America’s Money Machine

THE QUESTION may now be raised as to what specific reforms are required to restore integrity to the monetary system. It is a question which we have avoided, preferring to leave the answer to monetary technicians, on the principle succinctly stated by the British poet Alexander Pope: “For forms of government let fools contest; / That which is best administered is best.”

Essentially, the answer lies in the devotion to moral integrity on the part of the electorate—a conviction, however, that is mightily assisted by the realization that such devotion is not abstract idealism, but of practical consequence in a more harmonious, contented and prosperous society. It is only “if you will keep my commandments,” as the Lord reminded the children of Israel, that a people is led into a land of milk and honey. High among these commandments is that of “just balances, just weights, a just ephah and a just hin.”

Certain heresies persist, however—false gods of doctrine which economists and money managers have long sanctified—demons that must be exorcised before a sound and honest monetary system can be re-established.

First among these is the conception held by many conservative economists that an expanding economy needs a continually expanding money supply, and that as the quantity of precious metals is limited and new production inadequate, the metallic circulation may—and must, if necessary—be supplemented by a fiat-paper circulation. While this proposition is a subject of vast literature, few question the basic premises, and the argument is generally over the rate of expansion and the quality of the circulation.

Simply expressed, the proposition says no more and no less than that if a cloth merchant doubles his yardage sales he must double the number of yardsticks in his establishment. So obvious is the distinction that some theorists include in their equation a factor for “velocity of circulation,” but regrettably, the raw material of their data do not permit such fine factoring. Since production of economic wealth is expressed in monetary terms, as the only common denominator, the theory becomes a cat chasing its tail, for the production figure will rise as prices rise, themselves a function of the monetary supply, and as no satisfactory price index has ever been devised that will satisfy all interests, so no deflator has been devised to exclude the effect of the money supply in the equation. For that matter, neither has “velocity of circulation” been adequately defined.

Actually, if advancing technology means anything, it is that goods should gradually decrease in price as the forces of nature are harnessed for their greater production. The only reason prices must be stable, or rising, is that of supporting a burden of interest payments on a burden of debt that steadily rises as a function and effect of the monetary system.

A third misconception is that debt, or debt instruments, can be or serve as money. To accept this view is to cast aside the traditional definition of money as a medium of exchange, a standard of deferred payments, and a store of wealth. Since a particular debt must be repaid—at least such is commonly believed—the extinguishment of a debt instrument that has been monetized, that is, has been made the basis of legal tender currency, would cause a contraction of the “money supply” and, supposedly, economic catastrophe. Therefore new debt must be incurred and monetized to maintain the former equilibrium. To encourage such debt attractive terms must be given; that is, the monetary authority must advance legal-tender currency in exchange for the debt at lower terms than the prevailing market. This is known as the discount rate. That the Federal Reserve is continually in the market buying debt instruments—either private or public (Treasury)—is a persistent stimulus to the creation of debt. The amount of this debt today defies calculation.

A fourth misconception is as to the power of the Federal Reserve to influence the economy—a misconception written into law in the Full Employment Act of 1946 and the later Full Employment and Balanced Growth Act of October 27, 1978. “Fine tuning” became a phrase to describe its efforts to achieve these political ends by adjusting the so-called money supply. It did so—at least in theory—by buying or selling its own debt instruments, which thereafter became money equivalents in the banks to which they were sold, and permitted the banks to extend their own debt commitments through deposit liabilities.

Apart from the debased subsidiary coinage, money supply was defined as the legal tender currency in circulation plus demand deposits in the banks and designated M1. Neither represented substance; rather they were debt instruments. The awareness soon dawned that M1 was not an adequate measure of the demand debt outstanding, since savings banks customarily paid out time deposits on demand. The money-supply concept was now broadened to include such deposits and termed M2. Eventually there was an M3, an M4 and an M5 to designate various levels of debt. By the time M5 was reached the monetary authority was struggling to control or modify a mass of debt in the market totalling some $1.6 trillion in various forms and extensions.

