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There is a great mystique surrounding the nature of money.
It is generally regarded as beyond the understanding of mere mortals. Questions of the origin of money or the mechanism of its creation are seldom matters of public debate. We accept them as facts of life which are beyond our sphere of control.
Thus, in a nation which is founded on the principle of government by the people, and which assumes a high level of understanding among the electorate, the people themselves have blocked out one of the most important factors affecting, not only their government, but their personal lives as well.
There was a time in the fairly recent past when the humble voter - even without formal education - was well informed on money matters and vitally concerned about their political implementation. In fact, as we shall see in a later chapter, major elections were won or lost depending on how candidates stood on the issue of a central bank. It has been in the interest of the money mandarins, however, to convince the public that, now, these issues are too complicated for novices.
Through the use of technical jargon and by hiding simple reality inside a maze of bewildering procedures, they have caused ar* understanding of the nature of money to fade from the public consciousness.
For example, the July 20, 1975 issue of the New York Times, in an article entitled "Money Supply: A Growing Muddle/' begins with the question:
The Wall Street Journal of August 29,1975, comments:
And, in its September 24,1971 issue, the same paper said:
Even the government cannot define money. Some years ago, a Mr. A.F. Davis mailed a ten-dollar Federal Reserve Note to the Treasury Department.
In his letter of transmittal, he called attention to the inscription on the bill which said that it was redeemable in "lawful money," and then requested that such money be sent to him. In reply, the Treasury merely sent two five-dollar bills from a different printing series bearing a similar promise to pay.
Mr. Davis responded:
One week later, Mr. Davis received the following reply from Acting Treasurer, M.E. Slindee:
The phrases "...will pay to the bearer on demand" and "...is redeemable in lawful money" were deleted from our currency altogether in 1964.
Yet, if no one is able to define what money is, how can we have an opinion about how the System is performing? The answer, of course, is that we cannot, and that is exactly the way the cartel wants it.
Furthermore, the process is not only painless, it is - believe it or not - intensely interesting.
What is money?
For the purpose of our analysis, however, it will be necessary to establish one definition so we can at least know what is meant when the word is used within this text.
To that end, we shall introduce our own definition which has been assembled from bits and dabs taken from numerous sources. The structure is designed, not to reflect what we think money ought to be or to support the view of any particular school of economics, but simply to reduce the concept to its most fundamental essence and to reflect the reality of today's world. It is not necessary to agree or disagree with this definition. It is introduced solely for the purpose of providing an understanding of the word as it is used within these pages.
This, then, shall be our working definition:
Understanding the difference between these forms of money is practically all we need to know to fully comprehend the Federal Reserve System and to come to a judgment regarding its value to our economy and to our nation. Let us, therefore, examine each of them in some detail.
Mr. Jones swaps his restored Model-T Ford for a Steinway grand piano.1
1. Strictly speaking, each party holds the value of what he is receiving to be more than what he is giving. Otherwise he would not make the trade. In the mind of the traders, therefore, the items have unequal value. That opinion is shared equally by them both. The shorter explanation, however, is less unwieldy.
This exchange is not monetary in nature because both items are valued for themselves rather than held as a medium of exchange to be used later for something else.
Note, however, that both items have intrinsic value or they would not be accepted by the other parties. Labor also may be exchanged as barter when it, too, is perceived to have intrinsic value to the person for whom the labor is performed.
The concept of intrinsic value is the key to an understanding of the various forms of money that evolved from the process of barter.
This was because they had certain characteristics which made them useful or attractive to almost everyone. Eventually, they were traded, not for themselves, but because they represented a storehouse of value which could be exchanged at a later time for something else.
At that point, they ceased being barter and became true money. They were, according to our working definition, a medium of exchange. And, since that medium was a commodity of intrinsic value, it may be described as commodity money.
But these never seriously challenged the use of cattle, or sheep, or corn, or wheat, because these staples possessed greater intrinsic value for themselves even if they were not used as money.
This was the dawning of the Bronze Age in which iron, copper, tin, and bronze were traded between craftsmen and merchants along trade routes and at major sea ports.
In addition to being of intrinsic value for uses other than money, they are not perishable, which is more than one can say for cows; by melting and reforming they can be divided into smaller units and conveniently used for purchases of minor items, which is not possible with diamonds, for example; and, because they are not in great abundance, small quantities carry high value, which means they are more portable than such items as timber, for example.
The ability to precisely assay metals in both purity and weight makes them ideally suited for this function. Experts may haggle over the precise quality of a gems tone, but an ingot of metal is either 99% pure or it isn't, and it either weighs 100 ounces or it doesn't.
One's opinion has little to do with it. It is not without reason, therefore, that, on every continent and throughout history, man has chosen metals as the ideal storehouse and measure of value.
Even today, in a world where money can no longer be defined, the common man instinctively knows that gold will do just fine until something better comes along. We shall leave it to the sociologists to debate why gold has been chosen as the universal money. For our purposes, it is only important to know that it has been. But we should not overlook the possibility that it was an excellent choice.
As for quantity, there seems to be just the right amount to keep its value high enough for useful coinage. It is less plentiful than silver - which, incidentally, has run a close second in the monetary contest - and more abundant than platinum. Either could have served the purpose quite well, but gold has provided what appears to be the perfect compromise.
Furthermore, it is a commodity in great demand for purposes other than money. It is sought for both industry and ornament, thus assuring its intrinsic value under all conditions.
And, of course, its purity and weight can be precisely measured.
On the surface, that may sound logical - after all, we do need a lot of money out there to keep the wheels of the economy turning - but, upon examination, this turns out to be one of the most childish ideas imaginable.
1. See Elgin Groseclose, Money and Man: A survey of Monetary Experience, 4th ed. (Oklahoma: University of Oklahoma Press, 1976), p. 259.
There undoubtedly is at least an additional 30% in jewelry, ornaments, and private hoards. Any commodity which exists to the extent of 75% of its total world production since Columbus discovered America can hardly be described as in short supply.
We could even use multiple rulers, but no matter what measurement we use, the reality of what we are measuring does not change. Our rug does not become larger just because we have increased the quantity of measurement units by painting additional markers onto our rulers.
Each person has been given a starting supply of play money with which to transact business. It doesn't take long before we all begin to feel the shortage of cash. If we just had more Money, we could really wheel and deal. Let us suppose further that someone discovers another game-box of Monopoly sitting in the closet and proposes that the currency from that be added to the game under progress.
When the quantity of money expands without a corresponding increase in goods, the effect is a reduction in the purchasing power of each monetary unit. In other words, nothing really changes except that the quoted price of everything goes up. But that is merely the quoted price, the price as expressed in terms of the monetary unit. In truth, the real price, in terms of its relationship to all other prices, remains the same. It's merely that the relative value of the money supply has gone down.
This, of course, is the classic mechanism of inflation. Prices do not go up. The value of the money goes down.
1. Those who rushed to market first, however, would benefit temporarily from old prices. Under inflation, those who save are punished.
1. Murray Rothbard, What Has Government Done to Our Money? (Larkspur, Colorado: Pine Tree Press, 1964), p. 13.
In this, of course, it has failed miserably. The irony, however, is that maintaining stable prices is the easiest thing in the world. All we have to do is stop tinkering with the money supply and let the free market do its job. Prices become automatically stable under a commodity money system, and this is particularly true under a gold standard.
That means that the labor, tools, materials, and talent required to mine and refine one ounce of gold are equally traded for the labor, tools, and talent required to weave and tailor the suit. Up until now, the number of ounces of gold produced each year have been roughly equal to the number of fine suits made each year, so prices have remained stable.
