Book Outline: Secrets of the Temple
Secrets of the Temple, by William Grieder
Copyright 1987, ISBN 0-671-47989-X,
Published by Touchstone / Simon & Shuster
Note: In outlines, I try to just convey what the author said and minimize my personal bias, neither agreeing nor disagreeing with what they say.
This outline created 12/6/08, BGJ
So far, the outline only covers through chapter 8.
Part One: Secrets of the Temple
Chapter 1: The Choice of Wall Street
Chapter 2: In the Temple
Chapter 3: A Pact with the Devil
Chapter 4: Behavior Modification
Chapter 5: The Liberal Apology
Chapter 6: The Roller Coaster
Part Two: The Money Question
Chapter 7: The God Almighty Dollar
Chapter 8: Democratic Money
Chapter 9: The Great Compromise
Chapter 10: Leaning Against The Wind
Part Three: The Liquidation
Chapter 11: A Car with Two Drivers
Chapter 12: That Old-Time Religion
Chapter 13: Slaughter of the Innocents
Chapter 14: The Turn
Part Four: The Restoration of Capital
Chapter 15: A Game of Chicken
Chapter 16: Winners and Losers
Chapter 17: “Morning Again in America”
Chapter 18: The Triumph of Money
Part One Summary
The 6 chapters of Part One are a narrative of the events of 1979-1980, when the Fed led by Paul Volcker was trying to rein in inflation, and tried to switch from Keynesianism to Monetarism. It also gives background on the history of the Fed, how it works.
Part Two Summary
It talks about the history of money, from ancient sea shells or cattle as money, through today.
Part Three Summary
Part Four Summary
Chapter 1: The Choice of Wall Street
• There is an inherent conflict between democracy and capitalism. The larger number of poor people often want different policies than the fewer rich people do.
• If people expect inflation, they will take out loans so as to pay them off in depreciated dollars. Inflation rewards debtors and punished savers.
• The Fed is supposedly apolitical.
• In inflationary times, there is a greater demand for hard assets such as gold and silver, which drives up their price.
• In 1979, there were ~14,000 banks of various sizes, but only 16 “mega” banks with over $10 billion in deposits. 8 in New York, 5 in California, 2 in Chicago, 1 in Pittsburgh.
• Inflation redistributes wealth down, deflation redistributes wealth up (assuming wages rise or fall in parallel with inflation rate)
• Types of banks
o Commercial banks – short term loans to businesses
o Investment banks – long term loans (bonds), to businesses
o Savings & Loans – Home mortgages, car loans
• Capitalism does not distribute the ownership of financial wealth very broadly.
• A study of inflation from 1969 to 1974 showed that incomes kept up, for working class, but also for the poor and elderly on “fixed incomes” (with scheduled increases).
Chapter 2: In the Temple
The Federal Board of Reserve (“The Fed”)
• The Chairman is appointed by the President to a 4 year term.
• Board of Governors: 6 members, appointed by the President to 14 year terms, staggered.
• The Federal Open Market Committee: Heads of 12 Regional Federal Reserve Banks, plus the Board of Governors. Only 5 of the 12 banks vote, in rotation.
These long terms provide a lot of independence and insulation for the Fed.
Regional Federal Reserve Banks (There are 12 of them):
St. Louis, Philadelphia, Boston, New York, Richmond, Atlanta, Kansas City, Cleveland, Chicago, Dallas, San Francisco, Minneapolis
As of 1987, 55% of families had a negative overall net worth
The history of Fed Chairs: Mariner Eccles, William McChesney Martin, G. William Miller, Arthur Burns, Paul Volker, Alan Greenspan, Ben Bernanke (appointed 2/1/06)
The bond market hates inflation for diluting the value of bonds (debtors love inflation)
The “real interest rate” = the posted interest rate – inflation rate
Federal Funds
Open Market Desk: Fed buys/sells government securities
Discount Window: Member banks (commercial only?) borrow here
Main financial markets: Stock, bonds, money market
The US central bank (The Fed) has much more independence from the government than other central banks (England, Japan, France, Italy). Other central banks take orders directly from politicians, or need approval.
Money Supply
M1 – checking account deposits, currency
M2 – M1 plus savings accounts, CDs, money market mutual funds
M3 – M2 plus large items such as institutional $100k CDs
1935 reform of the Fed & Banking
• Started federal insurance on bank deposits (FDIC)
• Took authority from Regional Reserve Banks and put it with the Board of Governors
• Speculators could only borrow 50% of investment instead of 90%
• Checking could no longer bear interest
• Split banking into commercial & investment banking
• The FOMC (Federal Open Market Committee) was created
In the 1930’s mortgages went from 7 or 10 years duration to 20 years
Say’s Law (discredited): Supply produces demand
Keynes: Demand produces supply. Problem with Keynes: When inflation rears up and politicians per this theory are supposed to reduce or eliminate deficits (reducing spending is unpopular), they break under pressure and continue to spend
Milton Friedman. Monetist. Discredited by the 80’s.
