Manning The Sea Walls

The recent Toronto convocation of international bankers for the annual meeting of the World Bank and International Monetary Fund considered the approaching flood, but their efforts were like those of a platoon of Dutch school boys recruited to stick their fingers in the leaking dykes. In desperation they shouted for more bags of the sand that was being washed away; that is, more international credit, more fiat money of the sort that was already being diluted into muddy liquid.

For the United States, with business bankruptcies soaring and the banking system tottering, confidence has begun to ebb in the power of the omnipotent Federal Reserve to control the flood. Although it mans the sluice gates of a mighty reservoir of credit, some see cracks in the great dam below which the economy sits like a present-day Johnstown. One journalistic commentator declares that the country faces its greatest economic crisis in fifty years.

The Great Debate

A popular cry is to denounce Reaganomics with its devotion to free market economics; more radical theorists accuse the capitalistic system and argue for authoritarian communist and socialist forms of government.

Advocates of more government intervention, however, face the dilemma that the crisis is severest in the Third World, most of which is governed by Marxist or socialistic principles under authoritarian regimes. Indeed, it is the collapse of Third World economies, despite a thirty-five year drain of Western resources under various foreign aid programs, that has complicated the problems of the West; it is the defaults of Third World countries on loans from Western banks that now threaten the international banking structure.

Advocates of more government subsidies and intervention, however, ignore the fact that if Reaganomics has not borne the expected fruit, it is because of its failure to extend free market principles into the most important area of enterprise—the money system.

Despite dismantling of many government barriers to trade, money—which is the lifeblood of enterprise—remains under authoritarian controls by a bureaucracy as aloof, as unrestrained, as a Soviet Polit-bureau. This is the Open Market Committee of the Federal Reserve which congeals the wisdom of twelve mortal beings enjoying long tenure into directives as to the amount and direction of money flow; each Friday the markets of the world await with bated breath the effect of their deliberations.

Historical Review of System

The development of this autocratic power was gradual and often unperceived. For twenty- seven centuries, mankind regarded as axiomatic that the only valid means of payment is intrinsic money, that is, coinage. Rulers throughout history, however, have wherever possible circumvented this principle by degrading or counterfeiting the coinage. The most pervasive effort was in 13th-century China, when the Mongol emperors substituted paper notes for metallic coinage in circulation. The Venetian traveler Marco Polo admired the device which, he noted, gave the emperor enormous profits. Despite the inflation that followed, with the notes at a dis count, the practice spread to Europe; but in the Middle East, efforts to introduce paper notes were resisted by sedition, and in India, silver remained the standard money of account until the British introduced paper in 1893. The British paid the price; within 20 years they nearly lost their colony but for a U.S. rescue operation. Iran had only metallic money until the 1930s when Reza Shah introduced central banking, a la the Federal Reserve; this monarch lost his throne before a decade had passed.

Rise of “Scientific” Economics

The framers of the United States Constitution rejected paper currency, but despite Constitutional doubts, paper currency was introduced as a war measure during the Civil War; specie payments were resumed in 1879.

Meantime, there had been growing up in the 19th century a school of thinkers employing the concepts of mathematics and physics; they obtained respect for their novel theories by designating them as “scientific.” Karl Marx called his theory “scientific socialism.” Their view was that man was a creature of physical wants and demands that could be measured statistically and programed mathematically. The profession acquired status after World War II by the formation of an official Council of Economic Advisers, enjoying access to the head of state and more influential than the Secretary of the Treasury or the Secretary of State. Added prestige came in 1969 when a Nobel Prize in “economic science” was set up along with those in medicine and physics.

From this new profession came the philosophical framework for fractional reserve currency which came into being in 1913 with the Federal Reserve System. With fractional reserve currency, the Reserve banks were authorized to convert into cash the debt of member banks. In exchange for the member bank’s paper the Reserve banks could issue legal tender notes up to 21/2 times the amount of gold money held by the bank. The process was called discounting.

At first only short term commercial debt was generally convertible to cash, but such was the leverage given by this new mechanism, such was its power to create purchasing power by the stroke of a pen, that pressure for its expansion became irresistible. Government bonds became acceptable collateral—this helped finance World War I—the kinds of debt expanded; if not enough debt were offered for discount the Reserve, through the Open Market Committee, could go into the market and buy up debt either on the excuse of stabilizing the price level or of promoting employment. Eventually the requirement of a gold reserve was abandoned.

The Inflationary Flood and the Economic Consequences

The commercial banks, with this ever-ready fountain of liquidity, expanded their lending to the limits of their capital reserves. These dropped from around 25 percent of assets to currently less than 10 percent, with the 15 largest banks presently operating on margins of less than 5 percent.

Not finding productive use for this financial power, they have financed a rank and unhealthy growth of corporate conglomerates with an economic justification no one has yet been able to define. The system of fractional reserve currency became a world fashion like the current rage for blue jeans and lettered T-shirts that may be found on the Ginza and in Red Square. Countries, from Italian principalities governing only a mountain top to continental empires like China, engaged in the issue of currency through central bank emissions.

Despite the collapse of the system in 1933, when every bank in the country closed its doors, such is the fascination with fiat currency that ever-wider powers were conferred on the System. In 1980 Reserve banks were authorized to convert to cash practically any collateral they pleased. Under this authority, the Reserve has acquired some $2 billion of foreign government debt, and it is now being pressed to liquidate large chunks of the debt owed to United States banks by Poland, Mexico and others. Only John Law, in his effort in 1729 to turn the soil of France into money, showed such effrontery.

Despite the evidence that the main cause of the current world-wide economic debauch is fractional reserve currency adopted everywhere, the Secretary of the Treasury continues to voice confidence in the System. The President tentatively suggests that it should be brought under Treasury supervision. This would be disastrous.

The correct course is to dismantle the Federal Reserve System.

True Function of Money

The function of a monetary system is not to manipulate the flow of credit and banking transactions to maintain a given, or even stable, price level; nor is the function to create employment. The money system should be managed neither in the interest of creditors nor of debtors; neither in the interest of producers nor consumers; neither in the interest of government nor of taxpayers. The function of government is to maintain the integrity of the standard; its function toward money is the same as toward the measure of length or of weight or of quantity. It is as corrupt to vary the standard of value and deferred payments as to change the length of the yard in the interest of cloth merchants, or the content of a bushel in the interest of wheat farmers.

The means of maintaining the standard is the definition of the dollar in terms of a given weight of silver or gold; since 1900, the sole metal of the standard has been gold; the dollar is still by law and statute defined in terms of gold. The regime under which the money system has been corrupted came to a climax in 1934 when the mint was closed to the free coinage of gold. The mechanism by which the circulation is always adequate to the needs of trade is that of free coinage. Under free coinage anyone can bring gold to the mint and have it coined only for the cost of mintage. Under this system the free market, rather than a bureaucracy, determines the amount of circulating media.

Restoration of Free Coinage

The system of free coinage was established in England in 1666; for the first time in history the government monopoly of money ceased; during the succeeding centuries, gold flowed to England, the circulation was al-ways adequate, and England rose to be the principal commercial power of the world. The same system was adopted by the newly formed United States, and under this system the United States became the only rival of Great Britain as a commercial and industrial power. This is the system that should be re-established to restore stability in the United States. It is no more necessary for an international agreement to this end, as some argue, than for every country to agree on the length of a meter or the weight of a kilogram; the natural effect of integrity will compel them to do so.