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XVII. Conclusion: The Present Banking Situation and What to Do About It
1. THE ROAD TO THE PRESENT
With the Federal Reserve System established and in place after 1913, the remainder of the road to the present may be quickly sketched. After Fed inflation led to the boom of the 1920s and the bust of 1929, well-founded public distrust of all the banks, including the Fed, led to widespread demands for redemption of bank deposits in cash, and even of Federal Reserve notes in gold. The Fed tried frantically to inflate after the 1929 crash, including massive open market purchases and heavy loans to banks. These attempts succeeded in driving interest rates down, but they foundered on the rock of massive distrust of the banks. Furthermore, bank fears of runs as well as bankruptcies by their borrowers led them to pile up excess reserves in a manner not seen before or since the 1930s.
Finally, the Roosevelt administration in 1933 took America off the gold standard domestically, so that within the United States the dollar was now fiat paper printed by the Federal Reserve. The dollar was debased, its definition in terms of gold being changed from 1/20 to 1/35 gold ounce. The dollar remained on the gold standard internationally, with dollars redeemable to foreign governments and central banks at the newly debased weight. American citizens were forbidden to own gold, and private citizens' stocks of gold were confiscated by the U.S. government under cover of the depression emergency. That gold continues to lie buried at Fort Knox and in other depositories provided by the U.S. Treasury.
Another fateful Roosevelt act of 1933 was to provide federal guarantee of bank deposits through the Federal Deposit Insurance Corporation. From that point on, bank runs, and bank fears thereof, have virtually disappeared. Only a dubious hope of Fed restraint now remains to check bank credit inflation.
The Fed’s continuing inflation of the money supply in the 1930s only succeeded in inflating prices without getting the United States out of the Great Depression. The reason for the chronic depression was that, for the first time in American history, President Herbert Hoover, followed closely and on a larger scale by Franklin Roosevelt, intervened massively in the depression process. Before 1929, every administration had allowed the recession process to do its constructive and corrective work as quickly as possible, so that recovery generally arrived in a year or less. But now, Hoover and Roosevelt intervened heavily: to force businesses to keep up wage rates; to lend enormous amounts of federal money to try to keep unsound businesses afloat; to provide unemployment relief; to expand public works; to inflate money and credit; to support farm prices; and to engage in federal deficits. This massive government intervention prolonged the recession indefinitely, changing what would have been a short, swift recession into a chronic debilitating depression.
Franklin Roosevelt not only brought us a chronic and massive depression; he also managed to usher in the inflationary boom of 1933–37 within a depression. This first inflationary depression in history was the forerunner of the inflationary recessions (or “stagflations”) endemic to the post-World War II period. Worried about excess reserves piling up in the banks, the Fed suddenly doubled reserve requirements in 1937, precipitating the recession-within-a-depression of 1937–38.
Meanwhile, since only the United States remained on even a partial gold standard, while other countries moved to purely fiat standards, gold began to flow heavily into the United States, an inflow accelerated by the looming war conditions in Europe. The collapse of the shaky and inflationary British-created gold exchange standard during the depression led to a dangerous world of competing and conflicting national currencies and protectionist blocs. Each nation attempted to subsidize exports and restrict imports through competing tariffs, quotas, and currency devaluations.
The pervasive national and regional economic warfare during the 1930s played a major though neglected role in precipitating World War II. After the war was over, Secretary of State Cordell Hull made the revealing comment that
war did not break out between the United States and any country with which we had been able to negotiate a trade agreement. It is also a fact that, with very few exceptions, the countries with which we signed trade agreements joined together in resisting the Axis. The political lineup follows the economic lineup.1
A primary war aim for the United States in World War II was to reconstruct the international monetary system from the conflicting currency blocs of the 1930s into a new form of international gold exchange standard. This new form of gold exchange standard, established at an international conference at Bretton Woods in 1944 by means of great American pressure, closely resembled the ill-fated British system of the 1920s. The difference is that world fiat currencies now pyramided on top of dollar reserves kept in New York instead of sterling reserves kept in London; once again, only the base country, in this case the U.S., continued to redeem its currency in gold.
