Jay Taylor spoke recently at the San Francisco Hard Assets Investment Conference providing some history on the Federal Reserve and why it was formed. Mr. Taylor is editor of J Taylor's Gold & Technology Stocks newsletter. He has worked as a commercial banker and as an investment banker, including time in the mining and metals group of ING Barings in New York.
To get things started, Mr. Taylor talked about a book titled, The Creature from Jekyll Island by Edward Griffin. “If you want to understand why Mr. Bernanke is doing what he’s doing; why the President is doing what he’s doing; why presidents don’t pay any attention to their campaign promises once they get elected, I highly recommend you read the book,” suggests Mr. Taylor. “It’s factual. It will explain who the interests are that wanted the Federal Reserve and why it was created back in 1913.”
To give some background, Mr. Taylor explains that in 1910, a group of men that represented 1/6th of the world’s wealth congregated on this little island called Jekyll Island off the coast of Georgia. “The purpose of the gathering was to find a way to get a central bank monopoly put into existence in the United States,” he relates. “In 1913, it did become law. So, we have the creature from Jekyll Island, the Federal Reserve, that has more power and spends more money than Congress and has no accountability for it.”
Purpose of the Federal Reserve
Mr. Taylor continues, “The Fed stated policy is that it’s here to help us, right? It has to sell that idea to the public. It has to maintain stable prices and to maintain full employment. The theory is that the Fed is an independent organization that doesn’t have to answer to politics.”
“I think there’s nothing further from the truth,” he exclaims. “It doesn’t have to answer to the general people, but it does have to answer to some money interests and those folks I would submit are related to the wealthy folks who actually set up the Federal Reserve.”
Mr. Taylor continues by looking at the Federal Reserves performance in terms of its stated goals. “If we look at full employment, it’s done a horrible job. If we used the same yardstick as was used in the 1930s to determine unemployment we would be at 22%,” he states.
“If we look at stable prices, we’ve lost something like 94% of the purchasing power since 1913. So, the Fed has not done a good job of maintaining the purchasing power of the currency.”
Going back to The Creature from Jekyll Island, Mr. Taylor relates that the book talks about why the Federal Reserve was created. He says, “Not the reasons that they talk about all the time, but the real reason.” He then lists a number of points:
- To stop the growing influence of small rival banks
As America grew, there was a great deal of wealth created by the private corporations and the public companies. They did their own financing and deposited their money at the local banks. So, the big New York banks and the big European money interests wanted to create a monopoly that would stop this loss of market share.
- To create a more elastic money supply
When we have downturns in the economy, we pump money into the system. In theory, that’s supposed to help keep things going.
- To pool the meager reserves of various banks
There was a requirement for a certain amount of equity to debt in the balance sheets. The idea was to homogenize the balance sheets of all the banks so that there wouldn’t be runs on banks.
- To shift the losses from the banks to the taxpayers
We saw this after Lehman Brothers when an enormous amount of money was created out of nothing and used to bail out the banks.
Who Owns the Federal Reserve?
“I think it’s always important to follow the money and who owns the Federal Reserve,” relates Mr. Taylor. A group of shareholders that consists of approximately 2900 individual set member banks owns the Fed. Each bank is required to contribute 3% of their capital stock in exchange for shares in the Fed and they receive a 6% annual dividend. “There are 4800 banks that are not members of the Fed, but there are 2900 members of the Federal Reserve,” points out Mr. Taylor.
Looking more closely, Mr. Taylor reveals that 4 members of the Fed own 57% of the Federal Reserve stock. “You have Bank of New York, JP Morgan Chase, Citigroup, and Wells Fargo. And many of these institutions are still held by those families that congregated back in 1910,” he provides. “About 9 banks own two thirds of the stock in the Federal Reserve. Those are the people that are going to be protected at our expense.”
Credit Expansion and Contraction
Moving on, Mr. Taylor relates that, regardless of policy there are certain things that take place in human history. He explains, “What you see going back to the revolutionary war, are these huge 60+ year cycles. We have sustained credit expansion and then contraction. You see gold prices, commodity prices, interest rates, and what takes place is that governments push their expansion to the point where they can’t expand any further. The real problem we have now is not that we have $57 trillion debt in America, that’s not the issue. The issue is the relationship of the GDP to debt.”
