-term refinancing operation, that capital; it flowed into sovereign debt of a few countries and in large part that is where much of this flowed. But Dr. Kamin, in terms of what that actually didwe have actually bought some time and space for a few highly indebted countries. Is that basically what has happened? Mr. KAMIN. I think that it is possible that the sect of the LongTerm Refinancing Operations (LTRO), in combination with the other measures that have been taken, basically might have some somewhat longer-term benefits. To be specific about that, it is true, as you say, that probably some of the LTRO money did flow to the purchase of sovereign bonds. But perhaps the more important thing that the LTRO funds did was alleviate many concerns by the market about the liquidity position and the financial position more generally of European banks. And so the way in which that may have led to reductions in the sovereign yields of some embattled European governments was not just directlythey had the funds and they could use them; but indirectly because European banks felt more solid in their financial position and more comfortable being able to buy these bonds. In turn, that improved situation in terms of European banks in the eyes of the markets may have led investors to believe that, therefore, European governments would not in turn be called upon to support banks. So, there was sort of a virtuous circle in process here, which has so far been very beneficial in terms of improving the tenor of markets. Now, all that said, you are absolutely right that the LTRO is the provision of liquidity by itself cannot be the only thing that will solve the European crisis. It is very important that European leaders work on a number of more lasting fundamental issues. One of them is they need to actually make the financial backstops for European governments higher and stronger, and that is a discussion they are having. They also need, quite obviously, and this is very challenging, to actually follow through on their many commitments to improve their fiscal situation. And finally, as we have discussed here today, improved fiscal performance must be buttressed by improved growth performance, and that is particularly challenging for the peripheral European economies. And so, they are going to have to follow through on a lot of fairly rigorous structural reforms.
Thank you. Mr. MCHENRY. Thank you. It sounds like psychology and economics are getting closer and closer in these current crisis times. Mr. KAMIN. I think they always have been. Chairman PAUL. I thank the gentleman. I want to follow up on this issue about how it is going to help our consumers here at home when we make these loans overseas. And I think, Dr. Dudley, you indicated that you already have some evidence that it has been helpful? Or are you just saying that if we do it, it could be helpful? Mr. DUDLEY. The evidence isit is soft evidence rather than hard evidence. But we have been monitoring the performance of the European banks who do business in the United States quite closely because they were having trouble getting dollar funding. Money market mutual funds which were providing dollar funding to the European banks during the summer and fall were pulling back. Other lenders, large asset managers, were also pulling back from the European banks. And this was causing those banks to start to get out of their dollar book of business. They were trying to sell off loans and pull back in terms of their willingness to provide credit. This was going on at a pretty feverish pitch through the late fall and in through the early winter. And I wouldnt say that it stopped, but the sense we get is it is happening now in a much more orderly way and not leading to the fire sale of assets at low prices; not leading to downward pressure on financial markets; not leading to a constraint in credit availability of U.S. households and businesses. So, from what I can tell, we are seeing that the leveraging of the European banks is continuing. But it is happening in an orderly way rather than a disorderly way, which is what our objective is. Chairman PAUL. You dont actually have a quantity, a number that you can Mr. DUDLEY. No, we dont have Chairman PAUL. to say that they did such and such to the consumers back here at home? Mr. DUDLEY. We dont have the details or data on that. But we do have discussions with those banks. Chairman PAUL. It seems like there is a conflict, at least in my mind, of the need to send more currency swaps over there when the banksI think the top eight banks in Europe actually had a tremendous increase in their reserves, a 50 percent increase in 1
year. So, why do they need more money? Why do they need more? It is already there. What about our banks? Our banks have $1.5 trillion. If it is a good deal and it needs these bailouts or these purchases that you want them to do by having these currency swaps to help the banks give the central banks to help buy some of this debt. If it is a good deal for anybody, why wouldnt some of our banksthey have $1.5 trillion? It seems like you are doing something that the market doesnt want you to do. And there is a reason. Maybe it is way too risky. And if we are sending money over to the European banks with the hope, but no evidence, actually, of some of this money coming back and actually stimulating our economy, why is it that just more credit and more money in the system is going to work if our banks are holding $1.5 trillion? There is something more to it than the lack of the ability or the lack of the willingness of the Fed to just endlessly create more and more credit. Why is it going to work better by just pumping more into, say, a European bank if the goalsee, you emphasized the help it is going toyou do it out of the interest of the American consumer. You diminish the possibility that it might be done to just prop up the banks because they are in over their headsthat they may have credit default swaps. And the banks over there areit is global. They have branches over there. It is just to prop up a system that is not viable. So why is there a disconnect? There seems to be a lot of money there. Why do you feel compelled that we have to keep sending more in order that hopefully it will help our consumers here at home? Mr. DUDLEY. I think that the U.S. banking system is a very different place than the European banking system. The U.S. banks have plenty of dollar assets that they canmonies that they can lend. They gather deposits through their retail branch networks here. So they dont have any shortage of dollar funds which they can lend. The European banks were in a different position because they were dependent on the wholesale funding market providing them with dollars. And as the European situation deteriorated last summer and fall, U.S. investors that had been providing dollars to these European banks were pulling back. And it was that pulling back and that difficulty for European banks to gain access to the wholesale dollar funding markets which was forcing them to pull back in terms of their willingness to lend to
U.S. households and businesses. U.S. banks dont need dollar liquidity right now, so there is noand they are not deleveraging. The issue is the European banks, their dollar book of business. They were having trouble funding that book of business, and that is why they were pulling back. Chairman PAUL. But they are holding all the reserves. If it were any advantage at all, they would do it. Obviously, there is no advantage to even helping out Europe. There is no law against them loaning the money, is there? Why do you feel compelled that you have to do something that the banks that are holding all this money wont do? Mr. DUDLEY. I think that the European situation was creating a lot of anxiety about the health of the European banking system because the health of the European banking system was tied up with the health of the individual national economies in terms of their fiscal positions. And the ECB basically has been trying to find a way to cut that tie. I think that long-term refinancing operations and the dollar swaps have sort of calmed down the anxiety in the market. And what we have actually seen now since the long-term refinancing operations have been put in place by the ECB and the dollar swaps have been put in place by us, is we have actually seen financing pressures in Europe subside. So the rates that the European banks have to borrow from other European banks or to borrow from U.S. banks in dollars, those rates have actually been coming down. So that is actually a beneficial consequence of the long-term refinancing operations and the dollarswap programs. The pressure on the markets is abating, which I think is a good thing. Chairman PAUL. I will recognize Mr. Luetkemeyer from Missouri. Mr. LUETKEMEYER. Thank you, Mr. Chairman. I am kind of curious. Who determines the rate for the swap lines, the interest rate? Mr. DUDLEY. The interest rate is established by the Federal Open Market Committee in discussions with the foreign central banks. Obviously, they have to agree to the rate that we are willing to Mr. LUETKEMEYER. How often is it reviewed to go up or down? How often do you review that: quarterly; semi-annually; once a year?
Mr. DUDLEY. The swap lines are outstanding. For example, the current set of swap lines are outstanding until February 1, 2013. But we certainly could review them at any Mr. LUETKEMEYER. The rate doesnt float? Mr. DUDLEY. at any point in time. The rate is set essentially at the Federal funds rate plus 50 basis points. So right now, it is about 0.6 percent of the interest rate. Mr. LUETKEMEYER. Okay, but the amount above the Fed funds ratethat stays constant for the entire length of the swap? Or do you float that or adjust that as well? Mr. DUDLEY. It had been at 100 basis points over the Federal funds rate up until last fall. And then, we lowered that spread from 100 basis points to 50 basis points. And the reason why we lowered that rate is that European banks were reluctant to use the swaps because they felt that using the swaps at that rate would be a sign of weakness. The swaps were actually not being very effective in containing pressure in financial markets. So a decision was made by us and the foreign central banks in which we have engaged with the swaps to lower the rate from 100 basis points over the Federal funds rate to 50 basis points over the Federal funds rate. Mr. LUETKEMEYER. If the European banks felt it was in their own best interests not to borrow money, not to swap because the rate was too high, why would you want to entice them into this with a lower rate? Mr. DUDLEY. They were reluctant to use the swap because they felt that if they used it, it would be a sign that they were particularly weak institutions. Mr. LUETKEMEYER. Why are they not viewed as weak now because they are using it now? Mr. DUDLEY. Because when the swap rate was lowered from 100 basis points over the Federal funds rate to 50 basis points over the Federal funds rate, it became broadly attractive to the rates that were then in place in markets. Mr. LUETKEMEYER. It made them look like better investors? Mr. DUDLEY. Pardon? Mr. LUETKEMEYER. It made them look like better investors, better money managers? Mr. DUDLEY. There was an economic rationale for borrowing from the swap lines at the lower rate, so lots of banks participated. And since lots of banks participated, there was very little stigma from participating in that program.
Mr. LUETKEMEYER. This whole thing is held together by confidence and the perception that everybody is doing okay, isnt it? Mr. DUDLEY. I think we have seen both in the case of the swaps and in the case of our own discount window in the United States, that there are times that banks dont want to use liquidity facilities, backstop facilities, because they are afraid that it is going to show that they are weak relative to other institutions. And that is just a problem in terms of these type of liquidity facilities. Mr. LUETKEMEYER. I am just kind of curious. I will follow up on Chairman Pauls line of questioning with regards to the ECB loaning it to the banks, and the banks turning around and loaning it to our American, I guess, companies and investors here. Why would they do that? Why are they not borrowing the money from us directly, our banks here? Mr. DUDLEY. The European banks have big books of business in the United States, especially in areas like trade finance, project finance, and reserve energy. They lend against oil-and-gas drilling, energy reserves. And they have specialized expertise in these areas. And so, that is why they undertake this business around the world. And in the United States, when they partake in this business, they do it in terms of lending dollars because obviously that is what the currency that we do business here in the United States. And so, they have a need for dollars to be able to sustain that business. Mr. LUETKEMEYER. So what you are saying is that there are banks in Europe that are better experts at lending in certain areas, certain fields, than we have lending institutions in this country. Is that what you just said? Mr. DUDLEY. I am saying that there are European banks that are specialized in certain areas. Now whether they are better or worse than U.S. banks that participate in the same areas, there is some overlap in the areas of competition. But there are certain areas where European banks historically have concentrated their lending. Project finance, trade finance, and energy reserve lending are probably three of the most predominant examples. Mr. LUETKEMEYER. Do the American corporations or entities that borrow from them, are they buying goods and services from Europe then, or are they buying goods and services from someplace else in the world, or the United States? Or is it kind ofdoes it kind of work like our export-import bank here, or how does that work? Mr. DUDLEY. I would presume that if you are borrowing in dollars, you are using those dollars to buy U.S. goods and services.
Otherwise, you wouldnt need the dollars. You would need some other form of currency. Mr. KAMIN. Congressman, if I could addthis is a very global financial system, and we are in the middle of a very global economic system. So, large banks operate all around the world and compete with each other. And that actually ends up being beneficial to non-financial Mr. LUETKEMEYER. I understand that, Dr. Kamin, but I am trying to get atI am kind of concerned here because we have foreign banks that are apparently competing against American banks, which is what you just said, yet we are loaning money to the ECB, to those banks, to be able to loan back and compete against our banks. Is that what you just said? Mr. KAMIN. What I said was just that both financial institutions and non-financial institutions compete with each other all around the world. Mr. LUETKEMEYER. Yes, but my concern is that if we, through these swap lines, are funding these international banks, and they are in turn competing against our banks, I dont think we need to be doing that. Do you? Mr. KAMIN. The primary concern of the Federal Reserve in setting up the swap lines was to maintain the flow of credit to American households and firms. That was key because that is what is needed in order to maintain the economic recovery and to move toward achieving our dual mandate of both price stability and maximum sustainable employment. So, that was the critical factor that motivated. Mr. DUDLEY. I think the U.S. banks also are interested in having a healthy U.S. economy, just like the European banks are. And I think that they probably broadly recognize that a forced liquidation of assets by Europeans banks would have negative consequences for the U.S. economy and for their banks. Mr. LUETKEMEYER. I see my time is up. Thank you, Mr. Chairman. Chairman PAUL. I now recognize Mr. McHenry for 5 minutes. Mr. MCHENRY. Thank you, Mr. Chairman. To follow up on the earlier question I had about the long-term refinancing operation, it is interesting to me, Dr. Kaminyou did walk through the whole thought process. And I do appreciate that, the willingness of a witness from an independent institution the Congress oversees to walk
through in sort of a very broad form; your thinking on this is rather impressive, and, dare I say, revolutionary. But it was very much appreciated because this is really just about trying to make sure policymakers on the Hill have an awareness of what the Fed is doing. And I dont have to explain to the Fed the chairman of this subcommittees vigorous intention of oversight of the Federal Reserve. That may be the understatement of the day. So with this injection of funds, of low-interest-rate loans for an extended period of time, much of this capitala large portion of this capital, I should sayof all the categories has gone to sovereign debt. Mr. KAMIN. This is the LTROs? Mr. MCHENRY. Yes. Mr. KAMIN. Thank you. Mr. MCHENRY. Yes. I am sorry. So in that operation, money is flowed to sovereign debt. So it has had one of the intended effects from the ECB, it appears. The question is, of course, What is our exposure to Europe? Right? In terms of a quantifiable dollar amount, by our private sector; that is one question. But really the bigger question here for policymakers is what is our exposure as a government, and the Federal Reserves exposure to Europe? Mr. KAMIN. Thank you, Congressman McHenry, for your kind remarks earlier, and for these questions. The Federal Reserve exposure to Europe would be basically encompassed by the value of our swap lines, which is around $50 billion or so, to the ECB, and then a very small amount to the Swiss National Bank. As we have discussed earlier, we think that those exposures are very secure. We have provided them with dollars. In exchange, they have provided us with their currency. And we appreciate the prudent management and the strong financial position of the ECB. The exposure of our private financial institutions to Europe is obviously much, much larger, both our banks and our money market funds. Those exposures to the most embattled so-called countries in Europe, particularly like Greece and Portugal and Ireland, are really very small; the exposures to Spain and Italysomewhat larger. But we have had many discussions with the banks that we supervise, and those are viewed to be quite manageable. Obviously, the exposures to core European banks which are, in turn, exposed to peripheral Europe are much larger.
But we are, in terms of thinking about the channels of spillover and how this exposure really workswhat is probably more of concern is not so much these direct financial exposures to European institutions, but rather the fact that if the situation in Europe took a turn for the worse, there will be these ancillary channels that we have talked about before; the disruptions of financial markets; the retreat from risk-taking that could disrupt financial markets around the world. And that is really the matter of greater concern, and that is where we focus a lot of our efforts in working with the banks that we supervise, and other regulatory institutions taking the same standpoint that the banks Mr. MCHENRY. Sir, explain to me how the swap lines benefit the American economy. Just in laymans terms. Mr. KAMIN. Sure. To begin with, many European financial institutions, as we have discussed, are engaged in direct extensions of credit to U.S. households and firms. Any situation where these European banks were unable to get the dollar funding they needed, they would be forced to pull back on lending from U.S. households and firms. They might be forced to sell assets, which would then depress asset values in the U.S. economy more generally. And both of those effects would directly affect the ability of the U.S. households and firms to grow and prosper. On top of that, funding difficulties by these European banks would lead to their cutback on credit, in terms of dollar lending, to other firms around the world; firms which buy a lot of the U.S. exports. And so, that would be an additional channel through which a funding shortage could hurt the U.S. economy. And that is what we hope to alleviate through the provision of these funds. Finally, in the event that the dollar funding was not available say in the absence of our swaps linesand European banks ran into more severe difficulties, this could be a contributing factor to a further and renewed deterioration of European financial conditions, that not only could severely impact the European economy and prolong the recession, but lead to distressed conditions around the world. So there might be larger, more ancillary effects from dollar funding problems then, again, the dollar swap lines are intended to alleviate. Mr. MCHENRY. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I recognize the gentleman from Michigan, Mr. Huizenga.
Mr. HUIZENGA. Thank you, Mr. Chairman. I appreciate the opportunity, and I thank the witnesses for coming in. I want to maybe touch on a couple of quick things and continue on the currency swaps. How far are we going to bring this along, I guess would be part of my question? How long are we going to stick into this game and be part of it? If Europe remains dependent on currency swaps, these same swaps become increasingly risky. Are you prepared to allow these currency swaps to wind down? Or what is going to happen there? And then, the short-term dollar funding in Europe seemed to be the discussion point; right? How would you define short term versus medium term and long term? Mr. KAMIN. I will start. Or, why dont you go ahead? Mr. DUDLEY. Okay. What we would hope is that the European countries do the right thing in terms of getting their fiscal houses in order and improving their competitiveness, so that investors start to have more confidence in the sustainability of the European Union and how all these countries are going to persist. If that happens, and at the same time, the European banks are shown to have good earnings, liquidity, and capital, then I think that the willingness of private lenders to provide dollar liquidity to the European banks will emerge very much intact. And in that situation, our swaps will be at rates that are actually higher than the market, and the swap programs will just sort of wind down automatically. This is what we saw during 2007, 2008, 2009, during the first big wave of swaps; that as market conditions normalized, the swap usage came down pretty automatically. Mr. HUIZENGA. I am kind of curious about that, because I am looking at some information in front of me here that says interest rates on dollar loans from the ECB are around 0.6 percent; interest rate on ECB charges for its euro loans is 1 percent. I dont have my Ph.D. in economics, however, I can see the incentive there. Why by making dollar financing cheaper than euro financing, how are they ever going to get out of that cycle? Mr. DUDLEY. I am not sure that I would agree with that, if that is the right comparison. The 1 percent is to borrow euros. The 0.6 percent is to borrow dollars. And the alternative is to borrow dollars from a U.S. bank when the Federal Reserve is paying 25 basis points on the interest rate that we pay on excess reserves.
There is quite a bit of room between the 25 basis points we pay on the reserves here in the United States, and the 0.6 percent on the dollar swaps. So we would expect that if the conditions in Europe were to continue to improve, that the rate at which European banks could borrow dollars would be somewhat north of 25 basis points perhaps, but below that 0.6 percent. So we would think that there is plenty of room in that difference for the European banks to obtain credit from private entities. And, in fact, we have actually seen private suppliers of dollars to the European banks return subsequently to the large, long-term refinancing operations and the dollar swap programs. So it looks like Mr. HUIZENGA. But doesnt that Mr. DUDLEY. the market is already starting to normalize the dollar swaps. Mr. HUIZENGA. But doesnt that weaken the value of the euro, what they are doing? Mr. DUDLEY. I think the euro has really basically been trading in line with how the situation in Europe looks. As the European situation worsens, the euro depreciates. As the European situation improves, the euro appreciates. So it is really based on the outlook for Europe, of course relative to the outlook in the United States. Mr. HUIZENGA. Help me to understand how if it is a weaker euro, doesnt that mean a typically a weaker Eurozone, since we have sort of flagged this off as a European issue, and trying not to get dragged into it here from the U.S. side? Mr. DUDLEY. You are certainly right that if the European outlook were to deteriorate, the euro would probably weaken as a consequence. The good news is that over the last 4 or 5 months, the euro has actually strengthened a bit, because Europe has actually made some progress in terms of addressing some of their issues. Mr. HUIZENGA. Okay. And then, my time is almost up, and I willDr. Kamin, do you want to say something as well? But I am just curious: What keeps you up at night? What other countries? You specificallyI think in Dr. Kamins testimony, he talked briefly about Greece. And then, you just were touching on Spain and Portugal. But where are we at with Italy and Ireland? Are we on solid footing are they on solid footing in France and Germany and some of those other countries that have been leading this?
Mr. KAMIN. Certainly, the euro crisis in general is what keeps me up at night, and what occupies much of my thinking time during the day as well. Obviously, the situation in Greece has been very difficult. And we have been following that very closely. We also, obviously, are very focused on, basically, Ireland and Portugal, which are the recipients of IMF funds. And we think it is critically important that these problems not move further into Spain and Italy, which have also been the focus of market attention. And we think it is absolutely critical to make sure that you dont have further contagion beyond that. So far, things have been looking on the brighter side. There have been improvement in markets. But we have continued to monitor the situation as closely as ever. And then, while most of my thinking lately is focused on Europe, obviously I am thinking about oil prices as well, because that is another area that poses a potential threat at least down the road. Mr. HUIZENGA. Thank you. Chairman PAUL. Thank you. I have a couple of additional questions I would like to ask. I am interested in one line on the Federal Reserve sheet at each week on other assets, other Federal Reserve assets. And it has been growing a bit. It used to be a small number, but even in recent years, it has gone up. I think it is about $160 billion now. What does that include? Does that include anything foreign? Is there any type of a foreign asset or a swap or anything involved in there that would help me understand this international financial crisis that we are in? Mr. KAMIN. Chairman Paul, we definitely put on our balance sheetwe list our holdings of foreign assets. I dont recall offhand if that is where the other assets are. I dont think so. The other assets have, as you point out, risen over time. And there is one main contributing factor to that, which is when we buy securities in the markets, sometimes we buy them at a value that is above their par or face value, because interest rates had declined since they were first issued. That raises the value of those securities. So then, we place the par value of the securities in one line on our balance sheet, and then that additional part that is over the par value, the premium, that is placed in our other assets line. So as we have continued to purchase securities in the market, the amount of the premium part of our purchases, which has gone into the other assets line, has continued to rise.
Chairman PAUL. So you say you are buying securities. Would this be like mortgage securities? Mr. DUDLEY. This would be predominantly the maturity extension program, in which we are selling short-dated Treasury securities and buying long-dated Treasury securities. We are also buying mortgage-backed securities, but with emphasis to rolling over existing maturing mortgage-backed securities, so the size of the mortgagebacked securities portfolio is pretty constant. Chairman PAUL. So, the significant increase of $160 billion of just saying they are other, it is definitely related to the international financial crisis that we are involved in right now? Mr. DUDLEY. As Steve related, it is related to the expansion of the Feds balance sheet and the types of assets that we are buying in the market. The maturity extension programwe are selling shortdated Treasuries; we are buying long-dated Treasuries. To the extent that we are buying Treasuries that are selling above par because interest rates has declined, that is different than what Steve was saying is booked in the other assets category. Chairman PAUL. What does this mean, if this were to continue to grow at the rate it is growing now? Mr. DUDLEY. No. I would expect that once the maturity extension program or other asset purchase programs are ended, then I would expect the other assets category actually to probably come down over time as that premium was amortized over time. So, I would view this as a temporary phenomenon. Chairman PAUL. But there is no one place in the Federal Reserve reports that would give me a full explanation of exactly what the $160 billion is? You dont send out a report each month and say exactly what that is made up of? Mr. KAMIN. There is an interactive portion of our Web site that offers more analysis of the different lines. That is the first thing. The second thing I want to follow up on is having checked, the other assetsI just think the other assets category does indeed, as you suggest, also include foreign currency denominative assets, but not the swap lines. It is the other European and the undenominated securities that we hold. Chairman PAUL. Okay. The other thing I have noticed since 2008 is if you look at a longterm chart of currency in circulation, it is a steady increase and very predictable. But since 2008, it has been going up much more rapidly. This is cash as currency. Where is the demand for more cash? Do you
know exactly where that goes? Does that end up overseas? Is that in circulation here? Or is it in a shoebox someplace? Mr. DUDLEY. Probably in both places. With interest rates this low, the opportunity costs of holding more currency obviously is very low. If you hold the currency, you get a 0 percent return. But if you have gone to your bank these days, you dont get much more than that. So, people probably are carrying around more currency in their pockets because there is less cost of holding the currency versus holding it in a bank. This may also be true internationally, although I am not familiar with how much currency is held here versus abroad. I know historically, it has been about one third here, and two thirds abroad. But I dont know how that has been changing recently. Chairman PAUL. I have one quick question for both of you. You can probably answer this rather easily. You are very much involved in dealing with the value of our money, the value of our dollar and our financial system. But I have trouble finding the legal definition for the unit of account that we have as a dollar. Can you tell me your definition ofwhat is a dollar? Mr. DUDLEY. I view the dollar as the legal tender in the United States, so that if someone pays a dollar as payment, the shopkeeper has to accept that dollar for that transaction. Mr. KAMIN. Also the classic definition of money, I think of it as three things. It is store value, which it is a medium of transaction. Mr. DUDLEY. And usually has portability. Mr. KAMIN. Yes. And then it is a medium of accounts. In other words, you measure value by using a dollar. Chairman PAUL. But you do realize there was a more precise definition of a dollar most of our history where you could actually know what it meant. But it seems like there is no definition at all. You say it is just a unit of account. And that is probably the reason why we have lost about 98 percent of the value of that dollar since 1913, since it has been the responsibility of the Federal Reserve to protect the value of our currency. So, I have trouble believing that we will be able to solve any of our problems financially or even fiscally if we can create money endlessly and out of thin air and accommodate the politicians who spend money, who spend money overseas, who spend money on foreign policy that indirectly you have to deal with. Look how the sanctions and the threat of war in Iran affects the finances of the world, not only perception-wise in trade and pushing up oil prices, but also the need to keep monetizing this debt.
Federal Reserve Chairmen endlessly, for all the years I have been here, have said, If the Congress would quit spending so much money and didnt have so much debt, we wouldnt have such a tough problem managing the currency. At the same time, the debt wouldnt be there if the Federal Reserve wasnt there willing to monetize the debt, because you are the lender of last resort. You guarantee the moral hazard that politicians are going to spend money. And it seems like to coordinate the two and have a sound economic system instead of a financial bubble that is based on debt and a monetary standard based on debt with the world awash in an exploding amount of debt. I dont know how we will ever get out of this unless we finally come up with a definition, once again, of what the unit of account is and what a dollar means. This hearing is now adjourned. The Chair notes that some Members may have additional questions for the panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for Members to submit written questions to these witnesses and to place their responses in the record. [Whereupon, at 11:42 a.m., the hearing was adjourned.]
UESTION
FOR THE RECORD