It took a great deal of American pressure, wielding the club of Lend-Lease, to persuade the reluctant British to abandon their cherished currency bloc of the 1930s. By 1942, Hull could expect confidently that “leadership toward a new system of international relationship in trade and other economic affairs will devolve very largely upon the United States because of our great economic strength. We would assume this leadership, and the responsibility that goes with it, primarily for reasons of pure national self-interest.”2
For a while, the economic and financial leaders of the United States thought that the Bretton Woods system would provide a veritable bonanza. The Fed could inflate with impunity, for it was confident that, in contrast with the classical gold standard, dollars piling up abroad would stay in foreign hands, to be used as reserves for inflationary pyramiding of currencies by foreign central banks. In that way, the United States dollar could enjoy the prestige of being backed by gold while not really being redeemable. Furthermore, U.S. inflation could be lessened by being “exported” to foreign countries. Keynesian economists in the United States arrogantly declared that we need not worry about dollar balances piling up abroad, since there was no chance of foreigners cashing them in for gold; they were stuck with the resulting inflation, and the U.S. authorities could treat the international fate of the dollar with “benign neglect.”
During the 1950s and 1960s, however, West European countries reversed their previous inflationary policies and came increasingly under the influence of free market and hard money authorities. The United States soon became the most inflationist of the major powers. Hard money countries, such as West Germany, France, and Switzerland, increasingly balked at accepting the importation of dollar inflation, and began to accelerate their demands for redemption in gold. Gold increasingly flowed out of the United States and into the coffers of foreign central banks.
As the dollar became more and more inflated, especially relative to the newly sounder currencies of Western Europe, the free gold markets began to doubt the ability of the United States to maintain the cornerstone of the Bretton Woods system: redeemability of the dollar into gold (to foreign central banks) at $35 an ounce. To keep the gold price down to $35, the Treasury began to find it necessary in the 1960s to sell more and more gold for dollars in the free gold markets of London and Zurich. In this way, private citizens of European and other countries (U.S. citizens were not allowed to own any gold) were able to obtain a kind of redeemability for their dollars at $35 an ounce of gold. As continuing inflationary policies of the United States accelerated the hemorrhaging of gold on the London and Zurich markets, the United States began the unraveling of the Bretton Woods system by installing the two-tier gold system of 1968. The idea was that the United States was no longer committed to support the dollar in the free gold markets or to maintain the price at $35 an ounce. A bifurcated gold market was to be constructed: The free market would be left strictly alone by the central banks of the world, and the central banks pledged themselves never to have anything to do with the free gold markets and to continue to settle their mutual foreign balances at $35 an ounce.
The two-tier system only succeeded in buying a little time for the Bretton Woods system. American inflation and gold outflow proceeded apace, despite the pleas of the U.S. that foreign central banks abstain from redeeming their dollars in gold. Pressure to redeem by European central banks led President Nixon, on August 15, 1971, to end Bretton Woods completely and to go off the gold standard internationally and adopt a pure fiat standard. The short-lived and futile Smithsonian Agreement of December 1971 tried to retain fixed exchange rates but without any gold standard—an effort doomed to inevitable failure, which came in March 1973.3
Thus, President Nixon in effect declared national bankruptcy and completed the failure to honor commitments to redeem in gold initiated by Franklin Roosevelt in 1933. In the meanwhile, Congress had progressively removed every statutory restriction on the Fed’s expansion of reserves and printing of money. Since 1971, therefore, the U.S. government and the Fed have had unlimited and unchecked power to inflate; is it any wonder that these years have seen the greatest sustained inflationary surge in U.S. history?
