The most Powerful individual in any organization is the
person who con trols the purse. The person controlling the keys to the
vault where the cash is kept really has more power than many people who
in an organizational sense should be in a position to order, or refuse
to order, disbursement of funds.
In any attempt to control the Federal Government and
the activities of the government we must first discover who is the
keeper of the purse. Which branch, which person or which agency is
actually in control. It does little good to look at an organizational
chart-it will only confuse the issue. However, if we examine the actions
of the Federal Government it soon becomes apparent that it is not the
President, nor is it the Congress that is really in control, although
both of these frequently announce that they are in charge. The real
control is a semipublic agency known as the Federal Reserve System. Any
person in control of the Federal Reserve really controls the system.
Governments have been successful in hiding the cost of
many new programs because they have a monopoly in the creation and
control of money. Because of this monopoly the government does not have
to support new programs and other activities by taxation or the closing
down of old programs. These new Programs can be financed by the proper
control of the money system. Nearly everyone thinks that this important
activity must be run by and Supervised by the government. It was thought
to be so important that it was even written into the original United
States Constitution, and it has remained there.
The Article is written ". . . shall have the power to
coin money and regulate the value thereof" It has been fairly easy for
the government to discharge the responsibility to coin money, but this
regulation of the "value thereof " is a bit more difficult.
Tied to Gold
Some want the money supply tied to some particular
metal, the most popular of which has been gold and/or silver. The
argument in its simple form is that the value of the money supply will
be controlled automatically, and there seems to be a profound trust in
anything that is automatic. But although it is automatic there is no
assurance that the money supply will behave in such a way as to give us
anything like a stable price level or full employment or any of many
other things which we desire.
Under the gold or some metal standard whether or not
your price level remains stable will depend on three factors: (1) the
supply of goods, (2) the supply of money (gold), and (3) the price of
the money-usually referred to as the price at which the government will
buy and sell gold. Under conditions where the supply of goods and the
supply of gold remain constant or change at the same rate, the price
level will remain relatively stable. However, that would be a rather
unique situation and has happened only a few times in history.
The factors that control the supply of goods in a
general sense are not the same factors that control the supply of one
particular good such as gold (and it won't help much if the standard
money is to be one, two or even three commodities). Witness what
happened to the general price level following the discovery of gold in
California in 1849, or the period from 1872-1896.
But the gold standard people have one ace in the hole.
If things get too far out of balance they can always change the price of
gold. However, this presents two problems:
(1) If the price is not changed quickly enough, we may
have either deflation or inflation.
(2) This gives some government agency the power to
control the money supply and thus control the price level and the change
in the price level.
So it should be apparent, if we adopt or revert to the
classical gold standard and then let it alone to operate in its
automatic way, we will be subject to long periods of inflation or
deflation and not stable prices at all. Whether we have inflation or
deflation will depend upon the increase in supply of goods and services
relative to the increase in the supply of money. Even this assumes we
know something about money velocity (the number of times a unit of money
is used in a given period of time).
The other alternative, of course, is changing the price
of the money, and that supposes that some individual (or group of
individuals in some government agency) is able to determine when and by
how much the price of money should be changed. It is likely that the
price of the metal that is used as money might be changed to help
finance new programs in situations where it seems undesirable to
increase taxes or to eliminate older programs. If a metal is selected as
our money standard, the price of the metal should at least be allowed to
change as market conditions change on a worldwide basis, which means
that the price of money should be determined by supply and demand
conditions on a worldwide market. Indeed, this might well be the second
best solution to our money problem.
Some individuals who can see the need for some changes
in the supply of money over time but sense the inherent weakness of the
classical gold standard are willing to settle for a constant increase in
the money supply. These people point out that the productive capacity of
the country will no doubt increase over time, so some increase in the
money supply is needed (the alternative being, of course, long term
deflation). If the money increases at about the same rate as the
production of goods and services the result will be stable prices. This,
of course, assumes that the velocity of money does not change to any
significant degree. This rather simple solution to a complex problem
overlooks at least three rather basic problems:
(1) It is difficult to increase the money supply at
some preannounced rate. Although we may want the money supply to
increase at four per cent or five per cent or some other magic figure,
it is necessary to control the actions of the commercial banks as well
as the saving institutions to achieve this desired result.
