Things I've Tagged ‘Banking’

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#Banking, #Gold Standard, #Greenspan, #Money

Gold, Welfare Statists, and Economic Freedom

A formerly wiser man once warned of “an almost hysterical antagonism toward the gold standard” as a force which unites all statists. I wanted to wrap my mind around that particular statement because I’ve grown up in an era entirely dominated by fiat money, easy credit, booms and busts, and a great deal of inflation; and because I wanted to know why it would be beneficial to a statist, or someone interested in affecting a “positive” change in the economy, to seek to abolish the gold standard, I had to explore popular thinking on the matter.

What would a gold standard accomplish in terms of wealth and debt, and what would a system based entirely on fiat, or paper, secure without the backing of a commodity as a store of actual wealth?

In 1966, Alan Greenspan wrote that, “in order to understand the source of their [statist’s] antagonism, it is necessary first to understand the specific role of gold in a free society.” 1 We must first assume that money, as a commodity, is the means by which economic transactions take place, whether it be for goods or services, in a given society, “and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.” 1 Without it we cannot build wealth, discharge debts, exchange goods and services, or plan for the long term in any meaningful fashion. Exchange of any asset would become quite difficult. 1

In the development of international economic systems, precious metals, particularly gold, became the means by which goods and services could be exchanged; gold became a preferred choice because by “having both artistic and functional uses and being relatively scarce, [it had] significant advantages over all other media of exchange.” 1 Gold is a limiting resource in this fashion simply because of its scarcity; if all transactions were paid in gold, it would become difficult to handle larger payments and economic development would be sharply limited. “Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.” 1

Greenspan dives into what this development means in terms of free banking:

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

Unbalanced expansions of business activity (the booms we often see in modern times) are held in check because credit cannot be extended too far beyond limited gold reserves; however, in some cases banks would extend credit too far, and “as a result of [this] overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession.” 1 Most often these recessions were seen as mild in comparison to more modern experiences.

In order to solve this economic puzzle, it was determined that if shortages were what caused declines in business activity it would be best to ensure that no shortages ever existed.

If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (paper reserves) could serve as legal tender to pay depositors. 1

In 1927, business in the United States experienced a mild contraction, and in order to shore up the possibility of a shortage, the Federal reserve printed more paper reserves; more disastrously, “however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable).” 1

The basic idea was to pump excessive paper reserves into the US system in order to create interest rates that would be comparable to England’s, thus stopping the outflow of gold. Unfortunately the success of this plan in stopping the outflow of gold added additional credit to the market that created a speculative boom in the markets. To stop this boom, Reserve officials decided to destroy the excess paper reserves; unfortunately it was too late because “by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence.” 1

The American economy collapsed. “Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. World economies plunged into the Great Depression of the 1930’s.” 1 In short, the machinations of central banking created a mess that was largely blamed on the gold standard, because, it was reasoned, “if the gold standard had not existed…Britain’s abandonment of gold payments in 1931 would not have caused the failure of banks all over the world.” 1 Irony in this case is not lost on Greenspan, as he notes that we had not in fact been on a de facto gold standard since 1913, but instead a sort of mixed system.

Under a gold standard, the amount of credit that an economy can support is determined by the economy’s tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government’s promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. 1

Abandoning this standard made it possible for welfare statists to expand credit in an unlimited fashion; paper reserves are treated as a commodity, as assets, as if they were a gold deposit. “The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets.” 1 Thus because as the supply of money increases relative to assets, prices are forced to rise in order to balance the books. Money is devalued, thus any savings–and relative wealth in terms of money–is diminished in value. “When the economy’s books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.” 1

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

Thus, one could conclude a government that is dedicated to welfare state policies, dedicated to spending on a deficit, and dedicated to the confiscation of wealth in order to suit their plans and maintenance of power, will make a return to the gold standard increasingly less likely as time passes–if not impossible.

