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America's Central Banks: An Evaluation of How They and The Federal Reserve Bank Have Performed (Part 2)

By Tom Rose
February 01, 2003

Vera Smith made an exhaustive study of central banks in 1935. She sought the answer to two questions: "Why do central banks come into being in the first place?" and "Why have they persisted?" Here is a summary of her findings:

[T]he early ones [central banks] were founded for political reasons connected with the exigencies of State finance . . . but once established, the monopolies persisted right up to and beyond the time when their economic justification did at last come to be questioned . . . and thereafter the superiority of central banking over the alternative system [i.e., the system of free banking] became a dogma which never again came up for discussion and was accepted without question or comment in all the later foundations of central banks.. . . 1
A central bank is not a natural product of banking development. It is imposed from outside or comes into being as the result of Government favours. 2

She points out that, under a system of true free banking:

No bank would have the right to call on the Government or on any other institution for special help in time of need. No bank would be able to give its notes forced currency by declaring them to be legal tender for all payments.... A general abandonment of the gold standard is inconceivable under these conditions, and with a strict interpretation of the bankruptcy laws any bank suspending payments would at once be put into the hands of a receiver.
A central bank, on the other hand, being founded with the aid either direct or indirect of the Government, is able to fall back on the Government for protection from the disagreeable consequences of its acts. The central bank, which cannot meet its obligations, is allowed to suspend payment and to go off the gold standard, while its notes are given forced currency. The history of central banks is full of such legalised bankruptcies.3

When President Franklin D. Roosevelt issued his Executive Order in 1933 that denied Americans their right to convert Federal Reserve Notes into gold, he in effect relieved the Federal Reserve from its legal obligation to either "pay up on demand" or go bankrupt. In short, the banking elite escaped the legal responsibility of "paying up on demand," thus the burden of debt incurred by elite financiers was forcibly shifted onto the common man.

A bonafide gold-coin standard (the legal guarantee of converting paper banknotes into gold or silver coins upon demand) was still in effect in 1913 when Congress passed the Federal Reserve Act. We are again reminded of Biblical admonitions that people should not place their trust in princes (Ps.118:9; 146:3).

The Blessing of a Gold-Based Currency
As the [Second] Bank was closing down (1833-1835), the Treasury reported the following increases in the circulation of metallic coins. This additional circulating media replaced the paper banknotes which the Bank was forced to draw out of circulation because of the reduction in government deposits held by the Bank:

 

1833:Gold
=
$   978,550
 Silver
=
  2,759,000
 Copper
=
       28,160
 Total
=
  3,765,710
    

1834:

Gold
=
  3,954,270
 Silver
=
  3,415,002
 Copper
=
       19,151
 Total
=
  7,388,423
    
1835:Gold
=
  2,186,175
 Silver
=
  3,443,003
 Copper
=
       39,489
 Total
=
  5,668,667
    
Totals:Gold
=
  7,118,995
 Silver
=
  9,617,005
 Copper
=
       86,800
 Total
=
16,822,800

What is the significance of the amount of metallic coinage issued by the Treasury to replace the paper banknotes that had been issued by the [Second] Bank? The answer is straightforward:

"Power is where the gold is!" If gold (and silver) is in the hands of the civil government or in the hands of central bankers, they are the ones who wield economic and political power over the citizens. But if gold (and silver) is in the hands of citizens, then they are the ones who are in a position to wield economic and political power over the civil authorities and bankers. The people can wield such power through the simple process of invoking what I call their "veto power," by cashing in their paper money or checking accounts to withdraw gold (or silver) from the banking system. A gold-coin standard guarantees the right of people to exchange paper money for gold (or silver) whenever they choose to do so, for any reason, or for no reason at all. When in the hands of ordinary citizens, this robust monetary discipline sends helpful chills of fear into the hearts of both civil authorities and bankers. It keeps them honest! And politicians, government bureaucrats, and central bankers especially, do not like to live in such a wholesome atmosphere of citizen-imposed discipline! When such power is in the hands of politicians and banks, the people suffer under tyranny. But when such power rests in the hand of citizens, people enjoy the blessings of freedom, self-responsibility, and privacy from government snoops. In a republic, the only safe repository for insuring honest control of the money and banking system is in the hands of widely dispersed individuals.4

This widespread dispersal of economic power in the hands of the common man is exactly what President Andrew Jackson achieved in his successful battle against the [Second] Bank. His elimination of America's second central bank had a lasting and dynamic effect of empowering the average citizen economically and politically.

