What Is Money? Part 4: Bait and Switch

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The phrase “bait and switch” refers to a sales practice of advertising a desirable item at a low price to get potential buyers into a showroom. Then the salesman tells the shopper that the firm has run out of the sought-after item. The salesman then uses his sales skills to sell the shopper a more expensive item.

This practice is illegal. It is a form of fraud. It steals time from the shoppers.

Bait and switch is at the heart of all fractional reserve banking. It is not illegal. It is the heart of the modern economy.

A century ago, gold coins were money. There were no Federal Reserve Notes. Today, Federal Reserve Notes are money. Gold is not, except for central banks. This reversal was the product of a national bait-and-switch operation that began in 1914. A similar reversal occurred at the same time, though much more rapidly, in Europe: the outbreak of World War I.

The story of how this switch was planned at the highest levels of the banking industry in the United States is one of the stories that never gets into college-level textbooks. It is told in eloquent detail in Part 2 of Murray Rothbard’s book, A History of Money and Banking in the United States. You can download it for free here.

Burt Blumert, who sold gold and silver coins for half a century, used to teach people about the history of American inflation by showing them a series of paper money notes. He would show how the promises on the bills changed over time. He would give a running commentary on the purchasing power of the dollar. The decline of the dollar can be tied to the change in the promises. People who were taught by Blumert for five minutes gained a better understanding of the history of inflation in the United States than the typical college graduate possesses, even if he took an introductory course in economics.


A century ago, there were no Federal Reserve Notes. There were gold coins in wide circulation. Americans recognized gold coins as money. The double eagle, or $20 gold piece, was how millions of workers were paid each week.

A person could walk into a store and buy what was for sale for $20 or less. There was no doubt about a $20 gold piece as lawful money. A buyer did not have to explain what a $20 gold piece was. He did not have to offer a discount to the seller because he was using a $20 gold piece. He did not have to make any prior arrangements before coming into the store in order to make a purchase with a $20 gold piece. American gold coins were money. He probably would have been able to buy anything with a gold coin issued by any other government. When it came to gold, sellers were not picky.

For smaller purchases, silver coins were popular. A silver coin functioned as money in the same way that a gold coin did. People did not have to be told what silver coins were.

The problem facing every fractional reserve bank in the United States in 1909 was simple: if it issued too many IOUs for money, anyone owning an IOU could come down to the bank and exchange it for either gold or silver coins. If the bank faced a long line of depositors coming down to get silver coins or gold coins, it might go out of business. It would run out of coins.

A bank had promised depositors that they could get gold or silver coins on demand. When a bank was incapable of delivering the coins on demand, it was legally bankrupt. This was always the fear of every commercial banker in the days before the FDIC.

The problem arose because banks always issued more IOUs for gold and silver coins than they had coins on hand to redeem. They issued these receipts because they were paid interest on the money loaned. The more receipts to gold and silver coins that they issued, the more money they would receive in interest. This is the logic of all banking.

The depositors could demand payment in legal money — U.S. coins — at any time. On the other hand, the bank could collect money from borrowers except on whatever terms the original contract specified. The banks were borrowed short and lent long. They could be caught in a squeeze whenever depositors decided it was time to redeem their written promises for real money.

Bankers therefore wanted protection. They wanted protection from depositors. Bank robbers were only rarely a problem for a bank. They could collect only the as-yet unloaned money in the vault. In contrast, depositors could wipe out a bank at any time. They could force it into bankruptcy: ruptured bank status.

Depositors are always the enemies of fractional reserve banks, because the banks have lent long and borrowed short. The banks face bankruptcy whenever depositors believe that it is time to redeem the promises for real money. This is the Sword of Damocles hanging over the head of every banker.


Bankers in the United States decided in the late 19th century that it would be a good idea to have a national central bank. The central bank would make money available to any bank that was suffering a bank run. It would serve as a gigantic insurance company to the banks of the nation. With a line of credit available from the central bank, individual commercial banks could issue even more IOUs to money and gain interest from loans. If they could just reduce the risk of bankruptcy in a bank run, bankers knew that they could earn far more money on deposits in the bank. So, they began to organize to persuade the government to establish a central bank.

