Monetary Liberty Lost

During the early years of the twentieth century, and particularly after the Panic of 1907, the very process of economic self-diagnosis, correction and cure underwritten by the gold standard was misdiagnosed as an intolerable disease. If a shortage of bank reserves caused a decline in the volume and pace of business activity, argued a growing band of economic interventionists, why not devise a way to supply increased reserves to the banks? If banks can continue to lend money indefinitely, the interventionists also claimed, then slumps, recessions and depressions could be consigned to the dustbin of history. And so with this intent in mind the U.S. Federal Reserve System was organised in 1913 (see in particular Murray Rothbard, The Case Against the Fed, Ludwig von Mises Institute, 1994, ISBN: 094546617X).

“The Fed” comprised twelve regional Federal Reserve banks that were nominally owned by private bankers but in reality sponsored, controlled, and supported by the U.S. Government. The credit extended by central banks is in practice (although not in law) backed by the taxing power of the federal government. Credit extended by the Federal Reserve to commercial banks and the U.S. Government, in other words, is not backed by a finite and objectively-determined quantity (i.e., the amount of gold saved by individuals and stored in vaults); rather, it is “backed” by a much less finite and far more subjective quantity: the amount of taxation that the government can confiscate from its citizens. Technically, for twenty years after the creation of the Federal Reserve System the U.S. remained on the gold standard. Until 1933 individual Americans were still free to own gold, and gold continued to be used as bank reserves. But this was a bastardised “gold standard”: in addition to gold, the credit extended by the Federal Reserve banks (i.e., paper reserves) was legal tender. Creditors, in other words, no longer possessed an unabridged right to redeem their debts in gold.

Whether the Fed’s creation was constitutional is a matter for debate. Joseph Sobran writes that “the Constitution says that Congress shall have the power to coin money and regulate the value thereof. The word ‘regulate’ in this context meant ‘regularise,’ not ‘arbitrarily change.’ Congress is supposed to keep the value of money stable. Otherwise government becomes a huge counterfeiting ring … Ninety years ago, Congress unconstitutionally delegated this responsibility to the Federal Reserve System, a quasi-private agency. The idea was that private bankers would know how to protect the U.S. currency against inflation. Result? The value of the dollar has been fluctuating – and mostly shrinking – ever since.

Your ‘dollar’ is actually a near-total counterfeit.”Sobran omits another important consideration: not only is the Fed an unconstitutional creation uniquely responsible for the bastardisation of American money and the cumulative destruction of its value, it also did much during the late 1920s to turn a recession into the Great Depression. (On 8 November 2002, at the conference held to honour Milton Friedman’s 90th birthday, Fed Governor Benjamin Bernanke said “let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna, regarding the Great Depression, you’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”)

When business conditions in America suffered a mild contraction in 1927, the Fed created more paper reserves in order to forestall any possible shortage of bank reserves. More disastrous, however, was the Fed’s attempt to assist Britain – which had been losing gold to America because the Bank of England refused to allow interest rates to rise when market forces dictated that they should do so. In Britain, a rise of interest rates was deemed to be politically intolerable. Monetary authorities reasoned that if the Fed pumped excessive paper reserves into American banks, then interest rates in the U.S. would fall to a level comparable to those in Britain. This equalisation of interest rates in the major English-speaking countries would decelerate and finally stop Britain’s loss of gold – and thereby avoid the political embarrassment of a rise of interest rates.

The Fed “succeeded.” It indeed stopped Britain’s haemorrhage of gold; but in the process it thoroughly wrecked the American, British Empire and other major economies. The excess credit that the Fed pumped into the banking system found its way into the markets for financial assets – that is to say, Wall Street – and triggered a fantastic speculative boom. Belatedly, Fed officials attempted to remove the excess reserves and finally halted the boom. But it was too late: by 1929 speculative imbalances had become so destabilising that the Fed’s attempt to mitigate them precipitated a monetary and economic retrenchment of almost unparalleled severity and duration. Britain fared even worse than America, and rather than absorb the full consequences of her previous folly, in 1931 its monetary and political authorities abandoned the gold standard. When it did so, and in 1933 when the U.S. Government reneged on its promise to pay its debts in gold, what remained of the fabric of business confidence was even more grievously damaged. These actions induced a series of bank failures around the world and further extended the Great Depression (see also Rethinking the Great Depression: Implications for Value Investors).

Central Banks and Welfare Statists

Statists have for decades contended that the credit débâcle which led to the Great Depression was caused primarily by the gold standard. If the gold standard had not existed, they have argued, Britain’s abandonment of gold payments in 1931 would not have encouraged the failure of banks all over the world. Since the Fed’s creation in 1913, America had not been on a gold standard but rather on what might be termed a “mixed gold-paper standard.” Gold, in other words, comprised only part of the Fed’s reserves, yet gold was accorded all of the blame for the Depression.

The growing opposition to a gold standard came primarily from a particular group. And their hostility to gold was motivated by a subtle but profound insight. The growing number of people who opposed laissez-faire and advocated a dirigiste welfare-warfare state sensed correctly that the gold standard is incompatible with chronic deficit spending. They correctly sensed, in other words, that the gold standard was incompatible with the very hallmark of the welfare state. Stripped of its academic jargon, the welfare state is a mechanism by which governments confiscate wealth from the productive members of a society in order to subsidise a wide variety of schemes that individuals, when left to their own devices and choices, do not undertake (see in particular Hans-Hermann Hoppe, Democracy, The God That Failed: The Economics and Politics of Monarchy, Democracy and Natural Order, Transaction Books, 2002, ISBN: 0765800888). A substantial part of this confiscation is achieved through taxation. Welfare statists recognised that if they wished to extend and maintain the welfare state then the amount confiscated must constantly rise. Yet if welfare statists wished to retain political power, as they undoubtedly did, then taxation had to be limited to the amount that the public could tolerate at any one point in time. Welfare statists therefore had to resort to programs of massive deficit spending. They had, in other words, to borrow money by issuing government bonds and thereby to finance welfare and warfare expenditures on a large and ever-growing scale.

...continued in Part IV