Much of this material is available on the Midnight Communism youtube channel or on TankieTalk as episodes 6, 7, and 8 respectively, that is: Credit, Crisis, and the State, Financialization, and The Central Bank.
The capitalist world was rocked last week with the failure of an important venture capitalist banking firm, Silicon Valley Bank (SVB), which puts the topic of capitalist crisis once again on the forefront of everyone’s minds. What exactly is credit, and how did the bank collapse so swiftly? Where did all that money go? The answers to these questions seem like mysteries, particularly when you listen to the babbling of capitalist economists. They talk a lot about confidence and contagion, but they fundamentally leave you feeling like money itself isn’t real. That’s because they don’t understand it.
What is the Federal Reserve?
The U.S. central banking system was created in 1913 after two centuries of fighting between Yankee merchants and Dixie planters. The Civil War and Reconstruction had finally settled the fight between slave and industrial capital and, with the economic death of the slave-based planter class, the slavers’ objections to banks gave way to the need for a rationalized banking system to support the industrializing U.S. east.
After experimenting with many small private banks and no organizing authority at the end of the 19th century (this was, after all, the period of “free market” capitalism), the many monetary crises and bank failures that resulted convinced the wealthy U.S. capitalists that they needed a system to ensure monetary stability. Enter, the Federal Reserve Act of 1913. Today, the Fed (as it’s known) prints all paper bills, monitors and controls the money supply, and (loosely) controls the credit system. Because it “impinges” on the old unfettered right of capitalists to engage in certain kinds of speculative theft, extreme fiscal reactionaries are always screaming about abolishing it so they can more nakedly swindle the working masses. In reality, the Federal Reserve is one of the most important tools in the U.S. capitalist arsenal to maintain stability and delay the periodic crises of overproduction that cause depressions and recessions.
The Fed is a system of 12 chartered, state banks, funded by an excise on the private banks in the U.S. that operate as the country’s monetary authority. It operates through the tacit agreement of the capitalist class. Above all else, it serves the monopoly capitalists by giving structure and stability to finance capital. As a “neutral” arbiter, the Fed stands above the individual whims of the thieving capitalists and works to coordinate the overall economy. It manipulates U.S. credit and currency, punishes the capitalists that step too far out of line or try to cheat other capitalists too brazenly or completely, and works diligently to shift the result of every capitalist misstep from the shoulders of the capitalists themselves so their costs are borne by the working classes.
The Fed controls the money supply. That’s the amount of circulating currency (and credit) in the U.S. economy. It controls real physical bills because it is the issuer of all new currency and it destroys old currency to maintain a desired number of bills in circulation. Credit is a more complicated creature, but rest-assured that the Fed has a wide variety of tools for controlling the credit system, all of which will be addressed below. Finally, the Federal Reserve is the so-called lender of last resort.
Raising Money
When the federal government of the U.S. empire needs to spend money to act – for instance, to pay off a segment of its bourgeois capitalist class so it can buy the shiniest and deadliest new weapons for the U.S. armed forces – it can’t turn to taxes. The federal government has been engaged in “deficit spending” – spending more than it raises in taxes – since 2001.
To get new money to spend on programs to buy off the working classes, to pay the salaries of flunkies and lackeys, to manufacture deadly missiles or fund invasions, the Federal Reserve sells securities. These are debt-instruments, basically government I.O.U.s. They’re known as treasury bills, notes, and bonds. You may see savvy capitalists referring to these as T-bills, T-notes, and T-bonds.
Treasury bills are a promise to pay at a future date – a kind of credit. Treasury bills have a face value, generally $1,000 although bills in excess of $5m have been sold. They have a maturity date which can be 4, 8, 13, 26 or 52 weeks. Treasury bills are sold at a discount, meaning the Fed promises to pay $1,000 for some amount less than $1,000 at the time of purchase. The Fed auctions off treasury bills in exchange for currency. The currency thus acquired is used to pay current government debts.
Treasury notes are essentially the same as treasury bills, however they have a maturity date between 2 and 10 years and they pay interest rather than maturing to face value.
Treasury bonds are exactly the same as treasury notes, except they have maturity dates between 10 and 30 years.
When these state debt instruments are sold, they are exchanged for currency, which can either be used to fund government spending, or taken out of circulation if the Fed is attempting to shrink the money supply.
