In The Creature from Jekyll Island, Edward Griffin makes a case for abolishing the Federal Reserve, arguing that much of what it does is contrary to the best interests of the American people. The title of the book requires a bit of explanation: According to Griffin, the Federal Reserve System was originally designed as a banking cartel by six influential businessmen who met secretly in 1910 at a hunting lodge on Jekyll Island. Their ideas hatched the “creature” that became the Federal Reserve System.
(Shortform note: While “Jekyll Island” might sound like something out of horror fiction, thanks to the famous novel Dr. Jekyll and Mr. Hyde, the island is a real place in the state of Georgia. It was named after an English financier long before the horror novel was written. Today the island is a state park.)
As an author and filmmaker, Griffin is known as a conspiracy theorist. Among other things, his books and movies support the chem-trail conspiracy and a theory that the pharmaceutical industry has long known about and concealed the cure for cancer. In The Creature from Jekyll Island he asserts that wealthy financiers conspired to create the Federal Reserve (the Fed) and that they dictate its operations to this day. He weaves his rationale for abolishing the Fed together with historical anecdotes and evidence for his conspiracy theories to make his book read more like a detective story than a financial textbook. However, many of his reasons for wanting to abolish the Fed relate to what it does and how it operates, irrespective of who controls it.
As such, in this guide, we’ll briefly consider Griffin’s conspiracy theories to provide context, but we’ll focus mostly on his core criticisms of the Fed. We’ll examine the problems he identifies with how the Fed operates and how it hurts the American people. We’ll compare his analysis of the problems with the perspectives of economists like Thomas Sowell (Basic Economics) and Henry Hazlitt (Economics in One Lesson). Finally, we’ll compare Griffin’s solution to a different proposal by Saifedean Ammous in The Bitcoin Standard.
Griffin feels that too many people dismiss conspiracy theories because they don’t believe that elite groups conspire to undermine institutions or the general public. In his view, explanations based on conspiracy tend to be more credible because they are consistent with human nature.
Humans naturally tend to be self-serving: With relatively few exceptions, they do what they think is most likely to increase their own wealth, power, or happiness. So if they think they can get ahead by forming secret alliances with other influential people (and if they think they can get away with it) then they do it. As such, Griffin believes there are always webs of conspiracy running through and behind the power structures of every civilization. The more we uncover these conspiracies and their intentions, the better we can understand history and current events.
In the case of the Federal Reserve, prominent bankers wanted to form a cartel—a secret coalition that limits competition by standardizing prices and practices across supposedly-competing businesses within an industry. In this way, they hoped to increase their profits and bring the rest of the nation's banks at least loosely under their control by forcing them to join the cartel. When they met on Jekyll Island, they designed the Federal Reserve System to function as a banking cartel.
Griffin explains that disguising the banking cartel as a government agency not only gave it the appearance of legality and legitimacy, but also gave it two important advantages over most cartels:
But Griffin’s conspiracy is about more than just profits: It’s also about power. Griffin asserts that many prominent people in the banking cartel, as well as their modern-day successors, also have ties to a secret society bent on literal world domination. In this society, a small, secret inside circle of leaders directs the actions of organizations that can operate in full view of the public because their members have no idea that their work is designed to advance the society’s secret agenda.
The society’s ultimate goal is to create a one-world government, which they would control by controlling the world’s wealth and providing financial backing only to political leaders they could easily manipulate.
According to Griffin, part of the secret society’s agenda involves weakening America’s economy, reducing America’s industrial capacity, and lowering Americans’ standard of living so that the United States will be less able to resist giving up national sovereignty to an international government. This would explain why the Federal Reserve facilitates so much harm to the American economy, even in ways that don’t necessarily generate profits for bankers.
Are Conspiracies Inherently Unstable?
Some people agree with Griffin that humans are, by nature, filled with selfish ambition, but contend that this actually prevents conspiracies from becoming very powerful. Oxford physicist David Grimes even formalized this argument into a mathematical model.
According to this view, a few individuals acting in isolation generally can’t accomplish much on their own. So, to become powerful, conspiracies have to become relatively large. But the more people who are in on the conspiracy, the harder it is to keep the organization secret, and the more likely the conspiracy will be exposed.
