Money: Currency's Circuits
Robert Batt
[Reprinted from an online Land-Theory
discussion, 1998]
This paper is in response to stimuli from Fred Foldvary, Scott,
Victor Levis and Harry Pollard. Outside the list, stimulus sources
include Larry Parks, Ph.D. (Foundation for the Advancement of Monetary
Education [URL : fame.org]), and Howard Sharpe, Ph.D. (and
semi-Georgist.) The latter two duked it out after Larry's lecture on
money and gold that he presented at a Republican fund-raiser here in
NYC that I and various libs and others (maybe even a few Rebublicans)
attended. My interest in the subject was significantly heightened back
around 1990 after reading "Extraordinary Delusions and Popular
Beliefs and the Madness of the Crowds" by Chas. MacKay (Circa
1825). Sociological trends have for a long time been an obsession for
me.
Thus far, I only have Book I of two prepared for view. Because Book
II is much longer and more complex, I may send it one or two chapters
at a time.
Preface
In the first four chapters of Book I, we will review the basics of
money. A typical approach is to start with definition, then onto
origin and evolution. I have chosen to place origin and evolution
before definition because of the highly subjective treatment of the
valuation and nature of money. The origin and evolution of money *are*
for a large part its definition. This is true if we willing to accept
the idea that common usage is the proper yardstick of definition. In
the case of the word "money," common usage of it is
associated with a dangerously destructive conception if we act on
these notions. While there are objective measures of valuation, they
are seldom considered.
The fifth chapter is a time line citing significant events pertaining
to monetary affairs, presented for the purpose of proper analysis of
the strengths and weaknesses in the banking system, and to invoke
thought as to what a workable solution may be. In addition, as it may
be a little naive to think that any single interest can alter the
course of development, I feel it essential to explore the past and
current trends. That is, the positive events that indicate effective
shifts in sentiment, as opposed to just exploring the normative
ponderings. The last chapter of this Book I, along with the
bibliography is being sent in a separate attached file (b1_ch5.txt)
The essence of money and banking that has been laid out in book I is
further explored, developed, and analyzed in book II. We will be
venturing into the relations between the key players in the industry,
their relations to the state, and the affects of such relations on the
daily lives of the individual citizen.
Introduction
I wish to make it clear that this is a work in progress. I do not
claim that its contents are a comprehensive coverage of all the major
aspects pertaining to the topic. Rather than to take the arrogant
attitude that is all too common amongst writers on this subject, I
shall put my ego aside, as I recommend we all discipline ourselves to
do, so as to better facilitate the development of a clear assessment.
This is especially necessary in this field of study due to the rapidly
shifting dynamics within the industry. While there are universal and
timeless truths pertaining to the subject, it is the relative
significance of these truth that is of particular concern. I welcome
any comments, and or notes of corrections, omissions, providing that
they have been thoughtfully prepared. In bringing new information to
light, it is essential to cite the source, whether it be other
writings, or your own reasoning. If the latter, then be specific as to
both the inductive and deductive reasoning processes. If you haven't
already, you may wish to form a database containing your reference
material. It will help in conveying your views, and in crystallizing
your ideas in your own mind. This is a preliminary draft, and
therefore the structure and sequence of the chapters undoubtedly will
change as new information is introduced. The logical structure of the
chapters in Book II are admitingly flawed. In fact, much of book II,
as well as parts of book I, are still in their embryonic stages. Until
book II is complete, or should I say 'presented', for it will not be
complete without your contemporary inputs, I will entertain questions
only for the purposes of clarification.
Book I On Origin and Evolution
Chapter 1) What is Money?
To answer the question "What is money?", it is helpful to
look at its origin and evolution.
The origin and evolution of money.
