Recently by Gary North: The Foundational Economic Myth of Our Era: ‘Government Cured the Great Depression’
On August 15, 1971, a Sunday, President Nixon unilaterally suspended the last traces of the gold standard. He “closed the gold window” on his own authority. From that time on, no government or central bank has been able to exchange dollars for Treasury gold at a fixed price. Nixon broke the Bretton Woods agreement of 1944. He broke the nation’s word. He cheated. That was his way. Ever since that day, American monetary policy has been Nixonomics.
Eight months earlier, he had announced his conversion to Keynesianism. This passage is from the amazingly good documentary on PBS, “Commanding Heights.”
For one thing, whatever the effects of the Vietnam War on the national consensus in the 1960s, confidence had risen in the ability of government to manage the economy and to reach out to solve big social problems through such programs as the War on Poverty. Nixon shared in these beliefs, at least in part. “Now I am a Keynesian,” he declared in January 1971 — leaving his aides to draft replies to the angry letters that flowed into the White House from conservative supporters. He introduced a Keynesian “full employment” budget, which provided for deficit spending to reduce unemployment.
If you think I am trying to tar and feather critics of the gold standard and defenders of Keynesian economics by connecting their ideas to a pragmatic, lying politician, then you’re brighter than your brother-in-law thinks.
THE NEW YORK TIMES
It should come as no surprise that the premier mouthpiece of American Establishment official opinion, The New York Times, is hostile to the traditional gold coin standard or any state-guaranteed version of the gold standard.
The New York Times used to be called “the gold standard of journalism.” But it was always a fiat standard. And like the fiat United States dollar, its value keeps sinking.
The gold coin standard places limits on a central bank’s ability to create money out of nothing, meaning counterfeiting. This is why its critics hate it.
At the center of almost every national economy today is a central bank that has been granted the government-sanctioned authority to intervene in the financial sector on behalf of large multinational banks. In the city of over-leveraged multinational banks, the New York Times wants no limits placed on the ability of the Federal Reserve System to bail out over-leveraged multinational banks.
The Times is well aware of the fact that Ron Paul is most famous for his position, which is also his book’s title, to end the FED. This position was considered crackpot, even within conservative political circles, prior to Paul’s run for the Republican Party’s nomination for President in late 2007. His was a well-timed candidacy. The economy went into a recession in December of 2007.
His stand against the FED spread rapidly in late 2008, after the FED and the U.S. government bailed out the biggest banks. The anti-FED genie is out of the bottle. Never before in America’s post-1913 history has there been this much public opposition to the FED.
The Times can do nothing about this, other than to publish an occasional obligatory article that announces: “You know where we stand.” Of course we know. We also know that the fiscally besieged Times is going bankrupt.
We know that its influence is fading, along with all print media. We know that there will not be enough paying online subscribers to offset the declining revenues from advertising, which the Times cannot command these days in the face of its declining readership.
So, for old Times sake, I offer my critique of its recent piece, “Be Careful Wishing for the Fed’s End.” That warning makes about as much sense to me as this one: “Be Careful Wishing for the Times‘ End.” The author is the company’s in-house financial columnist, Roger Lowenstein.
A CRISIS OF CONFIDENCE IN THE FED
Lowenstein leads off with one of the most heart-warming paragraphs of my intellectual life.
Ben S. Bernanke, the Federal Reserve chairman, faces a crisis of confidence. He is excoriated on the right for debasing the currency, and blasted on the left for failing to stimulate more than he has. It has gotten so bad that last week Mr. Bernanke, who prefers to discuss monetary policy with erudite professors like himself, submitted to the indignity of a news conference. Among the uninvited was Representative Ron Paul, who is flirting with a presidential run, and who, if he took office in 2013, would like nothing more than to celebrate the Fed’s centennial by … abolishing it.
Think about this paragraph. Never before in the FED’s history has any chairman faced this kind of opposition.
And that got me to thinking: What if there were no Fed? Don’t laugh; it has happened before. The United States had a primitive central bank, conceived by Alexander Hamilton, but President James Madison let its charter lapse in 1811.
