The Future of Freedom Foundation reports about Separating Money and the State.
Separating Money and the State
by Douglas E. French, October 1994
Part 1: Eighty Years of Destruction
On December 23, 1993, the Federal Reserve System marked its 80th birthday. But few were celebrating.
The Federal Reserve Act, which was signed into law in 1913 by President Woodrow Wilson, is described by economist Hans Sennholz as "probably the most tragic blunder ever committed by Congress."
According to the Federal Reserve's Board of Governors, "The function of the Federal Reserve System is to foster the flow of credit and money that will facilitate orderly economic growth, a stable dollar, and long-run balance in our international payments."
The results have been the exact opposite. The government's money and banking monopoly has created an unstable modern American economy, while only serving the political and bureaucratic needs of the federal government.
The Federal Reserve's worst crime is its decimation of the dollar. The buying power of the dollar has shrunk 99 percent since the Fed's creation in 1913.
The idea of having a central bank in America waxed and waned during the 19th century. But, as Wall Street analyst and historian James Grant wrote, it took the Panic of 1907 to produce "a critical mass of disillusionment with the financial system as it was."
A run on New York's Knickerbocker Trust Co. sparked the panic. Knickerbocker's president had invested heavily in the stock of United Copper Company. When United Copper's price collapsed, the 18,000 Knickerbocker depositors wanted their money back.
The Knickerbocker failed, and nervous depositors at other trust companies demanded their money, setting off a panic. Chase National Bank economist Benjamin Anderson described the Panic of 1907 as "almost purely a money panic" that had "pulled us up before the boom had gone too far."
Pierpont Morgan came to the rescue in November 1907, orchestrating a deal that saved the trust companies. But, as author Ron Chernow wrote in The House of Morgan: "Everybody saw that thrilling rescues by corpulent old tycoons were a tenuous prop for the banking system. Senator Nelson W. Aldrich declared: Something has got to be done. We may not always have Pierpont Morgan with us to meet a banking crisis."
That "something" began to take shape three years later when J.P. Morgan partner Harry Davison called together other key Wall Street bankers for a "duck-shooting holiday" at the Jekyll Island Club off the Georgia coast.
The ducks were safe, because Davison and company spent their time inside devising a central-bank plan calling for regional reserve banks to be supervised by a board of commercial bankers.
Using this plan as a blueprint, Senator Aldrich introduced his central-bank bill to Congress. The first time around, the Democrats blocked it.
The Jekyll Island plan reappeared in 1913 when Democratic Congressman Carter Glass from Virginia used it as the basis for the Federal Reserve Act.
New York Republican Senator Elihu Root argued against the bill for three hours on the Senate floor. In Money of the Mind, James Grant wrote:
He [Root] warned against the reduction in bank reserves and against the certainty that, following the inevitable inflation, foreigners would sell American securities [dollars]. Root was more farsighted than he could have known. The dollar crisis to which he alluded was fifty years away, and the first recognition of the loss of the government's creditworthiness was even further off in the future.
Root's arguments fell on deaf ears. The Federal Reserve Act was passed. The bill's final version called for the twelve private regional reserve banks to be supervised by a Washington board to include the Treasury secretary and presidential appointees.
Although the Act describes the twelve reserve banks as "private," this is a misnomer [key point]. The Federal Reserve's officials are appointed by the government, and the banks are forced to own the Federal Reserve by government statute. As economist and historian Murray Rothbard has observed: "The Federal Reserve Banks should simply be regarded as governmental agencies."
Carter Glass described the Federal Reserve as "an altruistic institution," that is, "a part of the Government itself, representing the American people, with powers such as no man would dare misuse." [HAH!]
History has proven that Congressman Glass was, at best, naive. [Glass was well intentioned (but VERY naďve)]
A government-controlled central bank was just a part of the government's encroachment into the economy. As Rothbard has noted: "Control over a nation's money is a prerequisite for dictation over the rest of the economy." [exactly]
To gain passage of the bill, the pro-Fed forces promised to preserve the gold standard. However, this promise soon withered.
Reserve requirements were quickly reduced, and an immense explosion in bank credit ensued, with the bubble finally bursting in 1929 with the great stock-market crash.