In more primitive civilizations it was possible to trade using a
barter system. That is, direct exchange of goods for goods from one
consumer to another. As division of labor arose as the new mode of
production, it became necessary the develop a means of exchange. What
one person produced might not be what another desired. Therefore,
people need a way to account for their product that may be demanded
elsewhere in the marketplace. This needed to be a standard unit of
measure to be accepted as widely as possible. The earlier methods
devised used commodities such as cattle or tobacco as currency. These
commodities were impractical in that they were not easily
transportable and not very durable. The first quality,
transportability, is necessary because without it, your geographical
trading range is limited. The second, durability, is seen as necessary
in order to defer trade. That is, to save or store earnings. We began
to seek a currency that could be easily carried, would be universally
accepted, and would be durable. In smaller communities where everyone
knew each other, tokens such as sea shells were sufficient for trade,
much in the same way that personal checks are used today. As we began
to trade with those who we did not know, the need arose to have a
system that did not rely on trust as much. So we turned to precious
metals, primarily gold. In a small town, a trustworthy goldsmith would
keep gold deposits for the people for a small fee. When a depositor
needed to trade, he or she would go to the goldsmith and get an amount
of gold sufficient enough for the trade. This method was somewhat
bothersome, having to go to the goldsmith, then to the trading partner
who would just bring the gold back the smith anyway. So a system
developed whereby a buyer in the market would simply use his receipt
from the goldsmith as currency. This was our first paper money. As you
can see, this system that is the essence of the gold standard was not
designed. Rather, it simply evolved out of a perceived necessity. This
system worked fine as long as the seller also knew and trusted the
goldsmith. If not, as with larger purchases from out of towners, the
seller would ask for the gold instead of the receipt.
Over time, it became obvious to the goldsmith that he could lend out
a portion of the gold at interest, as it would not all be demanded at
once. As was sensible, the goldsmith began to issue notes as loans of
gold in excess of the actual amount of gold in his vaults. If he got
too ambitious in lending out gold, or if some other exogenous event
unfavorably upset the gold supply and demand balance, or the supply
and demand balance of goods, the goldsmith could become insolvent.
That is, if demands for gold outstripped its supply, the receipts and
notes were perceived as worthless. This was the case with many
goldsmiths and their ancestors, the banking institutions, at different
points in history.
There are three basic functions of money that are accepted by a most
diverse group of economists. They are: a) a means of exchange; b) a
unit of account; c) a store of wealth.
3) Is there more than one type of money?
Yes. While a number of different currencies (currency meaning money
in use,) will take similar physical form, that is, paper or coin, they
may differ in how they are backed. Some are 100% backed by gold on
deposit, while others are fractionally backed, meaning only a portion
(perhaps 8-20%) of the gold that the bill or coin represents is kept
on deposit. These may or may not be convertible into gold on demand.
If they are not convertible, then the gold serves only as a unit of
account to gauge the value of the currency in relation to the value of
various goods. There are also paper currencies that are not backed by
gold, but by the full faith and credit of a government. This type is
referred to as fiat money. I suppose technically speaking, the sea
shells used in more primitive societies qualify as fiat money as well.
4) What are the basic theories of money?
One widely accepted theory of money is known as the Quantity Theory
of Money. This simply states that the price level of money is a
function of the quantity of money as it relates to the demand for
money necessary to meet the needs of current transactions. This is
referred to as the transactions demand for money. Here's a brief
explanation: For the purpose of analysis, let us assume that full
employment is the natural state of the economy. Further, we shall
assume that the total output (GNP) is at its maximum in this natural
state. That is, technological advances are ignored. In such an
economy, an increase in the supply of money will cause people to spend
the added quantity. That is, aggregate demand for goods will increase.
This in turn, with output fixed, will push up prices until a new
equilibrium is established. Thus, the increase in money supply can
only increase price levels.
Conversely, given the same conditions, if the supply of money is
decreased, aggregate demand will fall, and with it, prices. in a word,
deflation.
In the real world however, one can expect deflation to lead to
unemployment before a new equilibrium is reached. This does not
invalidate the theory however. There is empirical evidence that the
quantity theory does operate:
- a) As the Spanish took gold home from the New World, their
money supply increased at home. In line with the theory, prices
rose because there was no corresponding increase in the
transactions demand for money which is a function of an increase
in output.
- b) From 1800-1865, there was rapid economic growth here and in
Europe. Yet the money supply did not expand as rapidly because
gold supply was too scarce. Prices fell as a result.
- c) During the New Deal era, tax increases to fund government
spending were not politically feasible, but "pump-priming,"
deficit spending seemed like a good idea at the time, so the
government borrowed from the central bank by issuing bonds,
thereby increasing money supply. Price increases followed for a
long time to come. Short-run affects of money supply tinkering are
discussed in book II, chapter 3.
While the basic theory has withstood the test of time, Neo-classical
economists have expanded it so that precautionary and speculative
demands for money are added to the transactions demand for money.