The price of a suit is one ounce of gold, and the value of one ounce of gold is equal to one finely-tailored suit.
The result of this expansion of the money supply over and above the supply of available goods is the same as m our game of Monopoly. The quoted prices of the suits go up because the relative value of the gold has gone down.
When this happens, the annual production of gold goes down while the production of suits goes up, and an equilibrium is reached once again in which suits and gold are traded as before. The free market, if unfettered by politicians and money mechanics, will always maintain a stable price structure which is automatically regulated by the underlying factor of human effort.
The human effort required to extract one ounce of gold from the earth will always be approximately equal to the amount of human effort required to provide the goods and services for which it is freely exchanged.
The German mark had become useless, and barter was common. But one item of exchange, namely cigarettes, actually became a commodity money, and they served quite well.
Some cigarettes were smuggled into the country, but most of them were brought in by U.S. servicemen. In either case, the quantity was limited and the demand was high. A single cigarette was considered small change.
A package of twenty and a carton of two hundred served as larger units of currency. If the exchange rate began to fall too low - in other words, if the quantity of cigarettes tended to expand at a rate faster than the expansion of other goods - the holders of the currency, more than likely, would smoke some of it rather than spend it.
The supply would diminish and the value would return to its previous equilibrium. That is not theory, it actually happened.1
Furthermore, similar technological efficiencies are being applied in the field of mining, so everything tends to balance out. History has shown that changes in this natural equilibrium are minimal and occur only gradually over a long period of time. For example, in 1913, the year the Federal Reserve was enacted into law, the average annual wage in America was $633 - exchange value of gold that year was $20.67.
That means that the average worker earned the equivalent of 30.6 ounces of gold per year.
That is an increase of only 73 per cent, a rise of less than 1 per cent per year over that same period. It is obvious that the dramatic increase in the size of the paycheck was meaningless to the average American. The reality has been a small but steady increase in purchasing power (about 1 per cent per year) that has resulted from the gradual improvement in technology.
This and only this has improved the standard of living and brought down real prices - as revealed by the relative value of gold.
That is almost exactly the same cost today, two-thousand years later, for a hand-crafted suit, belt, and a pair of dress shoes. There are no central banks or other human institutions which could even come close to providing that kind of price stability. And, yet, it is totally automatic under a gold standard.
Lenin claimed that gold was used only to keep the workers in bondage and that, after the solution, it would be used to cover the floors of public lavatories, ^e Soviet Union under Communism became one of the world's biggest producers and users of gold.
Economist John Maynard Keynes once dismissed gold as a "barbaric metal." Many followers of Keynes today are heavily invested in gold. It is entirely possible of course, that something other than gold would be better as the basis for money.
It's just that, in over two thousand years, no one has been able to find it.
The process, therefore, may be stated as a natural law of human behavior:
As the concept of money was slowly developing in the mind of ancient man, it became obvious that one of the advantages of using gold or silver as the medium of exchange was that, because of their rarity as compared to copper or iron, great value could be represented by small size.
Tiny ingots could be carried in a pouch or fastened to a belt for ease of transportation And, of course, they could be more readily hidden for safekeeping. Goldsmiths then began to fashion them into round discs and to put their stamps on them to attest to purity and weight. In this way, the world's first coins began to make their appearance.
Groseclose describes the result:
1. Groseclose, Money and Man, p. 13.
EXPANDING THE MONEY SUPPLY BY COIN CLIPPING
Unscrupulous merchants began to shave off a tiny portion of each coin they handled - a process known as coin clipping - and then having the shavings melted down into new coins. Before long, the king's treasury began to do the same thing to the coins it received in taxes. In this way, the money supply was increased, but the supply of gold was not.
The result was exactly what we now know always happens when the money supply is artificially expanded. There was inflation. Whereas one coin previously would buy twelve sheep, now it would only be accepted for ten. The total amount of gold needed for twelve sheep never really changed. It's just that everyone knew that one coin no longer contained it.
By royal decree, the "coin of the realm," was declared legal for the settlement of all debts.
Anyone who refused it at face value was subject to fine, imprisonment, or, in some cases, even death. The result was that the good coins disappeared from circulation and went into private hoards. After all, if the government forces you to accept junk at the same rate of exchange as gold, wouldn't you keep the gold and spend the junk?
That is what happened in America in the '60s when the mint began to issue cheap metal tokens to replace the silver dimes, quarters, and half-dollars. Within a few months, the silver coins were in dresser drawers and safe-deposit boxes. The same thing has happened repeatedly throughout antiquity.
In economics, that is called Gresham's Law:
The final move in this game of legal plunder was for the government to fix prices so that, even if everyone is using only junk as money, they can no longer compensate for the continually expanding supply of it. Now the people were caught. They had no escape except to become criminals, which most of them, incidentally, chose to do.
The history of artificially expanding money is the history of great dissatisfaction with government, much lawlessness, and a massive underground economy.
Instead of clipping coins, it is done through the banking system The consequences of that process were summarized in 1966 by Alan Greenspan who, a few years later, would became Chairman of the Board of Governors of the Federal Reserve.
Greenspan wrote:
Unfortunately, when Greenspan was appointed as Chairman of Federal Reserve System, he became silent on the issue of gold. Once he was seated at the control panel which holds the levers of power, he served the statists well as they continued to confiscate the people's wealth through the hidden tax of inflation.
Even the wisest of men can be corrupted by power and wealth.
There are many examples throughout history of regents and kingdoms which used great restraint in money creation. Ancient Greece, where coinage was first developed, is one of them. The drachma became the defacto monetary unit of the civilized world because of the dependability of its gold content. Within its borders, cities flourished and trade abounded.
Even after the fall of Athens in the Peloponnesian War, her coinage remained, for centuries, as the standard by which all others were measured.2
1. Alan Greenspan, "Gold and Economic Freedom/' in Capitalism: The Unknown wad, ed. Ayn Rand (New York: Signet Books, 1967), p. 101. 2. Even the Greeks, under Solon, had one, brief experience with a debased currency. But it was short lived, and never repeated - See Groseclose, Money and Man, PP-14,20-54.
Building on the sound monetary tradition of Greece, the emperor Constantine ordered the creation of a new gold piece called the solidus and a silver piece called the miliarense. The gold weight of the solidus soon became fixed at 65 grains and was minted at that standard for the next eight-hundred years. Its quality was so dependable that it was freely accepted, under the name bezant, from China to Brittany, from the Baltic Sea to Ethiopia.
1. he livre du prifet ou Vempereur Uon
le Sage sur les corporations de Constantinople. French translation from the
Geneva text by Jules Nicole, p. 38. Cited by Groseclose,
Especially in the later Empire, debasement of the coinage became a deliberate state policy. Every imaginable means for plundering the people was devised. In addition to taxation, coins were clipped, reduced, diluted, and plated. Favored groups were given franchises for state-endorsed monopolies, the origin of our present-day corporation.
And, amidst constantly rising prices in terms of constantly expanding money, speculation and dishonesty became rampant.
Yet, the politicians point the accusing finger at everyone else for their "greed" and "disregard for the common good."
Diocletian declared:
1. As quoted by Grosedose, Money and Man, pp. 43-44.
What followed was an incredibly detailed list of mandated prices for everything from a serving of beer or a bunch of watercress to a lawyer's fee and a bar of gold.
The result? Conditions became even worse, and the royal decree was rescinded five years later.
For all practical purposes, money became extinct, and the Roman Empire was no more.
The invention was truly a giant step forward for mankind, but there were many problems yet to be solved and much experimentation lay ahead. The development of paper money was a case in point. When a man accumulated more coins than he required for daily purchases, he needed a safe place to store them.