Madison did nothing of the kind. By the terms of its incorporation, it automatically lapsed, and no President had any authority to keep it from lapsing.
Lowenstein does not mention that, during the long fight over the re-chartering of the Bank, Albert Gallatin, the Secretary of the Treasury, had favored the Bank’s re-chartering from 1809 to 1811. At no time did Madison fire him or suggest that he did not speak for Madison on this issue. Madison had two years to do so; Gallatin repeatedly lobbied Congress for the renewed charter. In 1811, the vote to re-charter failed by one vote in the House. In the Senate, the vote was tied; Vice President Clinton voted against it. Therefore, Madison did not let the First Bank’s charter lapse. Congress did, just barely. If Madison had publicly opposed the re-chartering, the votes would not have been close. But he kept silent. He let Gallatin speak for him. In 1816, Madison favored the creation of the Second Bank of the U.S. He signed it into law.
Having misled his readers regarding the First Bank of the United States, Lowenstein goes on to mislead them about the second Bank, i.e., Madison’s Bank.
A second such bank became the target of President Andrew Jackson, who viewed it as a “hydra” and a “curse” upon the nation. Jackson sought to decertify the bank and, in 1836, succeeded. Never mind that the following year, the United States was plunged into a serious financial panic. The curse had been lifted, not to reappear for nearly a century.
Never mind? Here is what he wants his readers not to mind. The president of the Bank, Nicholas Biddle, filed for re-chartering in 1831, five years early. The election of 1832 was fought mainly over the re-chartering of the Bank. Jackson vetoed the bill to re-charter. Congress failed to override the veto. Jackson’s Party had a smashing victory in November. The government ceased depositing funds in the Second Bank. Biddle’s bank began calling in loans, to pressure Jackson to comply. This action failed. The panic of 1837 was the result of an expansion of fractional reserve banking at the state level, 1833-36, over which the U.S. government had no constitutional control.
If the U.S. government had simply refused to deposit tax receipts in the banks, calling in specie and holding it as “excess reserves,” to use the nomenclature of today’s Federal Reserve System, there would have been no boom or bust, 1833-37. This idea was well known. It was called the independent Treasury system.
There was an inflow of silver, 1833-37, because of the inflationary policies of Santa Anna’s government. It was the result of Gresham’s law: a fixed exchange rate on silver. This inflow had nothing to do with Jackson or the Second Bank. The monetary base grew. Reserve requirements were not raised by state banks, including the Bank of the United States, still run by Biddle. The problem was fractional reserve commercial banking, as always: the state-granted license to counterfeit money.
IF THERE WERE NO FEDERAL RESERVE
The Establishment can no more conceive of money without a central bank than it could conceive of television programming standards without the Federal Communications Commission in 1970 or airline ticket pricing without the Civil Aeronautics Board in 1977.
Established in 1913, the Fed was to be a banker to the nation’s banks, controlling the money supply and, thus, the value of the currency. Without a Fed, someone else would have to handle these (and other) tasks of central banking.
Under the FED, there was monetary inflation in the World War I era, then the recession of 1920-21, and then the monetary inflation and bust of 1926-30, followed by the Great Depression. Stability? There was none.
“Money,” observes the Fed historian Allan H. Meltzer, “does not take care of itself.” But who else could regulate the value of money? And regulate its value in relation to what?
Why doesn’t money “take care of itself”? Because governments want to control it. Contract law serves the other markets. Why not money? Why should money be under the control of a system of 12 privately owned banks that are under a government board?
In its founding days, the United States defined the dollar by an explicit weight of gold or silver.
No, it didn’t. The dollar was always a silver standard. Then a price control with gold was set by the government, which led to Gresham’s law. Sometimes gold would be in short supply, sometimes silver. That is what price controls produce: gluts and shortages.
During the first half of the 19th century, state-chartered banks issued notes, preferably backed by metal, that circulated much as dollar bills do today. But since these banks were private, and differed widely in their standards, their notes were accorded different values. In effect, the country had lots of “monies.”