Precautionary Demands for Money
Precautionary Demands for money involve the retention of cash for the
purposes of protecting against the uncertainties of the timing of
receipts and payments. For instance, A proprietor may order a good not
knowing if credit will be extended, nor on which specific day those
goods may be delivered. He or she may simultaneously hold the other
side of a transaction meaning that he or she may not know if credit
should be extended, or when the goods will be ready for shipment. For
these reasons, there is an additional demand for money over and above
that which is needed for current transactions.
Speculative Demands for Money
Speculative demands for money are those associated with the
withholding of expenditures in anticipation of a lower price being
offered in the future. Increased demands for money will arise from the
uncertainty of short-term price levels. For example, if one perceives
the price of a good to be too high at a particular point in time, he
or she may hold off on spending until par value or lower is perceived.
This reserve increases the total amount of money necessary for trade
in real time, the currency.
These three functions of demand (transactions, precautionary and
speculative) are a complete set, and are separate from the other two
primary functions of money: a unit of account, and a store of wealth.
For a review of the Gold Standard in theory and practice, see Book
II, Chapter 1.4.
The last chapter of this book I, along with the bibliography is being
sent in a separate attached file (b1_ch5.txt)
Chapter 5) Timeline: US History 1789 to Present
1789: On September 11, 1789, Alexander Hamilton becomes the first
secretary of the Treasury.
1791: As a plan to recover from bankruptcy, following Hamilton's
plan, the US Bank was established. These were private banks working
under either federal or state charters.
1811: The dissolution of the US Bank as its charter expires.
1816: The second Bank of the US was established to replace the state
charters that floundered in corruption.
1833: Jackson orders withdrawal of all treasury deposits from the US
bank, citing abuse by polticians who borrowed from it.
1837: The panic in financial markets. To head off "Wildcat"
currency with no backing from being used for land speculation, Jackson
orders payment in gold or silver only for land purchases.
Consequently, banks failed here and in England.
1840: In an attempt to facilitate accountability, a Sub-Treasury
system was put in place in which government funds were kept in
Independant Treasury Vaults in large cities.
1857: Panic in financial markets caused by speculation in industry
and over-expansion in railways.
1863: Congress passes into law the formation of a federal body, the
O.C.C., to overlook the activities of the national banking system.
1873: Financial and business failures, including Jay Cooke & Co.
which failed after The Philadelphia Ledger exposed a plan for
government money set to be channeled into Jay Cooke & Co.,
agricultural distress caused by Civil War burden. 2,000,000,000 in
debt was accrued. The Greenback movement, a push for inflation through
expansion of money supply to help agriculture, gains momentum.
1878: The Bland-Allison Act allows for the purchase of Silver at the
rate of 2,000,000 - 4,000,000 per month.
1879: The not so common commoner, Henry George publishes "Progress
and Poverty" which out-sold Adam Smith's "Wealth of Nations."
In this book, George pointed out the linkage between land speculation
and the boom and bust cycles, and promoted a single tax on land value
as the remedy.
1887: Henry George runs for mayor of New York City, but the
notriously corrupt Tammany Hall political machine thwarts his efforts,
in spite of George's overwhelming popularity especially amongst the
Irish immigrants who suffered the plight of the Potatoe Famine, and
who, like much of rest of the populous were virtually enslaved by the
railroad tycoons here by the means of a pathological corporate-state
alliance.
1887-1933: A series of ten major federal regulations were enacted to
curb abuses primarily in the railroad industry. The intense effort to
regulate this indusrty is known as the Granger Movement.
1890: The Sherman Silver Purchase Act upped the anty of silver
purchases to $4,500,000 monthly. This pushed gold and gold - backed
currency down. As people cashed in gold notes, and traded gold
overseas, a depletion of gold reserves ensued. Silver kept falling,
making it worth only sixty cents to a dollar of gold.
1893: Cleveland Repeals the Sherman Silver Purchase Act. In an
attempt to replentish gold reserves, the government issued bonds to
buy gold. This attempt failed because people who wished to buy the
bonds merely had to cash in thier notes for gold. Financial
speculation leading to failures of its intitutions as well as those in
business in general. Labor unrest, Populist movement. Rebound in 1910.
1895: In order to defer the circular flow of money, the government
bonds were sold to J.P. Morgan instead of to the public.
1900: Gold Standard enacted in the US. One dollar, represented by
25.8 grams of gold 9/10ths fine would be the standard unit of measure.
1907: Panic in the environment of excessive business consolidation.