The goldsmiths, who handled large amounts of precious metals in their trades, had already built sturdy vaults to protect their own inventory, so it was natural for them to offer vault space *o their customers for a fee. The goldsmith could be trusted to guard the coins well because he also would be guarding his own health.
Eventually, however, it became customary for the owner to merely endorse his receipt to a third party who, upon presentation, could make the withdrawal. These endorsed receipts were the forerunners of today's checks.
As the population learned from experience that these paper receipts were truly backed by good coin in the goldsmith's warehouse and that the coin really would be given out in exchange for the receipts, it became increasingly common to use the paper instead of the coin
As long as the coin was held in safe keeping as promised, there was no difference in value between the receipt and the coin which backed it. And, as we shall see in the next chapter, there were notable examples of the honest use of receipt money at the very beginning of the development of banking. When the receipt was scrupulously honored, the economy moved forward.
When it was used as a gimmick for the artificial expansion of the money supply, the economy convulsed and stagnated.
For our purposes, it is sufficient to recognize that human behavior in these matters is predictable and, because of that predictability, it is possible to formulate another principle that is so universal that it too, may be considered a natural law.
Drawing from the vast experience of this early period, it can be stated as follows:
As we shall see in the following chapters, the centuries of monetary upheaval that followed that early period contain no evidence that this law has been repealed by modern man.
SUMMARY
Contrary to common belief, the topic is neither mysterious nor complicated. For the purposes of this study, money is defined as anything which is accepted as a medium of exchange.
Building on that, we find there are four kinds of money: commodity, receipt, fiat, and fractional. Precious metals were the first commodity money to appear in history and ever since have been proven by actual experience to be the only reliable base for an honest monetary system. Gold, as the basis of money, can take several forms: bullion, coins, and fully backed paper receipts.
Man has been plagued throughout history with the false theory that the quantity of money is important, specifically that more money is better than less. This has led to perpetual manipulation and expansion of the money supply through such practices as coin clipping, debasement of the coin content, and, in later centuries, the issuance of more paper receipts than there was gold to back them.
In every case, these practices have led to economic and political disaster.
In those rare instances where man has refrained from
manipulating the money supply and has allowed it to be determined by
free-market production of the gold supply, the result has been prosperity
and tranquility.
The two characteristics of fiat money, therefore, are,
Legal tender simply means that there is a law requiring everyone to accept the currency in commerce.
The two always go together |because, since the money really is worthless, it soon would be rejected by the public in favor of a more reliable medium of exchange, such as gold or silver coin. Thus, when governments issue fiat money, they always declare it to be legal tender under pain of fine or imprisonment. The only way a government can [exchange its worthless paper money for tangible goods and services is to give its citizens no choice.
The famous explorer gives us this account:
1. Original from Henry Thule's edition of Marco Polo's Travels, reprinted in W. Vissering, On Chinese Currency: Coin and Paper Money (Leiden: E.J. Brill, 1877), reprinted 1968 by Ch'eng-wen Publishing Co., Taiwan, as cited by Anthony Sutton, The War on Gold (Seal Beach, California: '76 Press, 1977), pp. 26-28.
One is tempted to marvel at the Kaan's audacious power and the subservience of his subjects who endured such an outrage; but our smugness rapidly vanishes when we consider the similarity to our own Federal Reserve Notes.
They are adorned with signatures and seals; counterfeiters are severely punished; the government pays its expenses with them; the population is forced to accept them; they - and the "invisible" checkbook money into which they can be converted - are made in such vast quantity that it must equal in amount all the treasures of the world.
And yet they cost nothing to make. In truth, our present monetary system is an almost exact replica of that which supported the warlords of seven centuries ago.
In fact, after China, the next place in the world to adopt the use of fiat money was America; specifically, the Massachusetts Bay Colony. This event has been described as,
1- Ernest Ludlow Bogart, Economic History of the American People (New York: Longmans, Green and Co., 1930), p. 172.
In 1690, Massachusetts launched a military raid against the French colony in Quebec.
She had done this before and, each time, had brought back sufficient plunder to more than pay for the expedition. This time, however, the foray was a dismal failure, and [the men returned empty handed. When the soldiers demanded their pay, Massachusetts found its coffers empty.
Disgruntled soldiers have a way of becoming unruly, so the officials scrambled for some way to raise the funds. Additional taxes would have been extremely unpopular, so they decided simply to print paper money.
In order to convince the soldiers and the citizenry to accept it, the government made two solemn promises:
Both pledges were promptly broken.
Only a few months later, it was announced that the original issue was | insufficient to discharge the government's debt, and a new issue almost six times greater was put into circulation.
The currency wasn't redeemed for nearly forty years, long after those who had made the pledge had faded from the scene.
Next came the disappearance of gold or silver coins which
went, instead, into private hoards pr to foreign traders who insisted on the
real thing for their wares. Many of the colonies repudiated their previous
money by issuing pew bills valued at multiples of the old.
By 1716, the penalty had been increased to "treble the value."1
We can get some idea of the ferment of the times by noting that, in 1736, writing in his Pennsylvania Gazette, Franklin apologized for its irregular publication, and explained that the printer was,
The printing of money was apparently a major, time-consuming operation.
Naturally, these inflations all had to come to an end and, when they did, they turned into equally massive deflations and depressions.
It has been shown that, even in colonial times, the classic booms and busts which modern economists are fond of blaming on an "unbridled free market" actually were direct manifestations of the expansion and contraction of fiat money which no longer was governed by the laws of supply and demand.5
1. Statutes at Large of South Carolina, II 211,665, as cited by George
Bancroft, A Plea for the Constitution (Originally published by Harpers in
1886. Reprinted in Sewanee, Tennessee: Spencer Judd Publishers, 1982), p. 7.
Merchants from abroad were interested in neither of those, however, and international trade ground almost to a halt
The bank liad used its influence with the Crown to forbid the colonies to mint their own coins or to establish local banks. This meant that, if the colonists wanted the convenience of paper money, they would be forced to use the notes issued by the Bank of England. No one had ^anticipated that the colonial governments would be so inventive as to create their own paper money.
So, in 1751, Great Britain began to pressure the colonies to redeem all of their currency and withdraw nt from circulation. This they eventually did, and at bargain prices, fey then, their fiat money was heavily discounted in the market Mace and the governments were able to buy back their own currency for pennies on the dollar.
At first, the doomsdayers predicted this would spell further ruin for the colonial economy.
But there was, indeed, quite enough for, as we have already seen, any amount is sufficient
Such items as nails, "umber, rice, and whisky filled the monetary void, but tobacco was the most common. Here was a commodity which was in great demand both within the colonies and for overseas commerce.
It pad intrinsic value; it could not be counterfeited; it could be divided into almost any denominational quantity; and its supply could not be increased except by the exertion of labor. In other words, it was regulated by the law of supply and demand, which gave it great stability in value.
In many ways, it was an ideal money. It was officially adopted as such by Virginia in 1642 and a few years later by Maryland, but it was used unofficially in all the other colonies, as well. So close was the identity of tobacco with money that the previous fiat currency of New Jersey, not a tobacco growing state, displayed a picture of a tobacco leaf on its face.
It also carried the inscription:
Tobacco was used in early America as a secondary medium of exchange for about two-hundred years, until the new Constitution declared that money was, henceforth, the sole prerogative of the federal government.
The law of supply and demand was visibly at work.