Given that conspiracies depend on secrecy for survival and success, there’s always a temptation for a self-interested member to expose the conspiracy in hopes of being rewarded by those who oppose the conspiracy’s agenda. And the likelihood of someone yielding to that temptation increases as the size of the organization increases, creating a catch-22: If the conspiracy remains small, it will never be very powerful, but if it grows large it will eventually be exposed and fall apart.
Griffin would probably concede that there is some validity to this principle, given his acknowledgment that many cartels fail because of internal distrust among members. However, he argues that this problem can be overcome through careful design of the organization—an argument that philosophy professor Kurtis Hagen has also made more formally.
In the case of the world-domination conspiracy, Griffin explains that the secret society is designed to have multiple layers that allow it to function with minimal threat of exposure: The real leaders are part of a small inner circle, whose very existence is a closely-guarded secret.
Beyond his allegation that it was created through a conspiracy and continues to be run by conspiracists who probably don’t have your best interests at heart, Griffin identifies several problems with the Federal Reserve System that would warrant its abolition in and of themselves, and not because of who’s running the system.
Specifically, he argues that the Fed facilitates and legalizes certain types of fraud, destabilizes the economy by making business cycles more severe and by encouraging unwise investments, exacts a hidden tax in the form of inflation, promotes war, and enables wasteful government spending. Let’s consider each of these problems in turn.
Griffin asserts that the Fed facilitates and legalizes fraud by allowing banks to engage in fractional lending. Fractional lending is when a bank keeps only a fraction of its depositors’ money on hand and loans out the rest. Fractional lending is profitable because it allows the bank to loan out more money and to charge interest on it.
But fractional lending is also akin to bluffing: The bank is gambling on the likelihood that only a fraction of its depositors will want to withdraw their money before the loan is repaid, and that this fraction will be no larger than the fraction of their money that the bank kept on hand. Griffin argues that fractional lending is fraudulent because the bank is essentially loaning out money it doesn’t have, making it look like the money is in two places at once.
For example, suppose 100 people each deposit $1,000 in checking accounts at a given bank, so the bank has $100,000 in total deposits. The bank lends out $80,000 to someone, who uses it to purchase something. Suppose the person she purchased it from then deposits the $80,000 in his checking account at the bank. That increases the bank’s total deposits to $180,000, but $80,000 of that is being double-counted, because the bank owes it to both its original depositors and the new depositor.
At this point, the bank only has the $100,000 it started with, but if all its depositors tried to withdraw their funds, the bank would be obliged to pay out $180,000. Once the loan recipient pays off the loan ($80,000 plus interest) the bank will have enough money to meet all its obligations, but until then, it’s just gambling that it won’t need to pay out more money than it has.
Griffin explains that to avoid this problem, banks would have to inform their depositors that their funds are not available for withdrawal for a period of time while the money is out on loan. If the money isn’t available for withdrawal until it’s repaid by the loan recipient, then it wouldn’t be double-counted. Banks already do this with term-certificate deposits, where the depositor agrees to commit the funds for a set period of time, and the funds are only available for withdrawal when the term ends. But they also lend out funds from accounts you can withdraw money from at any time, such as a checking account, leading to double-counting as we’ve seen.
And, as Griffin points out, the Federal Reserve presides over all the double-counting of money because the Fed dictates what fraction of depositors’ money banks are required to keep on hand. According to Griffin, by setting the required reserve ratio to anything less than 100% for demand accounts, the Fed is condoning, legalizing, and facilitating a fraudulent practice.
(Shortform note: At the time Griffin wrote The Creature from Jekyll Island, the required reserve ratio was 10%. As of 2020, the Fed reduced it to 0%. Griffin would likely see this as a deliberate removal of one of the last vestiges of restraint on fractional lending.)
The Ethical Controversy Over Fractional Lending
Not everyone shares Griffin’s perspective that fractional lending constitutes fraud. The mainstream perspective among economists, as expressed by Thomas Sowell in Basic Economics, is that fractional lending is a legitimate banking practice that allows for more efficient use of funds in the economy. After all, not all of a bank's depositors are going to need to withdraw all their funds at once, so fractional lending allows these otherwise unused funds to be put to use. Businesses benefit from the greater availability of loans, which enables them to operate on a larger scale, benefiting the economy. Banks profit from the interest on the loans, and pass on a fraction of the interest to their depositors.
