Organized Crime

CHAPTER32 How Central Banking Hides the Costs of War

Ludwig von Mises believed that the generation of price inflation by central banks was an “indispensable means of militarism” because it renders the repercussions of war much less obvious. “War weariness” would set in much more quickly if wars were financed by direct taxation instead.

American politicians have always resorted to the legalized counterfeiting of central banking to finance wars, the most expensive of all government programs. If citizens had a clearer picture of the true costs of war they would be more inclined to oppose aggressive intervention and to force all wars to quicker conclusions.

Government can finance war (and everything else) by only three methods: taxes, debt, and the printing of money. Taxes are the most visible and painful, followed by debt finance, which crowds out private borrowing, drives up interest rates, and imposes the double burden of principal and interest on taxpayers. Money creation, on the other hand, makes war seem costless to the average citizen, who is more likely to blame the higher prices caused by the central bank on “greedy corporations” than their real source, the state.

As a general rule, the longer a war lasts, the more centrally planned and governmentally-controlled the entire economy becomes. And it remains so to some degree after the war has ended. War is the health of the state, as Randolph Bourne famously declared, and the growth of the state means a decline in liberty and prosperity. As Robert Higgs wrote in Crisis and Leviathan, for example, the effects of World War I were massive government collusion with organized special-interest groups; the nationalization or de-facto nationalization of the ocean shipping and railroad industries; the increased federal government intrusion in labor and capital markets, communications, and agriculture; and enduring changes in constitutional doctrines regarding military conscription and civil liberties, especially freedom of speech.

Inflationary war finance often leads to calls for price controls, which inflict even greater damage on the private enterprise system by generating shortages of goods and services. The state uses the excuse of shortages that it created to grant itself even more powers to allocate the shortages however it sees fit. Inflating the currency as a method of war finance is often a first step in the adoption of what is essentially economic fascism.

Paper and printing is said to have been invented in China, but American politicians were probably the first to use government paper money. It was adopted by the colonial government of Massachusetts in 1690. As Murray Rothbard wrote in A History of Money and Banking in the United States, the Massachusetts government at that time was accustomed to launching “plundering expeditions” against the prosperous French in Quebec. Some of the loot was typically used to pay mercenary soldiers, but when some of the plundering expeditions failed to come up with any plunder and the mercenary soldiers threatened mutiny, the Massachusetts government printed 7,000 British pounds in paper notes to pay them. The government promised to redeem the paper money in gold or silver, but took forty years to do so. Meanwhile, the public was so suspicious of the notes that they depreciated by 40 percent in the first year after they were issued.

By 1740 every colony except for Virginia had followed Massachusetts’ lead in issuing fiat paper money. The results were dramatic price inflation, a depreciated currency, and boom-and-bust cycles. During the American Revolution a form of centralized banking was adopted when the Continental Congress issued the “Continental” in 1775. Because it was not backed by anything of value, the Continental depreciated so severely that it was virtually worthless by 1781. “Not worth a continental” became a popular slang phrase.

Some of the states attempted to deal with the inflation caused by the massive printing of Continentals with price-control laws. The predicable effect (to students of economics) was shortages so severe that George Washington’s army almost starved in Pennsylvania. The situation became so desperate that the Continental Congress issued a resolution on June 4, 1778 urging all the states to abolish their price control laws.

Within three months the army was well provided for as a result of this change in policy, wrote Robert Scheuttinger and Eamon Butler in Forty Centuries of Wage and Price Controls: How Not to Fight Inflation.

Despite the economic calamities caused by America’s first foray into centralized control of the money supply, at the end of the Revolutionary War the nation’s first central bank—the Bank of North America—was created, with defense contractor/Congressman Robert Morris implanted as its president. Centralized banking might have been ruinous for the general public, but political insiders like Morris profited handsomely. The bank was given a monopoly license to issue paper currency, and it used most of its newly created money for loans to the federal government. In so doing, it inflated its currency so rapidly that within one year the market lost all confidence in the bank and it was privatized.

Alexander Hamilton was the real founding father of central banking, as the Federal Reserve Board declares in one of its publications. His Bank of the United States, established in 1791, was partly intended to finance “sudden emergencies” like war, in Hamilton’s own words. The BUS was not re-chartered in 1811 when its original charter ran out, but the federal government still devised a way to monetize the war debt. It encouraged the creation of dozens of private banks, then in 1814 declared a “suspension of specie payment.” That is, banks were not required to redeem their paper currency in gold or silver. Thus, under the direction of the U.S. Congress, banks were encouraged to inflate their currencies at will for two-and-a-half years. Price inflation during the war years averaged 35 percent.