2. THE PRESENT MONEY SUPPLY
In considering the present monetary situation, the observer is struck with a phenomenon we mentioned at the beginning of this work: the bewildering series of Ms: Which of them is the money supply? The various Ms have been changing with disconcerting rapidity, as economists and monetary authorities express their confusion over what the Fed is supposed to be controlling. In particularly shaky shape are the Friedmanite monetarists, whose entire program consists of ordering the Fed to increase the money supply at a steady, fixed rate. But which M is the Fed supposed to watch?4 The puzzle for the Friedmanites is aggravated by their having no theory of how to define the supply of money, which they define in a question-begging way by whichever of the Ms correlates most closely with Gross National Product (correlations which can and do change).5
Everyone concedes that what we can call the old M-1 (currency or Federal Reserve Notes + demand deposits) was part of the money supply. The controversial question was and still is: Should anything else be included? One grievous problem in the Fed’s trying to regulate the banks is that they keep coming up with new monetary instruments, many of which might or might not be treated as part of the money supply. When savings banks began to offer checking services as part of their savings accounts, it became clear even to Friedmanites and other stubborn advocates of only checking accounts as part of the money supply, that these accounts—NOW and ATS—must be included as part of any intelligible definition of the money supply. Old M-1 then became M-1A, and NOW and ATS figures were included in a new M-1B. Finally, in 1982, the Fed sensibly threw in the towel by calling a new M-1 figure the previous M-1B and scrapping the M-1A estimates.6
The inclusion of new forms of checking accounts at savings and savings and loan banks in the new M-1, however, by no means eliminates the problem of treating these thrift institutions. For regular savings accounts at these institutions, and indeed at commercial banks, while not checkable, can be easily withdrawn in the form of a cashier’s or certified check from these banks. What genuine difference, then, is there between an officially checkable account and one that can be drawn down by a simple cashier’s check? The typical answer that a savings account must be withdrawn by presenting a passbook in person hardly seems to offer any genuine obstacle to withdrawal on demand.
No: The crucial distinction, and the crucial way to decide what is part of the money supply, must focus on whether a certain claim is withdrawable instantly on demand. The fact that any bank may be able legally to exercise a fine-print option to wait 30 days to redeem a savings deposit is meaningless, for no one takes that fine print seriously. Everyone treats a savings deposit as if it were redeemable instantly on demand, and so it should be included as part of estimates of the money supply.
The test, then, should be whether or not a given bank claim is redeemable genuinely and in fact, on demand at par in cash. If so, it should be included in the money supply. The counter-argument is that noncheckable deposits are transferred more slowly than checking. Indeed, we saw above how commercial banks were able to engineer credit inflation in the 1920s by changing from demand to alleged time deposits, which legally required much lower reserves. We also saw how several bank runs on these savings deposits occurred during the 1930s. Everyone treated these deposits as if they were redeemable on demand, and began to redeem them en masse when the banks insisted on the fine-print wait of 30 days.
The test, then, should be whether or not a given bank claim is redeemable, genuinely and in fact, on demand at par in cash. If so, it should be included in the money supply. The counter-argument that noncheckable deposits are transferred more slowly than checking accounts and therefore should not be “money” is an interesting but irrelevant fact. Slower-moving money balances are also part of the money supply. Suppose, for example, in the days of the pure gold coin standard, that individuals habitually had kept some coins in their house to be used for day-to-day transactions, while others were locked up in vaults and used only rarely. Weren’t both sets of gold coins part of their money stocks? And clearly, of course, the speed of spending the active balances is deeply affected by how much money people have in their slower-moving accounts. The two are closely interrelated.
On the other hand, while savings deposits are really redeemable on demand, there now exist genuine time deposits which should not be considered as part of the money supply. One of the most heartwarming banking developments of the past two decades has been the “certificate of deposit” (CD), in which the bank flatly and frankly borrows money from the individual for a specific term (say, six months) and then returns the money plus interest at the end of the term. No purchaser of a CD is fooled into believing—as does the savings bank depositor—that his money is really still in the bank and redeemable at par at any time on demand. He knows he must wait for the full term of the loan.
A more accurate money supply figure, then, should include the current M-1 plus savings deposits in commercial banks, savings banks, and savings and loan associations.
The Federal Reserve, however, has not proved very helpful in arriving at money supply figures. Its current M-2 includes M-1 plus savings deposits, but it also illegitimately includes “small” time deposits, which are presumably genuine term loans. M-2 also includes overnight bank loans; the term here is so short for all intents and purposes as to be “on demand.” That is acceptable, but the Fed takes the questionable step of including in M-2 money market mutual fund balances.
