Part one of a paper I wrote this past semester on the nature of money, central banking, and the Fed. I’ve broken it up in several sections so that it will be able to be read and critiqued in installments, probably one every few days. Feedback is of course appreciated. Enjoy.
IN NOTHING WE TRUST: THE TRUTH ABOUT THE FEDERAL RESERVE
by Joshua R. Kern
“If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.” — Thomas Jefferson
Money, they say, is the root of all evil. They, who need any number of products and services to simply stave off the night cold and morning’s hunger regard the simple common medium of exchange that allows them bread (from the wheat they did not plant or harvest) as evil. That which they can exchange for heat from the furnace they did not invent (fueled by the oil they did not locate, drill, refine and deliver) is a tool of Satan. That slip of paper, a promise to deliver a good or service relative to the perceived value of that note, they say, is an abomination unto this Earth. How then are the inhabitants of this Earth supposed to live any sort of life that is not wholly devoted to eking out a meager existence of whatever can be produced by their own time, labor, skills and intellect? Novelist and philosopher Ayn Rand, in her magnum opus Atlas Shrugged, clarifies:
“Or did you say it’s the love of money that’s the root of all evil? To love a thing is to know and love its nature. To love money is to know and love the fact that money is the creation of the best power within you, and your passkey to trade your effort for the effort of the best among men. It’s the person who would sell his soul for a nickel, who is the loudest in proclaiming his hatred of money – and he has good reason to hate it. The lovers of money are willing to work for it. They know they are able to deserve it.”
Scrawled on papers in a checkbook, fattening leather wallets, rolling from the presses or staring back from a computer screen as a monolithic column of numbers, the money Americans use is taken for granted as a constant of our lifestyle. Money makes the world go round and Big Money goes around the world, but what exactly is money? Who or what creates it and who (if anybody) does or should control its availability and value? Furthermore, is a paper money more desirable than a money system born from the market itself? A brief glimpse at monies through the ages, and an overview of some key events in the baking history of the United States are critical before attempting to answer those questions.
PART ONE: MONEY THROUGH THE AGES
Since the dawn of man, he has traded his skills and his products for the skills and products of others. That is the simplest form of economy. The occupations commonly called trade skills are not a misnomer; they are specializations in the only universal and inexhaustible value of exchange – labor. A rational and civilized society deals with one another as traders, that is, exchanging a value for an equal value. Those with meager skills or abilities with which to trade for the goods or services they need or desire trade with one another, each offering something of value to satisfy a double coincidence of wants – that is, a mutually consensual and beneficial trade of values. This type of exchange is called bartering, but barter has limitations in the marketplace. Robert L. Hetzel (Senior Economist and Policy Adviser in the Research Department of the Federal Reserve Bank of Richmond) says that “economic specialization rests on two pillars: free trade and stable money. Stability of the purchasing power of money makes possible roundabout exchange instead of barter.” (p. 11)
A man offering carpentry services may not need or be willing to accept whiskey, eggs, or hats for his work. He may instead accept some other commodity that another person is likely to also accept in an indirect exchange of values. Money, regardless of its form, is an abstraction of the division of labor allowing the satisfaction of a double coincidence of wants. The most commonly sought commodity in a society becomes valued as a medium of exchange, conforming to certain preconditions: the commodity must be small and easily mobile, have a high value to weight ratio, and be relatively scarce or difficult to produce. The Ludwig von Mises Institute (an international affiliation of free market economists based in Auburn, Alabama) points to several historical examples of seemingly worthless commodities valued as media of exchange: The Mayans traded feathers from the ketsel birds up until the 15th century. Tealeaves pressed into bricks were traded in Asia through the 1800’s, Native North Americans traded belts made from wampum shells, and the lifeblood that sustained the Byzantine Empire was simply olive oil. Every civilization to have ever roamed the Earth has traded furs cut from bested beasts. Campaign after bloody campaign was waged to procure spices and fine silks, instigating seafaring explorers to seek alternate routes to the Far East.
The tiny island of Yap is noted by many economists (Keynes, Friedman, Furness) as an example of a culture with an unusual yet highly valued medium of common exchange – massive, round stones. Their appearance would imply being millstones, but no mills have ever existed there. The stones are “crystalline” in appearance and imported from distant islands making them relatively scarce (Goldberg, p.960). The larger stones are considered entirely beyond price. Essentially, the stones are Yap’s version of gold, only without the functional utility of gold and silver.
As the human being’s capacity for abstract thought gave way to increasing ingenuity in the crafting of tools, new resources were discovered and new tools developed for extracting and producing things of even greater value: pearls, precious stones, minerals and metals; metal coins began to emerge in Greece and Asia Minor in the early seventh century B.C.E (LVMI)
Exalted above all else in Western societies, gold and silver became the standard of indirect exchange. While too soft to serve any purposes of physical utility, their pleasing appearance and luster became valued for ornamentation in the decorative arts. Being of a limited supply, easily divisible, and in high demand, gold and silver satisfied the prerequisites of a stable medium of exchange. While portions of iron would over encumber a trader, pieces of gold and silver of the same size weigh next to nothing and are not a nuisance but a pleasure to carry.
So valuable had gold become by the 13th century that the major powers of European monarchies dispatched their agents to newly “discovered” areas of the world, not yet trod upon by Europeans, in search of anything of value to return to the lord. Thus began the conquest of the Americas by Europeans. The English and French monarchs grew richer with furs and timber. The Spanish and Portuguese swam in a bounty of gold and slaves.
The occupation of goldsmith emerged to satisfy a new market need – security to possessors of gold. Depositors turned an amount of their gold over to a goldsmith, paid them an additional fee for storing and protecting the gold, and were issued a receipt. The receipt, a promissory note, was a guarantee for the goldsmith to exchange a given amount of gold for the note. By that act, goldsmiths became the first banks. (Money, Banking and the Federal Reserve) In an essay entitled “Gold and Economic Freedom” (featured in a collection titled Capitalism: The Unknown Ideal”) former Federal Reserve chairman Alan Greenspan explains the emergence of banking in a gold trading society: “If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society’s divisions of labor and specialization. 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.”
A fatal breach of ethics in goldsmith practices is now the model for modern banks and the eventual destructor of all monetary systems – fractional reserve banking. A depositor holding a note has in effect made a loan to the bank, allowing the bank to use his money to in turn loan to its customers. This is done on the premise that the note he holds is redeemable on demand for the money leant to the bank, inflated with interest as an incentive. Fractional reserve lending occurs when a bank produces and distributes more redeemable receipts than it has assets to exchange them for. This greatly increases the amount of money available in the economy than actually exists in real commodities, creating the illusion of wealth. It is not a system composed of wealth, but rather one of debts. The longevity of a bank that operates this way is beholden to the trust its note-bearers have in it. When that faith is lost, a run on the bank may occur. In that instance, the demand for redemption in hard assets far outweighs the actual reserve of assets
resulting in a failure of the bank – complete insolvency. That can be correctly condemned as an ethical breach as the implied contract with depositors is that their deposit is secured and redeemable in full on demand. A fractional reserve lending policy violates that basic trust by issuing claims to securities the lender does not have, therefore endangering the depositor’s assets.
That does it for Part One. If any frequenters would like to read the remaining four sections, I will post them one every day or so. Thanks for reading. No Gods. No Masters.