Bankers wanted an ideal situation. They wanted the central bank to be authorized by the Federal government. They wanted the public to trust it. But they did not want the central bank to be an agency of the Federal government. They wanted the central bank to be an agency of commercial banks. Bankers wanted to be in charge of monetary policy. But they knew that it was unlikely that the government would grant a monopoly privilege of regulating the banking system without something in return.

What might that be? A guaranteed buyer for Treasury debt.

Strategists at the largest banks, namely, the house of Morgan and the Rockefeller banks, put together a plan in 1910. They would propose a central bank in which the Board of Governors would be appointed by the President. The Board of Governors would report to Congress on a regular basis.

There would also be a series of regional banks, all bearing the name of the central bank — Federal Reserve — but which would not be controlled by the Federal government. They would be controlled by the region’s commercial banks. The regional Federal Reserve banks would be owned by the commercial banks in the same region as the regional branch of the Federal Reserve.

The men who devised this system were well aware of the fact that there was general hostility among voters to the creation of a central bank. The voters recognized that a central bank would be an agency of the largest commercial banks. So, the promoters decided to name the central bank the Federal Reserve System. They named the regional banks Federal Reserve banks, but not the system as a whole. They did this because they believed that this would create an illusion that the regional banks were under the control of Congress, because Congress officially controlled something called the Federal Reserve System. Congress never has controlled the Federal Reserve System, if by “system” we refer to a conglomeration of 12 privately owned regional banks that technically are under the jurisdiction of a government-appointed Board of Governors. But it pretends that it does.

Another pretence: that the regional banks had real power. Only one did then or does now: the Federal Reserve Bank of New York.

When the Federal Reserve System began operations in 1914, it took care not to appear to be a national central bank. The men in charge created the illusion that the system had been designed for the benefit of the public, in order to protect the public against two groups: Congress and commercial bankers. The organizers defended the system on the basis that the public had to be protected from the spendthrift Congress and also greedy commercial bankers.

The rulers never came out and said what they really meant. What they really meant was that democracy is a threat to commercial banking. If Congress can set policy governing monetary affairs, then Congress can use the banking system in order to fund its own operations. Congress will then pressure the banking system to create fiat money so that Congress can spend this money on pork projects. That is exactly what Congress would like to do. It is what Congress has always wanted to do.

So, the defenders of the Federal Reserve System have always said that there has to be an independent FED. When they say “independent,” they really mean “independent of voters.” They dare not say openly what is really involved, namely, a bureaucratic attempt to escape from the voters.

There is no doubt that Congress is a threat to voters at all times. Congress is perfectly willing to run up huge budget deficits, just so long as this does not raise interest rates. If interest rates go up, then Congress has to pay more to investors who buy Treasury debt.

Congress wants the central bank to intervene and purchase some percentage of the Treasury’s debt. This will hold down short-term interest rates: rising supply of fiat money to meet rising demand. Congress wants the Federal Reserve System to serve as the lender of last resort.

This goal goes back to 1694 with the creation of the Bank of England. That, too, was another government-licensed monopoly bank that was owned and operated by private investors. This structure has served as the model for central banking ever since.


The goal of commercial bankers has always been to issue more promises to redeem on demand than their banks had assets to redeem. Commercial bankers wanted to protect themselves from depositors. They did not trust the depositors, because depositors had the legal authority to walk into the bank, hand over their written promise issued by the bank to pay gold or silver coins, and walk out of the bank with coins instead of written promises. The bankers made their money on the promises, and any attempt by depositors to redeem the promises for gold reduced the amount of money to bankers could lend at interest.

The bankers saw the creation of the central bank as the best way to reduce the likelihood of bank runs. In other words, they realized they had issued more promises than they could redeem. Their goal was not to reduce the number of promises. Their goal was to increase the number of promises, but reduce the likelihood that the promises would be redeemed by depositors.

The entire system was geared to the goal of issuing more promises rather than reducing their number. The goal was to persuade the public to accept written promises for gold, so that the public would not keep gold coins in their possession. If the public kept gold coins in their possession, this would reduce the ability of bankers to lend money to borrowers. The goal of the bankers was to get as much of the gold into their hands, issue as many warehouse receipts to this gold they could get away with, and then create a central bank, so they could get away with issuing even more IOUs for gold. They wanted more inflation, but they did not want the threat of bank runs, which is ultimately the threat of monetary deflation.