This presents an intriguing question: Should money market funds be incorporated in the money supply? The Fed, indeed, has gone further to bring money market funds under legal reserve requirements. The short-lived attempt by the Carter administration to do so brought a storm of complaints that forced the government to suspend such requirements. And no wonder: For the money market fund has been a godsend for the small investor in an age of inflation, providing a safe method of lending out funds at market rates in contrast to the cartelized, regulated, artificially low rates offered by the thrift institutions. But are money market funds money? Those who answer Yes cite the fact that these funds are mainly checkable accounts. But is the existence of checks the only criterion? For money market funds rest on short-term credit instruments and they are not legally redeemable at par. On the other hand, they are economically redeemable at par, much like the savings deposit. The difference seems to be that the public holds the savings deposit to be legally redeemable at par, whereas it realizes that there are inevitable risks attached to the money market fund. Hence, the weight of argument is against including these goods in the supply of money.
The point, however, is that there are good arguments either way on the money market fund, which highlights the grave problem the Fed and the Friedmanites have in zeroing in on one money supply figure for total control. Moreover, the money market fund shows how ingenious the market can be in developing new money instruments which can evade or make a mockery of reserve or other money supply regulations. The market is always more clever than government regulators.
The Fed also issues an M-3 figure, which is simply M-2 plus various term loans, plus large denomination (over $100,000) time deposits. There seems to be little point to M-3, since its size has nothing to do with whether a deposit is a genuine time loan, and since term loans should not in any case be part of the money supply.
The Fed also publishes an L figure, which is M-3 plus other liquid assets, including savings bonds, short-term Treasury bills, commercial paper, and acceptances. But none of the latter can be considered money. It is a grave error committed by many economists to fuzz the dividing line between money and other liquid assets. Money is the uniquely liquid asset because money is the final payment, the medium of exchange used in virtually all transactions to purchase goods or services. Other nonmonetary assets, no matter how liquid—and they have different degrees of liquidity—are simply goods to be sold for money. Hence, bills of exchange, Treasury bills, commercial paper, and so on, are in no sense money. By the same reasoning, stocks and bonds, which are mainly highly liquid, could also be called money.
A more serious problem is provided by U.S. savings bonds, which are included by the Fed in L but not in M-2 or M-3. Savings bonds, in contrast to all other Treasury securities, are redeemable at any time by the Treasury. They should therefore be included in the money supply. A problem, however, is that they are redeemable not at par, but at a fixed discount, so that total savings bonds, to be accurately incorporated in the money supply would have to be corrected by the discount. Still more problems are proffered by another figure not even considered or collected by the Fed: life insurance cash surrender values. For money invested for policyholders by life insurance companies are redeemable at fixed discounts in cash. There is therefore an argument for including these figures in the money supply. But is the Fed then supposed to extend its regulatory grasp to insurance companies? The complications ramify.
But the problems for the Fed, and for Friedmanite regulators, are not yet over. For should the Fed keep an eye on, and try to regulate or keep growing at some fixed rate, a raw M-1, or M-2 or whatever, or should it try to control the seasonally adjusted figure?
In our view, the further one gets from the raw data the further one goes from reality, and therefore the more erroneous any concentration upon that figure. Seasonal adjustments in data are not as harmless as they seem, for seasonal patterns, even for such products as fruit and vegetables, are not set in concrete. Seasonal patterns change, and they change in unpredictable ways, and hence seasonal adjustments are likely to add extra distortions to the data.
Let us see what some of these recent figures are like. For March 1982, the nonseasonally adjusted figure for M-1 was $439.7 billion. The figure for M-2 was $1,861.1 billion. If we deduct money market mutual funds we get $823 billion as our money supply figures for March 1982. There are at this writing no savings bonds figures for the month, but if we add the latest December 1981 data we obtain a money supply figure of $891.2 billion. If we use the seasonally adjusted data for March 1982, we arrive at $835.9 billion for the corrected M-2 figure (compared to $823.1 billion without seasonal adjustments) and $903.6 billion if we include seasonally adjusted savings bonds.
How well the Reagan Fed has been doing depends on which of these Ms or their possible variations we wish to use. From March 1981 to March 1982, seasonally adjusted, M-1 increased at an annual rate of 5.5 percent, well within Friedmanite parameters, but the month-to-month figures were highly erratic, with M-1 from December 1981 to February 1982 rising at an annual rate of 8.7 percent. Seasonally adjusted M-2, however, rose at a whopping 9.6 percent rate for the year March 1981-March 1982.