For a while, Massachusetts had returned to specie while Rhode Island remained on fiat money. The result was that Newport, which had been the trade center for the West Indies, lost its trade to Boston and became an empty port. After the colonies had returned to coin, prices quickly found their natural equilibrium and then stayed at that point, even during the Seven Years War and the disruption of trade that occurred immediately prior to the Revolution.3
There is no better example of the fact that economic systems in distress can and do recover rapidly if government does not interfere with the natural healing process.
Wars are seldom funded out of the existing treasury, nor are they even done so out of increased taxes. If governments were to levy taxes on their citizens fully adequate to finance the conflict, the [amount would be so great that many of even its most ardent supporters would lose enthusiasm. By artificially increasing the money supply, however, the real cost is hidden from view.
It is still Laid, of course, but through inflation, a process that few people understand.
By the end of the year, another $3 million.
And still more: the Continental Army issued its own "certificates" for the purchase of supplies totaling $200 million.
A total of $425 million in five years on top of a base of $12 million is an increase of over 3500%. And, in addition to this massive expansion of the money supply on the part mi the central government, it must be remembered that the states were doing exactly the same thing.
It is estimated that, in just five years from 1775 to the end of 1779, the total money supply expanded by 5000%.
By contrast, the amount raised in taxes over the five-year period was inconsequential, amounting to only a few million dollars.
In 1775, paper Continentals were traded for one dollar in gold. In 1777, they were exchanged for twenty-five cents.
By 1779, just four years from their issue, they were worth less than a penny. The phrase "Not Worth a Continental" has its origin in this dismal period. Shoes sold for $5,000 a pair. A suit of clothes cost a million.
It was in that year that George Washington wrote,
In a mood of sarcasm, he wrote:
1. Letter to Samuel Cooper, April 22, 1779, quoted by Albert Henry Smyth, ed., The Writings of Benjamin Franklin, (New York: Macmillan, 1906), Vol. VII, p. 294.
When speaking of deficit spending, it is common to hear the complaint that we are saddling future generations with the bill for what we enjoy today.
Why not let those in the future help pay for what will benefit them also? Don't be deceived. That is a misconception encouraged by politicians to calm the public. When money is fiat, as the colonists discovered, every government building, public work, and cannon of war is paid out of current labor and current wealth.
These things must be built today with today's labor, and the man who performs that labor must also be paid today. It is true that interest payments fall partly to future generations, but the initial cost is paid by those in the present.
It is paid by loss of value in
the monetary unit and loss of purchasing power for one's wages.
INFLATION IS A HIDDEN TAX
But where does that purchasing power come from? Since fiat money has nothing of tangible value to offset it, government's fiat purchasing power can be obtained only by subtracting it from somewhere else. It is, in fact, "collected" from us all through a decline in our purchasing power. It is, therefore, exactly the same as a tax, but one that is hidden from view, silent in operation, and little understood by the taxpayer.
2. Thomas Jefferson, Observations on the Article Etats-Unis Prepared for the Encyclopedia, June 22, 1786, from Writings (New York: G.P. Putnam's Sons, 1894), Vol. IV, p. 165.
When that failed, there followed a series of harsh legal tender laws. One law even invoked the specter of treason.
It said:
Rhode Island not only levied a heavy fine for non-acceptance of its notes but, upon a second offense, an individual was stripped of citizenship. When a court declared the act unconstitutional, the legislature called the judges before it and summarily dismissed the offenders from office.
After the war, inflation was followed by deflation as reality returned to the market place. Prices fell drastically, which was wonderful for those who were buying. But, for the merchants who were selling or the farmers who had borrowed heavily to acquire property at inflated wartime prices, it was a disaster. The new, lower prices were not adequate to sustain their fixed, inflated mortgages, and many hard-working families were ruined by foreclosure.
Furthermore, most people still did not understand the inflation process, and there were many who continued to advocate the "paper money cure." Several of the states were receptive to the pressure, and their printing presses continued to roll.
Idleness and economic depression also led to outbursts of rebellion and insurrection.
In 1786, George Washington wrote to James Warren:
Two years later, in a letter to Henry Knox, he said:
1. Andrew C. McLaughlin, The Confederation and the Constitution (New York;
Collier Books, 1962), pp. 107-08.
Fortunately, there is a happy ending to that part of the story.
As we shall see in a subsequent chapter, when the state delegates assembled to draft the Constitution, the effects of fiat money were so fresh in their minds they decided to put an end to it once and for all. Then, the new republic not only rapidly recovered but went on to become the economic envy of the world - for a while, at least - until the lesson had been forgotten by following generations. But that is getting ahead of our story.
For now, we are dealing with the topic of fiat money; and the experience of the American colonies is a classic example of what always happens when men succumb to its siren call.
FRACTIONAL MONEY
And, to understand how this functions, we must return to Europe and the practice of the early goldsmiths who stored the precious metal coins of their customers for a fee.
Why not lend it out and earn a profit which then could be split between themselves and their depositors?
Put it to work, instead of merely gathering dust. They had learned from experience that very few of their depositors ever wanted to remove their coins at the same time. In fact, net withdrawals seldom exceeded ten or fifteen per cent of their stockpile. It seemed perfectly safe to lend up to eighty or even eighty-five per cent of their coins.
And so the warehousemen began to act as loan brokers on behalf of their depositors, and the concept of banking, as we know it today, was born.
In the beginning, they didn't even know that their coins were being loaned out.
They naively thought that the goldsmiths were lending their own money.
Let us suppose that we are playing a game of poker at the home of Charlie Smith. Each of us has given $20 to Charlie who, acting as the banker, has put our money into a shoe box and given us, in return, twenty poker chips. It is the understanding that, anytime we want to go home, we can get back a dollar for each chip we have at that time. Now let us suppose that Charlie's brother-in-law, Larry, shows up, not to play poker, but to borrow some money.
Since six of us are playing and each has put in $20, there is a total of $120 in the shoe box, and that turns out to be perfect for Larry's needs. You can imagine what would happen if Charlie decided to lend out the "idle" money. It is not available for lending.
They have been replaced - in concept at least - by the poker chips. If any of us are so touched by Larry's story that we decide to loan him the money ourselves, we would have to do it with other dollars or cash in our chips for the dollars in the shoe box. In that case, of course, we could no longer stay in the game. We cannot spend, loan, or give away the deposit and also consider the chips to be worth anything.
Consequently, those coins were not available for lending. Their monetary value had been assigned to the certificates. If the certificate holders had wanted to lend out their coins, they should have retired the certificates first. They were not entitled to hold spendable paper money and also authorize their banker to lend that same money as coins. One cannot spend, loan, or give away the coins and also consider the certificates to be worth anything.
But the bankers never bothered to explain that. The general public was led to believe that, if they approved of putting these supposedly idle funds to work, they would be helping the economy and earning a little profit besides.
It was an appealing proposal, and the idea caught on like wildfire.
They were then given receipts for these deposits which, as we have observed, were readily accepted in commerce as money.
At this point, things began to get I complicated. The original depositors had been given receipts for all of the bank's coins. But the bank now issued loans in the amount of eighty-five per cent of its deposits, and the borrowers were given receipts for that same amount. These were in addition to the original receipts. That made 85% more receipts than coins.
Thus, the banks created 85% more money and placed it into circulation through their borrowers. In other words, by issuing phony receipts, they artificially expanded the money supply. At this point, the certificates were no longer 100% backed by gold.
They now had a backing of only 54% but they were accepted by the unsuspecting public as equal in value to the old receipts.
The gold behind all of them, however, now represented only a fraction of their face value. Thus, the receipts became what may be called fractional money, and the process by which they were created is called fractional-reserve \banking.