By the 1930s, members of the public realized that the Fed was creating more and more dollars, and they began to take their dollars out of banks, converting them to gold. With banks only keeping a nickel for every dollar, cash reserves were at very low levels.
In 1933, the dearth of cash reserves led to the declaration of bank holidays throughout the country. The banks could not pay depositors their money.
The banks were reopened, but, as Benjamin Anderson explained: "Blanket authority was given the President [Roosevelt] to do pretty much as he saw fit regarding money and banking, including authority for the seizing of the gold and gold certificates in the hands of the people."
When people began protecting the value of their savings by converting to gold, Roosevelt retaliated by taking away that option. Even Carter Glass was appalled, telling the President: "It's dishonor, sir. This great government, strong in gold, is breaking its promises to pay gold to widows and orphans to whom it has sold government bonds with a pledge to pay gold coin of the present standard of value. It's dishonor, sir."
Senator Thomas Gore from Oklahoma was more succinct: "Why, that's just plain stealing, isn't it, Mr. President?"
FDR then enacted the Gold Reserve Act, which took gold from the Federal Reserve banks, giving it to the United States Treasury. He then devalued the dollar by 41 percent, setting the price of gold at $35.00 to the ounce.
With control of the money supply essentially in government hands — and government freed from the confining gold standard — World War II could be financed by the Federal Reserve.
From June 1939 to May 1945, the amount of money in circulation grew from $7 billion to $26 billion, a 271 percent increase. Commercial-bank demand deposits and U.S. government deposits increased 210 percent from June 1939 to December 1944.
In mid-1944, the Bretton Woods monetary conference was held. The Bretton Woods system called for the dollar to be convertible into gold at $35 per ounce. But only foreigners — and eventually only foreign governments — were allowed to convert dollars into gold. All other currencies were defined in terms of dollars. Thus, the dollar was treated as gold.
But the Federal Reserve could create dollars much faster than gold could ever be pulled from the ground.
In the 1960s, President Lyndon Johnson needed money to pay for both the Vietnam War and his Great Society programs. And the Fed accommodated.
Predictably, foreign governments began to see that as the Fed created more money, the dollar was overvalued at $35 to the ounce of gold. They began trading their dollars for gold. The U.S. supply of gold fell from 701 million ounces [19,873 tons] in 1949 to 296 million ounces [8,391 tons] by March 1968.
In the summer of 1971, the run on gold accelerated. In August, more than five billion dollars in gold and reserve assets were emptied from the Treasury in less than two weeks. On August 15, with only $2.23 in gold available to redeem every $100 of U.S. paper promises, President Nixon declared international bankruptcy by closing the gold window. After that Sunday, as former Congressman Ron Paul and Lewis Lehrman have explained: "There were now absolutely no checks on the ability of the United States to inflate." And inflate the Fed has. By all measures, the money supply has increased by 400% [between 1971 and 1993]
The period since 1971 has been one long, continuous inflation. The general price level, as measured by the implicit GNP deflator, has quadrupled in the 22 years after Nixon closed the gold window.
The consumer price index increased by only 10 percent in the 67 years prior to the Federal Reserve's creation in 1913. It has increased 625 percent during the 67 years since then. In 1833, 80 years prior to the Fed's creation, the index of wholesale commodity prices in the U.S. was 76.2; in 1913, it was 80.7 — a six percent increase. In November 1992, the wholesale index stood at 827.77 — a tenfold increase.
Part 2: Revoking Government's Money Monopoly
Every city in America has dozens of fast-food restaurants vying for our business. Which are successful? The ones that deliver on their promise to provide consistently good, quality food. Restaurants that do not, go out of business.
If government controlled the fast-food business the same way it controls the business of money and banking, every hamburger would be the size of a quarter — and all bun.
It is time that the American people ask their Federal Reserve officials: "Where's the beef?" Where is the sound money that the government promised eighty years ago, when the Federal Reserve System was established? Consumers, producers, and investors deserve real money — money that will retain its value over time — not the government's paper money that has continually lost its value over the past several decades and that the U.S. government, through legal-tender laws, forces us to use.
The Federal Reserve System is nothing more than socialized central planning in the monetary arena. In fact, Karl Marx and Frederick Engels wrote in The Communist Manifesto that one of the initial measures of the Communist Revolution would be "a centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly." And as Oscar B. Johannsen has written: "A socialized banking system is the precursor of socialism in all business."