The numerous problems of new bank instruments and how to classify them, as well as the multifarious Ms, have led some economists, including some monetarists, to argue quite sensibly that the Fed should spend its time trying to control its own liabilities rather than worrying so much about the activities of the commercial banks. But again, more difficulties arise. Which of its own actions or liabilities should the Fed try to control? The Friedmanite favorite is the monetary base: Fed liabilities, which consist of Federal Reserve notes outstanding plus demand deposits of commercial banks at the Fed. It is true that Federal Reserve actions, such as purchasing U.S. government securities, or lending reserves to banks, determine the size of the monetary base, which, by the way, rose by the alarmingly large annual rate of 9.4 percent from mid-November 1981 to mid-April 1982. But the problem is that the monetary base is not a homogeneous figure: It contains two determinants (Federal Reserve notes outstanding + bank reserves) which can and do habitually move in opposite directions. Thus, if people decide to cash in a substantial chunk of their demand deposits, FRN in circulation will increase while bank reserves at the Fed will contract. Looking at the aggregate figure of the monetary base cloaks significant changes in the banking picture. For the monetary base may remain the same, but the contractionist impact on bank reserves will soon cause a multiple contraction in bank deposits and hence in the supply of money. And the converse happens when people deposit more cash into the commercial banks.
A more important figure, therefore, would be total bank reserves, which now consist of Federal Reserve notes held by the banks as vault cash plus demand deposits at the Fed. Or, looked at another way, total reserves equal the monetary base minus FRN held by the nonbank public.
But this does not end the confusion. For the Fed now adjusts both the monetary base and the total reserve figures by changes in reserve requirements, which are at the present changing slowly every year.
Furthermore, if we compare the growth rates of the adjusted monetary base, adjusted reserves, and M-1, we see enormous variations among all three important figures. Thus, the Federal Reserve Bank of St. Louis has presented the following table of growth rates of selected monetary aggregates for various recent periods:7
While total reserves is a vitally important figure, its determination is a blend of public and private action. The public affects total reserves by its demand for deposits or withdrawals of cash from the banks. The amount of Federal Reserve notes in the hands of the public is, then, completely determined by that public. Perhaps it is therefore best to concentrate on the one figure which is totally under the control of the Fed at all times, namely its own credit.
Federal Reserve Credit is the loans and investments engaged in by the Fed itself, any increase of which tends to increase the monetary base and bank reserves by the same amount. Federal Reserve Credit may be defined as the assets of the Fed minus its gold stock, its assets in Treasury coin and foreign currencies, and the value of its premises and furniture.
Total Fed assets on December 31, 1981 were $176.85 billion. Of this amount, if we deduct gold, foreign currency, Treasury cash and premises, we arrive at a Federal Reserve Credit figure of $152.78 billion. This total consists of:
- float-cash items due from banks which the Treasury has not yet bothered to collect: $10.64 billion
- loans to banks: $1.60 billion
- acceptances bought: $0.19 billion
- U.S. government securities: $140.4 billion
Clearly, loans to banks, despite the publicity that the discount (or rediscount) rate receives, is a minor part of Federal Reserve Credit. Acceptances are even more negligible. It is evident that by far the largest item of Federal Reserve Credit, amounting to 79 percent of the total, is U.S. government securities. Next largest is the float of items that the Fed has so far failed to collect from the banks.
Changes in Federal Reserve Credit may be shown by comparing the end of 1981 figures with the data two years earlier, at the beginning of 1980. Total Reserve Credit, on the earlier date, was $134.7 billion, a rise of 13.4 percent in two years. Of the particular items, loans to banks were $1.2 billion in the earlier date, a rise of 33.3 percent in this minor item. The float’s earlier figure was $6.2 billion, a rise in this important item of 71.0 percent for the two years. The major figure of U.S. government securities had been $126.9 billion two years earlier, a rise of 10.6 percent in this total.
If we take gold as the original and proper monetary standard, and wish to see how much inflationary pyramiding our Federal Reserve fractional reserve banking system has accomplished on top of that gold, we may note that the Fed’s total of gold certificates on December 31, 1981 was $11.15 billion. On this figure, the Fed has pyramided liabilities (Federal Reserve notes plus demand deposits at the Fed) of $162.74 billion, a pyramiding of 14.6:1 on top of gold. On top of that, however, the banking system had created a money supply totaling $444.8 billion of M-1 for that date, a pyramiding of 2.73:1 on top of the monetary base, or, an ultimate pyramiding of 38.9:1 on top of the Fed’s stock of gold.