So everybody wins with fractional lending. How can it be fraud if all the involved parties benefit from it?
Griffin would likely answer that these benefits are outweighed by the harm that fractional lending causes. We’ll discuss the ways that he believes fractional lending harms the economy later in this guide.
Griffin notes that helping to stabilize the economy is allegedly a key part of the Fed’s mission, but he argues that, in fact, it tends to destabilize the economy. It does this in two ways.
First, Griffin asserts that by facilitating fractional lending, the Fed amplifies normal cycles of economic growth and contraction, thereby creating economic instability. He argues that if there were no fractional lending, and the money supply was fixed, there would still be fluctuations in the economy, but these business cycles would be much less pronounced than what we see today.
As we’ve discussed, fractional lending creates money out of thin air by loaning out the same money that a bank must keep available for withdrawal. When banks iteratively receive deposits and lend them out, the money gets repeatedly double-counted, so the total amount of money in circulation grows exponentially as long as banks are making loans.
Thus, as Griffin explains, when the economy is growing and businesses are borrowing money to finance new start-ups, the money supply grows rapidly. All the additional money in the economy creates a temporary boom. But as the supply of money increases, its purchasing power diminishes, and prices rise. As prices rise, some businesses are unable to complete their expansion projects or start-ups. As these ventures fail, the economy begins to contract.
Businesses stop borrowing and start trying to cut expenses. Some repay their loans, others default on them, and the same process that caused the money supply to expand now works in reverse, causing it to decrease exponentially. With money in short supply, the economy goes into recession. This is how fractional lending causes boom-and-bust cycles in the economy.
Austrian Business Cycle Theory
Griffin did not originate the idea that fluctuations in the money supply destabilize the economy by amplifying business cycles—this concept is central to Austrian Business Cycle Theory, which is a key component of the Austrian School of economic thought. The Austrian School offers some additional perspective on the subject, as well as some additional criticism of central banks such as the Federal Reserve.
The Austrian School asserts that central banks destabilize the economy not only through fractional lending but also by artificially lowering interest rates. The Fed (and other central banks) loan money to banks at a “discount window” or “discount rate,” increasing the availability of capital and driving down interest rates throughout the economy. Fractional lending, then, amplifies this effect by further increasing the money supply as loans are taken out at rates that are lower than they’d be if subject to natural economic pressures.
According to Austrian economic theory, interest rates reflect the value of money plus time, and allow business people to assess whether a project is worth taking on: Will a business venture return more profit than interest rates would, given time?
But interest rates that the Fed sets lower than they would be based on market forces lead to inaccurate projections, which lead to failed business ventures. As these failed ventures accumulate, they trigger contraction of the money supply as they are liquidated to pay off their loans or default on them outright. These small contractions are amplified by fractional lending, leading to ever-larger economic contraction and triggering economic recession.
Thus, according to Austrian economic theory, the Fed introduces microeconomic instability by artificially depressing interest rates, and fractional lending (which, as Griffin points out, the Fed facilitates) amplifies the effect, resulting in macroeconomic instability.
(Note: Despite the name, the Austrian School is not geographically confined to Austria—it merely originated there. It is the third most common economic perspective in the United States after Keynesianism and Monetarism.)
The second way that the Fed destabilizes the economy, according to Griffin, is by sheltering banks from the consequences of poor business decisions, thereby incentivizing them to engage in risky business practices. He discusses three mechanisms that remove banks’ incentive to operate responsibly.
Mechanism 1: Lender of Last Resort. One of the Fed’s original core functions was to act as a benevolent “lender of last resort,” allowing banks to borrow practically unlimited funds in case of a liquidity emergency (a situation where the bank doesn’t have enough cash or other “liquid assets” to operate). By performing this function, the Fed insulates banks from risk by ensuring that they can always borrow enough funds to meet their immediate obligations. This incentivizes practices like fractional lending, where the bank would be obliged to pay out more money than they have if all their depositors withdrew their money at the same time.