Bretton Woods Treaty: The dollar tied to gold, & foreign currencies to the dollar. Nixon abandoned it in 1971, “closed the gold window”.
A study by the National Builders Association (date not provided) tried to prove that the Board of Governors was drawn from the rich and they were therefore more sympathetic to the rich. It actually found that the vast majority came from the middle to lower middle class.
The banking industry suffered very few failures. One might conclude that any industry with such an unnaturally low bankruptcy rate must be highly protected and/or subsidized (by the laws and policies of government).
Chapter 3: A Pact with the Devil
Milton Friedman, an economist at the University of Chicago. Said Keynesianism (stimulation of demand through fiscal policy) was wrong. Recommended strict control of the size of the money supply, that M1-M3 should be regulated to grow at the same rate as the GDP historically. This was called monetarism.
Historically, the biggest spikes in inflation coincided with one war or another. First, the Revolutionary War, then the War of 1812, the Civil War, World War I and finally World War II. However, after World War II, the Cold War started. Federal budget deficits (for military spending) continued even though we were at peace. It is true that some developing countries were freed from colonial domination and started to demand higher prices, but this is considered a lessor factor largely (oil prices being the exception).
Greenbacks were money printed by Lincoln without selling Treasury bonds, around $500 million. So they were inflationary.
Chairman Volcker was attracted to monetarism because it would have the result he really wanted (higher interest rates) while allowing him to claim that he was not to blame, that he was simply controlling the money supply. It gave him political cover. Changing from Keynesianism to monetarism represented a change in operational approach for the Fed.
Once upon a time, the money banks used to make a loan came only from depositors. However they wanted to expand faster than they could attract new depositors, and begin to borrow money from other banks. Their profit came from the difference in the interest rate they paid versus the interest they earned. This practice was called “managed liabilities”.
The book did not explain clearly what mechanism was to be used to control the money supply. The release of new money in the form of Treasury Bond sales might be the tool.
Carter knew that the Fed’s tightening would cause a recession which might lose him the upcoming 1980 election, but he was already politically weak and had no leverage to force the Fed to abandon its plan.
Chapter 4, Behavior Modification
The initial effect of the change to monetarism was large swings in interest rates, lots of volatility.
The Fed’s Open Market Desk dealt with 36 authorized dealers to sell Treasury bonds.
Under tightening credit conditions, banks can actually run out of money to loan out, which did happen in 1980 after the Fed switched to monetarism.
During times of tightening credit, the smaller and weaker get the denials more often than the strong. The pain is not evenly distributed. The government could correct this, could try to steer the available credit more towards those who need it, such as through bank regulations or tax codes. But it won’t do that because the stronger are more influential at the political level. This unevenness applied not just for clients who wanted loans, but also for banks that wanted to supply loans. Larger banks could still afford access to money to loan out, but small banks couldn’t and would run out of money to loan out.
While theoretically the Fed could discipline a bank by refusing a loan request by the bank at the Fed’s Discount Window, the Fed never refused a request unless a bank was truly insolvent and doomed.
The Fed’s tightening of the supply of dollars in 1980 was severely diluted by the supply of dollars in Europe, the “Eurodollars”.
The initial efforts of the Fed were ineffective although unemployment hit 8.5%. The Consumer Price Index rose to around 18%.
Chapter 5, The Liberal Apology
From 1913 to 1980, only commercial banks could be part of the Federal Reserve System. But membership was optional. They were required to keep a reserve with the Fed, which bears no interest, but gain access to the Fed’s Discount Window for emergency borrowing. They also had access to the Fed’s check clearing and payment systems.
However, in the 70’s, banks were increasing choosing not to be members. The Fed argued that membership must remain high for the Fed to maintain control. However, many felt that the Fed could maintain control with just the fewer large banks in the system. The Fed still argued the control issue.
The constituency of the Fed is the group of very large New York banks. These banks help pressure Congress to leave the Fed its independence during times when Congress is tempted to put the Fed under its own authority or that of the president. These banks lobby Congress, and they lobby the smaller banks to intercede as well. The smaller banks are in the home town of this or that Congress member and have personal relationships with members. The large banks protect the Fed as an institution and the Fed in turn protects the interests of the large banks. This can be at the expense of the people, and even at the expense of the smaller banks.