3. HOW TO RETURN TO SOUND MONEY
Given this dismal monetary and banking situation, given a 39:1 pyramiding of checkable deposits and currency on top of gold, given a Fed unchecked and out of control, given a world of fiat moneys, how can we possibly return to a sound noninflationary market money? The objectives, after the discussion in this work, should be clear: (a) to return to a gold standard, a commodity standard unhampered by government intervention; (b) to abolish the Federal Reserve System and return to a system of free and competitive banking; (c) to separate the government from money; and (d) either to enforce 100 percent reserve banking on the commercial banks, or at least to arrive at a system where any bank, at the slightest hint of nonpayment of its demand liabilities, is forced quickly into bankruptcy and liquidation. While the outlawing of fractional reserve as fraud would be preferable if it could be enforced, the problems of enforcement, especially where banks can continually innovate in forms of credit, make free banking an attractive alternative. But how to achieve this system, and as rapidly as humanly possible?
First, a gold standard must be a true gold standard; that is, the dollar must be redeemable on demand not only in gold bullion, but also in full-bodied gold coin, the metal in which the dollar is defined. There must be no provision for emergency suspensions of redeemability, for in that case everyone will know that the gold standard is phony, and that the Federal government and its central bank remain in charge. The currency will then still be a fiat paper currency with a gold veneer.
But the crucial question remains: For there to be a gold standard the dollar must be defined as a unit of weight of gold, and what definition shall be chosen? Or, to put it in the more popular but erroneous form, at what price should gold be fixed in terms of dollars? The old definition of the dollar as 1/35 gold ounce is outdated and irrelevant to the current world; it has been violated too many times by government to be taken seriously now. Ludwig von Mises proposed, in the final edition of his Theory of Money and Credit, that the current market price be taken as the definition of gold weight. But this suggestion violates the spirit of his own analysis, which demonstrates that gold and the dollar are not truly separate commodities with a price in terms of the other, but rather simple definitions of unit of weight. But any initial definition is arbitrary, and we should therefore return to gold at the most conveniently defined weight. After a definition is chosen, however, it should be eternally fixed, and continue permanently in the same way as the defined unit of the meter, the gram, or the pound.
Since we must adopt some definition of weight, I propose that the most convenient definition is one that will enable us, at one and the same time as returning to a gold standard, to denationalize gold and to abolish the Federal Reserve System.
Even though, for the past few years, private American citizens have once again been allowed to own gold, the gold stolen from them in 1933 is still locked away in Fort Knox and other U.S. government depositories. I propose that, in order to separate the government totally from money, its hoard of gold must be denationalized; that is, returned to the people. What better way to denationalize gold than to take every aliquot dollar and redeem it concretely and directly in the form of gold? And since demand deposits are part of the money supply, why not also assure 100 percent reserve banking at the same time by disgorging the gold at Fort Knox to each individual and bank holder, directly redeeming each aliquot dollar of currency and demand deposits? In short, the new dollar price of gold (or the weight of the dollar), is to be defined so that there will be enough gold dollars to redeem every Federal Reserve note and demand deposit, one for one. And then, the Federal Reserve System is to liquidate itself by disgorging the actual gold in exchange for Federal Reserve notes, and by giving the banks enough gold to have 100 percent reserve of gold behind their demand deposits. After that point, each bank will have 100 percent reserve of gold, so that a law holding fractional reserve banking as fraud and enforcing 100 percent reserve would not entail any deflation or contraction of the money supply. The 100 percent provision may be enforced by the courts and/or by free banking and the glare of public opinion.
Let us see how this plan would work. The Fed has gold (technically, a 100 percent reserve claim on gold at the Treasury) amounting to $11.15 billion, valued at the totally arbitrary price of $42.22 an ounce, as set by the Nixon administration in March 1973. So why keep the valuation at the absurd $42.22 an ounce? M-1, at the end of 1981, including Federal Reserve notes and checkable deposits, totaled $444.8 billion. Suppose that we set the price of gold as equal to $1,696 dollars an ounce. In other words that the dollar be defined as 1/1696 ounce. If that is done, the Fed’s gold certificate stock will immediately be valued at $444.8 billion.