Mechanism 2: Bailouts. When a large enough bank gets into financial trouble, the government typically steps in to prevent it from failing, ultimately transferring the bank’s losses to American taxpayers. But, perhaps more importantly, the government also bails out large corporations and foreign governments that borrow from banks in the US. As such, if the borrower is big enough to be eligible for bailout, then the bank doesn’t need to consider the soundness of the borrower’s business practices. The availability of large loans to fund risky or wasteful business ventures leads to large failed business ventures, which contribute to economic instability.
This is because the loan carries no risk for the bank, since even if the borrower defaults, someone (usually American taxpayers) will still pay back the loan with interest. Griffin concedes that in bailout situations, banks often take a token loss, but he argues that the amount banks write off in such cases isn’t large enough to make a dent in their profit from the loan. He also notes that, while Congress is responsible for most bailouts, the Fed facilitates the process.
Mechanism 3: Deposit Insurance. Through the Federal Deposit Insurance Corporation (FDIC), the Fed insures all bank deposits, so depositors have little reason to vet the credibility of their banks, and banks don’t have to compete with each other for depositors’ trust by adhering to sound business practices.
Griffin thinks that if the FDIC were abolished, private insurance companies would begin offering deposit insurance to banks. He expects these companies would scrutinize each bank’s business practices and adjust their premiums based on the risk that each bank posed. This would incentivize banks to avoid risky practices (fractional lending, for example), in contrast to the FDIC’s flat rates, which provide no incentive for banks to handle their depositors’ money responsibly.
How Much Does the Fed Really Protect Banks From Risk?
Some economists argue that banks aren’t sheltered from risk as much as Griffin says because the picture that he paints of how the FDIC and the Fed operate is incomplete.
In the case of the Fed acting as a lender of last resort, most economists acknowledge that this function does involve a moral hazard (a financial incentive to take risks because you’re sheltered from the consequences), but they argue that not having a lender of last resort would present an even greater hazard overall. Without a lender of last resort, banks facing liquidity crises would fail. Bank failures disrupt the business of the bank’s depositors, which, in turn, disrupts the economy. Thus, the economic instability introduced by bank failures is arguably greater than the economic instability introduced by the moral hazard of having a lender of last resort for banks to fall back on.
In the case of bailouts, generally, the government only bails out businesses whose failure would cause systemic collapse of the US economy. A bank can’t know in advance whether the government would bail it out during a crisis. For example, in the 2008 housing market crash, the government bailed out several large financial institutions, but it let Merrill Lynch fail and be bought up by Bank of America. Thus, banks are unlikely to base their business decisions on the chance of a bailout.
It’s also worth noting that, in the case of the 2008 bailouts, the US Treasury reports that in the end, the financial institutions it bailed out not only survived but eventually repaid the money they received with interest, so the bailout ended up being a good investment of taxpayers’ money. This tends to imply that, while these companies unquestionably made some poor business decisions leading to the crash, at least they learned from their mistakes and went on to become profitable again.
Furthermore, with the passage of the Dodd-Frank Act in 2010, the government seems to be trying to get out of the bailout business. The Dodd-Frank Act endeavors to replace bailouts with “bail-ins.” In a bail-in, a financial institution that gets into financial trouble but whose failure would jeopardize the economy at large is allowed to cannibalize its depositors’ “unsecured assets.” (Unsecured assets are those not protected by the FDIC, such as deposits in excess of the threshold that the FDIC insures.) Basically, a bail-in enables a financial institution to avoid a complete failure without the injection of outside capital by passing on some of its losses to its depositors.
As such, bail-ins highlight the limitations of FDIC deposit insurance, and imply that banks do have to compete for the trust of their depositors, since their depositors are at risk of losing money if the bank has to execute a bail-in. This is especially important for large depositors, whose balances are more likely to exceed FDIC thresholds.
Griffin asserts that the Fed is responsible for inflation, and he is concerned that inflation constitutes an unfair, hidden tax whereby the American people pay for the government’s expenditures without realizing it.
As Griffin explains, the Fed issues the fiat currency of the United States. Fiat currency, by definition, isn’t backed by gold or silver or any other tangible material, so in principle, there’s no limit on how much currency the Fed can create.
In practice, the Fed creates as much additional currency as the government needs to finance its operations. However, as the supply of US dollars increases, the purchasing power of each dollar decreases, meaning American consumers can’t buy as much with their money—this is inflation. Thus, by creating more currency and causing inflation, the Fed takes purchasing power away from everyone else who owns US dollars.