It was John Maynard Keynes who observed:
1. As quoted by Lever and Huhne, Debt and Danger: The World Financial Crisis (New York: The Atlantic Monthly, 1986), p. 42.
CREATING MONEY OUT OF DEBT
In the beginning, banks served as warehouses for the safe keeping of their customers' coins.
When they issued paper receipts for those coins, they converted commodity money into receipt money. This was a great convenience, but it did not alter the money supply. People had a choice of using either coin or paper but they could not use both. If they used coin, the receipt was never issued. If they used the receipt, the coin remained in the vault and did not circulate.
When the fraction finally reaches zero, then it has made the complete transition and becomes pure fiat. Furthermore, there is no example in history where men, once they had accepted the concept of fractional money, didn't reduce the fraction lower and lower until, eventually, it became zero.
Most of the balance of this book will be devoted to a study of that Creature, but, for now, suffice it to say that the euphoria of being able to create money without human effort is so great that, once such a narcotic is taken, there is no politician or banker who can kick the habit.
As William Sumner observed:
1. William Graham Sumner, A History of American Currency (New York: Holt, 1884), p. 214.
NATURAL LAW NO. 4
It can be stated as follows:
So much for the overview and generalities. In the next chapter We shall see what history has to say on this process. And what a history it is!
The first recorded appearance of fiat money was in thirteenth century China, but its use on a major scale did not occur until colonial America. The experience was disastrous, leading to massive inflation, unemployment, loss of property, and political unrest. During one period when the Bank of England forced the colonies to abandon their fiat money, general prosperity quickly returned.
The Revolutionary War brought fiat money back to the colonies with a vengeance. The economic chaos that resulted led the colonial governments to impose price controls and harsh legal tender laws, neither of which were effective.
Fractional money always
degenerates into pure fiat money.
They were also required to open their books for public Inspection and to keep their stockpile of coins available for viewing pt all reasonable times. In 1524, a board of bank examiners was treated and, two years later, all bankers were required to settle accounts between themselves in coin rather than by check.
Having learned from the recent experience with bankruptcy, the new bank was not allowed to make any loans. There could be no profit from the issuance of credit. The bank was required to sustain itself solely from fees for loin storage, exchanging currencies, handling the transfer of payments between customers, and notary services.
This was because there were so many kinds of coin in circulation and such a wide variance of quality within the same type of coin that one had to be an expert to evaluate their worth. The bank performed this service automatically when it took the coins into its vault. Each was evaluated, and the receipt given for it was an accurate reflection of its intrinsic worth.
The public, therefore, was far more certain of the value of the paper receipts than of many of the coins and, consequently, was willing to exchange a little bit more for them.
So, in 1619, the Banco del Giro was formed, which, like its bankrupt predecessor, began immediately to create money out of nothing for the purpose of lending it to the government. Eighteen years later, the Banco della Piazza del Rialto was absorbed into the new bank, and history's first tiny flame of sound banking sputtered and died.
That is not to say that their owners and directors did not prosper.
It merely means that their depositors lost all or a part of their assets entrusted for safekeeping.
The bank only accepted deposits and steadfastly refused to make loans. Its income was derived solely from service fees. All payments in and around Amsterdam soon came to be made in paper currency issued by the bank and, in fact, that currency carried a premium over coin itself. The burgomasters and the city council were required to take an annual oath swearing that the coin reserve of the bank was intact.
Galbraith reminds us:
1- Galbraith, p. 16.
The principles of honesty and restraint were not to be long lived, however.
The temptation of easy profit from money creation was simply too great. As early as 1657, individuals had been permitted to overdraw their accounts which means, of course, that the bank created new money out of their debt. In later years [enormous loans were made to the Dutch East Indies Company. The truth finally became known to the public in January of 1790, and demands for a return of deposits were steady from that date forward.
Ten months later, the bank was declared insolvent and was taken over by the City of Amsterdam.
For over two centuries it faithfully adhered to the principle of safe deposit. So scrupulous was its administration that, when Napoleon took possession of the bank in 1813, he found 7,506,956 marks in silver held against liabilities of 7,489,343. That was 17,613 more than was actually needed.
Most of the bank's treasure that Napoleon hauled away was restored a few years later by the French government in the [form of securities. It is not clear if the securities were of much value Put, even if they were, they were not the same as silver.
Because of foreign invasion, the bank's currency was no longer fully convertible into coin as receipt money. It was now fractional money, and the self-destruct mechanism had been set in motion. The bank lasted another fifty-five years until 1871 when it was ordered to liquidate all of its accounts.
But there were to be many interesting twists and turns in its development before it would be ready for something as sophisticated as the Federal Reserve System.
It was pure fiat and, although it was decreed legal tender, it was not widely used. It was replaced in 1696 by the exchequer bill. The bill was redeemable in gold, and the government went to great lengths to make sure that there was enough actual coin or bullion to make good on the pledge. In other words, it was true receipt money, and it became widely accepted as the medium of exchange.
Furthermore, the bills were considered as short-term loans to the government and actually paid interest to the holders.
It had been given a monopoly over the issue of banknotes within London and other prime geographic areas, but they were not yet decreed as legal tender. No one was forced to use them. They were merely private fractional receipts for gold coin issued by a private bank which the public could accept, reject, or discount at its pleasure. Legal tender status was not conferred upon the bank's money until 1833.
The Bank of England, however, was favored by the government above all others and, time after time, it was saved from insolvency by Parliament. How it came to be that way is an interesting story.
By the time of the War of the League of Augsberg in 1693, King William was in serious need for new revenue.
Twenty years previously, King Charles II had flat out repudiated a debt of over a million pounds which had been lent to him by scores of goldsmiths, with the result that ten-thousand depositors lost their savings. This was still fresh in everyone's memory, and, needless to say, the government was no longer considered a good investment risk.
Unable to increase taxes and unable to borrow, Parliament became desperate for some other way to obtain the money.
The objective, says Groseclose, was not to bring,
There were two groups of men who saw a unique opportunity arise out of this necessity.
The first group consisted of the -political scientists within the government. The second was comprised of the monetary scientists from the emerging business of banking.
The organizer and spokesman of this group was William Paterson from Scotland.
Paterson had been to America and came back with a grandiose scheme to obtain a British charter for a commercial company to colonize the Isthmus of Panama, then known as Darien. The government was not interested in that, so Paterson turned his attention to a scheme that did interest it very much, the creation of money.
There is no other word that could so accurately describe this group.
With much of the same secrecy and mystery that surrounded the meeting on Jekyll Island, the Cabal met in Mercer's Chapel in London and hammered out a seven-point plan which would serve their mutual purposes:
The circular which was distributed to attract subscribers to the Bank's initial stock offering explained:
1. For an overview of these agreements,
see Murray Rothbard, The Mystery of Banking (New York: Richardson & Snyder,
1983), p. 180. Also Martin Mayer, The Bankers (New York: Weybright & Talley,
1974), pp. 24-25.
The charter was issued in 1694, and a strange creature took its initial breath of life. It was the world's first central bank.
Rothbard writes:
THE SECRET SCIENCE OF MONEY
The political scientists had been seeking about £500,000 to finance the current war. The Bank promptly gave them more than twice what they originally sought. The monetary scientists started with a pledged capital investment of £1,200,000.
Textbooks tell us that this was lent to the government at 8% interest, but what is usually omitted is the fact that, at the time the loan was made, only £720,000 had been invested, which means the Bank "loaned" 66% more than it had on hand.2
1. Rothbard, Mystery, p. 180.
Furthermore, the Bank was given the privilege of creating at least an equal amount of money in the form of loans to the public. So, after lending their capital to the government, they still had it available to loan out a second time.