I propose, then, the following:
1. That the dollar be defined as 1/1696 gold ounce.
2. That the Fed take the gold out of Fort Knox and the other Treasury depositories, and that the gold then be used (a) to redeem outright all Federal Reserve Notes, and (b) to be given to the commercial banks, liquidating in return all their deposit accounts at the Fed.
3. The Fed then be liquidated, and go out of existence.
4. Each bank will now have gold equal to 100 percent of its demand deposits. Each bank’s capital will be written up by the same amount; its capital will now match its loans and investments. At last, each commercial bank’s loan operations will be separate from its demand deposits.
5. That each bank be legally required, on the basis of the general law against fraud, to keep 100 percent of gold to its demand liabilities. These demand liabilities will now include bank notes as well as demand deposits. Once again, banks would be free, as they were before the Civil War, to issue bank notes, and much of the gold in the hands of the public after liquidation of Federal Reserve Notes would probably find its way back to the banks in exchange for bank notes backed 100 percent by gold, thus satisfying the public’s demand for a paper currency.
6. That the FDIC be abolished, so that no government guarantee can stand behind bank inflation, or prevent the healthy gale of bank runs assuring that banks remain sound and noninflationary.
7. That the U.S. Mint be abolished, and that the job of minting or melting down gold coins be turned over to privately competitive firms. There is no reason why the minting business cannot be free and competitive, and denationalizing the mint will insure against the debasement by official mints that have plagued the history of money.
In this way, at virtually one stroke, and with no deflation of the money supply, the Fed would be abolished, the nation’s gold stock would be denationalized, and free banking be established, with each bank based on the sound bottom of 100 percent reserve in gold. Not only gold and the Mint would be denationalized, but the dollar too would be denationalized, and would take its place as a privately minted and noninflationary creation of private firms.8
Our plan would at long last separate money and banking from the State. Expansion of the money supply would be strictly limited to increases in the supply of gold, and there would no longer be any possibility of monetary deflation. Inflation would be virtually eliminated, and so therefore would inflationary expectations of the future. Interest rates would fall, while thrift, savings, and investment would be greatly stimulated. And the dread specter of the business cycle would be over and done with, once and for all.
To clarify how the plan would affect the commercial banks, let us turn, once more, to a simplified T-account. Let us assume, for purposes of clarity, that the commercial banks' major liability is demand deposits, which, along with other checkable deposits, totaled $317 billion at the end of December 1981. Total bank reserves, either in Federal Reserve notes in the vaults or deposits at the Fed, were approximately $47 billion. Let us assume arbitrarily that bank capital was about $35 billion, and then we have the following aggregate balance sheet for commercial banks at the end of December 1981 (Figure 17.1).
FIGURE 17.1 — THE STATE OF THE COMMERCIAL BANKS: BEFORE THE PLAN
We are proposing, then, that the federal government disgorge its gold at a level of 100 percent to total dollars, and that the Fed, in the process of its liquidation, give the gold pro rata to the individual banks, thereby raising their equity by the same amount. Thus, in the hypothetical situation for all commercial banks starting in Figure 17.1, the new plan would lead to the following balance sheet (Figure 17.2):
FIGURE 17.2 — THE STATE OF THE COMMERCIAL BANKS: AFTER THE PLAN
In short, what has happened is that the Treasury and the Fed have turned over $270 billion in gold to the banking system. The banks have written up their equity accordingly, and now have 100 percent gold reserves to demand liabilities. Their loan and deposit operations are now separated.
The most cogent criticism of this plan is simply this: Why should the banks receive a gift, even a gift in the process of privatizing the nationalized hoard of gold? The banks, as fractional reserve institutions are and have been responsible for inflation and unsound banking.
Since on the free market every firm should rest on its own bottom, the banks should get no gifts at all. Let the nation return to gold at 100 percent of its Federal Reserve notes only, runs this criticism, and then let the banks take their chances like everyone else. In that case, the new gold price would only have to be high enough to redeem outfight the existing $131.91 billion in Federal Reserve notes. The new gold price would then be, not $1,690, but $500 an ounce.