Under this system, deception was vital. First, there had to be deception regarding the written promises. The deception was to persuade depositors (and other bankers) that there was sufficient gold in reserve to redeem the promises. The written promises all looked alike, so the public could not tell which of the promises could be redeemed and which could not in a crisis. The promises that would be redeemed would be the ones that were presented early in the bank run. Everybody who presented his promises late in the process was likely not to have the IOU redeemed.

The Federal Reserve System had the same problem. It, too, had issued more promises to pay gold than it had gold in reserve. It, too, wanted to reduce the likelihood of bank runs. If anyone could walk into a bank with a Federal Reserve-issued note and demand gold coins, then the local bank would present the note to the regional FED bank for reimbursement.

The commercial banks wanted to substitute paper IOUs for coins. Similarly, the FED wanted to substitute non-redeemable Federal Reserve Notes for notes promising to redeem for gold or silver. It took half a century for the FED to achieve this goal.

Burt Blumert’s presentation was better than mine. Here is my crude version.

First, the public had to accept Federal Reserve Notes in lieu of U. S. Treasury notes.

The Federal Reserve began the bait and switch. It persuaded the public to accept its notes rather than notes issued by the U.S. Treasury. That would require a promise. The notes bore this promise. The promise was made to note-holders. They could use the notes to pay taxes or buy gold . . . but only at the Treasury. This made the note-holders dependent on banks, which would redeem the notes at the Treasury. Banks were still in on the deal.
This note is receivable by all national and member banks and Federal Reserve Banks and for all taxes, customs and other public dues. It is redeemable in gold on demand at the Treasury Department of the United States in the city of Washington, District of Columbia or in gold or lawful money at any Federal Reserve Bank. (1914—18)

Redeemable in gold on demand at the United States Treasury, or in gold or lawful money at any Federal Reserve Bank. (1928—33)

To the extent that the Federal Reserve System could persuade the public to use Federal Reserve Notes instead of gold certificates or silver certificates, the Federal Reserve gained a way of escaping the bank run.

In 1933, Franklin Roosevelt declared it illegal for Americans to own gold. Congress soon ratified his declaration. So did the Supreme Court. The promise changed. The law now brought every creditor under the obligation to accept the notes.
This note is legal tender for all debts, public and private, and is redeemable in lawful money at the United States Treasury, or at any Federal Reserve Bank. (1934—63)

In 1963, a run against silver coins began, and the result was that the Federal Reserve could not get enough silver coins to deliver local banks to hand out to people who brought in silver certificates and demanded payment in silver coins. This mandated a new promise.
This note is legal tender for all debts, public and private. (1963—today)

In 1964, the U.S. Mint began issuing copper coins covered in silver laminate. This was the bald-faced bait-and-switch operation of the late Roman Empire.

The Federal Reserve System in 1963 began issuing $1 Federal Reserve Notes. These notes could be not be redeemed for silver coins.

At that point, the FED began to increase the expansion of money in earnest.

The final promise to be abandoned was the promise of the U.S. government to redeem dollars for gold at $35/oz. This promise had been made ever since 1934. It was made to foreign governments and central banks. Richard Nixon imitated Roosevelt on August 15, 1971. He declared that this promise was null and void.

From 1964 until 2009, according to the inflation calculator of the Bureau of Labor Statistics, consumer prices in the United States rose by 6.8 times. From 1914 to 1963, they rose by a factor of three.


Bait and switch is the heart of all fractional reserve banking. Bankers knowingly promise more than they can deliver to every depositor. The history of commercial banking has been the history of bankers’ attempts to transfer liability for bank failures to the government, while maximizing income from making loans.

That was what the banking crisis of September and October 2008 was all about.

You might think that Congress would eventually catch on. It never does. Congress is busy making far greater promises that will be reneged on. It has no time to pay attention to such arcane matters as these. It is easier for Congress to pass a bill to bail out the banks than it is for Congress to go the voters in the month before the Presidential election and say, “We did nothing. The largest banks are no more. Sorry about that.”

Congressmen knew that the public would re-elect most of them, despite the big bank bailout. They were correct.

Lenin said that in order to make an omelet, you must break a few eggs. What is the omelet? The desire of Congressmen and Senators to be re-elected. What are the eggs? Your plans for the future.

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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