But, with the new secret science, they were able to earn 8% on £1,200,000 given to the government plus an estimated 9% on £720,000 loaned to the public. That adds up to £160,800, more than 22% on their investment. The real point, however, is that, under these circumstances, it is meaningless to talk about a rate of interest. When money is created out of nothing, the true interest rate is not 8% or 9% or even 22%. It is infinity.
By creating money through the banking system, however, the process became mystifying to the general public. The newly created bills and notes were indistinguishable from those previously backed by coin, and the public was none the wiser.
This is a godsend to the political scientists who no longer must depend on taxes or the good credit of their treasury to raise money. It is even easier than printing and, because the process is not understood by the public, it is politically safe.
Their compensation, therefore, should be called what it is: a professional fee, or commission, or royalty, or kickback, depending on your perspective, but not interest.
The country banks outside of the London area were authorized to create money on their own, but they had to hold a certain percentage of either coin or Bank of England certificates in reserve. Consequently, when these plentiful banknotes landed in their hands, they quickly put them into the vaults and then issued their own certificates in even greater amounts.
As a result of this pyramiding effect, prices rose 100% in just two years.
Then, the inevitable happened:
When banks cannot honor their contracts to deliver coin in return for their receipts, they are, in fact, bankrupt.
They should be allowed to go out of business and liquidate their assets to satisfy their creditors just like any other business. This, in fact, is what always had happened to banks which loaned out their deposits and created fractional money. Had this practice been allowed to continue, there is little doubt that people eventually would have understood that they simply do not want to do business with those kinds of banks.
Through the painful but highly effective process of trial and error, mankind would have learned to distinguish real money from fool's gold. And the world would be a lot better because of it today.
In May of 1696, just two years after the Bank was formed, a law was passed authorizing it to "suspend payment in specie."
By force of law, the Bank was now exempted from having to honor its contract to return the gold.
In Europe and America, the banks have always operated with the assumption that their partners in government will come to their aid when they get into trouble. Politicians may speak about "protecting the public," but the underlining reality is that the government needs the fiat money produced by the banks. The banks, therefore - at least the big ones - must not be allowed to fail.
Only a cartel with government protection can enjoy such insulation from the workings of a free market.
For example, Galbraith tells us:
1. Galbraith, p. 34.
The natural and immediate result was the granting of massive loans for just about any wild scheme imaginable. Why not? The money cost nothing to make, and the potential profits could be enormous.
So the Bank of England, and the country banks which pyramided their own money supply on top of the Bank's supply, pumped a steady stream of new money into the economy. Great stock companies were formed and financed by this money. One was for the purpose of draining the Red Sea to recover the gold supposedly lost by the Egyptians when pursuing the Israelites.
£150,000,000 were siphoned into vague and fruitless ventures in South America and Mexico.
The verdict handed down in the final report was a model of clarity. Prices were not going up, it said. The value of the currency was going down, and that was due to the fact that it was being created at a faster rate than the creation of goods to be purchased with it.
The solution? The committee recommended that the notes of the Bank of England be made fully convertible into gold coin, thus putting a brake on the supply of money that could be created.
Ricardo argued that an ideal currency,
He conceded that precious metals were not perfect in this regard because they do shift in purchasing power to a small degree.
Then he said:
1. David Ricardo, The Works and Correspondence of David Ricardo: Pamphlets
2515 - 1823, Piero Sraffa, ed. (Cambridge: Cambridge University Press,
1951), Vol. IV, p. 58.
England continued to |use the central-bank mechanism to extract that revenue from the populace.
The Corn Act was passed that year to protect local growers from lower-priced imports.
Then, when corn and wheat prices began to climb once more in spite of the fact that wages and other prices were falling, there was widespread discontent and rebellion.
1- Roy W. Jastram, The Golden Constant (New York: Wiley, 1977), p. 113.
In 1821, after the war had ended and there was no longer a need lo fund military campaigns, the political pressure for a gold standard became too strong to resist, and the Bank of England returned to a convertibility of its notes into gold coin.
The basic central-bank mechanism was not dismantled, however. It was merely limited by a new formula regarding the allowable fraction of reserves.
The Bank continued to create money out of nothing for the purpose of lending and, within a year, the flower of a new [business boom unfolded. Then, in November of 1825, the flower matured into its predestined fruit. The crisis began with the collapse of Sir Peter Cole and Company and was soon followed by the failure of sixty-three other banks. Fortunes were wiped out and the economy plunged back into depression.
V/hat feel's Bank Act of 1844 attempted to do was to limit the amount of money the banks could create to roughly the same as it would be if their banknotes were backed by gold or silver.
It was a good try, but it ultimately failed because it fell short on three counts:
THE ROLLER COASTER CONTINUES
But when the Bank of England tottered on the edge of insolvency, once again the government intervened. In 1847, the Bank was exempted from the legal reserve requirements of the Peel Act. Such is the rock-steady dependability of man-made limits to the money supply.
1. Groseclose, Money and Man, pp. 195-96.
The Rank of Prussia became the Reichsbank. Napoleon established the Banque de France. A few decades later, the concept became the venerated model for the Federal Reserve System. Who cares if the scheme is destructive? Here is the perfect tool for obtaining unlimited funding for politicians and endless profits for bankers.
And, best of all, the little people who pay the bills for both groups have practically no idea what is being done to them.
In the beginning, there were notable examples of totally honest banks which operated with remarkable efficiency considering the vast variety of coinage they handled. They also issued paper receipts which were so dependable they freely circulated as money and cheated no one in the process. But there was a great demand for more money and more loans, and the temptation soon caused the bankers to seek easier paths.
They began lending out pieces of paper that said they were receipts, but which in fact were counterfeit. The public could not tell one from the other and accepted both of them as money. From that point forward, the receipts in circulation exceeded the gold held in reserve, and the age of fractional-reserve banking had dawned.
This led immediately to what would become an almost unbroken record from then to the present: a record of inflation, booms and busts, suspension of payments, bank failures, repudiation of currencies, and recurring spasms of economic chaos.
Since it all seemed to be wrapped up in the mysterious rituals of banking, which the common man was not expected to understand, there was practically no opposition to the scheme.
The arrangement proved so
profitable to the participants that it soon spread to many other countries
in Europe and, eventually, to the United States.
His specialty was creating things out of nothing and, when appropriate, to make them disappear back into that same void. It is fitting, therefore, that the process to be described in this section should be named in his honor.
This also is misleading because it implies that debt exists first and then is converted into money. In truth, money is not created until the instant it is borrowed. It is the act of borrowing which causes it to spring into existence. And, incidentally, it is the act of paying off the debt that causes it to vanish.1
There is no short phrase that perfectly describes that process. So, until one is invented along the way, we shall continue using the phrase "create money out of nothing" and occasionally add "for the purpose of lending" where necessary to further clarify the meaning.
The fraction is not 54% nor 15%. It is 0%. It has travelled the path of all previous fractional money in history and already has degenerated into pure fiat money. The fact that most of it is in the form of checkbook balances rather than paper currency is a mere technicality; and the fact that bankers speak about "reserve ratios" is eye wash.
The so-called reserves to which they refer are, in fact, Treasury bonds and other certificates of debt. Our money is pure fiat through and through.
They do it exactly the same way the goldsmiths of old did except, of course, the goldsmiths were limited by the need to hold some precious metal in reserve, whereas the Fed has no such restriction.