I can also conclude that a gold standard is the only real way to maintain wealth. In our current arrangement we are forced to invest for the future in order to outpace inflation, but no market can guarantee a secure investment and it is often subject to booms and busts as a result of the Federal Reserve’s management of the ‘money’ supply; but in order for the government to continue to operate it’s entitlement programs, as well as finance itself, we are forced to maintain this system not of wealth but of constant debt. And we do this by borrowing our own tax payments; ironically those payments are pretty worthless if you consider that we’re simply returning what was originally borrowed, at interest, in order to discharge the debt of the government. We are in perpetual debt to a perpetual debtor.

In light of this, how could one advocate for a system based entirely on paper reserves and tax obligations?


  1. Greenspan, Alan. Gold and Economic Freedom. Originally published in the Objectivist in 1966. Accessed at: http://www.ritholtz.com/blog/2008/11/gold-and-economic-freedom-by-alan-greenspan/. 7/8/2009.


#Banking, #Jefferson, #Money

I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a money aristocracy that has set the government at defiance.

This issuing power should be taken from the banks and restored to the people to whom it properly belongs.

If the American people ever allow private banks to control the issue of currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children will wake up homeless on the continent their fathers conquered.

I hope we shall crush in its birth the aristocracy of the moneyed corporations which already dare to challenge our Government to a trial of strength and bid defiance to the laws of our country.

Thomas Jefferson, 1791


#Banking, #Dollar, #Gold Standard

Why the Dollar is Worthless

In the United States our money supply is controlled by the Federal Reserve. I want to explore what this means for our supply of money, how the government maintains it’s own funds, and whatever other implications this has for the value–or rather its lack of–in the dollar.

The other day I posted a link to an article that discussed how our system found it’s way to where it is today, and a simple explanation of how it operates. To get a good handle on this subject, we need to know how the dollar was defined in the past, and how it is defined now.

In essence the dollar is always worth–or rather was always worth–a measurable amount of a valuable commodity–no more, no less–and inflationary pressures were likely reduced by this arrangement. “Representative money and the Gold Standard protect citizens from hyperinflation and other abuses of monetary policy, as were seen in some countries during the Great Depression.”2 However, “it is difficult to manipulate a gold standard to tailor to an economy’s demand for money, providing practical constraints against the measures that central banks might otherwise use to respond to economic crises.” 2 But the question for me is, what real powers of manipulation do central bank’s need, and doesn’t it sound a little fishy that they would want to manipulate the money supply anyway?

A Little History

During various wars, the convertibility of notes to gold coinage was suspended in order to ensure the war effort was properly funded. After the suspension in the UK during World War I, there was an active effort for the UK to return to the gold standard; this was accomplished by 1925 but at an economic cost. “Although a higher gold price and significant inflation had followed the wartime suspension, Churchill followed tradition by resuming conversion payments at the pre-war gold price. For five years prior to 1925 the gold price was managed downward to the pre-war level, causing deflation throughout those countries of the British Empire and Commonwealth using the Pound Sterling.” 2

At this point the British needed to do something in order to make up for the demand in conversion payments by increasing their gold holdings relative to goods. In order to do this, they needed to attract investment. Unfortunately this had a depressing effect on their economy and “the British government finally abandoned the gold standard [by] September 21, 1931. Sweden abandoned the gold standard in October 1931; and other European nations soon followed. Even the U.S. government, which possessed most of the world’s gold ($175 million flowed into the U.S. in 1929, and $280 million in 1930) moved to cushion the effects of the Great Depression by raising the official price of gold (from about $20 to $35 per ounce) and thereby substantially raising the equilibrium price level in 1933-4.” 2

After the second world war the international community established a sort of gold standard under the Bretton Woods agreement. “Under this system, many countries fixed their exchange rates relative to the U.S. dollar. The U.S. promised to fix the price of gold at $35 per ounce. Implicitly, then, all currencies pegged to the dollar also had a fixed value in terms of gold.” 2

This would not last. As illustrated here, trying to maintain a certain dollar value to gold ratio was an untenable position:

Reinforcing the relative decline in U.S. power and the dissatisfaction of Europe and Japan with the system was the continuing decline of the dollar—the foundation that had underpinned the post-1945 global trading system. The Vietnam War and the refusal of the administration of U.S. President Lyndon B. Johnson to pay for it and its Great Society programs through taxation resulted in an increased dollar outflow to pay for the military expenditures and rampant inflation, which led to the deterioration of the U.S. balance of trade position. In the late 1960s, the dollar was overvalued with its current trading position, while the Deutsche Mark and the yen were undervalued; and, naturally, the Germans and the Japanese had no desire to revalue and thereby make their exports more expensive, whereas the U.S. sought to maintain its international credibility by avoiding devaluation. Meanwhile, the pressure on government reserves was intensified by the new international currency markets, with their vast pools of speculative capital moving around in search of quick profits.

In contrast, upon the creation of Bretton Woods, with the U.S. producing half of the world’s manufactured goods and holding half its reserves, the twin burdens of international management and the Cold War were possible to meet at first. Throughout the 1950s Washington sustained a balance of payments deficit in order to finance loans, aid, and troops for allied regimes. But during the 1960s the costs of doing so became less tolerable. By 1970 the U.S. held under 16% of international reserves. Adjustment to these changed realities was impeded by the U.S. commitment to fixed exchange rates and by the U.S. obligation to convert dollars into gold on demand. 5

Thus, by 1971, the U.S. had moved to a floating currency, no longer fixed to gold and other world currencies soon followed.

Our Currency Today

We’re currently operating with a fiat currency, backed by nothing more than a law stating it is legal tender for the payment of all debts public and private, valued according to the taxes collected. It is essentially worthless, in that it is not backed by any commodity. It’s paper. Nothing more. And it really isn’t even U.S. currency, rather it is Federal Reserve debt that is not backed by the wealth of the United States 1, which I must say, leads me to question why we still hold so much gold. Is it because that is what our government’s wealth is based on?

Interesting to note is that, according to Jason Kirby’s article, under the system in which our currency used to operate, “debt freedom, once achieved, was much closer to absolute under such a money system. It bore no interest except when its owner consented to lend it to a borrower for a rate of return. When it was spent, it was considered at common law that a debt was paid. And it respected the tradition from time immemorial that in exchange, value would be exchanged for value; it was equitable. When it was saved, instead of spent, it preserved the wealth of the saver, who could reasonably expect prices to be within reasonable range of what they were when the coin was saved.” 1 That’s something that Dave Ramsey can get behind.

As banker Vince Rossiter has pointed out, ‘from 1814 to 1913, the U.S. fought four wars, enjoyed greater increases in population than any other nation in the world, suffered significant short-term inflation and deflation at intervals, and still it was possible to buy substantially the same basket of food in 1913 for approximately the same price that it cost in 1814, 100 years earlier.’ 6

This is not possible today, even if you were to travel back only 20 or 30 years.

What we had then (gold, silver coin) was replaced with what is today in your pocket and your bank account. Today, we use THEIR money. You cannot tell me that Federal Reserve Notes are our money. The Constitution does not contemplate them. The First Money Act of April 2, 1792 does not contemplate them. The code of the United States for most of our history does not contemplate them. It is not our money. It doesn’t matter that it has been around since granddad was a young man. Crime has been around for a long time too. The long lived perpetration of a wrong does not lend it legitimacy. It is alien to the Constitution, and our money is effectively in exile. Their money resembles ours, more or less, if you need glasses or don’t read; there are pictures of our dead Presidents on it. Many Americans simply believe it is our currency because that is the way it has been since their birth, and they don’t know what they are looking at. Or they do and do not distinguish between real value and debt. We, including those of us who know better, begrudgingly use it mainly because our own government refuses to follow the Constitution on the money issue. And we must use something so we use this. Our government has long since bought into central banking with debt-based irredeemable paper. If you want to read why, look up Alan Greenspan’s essay, “Gold and Economic Freedom,” which gives as good an explanation as any: it is the easiest way to set up and maintain a socialist welfare state.