FROM CHAIRMAN RON PAUL TO WILLIAM C. DUDLEY, PRESIDENT FEDERAL RESERVE BANK OF NEW YORK
Question 1: The Federal Reserve receives no appropriations from Congress and is completely dependent on funding itself through its own operations. During your testimony you stated that the Federal Reserve made a $4 billion profit from the central bank liquidity swap arrangements during 2008 and 2009. Considering that the Federal Reserves annual operating budget is roughly $4 billion, and money is fungible, could it be said that the Fed is funded by foreign central banks rather than through returns on its portfolio of Treasuries? Answer: While the Federal Reserves current operating budget and the profit to date on our liquidity swaps are roughly the same, it would not be accurate to say that the Federal Reserve is funded by foreign central banks. Profits on the liquidity swaps did not come in the regular course of the Federal Reserves operations, and, unlike income derived from our portfolio of government securities, are not a typical source of revenue for the Federal Reserve System. Question 2: With respect to the swap lines with the European Central Bank (ECB), you stated during the hearing that, We think we are very well secured in those transactions. We fully anticipate to be fully
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repaid. You also stated that you dont have enough information to assess the quality of the ECB balance sheet. As I stated in my testimony, we believe that these swap transactions are secure. First, at the initiation of each transaction, the Federal Reserve takes ownership of foreign currency that it holds for the duration of the trade. This provides an important safeguard: if a central bank failed to repay us, we could sell the currency into the market for dollars, which would limit the consequences to the Feds balance sheet and to the taxpayer of a failure to repay. Second, fluctuations in exchange or interest rates between initiation and maturity do not alter the contractual repayment amounts. At the end of each swap transaction, the Federal Reserve gets back all the dollars it provided plus a fee. Third, the Federal Reserve must agree to any request to draw on the swap lines. We are in frequent contact with our counterparts at each foreign central bank regarding developments abroad. If we became uncomfortable with our exposure at any time, we could stop further swap transactions with the central bank (or central banks) in question. Answer: As I stated in my testimony, we believe that these swap transactions are secure. First, at the initiation of each transaction, the Federal Reserve takes ownership of foreign currency that it holds for the duration of the trade. This provides an important safeguard: if a central bank failed to repay us, we could sell the currency into the market for dollars, which would limit the consequences to the Feds balance sheet and to the taxpayer of a failure to repay. Second, fluctuations in exchange or interest rates between initiation and maturity do not alter the contractual repayment amounts. At the end of each swap transaction, the Federal Reserve gets back all the dollars it provided plus a fee. Third, the Federal Reserve must agree to any request to draw on the swap lines. We are in frequent contact with our counterparts at each foreign central bank regarding developments abroad. If we became uncomfortable with our exposure at any time, we could stop further swap transactions with the central bank (or central banks) in question. Fourth, with respect to the ECB, the Federal Reserve has a
long track record of conducting successful operations not only with the ECB itself, but also with the national central banks of the euro area countries. Those national central banks and their national governments behind them are shareholders in the ECB and would be expected to backstop the ECBs obligations in the highly unlikely event that the ECB failed to repay us. Question 3: Has the Federal Reserve provided any other assistance either financial or technical in nature, aside from the central bank liquidity swap lines, to help mitigate the financial crisis in Europe? If so, please provide a thorough list and explanation of such assistance. Answer: I respectfully refer you to the response to this question provided by Steven Kamin, Director of the Division of International Finance at the Federal Reserve Board of Governors, and my co-panelist at the March 27th hearing. Question 4: Does the Federal Reserve have the ability and authority to provide financial assistance to Europe, aside from the central bank liquidity swap lines? If so, under what statute(s) does the Federal Reserve have such authority and what form(s) could such assistance take? Answer: The Federal Reserve derives its authority exclusively from the Federal Reserve Act, and all of our operations and actions are conducted pursuant to that statute. The Federal Open Market Committee (FOMC) established central bank liquidity swap arrangements with five foreign central banks, including the ECB, between 2007 and 2008 and reauthorized them in successive votes from May 2010 through the present. The current authorization runs through February 1, 2013. I am not aware of any additional plans or intentions within the Federal Reserve to provide financial assistance to European central banks or governments. Question 5: The International Monetary Fund (IMF) is not permitted to accept funds directly from the Federal Reserve. Notwithstanding the
restraint on the IMF, does the Federal Reserve have the authority to provide funding directly to the IMF? If so, please cite the legal statute(s). Answer: I respectfully refer you to the response to this question provided by Steven Kamin, Director of the Division of International Finance at the Federal Reserve Board of Governors, and my co-panelist at the March 27th hearing. Question 6: What would the ramifications be to the Federal Reserve if the ECB is unable to repay the dollars it has borrowed? Does the Federal Reserve have a contingency plan in the event the ECB does not repay the dollars? If so, what is this plan? Answer: The dollars involved in our swaps with the ECB are not borrowed; they are swapped in exchange for euros provided by the ECB. The ECB is bound by contract to return any dollars it draws from the swap line, and we believe it will uphold its obligation in every instance. Our expectation that the ECB will repay us the dollars we have swapped for euros is based on the financial strength of that institution and its shareholders the national central banks of the euro area countries. As mentioned above, the Federal Reserve has a long history of conducting successful operations with the ECB and with the national central banks of the euro area countries. Question 7: Payment transactions in the Eurozone are settled using the TARGET 2 system, a settlement system owned and operated by the Eurosystem, which is comprised of the 17 national central banks of the European monetary union and the ECB. Under TARGET 2, the various national central banks accumulate assets and liabilities amongst themselves. a. Is there a credit risk between the various national central banks of Europe as a result of the TARGET system? b. If so, under what circumstances could a national central bank incur a write-down or loss on its TARGET 2 assets? c. If such losses could occur, how does the Federal Reserve assess credit risk to the Federal Reserve's loans to the ECB?
Answer: I respectfully refer you to the response to this question provided by Steven Kamin, Director of the Division of International Finance at the Federal Reserve Board of Governors, and my co-panelist at the March 27th hearing.
FROM CHAIRMAN RON PAUL TO STEVEN B. KAMIN, DIRECTOR DIVISION OF INTERNATIONAL FINANCE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Question 1: Has the Federal Reserve provided any other assistance either financial or technical in nature, aside from the central bank liquidity swap lines, to help mitigate the financial crisis in Europe? If so, please provide a thorough list and explanation of such assistance. Answer: The Federal Reserve has no programs in place other than the central bank liquidity swaps that involve financial institutions in Europe. I would not that the main purpose of the swap lines is to protect financial markets in the United States from disruption in foreign markets and to help support the flow of credit to U.S. households and businesses. We have of course been in continual contact with our European counterparts and have closely monitored the situation, with an eye toward minimizing the potential spillovers to the U.S. economy. Question 2: Does the Federal Reserve have the ability and authority to provide financial assistance to Europe, aside from the central bank liquidity swap lines? If so, under what statute(s) does the Federal Reserve have such authority and what form(s) could such assistance take? Answer: As noted above, the Federal Reserve has no programs in place that involve financial institutions in Europe other than the central bank liquidity swaps, and participates in these swaps in order to protect U.S. financial markets and maintain the flow of credit in the U.S. economy. The Federal Reserve operats its swpal lines under the authority of Section 14 of the
Federal Reserve Act, which permits the Federal Reserve Banks to conduct operations in foreign exchange and to open and maintain accounts in foreign currency with foreign central banks. Any other action taken in response to the situation in Europe would be the decision of the Federal Reserve Board or the FOMC and would be taken in accordance with relevant statutes. Question 3: The International Monetary Fund (IMF) accept funds directly from the Federal Reserve. restraint on the IMF, does the Federal Reserve provide funding directly to the IMF? If so, statute(s). Answer: No, the Federal Reserve System would be prohibited by statute from extending credit to the Fund without Congressional approval. The Bretton Woods Agreements Act (BWA) reserves for Congress the ability to authorize certain actions to be taken on behalf of the United States with respect to the IMF. Under the Act, [u]nless Congress by law authorizes such action, neither the President nor any person or agency shall on behalf of the United Statesmake any loan to the Fund. For purposes of the BWA, a reserve bank would likely be considered a person and may be considered an agency, to the extent that it would be acting at the request of the Board or the FOMC. Question 4: What would the ramifications be to the Federal Reserve if the ECB is unable to repay the dollars it has borrowed? Does the Federal Reserve have a contingency plan in the event the ECB does not repay the dollars? If so, what is this plan? Answer: The dollars involved in our swaps with the ECB are not borrowed, they are swapped in exchange for euros provided by the ECB. The ECB is bound by contract to return any dollars it draws from the swap line, and we believe it will uphold it obligation in every instance. Our expectation that the ECB will repay us the dollars we have swapped for euros is based is not permitted to Notwithstanding the have the authority to please cite the legal
on the financial strength of that institution and its history of prudent decision-making: the Federal Reserve has a long track record of conducting successful operations not only with the ECB, but also with the national central banks of the euro area countries. As shareholders of the ECB< the national central banks and their national governments behind them would be expected to further backstop the ECBs obligations. Question 5: Payment transactions in the Eurozone are settled using the TARGET 2 system, a settlement system owned and operated by the Eurosystem, which is comprised of the 17 national central banks of the European monetary Union and the ECB. Under TARGET 2, the various national central banks accumulate assets and liabilities amongst themselves. a. Is there a credit risk between the various national central banks of Europe as a result of the TARGET system? Answer: The TARGET2 system settles domestic and cross-border interbank payments in the euro area by crediting and debiting banks reserve accounts at their respective national central banks. Any accumulation of assets and liabilities in the TARGET2 system by the various national central banks are claims on and liabilities to the ECB, not one another. The ECB and euro-area national central banks control for credit risk in their operations with monetary and financial institutions by applying haircuts in valuing the collateral they receive and by requiring their counterparties to adjust the marketable assets they post as collateral as the prices of those assets change. b. If so, under what circumstances could a national central bank incur a write-down or loss on its Target 2 assets? Answer: In the event that there is a credit loss despite these precautions, then according the Eurosystem rules, capital losses are allocated according the respective capital shares of the national central banks in the Eurosystem,
not according to TARGET2 balances. c. If such losses could occur, how does the Federal Reserve assess credit risk to the Federal Reserves loans to the ECB? Answer: The credit standing of the ECB is of the highest caliber, it has a very strong financial position, and we continue to view our swap lines with the ECB as safe. TARGET2 losses would not diminish either the effectiveness or the safety of the Federal Reserves swap operations with the ECB.
TATEMENTS

The Federal Reserve has recently begun to engage in an ongoing bailout of the European monetary system. Under the guise of providing dollar liquidity to strained European financial markets, the Fed is creating hundreds of billions of dollars out of thin air to prop up the euro. While still well under their 2008 peak, these latest dollar swap agreements are nonetheless a thinly-disguised bailout. Congress has been far too lenient in allowing the Fed to engage in unprecedented monetary policy operations without informing or explaining its actions to Congress. The American people need to understand the effects these actions have on the dollar so that the Fed can be held accountable. I hope that this hearing will get muchneeded answers to the very important questions surrounding the Feds involvement in bailing out Europe. For over 40 years, the Fed has been creating money out of thin air, propping up Wall Street while destroying the value of the dollar. This excessive money creation is what caused the financial crisis, yet just as a dog returns to its vomit, the Fed thinks that continuing to print money will somehow end the crisis. The trillions of dollars the Fed has created have eviscerated the purchasing power of American consumers, as anyone who has set foot inside a grocery store can see. While the government's official inflation rate is hovering around three percent, the original method of calculating the price index indicates that price inflation is over ten percent, which is more in line with what consumers are experiencing.
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Despite a world awash in dollars, the Fed continues to view the cause of every financial problem as a dearth of liquidity. When the banks say they do not have enough money, the Fed unquestionably believes them and provides them with new dollars created from nothing. But a bank saying that there is not enough money is like a broke college student saying that there are not enough Ferraris. What he really means is that there are not enough Ferraris for sale at a price that he can afford. The same is true with banks; there are plenty of dollars available for banks to borrow, but the banks don't want to pay the going interest rate on loans, so they run to the central bank for cheap money. Much of the Fed's intervention in the U.S. has been undertaken in an attempt to reflate the housing market. Rather than allowing house prices to fall so that supply and demand will re-equilibrate, the Fed has pumped liquidity into the system in an attempt to keep prices elevated. The federal funds rate has been kept artificially low for over three years now, and according to the Fed will be kept near zero for at least three years more. Because the Federal Reserve is so used to manipulating interest rates, it fails to see that interest rates are a price, the price of money and credit. While American banks may not be willing to lend dollars short-term to ailing European banks at 0.25 or 0.50%, you can bet that there would be a lot more dollars available to loan at 2, 3, or 4%. But in order for the markets to adjust and price loans at a market-clearing rate, the Fed needs to abstain from intervening to short-circuit this price discovery process. The Federal Reserve has pumped trillions of dollars into the American financial system, with banks now holding $1.5 trillion of excess reserves at the Fed, money which is literally just sitting there. The Fed pays an 0.25% interest rate on those excess reserves, which lessens the incentive of the banks to loan those funds to anyone, regardless of how safe the loan might be. This leads to a lessened availability of credit both domestically and abroad, with the result that credit markets are more contracted than they otherwise might be. The Fed views this credit market contraction as having its root in insufficient liquidity, which it then attempts to counteract by creating more money. This time around, the newly created dollars are being loaned through swap lines to the European Central Bank (ECB) in exchange for euros. The ECB loans the dollars to struggling European banks in exchange for collateral. Once those loans are repaid and the swap lines expire, the ECB returns the dollars to the Fed and takes back its euros. The interest rate on these loans is about 0.6%, so it is not
surprising that American banks are keeping their excess reserves safe at the Federal Reserve. After all, why loan dollars to weak and risky European banks at 0.6% when you can get a guaranteed 0.25% from the Federal Reserve? So the dollar markets dry up and the Fed steps in to fix the problem it created. We have to question what will happen if these loans from the ECB to European banks go bad. What happens if a major bank fails? If the ECB cannot return dollars to the Fed, does the Fed keep the euros it received from the ECB? Does it receive European government bonds, perhaps Greek bonds? Does it have recourse to the ECB's gold, as Chairman Bernanke alluded to last week? Even more importantly, what is the impact of these programs on the dollar and on the U.S. economy? While the Fed seems to think that these swap lines eventually will be drawn back down to zero, what happens in the meantime? These hundreds of billions of dollars may be created out of thin air, but their effects on the real economy are anything but ephemeral. And the Fed has failed to consider the possibility that these swap lines may rise even higher than the $600 billion level that was reached in 2008. Given the still precarious position of European governments and the European financial system, it would not be surprising to see a few hundred billion dollars more being created to continue the bailout of the euro. The Fed's continued intervention in financial markets creates a climate of uncertainty. For almost five years, financial institutions have had to wonder from one day to the next what the Fed will do. Will it continue with more asset purchases under its policy of quantitative easing? Will it bailout large firms in danger of collapse or allow them to fail? Will it allow markets to function or continue its intervention? In such uncertain times it is only natural for firms to sit back and wait to see what happens. And every action by the Fed, every attempt at stimulus, rather than placating that uncertainty, instead exacerbates it. The Fed's actions destroy markets, erode the earnings and savings of Americans, and sow the seeds for the next great crisis. I hope that this hearing is yet another step in holding the Fed accountable and will help both Members and the American people reconsider the necessity of a central bank.
ITNESS
ESTIMONY
WRITTEN TESTIMONY OF WILLIAM C. DUDLEY

PRESIDENT AND CHIEF EXECUTIVE OFFICER FEDERAL RESERVE BANK OF NEW YORK
I. Introduction Chairman Paul, Ranking Member Clay, and members of the Subcommittee, my name is Bill Dudley, and I am President of the Federal Reserve Bank of New York. It is an honor to testify today about the economic and fiscal challenges facing Europe, and the Federal Reserves efforts to support financial stability in the United States. Financial stability enables U.S. businesses and households to maintain their access to credit and ensures sustained economic growth. This is why promoting financial stability is an important objective of the Federal Reserve, and other central banks around the world. Let me preface these remarks by stating that the views expressed in my written and oral testimony are solely my own and do not represent official views of the Federal Reserve Board, the Federal Open Market Committee (FOMC) or any other part of the Federal Reserve System. Additionally, because I am precluded by law from discussing confidential supervisory information, I will not be able to speak about the financial condition or regulatory treatment or rating of any individual financial institution. The U.S. economy is currently expanding at a moderate pace, and strains in global financial markets, although having eased recently, continue to pose significant downside risks to the economic outlook. Because developments in Europe will have an important bearing on
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the prospects for growth and jobs here in the U.S., the Federal Reserve is monitoring the situation there closely. This is also why we have taken special steps in recent months, together with other central banks, to support the flow of credit to households and businesses. II. Europe The economic situation in Europe has been unsettled for the better part of two years, with pressure on sovereign debt markets and local banking systems. High debts, large deficits, and slow growth in several European countries have called into question the sustainability of the entire euro area. The resulting strains in European markets have affected the U.S. economy. The euro area has the capacity, including the fiscal capacity, to overcome its challenges. However, the politics are very difficult, both because the problem has many dimensions, and because many different countries and institutions in the euro area have to coordinate their actions in order to achieve a coherent and effective policy response. Europes leadership has affirmed its commitment to the European Union and its single currency union on numerous occasions. And the leadership is working harder than ever to achieve greater coordination in areas such as fiscal policy. A more robust and resilient European Union would be a welcome development for the United States. Three recent developments are especially encouraging in that regard. First, liquidity concerns have eased significantly following the European Central Banks long-term refinancing operations in December and February. Through this program, the ECB provides three-year loans to European banks at low rates, accepting a wide array of collateral in return. Hundreds of banks accessed the program in each operation, and the ECB lent nearly 1 trillion in total. As a result, the cost of funding throughout Europe has declined since the program began, the Euro has stabilized, and the sovereign bond market has improved. Changes in the ECBs collateral rules and reserve requirements have also had a positive impact. Second, earlier this month, the Greek government worked with European leaders and its largest creditors to restructure the bulk of its 206 billion of outstanding privately-held bonds. This not only reduced Greeces total indebtedness, it helped calm persistent worries that a disorderly Greek default could become the trigger for a global
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economic crisis. Shortly after the debt restructuring, the EU approved a 130 billion aid package for Greece. Together, these measures will provide key support to Greek leaders as they pursue the difficult fiscal reforms that are essential over the long term. Third, leaders in most euro area countries have approved a new treaty designed to increase fiscal coordination. The new rules already appear to be making a difference. Both Spain and Italy recently completed 2012 budgets that move their deficits closer to EU targets. Further, Spain and Italy took their fiscal actions in close consultation with finance ministers from other countries in the euro area, demonstrating a healthy ability to work together. While difficult work still lies ahead, countries in the euro area have made meaningful progress toward achieving long-term fiscal sustainability. Looking to the future, the difficult work that remains also presents special risks both for Europe and the United States. If Europe fails to chart an effective course forward, this could have a number of negative implications here. In particular, there are three areas of potential risk that I would like to highlight for the Subcommittee today. First, if economic conditions in Europe were to weaken significantly, demand for U.S. exports would decrease. This would hurt domestic growth and have a negative impact on U.S. jobs. It is important to recognize that the euro area is the worlds second largest economy after the U.S. and an important trading partner for us. Also, Europe is a significant investor in the U.S. economy, and vice versa. Thus, what happens in Europe has significant implications for our economy. Second, deterioration in the European economy could put pressure on the U.S. banking system. As the recent round of stress tests revealed, U.S. banks are much more robust and resilient than they were a few years ago. They have bolstered their capital significantly, built up their loan loss reserves, and have significantly larger liquidity buffers. The direct net exposures of U.S. banks to the so-called peripheral European countries are actually quite modest. The good news in the United States means that we are better able to handle bad news from Europe. With that said, the exposures of U.S. banks climb sharply when one also considers their exposures to the core European countries and to the overall European banking system. U.S. money market mutual funds, in particular, have significant European holdings. This means that if the crisis were to broaden further and intensify, it would put
pressure on the capital and liquidity buffers of U.S. banks and other financial institutions. Third, severe stresses in European financial markets would disrupt financial markets here, which could harm the real economy. Stress in the financial markets causes banks to more carefully husband their balance sheets. When that phenomenon occurs, the availability of credit to U.S. households and businesses becomes constrained. Such conditions could also cause equity prices to fall, impairing the value of Americans pension and 401(k) holdings. This would damage the U.S. recovery and result in slower output growth and less job creation. At a time when U.S. unemployment is very high, this is a particularly unacceptable outcome. In the extreme, U.S. financial markets could become so impaired that the flow of credit to households and businesses would dry up. III. U.S. Dollar Swaps In todays globally integrated economy, banks headquartered abroad play an important role in providing credit and other financial services in the United States. About $1 trillion in worldwide dollar financing comes from foreign banks, $700 billion in the form of loans within the U.S. For these banks to provide U.S. dollar loans, they have to maintain access to U.S. dollar funding. At a time when it is already hard enough for American families and firms to get the credit they need, we have a strong interest in making sure that these banks can continue to be active in the U.S. dollar markets. Banks headquartered outside the U.S. make extensive use of dollars in their financing activities. In part, this results from the fact that the U.S. dollar is the worlds number one currency a status that brings with it many benefits for our country. It is in our national interest to make sure that non-U.S. banks remain able to access the U.S. dollar funding they need to continue financing their U.S. dollar assets. If access to dollar funding were to become severely impaired, this could necessitate the abrupt, forced sales of dollar assets by these banks, which could seriously disrupt U.S. markets and adversely affect American businesses, consumers, and jobs. One way we can help to support the availability of dollar funding, and ensure that credit continues to flow to American households and businesses, is by engaging in currency swaps with other central banks. Such swaps are a policy tool the Federal Reserve has used to support dollar liquidity for nearly fifty years. Most recently, the Federal Reserve established dollar swap lines with major central
banks during the global financial crisis of 2008, and reactivated them in May 2010. Last November, the FOMC, cooperating with five other central banks, reduced the rate being charged on these swaps to increase usage. The swaps are intended to create a credible backstop to support but not supplant private markets. Banks with surplus dollars are more likely to lend to banks in need of dollars if they know that the borrowing bank will be able to obtain the dollars it needs to repay the loan, if necessary, from its central bank. Ultimately, these dollar swaps are designed to support financial stability, and avoid an unnecessary tightening in financial conditions, so that economic activity and job creation in the United States can continue to recover. Our principal aim is to protect U.S. banks, businesses, and consumers from adverse economic trends abroad. I am pleased that the swaps seem to be working. In conjunction with the ECBs long-term refinancing operations, the swaps have helped European banks avoid the significant liquidity pressures we feared a few months ago and have reduced the risk that they would need to sell off their U.S. dollar assets abruptly. IV. Conclusion In sum, I am hopeful that Europe can effectively address its current fiscal challenges. The Federal Reserve is actively and carefully assessing this situation and the potential impact on the U.S. economy. At this time, although I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States, we will continue to monitor the situation closely. Thank you for your invitation to testify today, and I look forward to answering your questions.
WRITTEN TESTIMONY OF STEVEN B. KAMIN