A booklet published by the Federal Reserve Bank of New York tells us:
Elsewhere in the same publication we are told:
1. I Bet You Thought, Federal Reserve Bank of New York, p. 11.
In a booklet entitled Modern Money Mechanics, the Federal Reserve Bank of Chicago says:
In the fine print of a footnote in a bulletin of the Federal Reserve Bank of St. Louis, we find this surprisingly candid explanation:
1. Modern Money Mechanics, Federal
Reserve Bank of Chicago, revised October 1982, p. 3.
That's right, there would be not one penny in circulation - all coins and all paper currency would be returned to bank vaults - and there would be not one dollar in any one's checking account. In short, all money would disappear.
The purpose of the hearing was to obtain information regarding the role of the Federal Reserve in creating conditions that led to the depression of the 1930s. Congressman Wright Patman, who was Chairman of that committee, asked how the Fed got the money to purchase two billion dollars worth of government bonds in 1933.
This is the exchange that followed.
It must be realized that, while money may represent an asset to selected individuals, when it is considered as an aggregate of the total money supply, it is not an asset at all.
A man who borrows $1,000 may think that he has increased his financial position by that amount but he has not. His $1,000 cash asset is offset by his $1,000 loan liability, and his net position is zero. Bank accounts are exactly the same on a larger scale. Add up all the bank accounts in the nation, and it would be easy to assume that all that money represents a gigantic pool of assets which support the economy.
Yet, every bit of this money is owed by someone. Some will owe nothing. Others will owe many times what they possess. All added together, the national balance is zero. What we think is money is but a grand illusion.
The reality is debt.
1. Irving Fisher, 100% Money (New York: Adelphi, 1936), p. xxii.
Here is the bottom line from the System's own publications.
The Federal Reserve Bank of Philadelphia says:
The Federal Reserve Bank of Chicago adds:
1- The National Debt, Federal Reserve
Bank of Philadelphia, pp. 2, 11
It gives those who expound it an aura of intellectualism, the appearance of being able to grasp a complex economic principle that is beyond the comprehension of mere mortals. And, for the less academically minded, it offers the comfort of at least sounding moderate.
After all, what's wrong with a little debt, prudently used and intelligently managed? The answer is nothing, provided the debt is based on an honest transaction. There is plenty wrong with it if it is based upon fraud.
Either way, the concept is the same.
If the money we are borrowing was earned by
someone's labor and talent, they are fully entitled to receive interest on
it. But what are we to think of money that is created by the mere stroke of
a pen or the click of a computer key? Why should anyone collect a rental fee
on that?
In reality, they have nothing to lend. Even the money that non-indebted depositors have placed with them was originally created out of nothing in response to someone else's loan.
So what entitles the banks to collect rent on nothing?
It is immaterial that men everywhere are forced by law to accept these nothing certificates in exchange for real goods and services. We are talking here, not about what is legal, but what is moral.
As Thomas Jefferson observed at the time of his protracted battle against central banking in the United States,
Certainly, any amount of interest charged for a pretended loan is excessive. The dictionary, therefore, needs a new definition.
Let us, therefore, look at debt and interest in this light Thomas Edison summed up the immorality of the system when he said:
1. The Writings of Thomas Jefferson,
Library Edition (Washington: Jefferson Memorial Association, 1903), Vol
XIII, p. 277-78.
Is that an exaggeration?
Let us consider the purchase of a $100,000 home in which $30,000 represents the cost of the land, architect's fee, sales commissions, building permits, and that sort of thing and $70,000 is the cost of labor and building materials. If the home buyer puts up $30,000 as a down payment, then $70,000 must be borrowed.
If the loan is issued at 11% over a 30-year period, the amount of interest paid will be $167,806.
That means the amount paid to those who loan the money is about 2½ times greater than paid to those who provide all the labor and all the materials. It is true that this figure represents the time-value of that money over thirty years and easily could be justified on the basis that a lender deserves to be compensated for surrendering the use of his capital for half a lifetime.
But that assumes the lender actually had something to surrender, that he had earned the capital, saved it, and then loaned it for construction of someone else's house. What are we to think, however, about a lender who did nothing to earn the money, had not saved it, and, in fact, simply created it out of thin air? What is the time-value of nothing?
That means all the American dollars in the entire world are earning I daily and compounded interest for the banks which created them. A portion of every business venture, every investment, every profit, 'every transaction which involves money - and that even includes losses and the payment of taxes - a portion of all that is earmarked as payment to a bank.
And what did the banks do to earn this perpetually flowing river of wealth? Did they lend out their own capital obtained through the investment of stockholders? Did they lend out the hard-earned savings of their depositors? No, neither of these were their major source of income.
They simply waved the magic wand called fiat money.
If you borrow $10,000 from a bank at 9%, you owe $10,900.
But the bank only manufactures $10,000 for the loan. It would seem, therefore, that there is no way that you - and all others with similar loans - can possibly pay off your indebtedness. The amount of money put into circulation just isn't enough to cover the total debt, including Interest This has led some to the conclusion that it is necessary for you to borrow the $900 for the interest, and that, in turn, leads to still more interest.
The assumption is that, the more we borrow, the more we have to borrow, and that debt based on fiat money is a never-ending spiral leading inexorably to more and more debt.
The bank, on the other hand, is now making $80 profit each month on your loan.
Since this amount is classified as "interest" it is not extinguished as is the larger portion which is a return of the loan itself. So this remains as spendable money in the account of the bank. The decision then is made to have the bank's floors waxed once a week. You respond to the ad in the paper and are hired at $80 per month to do the job.
The result is that you earn the money to pay the interest on your loan, and - this is the point - the money you receive is the same money which you previously had paid. As long as you perform labor for the bank each month, the same dollars go into the bank as interest, then out the revolving door as your wages, and then back into the bank as loan repayment.
The loop through which it travels can be large or small, but the fact remains all interest is paid eventually by human effort. And the significance of that fact is even more startling than the assumption that not enough money is created to pay back the interest. It is that the total of this human effort ultimately is for the benefit of those who create fiat money.
It is a form of modern serfdom in which the great mass of society works as indentured servants to a ruling class of financial nobility.
But it would be a shame to stop here without taking a look at the actual cogs, mirrors, and pulleys that make the magical mechanism work. It is a truly fascinating engine of mystery and deception.
Let us, therefore, turn our attention to the actual process by which the magicians create the illusion of modern money. First we shall stand back for a general view to see the overall action.
Then we shall move in closer and examine each component in detail.
When banks run short of money, the Federal Reserve stands ready as the "bankers' bank" to lend it. There are many reasons for them to need loans.
Since they hold "reserves" of only about one or two per cent of their deposits in vault cash and eight or nine per cent in securities, their operating margin is extremely thin. It is common for them to experience temporary negative balances caused by unusual customer demand for cash or unusually large clusters of checks all clearing through other banks at the same time.
Sometimes they make bad loans and, when these former "assets" are removed from their books, their "reserves" are also decreased and may, in fact, become negative.
Finally, there is the profit motive. When banks borrow from the Federal Reserve at one interest rate and lend it out at a higher rate, there is an obvious advantage. But that is merely the beginning. When a bank borrows a dollar from the Fed, it becomes a one-dollar reserve. Since the banks are required to keep reserves of only about ten per cent, they actually can loan up to nine dollars for each dollar borrowed.1
The total annual cost, therefore, is $80,000 (.08 X $1,000,000). The bank treats the loan as a cash deposit, which means it becomes the basis for manufacturing an additional $9 million to be lent to its customers. If we assume that it lends that money at 11% interest, its gross return would be $990,000 (.11 X $9,000,000).
Subtract from this the bank's cost of $80,000 plus an appropriate share of its overhead, and we have a net return of about $900,000. In other words, the bank borrows a million and can almost double it in one year.1
That's leverage...
