In 1913, two pivotal events occurred that would forever transform the financial landscape of the United States – the creation of a central banking system and the ratification of the federal income tax. These two developments, which may seem like ancient history, continue to have a profound impact on our money and taxes today.
The Birth of the Central Banking System
Prior to 1913, the United States did not have a central banking system. This changed with the establishment of a central bank, which was created with the stated purpose of preventing financial crises and banking panics.
The way the central bank was intended to work was fairly straightforward:
- If a bank was facing a liquidity crunch and customers were rushing to withdraw their deposits, the central bank could step in and provide that bank with emergency lending.
- This would theoretically prevent a “run on the bank” and stop the panic from spreading to other financial institutions.
- The central bank’s role as a “lender of last resort” was meant to bring stability to the banking system. However, the way the central bank has evolved over the past century tells a more complex story.
The Rise of Fractional Reserve Banking
To understand the true purpose of the central bank, we need to look at the banking system that existed before 1913 – fractional reserve banking.
Fractional reserve banking is a system where banks only hold a fraction of their customers’ deposits as cash reserves, and lend out the rest.
Here’s how it works in a simple example:
- You deposit $100 into a bank.
- The bank keeps $10 (10%) as a cash reserve, and lends out the remaining $90 to someone else.
- That $90 is then deposited into another bank, which keeps $9 (10%) as a reserve and lends out $81.
This process continues, with banks repeatedly lending out the majority of the money they receive in deposits. The problem with this system is that it creates the potential for a “bank run.” If too many customers try to withdraw their deposits at once, the bank won’t have enough cash on hand to meet the demand. This can cause the bank to collapse, and the panic can spread to other banks as well.
The Central Bank’s True Purpose
This is where the central bank comes in. Rather than being a neutral arbiter tasked with preventing banking crises, it was actually created to serve as a backstop for the fractional reserve banking system.
The central bank’s primary role is to provide emergency lending to banks that are facing liquidity issues, allowing the fractional reserve system to continue operating.
In other words, the central bank was designed to put a “band-aid” on the inherent instability of fractional reserve banking, rather than addressing the root cause of the problem.
This is an important distinction, because it reveals the central bank’s true purpose – to enable and perpetuate a banking system that relies on creating money out of thin air.
The Central Bank and Inflation
Another key function of the central bank is its ability to influence the money supply and interest rates. This power has significant implications for inflation.
Prior to 1971, the U.S. dollar was tied to the gold standard, meaning the central bank’s ability to print money was constrained by the amount of gold reserves the government held. However, in 1971, the link to gold was severed, giving the central bank free rein to expand the money supply as it saw fit.
Since then, the central bank has had the ability to create money out of thin air, leading to a steady erosion of the dollar’s purchasing power over time.
This is where the connection between the central bank and the federal income tax becomes clear. As the government’s spending has grown over the decades, the central bank has stepped in to provide the necessary funding by printing more money.
However, this money printing comes at a cost – inflation. And who ends up bearing the brunt of that cost? The average consumer, through the gradual decline in their standard of living.
The Hidden Tax of Inflation
While the federal income tax has become increasingly burdensome over time, it’s not the only way the government extracts wealth from its citizens. Inflation, driven by the central bank’s money printing, acts as a hidden tax that erodes the purchasing power of our dollars.
Inflation disproportionately hurts the average person, while benefiting investors and asset owners.
This is because inflation tends to drive up the prices of goods and services that consumers purchase, while investment assets like stocks and real estate tend to appreciate in value. As a result, the gap between the wealthy and the middle class has widened significantly over the past several decades.
The Importance of Financial Education
The story of the central bank and the federal income tax highlights the importance of financial education. Most people have little understanding of how the monetary system works, or how the actions of the central bank and the government can impact their personal finances.
This lack of financial literacy puts the average person at a significant disadvantage. Without a solid grasp of concepts like inflation, fractional reserve banking, and the role of the central bank, it becomes much harder to protect oneself and build wealth over the long term.
Strategies for Financial Success
So, what can you do to navigate this complex financial landscape and improve your chances of achieving financial freedom? Here are a few key strategies:
- Become an Investor
One of the best ways to combat the effects of inflation is to become an investor. By putting your money to work in assets like stocks, real estate, and precious metals, you can potentially outpace the rate of inflation and grow your wealth over time. - Understand the Importance of Passive Income
In addition to building investment assets, it’s also important to generate passive income streams. This could involve starting a side business, renting out property, or investing in dividend-paying stocks.
Passive income can help insulate you from the effects of inflation and provide a more stable financial foundation.
- Seek Professional Guidance
Given the complexity of the financial system and the ever-changing landscape of investment opportunities, it’s often wise to seek guidance from a qualified financial advisor.
An experienced advisor can help you develop a comprehensive financial plan, optimize your investment portfolio, and navigate the challenges posed by inflation and government policies.
- Stay Informed and Engaged
Finally, it’s crucial to stay informed about the latest developments in the economy, financial markets, and government policies. This will help you anticipate and adapt to changes that could impact your financial well-being.
By subscribing to a daily financial newsletter, you can stay up-to-date on the latest news and trends, and make more informed decisions about your money.
Conclusion
The events of 1913 – the creation of the central banking system and the ratification of the federal income tax – have had a profound and lasting impact on our financial system. Understanding this history, and how it continues to shape the economic landscape today, is essential for anyone seeking to achieve financial security and independence.
By becoming an informed investor, generating passive income, seeking professional guidance, and staying engaged with the latest financial developments, you can navigate the complexities of the modern monetary system and build the wealth and financial freedom you deserve.