DIRECTOR OF THE DIVISION OF INTERNATIONAL FINANCE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Thank you, Chairman Paul, Ranking Member Clay, and members of the Subcommittee for inviting me today to talk about the economic situation in Europe and actions taken by the Federal Reserve in response to this situation. For two years now, developments in Europe have played a critical role in shaping the tenor of global financial markets. The combination of high debts, large deficits, and poor growth prospects in several European countries using the euro has raised concerns about their fiscal sustainability. Such concerns were initially focused on Greece but have since spread to a number of other euro-area countries, leading to substantial increases in their sovereign borrowing costs. Pessimism about these countries fiscal situation, in turn, has helped to undermine confidence in the strength of European financial institutions, increasing the institutions borrowing costs and threatening to curtail their supply of credit. These developments have strained global financial markets and weighed on global economic activity. In the past several months, European leaders have taken a number of policy actions that have helped reduce financial market stresses. In early December, the European Central Bank (ECB) reduced its policy interest rate, cut its reserve requirement, eased collateral rules for its lending, and, perhaps most important, began providing three-year secured loans to banks. Second, euro-area leaders, the Greek government, and private-sector holders of Greek debt are taking steps to put that country on a more sustainable fiscal path. Additionally, European leaders announced and have started to implement proposals to strengthen fiscal rules and European fiscal coordination. Discussions to expand the euro-area financial backstop are on-going. These steps are positive developments and signify the commitment of European leaders to alleviate the crisis. Since early December, borrowing costs for several vulnerable European governments have declined, funding pressures for European banks have eased, and the tone of investor sentiment has improved. However, financial markets remain under strain. Europes authorities continue to face difficult challenges as they seek to stabilize their fiscal and financial situation, and it will be critical
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for them to follow through on their policy commitments in the months ahead. Here at home, the financial stresses in Europe have undoubtedly spilled over to the United States by restraining our exports, weighing on business and consumer confidence, and adding to pressures on U.S. financial markets and institutions. Of note, as concerns about the financial system in Europe mounted, many foreign banks, especially those in Europe, faced a rise in the cost of dollar funding and a decline in its availability. A great deal of trade and investment the world over is financed in dollars, so many foreign financial institutions have heavy borrowing needs in our currency. These institutions also borrow heavily in dollars because they are active in U.S. markets, purchasing government and corporate securities and lending to households and firms. While strains have eased somewhat of late, difficulty acquiring dollar funding by European and other financial institutions could ultimately make it harder and more costly for U.S. households and businesses to get loans. Moreover, disruptions to European access to dollar funding could spill over into the market for borrowing and lending in U.S. dollars more generally, raising the cost of funding for U.S. financial institutions. Although the breadth and size of all of these effects on the U.S. economy are difficult to gauge, it is clear that the situation in Europe poses a significant risk to U.S. economic activity and bears close watching. Swap Lines with Other Central Banks To address these potential risks to the United States, as described in an announcement on November 30, the Federal Reserve agreed with the ECB and the central banks of Canada, Japan, Switzerland, and the United Kingdom to revise, extend, and expand its swap lines with these institutions.382 The measures were taken to ease strains in global financial markets, which, if left unchecked, could significantly impair the supply of credit to households and businesses in the United States and impede our economic recovery. Such strains were particularly evident in Europe, and these actions were designed to help prevent them from spilling over to the U.S. economy. Three steps were described in the November 30 announcement. First, we reduced the pricing of drawings on the dollar liquidity swap lines. The previous pricing had been at a spread of 100 basis points
See Board of Governors of the Federal Reserve System (2011), Coordinated Central Bank Action to Address Pressures in Global Money Markets, press release, November 30, www.federalreserve.gov/newsevents/press/monetary/20111130a.htm. Similar announcements appeared on the web sites of the other participating central banks.
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over the overnight index swap rate. 383 We reduced that spread to 50 basis points. The lower cost to the ECB and other foreign central banks enabled them to reduce the cost of the dollar loans they provide to financial institutions in their jurisdictions. Reducing these costs has helped alleviate pressures in U.S. money markets generated by foreign financial institutions, strengthen the liquidity positions of European and other foreign institutions, and boost confidence at a time of considerable strain in international financial markets. Through all of these channels, the action should help support the continued supply of credit to U.S. households and businesses. Second, we extended the authorization for these lines through February 1, 2013. The previous authorization had been through August 1, 2012. This extension demonstrated that central banks are prepared to work together for a sustained period, if needed, to support global liquidity conditions. Third, we agreed to establish, as a precautionary measure, swap lines in the currencies of the other central banks participating in the announcement. (The Federal Reserve had established similar lines in April 2009, but they were not drawn upon and were allowed to expire in February 2010.) These lines would permit the Federal Reserve, if needed, to provide euros, Canadian dollars, Japanese yen, Swiss francs, or British pounds to U.S. financial institutions on a secured basis, much as the foreign central banks provide dollars to institutions in their jurisdictions now. U.S. financial institutions are not experiencing any foreign currency liquidity pressures at present, but we judged it prudent to make arrangements to offer such liquidity should the need arise in the future. I would like to emphasize that information on the swap lines is fully disclosed on the Federal Reserves website--through our weekly balance sheet release and other materials--and information on swap transactions each week is provided on the website of the Federal Reserve Bank of New York.384
The dollar overnight index swap rate is the fixed rate that one party agrees to pay in exchange for the average of the overnight federal funds rates over the life of the swap. As such, it is a measure of the average federal funds rate expected over the term of the swap. 384 For the outstanding amount of dollar funding through the swap lines as it appears each week in the Federal Reserve balance sheet, see www.federalreserve.gov/releases/h41. For other relevant information and materials on the Federal Reserves website, see www.federalreserve.gov/monetarypolicy/bst_liquidityswaps.htm. For weekly information on the Federal Reserves swap transactions with other central banks, see www.newyorkfed.org/markets/fxswap/fxswap.cfm. Finally, for copies of the agreements
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I also want to underscore that these swap agreements are safe from the perspective of the Federal Reserve and the U.S. taxpayer, for five main reasons: First, the swap transactions themselves present no exchange rate or interest rate risk to the Fed. Because the terms of each drawing and repayment are set at the time that the draw is initiated, fluctuations in exchange rates and interest rates that may occur while the swap funds are outstanding do not alter the amounts eventually to be repaid. Second, each drawing on the swap lines must be approved by the Federal Reserve, which provides the Federal Reserve with control over use of the facility by the foreign central banks. Third, the foreign currency held by the Federal Reserve during the term of the swap drawings provides added security. Fourth, our counterparties in these swap agreements are the foreign central banks. In turn, it is they who lend the dollars they draw from the swap lines to private institutions in their own jurisdictions. The foreign central banks assume the credit risk associated with lending to these institutions. The Federal Reserve has had long and close relationships with these central banks, and our interactions with them over the years have provided a track record that justifies a high degree of trust and cooperation. Finally, the short tenor of the swap drawings, which have maturities of at most three months, also offers some protection, in that positions could be wound down relatively quickly were it judged appropriate to do so.
The Federal Reserve has not lost a penny on any of the swap line transactions since these lines were established in 2007, even during the most intense period of activity at the end of 2008. Moreover, at the maturity of each swap transaction, the Federal Reserve receives the dollars it provided plus a fee. These fees add to overall earnings on Federal Reserve operations, thereby increasing the amount the Federal Reserve remits to taxpayers. Conclusion
between the Federal Reserve and other central banks, as well as other information, see www.newyorkfed.org/markets/liquidity_swap.html.
The changes in swap arrangements that I have discussed have had some positive effects on dollar funding markets. After the announcement of the changes at the end of November, draws on the swap lines increased considerably, peaking at $109 billion in midFebruary, and measures of the cost of dollar funding declined. In recent weeks, reflecting the improvement in market conditions, usage of the swap lines has fallen back to about $65 billion. That being said, many financial institutions, especially those from Europe, continue to find it difficult and costly to acquire dollar funding, in large part because investors remain uncertain about Europes economic and financial prospects. Ultimately, the easing of strains in U.S. and global financial markets will require concerted action on the part of European authorities as they follow through on their announced plans to address their fiscal and financial difficulties. The situation in Europe is continuously evolving. Thus, we are closely monitoring events in the region and their spillovers to the U.S. economy and financial system. Thank you again for inviting me to appear before you today. I would be happy to answer any questions you may have.
XPERT
OMMENTARY
PHILIPP BAGUS, Ph.D.

AUTHOR AND ASSOCIATE PROFESSOR UNIVERSIDAD REY JUAN CARLOS
GLOBAL FIAT CURRENCY COOPERATION The Supremacy of the Dollar The global fiat currency cooperation is organized by the Federal Reserve (FED) in a form of hegemonic cooperation (Mises 1998, 196). In practice, the FED is the worlds central bank. The hegemony of the FED is explained by the role of the dollar as the world reserve currency and the political power of the U.S. 385 government. Due to the wealth created by the economic liberty that exceeds the one most other countries enjoy, the U.S. government could command enough resources to be the determining factor in two world wars. The U.S. have been maintaining the most powerful army with troops stationed in approximately 130 countries around the globe (Politifact 2011). Its defense budget is almost as high as that of all other countries combined (U.S. military spending is currently at 41% of the world military spending, Stockholm International Peace Institute 2011). The military and political power has been used to impose a dollar based global fiat currency regime after World War II when the British
The size of the US economy is another important reason for the dollar being world reserve currency. The US has the biggest and most liquid financial markets. However, the economic factor alone does not explain why foreign central banks hold on to continuously depreciating dollar reserves. 1367
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Empire faded. Along the British political and military power the British pound, the former world reserve currency, lost its status. At the same time the U.S. emerged as world power number one (Hoppe 386 1990) and with it the dollar as the world reserve currency. The Bretton Woods System designed in 1944 made the dollar the backbone of the international monetary system. Currencies maintained fixed exchange rates to the dollar which was still linked to gold; and in fact, the only currency redeemable into the yellow metall. Foreign central banks did not exchange their own currencies into gold, but they could redeem dollars into gold at the FED. In this system central banks expanded their reserves on top of dollar reserves, which supposedly were as good as gold. The Bretton Woods System allowed the U.S. to import goods and services in exchange for dollars that would accumulate in the vaults of foreign central banks or in the hands of private persons living in high inflation countries. A steady flow into the U.S. of goods and services in exchange for dollars developed. The great advantage for the U.S. government was and still is that due to the status of the dollar, part of the costs of money production could be externalized on foreigners. Foreign governments accepted the system not only due to the economic status of the U.S. as the largest economy, but mainly due to the political power and pressure by the U.S. government. Allied governments that hoped for protections were pressured to accumulate and hold on to their dollar reserves, in the same way that Great Britain in its heydays had ensured that countries under its influence held pound reserves. In the famous Blessing letter of 1967, the President of the Bundesbank Karl Blessing assured his U.S. colleague that Germany would not redeem dollars into gold in order to support the U.S. with the cost of American troops occupying Germany. Indeed, the countries with the highest number of U.S. troops, Germany and Japan, were the most loyal to their dollar reserves and did not redeem their reserves massively against gold in the Bretton Woods System. Despite of this loyalty the U.S. slowly lost gold reserves, as the government used the printing press to finance its expenditures such as the Vietnam War. It was French President Charles de Gaulle that gave the order to massively redeem French dollar reserves into gold. Thereby independent France, that also withdrew its troops from NATO command, contributed decisively to the end of the Bretton
On the substitution of the pound by the dollar as the world reserve currency see Schenk (2009).
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Woods System. In 1971 U.S. President Richard Nixon broke the U.S. redemption promises and the last links to gold disappeared. Even though, the Bretton Woods System disappeared, U.S. dominance did not. Dollars that had not been redeemed into gold in time remained in the vaults of foreign central banks. Thanks to the U.S. economic and military power, the U.S. dollar still is the main world reserve currency. U.S. allies cannot be expected to massively sell its dollar reserves. Fittingly, countries that want military protection from the US, such as Japan, Taiwan and Saudi Arabia 387 hold very high dollar reserves. As long as the U.S. hegemony lasts, the dollar is likely to remain the world reserve currency. The status of being the world reserve currency still allows the U.S. to enjoy advantages similar to the ones it enjoyed in the Bretton Woods System. By producing and exporting dollars the U.S. can partially finance its government and trade deficit. Issuing the World Reserve Currency The status of being the world reserve currency also implies that the central bank issuing this currency becomes the world central bank coordinating central bank cooperation. As dollars are held to a large extent outside the U.S. and are used in international transactions, international financial markets trade mainly in dollars. One of the main businesses of banks today is maturity mismatching: Borrowing short and lending long. Banks have engaged in this practice extensively during the last 10-15 years and internationalized this practice. Indeed, banks foreign claims increased from 2000 to 2007 from $10 trillion to $34 trillion (McGuire and von Peter 2009, 9). Banks borrowed dollars short term in international wholesale markets (from money market funds, in the interbank market or in the foreign exchange swap market) an invested them long term, by granting loans to companies or households. Maturity mismatching is quite risky, because if the bank 388 cannot roll-over the short term debt, it gets into liquidity problems. In may be forced to fire sale its long term assets, incurring in losses
As an exception to the rule China, not a traditional U.S. ally, holds a lot of dollar reserves. These reserves stem from the deliberate undervaluation of the Chinese currency in order to foster export growth on cost of internal consumption. They are a result of a form of forced savings. China, in contrast, to allies as Japan, Tawain or Saudi Arabia, could actually sell its reserves and put the dollar under enormous pressure in the future. 388 For an analysis of the causes and consequences of maturity mismatching see Bagus (2010a) and Bagus and Howden (2010).
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and triggering solvency problems. These risks are alleviated if there exists a lender of last resort that will come to help in times of trouble. The global lender of last resort is the central bank that issues the reserve currency.
The FED as the Dollar Lender of Last Resort in the Financial Crisis Banks world-wide played the game of maturity mismatching, because they expected that in case of emergency, a lender of last resort would come to rescue. The lender of last resort of the world reserve currency was the FED: The world central bank. During the financial crisis, the FED came to fulfill the expectations and bailed out the world financial system via two main instruments. Dollar Liquidity Swap Lines First, when international interbank lending showed the first signs of stress, the Fed instituted dollar liquidity swap lines with the 389 ECB and the Swiss National Bank (SNB) in December 2007. In such a swap transaction, the FED sells dollars to the ECB or SNB and buys them back later at the same price, receiving interests. This construction resembles a dollar loan to the ECB or SNB. The ECB or SNB can then use these dollars to lend them to troubled Eurozone 390 and Swiss banks. The institution of swap lines solved the predicament that, for instance, the ECB could not have saved European banks that were short on dollars. These banks owned long term dollar assets in dollars financed with short-term funding, i.e. they had a foreign currency funding gap. MacGuire and von Peter (2009) estimate that the short term dollar shortage of European banks in 2007 was between $1 trillion and $6.5 trillion. When in 2008 investment banks Lehman Brothers collapsed, international short term liquidity dried up even more drastically, the
This is not the first incident where the Fed used swap lines to support the international banking system as it has employed this instrument already after the terrorist attacks of September 11, 2001 (Fleming and Klagge 2009, 3). 390 The same applies mutatis mutandis for the SNB.
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FED doubled the swap lines in size, instituted new lines with additional central banks and lowered interest rates. Central bank cooperation continues also along other lines. In the beginning of October 2008 the FED, the ECB, the Bank of England, the SNB, the Bank of Japan, the Swedish Central Bank and the Bank of Canada in an unprecedented coordinated move lowered interest rates. Major central banks also lengthened maturities of their lending operations and expanded the range of collateral accepted. By the end of 2008, the Fed had instituted swap lines with a dozen central banks: Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England, the European Central Bank, the Bank of Japan, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges 391 Riksbank, and the Swiss National Bank (Federal Reserve 2011). In mid October the FED opened the dollar floodgates totally and removed limits to the swap lines to the ECB, Bank of England, the Bank of Japan and SNB lending as many dollars as demanded at a fixed rate at 100 basis points over OIS. At its heights in December 2008, the Fed lent through its swap lines to foreign central banks about $620 bn. (Goldberg, Kennedy and Miu 2011). In sum, major central banks cooperated during the financial crisis to maintain the global fiat system afloat. If the system had broken down, their respective governments would have gotten into severe funding problems and, indeed, central banks could have lost their reasons to exist. It is all in the interest of central banks to 392 cooperate.
While the FED provides lender of last reserve services to the world, other central banks have also lent to foreign national banks. The ECB provided euros to countries such as Hungary, Poland and Denmark via central bank swap lines. The Swiss National Bank provided swap lines to Poland and Hungary as well. The Norwegian, Danish and Swedish National Banks provided swap lines to the Central Bank of Iceland. While the dollar is the basis of the global fiat money system on which credit is expanded, there are additional layers of credit expansion on top of secondary reserve currencies such as the euro or the swiss franc. 392 In practice this coordination was achieved through occasional meetings and phone calls (Bernanke 2008). The main coordination occurred between Bernanke and Trichet. One reason why the U.S. government favored and supported the introduction of the euro was that with the
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Dollar Lending to U.S. Subsidiaries of Foreign Banks Second, during the financial crisis between 2007 and 2009 (Kuntz and Ivry 2011), European banks were bailed out by the FED through secret emergency loans to their subsidiaries in the United States (Bloomberg 2011). For instance, a subsidiary of Deutsche Bank in the U.S. could take mortgage backed securities and offer them as collateral for a new dollar loan from the FED. Of course, these bailouts were not altruistic. In a fractional reserve fiat currency system (also in its global variety), a central bank has to bail out important banks if it wants to maintain its power. Important banks are too big to fail in the sense that their collapse threatens through banks interconnectivity and general losses of confidence, the very stability of the system. The system depends on the confidence that the central bank will bailout the banking system. In other words, if the dollar based global fiat currency regime was to be maintained, and a general panic with mass bankruptcies be prevented, the FED had to bail out foreign banks in its role of the worlds central bank. A collapse of the world financial system could mean the end of the dollar as the main reserve currency, and thereby mean the end of the advantages derived from it. Without the dollar privilege, the U.S. government would have had to downsize importantly. Another Covert Bail Out After drowning the market with liquidity, the financial crisis was stalled in 2009 and conditions improved. In February 2010 central bank swap lines expired. However, already two months later in May 2010, the FED reestablished swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank. This time the liquidity problem had its source in Europe. But why did European banks need help from the FED again? European banks had continued to borrow dollars short term in international wholesale markets and lent these dollars for the long term to US companies or households. Again, the maturity mismatch
euro monetary coordination between the U.S. and Europe got easier. Bernanke only had to call Trichet instead of calling the presidents of the different central banks in todays Eurozone.
is highly risky, because once a bank cannot renew its short-term debts it becomes illiquid. The situation of European banks deteriorated in 2010 and 393 2011. European banks had been pressured by their governments to buy their governments' debts. Italian banks are loaded with Italian government bonds, Spanish banks with Spanish bonds and so on. As the sovereign-debt crisis increased once again in the summer of 2011 with governments short of collapsing, European banks had increasing difficulties renewing their short-term loans in wholesale markets. Quickly the ECB provided the missing short-term euro liquidity. However, as the ECB can only print euros, not dollars, European banks got nervous. While US banks did not want to lend to European banks anymore, in November 2011, the FED stepped in and reduced the swap rate from the U.S. dollar OIS rate plus 100 basis points to the OIS rate plus 50 basis points. Effectively, the FED bailed out European banks and assumed its role as the international lender of last resort again. This time the FED abstained from the second option: emergency loans to European bank subsidiaries in the U.S. since when these FED loans to foreign banks had been made public the FED had received harsh critics for having helped foreign financial institutions. Thus this time the FED used exclusively instruments that were less direct and obvious such as liquidity swap lines with foreign central banks in a covert bailout of European banks (ODriscoll 2011). Interestingly, in a March 2012 meeting of the Committee of Financial Services FED officials did not deny the bailout of European banks by the FED. Rather, they claimed that the bailouts are basically a free lunch for U.S. taxpayers, as they would get an almostrisk-free benefit in the form of the interest on the swap. Further, the FED officials maintained that the bailout was necessary because a default of European banks would cause stress in financial markets. Through the interconnectivity of financial markets, U.S. banks would get into problems; lending to US households and companies would be affected negatively.
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For an overview of the European sovereign debt crisis see Bagus (2010).
Lastly, they made assurances that the FED would end the swapbailout policy once it becomes imprudent and the costs and risks of such a policy exceed the benefits for the US public. Let's have a look at these startling arguments. First, there ain't no such a thing as a free lunch; not even for the FED, the ultimate money producer. Just remember that US banks did not want to lend to European banks, because they regarded it as too risky. Even the central-bank swap is not risk free. It is true that the FED has locked in the exchange rate and expects to get back the same amount of dollars plus interest. Yet there remains counterparty risk: what if the ECB, goes bust? Then the creditors, including the FED, will take over the ECB's assets. Creditors would receive assets such as Greek government bonds, or loans to Portuguese banks. These banks depend on ECB liquidity lines and are collateralized by bonds issued by the Portuguese government, which also depends on the ECB to support it. In the end, the ECB balance sheet is backed to a large extent by bonds from insolvent governments that are only kept afloat thanks to the ECB's promises to keep printing money and the pledged support of German taxpayers. While an ECB bankruptcy does not seem imminent, the ECB has increased its capital to make good for potential losses already back in 2010 (ECB 2010), and the Bundesbank increased its provisions for losses in 2011 (Mallien 2012). In the mean time, the ECB has bought even more Greek government debt. The ECB is probably one of the most highly leveraged banks in history. Of course, the FED hopes that eurozone governments will always recapitalize the ECB if it is necessary, so that ultimately taxpayers return the dollars to the FED. But what if Germany leaves the eurozone? While this is unlikely in the short term, the possibility exists for the long run. Then southern European governments will default on their debts and take their banks and the ECB down with them. Then who will pay back dollar swaps to the FED? The swap is also no free lunch as opportunity costs are involved. By abstaining from producing dollars and lending them to the ECB, the US-dollar money supply would be smaller or backed by betterquality assets (not indirectly by Greek government bonds). The dollar
production also implies a redistribution toward the first receivers of the new dollars, the ECB, European banks, and their borrowers (mainly irresponsible and insolvent governments) to the detriments of the last receivers, mainly US citizens, who are confronted with a debased dollar. There are other opportunity costs. The FED could have produced the same amount of dollars and not invested in the central-bank liquidity swap lines. These swaps earn very low interest. Instead of the swaps, the FED could have purchased other assets, like stocks of Apple or gold, which may rise more in value. One cost of the swap operation acknowledged by the officials in the hearing is the moral hazard created. Banks and governments worldwide may expect that the FED will come to save them, too, especially if they are well connected with the US financial system. So why be prudent? The highest cost of the swaps, though, may be something else. Through the swaps, the FED is helping the ECB to bail out European banks that finance insolvent and irresponsible governments. The FED is indirectly bailing out countries like Greece, Portugal, and Spain, debasing the dollar with unlimited swap lines. The FED has promised to print unlimlited amount of dollars and lent it to insolvent European banks via the ECB. Thanks to the bailouts, the political project of the euro continues. Without the swaps, some European banks might have failed, and with them their sovereigns. Thanks to the swaps, the eurozone stays intact. The project of the euro leads to an ever-increasing rescue fund, and gradually toward a fiscal union and more centralization. A European financial government and the European super state, which would most likely abolish tax competition in Europe, are on the horizon. The highest cost of the FED policy, therefore, may be liberty in Europe. The FED officials also made clear that they think the swap arrangement benefits the US public by keeping stress away from US banks and financial markets. The FED does not want stock markets to fall or interest rates to increase. For them, low interest rates are the panacea for all economic ills. However, having artificially low interest rates climb back to more normal levels is no disaster.
Sustainable investments are always restricted by real savings. Lowering interest rates does not increase the amount of real savings at all. Moreover, an important feature of a market economy is that people take responsibility for their actions. If US banks have granted loans to European banks and governments, they should assume the losses from their risky behavior. Finally, the FED claims to be prudent. But how can the FED know the point at which it is no longer prudent to bail out foreign banks? How can it know when the costs of the bailouts start to exceed the benefits to the US public? How can they know what is best for the United States? Interpersonal-utility comparisons are arbitrary. Thanks to the bailouts, some banks may win, some stock owners may win, but at the cost of liberty in Europe and to the detriment of dollar users. Moreover, bailouts produce moral hazards, crises, and losses for individuals in the future. Yet the FED claims to know what to do: social engineering at its best or, as Hayek would put it, a fatal conceit on the part of central (banking) planners. Conclusion International central bank cooperation is coordinated by the FED, which issues the world reserve currency. The dollar is not only a reserve asset for central banks, it is also the currency of international financial transaction implying important advantages for the producers of dollars who can externalize part of the costs of money production on foreigners. To maintain the fragile fractional reserve fiat currency system, the FED has to act as a lender of last resort, thereby contributing to its instability encouraging risky behavior and financing indirectly government spending. As the financial crisis and the European debt crisis illustrate, the FED cooperates with other central banks in stabilizing the global fiat currency system. To this effect, the FED provided emergency loans to European banks and installed liquidity lines for foreign central banks. In short, the FED has assumed the task of bailing out the financial industry and governments worldwide by debasing the dollar.
References: Bagus, Philipp. 2010a. Austrian Business Cycle Theory: Are 100 Percent Reserves Sufficient to Prevent a Business Cycle? Libertarian Papers, 2 (2). Bagus, Philipp. 2010b. The Tragedy of the Euro. Auburn, Ala: Ludwig von Mises Institute. Bagus, Philipp and David Howden. 2010. The Term Structure of Savings, The Yield Curve, and Maturity Mismatching, Quarterly Journal of Austrian Economics 13 (3): 64-85. Bloomberg. 2011. The Feds Secret Liquidity Lifelines. Available at: http://www.bloomberg.com/data-visualization/federal-reserveemergencylending/#/overview/?sort=nomPeakValue&group=none&view=pea k&position=0&comparelist=&search= Bernanke, Ben S. 2008. Policy Coordination Among Central Banks. Speech at the Fifth European Central Bank Central Banking Conference, The Euro at Ten: Lessons and Challenges, Frankfurt, Germany. November 14. http://www.federalreserve.gov/newsevents/speech/bernanke20081 214a.htm ECB. 2010. ECB increases its capital. Press Release. Available at: http://www.ecb.int/press/pr/date/2010/html/pr101216_2.en.html Federal Reserve. 2011. Central Bank Liquidity Swaps. Available at: http://www.federalreserve.gov/monetarypolicy/bst_liquidityswaps. htm Fleming, Michael J. and Nicholas J. Klagge. 2009. The Federal Reserves Foreign Exchange Swap Lines. Current Issues in Economics and Finance, 6 (4): 1-7 Goldberg, Lina S., Craig Kennedy, and Jason Miu. 2011. Central Bank Dollar Swap Lines and Overseas Dollar Funding Costs. FRBNY Economic Policy Review, May: 3-20. Kuntz, Phil and Bob Ivry. 2011. Fed Once Secret Loan Crisis Data Compiled by Bloomberg Released to Public. Bloomberg. Available at: http://www.bloomberg.com/news/2011-12-23/fed-s-once-secretdata-compiled-by-bloomberg-released-to-public.html Mallien, Jan. 2012. Weidmann verteidigt die Bundesbank gegen die Euroretter. Handelsblatt. March 13th. Available at: http://www.handelsblatt.com/politik/konjunktur/geldpolitik/gewin
n-sinkt-deutlich-weidmann-verteidigt-die-bundesbank-gegen-dieeuro-retter/6320302.html Hoppe, Hans-Hermann. 1990 Banking, Nation States, and International Politics: A Sociological Reconstruction of the Present Economic Order, The Review of Austrian Economics, no. 4, pp. 55-87. McGuire, Patrick and Gtz von Peter. 2009. The US dollar shortage in global banking and the international policy response. BIS working papers. No. 291. Mises, Ludwig von. 1998. Human Action. Scholars edition. Auburn, Ala.: Ludwig von Mises Institute. ODriscoll, Gerald P. 2011. The Federal Reserves Covert Bailout of Europe. Wallstreet Journal. Available at: http://www.cato.org/publications/commentary/federal-reservescovert-bailout-europe Politifact, 2011 Ron Paul says U.S. has military personnel in 130 nations and 900 overseas bases, Politifact.com, http://www.politifact.com/truth-ometer/statements/2011/sep/14/ron-paul/ron-paul-says-us-hasmilitary-personnel-130-nation/. Schenk, Catherine. 2009. The Retirement of Sterling as a Reserve Currency after 1945: Lessons for the US Dollar? Working paper, http://www.cirje.e.utokyo.ac.jp/research/workshops/history/history_paper2009/history 1109.pdf. Stockholm International Peace Institute. 2011. The SIPRI Military Expenditure Database. http://milexdata.sipri.org/
EARING XIII.
INVESTIGATING THE GOLD: H.R. 1495, THE GOLD RESERVE TRANSPARENCY ACT OF 2011 AND THE OVERSIGHT OF UNITED STATES GOLD HOLDINGS
THURSDAY, JUNE 23, 2011