Mr. Taylor states that the policies we are following now are the same as those from the 1930s. The book, America’s Great Depression by Murray Rothbard, points out that the government tried manipulating the money supply then and is trying it again now. “It’s the same aggressive policy of pumping money into the banking system trying to get the banking system to expand the money supply and create demand in the economy,” explains Mr. Taylor.
Mr. Taylor doesn’t see this strategy of pumping money into the banks as having the desired affect. The money is not getting out into the economy it’s staying in the banks. “The Fed went out and bought the distressed debt on the market and it pumped money into the banks just as it did in the 1930s. So we see the adjusted monetary base skyrocketing after Lehman Brothers, but at the same time, we see excess reserves at depository institutions also skyrocketing.” He again points to unemployment and mentions the housing problems to demonstrate that the money is not making it into the economy.
Policies Need to Change
How does this problem get resolved, Mr. Taylor asks. His answer to his question is, “It’s not going to get resolved through current policies. All the policies in the U.S. and in Europe are going to make things worse.”
Looking historically at our debt to GDP, Mr. Taylor mentions the previous high was in 1932. Then it was about 250%. He says, “We’re now north of 350% and we’re not going to come out of this recession until this comes back down to some meaningful level. And we have a long way to go to get to some meaningful level.”
His next question, “Do we now go through a hyperinflationary situation or a massive deflationary strong dollar situation? Without having the time to explain it here, I can tell you that I am biased toward the deflationary side.”
He explains his opinion by quoting from Robert Prechter in his book Conquer the Crash: “Countless people say that deflation is impossible because the Federal Reserve Bank can just print money to stave off inflation…the Feds main function has been to foster the expansion of credit. Printed fiat currency depends almost entirely upon the whims of the issuer, but credit is another matter entirely.”
In other words, you can put money into the banks, but the banks are not lending. He suggests, “Instead of giving $2 trillion to the banks to bail them out, you could give everybody their tax payments back for the last 3 years and you would have had a bottoms up revival in the economy, I believe. I’m not saying this is the right policy, but you could have created demand and I think a lot of inflation.” Mr. Taylor doesn’t see inflation happening. He only sees them protecting the banks. “And it’s not hard to understand why their protecting the banks because the Federal Reserve is owned by a very small number of very rich families and institutions that they have a very strong interest in.”
Credit Contraction
When we enter into a period of contraction, people sell off the speculative, luxury items that they don’t need for survival. Mr. Taylor says, “This is when the margin clerk calls for repayment of the loan, which necessitates people sell off these items.” People then look for the most liquid assets, those being gold and the Federal Reserve notes. “That’s the money you carry around in your pocket and you put under your bed. Not in your bank account because that is not a very secure place when the whole system starts to implode.”
Mr. Taylor sees us in the sixth major credit contraction in the last 300 years for the senior currency. In each of these cases, the price of gold has risen dramatically. “With that we see a skyrocketing increase in the earnings of major mining companies from the $5.77 cents in 2008 to the $28 projected for next year,” Mr. Taylor predicts.
When will this be over?
Mr. Taylor ends with what he believes needs to happen to turn things around. When the following happen:
- The Dow to gold ratio gets to 1 to 1
- The U.S. debt to GDP gets down to more reasonable levels
- Blue chip stocks sell at 10 times PE
- The real price of gold tops out
To his last point, Mr. Taylor states, “Research shows that the real price of gold rises and stays high for 15 to 20 years. We just started this bull market in gold in 2007 in my view.” He adds, “Commodities don’t do as well during these credit deflations. Gold does extremely well.”
“We could have a hyperinflationary problem if the dollar really crashes,” he admits.
Before ending his session, Mr. Taylor quickly listed off some companies that he likes and is watching:
- Dynacor Gold Mines
- Sandstorm
- Alexco Resources
- Great Panther
- Uranium Energy
- Merrex Gold
- Rye Patch Gold