Exchange rates set the value of these notes, just as the free market does in the currency markets today. With computerization in our day, this is no problem. The government can set what currency it requires for tax payments. Gold would be a good choice. The government does not need to set currency ratios. It does not need to monopolize money. But politicians want to.
The United States moved to normalize the situation during the Civil War. It restricted the issuance of notes to more uniform, federally chartered banks, which were required to hold Treasury bonds (as well as gold) in reserve.
The government did this to gain more control over the money supply. It had suspended payment in gold in late 1861 — a violation of contract. Then it created “greenbacks” — unbacked paper money — in a wave of price inflation. The South did the same, only much worse. It was theft: first the suspension of specie payments, then from the people through inflation.
Should the Fed be interred, this abbreviated history provides some clues about alternatives. One solution would be for private banks to issue money — perhaps bearing the likeness of Jamie Dimon and the seal of his bank, JPMorgan Chase. Alternatively, the Treasury could do it.
Private agencies of all kinds could issue money. The market would decide which to use. Money tied to gold or silver would enjoy a great advantage. Banks do this now, but without being tied to gold. Their digits are money.
If the government ever does this, then hyperinflation is a sure thing. This would be greenback economics, which is always political and inflationary in modern times. On greenback economics, click here.
A GOLD STANDARD
As long as contracts are not violated, private money would work far better than the Federal Reserve’s legalized counterfeiting does. Any firm could issue an IOU for gold or silver or platinum coins of a specific weight and fineness. Just be sure it has the metals in reserve.
But what will the money represent? Gold is the first obvious answer. James Grant, the newsletter writer, author and gold bug par excellence, asserts that gold money is superior to the “fiat” money of the Fed. By fiat, he means that it has value only because the Fed says it does. (Representative Paul, less diplomatically, refers to Federal Reserve notes as “counterfeits” and to the Fed as a price fixer.)
Grant is correct. Paul is correct. Fiat money is counterfeit money. Let the banks issue warehouse receipts 100% backed by gold. Contract law will take over. There will be a market for gold coins.
Let us interject that in any monetary system, some authority must fix either the price of money or the supply. McDonald’s can either set the price of a hamburger and let the market consume the quantity it will — or, it can insist on selling a specified quantity, in which case consumer demand will determine the price.
I will not let “us” interject anything of the kind. There is no logic to it. Gold, silver, and platinum are limited by mining costs, but there is no fixed money supply. There never has been in man’s history. The statement is conceptually ludicrous and historically ludicrous. No authority need fix either the supply or the price of anything.
The Fed has a similar choice with money. The Bernanke Fed, which is trying to stimulate the economy, regulates the price of money — the interest rate — presently 0.0 percent. Paul Volcker, who assumed command of the Fed in 1979, when inflation was rampant, chose the opposite tactic. Mr. Volcker provided a specific (and, dare I say, miserly) quantity of liquidity, letting interest rates go where the market directed — ultimately 20 percent. There is an element of arbitrary choice either way.
The element of arbitrary choice is the heart of the problem: it will eventually be misused. Central banking’s cheerleaders want us to believe that wise, salaried bureaucrats should control the monetary base. There is a problem here: these bureaucrats then must let commercial bankers, speculators, and governments decide what the money is worth. They cannot determine this on their own authority.
The gold standard, in effect, replaces the Fed chief with the collective wisdom (or luck) of the mining industry. Rather than entrust the money supply to a guru or a professor, money is limited by the quantity of bullion.
He’s got it! The private property rights system restricts the money supply, so that neither politicians nor central bank committees are in charge of our money. We can trust mining costs with greater confidence than politicians with badges and guns and a printing press.
The law in the early 20th century stipulated that dollars be backed 40 percent in gold. This fixed the dollar in relation to metal but not in relation to things, like shoes or yarn, that dollars could buy. This was because the quantity of bullion that banks had in reserve, relative to the size of the economy, fluctuated. As a historian noted, it was as if “the yardstick of value was 36 inches long in 1879 … 46 inches in 1896, 13 and a half inches in 1920.”