WITNESSES Thorson, Hon. Eric M., Inspector General, U.S. Department of the Treasury Engel, Gary T., Director, Financial Management and Assurance, U.S. Government and Accountability Office
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ACKGROUND
The Subcommittee on Domestic Monetary Policy and Technology held a hearing entitled Investigating the Gold: H.R. 1495, the Gold Reserve Transparency Act and the Oversight of United States Gold Holdings at 2:00 p.m. on Thursday, June 23, 2011 in Room 2128 of the Rayburn House Office Building. H.R. 1495 requires the Department of the Treasury to assay, inventory, and audit gold reserves held by the United States government. This hearing focused on previous audits of U.S. gold reserves; the methodology for conducting the audit called for by the legislation; the proposed review of that audit by the U.S. Government Accountability Office (GAO); and possible improvements to the legislation. This was a one-panel hearing with the following witnesses: The Hon. Eric M. Thorson, Treasury Department Inspector General (Treasury IG) Gary T. Engel, Director of Financial Management and Assurance, GAO
Summary of the Legislation H.R. 1495, the Gold Reserve Transparency Act of 2011, was introduced on April 12, 2011 by Subcommittee Chairman Paul and was referred to the Domestic Monetary Policy Subcommittee. The bill directs the Secretary of the Treasury to complete a full accounting of the U.S. governments gold reserves within six months of date of enactment of the legislation. The bill requires the Treasury Department to take a full inventory of the U.S.s gold reserves; assay the reserves; and then conduct a full audit. The Treasury Department is directed to visit all locations where gold reserves are
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held, and to assess the sufficiency of measures taken to ensure the security of the reserves. After the Treasury Department completes its audit of the U.S.s gold reserves, the bill directs the GAO to review the Treasury Departments work and to report to Congress within nine months with any additional findings regarding the state of the gold reserve. The legislation grants the GAO access to any facility where gold reserves are held. The bill also directs the Treasury Department to give the GAO full access to any relevant material pertaining to its review of the gold reserves. Gold in the Monetary System Like most other countries in the eighteenth century, at its founding the United States monetary system was based on gold and silver coins. In 1933, President Franklin Roosevelt, under Executive Order 6102, criminalized the possession of gold coins, gold bullion, and gold certificates. All individuals, with very minimal exceptions, were required to surrender their gold coins, bullion, and gold certificates to the Federal Reserve Banks or member banks of the Federal Reserve System. Thereafter any privately-held gold certificates, United States Notes, Federal Reserve Notes, National Bank Notes, or gold-denominated savings bonds were no longer redeemable for gold. In 1934, all gold held by the Federal Reserve System was ordered to have its title transferred to the federal government. The overwhelming majority of the 261.5 million troy ounces of gold owned by the United States is from this transfer of gold from the people to the government in the 1930s. From that point on, only foreign governments could redeem their dollars for gold. This practice, however, ended on August 15, 1971, when President Nixon took the U.S. entirely off the gold standard by closing the U.S. governments gold window, thereby preventing other central banks from converting the dollar to gold directly. In the current international monetary regime, gold no longer plays a role as money, and members of the International Monetary Fund (IMF) are even forbidden from linking their currencies to gold. As a result, gold is now primary used as one of many assets held by national central banks. Despite the lack of an official monetary role for gold, many countries hold gold reserves in significant quantities to defend the value of their currencies and to hedge against the dollar, which forms the bulk of their liquid currency reserves. Because gold is sufficiently scarce and can be easily traded, it has served as a store of value, a unit of account, and a medium of exchange for millennia,
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and does not appear to have lost this standing even in a global fiat monetary system. Despite the demonetization of gold by President Roosevelt and subsequently President Nixon, the U.S. Mint still issues a number of gold commemorative coins and investment-grade bullion coins in gold, silver, and platinum. The U.S. gold coins issued today by the Mint bear nominal face values that are not at all indicative of the commodity value of the gold contained in the coin. Bullion coins are sold for a price that includes the spot price of the metal plus a small manufacturing fee, while commemorative and collector versions have an additional markup. Gold Holdings of the U.S. Government The United States government is the worlds largest single holder of gold, with 261.5 million fine troy ounces394. The majority of the gold is held in the form of 700,000 bars, many of which were made by melting gold coins collected after President Roosevelts gold seizure in 1933. Some of the gold is in the form of coins held for historic or exemplar purposes. About 95 percent of the United States governments gold stock is held in three deep storage vault locations, the most famous of these storage locations being in Fort Knox, KY; The other storage facilities are the U.S. Mints production facility in Denver, CO, and the Mints production facility at West Point, NY. Small amounts of gold are held in the Mints production facility in Philadelphia and in the Mints headquarters in Washington, DC. The precise amount of gold held by the Mint varies because it uses some of its gold to produce bullion coins and collector coins, which it then sells. The gold it uses to make coins is processed, sold, and replaced. Otherwise the U.S. stock has been relatively stable since the early 1970s. The Federal Reserve Bank of New York stores 5 percent of the United States governments gold holdings in its vault. The New York Fed also holds gold on behalf of other governments or central banks, although that amount has been steadily dropping and does not count as part of the total U.S. gold stock. The Federal Reserve once held sizeable stocks of physical gold with which to back the Federal Reserve Notes it issued, it was forced to surrender this gold stock to the Treasury in 1934, and now owns no
Gold is weighed in troy ounces rather than the avoirdupois ounces to which most Americans are accustomed. One troy ounce is 480 grains, or roughly 31.1 grams, while a troy pound is 12 troy ounces; an avoirdupois ounce is 437.5 grains, or around 28.35 grams, while an avoirdupois pound is 16 avoirdupois ounces (7000 grains).
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gold. The Federal Reserve today carries on its books gold certificates issued by the Treasury in exchange for that gold surrendered by the Federal Reserve. The certificates are valued at about $11 billion, or $42.22 per ounce of gold surrendered. The gold held by the United States government is officially valued for accounting purposes at $42.22 per ounce. Gold had been officially valued at $35 per ounce until President Nixon closed the gold window in 1971. Thereafter the dollar was officially devalued by revaluing gold at $38 per ounce, and then again at $42.22 per ounce in 1973. Even at that time the official accounting price was significantly under the market price of gold. At the time this hearing was held, the market price for gold was over $1500 per ounce. In 2012, the market price for gold peaked near $1800 per ounce. Storage and Custody of U.S. Gold Holdings The U.S. Mint is the custodian of a significant portion of the United States governments gold and silver reserves. Deep storage is the U.S. gold and silver bullion reserve secured by the U.S. Mint in sealed vaults, which comprises the vast majority of U.S. reserves and consists primarily of gold bars. The U.S. Mint prepares the custodial schedule for the deep storage gold and silver reserves, establishes and maintains internal controls for securing the reserves, and is responsible for complying with laws and regulations applicable to its custodial responsibilities for the reserves. In October 2010, the Treasury Departments Inspector General released a report on its audit of the U.S. Mints deep storage gold reserves.395 The Treasury IG concluded that in all material respects, the balance of the deep storage gold and silver reserves in Mint custody were in conformity with U.S. generally accepted accounting principles. The Treasury IG also rendered an unqualified opinion that there were no material weaknesses related to internal control over financial reporting and no instances of reportable noncompliance with laws and regulations. Unfortunately, these regular financial audit reports from the Treasury IG show a limited picture of the condition of the U.S. gold holdings, focusing solely on an examination and approval of financial statements. They do not detail important information such as the last
Department of the Treasury Office of Inspector General, Audit of the United States Mints Schedule of Custodial Deep Storage Gold and Silver Reserves as of September 30, 2010 and 2009, Oct. 21, 2010, available at http://www.treasury.gov/about/organizationalstructure/ig/Documents/oig11004.pdf .
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time it was assayed (examined for purity) or inventoried. As a result, the condition of the U.S. gold holdings has been a topic of much debate, prompting questions as to whether the gold is encumbered in financial transactions, whether its quality is accurately reflected on financial statements, and, for some, whether it is even in the vaults at all. It was not until the preparation for this hearing that a more complete picture emerged as to the audits that have been conducted and the condition of the gold reserves. While not available in any widely distributed reports, the U.S. Mint and other Federal agencies have been performing audits of the U.S. gold holdings periodically since 1975. Gold Audit Timeline In preparation for this hearing, the Treasury IG reported that between 1975 and 1986 an extremely thorough audit of the gold storage vaults was conducted: the vaults were inventoried, some bars were assayed on a random basis, and those results were audited. The vaults then were sealed with tamper-proof seals, signed by representatives of the U.S. Mint, the bureau that was the predecessor of the Treasury Departments Financial Management Service, and the Federal Reserve Bank of New York, all of whom were present for the entire audit process. This audit covered roughly 92 percent of the gold in the custody of the Mint. After 1986 gold audits and inventories continued but were conducted solely by the Mint, without independent parties present for the sealing of the vaults. In 1993, the Treasury IG began conducting inventories again, and between 1993 and 2008 the OIG examined the 8 percent of the Mints gold holdings not audited during the 19751986 audits. Another 13 percent of the gold was examined during this period for a total audit of roughly 21% of the Mints custodial gold. In the process, the vaults were inventoried, bars were assayed on a selective basis, the results audited, and the vaults sealed and signed. Seals from the 1975-1986 audits were reviewed and some of the older ones were replaced where they were found to have begun deteriorating. According to the U.S. Mint, all of the United States gold reserves (aside from those held at the New York Fed) have thus been audited, inventoried, and assayed, and the vaults in which the reserves are held have been sealed. The gold cannot be moved out of the vaults without breaking the seal. If a seal needs to be replaced for any reason if, for example, a light bulb in a vault burns out and
must be replaced the Treasury IG must witness the old seal being broken and the affixing of a new one. In 2012, the U.S. Mint undertook an audit of the gold held at the Federal Reserve Bank of New York. As of December 2012, the results of that audit were not made available to the public.
RANSCRIPT
The subcommittee met, pursuant to notice, at 9:31 a.m., in room 2128, Rayburn House Office Building, Hon. Ron Paul {chairman of the subcommittee} presiding. Members present: Representatives Paul, Jones, Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Green. Chairman PAUL. This hearing will come to order. Without objection, all members opening statements will be made a part of the record. I will start with my opening statement and proceed to anybody else who is anxious to do the same. For far too long, the United States Government has been less than transparent in releasing information relating to its gold holdings. Not surprisingly, this secrecy has given rise to a number of theories about the gold at Fort Knox and other depositories. Some people speculate that the gold has been involved in gold swaps with foreign governments or bullion banks. Others believe that the gold has been secretly shipped out of Fort Knox and sold. And, still others believe that the bars at Fort Knox are actually gold-plated tungsten. Historically, the Treasury and the Mint have dismissed these theories rather than addressing these concerns with substantive rebuttals. No one from Congress has been allowed to view the gold at Fort Knox in nearly 40 years. Recent photographs of gold holdings seem to be hard to come by. And the Mint and the Inspector Generals audit statements contain only the bare minimum of information. Because the Government has for so long refused to provide substantive information on its gold holdings, it is not surprising that so much confusion abounds, both within and without the Government.
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The difference between custody and ownership, questions about the responsibility for U.S. gold held at the New York Fed, and that issue of which division at Treasury is ultimately responsible for the gold reserves are just some of the questions that have come up during the research for this hearing. In a way, it seems as though someone decided to lock up the gold, put the key in a desk somewhere, and walk off without telling anyone anything. Only during the preparation for this hearing was my office informed that the Mint has in fact conducted assays of statistically representative samples of gold bars, and we were provided with a sample assay report. This type of information should be reported, or at least tabulated and published, so that the public knows exactly how many bars of gold exist, what their fineness is, and whether they are encumbered in any way through loans or swaps. While the various agencies concerned have been very accommodating to my staff in attempting to shed some light on this issue, it should not require the introduction of legislation or a congressional hearing to gain access to this information. This information should be published and available to the American people. This gold belongs to the people, especially since much of it was forcibly taken from them in the 1930s, and the Government owes it to the people to provide them with the details of these holdings. We would greatly benefit from a full, accurate inventory audit and assay with detailed explanations of who owns the gold and who is responsible for ownership, custody, and auditing. While the Mint and the Inspector General trust the accuracy of the audits performed between 1975 and 1986, this still means that at least two-thirds of the gold reserves were last audited over a quarter century ago. Surely, a full audit every 25 years is not too much to ask. I look forward to the testimony of the witnesses regarding the conditions of the gold reserves, the accounting audits that are regularly performed, and the inventories and assays that have been conducted on some of this gold over the years. I am also very interested to hear the comments on the Gold Reserve Transparency Act, so that we may put forward a measure that provides the public with accurate and complete information on their gold. I yield back the remaining time of my 5 minutes, and yield to Mr. Clay for his 5 minutes. Mr. CLAY. Thank you, Mr. Chairman. And thank you for holding this hearing, entitled, Investigating the Gold: H.R. 1495, the Gold
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Reserve Transparency Act of 2011 and the Oversight of United States Gold Holdings. I, too, look forward to the witnesses testimony. And I also noted that in the Treasury Inspector Generals written testimony, he wrote that the IG is required by law to perform an annual audit of the Mint public enterprise funds financial statements. And those statements include the balance of custodial deep storage gold reserve held by the Mint. It seems as though there is already an annual audit that both the IG and the GA believe is required of them. However, Mr. Chairman, one other suggestion is perhaps we, as a subcommittee, may consider taking a tour of Fort Knox and the other place or places that house the gold and really witness for ourselves if it is goingI dont know if that would be enough to determine if the gold is authentic. But, it may be something for the committee to consider. So I look forward to the witnesses testimony. And, again, I thank the chairman. Chairman PAUL. I thank the gentleman. I also thank the gentleman for his suggestion. I think it is a good idea to go and at least show our interest. But I personally would feel like I would have shortcomings on looking at a bar and knowing exactly what I was looking at. But there is no reason why we cant at least consider that as a starting point. Would any other member like to make an opening statement? Okay. I will proceed to the witnesses. I would like introduce our two witnesses. Mr. Gary Engel is the Director of Financial Management and Assurance at the Government Accounting Office. He directs GAOs annual audit of the U.S. Governments consolidated financial statements, as well as audits of key financial statements at the Department of the Treasury. And I want to welcome Mr. Engel, as well as the honorable Eric M. Thorson, who has been the Inspector General of the Department of the Treasury since 2008. He manages oversight of the Treasury through independent audits, investigations, and review. And we will go ahead and proceed with the testimony of Mr. Thorson.
STATEMENT OF THE HONORABLE ERIC M. THORSON396 INSPECTOR GENERAL U.S. DEPARTMENT OF THE TREASURY
396
[The prepared statement of Inspector General Thorson can be found on page 1432.]
Mr. THORSON. I thank you for the opportunity to appear before you this afternoon. My testimony will cover the audits done by my office on the United States Mints Schedule of Custodial Deep Storage Gold Reserves. Hereafter, I will mostly refer to them simply as the gold reserves. Before I discuss the details of the audits that are the topic of this hearing, I want to make one point very clear: 100 percent of the U.S. Governments gold reserves in the custody of the Mint has been inventoried and audited. Furthermore, these audits found no exceptions of any consequence. I also want to assure you that the physical security over the gold reserves is absolute. I can say that without any hesitation, because I have observed the gold and the security of the gold reserves myself. Accordingly, the requirements of H.R. 1495, which calls for a full assay, inventory, and audit of gold reserves of the United States, together with an analysis of the sufficiency of the measures taken for the security of such reserves, is redundant of audit work already done. Since 1993, my office has performed annual audits of the Governments deep storage gold reserves held by the Mint. In fact, our Fiscal Year 2011 audit of the gold reserves is currently under way. My testimony today will briefly describe what the Mint gold reserves include, and the annual audits performed by my office since 1993. The Mint maintains its storage gold reserves in three highly secure locations: Fort Knox, Kentucky; West Point, New York; and Denver, Colorado. While it would be inappropriate for me to discuss the details of the security arrangements in place at these facilities, I can tell you that they are multilayered and include substantial physical barriers, armed guards, cameras, and metal detectors. In all, 42 compartments at these 3 hardened facilities hold 699,515 gold bars with a fineness or purity ranging from 0.47 to 0.9999, with an average fineness of 0.9006. As of September 30, 2010, the audited quantity of the gold reserves held by the Mint was over 245 million fine troy ounces, weighing over 9,300 tons, with a market value of $320.6 billion. I might add that each gold bar weighs about 27 pounds and has an average value of about $0.5 million. In June 1975, the Treasury Secretary authorized and directed a continuing audit of U.S. Government-owned gold for which Treasury is accountable. Pursuant to that order, the Committee for Continuing
Audit of the U.S. Government-owned Gold performed annual audits of Treasurys gold reserves from 1975 to 1986, placing all inventoried gold that it observed and tested under an official joint seal. The committee was made up of staff from Treasury, the Mint, and the Federal Reserve Bank of New York. The annual audits by the committee ended in 1986 after 97 percent of the Government-owned gold held by the Mint had been audited and placed under official joint seal. It should be noted that during the entire period of these audits and up to today, no discrepancies of any consequence have ever been found. This is an example of the sealand I have put pictures of these in my testimony. This is an actual seal that came off one of the compartments. My office began conducting annual audits of the gold reserves in Fiscal Year 1993. Since 2005, these audits have supported the annual audits of the Treasury Departments consolidated financial statements, which incorporate the balances of the gold reserves held by the Mint. The financial statement audit is performed by KPMG under contract with my office. KPMG has relied on our audits of the gold reserves when rendering its opinions on the Mints and Treasurys financial statements. They have assured themselves as to the independence, reputation, and qualifications of my audit staff. In addition, they have satisfied themselves with the adequacy of the audit procedures performed. The audit work performed by both my office and KPMG is done in accordance with Government auditing standards established by the GAO. Since 1993, when we assumed responsibility for the audit, my office has continued to directly observe the inventory and test the gold. In fact, my auditors signed the official joint sealssuch as the one I showed youplaced on those compartments, inventoried and tested in their presence. At the end of Fiscal Year of 2008, all 42 compartments had been audited by either the GAO, the Committee for Continuing Audit of the U.S. Government-owned Gold, or my office, and placed under official joint seals. There has not been any movement of inventoried gold since that time. Furthermore, in addition to observing the inventory of the gold for all of the audit periods, we selected and tested a statistically valid random sample of gold bars using a 95 percent confidence level. We found, without fail, that any differences between the fineness
reported by the Mint and the fineness based on our independently obtained assay reports were immaterial and negligible. For example, during our Fiscal Year 2008 audit, we sampled gold valued at $75 million. Based on the independent assay of those samples, we projected the dollar value of the difference, based on the assay report and the Mints inventory records, to be $3,820, or 0.005 of 1 percent of the gold inventory. As discussed earlier, by the end of Fiscal Year 2008, all of the gold reserves in the Mints custody had been 100 percent inventoried and audited. In closing, based on the work performed by my office and by my own personal observations, I can assure the subcommittee and, as you said, sir, the American people, that both the quantities and the value of the U.S. Governments deep storage gold reserves held and reported by the Mint are reliable and fully audited. I mentioned the American people because, as you said, sir, they own this gold. The reason we go through all of the procedures that I just mentioned is to give the American people the absolute confidence that the gold reserves are as represented. Fort Knox, for instance, isnt just a huge stockpile of gold. It is also a symbol of the stability and financial soundness of their Government. To create doubt about the value or the security or even the very presence of the gold reserves without reason contributes to the distrust in Government that seems to be a growing trend today. It is the obligation of every Inspector General to report to the Congress, and to the public, areas of concern that need to be fixed. But I believe it is also my obligation to report to you when something is being done right, and that is the case here today. That concludes my statement. Chairman PAUL. I thank the gentleman, and we will proceed with Mr. Engel.
STATEMENT OF GARY T. ENGEL397 DIRECTOR, FINANCIAL MANAGEMENT AND ASSURANCE, U.S. GOVERNMENT ACCOUNTABILITY OFFICE (GAO)
Mr. ENGEL. Thank you, Mr. Chairman, Ranking Member Clay, and other members of the subcommittee. I am pleased to be here today to discuss H.R. 1495, the Gold Reserve Transparency Act of 2011. As of September 30, 2010, about 95 percent of the reported U.S. gold reserves were in the custody of the Mint, of which nearly all is
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[The prepared statement of Mr. Engel can be found on page 1444.]
deep storage gold. The remaining U.S. gold reserves were in the custody of the Federal Reserve Bank of New York. In 1974, in response to congressional interest and in conjunction with the Mint, GAO assisted in the planning and observed the inventory of U.S. gold reserves in the depository at Fort Knox. GAO selected and audited 3 of the 13 compartments at that depository. As part of this audit, GAO recommended that a cyclical inventory of the gold in Mint custody be performed annually to ensure that the gold in all compartments would be inventoried over a specified period of years. Acting on this recommendation, in 1975 Treasury established the Committee for Continuing Audit of the U.S. Government-owned Gold. Treasury OIG officials estimate that about 92 percent of the U.S. gold reserves have been audited by either GAO or the Committee for Continuing Audit as of September 30, 1986. Of this percent, GAOs audit in 1974 represented about 13 percent. More recently, the U.S. gold reserves have been presented in various financial reports and have therefore been subject to various audit efforts. For example, since issuing its audit report covering the Mints custodial schedule for Fiscal Year 1993, the Treasury OIG has annually audited the deep storage gold reserves in the custody of the Mint. For each of the fiscal years under audit, the Treasury OIG has issued a clean opinion on the Mints custodial schedules. Also, the Treasury OIG did not report any material weaknesses in internal control over financial reporting relating to these schedules for those fiscal years. 1495 provides for the Secretary of the Treasury to conduct and complete a full assay, inventory, and audit of the U.S. gold reserves, and an analysis of the sufficiency of the measures taken for the security of such reserves. In considering the provisions of H.R. 1495, it will be important to consider the cost, benefit, and timing of actions needed to implement the proposed requirements. 1495, if enacted, may result in duplication of certain past and current efforts. Nevertheless, GAO would be capable of reviewing the results of Treasurys actions as called for in the bill, should it be enacted. GAOs review would include visits to the facilities where the gold reserves are held to selectively observe the inventorying and the auditing of the gold. We would also examine various documentation supporting the required assay, inventory, and audit. 1495 also provides for GAO to transmit to the Congress not later than 9 months after enactment of the Act a report of GAOs findings
from such review and the results of Treasurys efforts. According to Treasury officials, because of the enormous quantity of gold that would need to be inventoried and assayed, it is unclear whether Treasury can complete such actions within the 6-month period provided for in H.R. 1495. If Treasurys efforts are not completed within this period, there would be limitations on the scope of GAOs work if GAO were still to be required to report out within the 9-month period. GAO stands ready to work with the subcommittee on developing changes to the provisions of H.R. 1495 that would most efficiently utilize the results of past and current gold reserve assay, inventory, and audit efforts. Mr. Chairman, and Ranking Member Clay, this concludes my prepared remarks. I would be pleased to answer any questions that you may have.
Chairman PAUL. I thank the gentleman. I will start off with yielding 5 minutes to myself for questions. I wanted to ask both of you this question. It has to do with what is happening in New York, because that has been a little more difficult to understand. There is a lot of uncertainty surrounding who has responsibility of the gold reserves held at the New York Fed. You did mention it in your testimony, but conversations with the Mint and the Office of the Inspector General, the main Treasury and the New York Fed, have all resulted in one or the other of these entities saying to check with the other, so we never got a full answer. The OIG has stated that it does receive financial statements from the New York Fed attesting to the gold held in storage there for purposes of their financial statement audits. However, there seems to be no definite answer as to who has the responsibility for the New York Fed gold, and no one seems to know the last time it was assayed or inventoried. A common rejoinder has been that it is just a small part of the gold reserves; it is only 5 percent. But when you look at the total amount of gold we have, 5 percent is pretty significant, because it is more than 13 million ounces of gold. And at $1,500 an ounce, we are talking about $20 billion that seems to be floating around out there and we just really cant pin it down. I know we are used to talking in trillions, but this just seems like poor governance.
Could either of you comment on the New York Fed-held gold, whether it has been assayed or inventoried, and whether it deserves to be thoroughly examined, as the legislation calls for? Mr. ENGEL. My understanding is that the gold reserves in the Federal Reserve Bank of New York have not been assayed. That is just based upon my reading of reports, not from work that GAO has done. But it is also my understanding from reading a Treasury OIG report from back in 1987, that pretty much 99.9 percent of the gold reserves that were in the Federal Reserve Bank of New York at that timeand I think that the amounts of fine troy ounces, when I looked, has not really changed to what it is nowwere being audited over periods of time by the Federal Reserve examiners, and that those inventories had been observed by members of the Committee for Continuing Audit that we spoke of earlier. Because it had not been assayed and because it is not under the control of that committee, they have not considered that as audited. But, there have apparently been inventories of it, and there have been observations of that inventory. The last report that I saw that said that was from back in 1986. So, I dont know what has been done since then. Chairman PAUL. Thank you. Mr. Thorson? Mr. THORSON. You are correct that we dont audit that. It is done by a third-party confirmation, which is an accepted practice under audit. But it is the Treasurys gold5 percent of it is there and it is really at this point is immaterial to the statement and the total numbers. Chairman PAUL. It is immaterial? Mr. THORSON. As an auditing term, I mean. It is not included in what we listed in the statements. Chairman PAUL. But it is a relevant amount of gold, obviously? Mr. THORSON. Right. Chairman PAUL. Since this is held at the New York Fed, and the New York Fed is obviously very much involved in international arrangements during the financial crisis, essentially every single transaction to the tune of trillions of dollars that they transacted involved foreign central banks. And over the last decade or two, central banks have been very much involved in gold swaps and loaning gold and selling gold. And to date, of course, we have no evidence that our Government has ever been involved. But it seems to me that if there was ever one place where they might have gotten involved, since the New York Fed
is involved in international transactions withyou probably dont have the answer on whether or not they did or did not but could it be conceivable that they could have done it without your knowledge? Mr. THORSON. I dont believe so, no. And as far as any encumbrances other than the gold certificates that are held by the Fed, we did ask that question before coming here. What I was told was as far as encumbrances, Not one troy ounce is encumbered. Chairman PAUL. Okay. I yield back, and now I yield 5 minutes to Mr. Clay. Mr. CLAY. Again, thank you, Mr. Chairman, for conducting this hearing. And let me thank both witnesses for your testimony today. According to the U.S. Mint, which is the custodian of nearly 95 percent of Americas gold reserves, the time required to move, weigh, assay, and re-store the bars of gold averages 6 minutes per bar with a team of 19 people. Now, the Mint points out that extrapolating that to 700,000 bars, as the legislation requires, would require nearly 1.3 million manhours of incremental labor. Therefore, to complete the inventory of just the gold bullion bars within 6 months, as this proposal specifies, would require approximately 1,280 individuals. And we know that since this is a domestic issue that, Mr. Chairman, your leadership would require an offset, so we would have to find the money to do this since this is a domestic issue, and we have to pay for all of those things. Would either of the witnesses view this bill as a prudent use of taxpayer funds? Mr. Thorson? Mr. THORSON. The numbers that you quote are probablyjust on my unscientific judgment having been therepretty accurate. It is a remarkably small area. It is really surprisingly so when you are actually standing there with the compartments. You are going to be able to use very few people in that area. I think you gave the figure of about 1,200 people? That is almost laughable when you actually see the space. So that means it is going to take a great deal longer than what you would normally think. And if you could put 1,200 people together, have them move the bars, it is going to take a very long time. I, obviously, as I said in my statement, dont see the benefit at any cost really. It is what we do; it is what we do every year. As I said, it almost loses its effect to stand there and actually see it all, because there is so much of it. It is there. Mr. CLAY. Thank you for that response.
Mr. Engel, is this a good use of taxpayers money, if this bill becomes law? Mr. ENGEL. I think, as I said in our testimony, that we would be willing to work with the subcommittee on possibly building off of the assays, the inventories and audits that have already been done to address concerns that there may be things within these vaults that are no longer there. I agree that they have been through an audit process. Auditors have checked these seals. But if the subcommittee wanted to have something done there, I would think we would be talking, rather than a full assay, maybe some sort of sampling, if you wanted to just get a feel that nothing has happened over the years since those vaults were sealed. But outside of that, it seems quite a bit redundant with what has already been done. Mr. CLAY. All right. I thank both witnesses for their responses. And Mr. Chairman, I yield back. Chairman PAUL. I thank the gentleman. I yield 5 minutes to Mr. Jones from North Carolina. Mr. JONES. Mr. Chairman, thank you very much. And Mr. Engel, it is nice to see you. I had a very pleasant business relationship with Mr. Thorson on a number of issues. And I thank you for always being there to be helpful. I think the reason that I wanted to be here to listen to the witnesses, and certainly my colleagues on both sides, is that as a Member of Congress, one of my biggest concerns is not so much the gold, whether it is there or not there. But it is the Americans distrust of all of us in Congress, quite frankly. And I was readingmy staff got for me thisI will read it. It has nothing to do with this hearing, but it will lead to something in a moment: The Federal Reserve Bank of New York is refusing to tell U.S. Government investigators how much money it sent to Iraq during the first years of the American invasion. The Iraqi officials suggested the missing and possibly stolen funds from that era is more than $18 billion. And there is Stuart Bowena wonderful Inspector General who has always exposed all the lost American moneygoing to the New York Fed, and they wont meet with him. And I think that is the reason that maybe this bill has been introduced, and maybe not. It is for other reasons as well.
But, if the American people could just regain a little bit of confidence in Washington, whether it be an agency or the Congress itself, it would really, I think, help the environment of America. And I was wondering, I was thinking when Mr. Clay was suggesting, and Mr. Paul, the chairman, kind of agreed, does it make any sense for there to be a congressional delegation of five people, three people, six people, that every so often when you do the auditI think you said once a year, or I might have missed that in the testimony, you may have to correct mebut is it already in the guidelines or the statute that there would be a couple of Representatives from the Senate and the House who would be able to accompany the inspectors when they go toor the auditors, not the inspectors, the auditors? To me, this is aboutthere is so muchif I could change one thing in America and Iraq, or Iif I could control one thing, it would be the Internet. There is more misinformation on the internet than there is accurate information. And all there has to be is some person who is challengedI am going to be careful about thiswho puts on the Internet that you cannot find the gold at Fort Knox. Then all of a sudden, thousands or millions of people are seeing that. They are not hearing what you are saying. So I just wonder, if it makes any sense, if it is in your regulations, or if it needs to be in the statute, that there would be a team of two Senators or two Representatives who would have the option of accompanying your inspectors to one of the sites? Mr. THORSON. Actually, that has happened under a situation very similar to this one in 1974. In September of 1974, I believe it was Congressman Rousselot took a delegation which included, I believe, one Senator, Senator Huddleston, and they went down with, I assume permission probably would have come from either the Secretary of the Treasury or the White House, and did tour the gold and there were pictures taken and there are video clips of that. I think that is exactly what you are describing. And it was done in 1974. Obviously, I dont think either one of us have any authority to say anything about such a visit. But it certainly is something that the committee can make a request for, because there is a precedent for having done it. Mr. JONES. I appreciate you sharing that. And I will close in just one second. But I think in the world we live in today, there is such distrust that it would be I think for at least during this deep recession that we are in, that if that could be accomplished, it would help, I think, with the publics trust.
Not so much that they should believe Members of Congress, but I think that if this was an announced group meeting and Members, then it gets some publicity, and maybe there could be a news conference after this. I dont know. I think there is validity in why we are having this hearing today, and I just wanted to share those thoughts with the panel and you, Mr. Chairman, and my colleagues. I yield back. Chairman PAUL. I thank the gentleman. I now recognize Mr. Luetkemeyer from Missouri for 5 minutes. Mr. LUETKEMEYER. Thank you, Mr. Chairman. In your testimony, I didnt hear any comments about the golds that we use to mint coins. Is that held separately, or is that not included in this report, or am I missing something? Mr. THORSON. You said the Federal Reserve gold is separate? Mr. LUETKEMEYER. Okay, the Federal Reserve has a separate of gold they use to mint coins. Is that the same? Mr. THORSON. Right. It is all part of Treasurys gold, but it is not reported on the Mints financial statement. It is reported on the Treasurys consolidated financial statements. Mr. LUETKEMEYER. Okay, so they are the ones then that will mint the coins and they dont have anything to do with the gold that we are talking about here today? Mr. ENGEL. No, there might be a misunderstanding. In the Mint locations, they have basically two types of gold. They have the deep storage gold, and then they have working-stock gold. I believe what you are talking about is the working-stock gold. Yes, there is workingstock gold that is kept in the different Mint locations. I think at the end of last year, it was about 3 million fine troy ounces. About 1 percent of the total is working-stock gold. And that is the kind that is used for minting coins, medallions, things like that. Mr. LUETKEMEYER. Okay, so is that audited as well, I assume, as part of Mr. ENGEL. Yes, that is part of the Mints financial statements. That is not part of the custodial schedules, but it is part of the Mints financial statements. Mr. LUETKEMEYER. Okay, so how do you replenish that stock then? Are you just using existing stock, or do you get new gold shipments in that you use up? Or how do you continue to be able to mint new gold coins?
Mr. ENGEL. I am not involved with it. But my understanding is that they replenish that by purchasing stock, you know purchasing from the outside Mr. LUETKEMEYER. just on the open market somewhere? Mr. ENGEL. Yes. Mr. LUETKEMEYER. Okay. That is kind of interesting. I was listening to the discussion here of my colleagues with regards to the congressional review of the actual gold. And I think it might be a good idea to do that from the standpoint of also looking at the protection and proceduresall the stuff that goes into it from the standpoint of, again, some reassurance that there are adequate procedures in place for protection of it. So it is kind of interesting to listen to that debate. Along the same lines, with regard to the amount of gold that we have, according to testimony in the documents that I have been reading here, we are carrying it on our books at $41, $42.22, I believe. Is that correct? Mr. ENGEL. That is the per fine troy ounce statutory value. Mr. LUETKEMEYER. Okay. And you evaluated a while ago at about $320 billion, is that right? Mr. ENGEL. At market. Mr. LUETKEMEYER. At the current value today? Mr. THORSON. That was September 30th of last year. And yesterday, we pulled it up, it would be $1,552 an ounce and $300 and roughlylet us see, we dont have theroughly $340 billion. Mr. LUETKEMEYER. Okay. Mr. Chairman a while ago asked the question with regards to using and swapping it out with regards to other things. It is not used as collateral for anything either right now, is it, other than the gold certificates? There is no Mr. ENGEL. I am not aware of anything Mr. LUETKEMEYER. in any other way Mr. ENGEL. especially in financial statements, there is nothingor in the Department-widethere is nothing disclosed about Mr. LUETKEMEYER. So, it is just sitting there right now, right? Mr. ENGEL. Yes, it is a reserve. Mr. LUETKEMEYER. Right, the reserve. Mr. THORSON. Right, it isand I would back up his statement as far as we are not aware of anything like that. Mr. LUETKEMEYER. Okay, what would happenthere is some discussion about going back to the gold standard. I dont know if we have a will, or if it is a good idea, a bad idea. But if we would, how would that change your operation?
Mr. ENGEL. I cannot speak to the gold standard and how it would change Mr. THORSON. On the gold standard issue? Mr. LUETKEMEYER. Yes, if we went back to the gold standard, how it will it change the operation of what you do? Mr. THORSON. I am not sure how Mr. LUETKEMEYER. But we have to have some morewould it be some transactions going on with regards to how you take care of it? Would it be that we would have to raise and lower the amounts that we have all the time, or things like that? Or how would we do that? Mr. THORSON. I would have to tell you, as far as any discussion regarding returning to the gold standard, that isyou are really getting into a much more a policy issue. We areboth of us, we are auditors, we will Mr. LUETKEMEYER. Okay. Mr. THORSON. We will certainly be able to look at any process or procedure or plan if that ever happened. But as far as commenting on that as a policy as to whether it is a good idea or a bad idea, that is really out of our realm. Mr. LUETKEMEYER. Okay. Thank you, Mr. Chairman. I appreciate the opportunity. Chairman PAUL. I thank the gentleman, and we will go on and have a second round of questions, if you care to. It seems that a portion of the Mint and the U.S. gold reserves were audited in an assay between 1993 and 2008, as you acknowledged. The Mint estimated that as much as one-third of the gold reserves were examined during this period. The other two-thirds, however, have not been inventoriedthat is according to my understandingor assayed since somewhere between 1975 and 1986. Do you think it would be worthwhile, at least, to inventory and assay this portion of the Mint-held gold? Mr. THORSON. ByI forget which date it was, I believe by 1986, wehold on just one second here, I got it. It basically coveredby 1986, 97 percent of the Governmentowned gold held by the Mint had been audited and placed under joint seal. So once you have done that, and that seal remains unbroken, then I am not sure what other benefit there would be to going back into it at that point. But by 1986, you had 97 percent was audited Chairman PAUL. But it just seems like, it is quite a bit different the way you described audits compared to, I think a general understanding of audits. They dont audit small portions over 20 and 30
years. An audit, I thought, was supposed to be audited as quickly as possible. Mr. THORSON. I think it is a little different. Because what you have as opposed to, for instance, if I am auditing inventory of a company, product goes out, product comes in, it is replaced, etc., etc. In this case, there is no movement. Those doors are not opened. There is nothing there that can happen, because once those doors are sealedand I have given you a couple of show-and-tell examples hereit is very obvious if those seals are ever broken. And it is not like, and as I mentioned in a normal audit, where product is moved out and I replace it and I move on. That is not what happens here. There is no movement. Those doors are not opened, if they are and a seal is broken, then those people who didit is replaced, the seal is put in place. So I guess, it is hard to imagine what benefit there would be, if in fact the seals that cover those doors are unbroken. Chairman PAUL. It just seems like it doesnt conform to my idea of what an audit is all about. But let me go on to another question dealing with the audits. There has been a lot of speculation as to the condition of the gold reserves. As I mentioned in my opening statement, it was not until legislation was introduced and a hearing scheduled that information surrounding assays and inventories conducted by the Mint and the Office of the Inspector General was forthcoming. And your offices have been very accommodating in the process. But it seems to me that all this information about the activities of the Mint and the IG have been engaged with respect to the gold reserves and the results of these activities should be gathered together in one place and made readily available, like it was mentioned on the Internet, maybe we could have it available to the public? That is what my bill proposes, assay and inventory the gold, evaluate whether it is encumbered in any transaction by the Treasury, have the Treasury issue a report. The GAO independently verifies that report as Congress investigative arm. Could you comment on the reporting element of the legislation, as well as the GAOs independent review? Could you also comment on the extent to which the information already available could be published? Can we get the information a little easier instead of dragging it out? If, for no other reason, for reassurance, because the questions have been building over the years. And when you say, Well, but
when was it fully audited? My understanding, a full audit of the gold, most people give me the date 1953. So what about the facilitating of information to give the American people the absolute reassurance that they are asking for? Mr. THORSON. I guess it would depend on what you wanted. We have published all of the audit reports on our Web site, they are public. You all asked for assay reports, which we certainly provided. We keep them for a while. There is really no secret about it. There was one thing, I guess, on the press release for this hearing that kind of got my attention when you said we were less than forthcoming, I believe, was the term. I dont understand that, sir, to be honest with you. We dont publish our work papers on the Internet. I dont think any auditor does that. But for the period which we have them, we keep them in the normal course of events. But this is an example of a public audit report on the gold. It is out there. And the assay reports, I believe your staff asked for, we provided them. The work papers, like I said, we dont normally do that. But I dont think any auditor in America does that. So whatever it is that we can do reasonably and under the proper rules of auditing, we are happy to do. Because I agree, transparency is our business. That is why we do what we do. If there are any suggestions, we are happy to listen to them. Chairman PAUL. What we were looking for was to getwe thought we would see a list of the bars or the assay details. There were gross numbers, but not a list of the bars and the precise assay results. Mr. THORSON. Clearly, the results of them are published. I think in my statement which is there is nothing hidden were all in the statement. I mentioned the range of from the assay reports, I think it was 0.6 to 0.999, something like that. That is what the assay tells you and then we gave you an average. So, those numbers are out there. I am not sure I understand why there is some confusion about that. Chairman PAUL. But I think it was incomplete and there werent total numbers. I think we have a much smaller number in a single report. Anyway, we might be able to work that out and figure it out. But there is still some confusion there. My 5 minutes is up, and I yield to Mr. Luetkemeyer for his 5 minutes Mr. LUETKEMEYER. Thank you, Mr. Chairman. I just have a couple of follow-up questions.
What is the annual cost to store and protect our U.S. holdings? Do you have an idea? Mr. THORSON. The cost? I am sorry? Mr. LUETKEMEYER. The annual cost to protect and hold these holdings? Mr. THORSON. What it would cost to follow through on this bill? Mr. LUETKEMEYER. No. Right now, we have the gold sitting in Fort Knox and Denver and Mr. THORSON. We dont really, because we do auditswe are doing many audits at the same time and that sort of thing, I dont think we have really ever broken down what it costs to do this particularat least, what it costs my office to do this Mr. LUETKEMEYER. Let me ask you what it costswhat is the cost to, I guess, the Government or the Mint or whomever pays the bill to protect the gold Mr. THORSON. Oh, the security. Mr. ENGEL. I think that would probably be something that the Mint would be able to tell youwhat that cost is. Neither of us I think would know that, but they would probably know what it costs for them to maintain the facilities and the depositories and things. Mr. LUETKEMEYER. That is not in your report? You dont go back and check the costs for the procedures of maintaining the Mr. THORSON. We are auditing the inventory of the gold, not the that would be a separate job and it is something that if your committee or somebody asked us to do, we could certainly look at that. Mr. LUETKEMEYER. All right. Mr. THORSON. But as you can see, that is really a different issue than how much gold is present at the locations. Mr. LUETKEMEYER. I would think protecting the gold would be pretty important, being able to count the gold. If you dont have it protected, you cant count what is not there if somebody takes it from you. Mr. THORSON. Having gone there, I have neverI am former Air Force and been involved with everything from nuclear weapons seen security like I saw in that vault. Mr. LUETKEMEYER. That is great and wonderful on that. But my question is, what does it cost us? Okay, move on. The IMF has the fourth largest gold reserves in the world. And my understanding is that the members who belong to the IMF have contributed gold to it. I guess my question is, is the gold that we
contributed, does IMF hold it, or do we maintain it here and just pledge it to the IMF? Or do you know? Mr. THORSON. State the last part, please, sir. Mr. LUETKEMEYER. Okay. All of the people who are members of the IMF have contributed gold to their reserve. The United States is a member of the IMF. Mr. THORSON. Right. Mr. LUETKEMEYER. When we pledged this gold, did we take it and physically move it to the IMF, or did we just have it pledged? Mr. THORSON. There are no encumbrances on that; there is no reason to move it. We have been assured that there is not one troy ounce that is encumbered; therefore Mr. LUETKEMEYER. Okay. So we have moved the gold to the IMF? Mr. THORSON. The gold. The encumbrances that I am aware of, the only ones are to gold certificates held by the Fed. And if they were to go to the physical side of it, what you are talking about is, if they were to redeem those gold certificates, they would be paid in currency. They wouldnt be paid in gold. The gold is collateral. It wouldnt be redeemed that way. Mr. LUETKEMEYER. Okay. According to my resources here, it says there are 261 million ounces that are reported as U.S. Treasuryowned gold that are part of the IMF reserve. And so, we dont hold it ourselves. The IMF holds it in their reserve, wherever that is at? Do we count it as ours? Mr. THORSON. Not that I know of. Mr. LUETKEMEYER. We dont count it as ours then? We count it as the IMF count it as theirs? Or we dontit is just sort of an account. It is kind of like having a savings account with another bank? Mr. THORSON. No. Mr. LUETKEMEYER. So, it is not our gold anymore? Is it IMFs, or is part ofis it ours as well? Mr. THORSON. I think what you are talking about is the three purposes the gold can be used for, and the third one is what you are discussing, of which we are not aware of any use in that category at all. I believe it says the third one is consistent with the obligations of the Government and the IMF on orderly exchange agreements and a stable system of exchange rates, etc., made with the approval of the President, and may deal in gold. We are not aware of any case where that is occurring. Mr. LUETKEMEYER. You are saying we have never done this? Mr. THORSON. It is what? Mr. LUETKEMEYER. You are saying that we have never done this?
Mr. THORSON. Not that Mr. LUETKEMEYER. We have never transferred Mr. THORSON. I am not aware of any time we have done that and, at least, certainly not that it affects the amount or the type of gold in the reservesno. I think you were talking about physically moving them back and forth. That has not happened in recent history. Going back all the way to, at least, we cover the 70s and more. So, no, I dont believe it has. Mr. LUETKEMEYER. Okay. Perhaps after the hearing today, we can get together and find out the answer to the question, because I am kind of concerned now that we dont know whether we have lost 261 million ounces. Either we gave it to, and have now an account with, the IMF, or we still have it in our possession and it is encumbered. Mr. THORSON. We know we still have it in our possession. Mr. LUETKEMEYER. Or we still have it in our possession, or we do not know where it is at, and it is encumbered. One or the other. Mr. THORSON. I can say, there has been no physical removal of any of the gold during that time. I think what you are asking is, Is there any obligation or something that would cause that? In other words, Who owns that gold? is really what you are saying, and to our understanding, that has not occurred. And we can certainly get you a more definitive answer. Mr. LUETKEMEYER. Okay. The information could be correct. But it is information that I would think would be correct. So it tells me that we would like a little more research to be done here. Thank you very much. Mr. THORSON. I guess my answer, to be really clear, was that we do not believe that has occurred. Mr. LUETKEMEYER. Okay. Thank you. Thank you, Mr. Chairman. Chairman PAUL. Thank you. I want to follow up on that, because you may have given the answer, but I still dont think it is very clear. Is it possible that the gold is counted twiceonce in the IMF, and also on our balance sheet of the 261 ounces? Is the gold at the IMF part of the 261 ounces that we claim we own? Mr. THORSON. I dont think it is possible that it could be counted. Chairman PAUL. So you dont Mr. THORSON. Do we count it twice, is it that it would affect the statement? Is that what you are asking?
Chairman PAUL. We have pledged gold to the IMF. Every country has to put so much gold in the IMF. So, is it sitting over here in the IMF and we no longer own it, right? Mr. THORSON. We do not auditobviously, we do not audit the IMF so I cant make any comment on that. Chairman PAUL. Yes, but we are trying to figure out the accounting procedures on whether when you go and audit the gold, maybe you dont know that you audit and check the gold and look at these bars, but they really have been pledged to the IMF. Is that a possibility? Mr. THORSON. No. I dont believeno. I am not going to comment on IMF or what they are doing, because we dont audit the IMF. But the statements that I have made regarding the gold reserves in the Mint, our Mint, our Treasury Department Mint, that is pretty absolute. And we know where it is. We know how much it is. And we know that it is there and none of it has been removed to, and nor do we believe there are any encumbrances it, other what I mentioned by gold certificates of the Fed. Chairman PAUL. We have the certificates, the Fed holds certificates that are called gold certificates. The Treasury holds the material in gold. What if a law was passed and we instructed Treasury to sell $20 billion worth of gold? Mr. THORSON. Right. Chairman PAUL. Can we do that, or do we have to get permission from the IMF? Maybe the encumbrance is to the Federal Reserve; maybe they are in charge and not Treasury. What can we do with that gold and who really owns it? Mr. THORSON. I think you are trying to back into the same question there, which I think if you wanted to do that, that would be a question that would go to the Secretary of the Treasury with consultation, I am sure, by the President, who could do that. I dont think theyre going to have to get permission from the IMF to do that, because there is no encumbrance on that gold, other than the gold certificates held by the Fed. Chairman PAUL. That would change the balance sheet of the Fed, because they count that. So, I dont know whether that wouldthe Fed is pretty secret, you know. Congress doesnt have much to say about what is going on over there. And they do a lot of hiding. So, I am not so sure the answer could be that helpful. Mr. THORSON. I understand you are asking the question. I have tried my best to reassure you that isnt the case. But, on the other
hand, remember, if somebody did try and redeem those gold certificateslet us say, they were pledged to somebody. They brought them forward and they wanted to redeem them. They would be paid in currency at the statutory rate. They would not be paid in gold. The gold is collateral. It is not the method of payment. So, they would receive whatever the value is of those certificates. The gold would remain in the custody of the United States and would no longer be collateral for those certificates that were redeemed. Mr. ENGEL. I could maybe add something to that. As it relates to the gold certificates, the gold certificates do not represent that the Federal Reserve has ownership of that gold. There is a liability that is actually recorded in the financial statements for about $11 billion that represents what Treasury owes the Federal Reserve for those gold certificates. Now, if we were to go to sell some of that gold, my understanding is that Treasury would have to retire those gold certificates. And then I think, as Mr. Thorson was saying, there would be a reduction in the cash balance that Treasury has over at the Federal Reserve at $42.22 per fine troy ounce for whatever amount of the gold certificates you were redeeming. But there is an actual liability that is recorded currently and has been for years on the Governments financial statements for the amount that they owe the Federal Reserve for those gold certificates. Mr. THORSON. Yes. And that is what I meant by the fact that if they were redeemed, obviously because it is a liabilityif they presented those, there is an obligation to pay those. But it would not be paid in gold bars. Chairman PAUL. I want to go back to asking for suggesting that we have more thorough reports in our request from you on these reports. We did get one assay report, which was given as an example. There were 86 bars involved and you showed the details on what you found. But, of course, there is a lot more. Why cant we get this list of each compartment, how many bars, what percentage, whether it is 0.999 or 0.90, and have the entire gold reserves that we have audited in that manner? So we see this one report, but we are askingsince there is a claim that all this has been audited and checked, couldnt that be all into one report, since we only got one assay report? Mr. THORSON. I think what you are describing is really what the Mint does as far asremember, the Mint inventories and assays, we audit. And there is a difference there. What you are asking for, I believe, really you need to direct that to the Mint and they can
probably satisfy you as to what kind of records you are really looking for there. Mr. ENGEL. The Mint should have records by bar and what the fineness is of each of those bars. I would think they would have records as to what has been assayed of those bars as part of the inventorying and all of that process. But, I think they are the ones that would have that type of detail. Chairman PAUL. All right, okay. I see Mr. Schweikert has come in. Are you ready to ask a question at this time? Okay. I will go back to Mr. Luetkemeyer, if he asked all of them. Mr. LUETKEMEYER. I just have one follow up here with regard to the last line of questioning. The more I think about it, the more concerned I am, because we need to know if the gold that the United States has contributed to the IMF is still counted as the U.S. gold reserve? In other words, if it is, then it is an encumbered amount of gold that we have sitting there and should be reported as such. If it is not, it should be reported like a savings account for an individual on their financial statement, and should be reported then on our financial statement of our Government as an asset sitting in the IMF. Mr. THORSON. I think what you are saying, clearly if it was encumbered or belonged to IMF or anyone else, that would need to be reflected on the statement, because we are representing that this is the Treasurys gold, and therefore, that would not be an accurate statement if it were encumbered. We have been assured that none of that is encumbered and, therefore, that is the total amount. And so I guess there are a number of theories you could put onboard as to how Mr. LUETKEMEYER. As the auditors of our gold, you should know whether that gold, if it is sitting in the IMF, is reported on our balance sheet somewhere for the Government. Mr. THORSON. And gold held by the IMF isit would not be like I said, we dont audit IMF, so I am not going to try and Mr. LUETKEMEYER. Yes, but arent you auditing the gold? Mr. THORSON. guess what is going on there. But if it were what we do represent is the Treasurys gold, the U.S. gold reserves, which we know where they are and they are not held by IMF or controlled by IMF. Mr. LUETKEMEYER. Who owns what is in the IMF then? Mr. THORSON. Who does?
Mr. LUETKEMEYER. Yes, who owns the goldthat is the United States Governments goldwho owns that then if it is sitting in the IMF? Do we not own that? Mr. THORSON. I want to make sure I give you an accurate answer, so I am going to defer until I can get you the proper answer that is absolutely accurate, because I cant give you an answer on that off the top of my head. Mr. LUETKEMEYER. Okay. We are supposed to have 17 percent of the IMF, and if we own 17 percent of the 90 million ounces, that is a whole lot of money. And we need to know where it is. Mr. THORSON. Right. Mr. LUETKEMEYER. But I certainly appreciate your willingness to work with us to find out, number one, is it counted among our reserves and we are not aware of it. And if we are notout there and if it is not, where does it appear on our balance sheet as an asset to the United States Government. Mr. THORSON. You asked a good question and that is why I said I dont want to give you an answer off the top of my head. I want a real answer. Mr. LUETKEMEYER. I want to work with you to find out and make sure where it is at. Mr. THORSON. And I will get you one. Mr. LUETKEMEYER. I appreciate it. I yield back. Thank you, Mr. Chairman. Chairman PAUL. I thank the gentleman. Mrs. Maloney? Mrs. MALONEY. Welcome. And thank you for this hearing, Mr. Chairman. I would like to ask both of the witnesses whether you believe this is a good use of your resources and funds, especially if it is true, as you testified, that it is duplicative of what you already have to do with respect to gold reserves. And I am mentioning basically Bill 1495. And in this the GAO wrote, Bill 1495, if enacted, may result in duplication of certain past and current efforts, especially with regard to inventorying and auditing the gold reserves of the United States. And the Treasurys IG wrote, I believe that the inventory and audit requirements proposed in The Gold Reserve Transparency Act of 2011 (H.R. 1495) to be redundant of the work that my office and the Mint currently perform. And basically, why should Congress pass legislation that both the IG and the GAO believe is not needed? That is my question.
It is good to see you both. Mr. Thorson, would you begin first, and then Mr. Engel? Mr. THORSON. In our statement, we did say we believe it is redundant, because the things that are called for in the Act are things we believe we are already doing, and that is a proper audit and assay. We do assay to a statistical sampling. We dont assay every bar of gold, but we do it to a 95 percent confidence level. So I am not sure what it is that you would want us to do that we arent already doing. Mrs. MALONEY. Mr. Engel? Mr. ENGEL. The one area that we talked about a little bit earlier is that maybe if you wanted to have something looked at, it is the gold reserves that are over at the Federal Reserve Bank of New York. Now, there has been some audit of work that was done years ago by the examiners of the Federal Reserve and apparently the Committee for Continuing Audit had observed some of that. But that has not been labeled as audited per se, as I understood it by the Committee for Continuing Audit. So if you did want to have something done, I guess you could have some work done over on the Federal Reserve Bank of New York. In terms of some of the other, it would be very redundant of what has been already done. Mrs. MALONEY. Can each of you comment on what you believe would be the cost to taxpayers of implementing H.R. 1495, since we are being very cautious about our deficit at this point? Mr. THORSON. I think both of us would agree. I think the Mint has worked up some numbers that are somewhere above $60 million or more. It would be in that range, but I think that is a question you should probably direct to the Mint. Mrs. MALONEY. Mr. Engel, do you have a comment? Mr. ENGEL. Yes. We do not know. We havent heard from the Mint what the amounts are. It is our understanding they were working up what they would estimate it would cost. In addition to the cost of actually doing the inventorying and moving all the bars, when you assay it, you are taking a drill and taking a part of the bar to be tested, and that is basically destroyed, whatever that piece is. So there will be some loss of the gold from the bars through the assaying process if you do that for every single bar that is out there. So that would be a loss from that process as well. Mrs. MALONEY. I have no further questions, so I yield back to the chairman. Thank you.
Chairman PAUL. I would like to address the subject of the cost, because our first estimateoh, okay. I will yield 5 minutes to Mr. Schweikert from Arizona. Mr. SCHWEIKERT. You are kind, Mr. Chairman. And forgive me if this has already been discussed. I am curious, so please educate a freshman. The different places that U.S. gold assets are held, IMF, you were just saying with the New York Fed, the Treasury, any other places? Mr. THORSON. Not that I can see. No. Mr. SCHWEIKERT. So those three would cover it? Is any of that pledged to loan facilities that would be World Bank or anything else we also touched? Mr. THORSON. No, and to go back to the IMF a little bit, like I said, I would like to find a direct answer for that one as well. Mr. SCHWEIKERT. Okay. My understanding from listening for a moment, Mr. Chairman, was that it has been how long since both of thewas it the New York Fed which actually would handle a lot of international transactions so, therefore, they would not only hold our gold reserves for the United States, but a number of other member nations? Mr. ENGEL. I believe they do hold gold for other nations in their vault. Mr. SCHWEIKERT. Just for the fun of it, any guess what is there? Mr. ENGEL. I dont know. Mr. SCHWEIKERT. Any guess on the number of participating countries? Mr. ENGEL. No. Mr. SCHWEIKERT. Okay. Mr. ENGEL. That would be something the Federal Reserve would obviously be able to answer, but I dont know. Mr. SCHWEIKERT. Okay. So if we have functionally three places, two that you are telling me we already have some audit history, Treasury, we have an audit history on gold supply? Yes? No? Mr. ENGEL. Gold reserves, yes. Mr. SCHWEIKERT. And we are still a little fuzzy was it on IMF? Mr. THORSON. I amlike I said, I am still a little concerned about that particular question. So, but no, that is it. Mr. SCHWEIKERT. And in a previous question just a moment ago, didnt we just tell the gentlewoman from New York it was how much to do the audit? Mr. THORSON. To do the audit? The Mints figure to dothe one that this bill would call forwas in the neighborhood of $60 million,
but that wasyou need tothat is a Mint number and you need to ask them that. And just to be clear, the ratio of money held by the Mint and held by the Fed is 95 and 5 percent, 5 percent is at the Fed. But as far as the cost of this bill to perform that, I believe your staff has already made an inquiry to the Mint on that. But that is reallywe can certainly audit that as it plays out and that kind of thing. But it is their number. Mr. SCHWEIKERT. Okay. It is just that it seems stunningly high, and it is always fun when you are having to audit the audits where we feel like we are in some of this very unusual circle. And it would be fun to find out how much of that is just counting, and how much of it is doing assay work. And Mr. Chairman, I know you wanted to inquire more on that point, so I yield back my time. Chairman PAUL. I thank the gentleman. I do have a few more short questions for you. Do you have any idea what the current audits cost? You do partial audits each year. What kind of expense does that involve? Mr. THORSON. No. As I mentioned, we use people on different audits at the same time and that kind of thing, so we have not really broken down per audit what this costs. Chairman PAUL. Okay. Where do you get the $60 million? Mr. THORSON. It waswe asked the same questions that you did as far as what would it be from the Mint when we were wondering what their statement might be. And that was a rough number that we were told that off the top of their head it would be in somewhere in that vicinity. Chairman PAUL. Of course, we have Treasurys statement that claimed that it would be $15 million, so we would like toif you can enlighten us more maybe in writing about really whether it is $60 million or $15 million. That is a big difference. And to suggest that I might be participating in the not being careful with the taxpayers money, I happen to be the most conservative Member of Congress when it comes to spending. But, we dont even need to appropriate money for this. The Mint could easily take care of this. When you have a monopoly, you tend to be able to make some money, and last year they made $400 million. So even if the high number was correct, we dont have a problem there. One of the few legitimate functions of Government is to check our ownership and be fiscally responsible to find out just what we
own and whether it is really there. So I think the total amount is not, in comparison to other things, very much. Also, back to this request that we get more details on the thing, and you said defer to themaybe I should ask the Mint that. And, of course, the Mint is in transition now and we couldnt get anybody over here from the Mint. But I believe it was your staff who told my staff that you got the reports and not the Mint, that you get the detailed reports on all these audits. Mr. THORSON. The assay reports, we do get the assay reports, sure. And I think we provided you some of those. The inventory of the bars, like you describe, as each onethat is definitely up to the Mint. As I said, we audit the work that they do and the records that they keep, so that would be under them. Chairman PAUL. Of course, if you have an assay, but you dont know how many bars there are, you dont know where it applies to which. It seems like you have to have both, together and matched up. But anyway, I believe we will follow up on that and ask for some more details. But if the gentleman from Arizona has no more questions, I will go ahead and adjourn the committee. The Chair notes that some members may have additional questions for this panel, which they may wish to submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. {Whereupon, at 11:27 a.m., the hearing was adjourned.}
UESTIONS
FOR THE RECORD