Griffin concedes that not all deficit spending money comes from the Fed. When the government needs money, it borrows it by issuing bonds. Some of these bonds are bought by private parties, but if Congress issues more bonds than people want to buy, the Fed is legally obligated to buy the rest. And it does so by creating additional dollars.
(Shortform note: If you’re an investor looking to build a low-risk portfolio for dependable income, US treasury bonds may be exactly what you need. Treasury bonds provide predictable income from the interest that the government pays on the bonds, and carry very little risk, in contrast to stocks, which promise a higher rate of return, but carry a much greater risk of loss.)
Is Taxation Through Inflation Unfair?
Griffin asserts that inflation—which the Fed creates by issuing additional currency—constitutes an unfair tax. It’s easy to see how inflation can be considered a tax if the government is creating new dollars to fund projects, while reducing the purchasing power of the money that was already in circulation, but how is this unfair? When money loses value, the loss in purchasing power is distributed among everyone who has money, and scales according to the amount of money they have, so those with the most money lose the most purchasing power and those with the least money lose the least. Some might argue that this makes it a very equitable tax.
But other authors have developed the case for the unfairness of inflation more fully. In Economics in One Lesson, Henry Hazlitt explains that inflation doesn’t happen all at once, but rather ripples outward from the point where the government first spends the new money. This means different groups will be affected differently as inflation takes effect.
When the government first buys goods and services with newly issued dollars, prices for those goods and services rise with the surge in demand. The businesses that sell them respond to the increased prices by expanding their operations, increasing the demand for labor and thus driving up wages in that particular line of business. Their employees eventually spend their increased incomes on other goods and services, increasing demand for most consumer goods and causing prices to rise. Increased prices again cause other suppliers to expand their operations, thereby raising wages—this time more generally—and the process repeats itself until the economy reaches a new equilibrium.
In the process, a few people saw their wages rise before the price of consumer goods started to rise, and thus actually benefited from this cycle of inflation, at least in the short-term (in the long term, the reduction in the value of their savings might outweigh this benefit). But other people (likely the majority) didn’t see their wages rise until after they’d been hit with higher prices, so they took a loss on top of the loss of value of their savings. So the effects of inflation are not uniform, but affect different people differently.
Additionally, in Basic Economics, Thomas Sowell argues that inflation disproportionately affects the poor because wealthy people have the resources to insulate themselves from inflation. The rich rarely keep any significant portion of their wealth in cash. Instead, they invest it in stocks, real estate, or other assets which will hold their value, rising in price as inflation occurs. But the poor generally can’t afford to invest in these kinds of assets and thus keep what little money they have in cash, which loses value as inflation progresses. So the poor end up losing a greater percentage of their purchasing power due to inflation than the rich do.
These principles—namely that in the short term, some people benefit from inflation while others lose out, and that in the long term, the poor lose the most purchasing power to inflation, while the rich lose the least—tend to strengthen Griffin’s argument that inflation is an unfair tax.
Griffin goes on to assert that by creating as much money as the government wants to borrow, the Fed encourages the government to waste money on projects that voters wouldn’t support if they had to pay for them through taxes (or if they knew that they were paying for them through inflation).
The primary example that Griffin gives of wasteful government spending is war and defense spending in preparation for possible wars.
(Shortform note: The unlimited financing that the Fed provides in time of war can also increase the scale of a war and thus the damage that the war causes, as Saifedean Ammous notes in The Bitcoin Standard while discussing the problems of fiat money. Ammous reasons that under a hard-money standard, where all currency is backed by gold or otherwise inherently limited in its supply, the government can only finance a war until its treasury is depleted. This gives governments an incentive to avoid war and limits the scope and scale of the wars they can fight. But the government’s ability to create fiat money removes these constraints, allowing it to continue fighting a war until it has exhausted all the resources of its entire population.)
Aside from war, Griffin expresses concern that welfare programs, foreign aid, and environmental protection initiatives often end up spending money wastefully. If the Fed couldn’t create unlimited currency to loan to Congress, these types of programs would have to be cut or at least run more efficiently.
