http://www.goldensextant.com/SavingtheSystem.html

Reading the pro-gold submissions incorporated in the Report of the U.S. Gold Commission twenty-some years ago is a humbling exercise. A lot of those old commentaries could have been written today. They say just what gold bugs say now: our monetary system is doomed, and its end will be marked by a major monetary crisis. The concluding chapter of the Minority Report
Ahem. To state the obvious, the gold bugs of a generation ago got it wrong. Congress did not adopt their sound money recommendations, and yet the sky did not fall, the paper-based system muddled through famously, and in fact it was gold that entered into a 20 year bear market in dollar terms.
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The creation of our fiat money, that is, money issued by decree, or “fiat”, occurs in two phases. Phase I is controlled by the Fed, which does two things. First, it sets the level of non interest-bearing “reserves” that banks are required to hold, expressed as a percentage of their checking deposit base. That percentage is known as the “reserve ratio”. Adjusting this ratio up or down has a massive contractionary or expansionary impact on the money supply, given the multiplier effect described below, and for that reason it has been left alone for years at a marginal rate of 10%. Banks must maintain these reserves either in the form of Federal Reserve Notes kept on hand (“vault cash”), or in the form of balances held in an account at a Federal Reserve Bank (“reserve balances”).
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Second, the Fed creates the reserves, and injects them into the banking system. This is where the gulf between form and substance is most telling, causing reasonable people to marvel at the brazenness of it all. The Fed creates reserves out of thin air, in the form of fresh paper notes (“Federal Reserve Notes” or “dollars”) that it prints up, or in the form of checks written on itself. It can inject reserves into the banking system in two ways. One way is to lend them to specific banks, at a rate of interest known as the “discount rate.” Reserves borrowed in this fashion are called, logically enough, “borrowed reserves.” This used to be an important tool of monetary policy, but is rarely used today.
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Fed buys an asset for $10 from Big Bank One. That $10 will support another $100 of fresh money in the banking system in the form of new customer deposit accounts. But the new $100 doesn’t materialize all at once, or on the books of Big Bank One alone. Instead, it comes into being as the result of a gradual series of loan transactions that Big Bank One sets in motion. In what Rothbard calls a “ripple effect”, Big Bank One lends out a portion of the $10, namely $9, (1 minus the reserve requirement, or .9, times $10). That $9 ultimately gets deposited at Big Bank Two, which is the second stop in the series. Big Bank Two lends out .9 times the $9, or $8.10, and so forth, throughout the series. At the end of the series, the total new money thus created in the form of fresh deposit accounts is roughly equal to $100. Thus is our money borrowed into existence.
The same process works in reverse if the Fed, instead of buying something, sells it. This has the effect of draining reserves from the banking system, and will result in a similarly high powered contraction of the money supply.
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It is easy to see why it is in the interest of the Fed to embrace the Volcker legend. For its moral is that the all-knowing, all-seeing Fed, reluctantly but sternly facing down a crisis, did what it had to do to kill inflation. It had the power, it had the knowledge, and, with the right person in charge, it had the will. If things ever get out of hand again – not that they’d ever tolerate that, mind you – they’d do the same thing, and whip inflation’s sorry backside once more.

       
It should be noted, however, that even during its stingy phase, the Volcker Fed made sure to enhance the system’s back door access to borrowed reserves, just in case. It did this by means of discount rates that were generally set at significantly lower  levels than Fed funds rates. See table entitled “Key Interest Rates during the Volcker Fed” in the following section.

In any event, the stinginess was short-lived. Things changed dramatically in July 1982. From that point on, the Fed put the hammer to the floor and inaugurated what would become its standard response thereafter to any perceived systemic threat: extremely aggressive monetary expansion. The specific catalyst for this was the failure on July 6, 1982, of a “reckless little bank in Oklahoma” known as Penn
Square.[27] Penn Square’s paper was widely held by a number of important money center banks whose failure in turn was not an attractive prospect to the monetary authorities. A more general catalyst was the imminent sovereign default of Mexico.

Over the next five years, non-borrowed reserves (“NBR”) expanded at a heroic rate, roughly doubling the levels at the beginning of the Volcker Fed. By way of comparison, over the eight year period commencing August 1971, that is to say, during the inflationary hurricane preceding Volcker, Seasonally Adjusted NBR only increased from 14,380 to 18,923, and Not Seasonally Adjusted NBR only increased from 14,094 to 18,612. By way of further comparison, over the eight year period commencing August 1987, that is to say, during the warmup phase of the Greenspan Fed, Seasonally Adjusted NBR only increased from 38,651 to 57,326, and Not Seasonally Adjusted NBR only increased 38,412 to 56,655. The Maestro, no slouch himself in the monetary reserve creation department, was a piker in comparison to post-Penn Square Volcker.


Indeed, Richard Timberlake marshals the foregoing data to support his charge that Volcker’s Fed, far from being monetarist in its policies, was just another Fed, ramping up the money supply to aid an incumbent president in an election year, and choking back once the results were in

Prior to the presidential election of 1980, Fed policy had been highly stimulative in the face of manifest inflation. This experience, as well as the Fed’s performance in earlier presidential elections, inspired observers to rename the FOMC the  “Committee to Reelect the President.” The Record of Policy Actions of the FOMC never mentioned the retention of the incumbent president as a “goal” of policy. Nonetheless, most of the Reserve Board members in any given election year owed their appointments to the incumbent and had every incentive to “play ball.” The Fed’s performances just before, during, and just after elections in 1960, 1964, 1968, 1972, 1976, and 1980 seemed to be clearcut examples of a pattern that was restrictive and then stimulative during the year before the election, and then usually restrictive enough to slow down the inflationary reaction after the election.