FROM CHAIRMAN RON PAUL TO THE HONORABLE ERIC M. THORSON INSPECTOR GENERAL, DEPARTMENT OF THE TREASURY
Question 1: As the Inspector General of the Department of the Treasury, can you get a definitive answer on when the last time the U.S. gold reserves held at the Federal Reserve Bank of New York were last assayed and inventoried? If so, what were the results of that assay and inventory? Answer: My office has not observed the assay and inventory of the U.S. gold reserves held at the Federal Reserve Bank of New York (FRB-NY). Members of the Committee for Continuing Audits of United States Government-owned Gold, however, did observe FRB Board of Governors examiners audit of 13.451 million fine troy ounces of the U.S. gold reserves held at the FRB-NY as of September 30, 1985. That represented 99.9 percent of the 13.452 million fine troy ounces under the custody of the FRB. The Board of Governors examiners audit procedures were essentially the same as those used by the Committee for Continuing Audits of United States Government-owned Gold when they performed their work at the Mints deep storage facilities, except that assay samples were not taken. With that as background, the following provides a broad
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overview and understanding of the custodial gold services provided by FRB-NY (this information was provided to us by FRB-NY representatives). The FRB-NY holds gold deposits on behalf of a number of account-holders, including the U.S. Government. Upon depositing gold, FRB-NY matches the markings on each bar to the customers deposit manifest, and verifies the gross weight of the bars deposited. The FRB-NY refers to this process as earmarking the gold. Once the gold is earmarked, it is physically segregated, for the most part, by account holder. Once segregated, the gold is physically safeguarded and held under what the FRB-NY calls a triple control, continuous audit process. According to the FRB-NY, its continuous audit process includes three-party certification/presence anytime a vault is opened. So, when a vault is opened, it must be done in the presence of one representative from vault custodian team one, one representative from vault custodian team two, and one representative from the internal audit staff. Furthermore, there are two separate combination locks (the combination of each known only to the respective vault custodian team representative), one audit lock, and an audit seal on every compartment containing customer gold. The FRB-NY also confirms the gold holdings of its respective customers upon request. It should be noted that we are currently working with the Department and the FRB-NY to inventory and audit the Treasury gold that is on deposit with the FRB-NY. As part of the audit, we plan to obtain independent assays of a sample of the gold bars. Question 2: With regard to the issue of gold possibly being encumbered in swaps or loans, 31 U.S.C. 5302 gives the Secretary of the Treasury the authority to deal in gold. It also states that "Decisions of the Secretary are final and may not be reviewed by another officer or employee of the Government." Is it conceivable that the Secretary could he encumbering U.S. gold reserves in gold swaps without your knowledge, for instance through overnight or short-term repo agreements? Would such short-term agreements he reflected in any way in the OIG's audit report? Answer:
INVESTIGATING THE GOLD QUESTIONS FOR RECORD1417
In my opinion, it is not conceivable. If the deep storage gold reserves were involved in swaps or loans, it would be incumbent upon the Department to record those transactions in its accounting records and disclose them in its financial statements. The Departments financial statements are currently audited by KPMG under our supervision. Similarly, the Mint would also be obligated to disclose such encumbrances in its financial reports as well. In this regard, we are not aware of the gold reserves ever being encumbered in swaps or loans through our audits of the Department or the Mint. Question 3: The Treasury's Office of the Inspector General provided my office with an example of an assay report which dealt with 86 samples that were assayed during the summer of 2008. Due to the nature of the assay process, a total of nearly 1.9 ounces of gold was destroyed during the assay. However, the Treasury Department's Financial Management Service website continues to maintain that Treasury-owned gold totals 261,498,899.316 fine troy ounces. This number has remained the same, quoted to a thousandth of an ounce, since at least 2007. How can the Treasury continue to report this same number when gold is, in fact, destroyed during the assay process? Does this not throw into doubt the accuracy of the Treasury's financial statements, as well as the independent auditor's opinion? Your testimony contains an example of a Mint Bureau official joint seal, which reflects the loss of some gold due to assaying, so why would subsequent losses to assay not be reflected in the financial statements? Answer: When the audit verification of custodial deep storage gold involved testing for purity, assay samples were taken to verify/determine the fineness of the gold. This process did, in fact, result in a small loss of gold. However, it has been the Mint's policy that the balance of custodial deep storage gold reserves remains unchanged, including when losses resulted from the assaying process. Therefore, in order to keep the balance unchanged, the small losses of gold that occurred during the assaying process were replaced with gold from working stock material, which is charged to the Mints Public Enterprise Fund (PEF). To accomplish this, the amount of material taken during the assay sample was concurrently
replaced with PEF working stock material, in the form of granules. The granules were of equal fine troy ounce weight of that taken for assaying. This process was carried out in its entirety, in our presence and under our direct observation. As a result, the reported quantity of the custodial deep storage gold has properly remained unchanged. Question 4: When I asked you about the "precise assay results" you responded by saying "Clearly, the results of them are published." The assay results are not, in fact, published in the OIG's audit reports, or in the Mint's financial statements. Can you provide the published materials that contain the results of those assays to my office and/or the Financial Services Committee? Answer: You are correct, the assay results are not published in our audit reports or in the Mints financial statements, only the balance of custodial deep storage gold reserves is reported. When requested, we did provide an example to your staff of the assay results we received for a 2008 statistically selected sample of inventoried gold bars by our office. We are also providing as Attachment 1,398 the assay reports obtained during our fiscal years 2004, 2005, 2006, and 2008 audits of the Mints Schedule of Custodial Deep Storage Gold and Silver Reserves. Question 5: In your opening remarks, you stated that any discrepancies found by the Inspector General's office between the fineness reported by the U.S. Mint and the fineness determined by independent assay reports were "immaterial and negligible." How do you define immaterial and negligible? What is the largest discrepancy of fineness found between an independent assay and the fineness reported by the Mint? Could you provide a list of the independent assays performed comparing the fineness determined in the assay to that listed by the Mint? Answer: Professional auditing standards define materiality as the magnitude of an omission or misstatement of accounting
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Attachment 1 can be found in Appendix F.
information in a financial report that makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omitted or misstated items inclusion or correction. With respect to our fiscal year 2010 audit of the Mints Schedule of Custodial Deep Storage Gold and Silver Reserves, we determined, consistent with auditing standards, that the materiality level for financial reporting purposes was $311 million. We considered differences individually or aggregated less than this amount to be immaterial for purposes of the Schedule. In other words, if audited differences were $311 million or more, we would not render a clean audit opinion. However, given the sensitive nature and the extraordinary physical security measures provided over these U.S. Government assets, we would expect discrepancies to be small. In this regard, the discrepancies in fineness identified in our audit tests over the years have been extremely small. The largest discrepancy of fineness identified between an independent assay report and the fineness reported by the Mint for a bar, in recent audits where independent assay reports were obtained (for the fiscal years 2004, 2005, 2006, and 2008 audits), was 0.0003 fine troy ounces. The market and statutory value of this difference, as of September 30, 2010, was $0.39 and $0.01, respectively, using the market and statutory value per fine troy ounce of gold of $1,307 and $42.2222, respectively. The net total of discrepancies for these years was 0.0078 fine troy ounces. The market and statutory value of the net total of these discrepancies, as of September 30, 2010, was $10.19 and $0.33, respectively, using a market and statutory value of gold per fine troy ounce of $1,307 and $42.2222, respectively. These discrepancies in my judgment are negligible. A list of bars assayed in recent Mint custodial deep storage gold reserves audits in which assays were performed (FY 2004, 2005, 2006 and 2008 audits), including a comparison of the fineness determined by the independent assayer to the fineness included in the Mint records, is presented in Attachment 2.399
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Question 6: In your opening remarks you stated that the " ... entire period of these audits and up to today [1975-present], no discrepancies of any consequence have ever been found." According to a GAO report to the Director of the U.S. Mint in 1978, a discrepancy was found in 1977 in which two melts had to be remelted, after which the fineness was still below that listed on the inventory schedule. How do you reconcile this fact with your statement? Do you consider the need to remelt gold to be "no discrepancy of any consequence"? Could you provide a list of all the discrepancies found, whether of consequence or not? Answer: As you indicated, that audit was conducted by GAO who reported that the difference between the level of fineness determined by the assay and the fineness reported on the inventory records resulted in a $158.77 adjustment to the records. Also in that same audit report, GAO determined that amount to be insignificant. I agree with GAOs assessment, only I described differences such as these as not of any consequence. Discrepancies of fineness identified between independent assay reports and the fineness reported by the Mint of gold bars, noted in recent Mint custodial deep storage gold and silver reserves audits where assays were performed (FY 2004, 2005, 2006 and 2008 audits), are presented in Attachment 2.400 Question 7: Could you provide a report, or an otherwise comprehensive document on the following items related to U.S. gold holdings? If such a report cannot be compiled in time for submission in the record of this hearing in response to this question, please indicate whether such a report could be generated and approximately how long it would take. a) A complete history of the audits, assays, and inventories conducted, at least as far back as 1975 if not earlier. Answer:
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A list of audits of U.S. gold holdings by GAO, the Committee for Continuing Audits of United States Government-owned Gold, and my office, is included in Attachment 3.401 It should be noted that most workpapers associated with our reports issued prior to 2004 have been destroyed in accordance with our records retention policy. b) The inventory schedules of the gold in the custody of the U.S. Mint, including information regarding the fineness and quantity of the gold. Answer: See Attachment 4402 for the Mints detail inventory schedules of custodial deep storage gold reserves including fineness and quantity. c) The inventory schedules of the gold in the custody of the Federal Reserve Bank of New York, including information regarding the fineness and quantity of the gold. Answer: See Attachment 5403 for the Federal Reserve Bank of New Yorks detail inventory schedules of gold held in its vault including fineness and quantity. The Federal Reserve Banks also hold gold bars and coins for display purposes, totaling 2,371 fine troy ounces. d) Any assay reports related to U.S. gold holdings. Answer: See Attachment 1404 for independent assay reports obtained during our fiscal years 2004, 2005, 2006, and 2008 audits of the Mints Schedule of Custodial Deep Storage Gold and Silver Reserves. Question 8: You claim that it would cost $60 million to carry out a full audit and assay of the gold reserves. Can you provide my office and/or the Financial Services Committee the precise methodology and calculations used to arrive at this figure?
Attachment 3 can be found in Appendix F. Attachment 4 can be found in Appendix F. 403 Attachment 5 can be found in Appendix F. 404 Attachment 1 can be found in Appendix F.
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Answer: In my testimony, I was merely recalling a figure that I had remembered the Mint estimating for performing a full inventory and assay of the gold reserves, which is what H.R. 1495 calls for (see line 1169). Since a full audit and assay of the gold reserves would be predicated on a full inventory and assay by the Mint, I indicated that the question should be directed to the Mint. For purposes of trying best to answer your question, I have included as Attachment 6,405 a letter dated July 22, 2011 to the Honorable Ron Paul, Chairman of the Subcommittee on Domestic Monetary Policy and Technology, from Richard Peterson, Acting Director, United States Mint, where the Mint estimates that it would cost $235 million to conduct and complete a full assay, inventory, and audit of the gold reserves it holds. The Mint estimates with a 10 percent assay, the total cost would be slightly over $71 million. It should be noted that on the face of what the Mint has included in its letter, these estimates do not include travel or per diem costs for individuals involved in the process. Furthermore, my office has not validated the Mints estimate. Question 9: Recent advances in ultrasound and X-ray technology have led to the development of hand-held devices that allegedly are able both to determine the authenticity of precious metal bars as well as their fineness. If such claims are true, one would imagine that using such devices would obviate the need for destructive assay testing and reduce the time required for assaying. This would lead to potential savings both by ending losses of gold through destructive assay testing, as well as reducing costs incurred through drilling, shipping, assaying, and returning gold samples. Has the Office of the Inspector General ever considered using non-destructive methods of assaying gold reserves? If not, would the OIG consider studying the possible use of such technologies in future? Answer: If, in the future, gold is moved or otherwise needs to be reinventoried, we will work with the Mint to consider the
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cost/benefit of using such technology. Of course this would only be in the event that the accuracy of such technology is determined to be reliable and accepted as an industry practice.
FROM CHAIRMAN RON PAUL AMD REP. BLAINE LUETKEMEYER TO THE HONORABLE ERIC M. THORSON, INSPECTOR GENERAL, DEPARTMENT OF THE TREASURY
Question 1: The IMF has the 3rd largest gold reserves in the world, most of which the IMF acknowledges as belonging to the member country who contributed it. The U.S. contributed a large portion of the IMF's gold reserves. How and where on the financial statements of the U.S. government is the portion of gold contributed by the U.S. to the IMF accounted? Is the U.S. portion of the IMF gold counted among U.S. gold reserves? Where is the gold contributed by the U.S. to the IMF held? Answer: The U.S. gold contributions to the IMF are not included in the U.S. gold reserves reported by the Mint or Treasury. From 1947 through 1970, the U.S. paid its initial quota subscription and subsequent increases to that quota subscription to the IMF in four separate contributions. Those contributions were in the form of gold and were each valued at the time the payments were made. Overall, the U.S. contributed 47.9 million ounces of gold, to the IMF. The total value of the U.S. gold contributions to the IMF, valued at the time the contributions were made, is $1,675.5 million. This amount is included as part of the line item Reserve Position in the International Monetary Fund on Treasurys consolidated balance sheet. The total line item reported as of September 30, 2010, was $12,938 million. It should be noted that once the gold contribution to the IMF was made, it became the property of the IMF. In return, the U.S. received a claim on the IMF equal to the amount of its gold payment. To reiterate, this amount is not included in the U.S. gold reserves. It is our understanding that the gold contributed by the U.S.,
as well as gold contributed by other countries, to the IMF is comingled. We have been told that the IMF holds its gold in the following Central Banks: the Federal Reserve Bank of New York, the Bank of England, the Bank of France, and the Central Bank of India. Question 2: What is the cost of protecting the gold in the custody of the U.S. Mint? Answer: It is the Mints responsibility to protect U.S. assets stored in its facilities. However, while the protection of the gold and silver bullion reserves are significant, they represent only a portion of what the Mint is responsible for protecting; it also protects its employees, facilities, products, and equipment. The Mints total protection cost for FY 2010, reported in its financial statements was $41.5 million. The actual cost for protecting only the gold in the custody of the Mint, including its working stock, would be a question more appropriately addressed to the Mint. Question 3: What has been the cost of audits performed on U.S. gold reserves in the past? Answer: The cost of our recent audits (labor and travel) of the Mints Schedule of Custodial Deep Storage Gold and Silver Reserves was approximately $31 thousand per audit when we observed the Mint perform an inventory count (fiscal years 2004 through 2008) and approximately $20 thousand per audit when our work was limited to inspecting the integrity of the previously placed seals (fiscal years 2009 and 2010).
TATEMENTS