They are also sold in secondary markets – that is, traded between people who own them. Their exchange value in the secondary market is a function of the interest rate that was set at the time of the bill’s issuance (which is usually related to the Federal Funds Rate, more on that below), maturity date, and demand. When the Fed increases the Federal Funds Rate to control inflation (as it is doing now), older T-bills are worth less because all newly issued T-bills will tend to match the higher Federal Funds Rate – and why buy a bill with an interest rate of 2% when you can buy one with a rate of 5%?
Quantitative Easing
This is the actual mechanism by which the Federal Reserve increases the money supply. Quantitative easing is performed by the Federal Reserve printing new money or creating new demand accounts or other forms of currency, and then using that sudden increase to buy back outstanding T-bills, notes, or bonds. Redemption auctions are how the money enters circulation. Money that did not exist before is thus exchanged for outstanding federal debt.
If this sounds to you like circular logic of the capitalists paying themselves for the benefit of buying their own debt and money, you aren’t far off. For instance, let’s say Northrop Grumman wants to sell its new, unreleased, B-21 for $700 million to the U.S. air force. The Fed issues 700,000 $1,000 T-bills and the money for the B-21 comes pouring in from the other corporations. The government turns around and buys the bomber using the money it’s taken in through these auctions. Then, let’s say there’s a credit crunch and the economy is “in danger” – that is, a number of banks fail and suddenly firms all over the U.S. are in danger of folding. The Fed can turn around and buy back that very same $700 million in T-bills using newly created money.
The logic behind this is to grant further liquidity to the economy – that is, to make it possible to circulate more money on investments, to stimulate spending and borrowing, and to keep capital turning over. In practice, this means devaluing the already-issued currency that’s out there. Because production hasn’t increased, because there are no new products on the market, the only thing that can change to handle the increased currency amount is an effective reduction in value; that is, inflation.
The Fed helps capitalist firms trade values like this, and every time anything goes wrong, it uses quantitative easing to make sure the capitalists have enough money to keep operating… and, because the new money is always issued to capitalist firms, the real, material effect of this is to shift the burden to those who can’t afford or don’t know to participate in these auctions: the working classes. By engaging in this practice, the Fed changes the overall distribution of currency, increasing its concentration in the hands of capitalists and reducing the purchasing power of the money in the hands of the working classes. It is the most sophisticated scheme of defrauding the public that has ever been devised.
The Reserve Requirement
The Fed, as a response to the market crash of 1929 which began the Great Depression, took regulatory steps to try to prevent bank runs from occuring in the future. A bank run occurs when a bank has lent more than it actually has (borrowing on credit and leveraging debt as described above) and enough account holders attempt to simultaneously withdraw their money that the bank can’t cover all the withdrawals.
The Fed has historically required banks to maintain a certain amount of currency so they can cover their debts. This requirement is flexible and generally set by the Federal Reserve Board. This rate each bank is required to keep is calculated by using the current reserve ratio. This is calculated as Bank Deposits x Reserve Ratio. For instance, if the Board sets the reserve ratio at 10% and a bank has deposits of $1 billion, the bank is required to keep at least $100 million of currency so it can cover a bank run of up to that amount.
Currently, the Reserve Ratio is 0%. This means banks are not required to keep any currency on-hand. The Fed changed this rule during the pandemic as part of the federal government’s program to force people back to work without crashing the capitalist economy. This is, of course, instead of a planned economy in which we would have been quarantined and taken care of – all of us – until the danger from the pandemic passed. Instead, Washington declared open season for speculation by telling the banks they could literally spend all of their money, and the Fed would make sure everyone’s deposits were covered.
Interest Rates, the Discount Rate, the Federal Funds Rate, and the Prime Rate
Interest rates are how much future production is owed for presently-issued credit. That is, if a loan is taken out and currency is given, a certain amount of currency will be due back at a future date, calculated at a percentage rate based on the loan agreement. This percentage-rate-over-time is the interest rate of the loan.The Federal Reserve controls interest rates by controlling the federal funds rate, which in turn is used by banks to set the prime lending rate, and all other rates for progressively less “credit-worthy” loans are calculated using the prime lending rate as a starting point.
Discount Rate and Federal Funds Rate
The federal funds rate is the rate that the Federal Reserve banks charge other banks to borrow excess cash reserves. What does this mean? If a bank is going to close its business day with less than the federally mandated reserve requirement on hand, it is required to borrow the difference from its local branch of the Federal Reserve bank, and to repay it with an interest rate set by the Federal Reserve. This is called the discount rate.
Banks could also choose to borrow from other banks to cover the reserve amount on the overnight loan. This is usually cheaper than borrowing from the Federal Reserve by 50 basis points (1/100th of 1%) and is called the federal funds rate. The federal funds rate is also set by the Fed. It is currently 0.25 as a result of the pandemic. The rate was 1.5 prior to the pandemic.