There is admittedly a great deal of charm to this position. Why shouldn’t the banks be open to the winds of a harsh but rigorous justice? Why shouldn’t they at last receive their due? But against this rigor, we have the advantage of starting from Point Zero, of letting bygones be bygones, and of insuring against a wracking deflation that would lead to a severe recession and numerous bankruptcies. For the logic of returning at $500 would require a deflation of the money supply down to the level of existing bank reserves. This would be a massive deflationary wringer indeed, and one wonders whether a policy, equally sound and free market oriented, which can avoid such a virtual if short-lived economic holocaust might not be a more sensible solution.
Our plan differs markedly from other gold standard plans that have been put forward in recent years. Among other flaws, many of them, such as those of Arthur Laffer and Lewis Lehrman, retain the Federal Reserve System as a monopoly central bank. Others, such as that of F.A. Hayek, doyen of the Austrian School of Economics, abandon the gold standard altogether and attempt to urge private banks to issue their own currencies, with their own particular names, which the government would allow to compete with its own money.9 But such proposals ignore the fact that the public is now irrevocably used to such currency names as the dollar, franc, mark, and so on, and are not likely to abandon the use of such names as their money units. It is vital, then, not only to denationalize the issuing of money as well as the stock of gold, but also to denationalize the dollar, to remove the good old American dollar from the hands of government and tie it firmly once again to a unit of weight of gold. Only such a plan as ours will return, or rather advance, the economy to a truly free market and noninflationary money, where the monetary unit is solidly tied to the weight of a commodity produced on the free market. Only such a plan will totally separate money from the pernicious and inflationary domination of the State.
- 1. Cordell Hull, Memoirs (New York: Macmillan, 1948), vol. 1, p. 81. See in particular, Murray N. Rothbard, “The New Deal and the International Monetary System,” in L. Liggio and J. Martin, eds., Watershed of Empire: Essays on New Deal Foreign Policy (Colorado Springs, Colo.: Ralph Myles, 1976), pp. 19–64.
- 2. Rothbard, “New Deal,” p. 52.
- 3. For a brief summary of the progressive breakdown of world currencies from the classical gold standard to the end of the Smithsonian agreement, see Murray N. Rothbard, What Has Government Done to Our Money? 2nd ed. (Santa Ana, Calif.: Rampart College, January 1974), pp. 50–62. On the two-tier gold market, see Jacques Rueff, The Monetary Sin of the West (New York: Macmillan, 1972).
- 4. That is only one of the two major problems confronting the Friedmanites: the other is what fixed rate should the Fed follow? Monetarist answers have ranged from 3 to 5 percent (with even higher rates allowed for a gradual transition period) and down to zero (for those Friedmanites who have noted that in recent years the demand for money has fallen by about 3 percent per year).
- 5. For an excellent critique of the question-begging nature of Friedmanite definitions of money, see Leland B. Yeager, “The Medium of Exchange,” in R. Clower, ed., Monetary Theory (London: Penguin Books, 1970), pp. 37–60.
- 6. Recently, however, Fed apologists are beginning to excuse the disconcertingly large increases in M-1 as “only” in NOW and ATS accounts.
- 7. Federal Reserve Bank of St. Louis, Monetary Trends (March 25, 1982), p. 1.
- 8. For a summary and explanation of this plan, see Murray N. Rothbard, “To the Gold Commission,” The Libertarian Forum, XVI, 3 (April 1982), testimony delivered before the U.S. Gold Commission on November 12, 1981; and a brief abstract of the testimony in Report to the Congress of the Commission on the Role of Gold in the Domestic and International Monetary Systems (Washington, D.C., March 1982), vol. II, pp. 480–81. The only plan presented before the Commission (or anywhere else, as far as I know) similar in its sweep is that of Dr. George Reisman, in ibid., vol. II, pp. 476–77.
- 9. On the Lehrman, Laffer, and similar plans, see Joseph T. Salerno, “An Analysis and Critique of Recent Plans to Re-establish the Gold Standard” (unpublished manuscript, 1982). On Hayek’s plan to “denationalize money,” see Murray N. Rothbard, “Hayek’s Denationalized Money,” The Libertarian Forum XV, nos. 5–6 (August 1981–January 1982): 9.