Whoever that unnamed historian was, he was an economic ignoramus. Money is not a measure. It is a social institution based on contract. The government wants to get control over it, so that it can create fiat money and thereby impose an inflation tax rather than tax voters directly.
The gold standard — which John Maynard Keynes termed a “barbarous relic” — led to ruinous deflations.
There have never been any ruinous deflations based on a contracting supply of gold. Gold’s supply constantly increases, though slowly. There were many deflations based on fractional reserve banking — fiat money allowed to commercial bankers by the state — when the over-leveraged (over-counterfeited) banks got hit by bank runs.
When gold reserves contracted, so did the money supply. David Moss, a Harvard Business School professor, asserts that the United States experienced more banking panics in the years without a central bank than any other industrial nation, often when people feared for the quality of paper; specifically, it experienced them in 1837, 1839, 1857, 1873 and 1907.
States authorize commercial bank counterfeiting. The Constitution does not authorize the U.S. government to intervene to stop this practice. That is what federalism is all about. That is what the Tenth Amendment used to be about, before it was gutted by the Supreme Court.
THE CREATURE FROM JEKYLL ISLAND
The Establishment occasionally admits that the November 1910 meeting on Jekyll Island was a quiet gathering. But it was not a conspiracy. Not at all. The difference is this. . . There must be a difference. . . Anyway, it was all for the public’s good.
The Fed was conceived to alleviate such crises; that is, to be “the lender of last resort.” This function was fulfilled, ad hoc, by the financier J. P. Morgan in the panic of 1907. But Morgan was old, destined to die the year the Fed was created; some institution was needed. Hostility toward central banks, an American tradition, was such that in 1910, lawmakers and bankers convened at Jekyll Island, Ga. — under the ruse of going duck hunting — to sketch a blueprint.
The FED was conceived to bail out the big New York banks. It was justified as a tool to alleviate crises. And, yes, it was a conspiracy consummated on Jekyll Island by a group of bankers and Senator Nelson Aldrich, John D. Rockefeller, Jr.’s father-in-law.
Part of the aim of the new central bank was a more flexible money supply — for instance, to lend to farmers in the winter. Another was to lend into the teeth of a panic — though only to solvent institutions and on sound collateral. The insurance giant American International Group — a controversial bailout recipient in 2008 — would not have qualified.
AIG surely qualified in 2008. That is what “flexibility” is for: to bail out insiders.
Farmers in the winter. Right! As if the FED cared a whit about farmers, back then or now. Did the FED save farms in the 1920s? No. Did it save farm area banks, 1930-33? No. In any case, prices for grain adjust in winter. That is what pricing is for. That is also why interest rates change. Conditions change. You don’t need counterfeiting to smooth out supply and demand based on seasons.
In its early days, the Fed maintained the gold standard — forcing it to maintain tight money even in 1931, in the midst of the Great Depression. Economists today regard this as a mistake.
This is Milton Friedman’s misleading intellectual legacy. The FED did not tighten money, 1930-31. See the chart provided by a vice president of the St. Louis Federal Reserve Bank. The monetary base was flat.
Money shrank because 9,000 banks went under. That ceased in 1934, when the FDIC was set up. The FED had no authority or ability to save 9,000 banks.
The circumstances are relevant to those who envision a Fed-less future. England had departed from the gold standard; worried that the United States would follow suit, people demanded to trade dollars for gold. Professor Meltzer deduces that the gold standard doesn’t work for one country alone; the bad paper money corrupts the good.
This is the ill-informed person’s view of Gresham’s law: that the free market rewards bad money. It doesn’t. When there are government-imposed fixed exchange rates — price controls on money — the artificially overvalued money drives out the artificially undervalued money. In other words, price controls create gluts and shortages. Every economist knows this. Any economist who promotes Gresham’s law without explaining this price control factor is trying to put the shuck on the rubes. Lowenstein is one of the rubes who got shucked.
AN ALTERNATIVE TO GOLD
Here is where Lowenstein lets his imagination soar.