Prime Lending Rate
The prime rate is the interest rate offered by banks to their most creditworthy corporate customers. All other loan interest rates are calculated using the prime rate as reference. Prime rates are different at every bank, and calculations are done as to how much they should charge customers who have very little chance of defaulting, but almost all of these calculations use the federal funds rate as a benchmark. Thus, by changing the federal funds rate and the discount rate, the Fed can influence the rates of all loans and all credit throughout the entire U.S. imperial monetary system.
Lender of Last Resort
The Fed is the U.S. “lender of last resort” – which means that, should a major bank or other institution fail to secure funds to remain solvent, the Fed will lend the required amount out to that bank to prevent its collapse. This is accomplished using the tools listed above, and is the Fed’s primary purpose: as a backstop to secure the entire U.S. economy.
The Current Crisis
The collapse of SVB and the threats now facing the economy are the direct result of this atmosphere of deregulation. It’s tempting to frame this as a return to the “bad old days” of the early 20th century, before regulations were adopted as the result of the Great Depression, but the fact of the matter is that this situation is actually worse. This isn’t a case where there is a kind of lawless frontier where there are no regulations – instead, the Fed has been actively encouraging wild speculation by promising cheap (actually, essentially free) and easy money.
That means loans have been given out like candy. The atmosphere of excessive speculation on bad investments started in 2008 with the general reduction in regulation to try to pull the economy back from the brink of the huge crisis that struck it that year; ever since, speculative investments (investments on things that promise huge returns but likely won’t pan out) have been spreading. Why not, if the Fed is going to give you zero-interest money to try things out with? As the rate of profit sinks, speculation becomes more attractive.
With COVID, things kicked into overdrive. The bourgeoisie, always half-grifter to begin with, has seen an explosion of companies that do absolutely nothing and promise the moon. Because firms, particularly tech firms, can take many years to pan out into profitability, every investor is looking for the next Apple- or Microsoft-to-be. Some of these tech companies, like Uber and DoorDash, model their entire business on keeping themselves alive through venture-capital infusions until they manage to take over the whole market, driving out the already-existing firms, and creating a tech-based monopoly. To get from plucky startup to tech supergiant, these firms need constant infusions of “venture capital,” or investment cash, because they don’t turn a profit. With money as loose and liquid as it has been, the number of hucksters and snake-oil salesmen has ballooned. Firms that never had any intention of producing anything resembling a profit sprang up overnight. Their “plucky” CEOs filled their pockets with investment cash and have every intention of declaring bankruptcy, shuttering the non-producing firm, and doing a runner with the money.
SVB was one of the chief repositories of investment cash for this kind of non-firm. As the Fed tried to reign in the inflation it had caused by creating and injecting twice the already-existing currency into the system (you read that right, the Fed increased the money so much during the pandemic that 2/3rds of all U.S. dollars currently in circulation have been created just since 2020) it put SVB and other speculator’s banks in danger. In order to fight inflation, the Fed raised the interest rates. When the interest rates go up, the value of Treasury bills goes down.
SVB, already under-capitalized and exposed to a potential catastrophe, held a lot of Treasury bills. The bank also “owned” a lot of intellectual property – the valuation of which is completely subjective. Intellectual property can’t be liquidated at a moment’s notice either; the only way to transform it into hard currency is either to sell it or to use it to produce profit.
As the price of its assets plummeted and its owners realized it wouldn’t be able to cover withdrawals from its major clients, it started emergency procedures to get more money… which tipped off its clients that it was in trouble, who then all simultaneously tried to withdraw their funds – causing a run on the bank.
Now the Fed has come in to save the day and repay all the depositors. Where will they get the money to do that? You guessed it, by selling Treasury bills! In fact, they announced they would sponsor a special loan program where they overvalue collateral. You can already see how this is kicking the can down the street for the next big crash, which is just around the corner. They’re trying to shore up a leaking ship. And the thing is, they’re shoring it up by punishing the working classes, none of whom receive any of this benefit.
Every day, a dollar in your hand is worth less than the day before. Every day, food costs more, fuel costs more, heat and cooling cost more. Every day, your paycheck shrinks. Why? Blame the thieves of thieves at SVB. Blame the flunkies and lackeys at the Fed. Blame your senator, who probably had dinner with a huge SVB investor last night – a man that asked them to make sure they were protected. But most of all, blame the monopoly capitalist – the speculator, who gets to walk away from the speculation, purse intact.