Boom/Bust Cycles
If we observe the historic expansions and contractions of the economy, which were caused by monetary injections (inflation) and monetary contractions (deflation), this is what we find: From 1800 to the present, we see that almost all economic "boom periods" were the result of injecting newly created unearned purchasing media into the economy by the civil authority and/or banks. These injections of unearned money caused prices and nominal profits to rise (and wages also), thus sending false economic signals to business entrepreneurs. These false economic signals led business entrepreneurs to make over-energetic decisions through which they made mal-investments, thereby generating losses instead of the hoped-for profits. Only banks, civil rulers, and counterfeiters are able to inject new, unearned money into the economy, with the effect of debauching the purchasing power of already-existing money. At heart, this is a moral problem regarding the commandment "Thou shalt not steal!"

During the 1800s general price levels always tended to return to "normal" after the inflationary booms, but only under one necessary condition: The necessary condition is the existence of a gold/silver-based monetary system through which citizens have the legal right at all times to demand conversion of government-created or bank-created paper money into gold or silver coins. Whenever this necessary condition existed, the U.S. dollar tended to rise in purchasing value over the long term, but whenever this necessary condition was not in operation, the purchasing power of the dollar tended to decline. Please study the following graph which shows the purchasing power of the dollar over the last 200 years (with 1792 = 1.00):

In 1933 President Franklin D. Roosevelt issued his unconstitutional Executive Order which took America off the gold standard. American citizens acquiesced because they trusted their civil rulers (a deadly mistake!). Since that time the purchasing power of the dollar has gone into a steep decline which has never been reversed. This long-term drop in the purchasing power of the dollar (rising price levels) is the direct result of the federal government and the Federal Reserve Bank having colluded with each other to generate a long-continued inflationary spiral, the result of ever-increasing deficit spending for both domestic and wartime spending and spending on so-called "foreign aid." All of this was financed by rising levels of taxation and insidious money-creation by the Federal Reserve Bank.

By the year 2000, the long-term inflationary monetary policy followed by the federal government and the Federal Reserve generated the largest speculative bubble in America's history, which is now in the process of disintegrating. It was the elimination of the gold standard in 1933 that made this long-term inflationary spiral possible. Remember, the people's legal right to express their "veto power" by demanding gold and silver coins in exchange for government-created and Federal Reserve-created paper money was taken away from them in 1933. With loss of the gold standard, Americans would no longer be able to impose a healthy economic discipline on civil rulers or on their central bank by forcing them to convert paper dollars into gold coins.

The purchasing power of the dollar dropped consistently, from almost 100 cents on the dollar in 1933, to only 8 cents in the year 2000. As we can see, the existence of the Federal Reserve Bank has not protected the purchasing power of the dollar, but has actually aided and abetted its demise! The loss of almost 92% in value of the dollar since 1933 tells the whole sad story! Contrary to promises that misled the American people to accept it in 1913, the Federal Reserve has proven to be a collusive "engine of inflation" which has systematically and insidiously served to plunder Americans of their wealth by debauching the currency.

