In This Bicentennial Year, it is paradoxical that with
all the reverence being addressed to the Constitution by the courts,
Congress, and presidential aspirants, no one has come forward to
challenge the Constitutionality of our money system.
The importance of such a reexamination is emphasized by
a recent Yankelovich survey reporting that the issue of greatest concern
among voters was inflation (53 per cent). Inflation is obviously a
problem which has eluded the skill of our money managers, working under
prevailing monetary theory, and has defied the edicts of Congress to
resolve.
On August 17, 1787, the Constitutional Convention,
sitting as a Committee of the Whole, discussed a draft article defining
the powers of Congress under the projected new Constitution. A portion
of the draft read, "Congress shall have power ... to coin money, emit
bills of credit, regulate the value thereof..."
Gouverneur Morris, delegate from Pennsylvania, highly
regarded as a financier, an associate of Robert Morris, who had been
largely responsible for the successful financing of the Revolution, rose
to propose an amendment. The amendment, as James Madison recorded in his
Notes on the Constitutional Convention, the principal record of the
proceedings, was to strike the words "emit bills of credit." In 1787
language, bills of credit were synonymous with paper money.
"In no country of Europe," a delegate noted, "is paper
money legal tender, but only gold and silver coin. " He had no need to
recall the flagrant paper money emissions of the first Continental
Congress, which by 1781 had totaled an estimated $200 million, an
enormous sum for the times, and which had fallen to a discount of 99 per
cent before Robert Morris stopped their emission.
There was little debate. The offending language was
removed by almost unanimous vote. It was clearly the intention of the
framers of the Constitution that paper should not be allowed as legal
tender in the new Union. To reinforce this conviction, the Convention
enacted a provision forbidding the member states of the Union to emit
paper money (bills of credit) or to declare as legal tender anything but
gold and silver coin.
In 1831, Albert Gallatin, who had served Jefferson and
Madison as Secretary of the Treasury (1801-1814) declared that "it
necessarily follows that nothing but gold and silver coin can be made
legal tender," and Daniel Webster in a speech in the Senate, in 1836,
proclaimed, "Most unquestionably there is no legal tender, and there can
be no legal tender in this country but gold and silver.."
While the idea was already being debated that the
supply of money should correspond to the needs of trade and some
political economists argued that sovereign states could declare their
paper money legal tender, the framers of the Constitution held to the
view that money should consist of something substantial, and that if
paper were issued as an expedient it should always be representative of,
and redeemable in, coin.
From this accepted principle, built into the foundation
of the American political system, modern practice has so far diverged
that money today consists of neither gold nor silver coin, but only a
degraded alloy together with a vast amount of paper money irredeemable
in any metal. John Law, the Scottish financier who became Comptroller
General of France, in a disastrous experiment tried to make paper money
representative of the wealth of France. What circulates today as money
is not evidence of wealth but paradoxically the very opposite, the
absence of wealth, that is to say, debt, which is no more than a pious
hope for later possession of wealth.
"Freeing up the Money Supply"
How did this revolution occur?
During the Civil War Congress, as a war measure,
authorized the issuance of circulating notes declared to be legal tender
The action was stoutly debated and, while it was eventually approved by
the Supreme Court, the principle continued to govern that paper money,
unless fully redeemable in lawful money, that is gold or silver coin,
was allowable only as a recourse of national emergency. It was not until
the Federal Reserve Act in 1913 that the view became authoritative that
circulating notes could be issued against evidences of debt. Until 1934
such notes could be regarded, in a sense, as representative of metal,
since they were redeemable in gold, but thereafter irredeemable by U.S.
citizens, and they were never full legal tender until 1965. After 1971,
they became completely inconvertible in metal. At present the
circulating media of this country consist of some $9 billion in degraded
coin and $77 billion of Federal Reserve notes, plus a small amount of
other notes.
Source of Inflation
The consequences of this revolution will be discussed
later. For a moment let us look at the intellectual atmosphere in which
it was nurtured. As a consequence of a sudden collapse of credit in
1907, leading to what has been called a money panic, the Federal Reserve
System came into being with the object of adjusting the supply of money
to finance the seasonal trade of a then mainly agricultural economy.
This limited concept of "flexible currency" was soon expanded under the
necessities of World War I when the Federal Reserve notes and credit
were used to finance the government.
In 1923, the Federal Reserve managers concluded that
the System's power should be used in the interest of a stable price
level, under the theory that as the production of goods rises the money
supply must also rise at comparable rate to provide business with the
means of payment. The theory flew in the face of the fact that a prime
purpose of technology is to make goods more abundant, and presumably
cheaper in order to be more widely distributed. It also overlooked the
fact that the technology of money was being improved, through banking
and credit procedures, so that a given supply of money could serve a
greater volume of transactions.
Nevertheless, the theory became a justification for a
steady expansion of the money supply, some economists advocating a
regular, mathematical rise in the money supply regardless of the rate of
physical growth. So embedded, in fact, has the idea become that both the
Democratic presidential candidate Gov. Carter and such a conservative
Republican as Secretary of the Treasury William Simon, have indicated
that they regard a monetary inflation of three per cent annually as
normal.
The use of debt money created by the Federal Reserve
was further expanded by the Employment Act of 1946, by which the Federal
government assumed responsibility for providing employment opportunities
for all.
Purchasing Power Theory of Money
In discharging its responsibilities under the
Employment Act of 1946, the managers of the System undertook a still
deeper intrusion of Federal authority into management of the economy.