For far too long, the United States government has been less than transparent in releasing information relating to its gold holdings. Not surprisingly, this secrecy has given rise to a number of theories about the gold at Fort Knox and other depositories. Some people speculate that the gold has been involved in gold swaps with foreign governments or bullion banks, others believe that the gold has secretly been shipped out of Fort Knox and sold, and still others believe that the bars at Fort Knox are actually gold-plated tungsten. Historically, the Treasury and Mint have dismissed these theories, rather than addressing these concerns with substantive rebuttals. No one from Congress has been allowed to view the gold at Fort Knox in nearly 40 years, recent photographs of the gold holdings seem to be hard to come by, and the Mint's and Inspector General's audit statements contain only the bare minimum of information. Because the government has for so long refused to provide substantive information on its gold holdings, it is not surprising that so much confusion abounds, both within and without the government. The difference between custody and ownership, questions about responsibility for US gold held at the New York Fed, and the issue of which division at Treasury is ultimately responsible for the gold reserves are just some of the questions that have come up during the research for this hearing. In a way, it seems as though someone
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decided to lock up the gold, put the key in a desk somewhere, and walk off without telling anyone anything. Only during the preparation for this hearing was my office informed that the Mint has in fact conducted assays of statistically representative samples of gold bars, and we were provided with a sample assay report. This type of information should be reported or at least tabulated and published, so that the public knows how many bars of gold exist, what their fineness is, and whether they are encumbered in any way through loans, swaps, etc. While the various agencies concerned have been very accommodating to my staff in attempting to shed some light on this issue, it should not require the introduction of legislation or a Congressional hearing to gain access to this information. This information should be published and available to the American people. This gold belongs to the people, especially since much of it was forcibly taken from them in the 1930s, and the government owes it to the people to provide them with the details of these holdings. We would greatly benefit from a full, accurate inventory, audit, and assay, with detailed explanations of who owns the gold and who is responsible for ownership, custody, and auditing. While the Mint and the Inspector General trust the accuracy of the audits performed between 1975 and 1986, this still means that at least two-thirds of the gold reserves were last audited over a quarter century ago. Surely a full audit every 25 years is not too much to ask? I look forward to the testimony of the witnesses regarding the condition of the gold reserves, the accounting audits that are regularly performed, and the inventories and assays that have been conducted on some of this gold over the years. I am also very interested to hear their comments on the Gold Reserve Transparency Act so that we may put forward a measure that provides the public with accurate and complete information on their gold. Since the U.S. Mint was unable to send a representative to testify at this hearing in person, here is an excerpt of their remarks sent to me regarding H.R. 1495:
INVESTIGATING THE GOLD STATEMENTS1427
ITNESS
ESTIMONY
WRITTEN TESTIMONY OF HON. ERIC M. THORSON