(Shortform note: There are reasons to believe that if limited funding forced aid programs to run more efficiently and be more accountable, that would increase their effectiveness. In When Helping Hurts, Steve Corbett and Brian Fikkert observe that a key problem with aid programs is that they provide the wrong kind of aid, defaulting to doling out temporary relief to people who really need other forms of assistance (such as training or opportunities for networking, leading to better job options). More limited funding might force aid programs to cut back on handouts, and greater accountability for how they are using their funding might motivate them to analyze situations more carefully and provide the right kind of relief.)
Based on the problems we’ve discussed, Griffin insists that the Fed should be abolished, but he concedes that simply repealing the law that created the Fed and shutting down the system would be disastrous for the US economy. This is because the economy runs on currency issued by the Fed. If all that currency disappeared, the economy couldn’t function. So Griffin proposes a sequence of actions that would successfully abolish the Federal Reserve System and correct the problems we’ve discussed.
For one thing, since the Fed facilitates government borrowing, Griffin sees the national debt as a problem that needs to be addressed prior to closing it. He proposes having the Fed issue enough money to buy up all the treasury bonds that it doesn’t already own, effectively paying off the national debt with newly issued money.
Of course, the Fed is also responsible for managing America’s fiat currency, so before we can abolish the Fed, we need to abandon fiat currency. Griffin proposes phasing out fiat dollars in favor of a new currency backed by precious metals. We’ll call that new currency “precious metal dollars,” or PMD’s.
Once fiat dollars are fully phased out, the Fed can be shut down. Without the regulation and safeguards that it provided, some banks will undoubtedly fail. But others will adjust their business practices to manage risk more conservatively, abandoning practices like fractional lending. And this shift toward better banking practices among the surviving banks will ultimately make the economy more stable.
An Alternative Solution: The Bitcoin Standard
Cryptocurrency may offer an alternative approach to abolishing the Fed, or at least solving the problems that it creates, according to Griffin. In The Bitcoin Standard, economics professor Saifedean Ammous criticizes fiat currency and the central banks that issue it for many of the same reasons that Griffin criticizes the Federal Reserve, including inflation, wasteful government spending (especially on wars), and artificially low interest rates that destabilize the economy by enticing businesses to borrow money for bad ventures.
But rather than trying to abolish fiat currency by abolishing central banks, Ammous suggests that using bitcoin as an international monetary standard could lead to the abolition of fiat currency through the natural operation of market forces.
Bitcoin—and currencies fully backed by bitcoin—wouldn’t suffer from the problems of fiat currency because, as Ammous explains, Bitcoin is impossible for any government to control. This, in turn, is because of its decentralized network structure, which is distributed across many independent parties in many countries. And it’s equally impossible for anyone to arbitrarily issue more bitcoin like governments issue fiat currency, so the supply of bitcoin is stable—much like the supply of precious metals.
In Ammous’s solution, the Federal Reserve wouldn’t necessarily need to be abolished. Its power over the economy would be greatly diminished, and some of its functions might become increasingly irrelevant. But it might be able to serve a more useful function by holding a large reserve of bitcoin (similar to its current gold reserves), and buying and selling bitcoin from other central banks to smooth out fluctuations in the demand for bitcoins.
Ammous doesn’t address the problem of the national debt explicitly, but if market forces drove the US economy to use primarily bitcoin-backed dollars, the demand for US fiat dollars would decrease, and with it the value of fiat dollars. Because the US national debt is owed in fiat dollars, that would mean the real value of the debt would also diminish, making it easier to pay off and less of a problem in the meantime.
Imagine that the United States decided to implement Griffin’s plan for abolishing the Federal Reserve. In this exercise, you’ll have a chance to contemplate how that might affect you personally.
As the Fed pays off the national debt, there’s going to be far more dollars in circulation all at once, causing a sudden surge of inflation, or rather devaluation of the fiat US dollar. What do you think you would do to reduce your vulnerability to inflation or devaluation at that time?
Once the Fed closes down, no longer regulating banks or insuring deposits, some banks will likely fail, and their depositors will likely lose their savings. How would you manage this risk?
Now that you’ve had a chance to think through some of the issues involved in implementing Griffin’s plan, do you support or oppose this plan for abolishing the Fed? Why or why not?