But don't forget the source of that leverage: the manufacture of another $9 million which is added to the nation's money supply.
1- The banks must cover these loans with bonds or other interest-bearing
assets which it possesses, but that does not diminish the money-multiplier
effect of the new deposit.
But, before jumping into this, a word of warning. Don't expect what follows to make any sense. Just be prepared to know that this is how they do it. The trick lies in the use of words and phrases which have technical meanings quite different from what they imply to the average citizen. So keep your eye on the words.
They are not meant to explain but to deceive.
In spite of
first appearances, the process is not complicated. It is just absurd.
It must be remembered, however, that this is purely arbitrary. Since the money is fiat with no precious-metal backing, there is no real limitation except what the politicians and money managers decide is expedient for the moment.
Altering this ratio is the third way in which the Federal Reserve can influence the nation's supply of money. The numbers, therefore, must be considered as transient. At any time there is a "need" for more money, the ratio can be increased to 20-to-1 or 50-to-1, or the pretense of a reserve can be dropped altogether.
There is virtually no limit to the amount of fiat money that can be manufactured under the present system.
This, however, is not necessarily true. It is quite possible to have either one without the other.
Therefore, the sale of government bonds to the banking system is inflationary, but when sold to the private sector, it is not.
That is the primary reason the United States avoided massive inflation during the 1980s when the federal government was going into debt at a greater rate than ever before in its history. By keeping interest rates high, these bonds became attractive to private investors, including those in other countries.1 Very little new money was created, because most of the bonds were purchased with American dollars already in existence.
This, of course, was a temporary fix at best.
Today, those bonds are continually maturing and are being replaced by still more bonds to include >the original debt plus accumulated interest. Eventually this process i must come to an end and, when it does, the Fed will have no choice but to literally buy back all the debt of the '80s - that is, to replace all I of the formerly invested private money with newly manufactured fiat money - plus a great deal more to cover the interest.
Then we will understand the meaning of inflation.
The massive -inflation of the money supply was made possible by converting commercial bank loans into "reserves" at the Fed's discount window and by the Fed's purchase of banker's acceptances, which are commercial contracts for the purchase of goods.
When the Fed creates fiat American dollars to give foreign governments in exchange for their worthless bonds, the money path is slightly longer and more twisted, but the effect is similar to the purchase of U.S. Treasury Bonds.
The newly created dollars go to the foreign governments, then to the American banks where they become cash reserves. Finally, they flow back into the U.S. money pool (multiplied by nine) in the form of additional loans. The cost of the operation once again is born by the American citizen through the loss of purchasing power.
Expansion of the money supply, therefore, and the inflation that follows, no longer even require federal deficits.
As long as someone is willing to borrow American dollars, the cartel will have the option of creating those dollars specifically to purchase their bonds and, by so doing, continue to expand the money supply.
Consequently, at the present time, this cozy contract between the banking cartel and the politicians is in little danger of being altered. As a practical matter, therefore, even though the Fed may also create fiat money in exchange for commercial debt and for bonds of foreign governments, its major concern likely will be to continue supplying Congress.
Therefore, as long as the Federal Reserve exists, America will be, must be, in debt.
All it has to do is create the required money through the Federal Reserve System by monetizing its own bonds. In fact, most of the money it now spends is obtained that way.
But, in the meantime, the increasing flood of money swirls out from the banker and engulfs the players. As the quantity of money becomes greater, the relative worth of teach token becomes less, and the prices bid for the properties goes up. The game is called monopoly for a reason. In the end, one person holds all the property and everyone else is bankrupt.
But what does it matter. It's only a game.
Furthermore, it is the most unfair tax of them all because it falls most heavily upon those who are thrifty, those on fixed incomes, and those in the middle and lower income brackets. The important point here is that this hidden tax would be impossible without fiat money. Fiat money in America created solely as a result of the Federal Reserve System.
Therefore, it is totally accurate to say that the Federal Reserve System generates our most unfair tax. Both the tax and the System that makes it possible should be abolished.
The partnership is merely looking out for itself.
The answer is twofold First, if it did, people would begin to wonder about the source of the money, and that might cause them to wake up to the reality that inflation is a tax. Thus, open taxes at some level serve to perpetuate public ignorance which is essential to the success of the scheme.
The second reason is that taxes, particularly progressive taxes, are weapons by which elitist social planners can wage war on the middle class.
Ruml had devised the system of automatic withholding during World War II, so he was well qualified to speak on the nature and purpose of the federal income tax. His theme was spelled out in the title of his article: "Taxes for Revenue Are Obsolete."
1. "Taxes for Revenue Are Obsolete/' by Beardsley Ruml, American Affairs, January, 1946, p. 35.
Ruml explained that, since the Federal Reserve now can create out of nothing all the money the government could ever want, there remain only two reasons to have taxes at all.
The first of these is to combat a rise in the general level of prices. His argument was that, when people have money in their pockets, they will spend it for goods and services, and this will bid up the prices.
The solution, he says, is to take the money away from them through taxation and let the government spend it instead. This, too, will bid up prices, but Ruml chose not to go into that.
He explained his theory this way:
REDISTRIBUTION OF WEALTH
This must always be done in the name of social justice or equality, but the real objective is to override the free market and bring society under the control of the master planners.
Ruml said:
1- Ruml, p. 36. 2- Ibid., p. 36.
As we have seen, Senator Nelson Aldrich was one of the creators of the Federal Reserve System.
That is not surprising in light of the cartel nature of the System and the financial interests which he represented. Aldrich also was one of the prime sponsors of the federal income tax. The two creations work together as a far more delicate mechanism for control over the economic and social life of society than either one alone.
The great bulk of federal funding continues to be created by the Mandrake Mechanism, the cost of government continues to outpace tax revenues, and the Ruml formula reigns supreme.
Just as money is created when the Federal Reserve purchases bonds or other debt instruments, it is extinguished by the sale of those same items. When they are sold, the money is given back to the System and disappears into the inkwell or computer chip from which it came. Then, the same secondary ripple effect that created money through the commercial banking system causes it to be withdrawn from the economy.
Furthermore, even if the Federal Reserve does not deliberately contract the money supply, the same result can and often does occur when the public decides to resist the availability of credit and reduce its debt. A man can only be tempted to borrow, he cannot be forced to do so.
Even though the Fed may try to pump money into the economy by making it abundantly available, the public can thwart that move simply by saying no, thank you. When this happens, the old debts that are being paid off are not replaced by new ones to take their place, and the entire amount of consumer and business debt will shrink.
That means the money supply also will shrink because, in modern America, debt is money.
And it is this very expansion and contraction of the monetary pool - a phenomenon that could not occur if based upon the laws of supply and demand - that is at the very core of practically every boom and bust that has plagued mankind throughout history.
SUMMARY
Its primary value lies in the willingness of people to accept it and, to that end, legal tender laws require them to do so. It is true that our money is created out of nothing, but it is more accurate to say that it is based upon debt. In one sense, therefore, our money is created out of less than nothing.
The entire money supply would vanish into bank vaults and computer chips if all debts were repaid. Under the present System, therefore, our leaders cannot allow a serious reduction in either the national or consumer debt.
Charging interest on pretended loans is usury, and that has become institutionalized under the Federal Reserve System.
The Mandrake Mechanism by which the Fed converts debt into money may seem complicated at first, but it is simple if one remembers that the process is not intended to be logical but to confuse and deceive. The end product of the Mechanism is artificial expansion of the money supply, which is the root cause of the hidden tax called inflation.
This expansion then leads to contraction and, together, they produce the destructive boom-bust cycle that has plagued mankind throughout history wherever fiat money has existed.
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