An alternative to gold, and to the Fed, was suggested by Mr. Bernanke’s hero, Milton Friedman: let a computer govern the money supply. John Taylor, a former Treasury official, has derived a formula, the Taylor Rule, which Fed policy often agrees with. Adopting the formula in a mechanical way would trim the deficit a bit, since the Fed could dismiss every one of its 200 economists. The problem with a formula (also its virtue) is its lack of flexibility. Alan S. Blinder, a former Fed vice chairman, notes that strict adherence to the Taylor Rule during the recent crisis would have mandated an interest rate of negative 5 percent. (That is, the economy was so weak, and people so unwilling to borrow money, the computer would have paid people 5 percent a year to accept it.) This being impractical, Mr. Bernanke was moved to improvise a remedy other than negative rates.
This is academic self-puffery. There is no Taylor rule at the FED. That is my point and Ron Paul’s point. There are no rules. You know: “flexibility,” as Lowenstein calls it. There is only ad-hockery, such as: (1) double the monetary base, (2) swap T-bills at face value for toxic assets held by large New York banks, and (3) lend billions to large foreign banks.
If the computer is out and the Fed shuttered, Professor Meltzer suggests that the dollar be backed by euros, pounds and yen (and, eventually, the renminbi). This new money would require that each of the financial powers commits to a targeted rate of inflation — say, 2 percent a year. People who didn’t trust the dollar to maintain its value could trade them for euros. Now there’s an idea that would delight the Tea Party — American money backed by France.
Professor Meltzer can say anything he wants. Nobody has to believe him. I surely don’t.
The dollar is not backed by anything, and has not been ever since August 15, 1971, when Nixon without authorization suspended payments in gold to foreign central banks. Nixon was a petty tyrant, but here the Congress and business cheered. He imposed price and wage controls. More cheering. Ben Bernanke presides over Nixonomics, as have all subsequent chairmen of the Board of Governors of the FED. But no one in the Establishment wants to call the system what it really is: Nixonomics.
Actually, this system is not terribly different from today’s. We have, indeed, fiat money, convertible into foreign exchange and regulated, not always successfully, with the intent of maintaining (or not too quickly depreciating) the dollar’s purchasing power. And if money is a unit of value, it is hard to conceive of a yardstick better than purchasing power.
I see. A yardstick. This “yardstick” has shrunk by over 95% since 1914, the year the FED opened for business. You can check this with the inflation calculator of the Bureau of Labor Statistics.
But the Fed, thanks to an act of Congress in 1978, and perhaps to America’s suspicious anti-central banking culture, has a dual mission — protecting the value of the dollar and promoting long-term growth and employment. In this, it differs (at least in degree) from Europe’s and other central banks. In many ways, this mission creep — the Fed’s expanded power and role in the economy — lies at the root of the animus that Americans feel for it.
This is not a dual mission. It is a dual public relations statement. Congress did not specify any numbers. The FED gets to make them up as it goes along . . . and does.
Banking purists would like, if not to abolish the institution, to return it to the job envisaged on Jekyll Island. They are, in a sense, the financial equivalent to strict constitutionalists. Nostalgia has its place, but so does pragmatism. Mr. Bernanke and his colleagues may be flawed, but democracy trusts in the power to elect, appoint and, if need be, remove. It is fine to lament their alleged excesses — for instance, the Fed’s swollen balance sheet in the name of stimulation, or “quantitative easing.” It is another to imagine that regulating the money could be as simple as it was in 1913, or that a formula, or a barbarous relic, could do the job.
In his view, defenders of the gold coin standard are quaint relics of the past, just as gold is. He writes: “They are, in a sense, the financial equivalent to strict constitutionalists. Nostalgia has its place, but so does pragmatism.” So, adhering to the Constitution is nostalgia. So is the idea of a world without the creature from Jekyll Island.
What Lowenstein wants is pragmatism. You know: flexibility.
This is what every central banker always wants. Also, every dictator.
Richard Nixon surely wanted it.
It is what Ron Paul does not want. Neither do I.
End the FED.
May 7, 2011
Copyright © 2011 Gary North