The U.S Federal Reserve: What's the purpose?

Factual Questions
1

I’m not an economist and I’m struggling to understand the purpose of the Federal Reserve. From what I understand, the Constitution gives Congress to appropriate tax dollars for useful (or non-useful) projects. These tax dollars stay in a kitty box in the U.S Treasury and are doled out to the Federal Reserve. The Reserve then lend money to banks, who then lends money to the people. From what I understand, the flow of money goes this way (Please correct if I’m wrong):

Congress -> U.S Treasury -> Federal Reserve -> Banks -> People
In this case, I cannot shake the feeling that the Federal Reserve is superfluous. If someone could answer these questions, it would be greatly appreciated:

  1. Why can’t U.S citizens open a banking account with the U.S Treasury?

  2. What would be the ramifications of abolishing the Federal Reserve and establishing a new central bank that all U.S citizens could take out loans, have checking & saving accounts and get credit at the same fire-sale interest rates Banks are currently given?

  3. Why is the Federal Reserve not an entirely public institution? What would be the ramifications of making it entirely public with no private counterpart?

  4. If the Banks stopped lending, are there any compulsory actions the government can take to “force” them to lend? If not, is there an emergency detour to credit and liquidity for U.S citizens? (I hope that made sense).

(and completely unrelated, but its been a splinter in my brain)

  1. Why is it illegal/not permissable for a U.S. citizen to purchase stock, bonds, or mutual funds without a broker? Has anyone ever questioned the to legitimacy of this rule? I mean, for example, why can’t Joe the Plumber take a flight to New York and purchase 1.5 shares of Microsoft at Wall Street, take the certificates, and fly back home? What would be the ramifications of allowing citizens to buy into the financial markets without a middle-man? Would the market collapse? Has this ever been tried in American history?
    Thanks for reading.
2

Yes.

No.

Sometimes (often), but this isn’t what they do in the main.

Official story !pdf!:

3

Most countries that are capitalist and have democratic elections have a similar system with a central bank that is not 100% government run. The idea is that they should be immune from the swings of politics.

4

The Federal Reserve is a separate institution. It is not directly linked with the U.S. Treasury, although they can cooperate at times to achieve various economic objectives.

The U.S. Treasury is not a bank. The U.S. Treasury’s bank is the Federal Reserve, and the Federal Reserve does not allow individuals to open accounts with them as matter of policy. It’s not what the Federal Reserve was designed to do.

I suppose a national, quasi-public banking system could be established if that’s what we really wanted. But why do you believe individuals would get better interest rates from such a banking system? Loaning money to individuals is a very different beast than loaning money to other banks and financial institutions.

See Bijou Drains’ response.

I doubt the government can legally force banks to lend money, but they can certainly take actions to encourage the banks to do so. Besides, it’s in the banks’ interest to lend since that’s how they make money.

Sure, the U.S. Government can provide liquidity, at least in the short term: deficit spending in the form of tax credits and refunds.

You need to have the proper training to conduct stock trades on an exchange; stock trades are legal contracts that occur in a regulated environment, after all. It’s a stock exchange, not eBay. Brokers must pass exams that demonstrate competency.

Some companies do allow you to purchase stock shares directly from the company itself. In this case, the company bears the burden of making sure the trade is properly handled.

5

I understand this much. Though it’s not clear to me that the Federal Reserve acts as a “bank” in a broad sense. If the Treasury is the only depositor of wealth in the Reserve, does the government earn interest on deposits?

You also said that the U.S Treasury is not a bank though all of the tax refunds I’ve received from the government, has its seal emblazoned in the upper left hand corner. If memory serves, the Federal Reserve isn’t even mentioned on the check. Why? If the Federal Reserve is the Treasury’s Bank, shouldn’t the funds be withdrawn from the Reserve and not the Treasury? I’m confused on that point.

There are three reasons:

  1. Supposedly, the U.S is the government of the People; though we refer to the “People” and “Public” as loose synonyms, it seems that all revenue belongs to the People or citizens of the United States. Given this, the movement of money from the Treasury’s coffers to the People shouldn’t be hinged on any private institutions. It seems like such an unnecessary step, wouldn’t you agree? You’ve already mentioned that if the banks stopped lending altogether, the government cannot force these institutions to lend. Though I’m not an economist (I’m a biologist), this seems like an accident waiting to happen.

  2. I think a central, public bank would offer better interest rates because most public institutions like the Post Office and the National Institutes of Health are tailored to operate at minimal profit or simply mandated to “break even”; this creates a scenario where public institutions could offer the best possible interest rate without worrying about their bottom line. (A parallel could be drawn with public / private health care, but I don’t want to get ahead of myself here).

Thank you.

6

Let me take a practical stab at some of these…

1. Why can’t U.S citizens open a banking account with the U.S Treasury?

The United States Treasury is not a bank, in any traditional sense. The Treasury Department manages the money of the United States government and also manages policies concerning money and its flow. It is not a depository institution nor was it designed to be. It’s more an accounting institution for the federal government.