There is no SUBSTANCE associated with their money. It may read X Dollars on the face, but dollars of what? Above you saw a dollar of gold and a dollar of silver. Above you saw gold and silver certificates that promised on demand to pay a dollar of silver or ten dollars of gold. A Dollar was a unit of value that related precious metal to a weight measured in grains.
1

A Federal Reserve note does not conform to the description above, nor does it conform to the

Act of February 12, 1873 (Sec. 14), [which] establishes ‘25.8 grains of gold’ 900/1000 fine (or 23.22 grains of fine gold), which bears the required stamp and impress…furthermore, the statute again cuts off all controversy regarding the worth of a dollar; for it says that the dollar (the printed piece of gold containing 25.8 grains of gold 900/1000 fine) ‘shall be the unit of value’ in our money system1

Kirby then goes on to criticize the Federal Reserve note:

The Federal Reserve Note, which is their money is not even a promise to pay. It makes no promise at all. Read any bill, you will not find any promise. What is in your pocket or your bank account is debt. As a nation, we have borrowed our own tax coupons and in commerce we accept and use them as if they were money. You do not own your currency free and clear. Borrowed first by the national government, it automatically arrives to the American people with interest due. It is a fiduciary asset which is absolutely simultaneously someone else’s interest-bearing liability. It bears interest for the benefit of its issuer and creator, the central banks and their stockholders, the instant it goes into circulation. The central bank, which supplanted the existing system—which was unique and American—was modeled after the Bank of England. “The Creature From Jekyll Island,” by E. G. Griffin, explains how that happened. Does that sound like our system? Yet when you lend your own money today, as a private lender, you are lending someone else’s debt. And when you spend it, you are discharging your immediate debt. When you accept it someone else’s immediate debt to you is discharged. But our collective perpetual debt remains. All debts become relative with our government being a first-level debtor, and we citizens being second-level; third-level debtors depending on how our borrowing is structured. The game we play is to cleverly move debts around until we have what we want and hopefully don’t find ourselves insolvent at some point. Even if you are technically debt free, all mortgages paid off and car loans too, you are responsible, in the eyes of the government, for your share of the national debt. Your debt freedom is relative, not absolute. How do you know they won’t come to you at any time to call for the principal, or principal and remaining interest? Do you have that guarantee? And being on the hook for a share of the national debt; and knowing that your children will also be so burdened; and knowing that all the currency that we use is borrowed, how could anyone refer to the currency we use today as our currency? 1

I can add nothing more to his premise other than to say, read this article.

Conclusion

Many criticics of fiat currency conclude “…that no sound economy can long endure under fiat money…prominent Austrian Economist Ludwig von Mises [argues] in his book Human Action that, ‘What is needed for a sound expansion of production is additional capital goods, not money or fiduciary media. The credit boom is built on the sands of banknotes and deposits. It must collapse.'” 3

There is much more to this subject that smarter individuals have had a chance to research and form more intricate opinions on, but I will stop by saying that in order to return our country to some sound standing, we must return to a commodity backed currency, and we must return to our constitutional principles.

Please also read: United States Note. There is a lot about the way our current system of currency operates that isn’t right, and could be seen as conspiracy theory garbage, but if you want to blame anyone for economic crises and panics, blame central bankers and their debt creation system.


  1. Kirby, Jason. The Amero vs. The Dollar. http://www.gold-eagle.com/editorials_05/kirby062806.html. Accessed 7/1/2009
  2. Gold Standard, Wikipedia. Accessed 7/1/2009
  3. Fiat Currency, Wikipedia. Accessed 7/1/2009
  4. Federal Reserve System, Wikipedia. Accessed 7/1/2009
  5. Bretton Woods System, Wikipedia. Accessed 7/7/2009
  6. Parity. ACRES, USA, by Charles Walters, Jr. Page 14. Via Kirby, Jason.