(2) Short time fluctuations in the growth rate of
either the money supply or of goods and services may cause serious
periods of inflation or deflation. These periods of inflation and
deflation will of course come to an end if we are willing to wait and do
not give in to the third defect of the system.
(3) If the government or some agency of the government
has the power to set the rate of increase in the money supply, they also
have the power to alter the rate of increase, and the rate of increase
can be changed to provide for inflation. That is the most serious defect
of the system.
The Federal Reserve
We, in the United States, have all tried to avoid the
pitfalls of either n, the gold standard or fixed increase in the money
supply. We have turned the control and operation of our monetary system
over to a semi-public agency known as the Federal Reserve System. The
Fed, as it has come to be called, is a rather large bureau and has
become self-supporting, gaining its revenue from the services it sells
to commercial banks and the interest on the government securities which
it "owns." The Federal Reserve also performs many services for the
Federal Government, such as acting as its agent in the selling of bonds.
However, the primary and most important function of the Federal Reserve
is to control the monetary system. The Fed has been in existence since
1913 and is one of the most respected of all government agencies.
However, when the Fed is measured against the yardstick of what it is
supposed to be doing, the record is not only unimpressive - it looks
like complete failure.
The best time to judge an institution is when it is
working under stress, but when the Fed is placed under stress it fails
to perform as we thought it would. This has been the case in every
period of economic stress since 1913.
For example, during wars the government needs and uses
large sums of money. The government really has only two ways to obtain
the needed funds: taxation or borrowing. In my opinion, taxation is the
preferred method, but they have chosen in every war and "police action"
to borrow large sums. This borrowing action has been handled by the
Federal Reserve, and in order to get the large sums needed the money
supply has been expanded at too rapid a rate, and the result has been
higher prices.
The alternative to money expansion was for the Fed to
bid the resources away from the private sector by raising the interest
rate paid on government securities, but in the short run situation we in
the United States seem to prefer inflation over high interest rates.
Following World War 11 when the Federal Reserve complained about
carrying this burden for the United States Treasury, the result was the
"accord" signed in 1951 which officially relieved the Federal Reserve of
this burden which they never really had in the first place. The Fed
sometimes keeps the money supply expansion at too low a rate causing
unemployment. However, the most usual error has been to expand the money
supply at too fast a pace so that prices have risen. This has been
especially true since 1950. The inflation rate has recently been above a
figure that was completely unacceptable in 1955.
The Great Depression
The worst recession, or depression, that this country
experienced was in 1929-33. At the time, few people understood what
happened or the reasons for what happened. But after the smoke cleared
it seemed apparent that the Federal Reserve was too busy getting the
gold standard restored in England during the 1920s, which was a
questionable objective for the United States Federal Reserve System.
Then, when it appeared that we were to have a slight or minor recession,
the Fed responded by actually forcing a reduction in the money supply.
At the bottom of the depression the officials made the statement which
by now has almost become a classic: "We could have stopped the recession
except that we didn't have enough power." The Congress responded by
giving them more power, and the Federal Reserve then used their new
weapons to cause the recession of 1937-38. This recession was more
severe but more short-lived than the recession of 1929-33. The short
duration of the recession was due to the upcoming war in Europe and the
fact that the Fed was shifting over to their new position of continuous
inflation to help the Federal government finance the war effort.
There have been times when the Federal Reserve has done
the right thing at the right time. But the more important question is,
have their good decisions outweighed their bad decisions?
It is true that there were recessions before the
creation of the Federal Reserve in 1913. It is also true that there were
periods of inflation before 1913. The important question is, has the
Federal Reserve been stabilizing or destabilizing? It seems to me that
the Fed has been destabilizing. Monetary authorities that are not
government connected are coming to this same conclusion.
