America’s Money Machine

APERSPECTIVE UPON THE POLITICAL, social and moral influences flowing world-wide from the adoption of the monetary theories enacted in the Federal Reserve System requires a step back into the nineteenth century—specifically, to the coronation in 1876 of Victoria, queen of England, as empress of India. That event, occurring just a century following the U. S. Declaration of Independence and the appearance of Adam Smith’s Wealth of Nations, produced not only a revolution in the British political structure but in monetary practice. India, though long a British dependency, governed indirectly by a British proprietary company, the East India Company, was now integrated into an imperial system, and British economic interest in India required a similar integration of the monetary system.

The problem arose from the fact that England was on the gold standard, with the paper circulation convertible into gold coins, while in India paper notes were unknown and the circulation consisted of silver rupees of high quality. (The thirteenth century Mongol overlords of the East had introduced paper circulation into China, but had never succeeded in doing so in the Middle East and South Asia.) In India, where banking institutions were undeveloped, silver coinage provided both a satisfactory medium of exchange and a store of value, particularly for the great masses of the poor. British colonial practice had been to assure a supply of rupees through the system of free coinage, by which anyone could take silver to the mint and, for a small mintage charge, have it coined into legal tender with purchasing power never lower than that of the market value of the metal.

As the relative market values of gold and silver fluctuated, the result was a continual uncertainty in the exchange parity of the monetary units. To resolve the problems of unifying two monetary systems, one based on gold and the other on silver, a royal commission was appointed to study and to recommend a method.

During the hearings of the Commission, influential Indian opinion arose in defense of the existing system and cited a statement made earlier (in 1877) by the government. The statement deserves quotation for its clarity and the integrity of its premise:

Despite Indian opposition, the government of India now closed the mints to the free coinage of silver and gradually restricted the quantity of metallic circulation to that determined by government policy. To pro-vide circulating media it also introduced paper notes of rupee denomination, the acceptance of which was cultivated by making them convertible into sterling (and hence, into gold).

The gold exchange system was instituted in 1893. The experiment lasted little more than two decades. With the outbreak of World War I, Great Britain promptly suspended convertibility of its sterling circulation to conserve its gold stocks, with resultant rupee inconvertibility. The consequences in India, of a vast population deprived of a traditional money, compelled to use pieces of paper of uncertain worth, were economic distress and political unrest. In order to provide silver to the masses, and allay discontent, Great Britain appealed to the U. S. for aid; an act of Congress authorized the melting of 350 million silver dollars for shipment to India to restore confidence and retain loyalty to the British raj.

With return of peace, Britain neglected to profit from the lesson and proceeded to compound the error by degrading the rupee coinage to only half silver with the difference in base metal alloy. The effect was further erosion of Indian confidence and further unrest among the masses. During World War II the U. S. again came to the rescue of the British government—as well as to the Dutch and French, which had aped British monetary policy in the administration of their overseas dependencies. In the process, over 410 million ounces of silver were provided to bolster European colonial regimes. (Fortunately for this purpose, as a result of the various silver purchase acts enacted from 1876 through 1934 to absorb the shock to the mining industry from the general demonetization of silver in those years, in 1942 the U. S. Treasury held an enormous stock of silver, some 1,365 million ounces.)

The second attempt to impose a fictitious paper money circulation in the ancient lands of the East was also a failure. By 1949 India was irretrievably lost to the British crown, and in the following years nearly all British colonial dependencies were swept away—a fate followed by those of other European powers.

It is not too much to say that an underlying—and generally unrecognized—cause of discredit of the presiding sovereignties, and rising resistance to their rule, was the loss of integrity of their money, carrying with it disbelief in the integrity of the governments themselves.1

It is now necessary to notice that the Federal Reserve System suffered the same fate as the British Indian—and within about the same time span. Within two decades from the institution of the Federal Reserve the System was forced to suspend gold redemption of its currency.

That bankruptcy was inevitable should have been apparent from the steady dilution of the reserves to meet the obligations of the System. By 1933, total note and deposit obligations of the System convertible into gold amounted to $5.9 billion against gold holdings of $3.8 billion. This, of course, is only the tip of the iceberg. Since the Federal Reserve bank deposits were the prime reserve of the banking system generally, the total demand obligations of the banking system, provisionally convertible into gold, amounted to some $15 billion.