While wartime spending by the federal government was reversed after World War I, the Federal Reserve, which helped finance the war through money creation, purposely turned to inflating the money supply again in 1924 to keep interest rates down. The purpose was to assist Britain to return to the gold standard at an unrealistic price in terms of Britain's monetary unit, the pound. In 1924 Montagu Norman, President of the Bank of England, invited Benjamin Strong, Governor of the New York Federal Reserve Bank, to visit him in England. Strong colluded with Norman for the Federal Reserve to follow a "loose" monetary policy to reverse the gold flow that America was attracting because of our higher interest rates. This policy caused a speculative bubble in the stock market which ended in the stock market crash of 1929. The underlying cause of the 1920s boom and the Great Depression in the 1930s was misguided monetary policy implemented by the Federal Reserve.6 Since establishment of the Federal Reserve in 1913, the way was open for political rulers, in secret collusion with the Federal Reserve, to use deficit spending to involve Americans in one foreign war after another and to embark on massive domestic spending programs through which citizens would be seduced to surrender their historic constitutional freedoms, thus becoming economically dependent on the central government. The above graph showing the purchasing power of the dollar cries out to be studied and clearly understood by freedom-loving individuals.

How Has the Federal Reserve Performed?
With the establishment of America's third central bank in 1913 (the Federal Reserve Bank), the big-bank interests had succeeded in giving birth to a "lender of last resort" which would be used time and time again, at taxpayers' expense, to bail big banks out of bad loans which were created through their own periodic monetary inflations.

When World War I broke out in 1914, the House of Morgan — which dominated the Federal Reserve at that time throughBenjamin Strong (Governor of the New York FRB), and which had long-term financial ties with key banking interests in England — sent Henry P. Davison, second in command at J.P. Morgan & Company, to England. He secretly negotiated to have the House of Morgan named as the sole purchasing agent in these United States for the Allied Powers (England and France). The House of Morgan also became the underwriter to market all the bonds in America that England and France would issue and sell to American citizens to pay for the immense amount of war materials needed to conduct the war against Germany.7Sale of these foreign bonds to Americans was fostered by the "loose" monetary policy the Fed followed during World War I to facilitate aiding the Allies. It served to involve these United States of America more deeply in the constant European wars, something President George Washington warned us about in his Farewell Address.

These international financial arrangements also gave the Morgan banking interests a strong motivation to see that England and France would win the war as assurance that they would pay off the bonds. Indeed, the British government set up an active propaganda office in New York City to flood the news media with false reports to change the existing pro-German public opinion in America to a pro-British stance. Thus, it is quite accurate to say that international banking intrigue and collusion served to induce Americans to "sell" war goods to England and France via credit-based banking in World War I. This served to draw America into its first foreign war during the twentieth century — an insidious and little-understood process that would be repeated again and againright up to the present time.

MurrayRothbard writes:

During World War I, Strong promptly used his dominance over the banking system to create a doubled money supply so as to finance the U.S. war effort and to insure an Anglo-French victory.... 8
The same process of massive loans to Britain and France — coupled with the Federal Reserve's unlimited power to create unearned, credit-based money — was again largely responsible for dragging these United States of America into World War II on the side of the Allies. My point in emphasizing this fact of history is to drive home this truth: The very existence of central banks with their money-creating power makes it much easier for political rulers and the elite powers behind the scenes (Eph.6:12) to involve peace-loving citizens in foreign wars. Citizens are much less susceptible to acquiesce in the war-mongering intrigues of political leaders and special interest groups when they have to pay for wars on a pay-as-you-go basis through higher taxes.9

A look at some 200 years of United States monetary history shows that gold-based and silver-based money is the common man's best friend when it comes to protecting the purchasing value of money. The guaranteed legal right of citizens to "trade in" their paper money for gold or silver coins, at any time they wish, is the only proven means of ensuring that the purchasing value of their money won't be insidiously debauched. The existence of a central bank will inevitably undermine the assurance of converting paper money into gold.

Where Are We Now?
In 2002 our country went through the deflationary phase of a long-continued inflationary monetary boom that was engineered by the Federal Reserve. Here is the recent history: In1985 U.S. monetary officials attended a meeting in Japan to engage in what is called "international monetary cooperation" (international monetary collusion would be a more accurate term to use). As a result, the Federal Reserve agreed to follow a "loose" monetary policy to hold down interest rates. This policy was almost an exact replay of the collusive agreement that Governor of the New York Federal Reserve Bank, Benjamin Strong, made with Montagu Norman in England in 1924, creating the speculative bubble of the 1920s which ended in a massive stock market crash in 1929. The collusive monetary agreement of 1985 also induced a speculative stock market bubble, ending in the stock market crash of 1987.

