The Fed and the Golden Fleece

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When I teach my economics classes about money, I pass around a $10 gold coin that is a replica of those that were in circulation around 1913, the year Congress created the Federal Reserve System. The coin is made from one-half of an ounce of gold, dating from the time when the dollar was based upon a standard of $20 an ounce.

If I were to value that coin today, according to current gold prices, it would sell for more than $400, which means that according to this way of measuring the value of money, the dollar is worth about 1/40 of what it was when the Fed came into being. Now, this is not necessarily the best or most accurate measure of the decline of the dollar, but it is good enough for the purposes of this article.

Whether or not the dollar has declined to 1/40 or 1/50 or even 1/30 of its value of what it was before the Fed was created really does not matter, or at least a precise numerical measurement is not particularly vital for our understanding. What we do need to understand, however, is that the dollar is a mere shell of that currency that existed about a century ago, and that the predations of the Federal Reserve System are the main reason why this has happened.

A popular chant at Ron Paul rallies was "End the Fed," but if we are going to call for the closing of the nation’s "central bank," we first must understand the role of this agency in the financing of government activities. Furthermore, we have to understand what it is that the Fed has done in order to justify our condemnation and our demands that it be eliminated from our body politic.

First, we have to remember that governments do not need a central bank in order to engage in the act of inflation. Abraham Lincoln financed most of his war against the Confederacy by circulating "Greenbacks," which actually were demand notes issued by the U.S. Department of the Treasury. These notes circulated as legal tender, but by 1879 ultimately were redeemed in gold, albeit indirectly.

Second, even commodity money can create inflation. When William Jennings Bryan ran on the Democratic ticket for president in 1896, his platform was based upon inflating the money supply with silver coins. In our day of fiat money, the idea of a silver-based inflation seems fantastic, but in 1896, the dollar was so valuable that it actually was possible to engage in a silver-based inflation. The problem was that there were large U.S. silver deposits and powerful U.S. senators from the newly-created western states were able to push through laws that obligated the Treasury to purchase large amounts of silver and strike new coins, many of which never were put into circulation.

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April 23, 2009

William L. Anderson, Ph.D. [send him mail], teaches economics at Frostburg State University in Maryland, and is an adjunct scholar of the Ludwig von Mises Institute. He also is a consultant with American Economic Services.

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