To help pay off the war debt the BUS was re-chartered in January of 1817 and empowered to issue a national paper currency, purchase public debt, and receive deposits of U.S. Treasury funds. Murray Rothbard explained the politics of the re-chartering of the BUS in his History of Money and Banking in the United States:

The Second Bank of the United States was pushed through Congress . . . particularly by Secretary of the Treasury Alexander J. Dallas . . . a wealthy Philadelphia lawyer [and] close friend, counsel, and financial associate of Philadelphia merchant and banker Stephen Girard, reputedly one of the two wealthiest men in the country. . . . Girard was the largest stockholder of the First Bank of the United States, and during the War of 1812 Girard became a very heavy investor in the war debt of the federal government. . . . [A]s a way to unload his public debt, Girard began to agitate for a new Bank of the United States.

The Second BUS “launched a spectacular inflation of money and credit,” wrote Rothbard, coupled with a heavy dose of bank fraud. It promptly created “the Panic of 1819,” the first real Depression in American history where large-scale unemployment in cities appeared for the first time. Rothbard noted in his book, The Panic of 1819, that unemployment in the manufacturing of handicrafts in Philadelphia fell from 9,700 persons in 1815 to only 2,100 in 1819.

After President Andrew Jackson vetoed the re-chartering of the Second BUS, the Bank became defunct, but the nationalist advocates of central planning through central banking never gave up. They finally succeeded during the Lincoln administration with the Legal Tender Act of 1862, which empowered the secretary of the Treasury to issue paper “greenbacks” that were not redeemable in gold or silver during the war years. The National Currency Acts of 1863 and 1864 created a system of nationally chartered banks that could issue bank notes supplied to them by the new comptroller of the currency. The Acts also placed a 10n percent tax on competing state bank notes to drive them out of business and establish a federal monetary monopoly.

The predictable effect was significant price inflation with greenback dollars devalued to the extent that they were worth only 35 cents in gold after one year. All of the negative economic effect of inflation—devaluation of private wealth, unfair redistribution of income from creditors to debtors, and hindrance to rational economic calculation—damaged the Northern war effort, but not by as much as that in the South. The North funded most of the Civil War with public borrowing; the South funded most of the war by printing Confederate dollars. Consequently, price inflation in the Confederacy averaged more than 2,200 percent per year.

The Federal Reserve Board was finally created in 1913 and was instrumental in financing America’s disastrous and futile participation in World War I. The Fed did not just print greenbacks, as was the case during the Civil War. It printed enough money to purchase more than $4 billion in government bonds that were used to finance the war. The amount of money in circulation doubled between 1914, the first year of the Fed’s existence, and 1920. The price level also doubled during those same years, generating an enormous hidden tax on American taxpayers by cutting the value of privately-held wealth in half and depressing real wages.

The boom created by the Fed’s war financing inevitably caused a bust—the Depression of 1920. The first year of the Depression of 1920 was even worse than the first year of The Great Depression a decade later. Gross Domestic Product declined by 24 percent from 1920 to 1921, while the number of unemployed Americans more than doubled, from 2.1 million to 4.9 million. The Great Depression of 1920 lasted only that one year, however, thanks to President Warren Harding’s inspired policy of cutting both government spending and taxes very dramatically.

In all the wars that followed World War II central banking has inflicted essentially the same kind of damage on American society: price inflation, economic chaos, reduced real wages, price controls and other destabilizing and impoverishing government controls and regulations, and ideological attacks on capitalism rather than on the real culprit, the Fed.

Adam Smith recognized the advantage of financing wars with taxes as opposed to public debt when he wrote in The Wealth of Nations that “Wars would in general be more speedily concluded, and less wantonly undertaken” with tax financing. “The people feeling, during the continuance of the war, the complete burden of it, would soon grow weary of it, and the government, in order to humor them, would not be under the necessity of carrying it on longer than it was necessary to do so.”

Central bank inflation renders the costs of war even more invisible than debt financing does and is therefore even more disastrous from the perspective of the taxpaying public.