Circumstances at home and abroad continued to increase the gold reserve of the System through the Great Depression and World War II to a maximum of some $27 billion by 1949—some 70 per cent of world monetary gold stocks. But the obligations of the System, both direct and indirect, continued to outrace the reserve. After 1949 the gold reserve began a steady decline, while, as we have noted, succeeding enactments of Congress freed the System of any mathematical relationship between its obligations and its gold reserves.

By 1968, when the central banks of the world ceased to deliver gold to the market at monetary parities, the Federal Reserve note circulation had increased to $42.3 billion in addition to which were some $5.3 billion in debased coinage. Demand liabilities of the banking system had risen to $148.5 billion. The gold stock had dropped to $10.9 billion. During the following ten years the “money stock,” as the note and coin circulation and demand deposits were now called, rose to $361 billion, and if all banking obligations are included (savings accounts and time deposits), the total ran to upwards of $500 billion—a forbidding sum of dollar liabilities to blanch the advocates of a circulating metallic currency.

The consequences of a depreciating currency—consequences that are immediately economic but spread from there to tincture the social and political fabric of a country, infecting it with the virus of moral decay—have been the subject of many treatises and will only be summarized here. Mommsen’s history of the Roman Empire and Andrew White’s classic Fiat Money Inflation in France describe in vivid terms these effects; those in post-war Germany are of too recent memory to require retelling.

Despite the tragic history of depreciating currencies advocates of monetary expansion continue to be lured by the prospect of cheap money—easier credit, abundant purchasing power for everyone. Paradoxically, the effects are the opposite, and here we find the core of the moral malaise implicit in the process—that avarice, the desire for unearned wealth, is self-defeating.

Thus, we find that as a fiat circulation increases, its purchasing power drops as its cost rises. This may be observed in the price structure. It takes more and more so-called money to buy a given amount of commodities and services, while the cost of acquiring this so-called money continually rises. The influence is frequently concealed, and when visible is attributed by the authorities to other causes.

Prices, of course, are affected by many forces, natural and man-made, from droughts and other natural catastrophes to wars, political upheavals, violence and corruption. It is not possible to separate mathematically their relative influence. Over a period of time, however, the recurrence of normal weather and other natural conditions, the resumption of peace or social tranquility, tend to establish a general line of regression, and any divergence of trend may be associated with the money system and supply.

Thus, during the first 20 years of the Federal Reserve System, except for World War I and its aftermath, prices rose by one-third, measured by the Bureau of Labor Statistics consumer price index of 35 in 1914 and 45 in 1933 (1957-59=100). Following suspension of gold convertibility prices rose until the outbreak of World War II by about 50 per cent (to an index high of 50 in 1937). By 1958 prices had doubled, partly under the influence of U. S. military involvement in Korea and thereafter in Southeast Asia, the expenses of which were financed increasingly by Federal Reserve purchases of Treasury obligations; by 1977 prices had again doubled, and the rate by then was accelerating to reach and to exceed 10 per cent annually.

Not only does an unhinged currency lead to steadily rising prices (decline in purchasing power of the circulation), but as the amount of circulation increases, so does its cost; that is, the rental rate of money, interest.

Despite the steady increase in circulation under the Federal Reserve System and the intervention of two world wars, interest rates on U. S. government long-term bonds (those with maturities of 15 years or more) declined to a mean of 2.2 per cent in 1946. Thereafter began a steady upward pressure to above 5 per cent in 1968, accelerating to as high as 9 per cent in 1979 (on bonds of 20-year maturity).

The reciprocal of rising interest rates is a decline in the principal, or capital, value of fixed-rate obligations acquired earlier—mortgages, bonds, preferred shares. If the going rate of interst is 9 per cent, then a long-term bond of 5 per cent coupon acquired at 100 will be marked down to a principal value that will yield the buyer 9 per cent on his investment. The consequence is an unwillingness of lenders to put their funds out at long term. This may be noted in the mounting difficulty of the Treasury in selling its long-term obligations. Thus, in 1941 of the total public debt of $41.6 billion, $8 billion, or 19 per cent, was in short term bills, notes and certificates. By 1968 the percentage had risen to 64 per cent, and a decade later, when the total interest bearing debt had reached $782 billion, of which $493 billion was marketable, only $46 billion, or less than 10 per cent, was in maturities of over 10 years.