INSPECTOR GENERAL DEPARTMENT OF THE TREASURY Chairman Paul, Ranking Member Clay, and Members of the Subcommittee, thank you for the opportunity to appear before you this afternoon for the hearing entitled Investigating the Gold: H.R. 1495, the Gold Reserve Transparency Act of 2011 and the Oversight of United States Gold Holdings. My testimony will cover the audits that my office has and is conducting on the United States Mints Schedule of Custodial Deep Storage Gold Reserves. Before I discuss the details of the audits that are the topic of this hearing, I would like to make one point very clear 100 percent of the U.S. Governments deep storage gold reserves in the custody of the Mint has been inventoried and audited. Furthermore, these audits have not found any noteworthy exceptions. I also want to make it clear that the physical security over the gold reserves is absolute. I can say that without hesitation because I have personally observed the gold myself. Accordingly, H.R. 1495, which calls for a full assay, inventory, and audit of gold reserves of the United States together with an analysis of the sufficiency of the measures taken for the security of such reserves, is redundant of audit work already done. My office has been extensively involved in the audit of the Departments consolidated financial statements and related entities since the enactment of the Chief Financial Officers Act of 1990. Since 1993, our financial statement audit work has included, and continues
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INVESTIGATING THE GOLD TESTIMONY1433
to include, independent annual audits of the U.S. Governments deep storage gold reserves held by the Mint. In fact, our fiscal year 2011 audit of those deep storage gold reserves is currently underway. As background, I will briefly describe what the Mints custodial deep storage gold reserves include, provide a short history of the audits conducted over the gold reserves from 1974 through 1986, and the annual audits performed by my office since 1993. The Mints Custodial Deep Storage Gold Reserves The Mint maintains its custodial deep storage gold reserves at the United States Bullion Depository, Fort Knox, KY; the United States Mint, West Point, NY; and the United States Mint, Denver, CO. The Departments deep storage gold reserves are stored at these three locations, in 42 compartments. In all, these compartments hold 699,515 gold bars with fineness406, or purity, ranging from 0.4701 to 0.9999 with an average fineness of 0.9006. Fort Knox houses 60 percent of the fine troy ounces of the deep storage gold reserves, Denver 18 percent, and West Point 22 percent. As of September 30, 2010, the audited quantity of custodial deep storage gold reserves held by the Mint was 245,262,897 fine troy ounces, over 9,300 tons, with a market value of $320.6 billion.407 Each gold bar weighs about 27 pounds and has an average value of about $500 thousand. All three of the deep gold storage facilities are highly secured. While it would not be appropriate for me to discuss the details of the security arrangements in place at these facilities, I can tell you that they are multi-layered and include substantial physical barriers, armed guards, cameras, and metal detectors. Audits of the Mints Custodial Deep Storage Gold Reserves Over the Years In 1974, in response to public and Congressional inquiries, the General Accounting Office (GAO), known as the Government Accountability Office since July 2004, in cooperation with the Department of the Treasury, conducted an audit of about 21 percent of the gold bars stored at the United States Bullion Depository, Fort Knox, KY, and concluded that the gold stored at that facility agreed with the records of the depository. Auditors from the United States Mint, the Bureau of Government Financial Operations (BGFO), 408 the
The fineness of a precious metal refers to the ratio of the primary metal to the total weight. Market value was based on the London Gold Fixing price for gold as of September 30, 2010. On that date, gold was priced at $1,307.00 per fine troy ounce. 408 BGFO was established in 1974 as a bureau of the Treasury. In October 1984, BGFO was renamed the Financial Management Service.
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U.S. Customs Service,409 and the Department of the Treasurys Office of the Secretary and GAO were part of a special audit committee established by the Director of the Mint to maintain physical control over the gold during the conduct of the inventory. In the report, Accountability and Physical Controls of the Gold Bullion Reserves, FOD-75-10, GAO also recommended that the Secretary of the Treasury request the Director of the Mint to include, as part of each depositorys annual settlement of accounts, a cyclical inventory of the Mints custodial gold holdings. In should be noted that the audit by GAO followed a Congressional visit to the Fort Knox facility. In this regard, the House Congressional Report for September 24, 1974, included the following statement by the Honorable John H. Rousselot: Mr. Speaker, the Congress can now be assured that there is gold bullion at the Fort Knox Depository. Several of us went there yesterday to try to make sure that many of these rumors and counterrumors were either correct or not correct. Members of the Committee on Banking and Currency and Senator Huddleston of Kentucky actually entered the Fort Knox Depository to check the validity of claims that U.S. gold bullion had been depleted. We can be assured that our civil servants are watching the gold at Fort Knox. It is there. On June 3, 1975, the Secretary of the Treasury issued Treasury Department Order No. 234-1 (TDO 234-1), Audit of Gold Stock, authorizing and directing the Fiscal Assistant Secretary, with the cooperation and assistance of the Director of the Mint, to conduct a continuing audit of U.S. Government-owned gold for which the Department is accountable.410 Pursuant to TDO 234-1, the Committee for Continuing Audit of the U.S. Government-owned Gold performed annual audits of Treasurys deep storage gold reserves from 1975 to 1986, placing all inventoried gold that it observed and tested under Official Joint Seal.411 The Committee was made up of Internal Audit
The U.S. Customs Service was a bureau of the Treasury until March 2003 when it was transferred to the Department of Homeland Security. 410 The Mint is directly responsible for safeguarding all of Treasurys deep storage gold reserves and working stock. Overall, the deep storage gold reserves account for about 94 percent and working stock about 1 percent of Treasurys gold holdings; the other 5 percent is held by the Federal Reserve Bank of New York. Treasury reports the value of its deep storage gold reserves held by the Mint and the Federal Reserve Bank of New York in its consolidated financial statements. 411 An Official Joint Seal is a pre-numbered document that includes wax seals. It is attached to an inventoried compartment door with tamperproof cloth tape. The pre-numbered document
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staff from the BGFO and the Mint, and the General Auditor staff from the Federal Reserve Bank of New York. The annual audits by the Committee for Continuing Audit of the U.S. Government-owned Gold ended in 1986, after 97 percent of the U.S. Government-owned gold held by the Mint had been audited and placed under Official Joint Seal. It should be noted that during the entire period of these audits, and up to today, no significant discrepancies have ever been found. From 1986 to 1992, the Mint continued to perform an annual inventory and verification of the gold reserves in accordance with its own policies over those compartments that had not been placed under Official Joint Seal by the Committee for Continuing Audit of the U.S. Government-owned Gold. According to Mint officials, this was done to comply with the 1975 GAO recommendation discussed earlier. My office began conducting annual audits of the Mints Schedule of Custodial Deep Storage Gold Reserves in fiscal year 1993. Our audits are made pursuant to 51 U.S.C. 5136, United States Mint Public Enterprise Fund, and the Government Management Reform Act (GMRA). In this regard, we are required to perform an annual audit of the Mint Public Enterprise Funds financial statements, and those statements include the balances of custodial deep storage gold reserves held by the Mint. Under GMRA, my office is also responsible for the annual audit of the Department of the Treasurys consolidated financial statements. Those financial statements incorporate the balances of the custodial deep storage gold reserves. It should be noted that the Mints financial statements and the Departments consolidated financial statements are audited by a contractor under our supervision -- the independent public accounting firm, KPMG LLP. KPMG has performed the audit of the Mints financial statements since fiscal year 2005 and the Departments consolidated financial statements since fiscal year 2004. Starting with the fiscal year 2005 audit, KPMG has taken responsibility for our work on the custodial deep storage gold reserves when rendering its opinions on the Mints and Treasurys financial statements. In order for KPMG to do that, they must satisfy themselves as to the independence, reputation, and qualifications of my audit staff. In addition, they must also satisfy themselves with the adequacy of the audit procedures performed. This has included, among other things,
includes all relevant information of the compartment inventoried and audited, e.g., the number of gold bars, gross weight, and fine troy ounces). The document is signed by those present at the inventory of the compartment (a representative from the storage facility, a representative from the Mint headquarters, and an OIG/independent observer).
accompanying my auditors on a number of observations of the deep gold storage facilities. By doing this KPMG can express its opinion on the Mints and Treasurys financial statements without making reference to us in their report. That also means that KPMG concurs with the amount and value of the gold as it is reported. The audit work performed by both my office and KPMG is done in accordance with government auditing standards established by GAO. For each of the fiscal years under audit, we have rendered unqualified or clean opinions on the Mints Schedule of Custodial Deep Storage Gold Reserves. In addition, for each such fiscal year under audit, we have not identified any material weaknesses in internal control over financial reporting related to these schedules, nor have we reported any instances of noncompliance with laws and regulations. When we assumed responsibility for the audit, reliance was placed on verification procedures performed by GAO and the Committee for Continuing Audit of the U.S. Government-owned Gold. Additionally, we relied on the intact Official Joint Seals that the Committee placed on the inventoried compartments that it observed and tested. If an Official Joint Seal had been tampered with, it would have been immediately evident as the wax on the seal would have been broken and the cloth tape used to attach it would have been detached. Since we assumed responsibility for the audit, my office has continued to directly observe the inventory and test the gold. Furthermore, my auditors sign the Official Joint Seals placed on those compartments inventoried and tested in their presence. At the end of fiscal year 2008, all 42 compartments had been audited by either GAO, the Committee for Continuing Audit of the U.S. Government-owned Gold, or Treasury OIG, and placed under Official Joint Seals. There has not been any movement of the inventoried gold since that time. Furthermore, for all of the audit periods where compartment inventories were observed by my auditors, as part of our work, in addition to observing the Mints physical inventory of the gold, we selected and tested a statistically-valid random sample of gold bars using a 95 percent confidence level and found, without fail, that any differences between the fineness reported by the Mint in its inventory records and the fineness projected based on our independently obtained assay reports to be immaterial and negligible. For example, during our fiscal year 2008 audit, we sampled gold statistically representing inventory valued at $75,036,352.12. Based on the independent assayers report on those samples, we projected the dollar value of the difference between the fine troy ounces
determined by the independent assay report and the fine troy ounces recorded in the Mints inventory records to be $3,819.84 or 0.005 percent (five thousandths of one percent) of the gold inventoried. The annual audit work performed by my office to verify the existence, quality, and valuation of Treasurys deep storage gold reserves412 has included two parts: DIRECT PHYSICAL OBSERVATION OF THE GOLD RESERVES IN THE DEEP STORAGE IN COMPARTMENTS INVENTORIED This included: Reviewing and evaluating internal control, to include the physical controls over the deep storage gold Verifying the existence of the gold bars in each compartment by visually inspecting the gold bars comparing the records for each compartment inventoried to the identifying information stamped into the gold bars Statistically selecting and testing a sample of the gold bars from the compartments inventoried for fineness re-weighing the statistically selected bars re-assaying the statistically selected bars (the selected bars are drilled, gold fragments are removed from the drilled hole, and those gold fragments are sent by us to an independent laboratory for assaying the independent laboratory directly provides us with its reports) Comparing the fineness recorded in the inventory records to the fineness reported by the independent assayer for the sample of gold bars selected from the compartments inventoried (any differences are projected to the universe of the gold bars inventoried) Participating in the placement of an Official Joint Seal on each compartment inventoried by the Mint and tested by my auditors Verifying the mathematical accuracy of the inventory records
For the gold reserves held by the Federal Reserve Bank of New York (which are not part of the deep storage gold reserves), my office obtains relevant evidence supporting the existence and valuation of the gold through a signed third party confirmation (confirmations are a widely accepted audit procedure for purposes of placing reliance on the item being confirmed).
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VISUAL INSPECTION OF OFFICIAL JOINT SEALS ON PREVIOUSLY INVENTORIED COMPARTMENTS This includes: Reviewing and evaluating internal control, to include the physical controls over the deep storage gold Inspecting the Official Joint Seals used to control compartments containing previously inventoried gold to determine whether the seals have been altered or compromised in any way Preparing an Official Joint Seal Inspection Report that includes identifying the condition of the Official Joint Seal, determining if the signatures on the Seal agree with the signatures on the copy of the original Official Joint Seal, and whether the Seal and lock had any evidence of tampering and whether the compartment door was locked
As discussed earlier, by the end of fiscal year 2008, all of the deep storage gold reserves in the Mints custody had been 100 percent inventoried and audited. During our fiscal year 2010 and 2009 audits of the deep storage gold, our audit procedures consisted primarily of inspecting the Official Joint Seals on the previously inventoried compartments to determine whether they had been altered or compromised in any way. We found no exceptions. More recently, the Mint decided to replace all of the previouslyplaced Official Joint Seals with new seals. The new seals are more durable, having a double security barrier seal that can only be removed by two cuts with a strong cable cutter. The Mint replaced all of the previously-placed Official Joint Seals with new ones during fiscal year 2010. 413 The seal replacement process consisted of two steps: a) inspection of all previously-placed Official Joint Seals on all the compartments containing deep storage gold to determine whether they had been altered or compromised in any way, and b) placement of a new Official Joint Seal. The seal inspection and replacement process was carried out for all 42 deep storage gold compartments, in the presence of a Treasury
Pictures of the old and new Official Joint Seals are provided as Exhibit 1[Figure 42 &Figure 43] and Exhibit 2 [Figure 44], respectively.
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OIG auditor, by a Mint headquarter staff person, representing the Mint Director, and a Mint storage facility staff person, representing the facilitys Plant Manager. For each Official Joint Seal removed, the Mint headquarters representative, the Mint storage facility representative, and the observing Treasury OIG auditor signed an inspection report; the same parties also signed the new Official Joint Seal that replaced the one removed. In September 2010, I took part in that process at Fort Knox. At that time, I personally saw the deep storage gold reserves located there. During my visit, I witnessed, along with officials from the Mint and one of my auditors, the replacement of all previously-placed Official Joint Seals with new Official Joint Seals. I would also like to note that shortly after my visit to the Mints Fort Knox facility I sent a letter to you, Doctor Paul, regarding my observations. A copy of that letter is provided as Exhibit 3. In closing, based on the work performed by my office and my own personal observations, I can assure the Subcommitee, and anyone else for that matter, that both the quantities and value the U.S. Governments deep storage gold reserves held and reported by the Mint are reliable and sufficiently audited. Therefore, I believe that the inventory and audit requirements proposed in The Gold Reserve Transparency Act of 2011, H.R. 1495, to be redundant of the work that my office and the Mint have and currently perform. That concludes my prepared statement. I will be happy to answer any questions that you may have. Thank you. Old Official Joint Seal Old Official Joint Seal New Official Joint Seal Inspector General Thorson Letter to the Honorable Ron Paul
Exhibit 1: Old Official Joint Seal
Figure 42
Exhibit 1: Old Official Joint Seal
Figure 43
Exhibit 2: New Official Joint Seal
Figure 44
Exhibit 3: Inspector General Thorson Letter to Honorable Ron Paul
WRITTEN TESTIMONY OF GARY T. ENGEL