Perceived lack of capital due to inelasticity of currency. Financial
speculation.
1908: The temporary measure of the Aldrich-Vreeland Act which allowed
for the issuance of currency backed by state and city bonds as well as
commercial paper (corporate bonds.)
1912: Socialist candidate for president, Eugene Debs, gets one
million votes.
1913: The establishment of the Federal Reserve with its twelve
district banks. (Federal Reserve Act, A.K.A the Glass-Owen Bill
December 23.) The intent was said to be to give flexibility to the US
banking system, with the hopes of heading off deep business cycles and
panics such as those in 1837, 1857, 1873, 1893, and 1907.
1931: Great Britain abandons the gold standard amdist world-wide
depression.
1933: FDR's formation of the Securities and Exchange Commission.
1933: The Glass-Stiegal Act prohibits banks from trading in
securities, and loaning money to loan officers. Also, it allowed the
formation of branch banks in states where permitted.
1933: FDR declares a gold embargo, prohibiting gold exports, thus
officially taking us off the Gold Standard. In a special session,
congress passes the Emergency Banking Act of 1933. FDR shut down the
banks for one day nation-wide, and was granted the power to regulate
gold, silver and foreign exchange. He then assigned "conservators"
to take charge of the national banks. On March 12, FDR announces that
the banks would re-open the next day after being approved and licenced
by the Fed. When the Federal reserve banks opened on the 13th,
deposits were much greater than withdrawals. By the 15th, 4/5ths of
the nation's banks were reopened and operating normally.
********
I am hereby deviating from a structured format of presenting only
facts in this time line. I inserted the following opinion for no
logical reason other than it was what happened to flow from my
keyboard at the time. My original intention was to possibly move it to
another chapter that would be in conformity with the structure, or to
omit it completely. I subsequently gained the courage to leave it be,
after having read a similar sentiment expressed in a publication
called "The Weirs Times" (New Hampshire, August 20, 1998.) I
will include this passage after my own:
In this time of uncertainty, paternalism seemed welcome.
If on the other hand, the uncertainty was seen as being the result
of tyrannical government (which of course it was,) the psychology
may been completely different. In the US in 1933, the corporation
was seen as the villain, and the state as the savior. Going back to
the revolution, the state was seen as the villain.
Liberation and laissez faire the solution.
Perhaps the level of sophistication in financial matters was lacking
at that time, hence accounting for the failure of Americans to utilize
their newly found liberty in a prudent manner. An alternative
explanation might be that there was something of a culture lag where
custom superceded rational thought. In any case, the heavy hand of
government was then ushered in. The same series of events took place
in Europe after the French Revolution of 1789. With King Louis XVI
beheaded, and the first republic in place, people seemed not to have a
clear idea of where to go from there. Disorder followed, and
Napoleon's dictatorship was welcomed in by the masses. FDR's
interventions however, were less dictatorial in the sense that for the
most part he had the backing of the public, congress and the supreme
court. The means by which the backing was obtained is an entirely
different issue.
From The Wiers Times:
"A democracy cannot exist as a permanent form of government. It
can only exist until the voters discover that they can vote themselves
money from the public Treasury. From that moment on, the voters always
vote for the candidate promising the most benefits from the public
Treasury with the result that a democracy always collapses from a
loose fiscal policy, always followed by dictatorship." Alex
Frazer Tyler, "The Decline and Fall of the Athenian Republic."
Return to conformity:
1934: Congress passes the Gold Reserve Act of 1934 which meant: a) to
nationalize the gold stocks of the country; b) to empower FDR to
reduce the value of the dollar by 50%; c) to create a 2 billion dollar
stabilization fund from the profits of the devaluation in order to
protect the dollar from speculative attacks in world markets.
1934: Pressure from the agricultural sector leads to the second
Silver Purchase Act as a means of inflating the currency. This was not
re-monetization of silver, but a means of expanding the currency
through more bank deposits made possible by borrowing from the banks.
This was more politically plausable than to directly issue fiat money.
1935: The Banking Act of 1935 creates the Federal Deposit Insurance
Corporation (FDIC.)
1935: In the ruling of the Farm Mortgage Moratorium Act as being
constitutional, the supreme court lays down the principle that during
an economic crisis, public welfare must outweigh the rights of private
property. Public welfare in this context means political stability.