The problem is that although many are able to agree
that the Federal Reserve System has worked less than perfectly, most
want to keep the government involved in the monetary system in some
fashion and try to correct the defects. However, it appears that the
Federal Reserve has worked so poorly that any attempt to patch the
system, which in most people's minds means giving it more power, will
not solve the problem. Everyone makes mistakes. Usually when a person
makes mistakes he affects his own future and the future of people with
whom he deals. When a government decision is a mistake it affects the
people that deal with that agency. Everyone is affected by the monetary
system, so this is one government agency that influences the lives of
everyone.
The solution, then, is to repeal the act (actually it
will be several acts) that created and expanded the Federal Reserve
System, and then amend the Constitution of the United States so that the
Federal Government no longer has the power or the responsibility "to
coin money and regulate the value thereof." This is drastic action, but
drastic action is needed.
Mistakes Inevitable
Any government unit will make mistakes, but there are
additional hazards with an agency that controls the money supply. Any
government unit that wants to run continuous deficits over a period of
time can do so only with the cooperation and aid of the people in
control of the monetary system. Money is too important to the operation
of the economy to trust the operation of the monetary system to
government. It must be left in the hands of the people. The new system
that will arise will handle our needs in better fashion, but of course
the system will not be perfect.
The result of getting the government out of the money
business will be chaos for awhile at least. After all, people for
generations have been accustomed to the government controlling the
monetary system. The point is that patching up the Federal Reserve, the
gold standard, or any automatic monetary rule is not going to solve the
problem. The problem is the government itself. A matter as important as
money can not be left to central government action.
Without government control there will be increased
uncertainty, especially in the short run. After we have developed a new
system the uncertainty will be at a minimum and the costs of operating
the system will be no greater than the present costs-they might even be
less. Remember that though the Federal Reserve operates without using
money obtained from the Federal Treasury, they collect both for services
rendered to commercial banks and interest on the securities that they
own.
Cost of operating the new system will not be of major
consideration. The cornerstone of the system will be that anyone who
wants to can get into the production and sale of money. There is, of
course, the problem of getting customers. This may be referred to as
acceptability, but in the marketplace it is known as producing a product
that consumers like.
Hopefully, under such a system the person or
corporation that issued money would be interested in maintaining
acceptability for that money. Some money would be worth more than
others, and exchange rates would be established in the marketplace among
the various monies offered. Some of these monies would become completely
worthless. In time (and this time period would be years, not days, weeks
or months) it is rather safe to assume that there would be only a few
issuers of currency.
Advantages of a Market Monetary System
The important point is that under this system there
would be no inflation. Individual issuers of currency would be
interested in maintaining the value of their currency, or else it would
not be used. There would, of course, be some fly-by-night operations.
Some peoplip would be taken in by worthless currency. These costs and
the cost of operating the system would be less than the cost of
operating the present Federal Reserve System, especially when inflation
is assessed as one of the costs of the present system. The issuers of
the currency would keep the system in operation, not because they are
particularly public spirited, but because it would be in their own best
interests.
Individual banks and/or other institutions would be
free to make loans, collect interest and perform other monetary
transactions. They would even be free to insure their deposits if they
thought it was in their own best interest to do so. Some are apt to
point to the Federal Deposit Insurance Corporation as a well-run
government agency. Needless to say, its record is somewhat better than
the record of the Federal Reserve, but then the FDIC has been operating
as an insurance agent during a period of almost continuing inflation.
Under these conditions there can be some bad debt, but one must wonder
if the FDIC would be able to survive a situation such as existed in
1929-33. It would be better to have several insurers of deposits, and
there is no reason why these could not be international in scope.
In summary, then, the thesis is that the government
should take itself by Constitutional amendment out of the money business
and turn it over to private interests. It is not that the private
interests will operate the system in a perfect manner, because they will
not. But the private sector can and would operate the system better than
the government has during the period since 1913.
At the time of the original publication, Dr. Lamborn
was a Professor in the Department of Economics at Boise state
University in Idaho.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
June 1980, Vol. 30, No. 6.
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