Is it any wonder that the Fed has failed to achieve a sound and stable monetary system?
After eighty years of failure, this Marxian relic — the Federal Reserve System — must now be torn down, like the Berlin Wall. Private enterprise and the free market, not government, should provide the money that people need to transact their business.
Money was not invented by government. The founder of the Austrian school of economic thought, Carl Menger, wrote in 1871: "Money is not the product of an agreement on the part of economizing men nor the product of legislative acts. No one invented it." Over time, individuals simply learned to trade the less salable commodities for more marketable commodities. With the more salable commodity, individuals could more easily satisfy their economic intentions.
In different parts of the world, different commodities served as money: cattle, cocoa beans, tobacco leaves, salt, sugar, and ivory, to name only a few. In each case, these commodities developed as the most salable and recognizable in their particular areas.
As economies developed and trade expanded, the metals that came to be used as money "because of their ease of extraction and malleability were copper, silver, gold, and in some cases also lead." Menger points out that, over time, "these three metals, being the most salable goods, became the exclusive means of exchange."
Gold and silver survived for many years as money. And with no government interference, price inflation for generations was virtually nonexistent.
However, by the early 20th century, all governments were in the money business — printing paper notes that were usually unredeemable and forcing their citizens to accept them through legal-tender laws.
The result has been depreciating currencies and constantly rising prices. In the words of economist H ans Sennholz, the 20th century has truly been the "age of inflation" — an age that has devastated the middle class, as well as those people at the bottom of the economic ladder.
How does the Fed create money? It continually buys government securities from banks in the open market with, as economist Murray Rothbard has described, "nothing [an unredeemable IOU]. Simply with checking accounts created out of thin air." Then, for every one dollar of Fed checkbook money, the banks in the Federal Reserve System can create ten dollars more in demand deposits — again, out of thin air.
This pyramiding atop the Fed account is how more and more money is created. This money has benefited the federal government first and foremost — financing its wars, its largess, and its increasing bureaucracy.
The Fed's function, Professor Rothbard has pointed out, is "that of a banking cartel organized and enforced by the federal government." This banking cartel has served its master, the federal government, at the expense of the public. Average wage rates have only increased 277 percent since 1971, while the Fed has created 400 percent more money. Thus, two incomes are now needed to support a family, while only one was needed before.
How would a free-market monetary system work? Private money issuers would have the same incentive that producers of any other product have in a competitive market: To earn a profit, they must provide a good-quality product.
In the case of money, that means money that will hold its value and enjoy wide acceptability. Money producers that overproduce, causing their money to depreciate vis-ŕ-vis other currencies and goods, will either stop inflating or go out of business, like any other producer that does not provide the market with what it wants.
Different goods have served as money throughout history. If left to the market, the future would be no different. A free market is always evolving to satisfy the consumer. Would it be gold, or platinum, or some other item? There is no way to predict the outcome of the market? What will matter is that the money chosen will be the result of the voluntary choices of consumers, producers and investors, and not the decision forced on people by government central planners.
The United States has given central banking an eighty-year trial. And the Federal Reserve has failed its mission. Government's money monopoly must be revoked. As author Oscar B. Johannsen wrote in 1958: "It is no more a function of the state to regulate money and banking than it is a function of the state to regulate growing and marketing of onions."
Sound money will only come through the free market — through the monetary choices of consumers, producers, and investors. As Nobel laureate Friedrich A. Hayek argued in 1977: "I am more convinced than ever that if we ever again are going to have sound money, it will not come from government; it will be issued by private enterprise."
It is time to separate money and the state by repealing the Federal Reserve Act, abolishing the central bank, and removing government totally from the monetary scene.
1) This shows the major problem with the gold standard: countries establishing/leaving gold standard create deflation/inflation in other countries on the gold standard.
2) This also shows the true cause of the great depression: England, France, and other countries trying to returned to the gold standard boosted value of gold, creating deflation in gold standard countries.
3) Debt deflation (the most common explanation for what happened in the 1930s) was only a secondary, less important, cause of the Great Depression.
4) After a period of monetary chaos (and we are about to enter the mother of all periods of monetary chaos), nations and individuals will bid more vigorously for the privilege of having gold.