Anyone who’s taken even a passing interest in the world of global finance will have no doubt heard frequent references to the Federal Reserve (also known as simply ‘the Fed’), the central bank of the United States.
As the custodian of the world’s most widely used currency, the US dollar, the Fed exerts a financial influence far beyond its domestic borders — and as such, its worth taking the time to learn a bit about when first beginning your journey as a forex trader.
Don’t know where to begin? No need to worry — read on for a whistle-stop tour of all you need to know about the most powerful central banking system on the planet!
A Brief History of the US Banking System
The Federal Reserve was established by the US Congress on 23rd December 1913 via the Federal Reserve Act. The arrival of the Fed was brought on by the government’s desire to assume greater centralised control of the country’s monetary system following a series of economic difficulties (for example the 1907 Banker’s Panic) and a perception that the existing decentralised financial system was too unreliable and ultimately unable to meet the demands of America’s growing economy.
Prior to the Federal Reserve’s existence, the US was served by First Bank of the United States (1791) and Second Bank of the United States (1816) respectively, which served as precursors to the modern system and were each responsible for issuing what small amounts of paper currency were available in the early American period.
However, once the Second Bank of the United States was dissolved in 1836, the country entered what is now known as the ‘Free Banking era’ for several decades, whereby no official state currency existed and instead a loose coalition of state-chartered banks (of which there were thought to be around 8,000 nationally by 1860) issued their own banknotes independently from one another!
This phase drew to a close at the onset of the US Civil War in the 1860s — when the failings of the decentralised system were brought to light as a result of the social and political divide — leading to the National Banking Act of 1863. This game-changing initiative mandated that a single national currency be implemented and ordered that only nationally chartered banks be eligible to issue bank notes, paving the way for the organisation of the Federal Reserve at the beginning of the next century.
Further reading: https://www.factmonster.com/math/money/brief-history-us-banking
The Layout of the Federal Reserve System
Officially speaking, the Federal Reserve is its own independent entity, though it the US Congress oversees the operation of both the organisation itself and its constituent parts. Purposefully designed to eschew the model of a single monolithic central bank, the Fed is split into three primary divisions, which are its Board of Governors — an agency of the Federal Government — the FOMC Federal Open Market Committee (FOMC, which we’ll discuss further below) and its 12 Federal Reserve Banks.
With regards to the latter part, the Fed system effectively splits the US into 12 distinct districts, each one represented (and served) by a separately incorporated regional Federal Bank — though it is worth noting that these areas were drawn up that reflected the prevailing trade hubs that existed around the country in 1913, so do not correspond neatly to state lines.
The 12 cities to have their own Fed base are:
· Boston, Massachusetts
· New York City, New York
· Philadelphia, Pennsylvania
· Cleveland, Ohio
· Richmond, Virginia
· Atlanta, Georgia
· Chicago, Illinois
· St. Louis, Missouri
· Minneapolis, Minnesota
· Kansas City, Missouri
· Dallas, Texas,
· San Francisco, California
Further reading: https://www.federalreserveeducation.org/about-the-fed/structure-and-functions
What is the Federal Open Market Committee (FOMC)?
The Federal Open Market Committee (FOMC) is the division of the Federal Reserve that is responsible for managing the US’ supply of money and overseeing the country’s monetary policy.
This hugely influential committee meets eight times per year as standard (with additional meetings if and when required) and comprises all seven members of the Fed’s Board of Governors, as well as five presidents from the regional Fed territories; four of these serve one-year terms on a rotational basis, whilst the New York Fed President remains a constant member.
The primary concern for the FOMC is deciding adjustments to the target for the overnight federal funds rate — i.e. the rate at which banks lend money to each other — depending on the current strength of the US economy, as this mechanism influences short-term interest rates.
In practice, this means reducing the target rate during periods when the economy requires additional stimulation, and conversely raising the rate when the economy needs slowing. Crucially, the FOMC is unable to change this rate by itself, though it can work to influence outcomes in numerous ways such as discounting the rate banks pay to borrow money from the Fed (making the federal funds rate more likely to decrease in tandem).
The committee can also amend banks’ reserve requirements, meaning the percentage of customers’ deposits they need to possess to cover withdrawals; this effectively ties banks’ hands by affecting how much money they can lend and leading them to change their own interest rates.
Further reading: https://www.thebalance.com/federal-open-market-committee-fomc-3305987
What are the Main Concerns of the Federal Reserve?
As the primary financial body for the US, the Fed is chiefly concerned with the country’s monetary policy, which in turn is largely centred around ensuring maximum employment levels within America and creating an economic system that is conducive to growth, both for individual businesses and the nation as a whole.
The Fed is also tasked with maintaining price stability across the country — defined as restricting inflation to around 2% — and promoting moderate interest rates over the long term. It also conducts research projects into various aspects of the economy and publishes a number of key informational artefacts such as its Beige Book (officially the ‘Summary of Commentary on Current Economic Conditions’) and the Federal Reserve Economic Data (FRED) database.
Furthermore, the Federal Reserve is responsible for supervising and regulating financial institutions in the US in order to safeguard consumers against losses and potential fraudulent activity, whilst helping optimise the country’s payment and settlement systems in terms of safety and efficiency.
Further reading: https://www.federalreserve.gov/faqs/what-economic-goals-does-federal-reserve-seek-to-achieve-through-monetary-policy.htm
How Does the Fed Affect the Supply of USD?
The Federal Reserve is able to either raise or decrease the amount of money in circulation, often working in collaboration with the US Mint to print additional currency and/or destroy any excess existing notes as needed.
The Fed can also purchase or sell government securities to its trading partners, which also affects the number of physical US dollars available for exchange across the economy.
Given that the USD is the most frequently traded currency worldwide, these and other Fed initiatives have knock-on effects throughout the wider global economy due to the implications they have on the supply vs demand of the world’s primary reserve currency.
In the most basic terms — when all other considerations are equal — the fewer US dollars in circulation, the lower the supply and the higher the demand, whilst the opposite is also true; oversupply of the US dollar leads to devaluing due to the amount available exceeding the organic demand.
Further reading: https://www.investopedia.com/articles/08/fight-recession.asp
Use at your own risk disclaimer
The content contained herein does not construe any form of advice and the user must not take this as such. We do not accept any liability for the direct or indirect usage of the content held in this article. We strongly advise that you obtain independent financial, legal and tax advice before proceeding with any currency or spot metals trades.