The effect of rising prices can be devastating for persons of fixed income from savings and pensions—the older citizens who as a group are generally increasing in numbers, in proportion, and in political influence to the total population, and who, as the elders of society, should be a stabilizing influence. For them, the pinch of outgo against income leads to unrest, disillusionment and resentment rather than support of the political establishment.

Since prices never rise and fall in unison, the inflow of fiat purchasing power into the market from new currency emissions, breeds further price and market dislocations that offer opportunity for the shrewd, for traders and speculators. The same rising prices, however, adversely affect the actual creators of wealth, for whom costs of materials and labor tend to rise faster than selling prices, while planning and programming are frustrated by price uncertainties, both as to the future costs of materials and supplies and the selling prices, the latter even more uncertain by reason of uncertain future demand.

The problem of inflation accounting has recently engaged official and financial market attention, because of the distortion of profit figures caused by price movements. Capital investment depreciated on a cost basis, for instance, must be replaced at a higher rate, the difference being an actual reduction in nominal profits. This phenomenon led the regulator of corporations, the Securities and Exchange Commission, to require corporations to estimate the losses from inflation in their financial reports, but this does not resolve the problem, due to the many imponderables. On a wider frame proposals are advanced for indexing wages, rents, profits, taxes, and other monetary entries, that is, to adjust the nominal amounts by the drop in prices; but no one has yet designed a satisfactory index of prices, and in any case the effect is that of putting the cart before the horse.

More insidious, however, because less visible in statistics, is the political unrest and moral decay that is served if not promoted by depreciating money. Beginning in the 1960’s, as many observers have noted, there occurred a widespread dissatisfaction with not only government—which may have been the result of involvement in an unpopular war—but with “establishments” unrelated to politics—from school to church, including conventions of behavior and dress. Young people took to living together without benefit of clerk or clergy; homosexuality emerged from the closet, like vermin from an upturned plank, and became a political influence; the use of narcotics and drug stimulants became open and even fashionable. Accompanying these happenings was an enormous increase in crime—bank robberies, murder, rape and sodomy, masochism, torture, child abuse.

Endemic also was the declining esprit and morale of government functionaries: teachers, police, firemen, upon whom the security of society rests, no longer hesitated to raise demands and enforce them by strikes.

Probably no more descriptive of the general state of affairs in the ninth decade of the century, or prophetic of the future, is the comment of a leading track operator, reported in the Times: “I have a recurring dream,” said John Finney, who managed the Saratoga sales, “that I am auctioning tulip bulbs”—a reference to the seventeenth century tulip mania in Holland.

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2It is not without interest that Reza Shah of Iran lost his throne within a decade of his demonetization of silver and institution of a paper currency, and that the absence of good metallic circulation among the masses at a time when wealth was pouring into the country from abroad may have been a factor in the revolution that cost his son Mohammed Shah his throne in 1979.

• 1Mrs. Fish’s social invasion of Washington may have been the result of the intimacy that existed between her husband and Roosevelt. It is important to recall this camaraderie in any attempt to understand the tangle of subsequent events. Both were New York aristocrats; both were Republicans; they had a common fondness for rural estate life; they had gone together on hunting trips to the South. It is reported that during the Fish residence in Washington, Roosevelt, who was accustomed to early morning canters in Rock Creek, would ride over to the house and shout up, “Stuy!” and when the railroad president came to the window would joke with him for a while before continuing his ride.
• 2Theodore Roosevelt returned from a year of big game hunting in Africa and a triumphal tour in Europe to find again an opprtunity and a demand for his political talents. Drawn by an appeal to public service, and perhaps to a considerable degree by ambition,* he began to angle for the leadership of the insurgent wing. In a speech at Osawatomie, Kansas, on August 31, 1910, on “The New Nationalism” he backed the Supreme Court’s attitude toward social legislation and announced the political doctrine “that every man holds his property subject to the general right of the community to regulate its use to whatever degree the public welfare may require it.”