Vast and powerful as its resources were, here was a behemoth of debt to which no bit could be fitted, upon which no bridle nor saddle could be laid. But the end was not yet. Struggling to determine the extent of its responsibility, the Federal Reserve has of late been trying to determine how much money-equivalents are in circulation in the form of credit card credits, and when that is done they may proceed down the scale until it encompasses such items as the IOU’s that circulate around the poker tables and game boards of the land.

In sum, the theory that money supply can be controlled, when it exists in the form of debt, is little short of ridiculous.

The misconception that debt can be a form of money arises from a further misconception of the nature of money, that its essence is purchasing power. Purchasing power is an attribute of money, but not its essence, as fragrance is an attribute of the rose, but not its substance—nor will the fragrance of new baked bread satisfy hunger. Whatever is in the market has purchasing power, from a woman’s smile to a tenor’s song or a lawyer’s opinion, but none of them is substance, far less the substance of money. A money system can be erected on nothing less than a transferable substance of market value, and any system lacking that cannot be called a monetary system.

A prevalent misconception is that the banking system is sound and solvent and that in any case depositors are protected by the bulwarks of the Federal Reserve lending power and the guarantees of the Federal Deposit Insurance Corporation. These are false hopes, and the guarantee instruments are self-defeating and counterproductive. The Federal Reserve was at the height of its power and influence in 1933, with ample gold reserves, but was powerless to prevent universal bank insolvency. The subsequently created system of bank deposit guarantee serves to allay disquiet on the part of depositors, who should rather be constantly alert and questioning as to the soundness of their depositary institutions, while the presence of these guarantees only leads the managers of bank funds into an equally false sense of security and encourages them to extend loans to the very edge of credibility.

After pointing out the added effect upon the soundness of assets from the rising inflation rate, he commented:

“One would think that with banks assuming a greater degree of risk, and the economy becoming more volatile, capital ratios would be increasing. In fact, just the opposite occurred. The ratio of equity capital to risk was approximately 30 per cent at the turn of the century. . . . After World War II the ratio steadily declined to 14 1/2 per cent in 1960, 11.3 per cent in 1970, and approximately 8 per cent last year.”

Chairman Irving H. Sprague of the Corporation also expressed his concern, noting that in 1969 there were under supervision as “problem banks” no bank with deposits in excess of $1 billion and only two with over $100 million deposits, but in 1979 five banks with deposits in excess of $1 billion were in trouble and 30 with deposits of $100 million to $1 billion.

Still another monetary misconception is that the supply of precious metals is inadequate to serve as money. It was upon the cry of metal famine, in fact, that the euphemism arose of the need to “economize gold” by creating fiat paper. Yet relative to production no metal is in greater supply. It is reliably estimated—and the figures are commonly used in the reports of the Director of the Mint—that some 40 per cent of all the gold mined since the discovery of America is still visible—with probably much more in private hoards and jewelry. For most commodities a visible supply of over a year’s production is enough to depress the market.

The fact is that the precious metal supply will always be adequate to the demand for use in transactions, for the amount of the metal required to make an exchange will adjust itself to the value of the exchange. If this seems a bit esoteric we may note that at $350 an ounce, the market price of gold in 1979, an ounce of gold would pay the cost of travel by air from New York to London and return—a purchasing power of gold unprecedented. At $400 an ounce, a price toward which the market was climbing as this was written, the gold held by the Treasury (acquired, incidentally, at $20.67 an ounce) would be sufficient to put a reserve of 100 per cent behind the total circulation, and thereby permit a return to a gold or gold-certificate currency.

A final and major misconception to be mentioned is that sovereign majesty is sufficient to gull a public into complacency over its hypocrisies, sophistries, and outright fraud. The scriptural admonition “Be sure your sins will find you out” applies to institutions as well as individuals. Eventually a defrauded people will turn against their government as they did in France in 1789 and in Iran in 1979.