The Fed considered starting to pay interest on reserves, but instead successfully lobbied Congress to mandate that all banks must be members (The Monetary Control Act of 1980). The Fed, the 12 Federal Reserve Banks, and the largest commercial banks wanted this so as to maintain a political base for the Fed. The Monetary Control Act also thoroughly deregulated the banking industry (no wall between savings & loans, investment banks, commercial banks, no limits on interest rates, and more). State usury laws were suspended.
The change from voluntary membership in the Fed system to mandatory membership brought in the small banks. The large banks benefited. The reserve requirements were lowered, which benefited large banks, who were already in the Fed system and had reserves with the Fed. The small banks were forced to join, and to start holding reserves with the Fed system where they didn’t have to before. The new system made banks pay for the Fed’s check processing services, but this was more than offset for the large banks by the lowered reserves.
The Monetary Control Act of 1980 is an example of the Fed protecting large banks at the expense of small banks. The Fed knew that deregulation would make it harder for them to control credit, because if people were willing to pay punishingly high rates, credit could expand indefinitely. But they had to support it because the large banks wanted it, and the Fed needed the support of the large banks.
There was a lot of pressure to deregulate from investors who saw inflation eating into their profits. The pressure also came from small investors. The Fed saw the pressure to deregulate as an opportunity to piggybank what they wanted, the universal membership requirement. The large commercial banks were the ones to defend the independence of the Fed against Congress.
The “Liberal Apology” refers to the fact that it was a Democratic congress that passed this deregulation, which benefited the wealthy most. Although the wealthy were not traditionally the base for the Democrats, inflation had convinced the rank and file that deregulation was to its benefit.
While deregulation made wealth flow from the many poor up towards the minority of wealthy people, the poor didn’t vote in large numbers.
Chapter 6, The Roller Coaster
1980 was a roller coaster. The Fed imposed credit controls then lifted them. They tried to reduce the money supply, then had to expand it.
In February, the money supply was up 13%. In the spring, it was down by 17%. In late summer, in one month it increased by 22.8%. In December, it was down 10%.
The prime rate was 20% in April, 11% in July, and 21.5% in December.
These gyrations were the nightmare some feared in switching to the monetarist system. At the end of the year, the Fed decided to stick to the monetarist system, but less rigidly.
1980 also provided another example of the Fed protecting money when it shouldn’t. The Hunt brothers had tried to corner the silver market, and had borrowed the bulk of the capital used. When their bubble burst, rather than let the Hunt brothers and the banks take their lumps (some would have failed), the Fed allowed an exception to the credit controls it had just imposed so that other banks could make loans to the stricken ones. Volcker protected these banks even though they had ignored him when he told them to avoid strictly speculative activities. They Fed did not similarly help other industries like Chrysler, even though it had the authority to do so if it wanted. Chrysler just wasn’t a bank. Same for Lockheed, the City of New York, and Midwestern grain farmers.
Around this time, banks were increasingly making excessively risky loans to South American countries. This situation would later explode (See Chapter xyz).
Chapter 7, The God Almighty Dollar
Before the US issued money, bankers issued notes. If a bank failed, the notes just became worthless.
Demand deposits (checking accounts) were introduced just after the Civil War, but didn’t gain wide acceptance until around 1900. In 1913, the law that created the Federal Reserve also nationalized money.
Gold coins were in common use in the early 1900’s, but by 1933 the US would no longer redeem dollar bills for gold. Europe had already been forced this way in 1913 by World War I.
This chapter discusses the relations between money and religion, & money and psychology.
Suggests the money is mysterious and that the common people want it to be, that they can only have faith in the value of money if it is not understood. People wanted money to have an absolute value, a “real” value. The independence of the Fed, and the myth of the Fed as all-knowing, and as apolitical let them believe that.
Wanting gold as the basis of money reflects a desire for “real” value, but an irrational basis. The monetarists wanted money to grow in strict relation to the real economy (the Gross Domestic Product), which also reflects a desire for a “real” value of money, but a rational one.
Chapter 8, Democratic Money
This chapter is about the Populist movement of the late 1800’s. The movement was sparked by the 30 year Great Deflation that started in 1866. During the civil war, massive government spending resulted in high inflation and abandonment of the gold standard. The deflation was caused by retiring currency, and by returning to the gold standard at pre-war levels. The Great Deflation forced commodity prices to very low levels and left farmers in a no win situation.
The book did not explain why the cost of seeds did not go down in parallel with the price of wheat, corn, etc. The book did not explain what effect deflation had on the rest of the economy such as manufacturing. But it did say that the farmers went into debt to the point they were losing their land, and that they formed the Populist movement in response.