1944: The Bretton Woods convention forms the IMF (International
Monetary Fund.) The objective was said to be to create a fund that
would be large enough to allow for the maintenance of a fixed rate of
exchange in the face of short-term fluctuations. This was a similar
measure to the Gold Reserve Act of 1934. The IMF however was different
in that its member nations had an agreed upon fixed rate of exchange
from which equilbria could deviate no more than 10%. It's known as the
trading band. This relatively nominal flexibility was deemed necessary
because of long-term labor contracts, local political pressures, and
other rigidities in the pricing systems.
1944: The Bretton Woods convention forms the International Bank for
Reconstruction and Development (A.K.A the World Bank.) Its purpose was
to facilitate long-term capital payments by homogenizing the pool of
credit, and improving access to information so as to issue loans more
efficiently. In some sense, the World Bank needed to be something of
an intelligence agency. They would also receive loans from member
countries. Also under the IMF, the Gold Exchange Standard is
formalized. This would clear balance of payment deficits and surpluses
between nations using a gold pool.
1967: France exits the GATT, leaving seven nations remaining. This
due to local political pressures, primarily due to inefficiencies in
their agricultural production, prompting them to place tariffs.
1967: Ayn Rand publishes her book entitled "Capitalism: An
Unknown Ideal" which included excerpts from Alan Greenspan's
speech in which he attacked the practice of the Fed in the excessive
issuance of fiat money, and supported the reinstatement of the Gold
Standard. Anti-statist sentiment runs high, partially due to
opposition to US involvement in Vietnam and partially due to the
changing dynamics of the economy marked by the waning industrialism in
developed nations that caused economic disequilibrium, among other
factors.
1968: Upward pricing pressures in the gold market due to speculation
that the target price of gold would need to be raised, forces the IMF
to discard any further attempts to fix the market price of gold at
$35.00 an ounce by its practice of buying and selling gold. A two
tiered variant of the Gold Exchange System develops where IMF members
maintain the $35.00 price level, while the market price rises to
$43.00. Central banks in the US and England faced with gold reserve
shortages caused by hoarding in the private sector, gold redemptions
by the French government, and dwindling gold production are forced to
resort to increasing fiat money supply.
1971: President Nixon abandons the Gold Standard entirely, leading to
global abandonment.
*Note: Due to the need for a contiguous time line to the present, I
am holding off on completion of the time line until I am able to fill
the gap between 1971 and 1980. I can then include the period from 1981
to 1998.
Bibliography:
Note: Book I draws primarily on the works from the itemized list
below inclusive of the following item numbers:
1,2,3,7,8,9,15
The other resources listed are of course used primarily in Book II,
although the sets are not mutually exclusive.
[1] Economics, Second Edition by
Richard G. Lipsey and Peter O. Steiner 1969;
[2] Visualized American History, by Philip Dorf 1944.
[3] Legalized Theft [author currently unavailable]
[4] Profits and the Future of American Society. by S.J Levy and David
Levy 1983.
[5] [title currently unavailable] Economist Jude Wanniski, Founder
and President of Polyconomics, Inc. URL: goldeagle.com 1998.
[6] The Financial Revolution by Adrian Hamilton 1986
[7] John Law, circa 1750 [title currently unavailable. Subject:
propasal for a French banking system, the Land Bank]
[8] "The Decline and Fall of the Athenian Republic." by
Alex Frazer Tyler
[9] Extraordinary Beliefs, Popular Delusions, and the Madness of the
Crowds Charles MacKay circa 1825
[10] Currency competition: Some Options Considered.
[11] Worldly Philosophers by Robert Heilbroner 0rignal c 1953
[12] The Law by Fred Bastiat circa 1825
[13] The Basic teachings of the Great Economists by John w. McConnel
1943
[14] Progress and Poverty by Henry George 1879
[15] The Science of Political Economy by Henry George 1897
[16] The condition of Labour by Henry George 1891
[17] How to Buy Life Insurance and Live to Enjoy it: A Shocking
Expose of the Insurance Industry. Lies, frauds and abuses, and how to
beat them, by Clifford G. Allen, Jr., CLU, and Murt Davis. The Equity
Press, 1993
[18] Thoreau: People, Principles and Politics by Milton Meltzer 1963
[19] Fragments [Individualist periodical:] Henry George's Theory of
Value by Jack Schwartzman (Editor-in-Chief); Value: A Subjective
Concept by Oscar Johannesen. Summer/Fall 1997
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