Heretofore money had been considered to consist only of the official
circulating media. The System now undertook to redefine money not in
terms of its substance but of its attributes. Money was purchasing
power, and since bank deposits were a form of purchasing power, the
System now began to treat money as the sum of the circulation plus
demand deposits. This purchasing power was called M1 to distinguish it
from the official circulation, known as M. The Federal Reserve is able
to influence the amount of such purchasing power by its authority over
the reserves which member banks of the System must carry.
It now became apparent that there were other forms of
purchasing power besides that represented by circulating notes and coin
and demand deposits, and to extend its authority over the economy the
System developed the concept of M2 consisting of circulating media and
demand deposits (Ml) plus savings bank deposits, since a savings bank
deposit can obviously be converted on notice to purchasing power by
means of a withdrawal or transfer to a checking account.
The Insubstantiality of Money
What is universal about all these forms of money-M, M1
, M2-is that they are forms of debt rather than substance. Bank deposits
represent the bank's liabilities to depositors, secured in turn by
various liabilities of others to the banks, plus a minute amount of
physical assets. The liabilities consist of loan obligations of bank
customers and investments, which in turn consist principally of debt
instruments, that is, corporate bonds and U.S. Treasury obligations, and
deposits at the Federal Reserve Bank, which in turn are obligations of
that institution. The bank may also hold a small amount of physical
assets, consisting of bank premises and furnishings, and real estate
acquired in liquidation of foreclosed loans, and in course of sale. The
bank may also hold a small amount of cash, but this cash, consisting of
Federal Reserve notes and coin is again in form of obligation, unless
coin is considered a physical asset to the extent of the market value of
the metal contained.
The consequences of this transferring the concept of
money from substance to purchasing power is to enter an uncharted realm
of theory, in which the power of government to intervene in individual
affairs is open to unlimited expansion. The idea of a government of
limited or delegated powers disappears. Thus, the question of the extent
to which credit cards are a form of money now engages the attention of
the System managers, since credit cards are a form of purchasing power.
But there are other forms more elusive. Thus, if A, a
grocer, gives his doctor a note of hand for services rendered, the note
represents purchasing power in that A thereby acquired services without
equivalent goods or services in payment. If the doctor in turn returns
the note to A in payment of merchandise, he has used purchasing power
that has escaped the statistics of the Federal Reserve. In short, any
good or service that has exchange value is a form of purchasing power,
and to put all this purchasing power under the control of the Federal
Reserve is to give that agency a control or influence over the
livelihood activities of the country, the extent of which is yet to be
tested.
The Consequences of the New Money
We may now examine briefly the consequences of this
departure from the monetary views of the Founding Fathers. In only 15
years, 1960-1974 1975, the Federal Reserve notes in circulation more
than doubled, from $271/2 billion to $77 billion, and coin in
circulation from $21/2 billion to $9 billion. In the same interval the
purchasing power fostered by the System in the form of demand deposits,
so-called M1, increased from $141 billion to $295 billion.
The flooding of the country with such an immense amount
of new purchasing power had its inevitable effect on prices, with the
index for consumer commodities doubling from 88 to 167.
The virus of inflation, feeding on the lush growth of
paper money, was not limited to this country, but has become a
world-wide plague, a disease carried by the U.S. dollar and the American
doctrine of central banking into every corner of the planet. Utilizing a
device first developed and approved by the Genoa Conference of 1922,
that the debts of a rich country could be counted as the assets of a
poor, impecunious governments set up central banks with power to issue
notes against U.S. Treasury obligations. Since the Federal Reserve notes
and deposits were until 1971 redeemable in gold, such obligations were
treated as the equivalent of gold.
Regrettably, the practice proved its own undoing. At
the end 4 World War II the U.S. Treasury held about $25 billion in gold
(at $35 an ounce), but U.S. fiscal recklessness, inordinate foreign aid
expenditures, and excessive credit issues domestically, led the shrewder
foreign governments to convert some of their U.S. Treasury debt into
gold, until by 1968 the U.S. stock had diminished to less than $11
billion (at $35 an ounce). The accelerating weakness of the dollar in
the succeeding years required the Treasury to put restraints on the
outflow, and in 1971 redemption ceased altogether. The consequence has
been a worldwide currency debacle with exchanges unstable and great
banks in bankruptcy from foreign exchange losses.
Consequences - Mathematical and Moral
Space does not permit an examination of the economic
and social consequences of continued inflation of prices from the issue
of fiat purchasing power, and they are too evident in the mounting
unrest and dissatisfaction with the political system to require
description. It is necessary only to add that the unwillingness of
governments to deal decisively with inflation is a leading cause of the
disintegration of U.S.-European political influence in world affairs.
The reason for this political impotence lies at a
deeper level than the economy. It goes profoundly to the realm of
morals. Money is rightly called the life blood of commerce. When the
blood is corrupt the whole body is diseased. There is an essential
corruption and moral debility in a monetary system that permits a
government to spend and distribute largess obtained without taxation, by
a process so simple as a bookkeeping entry or the operation of a
printing press, thereby to create purchasing power that enters the
market in competition with purchasing power gained through the efforts
of human labor and ingenuity.
Alexander del Mar quotes Antoninus Augustus: "Money had
more to do with the distemper of the Roman empire than the Huns or the
Vandals," and the system of fiat money into which this country has
fallen, in violation of the Constitution, may be the distemper to which
this country may soon succumb.
At the time of the original publication, Elgin
Groseclose, headed of Groseclose, Williams & Associates, financial
and Investment consultants of Washington, D.C., served also as
executive director of the Institute for Monetary Research, lnc.
He
is author of Money and Man (1934), the 4th edition of which, with
revisions and additions by the author, has just been published by the
University of Oklahoma Press.
Reprinted with permission from The
Freeman, a publication of the Foundation for Economic Education, Inc.,
October 1976, Vol. 26, No.10.
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