The Populist Movement
• First called Knights of Reliance, then Farmers Alliance
• Started in 1877
• Height of strength in 1890
• Died in 1896
• Lawrence Goodway wrote a history: “Democratic Promise, the Populist Movement in America”
• Their agenda:
o Progressive income tax
o Federal regulation on railroads, communications, legal unions, government price stabilization, & credit programs for farmers
o Monetary policy: They wanted to get off the gold standard, wanted federal regulation of banking
Populists
Wanted Congress in charge of money supply, somewhat monetarist.
The gold standard did not in reality mean stable prices, despite popular myth.
The supply of gold was constantly changing, was never tied to the growth of the real economy. Perhaps the real surprise would be if prices were stable.
Since inflation hurts investors and deflation hurts debtors, people claim that the ideal would be zero inflation so that nobody gets hurt. The long history of cycles of inflation and deflation under capitalism using the gold standard suggests that inflation/deflation is inherent in capitalism. Periods of easy money stimulates economic growth and inflation, resulting in capital accumulation. Then deflation leads to periods of ownership consolidation as people with money buy out people who go broke. Some argue that under conditions of stable money there would be no growth, leading to unrest and political upheaval.
The Populists had multiple internal divisions working against them. North versus South. White versus black.
Usury was common during the Great Deflation, with interest rates at 100% or more. Railroads charged a bushel in fees to ship a bushel. Eventually states wrote anti-usury laws.
These cycles were present in Europe as well, with and without central banks, and whether the government controlled money or private interests controlled money.
During this period, seasonal fluctuations in the need for money (farmers bringing in crops) caused great problems as well. The money supply could not expand quickly because of the gold standard. Gold had to be borrowed from Europe, which took 15 days to cross the Atlantic. Both farmers and bankers in the south and west resented being at the mercy of the big Wall Street banks for getting short term loans during these seasonal fluctuations.
Populists formed farmers coops
Populist wanted farmers, etc., to borrow directly from the Federal Government, which was to charge low interest. This plan cut out private banks, who naturally resisted.
The Federal Reserve of 1913 was subservient to the banks, not the public.
Why Wall Street banks backed having a Federal Reserve:
• The economy simply became too large for them to stabilize during panics
• Their influence was weakened by the growth of banking in the South & West. These regional banks were near the industries they supported. Industry was more frequently using its own profit to expand.
So Wall Street banks wanted a form of Federal Reserve that would restore & preserve their influence. And they got it.
1912: Study showed the 12 banks in New York, Chicago, Boston held 746 interlocking directorships in 134 vital industries.
The Fed
• Created in 1913 by Democrats
• Revised 1935 by Democrats to centralize control in D.C.
• Revised 1980 by Democrats to give it universal control over reserves of ALL private banks
The Fed has more power than the Congress of 1913 intended. Ability to influence prices generally, not just ease credit crunches. Leaving the gold standard gave it more power (World War I caused this departure).
In the 1800’s banks could simply run out of credit to give due to reserve requirements
The Fed was originally sold to the public to include transparency, but became secretive.
The Fed was an early case of government control over private economy. Later much repeated by liberalism, the New Deal.
In the 1920’s, the Federal Reserve Board allowed the Reserve Banks to form their own committee to control open market transactions, ceding authority out of ignorance.
First “Bank of U.S.” launched by Alexander Hamilton after Revolutionary war, expired in 1811.
Second “Bank of U.S.” started in 1817, expired 1834
European wealth was borrowed to develop America, and defaulted on massively many times. But others were paid off. And infrastructure in America was developed (canals, railroads).
The great deflation after the civil war ended with the huge gold discoveries in Alaska, Colorado, S. Africa, which allowed the money supply to expand. So this solution was just luck, not the result of any plan.
Alternative rules for Federal Reserve: Have it directly buy debt paper of employee owned companies, again low interest. Again cuts out private banks, who again resisted. Ordinary people would have easy access to capital credit.
Proposed alternate approach, during tightening, other than just interest rates: Reserve requirements would specify allocating some loans to small businesses, not just large.
Eurodollars – $$ in Europe
1980 – Financial deregulation
• Interest on checking accounts (NOW accounts)
• No interest rate caps
Washington has veto power over the budget for the 12 reserve banks (gives D.C. leverage).
1913, as part of law enacting the Federal Reserve, currency was nationalized
Fiat money – not backed by anything real (such as gold)
The Fed is not effective in discouraging banks from highly speculative lending, always bails them out.
Examples:
Penn Square bank in ~1982
Continental Illinois in 1984