DIRECTOR, FINANCIAL MANAGEMENT AND ASSURANCE GOVERNMENT ACCOUNTABILITY OFFICE H.R. 1495 GOLD RESERVE TRANSPARENCY ACT OF 2011 Mr. Chairman, Ranking Member Clay, and Other Members of the Subcommittee: I am pleased to be here today to discuss H.R. 1495, 414 the Gold Reserve Transparency Act of 2011. This proposed legislation, which was recently referred to your Subcommittee, provides for an audit of the gold reserves of the United States. Specifically, the bill calls for the Secretary of the Treasury to conduct and complete, not later than 6 months after passage of the act, a full assay, 415 inventory, and audit of gold reserves of the United States at the place or places where such reserves are kept, together with an analysis of the sufficiency of the measures taken for the security of such reserves. The bill also calls for the Government Accountability Office (GAO) to review the results of such assay, inventory, audit, and analysis and, not later than 9 months after passage of the act, prepare and transmit to the Congress a report of GAOs findings together with the results of the work performed by the Secretary of the Treasury. My testimony today will focus on (1) the reported holdings of gold reserves of the United States as of September 30, 2010; (2) past and current audit efforts regarding gold reserves of the United States, including those of the Department of the Treasurys (Treasury) Office of Inspector General (OIG); and (3) the requirements of H.R. 1495. We conducted our work from June 3, 2011, to June 21, 2011, in accordance with all sections of GAOs Quality Assurance Framework that are relevant to our objectives. The framework requires that we plan and perform the engagement to obtain sufficient and appropriate evidence to meet our stated objectives and to discuss any limitations in our work. We believe that the information and data obtained, and the analysis conducted, provide a reasonable basis for any findings and conclusions in this product.
Gold Reserve Transparency Act of 2011, H.R. 1495, 112 Congress (2011). To verify the fineness (the percentage of gold content at the time of melting) of a gold bar, it is assayed. This involves analyzing a sample from the bar to determine the quantity of gold in it. 1444
414 415 th
Gold Reserves of the United States The holdings of gold reserves of the United States are presented in various financial reports, including the United States Mints (Mint) Schedule of Custodial Deep Storage Gold and Silver Reserves (Mints Custodial Schedule), the Mints financial statements, and Treasurys departmentwide financial statements. As of September 30, 2010, most, or approximately 95 percent, of the reported gold reserves of the United States were in the custody of the Mint. The gold reserves in the custody of the Mint are comprised of deep storage and working stock gold. Deep storage gold, which consists primarily of gold bars, represented nearly all of the gold reserves in the custody of the Mint and was maintained in three locations: the United States Bullion Depository at Fort Knox, Kentucky; the Mint at Denver, Colorado; and the Mint at West Point, New York. Working stock which consists of bars, blanks, unsold coins, and condemned coins represented about 1 percent of the reported gold reserves in the custody of the Mint and can be used as the raw material for minting coins. The remaining reported holdings of gold reserves of the United States were in the custody of the Federal Reserve Bank of New York. Table 1 presents the reported amounts as of September 30, 2010, of fine troy ounces (FTOs)416 of gold reserves of the United States by category and the financial reports in which such categories were presented. From September 30, 2006, through September 30, 2010, the reported fiscal year-end amounts of FTOs of (1) deep storage gold reserves in the custody of the Mint and (2) gold reserves in the custody of the Federal Reserve Bank of New York have not changed.
Fine troy ounces represent the gold content of the melt (that is, the melting, pouring, and casting of metal into molds) as determined by multiplying the melts gross weight by its fineness.
416
Past and Current Audit Efforts Regarding Gold Reserves of the United States In 1974, in response to congressional interest and in conjunction with the Mint, GAO assisted in the planning and observed the inventory of gold reserves of the United States maintained by the United States Bullion Depository at Fort Knox. 417 GAO selected 3 of the 13 compartments at this depository to be audited. The audit procedures included observing and participating in a physical inventory of the entire contents of the three compartments. GAO did not report any differences between the gold stored in these compartments and the Fort Knox depositorys records. In addition, GAOs procedures included observing the assaying of a sample of gold bars. The results of the assays indicated that the recorded finenesses were within the tolerances the Mint established. In connection with this audit, GAO recommended that the Secretary of the Treasury request the Director of the Mint to annually perform a cyclical inventory of its gold holdings to ensure that the gold holdings in all compartments would be inventoried over a specified period of years. Acting on this recommendation, Treasury established the Committee for Continuing Audits of United States Government-owned Gold (Committee for Continuing Audits) in 1975 to oversee and provide guidelines and general direction for continuing
See GAO, Accountability and Physical Controls of the Gold Bullion Reserves, Department of the Treasury, FOD-75-10 (Washington, D.C.: February 1975).
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audits.418
The objectives of the continuing audits were to verify the accuracy of the inventory of gold and the adequacy of related accounting records and internal controls in accordance with Treasury audit policies. A March 1982 report to the Congress by the Gold Commission419 noted that the continuing audit of such gold was conducted on a cyclical basis because of the enormous quantity of gold to be handled and the related costs.420 In an April 1987 report on continuing audits of the United States government-owned gold,421 the Treasury OIG stated that the continuing audits were designed to ensure that about 10 percent of the United States government-owned gold was audited annually.422 Further, the Treasury OIG stated that on September 19, 1986, the Inspector General had recommended canceling Treasury Department Order No. 234-1, which had resulted in the creation of the Committee for Continuing Audits, because it was unnecessary in view of the authority of the Inspector General to conduct audits of the gold stock under other Treasury Orders. It was also stated that annual audits of government-owned gold were no longer necessary because (1) virtually all of the gold in the custody of the Mint had been audited and placed under seal and (2) there had been essentially no discrepancies found as a result of those audits. Moreover, it was noted that Treasury Department Order No. 234-1 was subsequently canceled. According to the Treasury OIG, about 92 percent of the United States government-owned gold had been
This committee was created as a result of the June 3, 1975, Department Order No. 234-1, issued by the Secretary of the Treasury authorizing and directing the Fiscal Assistant Secretary, with the cooperation and assistance of the Director of the Mint, to conduct a continuing audit of the United States government-owned gold for which the Treasury is accountable. 419 Pursuant to Public Law 96-389, 94 Stat. 1551, 1555, 10 (Oct. 7, 1980), the members of the Gold Commission were appointed by the Secretary of the Treasury to conduct a study to assess and make recommendations with regard to the policy of the U.S. government concerning the role of gold in domestic and international systems. 420 Report to the Congress of the Commission on the Role of Gold in the Domestic and International Monetary Systems, Volume II, Annex D: Continuing Audit of the United States Government-Owned Gold, March 1982. 421 Department of the Treasury, Office of the Inspector General, Summary Report of Continuing Audits of United States Government-owned Gold as of September 30, 1986, OIG-8742, (Apr. 24, 1987). 422 In this report, the Treasury OIG stated that the Committee for Continuing Audits was headed by the Chief of the Internal Audit Staff of Treasurys Bureau of Government Financial Operations and included the Chief of the Internal Audit Staff of the Mint and the Assistant General Auditor of the Federal Reserve Bank of New York. The Treasury OIG also stated that (1) effective October 1, 1982, the internal audit staffs of the Bureau of Government Financial Operations and the Mint were reorganized under the Treasury OIG, and (2) on October 10, 1984, the Bureau of Government Financial Operations became the Financial Management Service.
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audited by either GAO 423 or the Committee for Continuing Audits as of September 30, 1986. More recently, the gold reserves of the United States have been presented in various financial reports and have therefore been subject to various audit efforts. For example, while the deep storage gold reserves are a primary focus of the audit of the Mints Custodial Schedule, which is audited by the Treasury OIG, the deep storage gold reserves are also within the scope of the audit of the Mints financial statements, which are audited by independent public accountants. Also, as a bureau within Treasury, the balances and activity of the Mint are included on Treasurys departmentwide financial statements, which are required by law to annually be prepared, audited, and submitted to the Congress and the Director of the Office of Management and Budget. Specifically, 31 U.S.C. 3515(b) requires that the financial statements of covered executive agencies, of which Treasury is one, include the overall financial position of the offices, bureaus, and activities covered by the statements, including the assets and liabilities thereof; and the results of operations of those offices, bureaus, and activities. Treasury OIGs Audits of Gold Reserves in the Custody of the Mint The Inspector General Act of 1978, as amended, 424 (IG Act) created offices of inspector general at major federal departments, including the Treasury OIG,425 to provide independent audits and investigations; promote economy, efficiency, and effectiveness; and prevent and detect fraud, waste, and abuse in the respective departments programs and operations. 426 The Treasury OIG performs annual audits of the Mints Custodial Schedule,427 which reports the deep storage gold reserves. As shown in table 1, the deep
Of the about 92 percent of the United States government-owned gold that had been audited as of September 30, 1986, GAO audited approximately 13 percent in 1974. 424 Pub. L. No. 95-452, 92 Stat. 1101 (Oct. 12, 1978) (codified, as amended, at 5 U.S.C. App.). 425 The Treasury OIG was established by the Inspector General Act Amendments of 1988 (Public Law 100-504). 426 In accordance with the IG Act, the Treasury OIG was appointed by the President and confirmed by the Senate, which, among other provisions of the IG Act, allows the Treasurys OIG to perform audits in compliance with the independence requirements of Government Auditing Standards (See GAO, Government Auditing Standards, July 2007 Revision, GAO-07-731G (Washington, D.C.: July 2007), issued by the Comptroller General of the United States), 5 U.S.C. App. 4(b). 427 Prior to fiscal year 2000, the Mints Custodial Schedule was called a Statement of Custodial Gold and Silver Reserves. Additionally, beginning in fiscal year 2006, deep storage was added to the title.
423
storage gold reserves represent nearly all of the gold reserves in the custody of the Mint. Since issuing its first audit report on the Mints Custodial Schedules in 1995, which presented the results of its audit of the Mints Custodial Schedules as of September 30, 1994, and 1993, the Treasury OIG has annually audited the deep storage gold reserves in the custody of the Mint as reported in the respective Mints Custodial Schedules. For each of the fiscal years under audit, the Treasury OIG rendered unqualified or clean opinions on the Mints Custodial Schedules. In addition, the Treasury OIG did not report any material weaknesses428 in internal control over financial reporting relating to the schedules for these fiscal years. The Treasury OIGs most recent audit report on the Mints Custodial Schedules, which presented the deep storage gold reserves in the custody of the Mint as of September 30, 2010, was issued on October 21, 2010. In connection with the Treasury OIGs annual audits of the Mints Custodial Schedules, Treasury OIG officials told us that the Treasury OIG reviews the physical controls (e.g., security fences, armed guards, security cameras, metal detectors) at each of the three Mint locations where the deep storage gold reserves are maintained. According to Treasury OIG officials, as of September 30, 2010, there were 42 compartments of deep storage gold reserves spread among these three Mint locations. As previously noted, Treasury OIG officials estimate that about 92 percent of the United States government-owned gold was audited by either GAO or the Committee for Continuing Audits as of September 30, 1986. These officials told us that once the inventory of a compartment being audited was completed, the compartment was sealed with an official joint seal. A joint seal is intended to place the gold contained in a compartment under such control that subsequent representatives can accept the verification made by previous representatives as to the weight and count of the gold. According to Treasury OIG officials, the official joint seals, for all of the compartments that were audited by either GAO or the committee and that had not been opened since such audits, were inspected by the Treasury OIG, as part of its audits of the Mints
A material weakness is a deficiency, or a combination of deficiencies, in internal control such that there is a reasonable possibility that a material misstatement of the entitys financial statements will not be prevented, or detected and corrected, on a timely basis. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis.
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Custodial Schedules, to verify that the seals had not been compromised. These officials also told us that over the course of the Treasury OIGs audits of the Mints Custodial Schedules for fiscal years 1993 through 2008, the compartments containing the deep storage gold reserves not audited by either GAO or the committee, along with any previously sealed compartments that were opened, were selected and audited. These officials told us that such audits included verifying the following to the Mints inventory records: (1) the number of gold bars in each melt; (2) the melt number for each gold bar in the melt; and (3) the fineness stamped on each gold bar in the melt. In addition, as part of the audits of the selected compartments, Treasury OIG officials stated that the Treasury OIGs audit procedures have included selecting a statistical sample of gold bars from the selected compartments to be weighed and assayed and that no material differences were noted. These officials also told us that once the inventory of a selected compartment being audited was completed, the compartment was sealed with an official joint seal to control the gold reserves contained in the compartment. According to Treasury OIG officials, opening and sealing compartments require the presence of three individualsa representative of the facility where the gold reserves are held, a representative of the Director of the Mint, and a representative of the Treasury OIG. They also told us that, as of the end of fiscal year 2008, an inventory of each of the 42 compartments had been observed either by GAO, the Committee for Continuing Audits, or the Treasury OIG and that there has been no movement of deep storage gold reserves since that time. As such, in addition to considering internal control over financial reporting related to the Mints Custodial Schedules, Treasury OIG officials stated that the Treasury OIGs audit procedures since fiscal year 2008 have primarily focused on inspecting the official joint seals each year for all 42 compartments to verify that they had not been compromised. Independent Public Accountants Audits Covering Gold Reserves in the Custody of the Federal Reserve Bank of New York and the Mint The gold reserves of the United States on Treasurys departmentwide financial statements consist of the gold reserves in the custody of the Mint and those in the custody of the Federal
Reserve Bank of New York. Since fiscal year 2004, independent public accountants have rendered clean opinions on these financial statements. According to Treasury OIG officials, these independent public accountants primary audit procedure regarding the gold reserves in the custody of the Federal Reserve Bank of New York involves annually obtaining a confirmation from the Federal Reserve regarding the gold reserves of the United States that are in the Federal Reserve Bank of New Yorks custody as of fiscal year-end, including the amount of FTOs. The gold reserves in the custody of the Mint are also reported on the Mints annual financial statements. Independent public accountants have rendered clean opinions on the Mints financial statements for fiscal years 2005 through 2010. 429 According to Treasury OIG officials, these independent public accountants procedures with regard to the deep storage gold reserves in the custody of the Mint have included reviewing the Treasury OIGs audit documentation, accompanying the Treasury OIG on site visits to the Mints storage locations, reviewing the physical controls at the locations visited, and reperforming certain of the Treasury OIGs audit procedures. Requirements of H.R. 1495 H.R. 1495 provides for the Secretary of the Treasury to conduct and complete a full assay, inventory, and audit of gold reserves of the United States and an analysis of the sufficiency of the measures taken for the security of such reserves. In considering the provisions of H.R. 1495, it will be important to consider the cost, benefit, and timing of actions needed to implement the proposed requirements. H.R. 1495, if enacted, may result in duplication of certain past and current efforts, especially with regard to inventorying and auditing the gold reserves of the United States. Nevertheless, GAO would be capable of carrying out the required review of the results of the Secretary of the Treasurys actions called for by the bill, should it be enacted. GAOs review would include visits to the facilities at which the gold reserves of the United States are held to selectively observe the inventorying and auditing of the gold reserves and examinations of various documentation supporting the required assay, inventory, and audit.
With regard to the Mints financial statements for fiscal years 1993 through 2004, the Mints independent public accountants reported that they did not audit the gold reserves included in the Mints Custodial Schedules. Their opinions on these financial statements, in so far as they related to such gold reserves, were based solely on the reports of the Treasury OIG regarding the related Mint Custodial Schedule.
429
H.R. 1495 also provides for GAO to prepare and transmit to the Congress, not later than 9 months after enactment of the act, a report of GAOs findings from such review together with the results of the assay, inventory, audit, and analysis conducted by the Secretary of the Treasury. According to Treasury officials, because of the enormous quantity of gold that would need to be inventoried and assayed, there is uncertainty regarding the ability of Treasury to complete such actions within the 6-month period provided in H.R. 1495. If Treasurys efforts are not completed within the 6month period, there would be limitations on the scope of GAOs work if GAO were required to report within 9 months after enactment of the act. GAO stands ready to work with the Subcommittee on developing changes to the provisions of H.R. 1495 that would most efficiently utilize the results of past and current gold reserve assay, inventory, and audit efforts. Mr. Chairman and Ranking Member Clay, this concludes my prepared statement. I would be pleased to respond to any questions that you or other members of the Subcommittee may have at this time.

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WRITTEN TESTIMONY OF LAWRENCE M. PARKS, Ph.D.226,227

888RON PAULS MONETARY POLICY ANTHOLOGY

Exhibit 1: Sweeping Hungarian money into the sewer circa 1946

Exhibit 2: Burning German money for heat circa 1923

ROAD MAP TO SOUND MONEY TESTIMONY889

Exhibit 3: Children playing with blocks of German money circa 1923

Exhibit 4: Children playing with blocks of German money circa 1923

Exhibit 5: Burning German money to heat food circa 1923

890RON PAULS MONETARY POLICY ANTHOLOGY

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Exhibit 9: Sweeping Hungarian money into the sewer circa 1946

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7th Amendment to the Constitution.

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Exhibit 15: Sign that says cat And hang it on a dog,

Exhibit 16: Photo of a dog Does the dog become a cat?

Coinage Act of 1792

900RON PAULS MONETARY POLICY ANTHOLOGY

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930RON PAULS MONETARY POLICY ANTHOLOGY

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932RON PAULS MONETARY POLICY ANTHOLOGY

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934RON PAULS MONETARY POLICY ANTHOLOGY

Exhibit 41: Bartlett Manufacturing Company teardown on account of property taxes

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