Plus, imagine the shrieks from existing private banking firms if the federal government got involved in their industry! It would make the current kerfluffle about insurance look positively bi-partisan.

2. What would be the ramifications of abolishing the Federal Reserve and establishing a new central bank that all U.S citizens could take out loans, have checking & saving accounts and get credit at the same fire-sale interest rates Banks are currently given?

See above. It would, almost inevitably, lead to the death of the private banking industry. They could not compete with the economic muscle that the federal government could bring to bear. Also, it would inevitably lead to political influence concerning loans, types of loans, and interest rates. Congress would, by force of habit, begin using such a bank as a blunt instrument to influence behavior.

3. Why is the Federal Reserve not an entirely public institution? What would be the ramifications of making it entirely public with no private counterpart?

There is a certain history in United States policy of creating these quasi-governmental organizations and allowing them to run. The Postal Service is, without a doubt, the most famous and public of these. Frankly, though, provided insulation from the influence in my answers to #2, above, there’s little reason not to make such a move happen other than established history.

4. If the Banks stopped lending, are there any compulsory actions the government can take to “force” them to lend? If not, is there an emergency detour to credit and liquidity for U.S citizens? (I hope that made sense).

I suppose, if banks stopped lending at all, they could be forced to do so by the Federal Reserve through it’s ability to manipulate interest rates on their interbank loans. The Fed could, if they desired, be quite punitive on banks that don’t lend by making them pay an unsustainable amount on their overnight loans or delaying payments and checks being processed through the fed. Even a small amount of that could drive even the strongest bank to the edge.

**5. Why is it illegal/not permissable for a U.S. citizen to purchase stock, bonds, or mutual funds without a broker? Has anyone ever questioned the to legitimacy of this rule? I mean, for example, why can’t Joe the Plumber take a flight to New York and purchase 1.5 shares of Microsoft at Wall Street, take the certificates, and fly back home? What would be the ramifications of allowing citizens to buy into the financial markets without a middle-man? Would the market collapse? Has this ever been tried in American history? **

It is completely legal for stocks and bonds to be sold privately without a broker. I have done it myself. Note, though, that there are two classes of investors: qualified and non-qualified. Reporting on the two is markedly different. Qualified investors meet certain criteria such as a high net worth and experience buying and selling investments. Such investors are considered to be aware of the risks of investing and able to make their own informed judgements about such deals. Non-qualified investors (most people) require different reporting and information for businesses to sell shares to. I have, right now, an exemption from such reporting for a firm I run provided such presentations are limited to no more than 30 non-qualified individuals per year.

Outside of the issues you asked about I think you’re operating under a bit of a misapprehension concerning the Federal Reserve. While it does, to a certain extent, provide a service as a clearinghouse for banks, it’s main goal is the smoothing out of the business cycle and the ‘boom and bust’ roller coaster that free markets are prone towards. A study of economics in the 19th century will show the wild swings and fortunes of a completely unfettered market. The Fed is designed to encourage economic activity and expansion when things are slow and to rein in wildly optimistic over-growth that could lead to a bubble and crash when things are growing unsustainably. Everything outside of that has been, up until the recent unpleasantness, an extra that the Fed took on as a part of its main role.

7

The first thing you need to know is that the Federal Reserve system was not created until 1913. Until then the U.S. did not have a central bank. So we know very well the problems that the lack of a central bank would create. As Jonathan Chance said, as soon as the U.S. developed a modern economy dependent on corporations, large capital needs, and expanded governmental functions a central bank became indispensable. That’s too big a subject to handle here, but since every industrialized nation in the world came to the same conclusion at about the same points in their histories, the solution seems to be well-considered.

The second thing you need to know is that “bank” is not an all-inclusive word. There are dozens of different types of banks, only a few of which are like the banks that have branches on your street corner. A central bank is hardly at all like that corner bank. Its purpose is to control the money supply, not to make loans. You should have been paying more attention last year when there was a giant ruckus about the Fed making loans at all. The Fed spends far more of its time setting interest rates for bank-to-bank transactions than making loans. Bank-to-bank transactions are not loans in the sense you’re thinking of, either, although they share some features.

A central bank is a unique institution. By definition there can only be one central bank. If there is more than one that banks can play them off one another and nobody would ever know what the current state of the system would be. There would be no control. The Federal Reserve is controlled by [url=“http://www.federalreserve.gov/”]a Board of Governors/url]. That leads to a nifty play on words. The purpose of the Fed is to govern:

It governs - controls - the money supply to make sure it is never too large or too small or growing or shrinking too quickly. Not like your corner bank at all.

You’re asking the wrong questions because you don’t understand what a central bank is in the first place. Once you do the answers fall into place.