Let us list some of these official immoralities:

(1) The enactment of a monetary system that permitted the issuance of paper currency redeemable in gold to an extent of two and a half times the amount of gold held to redeem the paper. A comparable case would be that of a man laying aside for emergency 100 Krugerrands, only to discover when he needed them that 60 were nothing but lead covered with gold leaf. Since the Federal Reserve is the “reserve of last resort” for the entire U. S. banking and economic system, the dilution of its reserve, as permitted by law, was a total and unwarranted fraud. However much it was practiced in the open, by law, the great masses of the public were led to believe that their currency was the equivalent of gold.

(2) The expropriation in 1933 of gold held by private citizens. However rationalized as legal by a compliant Supreme Court, the action was contrary to accepted and traditional morality, and indeed contrary to the plain reading of the Constitution which declares, “nor shall private property be taken for public use, without just compensation” (Amendment V).

(3) The repudiation in 1933 of domestic gold delivery contracts, both public and private. While such action was not explicitly prohibited to the federal government by the Constitution, the principle was enunciated in regard to the states, which were forbidden to pass any law “impairing the obligation of contract” (Article I).

(4) The repudiation in 1971 of the international obligation taken in 1945 (in the Articles of the International Monetary Fund) to maintain gold convertibility of the dollar.

(5) The persistence in defining the dollar in terms of gold when gold has not been delivered at that rate since 1933, or at any rate.

True reform of the monetary system must begin with a return to a freely circulating metallic currency (or inviolable certificates of deposit of such money), the amount of which is self-regulating. The security of such a system would no doubt need a Constitutional amendment opening the mints to the free coinage of gold by the public (except for mintage cost); the establishment of a gold-coin dollar of a given weight and fineness as the standard of value, with gold as the only legal tender for public payments; prohibition against the issue by Congress of legal-tender bills of credit (as forbidden to the states) or any form of paper currency except certificates of deposit of gold in a federal depositary; and a prohibition against any official seizure or sequestration of such deposited metal.

Since gold coinage by reason of its content and uniformity and its legal tender quality commands a premium over the market price of the metal, a revaluation of the Treasury’s gold stock at slightly above present prices, would permit redemption of the total note issue. Such action would provide the market with a gold-coin or gold-certificate circulation, and put the Federal Reserve in possession of a gold reserve that it could use by making it available to the market for currency exigencies.

The Federal Reserve System would thus be returned to near its original design—as a sort of safety valve against credit explosions—in which short-term needs would be served by the issuance of Federal Reserve bank credit only against short-term, self-liquidating commercial paper, with the credit retired as the exigency passed. Such credit would not be legal tender, but like cashier’s checks, would serve as quasi-credit superior to that of the discounted commercial instruments. As we have noted earlier, such a system (in the form of clearing-house certificates) served well to curtail the 1907 panic.

Implicit in such a reform would be a prohibition against the issue of Federal Reserve credit against U. S. Treasury obligations, either purchased or discounted, and the abolition of the Open Market Committee as well as any authority of the Federal Reserve to acquire, on its volition, any debt instruments, its credit to be issued only against such short-term commercial obligations as were qualified and presented for discount.

Whether Americans are prepared for such basic reform of a monetary system so touted and copied throughout the world as has been the Federal Reserve System, is questionable. Indeed, it may be questioned whether a work like this is designed to achieve reform so much as to witness to a truth.

Efforts to reform institutions or societies by public appeal too often fail from diffusion. The seed must be drilled rather than broadcast. For the popular palate the strong vinegar of verity must be diluted to flatness; the message must be softened to a coax. Jeremiah, proclaiming to Judah its impending destruction, was cautioned by the Lord that the prophet’s warning would go unheeded. When Elijah complained that the people had forsaken the Covenant, thrown down the altars, slain the prophets, and that only he was left, the Lord rebuked him with the reminder that there were yet “left seven thousand in Israel, all the knees which have not bowed to Baal.” This is the word of hope. There remain always a Remnant who are bearers of the word and doers of the deed. If the message is sent to them in simplicity and sincerity, it will not return empty.