The following speech from a renegade Fed chairman is excerpted from The Flight of the Barbarous Relic.
There should be a sign on the front of the Eccles Building in Washington saying, “We work for the elites—the commercial bankers and government—at the expense of everyone else. Try and stop us.”
Let’s try, shall we?
Bankers and politicians have had a mutually-rewarding relationship for ages. Bankers create money and loan it out at interest, which can be very profitable. The trouble is, creating money electronically or with a printing press, which is what central banks do, is counterfeiting. In return for a share of the newly-created money, government lets banks get away with it. Government gets bigger, bankers get richer.
Bank counterfeiting, which is another name for inflation, fuels a great many evils for which it gets little credit, such as wars and depressions. To put an end to this racket we need to establish a free market in banking, which means opening it up to competition.
What would prevent banks from counterfeiting on a free market? Property rights enforcement. All money is someone’s property.
Gold won the competition as the most popular money long ago. When a rare commodity such as gold is used for money, the supply remains fairly constant.
People have always known that increasing the money supply dilutes the value of each monetary unit. But apparently they didn’t make a connection between this fact and government’s eagerness to adopt a fiat dollar as our monetary standard. When new money is created as a matter of policy, as it has been for generations with the encouragement of leading economists, the dollar is doomed, and so are dollar users.
We need to remember, though, that banking as such is crucial to higher civilization. As one commentator has astutely observed, without an international banking system most of us wouldn’t be alive today. Money and banking make possible the division of labor, which has drastically reduced child mortality and raised living standards wherever free markets flourished.
But it’s also true that throughout most of banking history, banks promised to redeem their notes in some precious metal, either gold or silver. Though they could keep that promise for only a small fraction of their customers, it still served as a vital check on their propensity to counterfeit.
For Americans, the gold standard was killed by presidential decree during the crisis of the Great Depression. In 1971, another president told foreigners they could no longer get gold for American dollars and thus removed the last trace of monetary gold from international trade. Since then all governments have been on a fiat money standard, depreciating their currencies as a matter of policy.
The story of gold’s disappearance is part of a larger narrative about the growth of government. Besides being a check on bank counterfeiting, or inflation, gold is also a serious restriction on government expansion. For the advocates of big government, therefore, gold becomes a barbarous relic that stands in their way.
Because of the banker’s reputation for trust and propriety, their notes were readily acceptable in trade as substitutes for the gold locked away in their vaults. People knew they could redeem the notes for gold any time they wished. But because of the convenience of carrying and doing business with banknotes rather than coins, people tended to leave their gold in the bank.
Because money was in the possession of bankers, businessmen would come to them for loans, and the bankers, seeking additional profit opportunities, found ways to accommodate them.
Unfortunately, they turned to counterfeiting as a means of accommodation. They began creating and loaning out deposit receipts that had no gold behind them. The new notes were counterfeit because they were being passed off with the understanding that they were genuine gold substitutes. But in fact the notes only looked like the real thing. The bankers knew, though, that as long as they didn’t issue too many of these counterfeit bills, they would escape detection.
In extending loans with counterfeit notes or by creating unbacked deposit accounts, they could point to conspicuous growth in the local economy. According to almost everything we read, bankers weren’t committing fraud, they were helping businesses grow, putting people to work, and helping them earn a living. As businessmen, the bankers could tell themselves they were merely reacting to the demands of the market, in their case a demand for money. And they reacted by simply printing and issuing it.
Looking back, most commentators now find little fault with what they were doing. So what if their notes weren’t backed by gold? Today’s financial press would say the bankers were “investing” or “accommodating” or “providing liquidity.” You never hear anyone call it counterfeiting, at least not in mainstream circles.
But by issuing banknotes or credit not covered by gold, the bankers were increasing the money supply, a process identical in its effects to counterfeiting. An increase in the supply of money confers no broad social benefits—but it does benefit early users of the new money at the expense of others: the first users have the advantage of buying goods at current prices. Later, when prices have gone up, the inflated money supply doesn’t benefit anyone. We improve the general welfare by increasing the production of goods, not by increasing the production of money.
Nevertheless, the banks’ practice of generating unbacked money substitutes prevailed. Invariably, some would go too far and cause depositors to begin doubting their banker’s rectitude. A few would start showing up at teller windows wanting their notes exchanged for gold. Other note-holders would catch on, and the bank was soon confronted with a run. But without enough gold to redeem, many of the banks had to shut their doors. As the panic spread, even the more cautious banks would experience massive demands for redemption.
For reasons of its own, the government took a strong interest in the bankers’ plight and usually issued moratoriums on note redemption. For a period sometimes lasting years, banks were permitted to default on their liabilities to note holders while being allowed to conduct all other banking activities.
Helpful as this privilege was, it wasn’t enough. Banks weren’t always allowed to renege on their promises, their easy credit policies created bankruptcies and recessions, and besides, bank runs were embarrassing. No banker liked seeing crowds swarming at his door demanding what was theirs, even if the law was on his side.
Fortunately for American bankers and their political allies, Europe provided examples of ingenious solutions to the dilemma of bank counterfeiting. During the early years of the twentieth century US bankers imported some of their ideas and, together with a few powerful politicians, devised a plan for a banking cartel.
The cartel would consist of all the national banks of the country organized under the authority of a central bank, which would be endowed by government with a monopoly on the note issue. Furthermore, all the deposits of the member banks would be moved to the central bank and held as reserves, with the central bank dictating to its members what fraction of its reserves they had to maintain when making loans. Historically, banks have been held to a ten percent reserve requirement most of the time, meaning they could extend nine dollars in loans for every dollar held in reserve. By dictating reserve ratios for all members, the central bank would control the rate of monetary inflation in a uniform manner so that any one bank wouldn’t get more reckless than the others and get itself and the rest of the banks in trouble.
Americans didn’t like cartels or centralized power, the planners realized, so they called their creature a “reserve system” instead of a banking cartel and dressed it up with regional branches to avoid the appearance of a concentration of power. As John Kenneth Galbraith observed many years later, the regional design was ingenious for serving local pride “and for lulling the suspicions of the agrarians.” Since no cartel will work without government guns, it was natural, perhaps, to attach the name “federal” to it, as well. Thus, the American central bank became known as the Federal Reserve System, or the Fed.
Signed into law on December 23, 1913, the Federal Reserve Act was hailed as a major victory of the Progressive Era’s fight against the alleged abuses of concentrated market power, in this case, the Money Trust. Banking was at last “rescued” from the hands of Wall Street and put under the enlightened care of the government. Greed had been tamed by the people through their selfless representatives in Congress and their man in the White House. Government would see that the Fed served the “public interest” and would ensure that it didn’t fail. And with the Fed providing the economy with an “elastic currency,” the ruinous panics and depressions of the past would be gone forever.
Those were the beliefs; the facts reveal a far different story.