To reverse falling stock prices, the Federal Reserve flooded the market with newly created, unearned money and encouraged private banks to readily supply loan money to stockbrokerage firms. Since 1987, every time the stock market sagged, the Federal Reserve has supported stock prices by injecting new money into the economy, resulting in rising price levels and lower interest rates which severely reduced the real incomes retired persons received from their savings. Thus, one segment of society (big banks) was helped by Federal Reserve monetary policy while other segments (retired people) were hurt. This is what Frederic Bastiat termed as "legal plunder" in 1849:

But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.10

The question to pose is, "Should central bank policy be used to benefit some segments of society at the expense of others, thus engaging in legal plunder?" Or better yet, does the history of America's central banks — the [First] and [Second] Banks of the United States as well as the Federal Reserve — show them to have been a blessing or a curse to Americans? Central banks are not necessary to the economic health of a country; they engage in a form of legal plunder by favoring certain special-interest groups at the expense of others, and they pose a real threat to, not only the political and economic freedom of the people, but also to their peaceful economic progress.

What Is the Conclusion?
An historical review of America's monetary and banking system shows that the existence of central banks:

  1. Has not protected the purchasing power of the dollar, but rather has served as an insidious "engine of inflation" to systematically debauch the currency.
  2. Encourages monetary collusion between international banking elites.
  3. Makes it easier for civil rulers to involve our country in foreign wars through credit-based deficit spending.
  4. Did not preserve the gold-coin standard but rather encouraged inflationary monetary policies that led to abandonment of the gold standard, thus robbing citizens of their individual "veto power" over the grandiose spending of civil rulers, and making citizens more dependent on civil rulers and government-bestowed "dainties."
  5. Fostered the development of fascism (national socialism) in America by empowering the Federal Reserve to constantly manipulate the economy for the benefit of powerful business, banking, and political interests, thus leading to periodic inflationary boom/bust cycles which tend to impoverish ordinary citizens.
  6. Poses a real threat to the economic and political freedom of American citizens.

Do not the blessings of liberty and self-responsibility demand that the control of money rest safely in the hands of citizens who individually have the power, at any time and for any reason, to "veto" the grandiose spending plans of civil rulers and the money-manipulation schemes of central bankers by demanding gold and silver coins in exchange for paper money in order to protect their hard-earned wealth and economic independence?

See Part One

Notes

1. Vera C.Smith, The Rationale of Central Banking (Westminster, England: P.S. King & Son Ltd.,1936; reprint,Indianapolis, IN: Liberty Press,1990), 167-68.

2. Ibid ., 169.

3. Ibid ., 170.

4. For many years I shared this maxim with students in my classes of Money and Banking and Economics.

5. “The Investor’s Dilemma,” Research Reports, American Institute for Economic Research, 23 December 2001,137.

6. For a detailed discussion of gold and its role in preserving man’s economic and political freedom, See: Tom Rose, “All About Gold,” chap.in God, Gold, and Civil Government (Mercer, PA: American Enterprise Publications,2002),101-125.

7. Murray N.Rothbard, The Case Against the Fed (Auburn, AL: The Ludwig von Mises Institute,1944),128.

8. Ibid ., 129.

9. We saw this process being implemented through the 2002 propaganda program to convince American citizens of the “need ” to attack Iraq.

10. Frederic Bastiat, The Law (Irvington-on-Hudson, NY: The Foundation for Economic Education, Inc., 1974), 21.



Topics: American History, Economics, Government

Tom Rose

Tom is a retired professor of economics, Grove City College, Pennsylvania. He is author of seven books and hundreds of articles dealing with economic and political issues. His articles have regularly appeared in The Christian Statesman, published by the National Reform Association, Pittsburgh, PA, and in many other publications. He and his wife, Ruth, raise registered Barzona cattle on a farm near Mercer, PA, where they also write and publish economic textbooks for use by Christian colleges, high schools, and home educators. Rose’s latest books are: Free Enterprise Economics in America and God, Gold and Civil Government.

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